Can an offshore Foundation be a useful tax planning tool?

In our newsletter titled “What in tarnation is a Foundation?” dated 3 December 2021, we explored what a Foundation is and how it works from a Mauritian tax perspective.

We are seeing more and more instances where Foundations are being used. This has raised the question as to how distributions from a Foundation would be treated for South African tax purposes, and whether there are any potential tax benefits in using a Foundation.

How is a Foundation treated for SA tax purposes?

A Foundation is not a concept dealt with in South African tax law, therefore the first hurdle is to understand whether a foundation will be treated as a foreign company or a foreign trust for South African tax purposes.

The definition of a “company” in section 1 of the South African Income Tax Act includes any association, corporation, or company incorporated under the law of any country other than South Africa.

A “trust”, in contrast, is defined as any trust fund consisting of cash or other assets which are administered and controlled by a person acting in a fiduciary capacity, where such person is appointed under a deed of trust or by agreement or under the will of a deceased person.

Based on the above definitions, the key distinguishing feature of a company is that it is incorporated, meaning that it is given legal status as a person. A trust is merely an arrangement, a non-person.

Foundations are, in most cases, seen as an incorporated legal entities in the country in which they are established. This is certainly the case with a Mauritian or Isle of Man Foundation.

Therefore, logic follows that, in most instances, a Foundation should be seen as a foreign company for South African tax purposes.

How are distributions from a foreign Foundation taxed in SA?

But does this mean that distributions from a Foundation will be classified as “foreign dividends” and taxes as such?

The answer is no. Confusing right? A Foundation generally has no “shares”, therefore the beneficiaries of the Foundation do not “hold” any “shares” but merely have a spec (hope) of a discretionary distribution.

Ultimately, the answer to the South African tax implications of any distribution from the Foundation will follow how the distribution is regarded from the Foundation’s country of residence. For example, if the Foundation’s country of residence views the distribution as a capital payment, the amount will be classified as a capital receipt for South African tax purposes. The converse will also apply. In most instances, the distribution should be seen as capital, resulting in no tax in the hands of the beneficiaries.

Another benefit of a Foundation is that, if no “shares” are held by South African tax residents, the South African-controlled foreign company rules should not apply.

In theory, a Foundation could provide the best of both worlds from a South African tax perspective, not having shares and therefore not falling foul of the controlled foreign company rules… but also not being a foreign trust (where the trust attribution rules may apply).

We should caution though that where a Foundation is used, taxpayers need to be very careful of any potential risks in terms of GAAR and substance over form.

For now, it seems that a Foundation could offer some tax planning benefits for certain taxpayers. If you would like to find out whether a Foundation could be of benefit to you or your company, please do reach out to us.