Estate planning update

In February 2010, in his first National Budget Speech, Minister of Finance Pravin Gordhan announced that there would be a review of the estate duty system. Since then nothing much has happened, so it would seem that estate duty is here to stay.

This is indeed a pity as all the performance that surrounds estate duty only results in about R1 billion out of a total tax collection of R829 billion per annum collected by SARS.

The cost of collection of estate duty is probably a substantial proportion of the actual tax collected.

The only justification for keeping estate duty would appear to be that the administration of deceased estates has to be overseen by the Master”s office, and that cost needs to be recovered.

The essential features

The essential features of the estate duty system are:

  • Collect all the worldwide assets of the deceased estate of a South African resident.
  • Deduct:
    • liabilities, other taxes and expenses;
    • bequests to charitable and other income-exempt institutions – no limits imposed;
    • bequests to surviving spouses – no limits imposed;
    • the estate-duty abatement of R3.5 million per estate plus any unutilised portion of the estate-duty abatement of any predeceased spouse(s).
  • The remaining balance is then subject to estate duty at 20%.

One must also not lose sight of the Capital Gains Tax (CGT) implications upon death:

  • CGT forms part of the last income-tax calculation of the deceased.
  • The deceased taxpayer is deemed to have disposed of his/her entire estate for CGT purposes.
  • Bequests to charities and other income-tax exempt institutions are exempted from CGT.
  • Bequests to surviving spouses are deferred or ‘rolled over’.
  • The resultant capital gain is then subject to an abatement of R300 000.
  • One-third of the remaining capital gain is then subject to income tax at full marginal rate.
  • This can lead to CGT being levied at an effective rate of up to 13.3%.

The combined maximum effect of 13.3% CGT plus 20% estate duty of the remaining balance of (100% – 13.3%) x 20% = 17.2% is 30.5%.

Estate duty and CGT are payable in cash. This often leaves the estate extremely cash-strapped.

That’s the ‘at worst position’, but then comes the reality check…

Today, few estates actually land up paying estate duty or CGT, for two reasons:

  1. People are living longer. For most South Africans who live beyond the age of 80, the 20-plus years spent in retirement will exhaust their capital prior to death. Remember that estate duty is a very old form of taxation that worked when life expectancy was far shorter.
  2. The simple use of the unlimited inter-spouse bequest exemption is generally sufficient to postpone estate duty and CGT until the death of the surviving spouse(s).

The stark reality is that many South Africans over-plan for estate duty and CGT exposure when they will never pay much. It’s far more likely that they will run short of capital during their retirement. For many South Africans estate duty and CGT on death can be legally avoided with a simple clause in the last will and testament, ‘I bequeath R3.5 million to my children and the free residue of my estate to my surviving spouse.’

But what happens if I don’t have a spouse?

Firstly, one does not have to be married to have a ‘spouse’ for purposes of claiming the estate duty abatement or the CGT rollover.

These concessions are driven by the income-tax act definition of ‘spouse’ which includes ‘a person who is the partner of such person in a same-sex or heterosexual union, which the Commissioner is satisfied is intended to be permanent.’

There are no objective tests as to what constitutes a permanent relationship, so it is generally the truly single person who has a real exposure to estate duty.

It is indeed strange that the Income Tax Act abandoned the joint taxation of husband and wife as it was thought to be unconstitutional. But when it comes to estate duty and CGT on death the inconsistencies remain.

Shouldn’t I form a trust anyway, just to be on the safe side?

Trusts can still be used to contain estate duty and CGT exposure. But there is a lot more to consider than simply signing off on a trust deed. The taxpayer that gets it all wrong in a trust arrangement and could pay far more income tax during a lifetime than any estate duty savings on death.

There are some fundamental questions that need to be carefully explored before transferring assets into a trust, some of which aren’t even tax-related.

1. Can I really afford to divest myself of my assets?

Any trust arrangement is based on the fundamental assumption that the donor/founder has truly transferred assets into the care of the trustees. In the past this requirement has often been taken lightly and even overlooked completely. This has left the trust arrangement subject to challenges from beneficiaries, creditors and SARS.

