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Estate Planning Principles |
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- The critical aspect in any estate plan is to transfer appreciating assets out of the estate of the planner at the lowest tax cost. These techniques are not complicated maneuverings involving specially created vehicles that are artificial. They are however straightforward stratagems that apply statutory provisions and no more. We are not in favour of complex estate plans with any degree of artificiality. Firstly the only object of such planning is essentially to avoid estate duty. Secondly it is likely to be hit by anti-avoidance provisions that are presently being considered. Thirdly no one will probably understand what is intended and there will be inevitable family disputes or other like acrimonious carryings on.
- The areas covered are as follows and the notes deal with 2, 4, and 6. Please otherwise refer to our website for articles on the other areas (ie Critical Estate Planning Techniques)
1. 4A Deduction and Possible Anti-avoidance Provision
2. Donations, Options and Massing;
3. Trusts and Companies ;
4. Fiduciary and Usufructuary Interests;
5. Offshore Trusts and Immigration;
6. Insurance Administration and different Jurisdictions for Wills;
- DONATIONS:
3.1 A donation is a gratuitous disposition by one person to another effected out of pure liberality including any gratuitous waiver or renunciation of a right. Section 55 of the Income Tax Act refers to this. The principle is that wherever value is given, it is not a donation. However under Section 58 SARS can deem the difference between the value given and their “donated” to be a donation.
3.2 Donation tax is payable at 20% within 3 months of the donation, the requirements for which are as in a will i.e. in writing and witnessed by two people if executory. If not paid by the donor within 3 months, the donee must pay. What you are doing then is paying tax upfront. There is generally little point in doing this other than as we will see later insofar as limited interests are concerned. However because of the rebate provided in Schedule 1, there may be some advantage gained depending on the age of the donee. 100% of the tax is rebated if death occurs within 2 years of the donor’s death, 80% within 4 years and so on.
3.3 What is critical however is to ensure that a full donations tax exempt sum of R100 000 per year is used up. I find it fascinating how this figure jumped from R50 000 to R100 000 in the 2007 tax year, where the 4A deduction was increased to R3.5 million. A whole different approach was suddenly adopted. I think to some extent this was a back door approach to discourage the use of Trusts! However in using this provision, often there is in effect a paper swap i.e. in the books of the Trust the loan is reduced by R100 000 on the basis that a donation has been effected. Para 12(5) then comes into play and the borrower i.e. the Trust is hit by CGT to the full extent of the write-off or reduction. Even swapping cheques is a problem if it takes place at the same time. In my view the safest method is for a cheque to be given in repayment of the loan in the sum of R100 000 and deposited. 3 months later a cheque in the same amount can be furnished by the donor. Second best is the other way around. Third best is 2 months and so on.
3.4 The case on the matter number 1793 related to a Will that had provided “whatever amount might be due by the Family Trust is bequeathed to that Trust”. In essence the court found that no consideration had been given and albeit a set-off had occurred, there had been a reduction of a debt for no consideration. I think the case was wrong in the sense that the consideration was the value given and as reflected in the Liquidation Account i.e. the full amount was reflected on the one side as having been credited to the Trust, it is not a fictitious amount. If the executor lets off a debtor, then clearly 12(5) applies. However I discussed this provision with Duncan MacAllister from SARS who drafted Schedule 8 and he confirmed that this provision was intended to apply to testamentary donations! It seems to me wrong and unfair. His justification was that the 4A deduction was increased to R3.5 million to cover this loss!
3.5 Section 56(g)(i - iii) excludes property acquired offshore for the first time before a person became a resident and inheritances from a non-resident. It is interesting to note that Section 56(g)(iv) referred to monies obtained by way of a trade also. This was deleted however with effect from November 2005. Thus previously any South African temporarily abroad, or any South African who had spent time abroad and obtained monies by reason of a trade i.e. employment or any form of exercise of skills could donate those monies donations tax free to an offshore Trust or whatever. The reason for this would be that those monies would otherwise be included in his estate as that exemption was not contained in Section 4(3)(e). Often as well returning emigrants believe that such property would not be subject to estate duty because it was acquired while they were non-residents. Unfortunately because they were born in SA, it can never be property acquired before they became residents in SA the first time! Such assets are not required to be reported to exchange control either as from 1st July 1997. Allied to this is the fact that donations tax only applies to tax residents, so if you are a South African resident temporarily abroad, which applies to some 2 million South Africans donate your assets to a Trust before you come home! You will note also that public companies can donate assets tax free. So too when the donation is made to a PBO.
