In the Constitutional Court we trust: The seminal judgment in Thistle Trust

By Dr Hendri Herbst and Louis Botha

It’s been a standout year for tax matters in the Constitutional Court (CC). Since the CC handed down the Metcash judgment in the late 90s, tax matters have not often been heard by the court. But in 2024 alone, the CC has already handed down three judgments dealing with important issues pertaining to value-added tax in the context of insurance products, controlled foreign companies in the context of the investment industry and trusts, respectively. Judgment has also been reserved by the CC in two matters pertaining to important tax administration issues.

Here we consider the seminal judgment The Thistle Trust v Commissioner for the South African Revenue Service,[i] a landmark decision by the CC that addresses the application of the conduit principle to the taxation of capital gains distributed through multiple trusts in a tiered trust structure. This case has significant implications for the taxation of trusts and their beneficiaries, particularly in the context of capital gains tax. We analyse this issue in detail below, with a specific focus on statutory interpretation. We will publish a separate article on the understatement penalty issue.

Background

The Thistle Trust (Thistle) is a registered inter vivos trust and a South African tax resident. It is a beneficiary of 10 vesting trusts described as the Zenprop Group (Zenprop), which is a property developer and property owner.

During the 2014, 2015 and 2016 tax years, Zenprop disposed of assets and realised capital gains, the proceeds of which it distributed to Thistle. Thistle, in turn, vested and distributed the proceeds of those capital gains to the natural persons who were its beneficiaries. The proceeds of the capital gains were all passed through the multi-tiered trust structure to the ultimate beneficiaries within the same tax years in which they were realized. Acting on legal advice, Zenprop and Thistle did not account for the capital gains in their tax returns, believing that the relevant amounts were taxable as capital gains in the hands of the ultimate beneficiaries.

Thistle initially succeeded in the Tax Court, which upheld its interpretation of the conduit principle, allowing the capital gains to be taxed in the hands of the beneficiaries. SARS appealed, and the Supreme Court of Appeal (SCA) overturned the Tax Court’s decision, ruling that Thistle was liable for capital gains tax. Thistle applied for leave to appeal to the CC, arguing significant points of law regarding the interpretation of section 25B of the Income Tax Act, 58 of 1962 (“ITA”) and paragraph 80(2) of the Eighth schedule of the ITA. It is also interesting that the court wrote majority and minority judgments.

The relevant provisions

During the 2014, 2015 and 2016 tax years, paragraph 80(2) stated the following, in relevant part:

Subject to paragraphs 64E, 68, 69 and 71, where a trust determines a capital gain in respect of the disposal of an asset during which a beneficiary of that trust…who is a resident has a vested right or acquires a vested right (including a right created by the exercise of a discretion) to an amount derived from that capital gain but not to the asset disposed of, an amount that is equal to so much of the amount to which that beneficiary of that trust is entitled in terms of that right –

• must be disregarded for the purpose of calculating the aggregate capital gain or aggregate capital loss of the trust; and
• must be taken into account as a capital gain for the purpose of calculating the aggregate capital gain or aggregate capital loss of that beneficiary.

As discussed below, the court focused on paragraph 80(2) in its decision but for the sake of context, it is sufficient to state that in terms of section 25B the amount that accrued to the trust would only be taxed in the hands of the beneficiary if such beneficiary acquired a vested right to the amount. If not, the amount would be taxed in the hands of the trust.

Key arguments

Ultimately, the case hinges on the interpretation of section 25B and paragraph 80(2), and the application of the common law conduit principle.

The court was broadly presented with two interpretations of paragraph 80(2).  On the one hand, as argued by Thistle, an interpretation to the effect that paragraph 80(2) facilitated the conduit pipe principle and should apply all the way to the ultimate beneficiaries. On the other hand, as argued by SARS, a more restrictive interpretation to the effect that the capital gain can only be vested through one trust. In other words, SARS argued that a trust that is a beneficiary of another trust, cannot vest the capital gain that is vested in it, pursuant to the initial vesting.

