Judgment summary
The Thistle Trust, a discretionary trust and beneficiary of the Zenprop Group of trusts, received distributions of capital gains realised by Zenprop and passed these on to its own individual beneficiaries within the same tax years (2014 to 2016) (paras 5 to 6).
SARS conducted an audit and took the view that Thistle, not its beneficiaries, was liable for capital gains tax on the amounts received from Zenprop. SARS raised additional assessments and imposed understatement penalties (para 8).
The Tax Court upheld Thistle's appeal, applying the conduit principle and section 25B of the Income Tax Act. The Supreme Court of Appeal reversed this on the capital gains tax point, holding that paragraph 80(2) of the Eighth Schedule, not section 25B, governed the matter and that the conduit principle did not extend beyond the first beneficiary trust. The Supreme Court of Appeal also held that Thistle could not be liable for understatement penalties because SARS had conceded the error was a bona fide inadvertent error (paras 13 to 18).
The Constitutional Court, by majority (Chaskalson AJ), granted leave to appeal but dismissed Thistle's appeal, holding that paragraph 80(2), as it read for the 2014 to 2016 tax years, confines the conduit principle to the first beneficiary trust in a multi-tiered trust structure. The conditional cross-appeal by SARS on understatement penalties was dismissed, and SARS was ordered to pay Thistle's costs in the cross-appeal, including the costs of two counsel (paras 93).
Bilchitz AJ, with Madlanga J concurring, dissented, finding that paragraph 80(2) was ambiguous and should be interpreted, applying the contra fiscum rule and principles of rationality, to give full effect to the conduit principle through the multi-tiered structure to the ultimate beneficiaries (paras 94 to 141).
Background
Thistle is a registered inter vivos discretionary trust and South African tax resident. It is a beneficiary of 10 vesting trusts known as the Zenprop Group, a property developer and owner (para 5).
In the 2014, 2015 and 2016 tax years, Zenprop disposed of assets and realised capital gains, which it distributed to Thistle. Thistle in turn distributed the proceeds to the natural persons who were its beneficiaries, all within the same tax years in which the gains were realised (para 6).
Acting on legal advice, Zenprop and Thistle did not account for the capital gains in their tax returns, on the basis that the amounts were taxable as capital gains in the hands of the ultimate beneficiaries under the conduit principle and the relevant provisions of the Income Tax Act. The beneficiaries accounted for the capital gains in their own tax returns and paid the resulting capital gains tax (para 6).
During the relevant tax years, individual beneficiaries were liable for capital gains tax on only 33.3% of their net capital gains, while Thistle, as an inter vivos trust, would have been liable on 66.6% of its net capital gain (para 7).
SARS audited Thistle and concluded that liability for the capital gains passed from Zenprop to Thistle but not further to Thistle's beneficiaries. On 21 September 2018, SARS raised additional assessments imposing capital gains tax and understatement penalties on Thistle (para 8). Thistle objected, relying on section 25B and paragraph 80(2) of the Eighth Schedule, and also objected to the understatement penalties on the basis of bona fide inadvertent error under section 222(1) of the Tax Administration Act 28 of 2011 (paras 9 to 10). SARS disallowed the objection and Thistle appealed to the Tax Court in March 2021 (para 11).
Core dispute
The central issue was how the common law conduit principle applies to capital gains distributed through a multi-tiered trust structure, and specifically whether section 25B or paragraph 80(2) of the Eighth Schedule to the Income Tax Act 58 of 1962 governed the taxation of capital gains realised by Zenprop and distributed through Thistle to its beneficiaries (paras 2 to 4).
Thistle argued that the conduit principle, informed by section 25B and paragraph 80(2), meant that the capital gains retained their character through the multi-tiered structure and were taxable only in the hands of the ultimate individual beneficiaries, not in Thistle's hands (paras 22 to 28).
SARS argued that section 25B did not apply to capital gains because it was introduced before capital gains tax existed, and that paragraph 80(2) specifically governed the position, operating to stop the conduit principle at the first beneficiary trust (Thistle) in a multi-tiered structure, rendering Thistle liable for the capital gains tax (paras 30 to 31).