3.6 Whatever advantages of pegging the value of growth assets in an estate, whether by way of donation or on sale against the creation of an interest free loan account there is a disadvantage. This is because of the all-inclusiveness of taxation today. In essence CGT has created the disadvantage on the other side of the coin. Now while one may avoid or reduce estate duty, one incurs CGT consequences. In any form of a donation, it is a disposition whereby the party donating incurs a gain in line with the market value. Where assets are disposed of on a sale/creation of loan basis and the loan is written down because of the, for instance, the decreased value of the assets sold, then there is still a CGT consequence and the seller cannot claim the loss except to the extent a capital gain is obtained later in relation to that same connected person. There is a qualification in this regard however that to the extent the capital gain is accounted for in the income of the debtor, to that extent the loss can be used in the lenders hand.
- OPTIONS:
A very simple scheme is proposed in regard to the use of options in various textbooks. I am concerned about their artificiality. In essence what occurs is that the farmer grants an option to his son to purchase the farm at the then market value, to be exercised within say 3 months of the farmer’s death. Obviously at the time of death, the farm is worth millions more, but for the purposes of the value of the property as an asset in the estate, it is a claim against the option holder to effect payment of that value. Apparently SARS’ attitude is that they value the property at the time of death and simply disregard what the parties have agreed. In a way I think this is correct, because the parties could agree a price for instance to buy back a partner’s interest on death or whatever, but at the end of the day, the principle of the occurrence of tax relates to a market value not what parties may or may not agree. Avoid it.
- MASSING:
5.1 This is now a little used technique and its benefits I think are doubtful! In essence it is an agreement between two people, generally spouses, to distribute their estates on the death of the first dying, to name beneficiaries, retaining a usufructuary interest in favour of the surviving spouse. The estate of the first dying is taxed as if the massing had not occurred. The bare dominium of the property passes directly to the beneficiaries i.e. the children.
5.2 Therefore there is a donation to the children by the surviving spouse of her interest in the bare dominium, which is then excluded from her estate when she dies at a later time i.e. because it is no longer her property. This donation is generally accepted to be the difference between the value of the usufructuary interests she bequeaths to the massed estate against the value bequeathed by the deceased. The trick is to ignore the donation i.e. the difference in value of the usufructuary interest, which the wife succeeds to. Its value is limited for two reasons in my mind. Firstly, at the end of the day the wife’s estate will be valued on the basis of a usufruct ceasing i.e. the expectation of life of the children will be used subject to the capping provision that that value is not to exceed the then market value less the value of the bare dominium i.e. at the end of the day not only the wife’s contribution but also the husband’s is taxed in full. More importantly there is a CGT consequence that the value of the bare dominium constitutes the base cost. If the children ever sell the property, they will incur a capital gain without the inclusion of the usufructuary value. A devastating consequence.
- LIMITED INTERESTS:
6.1 The critical task is to outlive the life expectation periods. If one doesn’t it is the person benefiting that has to pay the duty. You can of course provide that the estate has to pay for it. For a usufruct only there is a limitation on this valuation i.e. as before set out the value of a usufruct ceasing is determined by taking the market value of the asset multiplying it by the yield factor of 12% and multiplying this by the life expectancy discount factor provided by the Table A, provided that this value does not exceed the then market value of the asset less the value of the bare dominium at the time of the death of the testator. At that time one values a usufruct in the estate of the testator by determining the value of the usufruct on the life expectation of the surviving spouse and deducting that from the market value.
6.2 Generally using those tables one finds that even where the usufructuary is in his/her 50’s, the usufruct constitutes a substantial portion. This is a critical value feature for determining the 4A deduction where the bare dominium is left to heirs or a Trust and can be more or less exactly determined.
6.3 If you want to play it the other way around, namely that the donor is unlikely to live for more than a few years, then the donor can donate and the value for donations tax purposes is based on the life expectancy of the donor. This has a reversed consequence that on the death of the donor he is only holding the bare dominium, the value of which is determined by deducting the value of the usufruct based on the market value and the life expectancy of the person who will succeed to the usufruct i.e. a massive deduction to the extent the usufructuary is in the bloom of life!
6.4 Another way to extract advantage from the provisions of limited interest valuations is to sell the bare dominium to a Trust set up to look after one’s children. You will then pay transfer duty on the bare dominium only. (note how SARS pro rates this on the full value however.) CGT will otherwise be minimal on the value of the Bare Dominium. Of course the younger the usufructuary, the less the value of the Bare Dominium.