In support of Thistle’s interpretation, it contended firstly, that section 25B essentially overrides paragraph 80 and secondly, that paragraph 80(2) should be read in a way that gives effect to the conduit pipe principle via a multi-tier trust structure.

Thistle leveraged the conduit principle and section 25B to argue that capital gains vested and distributed by Zenprop should be deemed as the capital gains of Thistle and then as the capital gains of its beneficiaries. It further contended that section 26A, which includes taxable capital gains in taxable income, when read with section 25B, supports this position. Thistle further argued against SARS’ focus on paragraph 80(2), suggesting that section 26A is the relevant taxing provision and the Eighth Schedule only quantifies capital gains tax, not taxpayer liability. Additionally, Thistle claimed that even without section 25B, paragraph 80(2) aligns with the conduit principle, allowing capital gains to pass through Thistle to its beneficiaries, where it will be taxed accordingly.

To this extent, Thistle relied on the judgments in Armstrong[ii] and Rosen[iii]. It argued that the conduit principle is a rule of common law that applies to the taxation of trusts. Therefore, it must not only inform the interpretation of the relevant provisions of the ITA but also apply to the taxation of the relevant capital gains, unless the ITA has clearly excluded or qualified such application. Thistle further contended that there is nothing in the ITA that excludes or qualifies the application of the conduit principle to the capital gains in this case.

In turn SARS argued that section 25B of the ITA did not apply to capital gains, which should be governed by paragraph 80(2) of the Eighth Schedule. It contended that the capital gains realised by Zenprop and distributed to Thistle were taxable in Thistle’s and not the beneficiaries’ hands.

Majority judgment

The majority judgment, authored by Chaskalson AJ, held that paragraph 80(2) of the Eighth Schedule was the applicable provision for determining the tax liability of capital gains in a multi-tier trust structure. The court examined Section 26A and the Eighth Schedule of the ITA regarding the taxation of capital gains from trusts. Section 26A includes taxable capital gains in a person’s taxable income, as determined under the Eighth Schedule. The court noted that, while section 25B encapsulates the conduit principle for trusts, paragraph 80 of the Eighth Schedule specifically deals with the taxation of capital gains from the sale of trust assets.

The court disagreed with Thistle’s argument that the Eighth Schedule only quantifies capital gains, emphasizing that paragraph 80 has broader implications. Paragraph 80 determines the taxpayer liable for capital gains tax when a trust disposes of an asset and distributes the gain to a beneficiary within the same year of assessment. Therefore, paragraph 80 must be interpreted to identify the responsible taxpayer, extending beyond mere quantification.

Additionally, the court rejected SARS’ reliance on the judgment in Milnerton Estates[iv], asserting that the Eighth Schedule should not be viewed in isolation. The Eighth Schedule, particularly paragraph 80, goes beyond determining whether a capital gain or loss has occurred and seeks to identify the liable taxpayer.

The court examined the application of paragraph 80(2) in the current instance. Zenprop, which disposed of an asset, realised a capital gain and distributed this gain to Thistle. Thistle, in turn, distributed the gain to its beneficiaries. The court emphasised that paragraph 80(2) consistently refers to “the trust” that disposed of the asset. Therefore, Thistle, which did not directly dispose of the asset, could not benefit from disregarding the capital gain for its aggregate capital gain calculation.

Thistle argued for a broader interpretation of the term “determined” to include gains distributed to it by Zenprop. However, the court rejected this strained interpretation, noting that the relevant statutory language explicitly identifies “the trust” as the one that disposed of the asset, not merely the one that accounted for the gain.

The court also pointed out that the 2008 amendment to paragraph 80(2) sought to prevent the conduit principle from extending beyond the first beneficiary in multi-tiered trust structures, further invalidating Thistle’s argument. Before the amendment, paragraph 80(2) allowed the capital gain realised by the sale of assets in a trust to be distributed through multiple tiers of trusts to the ultimate beneficiaries. However, the amendment 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”, confining the operation of the conduit principle so that the capital gain would only be disregarded for the purposes of the first trust. The court found that the clear purpose of the amendment was to limit the conduit principle’s application in multi-tiered trust structures. Any other interpretation will render the amendment redundant.

