In terms of the Eighth Schedule to the Income Tax Act (the “Act”) capital gains tax (“CGT”) is levied in respect of the “disposal” of any “asset” by a person. The definition of “disposal” in paragraph 11 of the Eighth Schedule to the Act includes any act which results in the creation of an asset. The issue therefore arises whether, when a beneficiary of a trust makes a capital contribution to a trust, this results in CGT for the trust.
In particular whether there is a disposal by the trust through the creation of the personal rights which the beneficiary has against the trustees of the trust and whether the capital contribution made by the beneficiary constitutes proceeds in relation to such disposal. If this were the case then, on the basis that the trust does not have any base cost in the asset created, i.e. the personal rights, the capital contribution would constitute a capital gain in the hands of the trust.
The definition of “asset” as set out in paragraph 1 of the Eighth Schedule is wide and should include the rights of the beneficiaries in the trust, being incorporeal property, i.e. the rights in personam which the beneficiaries have against the Trustees to the income and capital due to them in terms of the Trust Deed (see Honore’s South African Law of Trusts, Cameron, E, De Waal, M, Wunsh, B, Solomon, P and Kahn, E, 5th Edition, 2002, p558).
It is arguable that the creation of the rights of the beneficiaries in a trust should not give rise to CGT for the following reasons:
- Firstly, on the basis that the creation of the rights does not constitute a “disposal” for purposes of the Eighth Schedule; and
- Secondly, should it be held that the creation of the rights constitutes a “disposal” that such disposal is not “by” any person and it is accordingly not possible to allocate the CGT to any person.
There is no “disposal” of the vested rights upon their creation
“Disposal” is defined in paragraph 1 of the Eighth Schedule to the Act as follows:
““disposal” means an event, act, forbearance or operation of law envisaged in paragraph 11 or an event, act, forbearance or operation of law which is in terms of this Schedule treated as the disposal of an asset, and “dispose” must be construed accordingly”
Paragraph 11(1) of the Eighth Schedule reads as follows:
“11. Disposals. - (1) Subject to subparagraph (2), a disposal is any event, act, forbearance or operation of law which results in the creation, variation, transfer or extinction of an asset, and includes -
- the sale, donation, expropriation, conversion, grant, cession, exchange or any other alienation or transfer of ownership of an asset;
- the forfeiture, termination, redemption, cancellation, surrender, discharge, relinquishment, release, waiver, renunciation, expiry or abandonment of an asset;
- the scrapping, loss, or destruction of an asset;
- the vesting of an interest in an asset of a trust in a beneficiary;
- the distribution of an asset by a company to a shareholder;
- the granting, renewal, extension or exercise of an option; or
- the decrease in value of a person’s interest in a company, trust or partnership as a result of a value shifting arrangement.”
It is arguable that there is no “variation, transfer or extinction”, as contemplated in the preamble to paragraph 11 of the Eighth Schedule to the Act, of the relevant asset, being the vested rights of the beneficiaries in the trust. The only disposal event that remains to be considered, is whether there may be said to be a “creation” of the vested rights which gives rise to a disposal as contemplated in the Eighth Schedule.
“Creation” is not defined in the Eighth Schedule or elsewhere in the Act and in accordance with the golden rule of the interpretation of legislation, the meaning of the legislator should be determined having regard to the literal meaning of the words used (see Nicholas JA in R Koster & Son (Pty) Ltd & another v CIR 1985 (2) SA 831).
“Creation” is defined in the Shorter Oxford English Dictionary as:
“the action of making, forming, producing, or constituting for the first time or afresh; invention; causation, production”
“Create” is defined in the Shorter Oxford English Dictionary as, most relevantly:
“to cause to come into existence.… to be the cause of…”
In light of the above, a creation is the action of making, or causing to come into existence, of something, in the present case, an “asset” as contemplated in the Eighth Schedule.
Having regard to the Eighth Schedule, it is arguable that a “creation” should not constitute a “disposal” where the person who created the asset continues to hold the asset. For example, a person building a house and retaining such house for his own benefit cannot be said to have “disposed” of the house for CGT purposes (see SARS’ Comprehensive Guide to CGT (Issue IV, dated 22 December 2011) (the “CGT Guide”) (p77)).