6.5 In disposing of the Bare Dominium one can thus either retain a usufruct for a fixed period of time or for the life of the seller. There are various alternatives in this event. If it is for life, then the seller’s estate will pay estate duty on the life expectancy of the person succeeding. I do not think that the person holding that usufructuary right albeit he was the seller, can bequeath the interest to someone else for a limited period subsequent to his death. It has become a personal right.
6.6 But if it is for a limited period of time, say 15 years or the like, the seller either outlives it or dies during it.
6.6.1 If he outlives it, the usufructuary interest quietly without notice to anyone, transfers to the Trust. There is no estate duty, there is no transfer duty and there is no CGT. I state the latter because of a complicated interpretational problem. This is that there are no proceeds payable, but the disposition is between connected persons and therefore the market value is applicable in terms of para 38. This however has to be factored against the life expectancy of the person then enjoying that interest (para 31(d)), but his interest has expired i.e. no one is enjoying the interest because it has become a different concept i.e. full property ownership. The value of the usufruct is therefore nil for CGT purposes! You may be surprised that CGT even comes into play. It does, because if you look at the definition under para 11 of a disposition, it includes any event or operation of law, which results in …. an extinction of an asset!
6.6.2 If the seller dies before the period expires, the only value for his estate purposes is the balance of the period. It has been suggested that if the seller provides in his Will that the unexpired period is bequeathed to his spouse, then even that is exempt under 4(q). I do not believe this sensible because in the estate of the spouse that will be valued in accordance with estate duty interpretation i.e. on the life expectancy of the successor, which would be a disaster!
6.7 This all looks excellent planning, but it has a serious downside. Again that is provided by CGT. If the Trust, which is now the full owner of the property, either on the death of the seller or the expiry of the limited period, wants to dispose of the property, the base cost will be based on the value of the bare dominium at the date of death of the testator or creation of the usufruct by the seller. Although at the end of the day, one probably effects a saving of 10% of the value of the usufruct at best.
6.8 Often the planner wishes to ensure that the surviving spouse retains the benefit of occupying the property the parties are living in. Thus for instance a usufruct of the residence entitles the wife for CGT purposes to a primary residence rebate of R1.5 million. This point is often forgotten. However until recently the value of property in South Africa was rising at an annual rate of something like 35%. The CGT advantage of deducting R1.5 million has thus become of lesser consequence. If therefore one adopts the stratagem of bequeathing the property to a Trust without creating a usufruct by way of a 4A deduction, the surviving spouse can continue to occupy the residence after death. There is no donation if the Trust allows the surviving spouse as a beneficiary to continue to reside because distributions from Trusts are specifically excluded from donations tax. I point this out because we all know that thousands of people are living in residences owned by Trusts. Very few have thought of the tax consequences of this. Albeit it is not a donation it is not unlikely that the Receiver will challenge this type of situation exactly as in the Brummeria case i.e. that the value of the free accommodation had an income tax value. However if the trustees provide by way of a resolution that accommodation is to be provided to the surviving spouse against the obligation of the surviving spouse being responsible for all maintenance costs, levies and the like, that would put an end to any such argument. In addition there is no bartering or sale of assets taking place.
6.9 That is why at the end of the day SARS will not be able to attack any form of sale by a seller to a Trust at arms-length market value payable by way of the creation of a loan repayable on demand interest free. There is no donation of an interest value, because the loan can be called up the next day and there is no capital asset created. It cannot be hit by Section 80(a) because it is a family situation, not one guided by business principles of what would normally take place between two businesses at arms-length. Totally different concepts apply. The same in my view applies to any form of a loan given to a family member even if to a non-resident child i.e. you cannot apply Section 31 of the Income Tax Act and deem an interest rate applicable. Of course the ultimate CGT value will be subject to Para 70/Section 7(5) i.e. the pro rata gain/income is taxable in the donor’s hands.
6.10 A sometimes adopted technique is to provide that the usufruct on the death on the surviving spouse is to vest in the children or a testamentary Trust for a limited period i.e. one year. The value then of the usufruct ceasing is based on that limited period, which can create a massive advantage. I am however concerned by the artificiality of this provision, but for the present and until certainly the new anti-avoidance provisions are effected, it provides a massive saving. At worst if it does not work because of the introduction of the anti-avoidance provisions, the value of the usufruct ceasing cannot exceed the market value less the bare dominium if the ultimate successor is the bare dominium owner. SARS’ approach is to look at the life expectancy of the real/ultimate beneficiaries. I again emphasise however that CGT consequences are the same as previously referred to.