A further, conditional issue arose on SARS's cross-appeal as to whether Thistle's failure to account for the capital gains was a bona fide inadvertent error under section 222 of the Tax Administration Act, precluding understatement penalties, or whether penalties should apply under item (ii) or (iii) of the table in section 223(1) of that Act (paras 32 to 34).
Court findings
The majority (Chaskalson AJ) held that although section 26A makes clear that capital gains form part of taxable income, and absent contrary indication section 25B would apply to capital gains, paragraph 80(2) is the specific provision addressing the conduit principle in relation to capital gains realised by the disposal of assets by a trust, and therefore governs over section 25B (paras 52 to 55).
Applying paragraph 80(2) as worded for the 2014 to 2016 tax years, the Court found that the provision could only refer to the trust that itself disposed of the asset (Zenprop) as "the trust" in subparagraph (a). Because Thistle had not disposed of any asset, it could not benefit from having the capital gain disregarded in calculating its own aggregate capital gain, and the gain therefore had to be taken into account in Thistle's aggregate capital gain (para 58).
The Court rejected Thistle's argument that paragraph 80(2) should be read with notional parenthetical commas to allow the conduit principle to run through multiple tiers, holding that there was no basis in the text for such linguistic surgery (para 60). It found this interpretation consistent with the purpose of the 2008 Amendment to paragraph 80(2), which changed the wording from "where a capital gain arises in a trust" to "where a capital gain is determined in respect of the disposal of an asset by a trust", a change confirmed by the 2008 explanatory memorandum as intended to prevent the conduit principle from operating through multiple discretionary trusts (paras 61 to 64).
The majority rejected reliance on the contra fiscum rule, holding it inapplicable because there was no ambiguity as to whether the capital gain was taxable, only as to which taxpayer was liable, and that in any event the rule only applies where ambiguity cannot be resolved by ordinary interpretive methods (paras 72 to 74). It also declined to find the resulting distinction between the treatment of capital gains and other income under section 25B irrational, since the issue had not been canvassed on the papers (paras 75 to 77).
On the cross-appeal, the majority found that although the interpretation of "bona fide inadvertent error" in section 222 of the Tax Administration Act raised an arguable point of law of public importance, it was not in the interests of justice to grant leave because neither the Tax Court nor the Supreme Court of Appeal had reached the issue, and SARS had no sustainable case for penalties in any event: Thistle's tax position was taken on legal advice and had been upheld by the Tax Court, and SARS's argument that reasonable care required ignoring that advice in favour of SARS's own stated position was rejected, citing Marshall (paras 84 to 90).
The dissenting judgment (Bilchitz AJ, Madlanga J concurring) found paragraph 80(2) ambiguous and preferred an interpretation giving full effect to the conduit principle through the entire multi-tiered structure to the ultimate beneficiaries, applying principles of rationality, non-arbitrariness and the contra fiscum rule in favour of the taxpayer (paras 94, 122 to 141).
Outcome
The Constitutional Court granted leave to appeal but dismissed Thistle's appeal, with no order as to costs in the appeal. The conditional application for leave to cross-appeal by SARS was dismissed, and SARS was ordered to pay Thistle's costs in the cross-appeal, including the costs of two counsel (para 93).
Major issues / areas of contention
- Whether section 25B or paragraph 80(2) of the Eighth Schedule to the Income Tax Act 58 of 1962 governs the taxation of capital gains distributed through a multi-tiered trust structure.
- Whether the common law conduit principle applies to allow capital gains to pass, retaining their character, through more than one tier of a trust structure to the ultimate beneficiaries.
- The proper interpretation of the wording of paragraph 80(2) as it read for the 2014 to 2016 tax years, including the effect of the 2008 Amendment to that provision.
- The relevance and weight to be given to explanatory memoranda, including the 2008 explanatory memorandum, in interpreting fiscal legislation.
- The applicability and scope of the contra fiscum rule in interpreting ambiguous tax legislation.
- Whether Thistle's failure to account for the capital gains constituted a bona fide inadvertent error under section 222 of the Tax Administration Act 28 of 2011, precluding understatement penalties.
- Whether it was in the interests of justice for the Constitutional Court to determine the meaning of bona fide inadvertent error as a court of first and last instance.