Accordingly, in interpreting the meaning of “creation” there potentially either has to be a change in ownership, or the person creating the asset must be a separate person from the person in whose favour the asset is created. Having regard to the aforegoing, it seems that in interpreting the meaning of “creation” in the definition of “disposal” such word should not be afforded its ordinary meaning, but that the meaning should be limited.
In order for an event to constitute a disposal under paragraph 11(1) of the Eighth Schedule, it should fall within the ambit of the specific events stipulated in paragraph 11(1)(a)-(g) of the Eighth Schedule. Such interpretation is aligned with the structure of the Eighth Schedule. In particular, paragraph 13 of the Eighth Schedule, which governs the time of disposal, only regulates the position with reference to the specific disposal events as set out in paragraph 11(1)(a) - (g) and in paragraph 12 of the Eighth Schedule. If the "events" described in the preamble to paragraph 11 also constituted disposals then there would be no provisions in the Eighth Schedule which would govern the timing of such “disposals”. In light hereof, it is arguable that the “creation” of an asset which constitutes a disposal, relates only to the specific disposal events stipulated in paragraph 11(1)(a)-(g) which are effected by way of a creation.
In the CGT Guide (p 70) the following events are listed as disposals of assets by way of a “creation”:
the granting of:
- a lease;
- a servitude;
- mineral rights;
- a licence; or
- an option; and
- the undertaking of a restraint of trade.
The following example is set out in the CGT Guide (p 70):
“when the owner of a property grants a lease over that property, the owner creates a contractual right in favour of the lessee. That right is an asset for CGT purposes. The creation of this right has given rise to a disposal of part of the full right in the property that the owner previously enjoyed. In other words, there has been a part-disposal. As can be seen, the ‘creation’ has given rise to both an acquisition and a disposal.
Similarly, in the case of a restraint of trade, it is the creation of the legal right in the restraining party’s hands that triggers the part-disposal of the right to trade freely in the hands of the restrained party.”
From the above, it appears that before there can be a disposal by way of a creation of an asset, there must be a pre-existing asset from which the specific right is created as each of the examples contemplates an existing asset, for example land in respect of which a lease is created, the right to trade freely in respect of which a restraint is created, etc.
Such view may find support in earlier Australian cases, before the relevant Australian CGT legislation was amended to cater clearly for the creation of contractual rights (in the Income Tax Assessment Act, 1997, section 104.35). The Australian courts have considered the issue whether the creation of a contractual right in favour of a person constitutes a “disposal” for CGT purposes in detail in the case of Hepples v Federal Commissioner of Taxation  HCA 39 which case made its way from the Administrative Appeals Tribunal, to the Federal Court of Australia and finally the High Court of Australia. In the High Court, the court held that the undertaking of a restraint of trade in favour of another, did not constitute a disposal of an asset for Australian CGT purposes, for a variety of reasons, the most relevant of which is the reasoning of McHugh J, with Mason C.J. concurring, which is set out below:
“Whatever the proper construction of the sub-section may be, its language demands that there be a “disposal of an asset that did not exist… but is created by the disposal”. Now, without straining the meaning of the word “disposal”, there are forms of property which can be said to be disposed of even though they did not exist until an act of the disponor simultaneously created and vested that property in another person. In Cooling, Hill J. gave as examples (p 63) the creation of an easement over an existing asset, the creation out of land of a profit a prendre, and the grant of a lease. His Honour also pointed out (at p 63) that “it is at least colloquial usage to refer to the grant of an option as involving a disposition of property”. But neither legal parlance nor the ordinary meaning of the words “disposal of an asset” could justify interpreting those words to cover the case where the ‘asset” is a personal right to sue the grantor of that right. When a person creates a right in another person to sue him or her, the grantor does not dispose of any asset of his or her own. The personal right to sue is never vested in the grantor, even momentarily. It is only when the right to sue is vested in the grantee, and not before, that it bears the character of a proprietary right. It would require a very strained construction of s. 160M(6) to hold that a transaction in which A incurred an obligation giving rise to a correlative right In B constituted a “disposal of an asset” (the right to sue) by A to B.”