The court noted that it had frequently used explanatory memoranda to understand the purpose of statutes or amendments, acknowledging that while these memoranda can aid interpretation, their weight is limited by the need for legal certainty and predictability. Taxation laws particularly require cautious use of explanatory memoranda due to their impact on how individuals organize their affairs. Despite this caution, explanatory memoranda are commonly used and were referred to by both parties in the case at hand to support their arguments regarding the 2008 amendment. Ultimately, it depends on the circumstances and the level of detail in the explanatory memorandum.

In response to Thistle’s assertion that the conduit pipe principle must apply without limitation in the interpretation of paragraph 80(2), Chaskalson AJ traced the origins of the conduit principle to English common law and its adoption into South African law. The principle treats a trust as a conduit for the transfer of taxable amounts into the hands of beneficiaries, maintaining the nature of the amounts for tax purposes. The judgment highlighted that the conduit principle was developed to address two main issues: identifying the taxpayer liable for taxation on particular income and protecting legislative choices in respect of the favourable or prejudicial income tax treatment of particular categories of income. However, in the current case the court found that the principle should not apply to all capital gains distributed by a trust. This principle, which taxes income in the hands of the recipient rather than the trust, would undermine the legislature’s intent to tax trust capital gains at a higher rate. Additionally, the court noted that past cases applied the conduit principle due to ambiguities in tax statutes, but when legislation explicitly addresses these issues, the focus should be on adhering to legislative intent.

In relation to the contra fiscum, which featured centrally in the minority judgment, Chaskalson AJ further held that even if the rule were deemed relevant, it would not aid Thistle as it only applies when ambiguity in fiscal legislation persists after using ordinary interpretative methods. The court emphasized that this presumption does not override standard interpretive principles and is only invoked where ambiguity cannot be resolved through context and language examination. According to the majority judgement, it was determined that the contra fiscum rule is more appropriate for cases questioning whether a specific type of income or activity should be taxed rather than determining the liable taxpayer.

Minority judgment

The minority judgment, authored by Bilchitz AJ, disagreed with the majority’s interpretation of paragraph 80(2). Instead, it held that the provision should be interpreted to allow the conduit principle to apply throughout a multi-tier trust structure, taxing the capital gains in the hands of the ultimate beneficiaries.

Bilchitz AJ commenced with a well-presented overview of the principles to statutory interpretation within the constitutional era, but specifically emphasised the need for statutory provisions to be interpreted harmoniously and in a manner that avoids arbitrary distinctions.

The court’s reasoning rests on the principle known as the contra fiscum rule, which stipulates that ambiguous tax legislation should be interpreted in favour of the taxpayer. This rule is grounded in the idea that tax laws, which impose significant burdens, must be clear and understandable to ensure taxpayers can comply adequately.

The minority highlighted that this rule aligns with the broader rule of law, which mandates that laws must be rational, capable of being followed, and provide reasonable certainty, even if not perfect lucidity. It recognized the inherent tension between the complexity of tax legislation and the need for clarity but emphasized the Legislature’s duty to be as explicit as possible.

Overall, the minority underscored that fiscal legislation should be clear enough to be followed, upholding the rule of law and ensuring fairness in the imposition of tax burdens.

In the recent case of Telkom SA SOC Ltd v Commissioner South African Revenue Service [v], the SCA acknowledged the existence of the contra fiscum rule in South African law but significantly limited its scope. The minority considered a quote from a master’s degree dissertation relied on in the SCA’s judgment in NST Ferrochrome.[vi] The view expressed there was that the contra fiscum rule is aligned with the values of the Constitution but added that if, after analysis, a purposive approach yields two equally plausible interpretations, the contra fiscum rule should apply, favouring the taxpayer. However, the minority opined that the requirement for equal plausibility conflicts with the statements suggesting that an interpretation only needs to be reasonably possible before the rule is applied and is challenging to apply, as judges rarely find two interpretations equally plausible.

Lastly, the minority reaffirmed this approach to applying the contra fiscum principle understanding by referencing multiple cases, underscoring that the rule is only applicable when the statutory provision remains unclear after contextual analysis. The emphasis was on resolving doubt in favour of the subject, without deviating from the correct interpretation if the provision’s meaning is clear.