There are many views on this subject of relinquishment of control of assets owned by a trust. And there are many solutions to the problem, some good and some not so good. But the principle remains that the donor/founder cannot simply transfer assets into a trust and take them back willy-nilly.

2. What taxes will be payable on transfer of assets to a trust?

Prior to the implementation of CGT on 1 October 2001 the taxes on transfer of assets into a trust were limited to transfer duty on residential property and Marketable Securities Tax on shares. CGT did not have to be considered, as it did not exist. Today, the transfer of assets into a trust is subject to CGT, determined with reference to market value. If assets are found to be transferred into a trust at below market value, both CGT and donations tax can be levied.

Following the infamous ‘Brumeria decision’ it can no longer be taken for granted that the use of an interest-free loan account could dispense with all donations-tax implications. Before transferring assets into a trust, an assessment of all taxes resulting from the transaction needs to be undertaken.

3. What taxes will be paid by the trust?

In general a trust is subject to tax at a flat rate of 40% on revenue income. This is equivalent to the maximum marginal rate applied to the individual taxpayer on taxable income exceeding R617 000 per annum.

Trusts can be taxed at the lower individual tax rate if the trust is classified as a ‘special trust.’ But this definition is very narrow.

A trust is also subject to CGT at 26.6% on capital income. This is potentially double the maximum CGT rate applicable to the individual taxpayer. At present the prudent taxpayer can cause the income of a trust to be taxed in the hands of the donor/founder or the beneficiaries of the trust in terms of section 7 or section 25B of the Income Tax Act. As the donor/beneficiaries are generally individual taxpayers this results in lower tax rates and CGT inclusion rates.

But there remain two additional issues to be considered:

  • By causing the income of the trust to be taxed in the hands of the beneficiary, the trust has effectively distributed the income to the beneficiary. This may be counter to the original objectives of preserving the assets within the trust.
  • There is a degree of uncertainty as to whether or not the current tax principles relating to trusts will be retained in the income tax act.

4. What will it cost to maintain the trust?

In years gone by the costs of trustees and administering a trust were generally absorbed into other fees charged by auditors and fund administrators. This is no longer generally the case. Today, the following annual costs must be considered:

  • Professional fees of external trustees and advisers.
  • Costs of preparation of annual financial statements, provisional tax returns and income tax returns.
  • The above fees can easily total R20 000 per annum.

Can the above problems be overcome using a company instead of a trust?

In general the formation of a company will not save estate duty and CGT exposure unless the shares in the company are in turn held by a trust. If the shares of a company are held by the individual they will simply be included in the estate duty/CGT computations, just like any other asset.

In addition to this, the recent increase in the CGT inclusion rate for companies from 50% to 66.6%, coupled with the increase in the dividends tax rate from 10% to 15%, have all but done away with the potential tax advantages of using companies for estate planning. In fact, from a CGT perspective, companies have now become highly tax inefficient.

Conclusion on trusts

Yes, there is still a case for the use of trusts by the high net worth individual. But specialist advice must be followed and careful consideration is needed before embarking on the exercise.

The use of retirement annuity funds in estate planning

Over the past five years there has been a range of amendments/incentives granted to retirement annuity funds. Combined, these make retirement annuity funds very attractive alternatives in estate planning. Where else can one find:

  • a tax-deductible investment (subject to limits);
  • complete exemption from income tax, CGT and dividends tax on investment income while the funds are retained in the retirement fund;
  • partial taxation on exit from the retirement annuity fund; and
  • complete exemption of death benefits paid by retirement annuity fund benefits from CGT and estate duty.

Certainly, for those who are looking to gradually build up wealth over a prolonged period, on a tax-deductible basis, containing costs, while retaining access to their wealth, estate planning using the retirement annuity funds would seem to have gained the edge over the use of trusts.

Originally published in glacier by Sanlam, The {Inside Story} Estate Planning Update article.


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