6.11 This situation can be avoided by the creation of a fideicommissum, namely on the death of the fiduciary the property is to pass to a fideicommissary. The valuation basis is exactly the same as for a usufructuary interest. Thus in the fiduciary’s estate the value of the fide commissum will be based on the life expectancy of the fideicommissary heir. If the fideicommissum is bequeathed for a limited period of time after the death of the fiduciary, as above set out for a usufruct, the value of the fideicommissum is substantially reduced. Also for CGT purposes then there is no loss in the base cost value of the property i.e. it is the full market value. There may be arguments in this regard because the fiduciary interest valuation under Schedule 8 (para 33) cannot be effected because it does not equate to full ownership, it is a different concept. However that argument is complex in the extreme and is unlikely to result in the fidecommissary obtaining any disadvantage for CGT purposes.
- INSURANCE POLICIES:
The advantages of assurance planning or providing insurance cover was dealt with fully in the last lecture. Power point slides were provided and these can be e-mailed to anyone requesting same. At the time the lecture was given, I pointed out to the presenter that the draft Revenue Laws Amendment Bill had just provided as follows:
LIFE INSURANCE AND PENSION BENEFITS
Current Legislation Estate duty is levied on lump sum benefits payable in terms of a life policy and pension benefit, because these assets are deemed to be part of the deceased’s estate. Annuities are exempt from Estate Duty. If a beneficiary paid the premiums on a life policy, the premiums and interest qualify as a deduction from the gross proceeds of the policy and the net amount is subject to estate duty.
Problem Statement
Most people rely on a life policy and pension benefit to address the potential financial problems of the surviving spouse and dependant children upon the death of the family’s income provider. Young families may have a demand for a bigger benefit from life policies. The tax treatment will depend on the form of savings, for instance pension funds provide exempt annuities but the lump sum is taxable. As for life insurance, some planning can reduce the tax (i.e. the subtraction for premiums). It is not in line with government’s social objectives to penalise the beneficiaries by reducing the value of the benefit, while the family’s overall economic circumstances have declined.”
I believe that this proposal has been withdrawn. I think you can work out why. It is far too broad and very clearly all sorts of eager insurance beavers will be at work to take advantage of this proposal. If for instance a planner were to take out a policy if possible a year or two before his death by paying a massive once-off premium, he will achieve complete estate duty protection! Otherwise at present, no policies are exempt from estate duty other than three types of policies, namely those effected or ceded under an ante nuptial contract. This exemption can be used to solve liquidity problems without attracting estate duty. However at that stage young people getting married are thinking of other things! Then there are the key man policies and those taken out by partners or co-shareholders. The former requires that the policy is not effected by or at the instance of the deceased and no premium was paid by the deceased. In addition no amount recoverable will be paid into the estate of the deceased or for the benefit of any relative of the deceased. This does not help an individual planner. For policies taken out by partners, this provides a useful solution to the succession difficulties in private companies, close corporations and partnerships and provided the policies are taken out by partners on the life of each other and the premiums are not paid by the person insured, they will be exempt from estate duty. This therefore provides the necessary liquidity to cover immediate expenses. The point being insofar as insurance policies are concerned over the life of a planner, is that the nominated beneficiary, normally the surviving spouse, will have immediate use of the money. That is the point and even though at present estate duty is payable thereon, it is a critical aspect to estate planning.
- ADMINISTRATION OF ESTATES:
8.1 An article in the latest Noseweek says it all “There is no free will.” It is so important for a planner to make sure that his estate is administered in a professional and objective manner. The article sent out with the notice of this meeting also says it all. Noseweek says a lot more about ABSA being appointed as an executor in a Will drawn for free. A substantial source of income and indeed professional pleasure is in reviewing “free Wills”. My advise therefore to professionals, is don’t offer the service of drawing Wills or administering estates unless it is within your expertise. It is otherwise folly for all concerned and causes anguish as often as not!
8.2 Insofar as different Wills for differing jurisdictions are concerned, I think this is a good idea from the point of view of effectiveness of administration, in other words if one leaves offshore assets, ensure that an offshore executor/trustee is appointed and that the winding up of that estate is not dependent on the winding up of some other estate. One aspect that I often find is that a person has executed a Will offshore and a local one and in each has cancelled all Wills etc previously executed. Whenever drafting a Will for a particular jurisdiction, make sure that the cancellation also only applies to a previous Will insofar as it affects that area of jurisdiction!
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