Since SARS failed to explain the distinction between section 25B and paragraph 80, and specifically the reason why paragraph 80 operates in this way, the minority judgment found that “the construction of the provision proposed by [SARS] would render the provision irrational and arbitrary”. Bilchitz AJ further concluded that SARS had an obligation to explain the rationale by stating that litigants are thus subject to a burden to demonstrate in what way the interpretation they propose construes the provision in such a way that it is rational and non-arbitrary”. According to the minority, the majority essentially failed to engage with this argument on the basis that the taxpayer did not raise the argument, and SARS was thus not in a position to respond.

Comment

While the majority judgment arguably arrived at the correct outcome, it is important to acknowledge the valid considerations raised by the minority judgment. The majority either rejected these points or failed to engage with them on procedural grounds, notably the contra fiscum rule’s ‘equally plausible’ approach and the scrutiny of whether the provisions meet the rationality requirement.

The minority judgment presents a compelling argument for a more taxpayer-friendly interpretation of tax legislation, which appears to be rooted in constitutional principles and recognised interpretative rules. The minority’s perspective highlights the Legislature’s duty to enact clear and understandable tax legislation, ensuring taxpayers can comply with their obligations without undue complexity or ambiguity. While the minority attempts to refine the application of the contra fiscum rule, one should note that this approach differs from how the rule was historically applied.

One point of concern in the majority judgment is its finding that applying the conduit principle instead of paragraph 80(2) would undermine the intention to tax trusts at a higher rate. Arguably, this point should have been made in a more nuanced way. The 2008 amendment to paragraph 80(2) merely limited the conduit principle’s scope of application to the first trust in a multi-tiered trust structure, specifically the trust disposing of the asset. If the intention was to tax trusts at a higher rate, the 2008 amendment would have likely further restricted or removed the application of the conduit principle.

The principles evolved since the landmark Endumeni case[vii] have been endorsed by the majority judgment, and provides a commendable practical application of these principles, even though the reasons for some approaches were not always expressly articulated. The process begins with the plain wording of the statute, assuming all words and legislation have meaning, and then evaluates this wording within the context of all relevant surrounding circumstances and available information, including the legislative history and purpose. Only when this method fails to resolve the issue, leaving two reasonably plausible interpretations, should the contra fiscum rule be applied.

The majority approach also suggests that if the legislation is not rational, it can be construed to give effect to constitutional principles but appears reluctant to intervene on this basis. Arguably, this is sensible given that overreaching constitutionally could create further uncertainty by undermining the reliability of written laws. This balanced approach ensures clarity and fairness in statutory interpretation, and while there may be room for debate on some points, the overall framework provides a robust method for interpreting tax legislation in line with constitutional values.

While the majority judgment takes a more restrained view of the contra fiscum rule’s application, the minority opens the door for future arguments that may further refine the balance between legislative clarity and taxpayer fairness. Ultimately, the ongoing dialogue between these judicial perspectives serves to enhance the robustness and equity of tax law interpretation in  South Africa.

[i] (CCT 337/22) [2024] ZACC 19 (2 October 2024).

[ii] Armstrong v Commissioner for Inland Revenue 1938 AD 343 at 348-9 (Armstrong).

[iii] Secretary for Inland Revenue v Rosen [1971] 1 All SA 180 (A); 1971 (1) SA 172 (A) (Rosen) at 188C and 190H-191A.

[iv] Milnerton Estates Ltd v Commissioner, South African Revenue Service [2018] ZASCA 155; 2019 (2) SA 386 (SCA) (Milnerton Estates) at para 22.

[v] [2020] ZASCA 19; 2020 (4) SA 480 (SCA) (Telkom) at paras 18-20.

[vi] NST Ferrochrome (Pty) Ltd v Commissioner for Inland Revenue 2000 (3) SA 1040 (SCA)

[vii] Natal Joint Municipal Pension Fund v Endumeni Municipality [2012] ZASCA 13; [2012] 2 All SA 262 (SCA).