The Judge concluded that the examples given in the explanatory memorandum, being the granting of a lease or giving of an option, are both cases where the taxpayer creates a right in favour of another person out of an asset of his own, which indicates that Parliament perceived the sub-section to be concerned with gains made from disposing of rights which were created out of or over existing assets by transactions which created and simultaneously disposed of those rights, and that section 160M(6) applied only where the asset disposed of was created out of or over an existing asset.
In the CGT Guide the following is stated in respect of a “disposal” by way of a “creation” of an asset:
“How does the creation of an asset result in a disposal? The concept sounds counter-intuitive but is valid despite suggestions to the contrary by some commentators. The confusion seems to stem from the impression that it is the party in whose hands the asset is created who has a disposal. This is clearly not the case because that party has acquired an asset, not disposed of one. The concept in fact refers to the creation of an asset by one person for the benefit of another. In creating the asset for the other person, the existing rights of the creator are diminished and it is this diminution that represents the disposal of an asset.” (our underlining)
In light of the above, a disposal of an asset by way of its creation should be limited to the creation of rights in respect of a pre-existing asset owned by the taxpayer.
As such, the creation of vested rights of the beneficiaries in a trust on the date that the beneficiaries become beneficiaries in the trust may not constitute a disposal on the basis that there is no creation of rights in respect of a pre-existing asset at such time and also as such disposal will not fall within any of the specific disposal events set out in subparagraphs (a) – (g) of paragraph 11(1) of the Eighth Schedule to the Act.
There is no disposal “by” any person
CGT is included in the taxable income of a taxpayer by virtue of section 26A of the Act which provides that there shall be included in the taxable income of a person for a year of assessment the taxable capital gain of that person for that year of assessment, as determined in terms of the Eighth Schedule. The “taxable capital gain” is essentially determined having regard to the person’s “capital gain” determined in accordance with the Eighth Schedule. In terms of paragraph 3 of the Eighth Schedule, most relevantly, “a person’s capital gain for a year of assessment in respect of the disposal of an asset (a) during that year, is equal to the amount by which the proceeds received or accrued in respect of that disposal exceed the base cost of that asset…”
These provisions do not allocate the disposal of an asset to a particular taxpayer. This attribution happens having regard to the provisions of the Eighth Schedule as a whole, including, for example, paragraph 2 referred to above, certain subparagraphs in paragraph 11 which refers to the disposal “by” the taxpayer (see for example paragraphs 11(1)(d) and (e) and paragraphs 11(2)(a) to (i)), paragraph 35 which provides that “the proceeds from the disposal of an asset by a person are…” (our underlining) and paragraph 38 which refers to “where a person disposed of an asset by means of a donation or for a consideration not measurable in money….”) (our underlining). In all of these instances the attribution of the capital gain arising in respect of a disposal of an asset can be attributable either to the person disposing of the asset, or to the person owning the asset.
A trust is a legal institution in which a person, the trustee, subject to public supervision, holds or administers property separately from his or her own, for the benefit of another person or persons, or for the furtherance of a charitable or other purpose (see Honore (supra) p1). A trust exists when the founder of the trust has handed over or is bound to hand over to another the control of property which, or the proceeds of which, is to be administered or disposed of by the other, the trustee, for the benefit of a beneficiary (see Honore (supra) p4). The manner in which the property is to be administered, is set out in the trust deed, which constitutes an agreement between, amongst others, the trustees and the founder. The trust deed may confer a discretion on the trustees to decide to which beneficiaries distributions will be made. Alternatively, the trust deed itself may prescribe the beneficiaries and the extent of their participation in the income or capital of the trust. In respect of the latter category, that is, where the relevant trust deed is specific as to which persons will be beneficiaries and the extent of their participation in the income or capital of the trust, the trustees do not have a discretion to determine same. As such, no act is required on the part of the trustees to create the rights of the beneficiaries, which are created by a multilateral juristic act (in this case involving the trustees, beneficiaries and donor) and no one of the parties can be said to have created the rights of the beneficiaries. On this basis it cannot be said that the trustees disposed of an asset by way of the creation of the rights of the beneficiaries, as the act of disposal is not performed by them.
In light of the above, it is arguable that there is no CGT upon the creation of the rights of the beneficiaries when they become beneficiaries of the trust as there is no disposal for CGT purposes, or, should it be held that there is a disposal, such disposal is not by any person, but as a result of the multilateral juristic act involving the trustees, beneficiaries and donor.