Without Prejudice December 2011
Intention is the key
In the case ITC 1835 the Tax Court in Kimberley
deliberated on whether a debt due to a deceased estate had been
discharged for no financial consideration and was therefore subject
to Capital Gains Tax (CGT) on the full value of the claim in terms
of paragraph 12(5) of the Eighth Schedule to the Income Tax Act.
Paragraph 12(5) was introduced to deal with the situation where a
creditor reduces or discharges a debt owed by a debtor to the
creditor for no consideration, or for an amount less than the face
value amount of the debt. In such instances the debtor is liable
for CGT on an amount equal to the relief received. The debtor
acquires a claim against the creditor equal to the debt and is
deemed to have disposed of the claim for a sum equal to the
debt.
In 1992 the testatrix (the deceased) and her husband executed a
joint will with a provision that the first-dying spouse bequeathed
various household possessions to the survivor and the residue of
their estate to an inter vivos trust, as the sole heir, subject to
a life-long usufruct in favour of the survivor and after the death
of the last-dying to their son for one year. On the death of the
testatrix the trust, through a loan account, owed her the sum of
R539 189 (the debt) as part of the residue of the estate. The
deceased died in June 2003 and was survived by her spouse and
son.
When winding up the deceased's estate the executor neither
demanded nor received payment of the debt from the trust but merely
reflected it in the Liquidation and Distribution Account. The debt
as a claim was awarded to the trust as sole heir of the residue of
the estate. The estate was wound up on these facts. However, SARS
issued a notice of assessment to the trust imposing CGT on it
calculated on the amount of the debt, in terms of paragraph 12(5)
read with s26A of the Act. s26A provides for inclusion of the
capital gain in the taxable income of a person for a year of
assessment, as determined in terms of the Eighth Schedule to the
Act.
SARS indicated that, in terms of the joint will, the debt owed by
the trust to the deceased had been discharged free of consideration
and the trust had acquired such debt for no consideration. The
trust was, he contended, therefore liable to pay Capital Gains Tax
on the full value of the debt. The Commissioner conceded that if
the executor had demanded and received payment of the debt due by
the trust to the estate, Capital Gains Tax would not have been
payable on the amount of the debt inherited by the trust. Payment
of the amount of the debt would then have been discharged of a
liability and not a debt discharged free of consideration.
SARS referred to the judgment of Bertelsmann J in ITC 1793
where he found that a trust was liable for payment of tax on a
bequest made by a testatrix in her will. In that case, the
testatrix sold shares to a family trust on loan and subsequently
bequeathed the debt to the trust. The court held that "the
situation through which set-off could occur was created by an act
on the part of the testatrix, namely the discharge of the Trust
(debtor). The testatrix (creditor) disposed of an asset by
discharging the Trust's debt for no consideration. This created
the situation where the claim against the Trust was extinguished by
operation of law, by way of set-off between the estate and the
Trust." It is not the set-off but the act (a discharge of the
debt) which becomes taxable in the hands of the debtor. (The
drawing of the will, which rendered the result of the set-off
taxable in the hands of the debtor and it coming into operation at
the date of death, is the act resulting in the discharge of the
debt.)
The trust opposed SARS in ITC 1835, indicating that the wording of
the will differed in principle from the wording of the will in ITC
1793. The trust argued that the solution could be found in the
wording of the will, not in the method employed by the executor in
winding up the estate.
Lacock J stated that in construing a will, he had to ascertain the
intention of the testator from the words used in the will. The
judge found the intention of the testator to be clear, namely that
the residue of the estate was bequeathed to the trust as the sole
heir thereof, subject to the usufruct in favour of the surviving
spouse and thereafter the son. "Residue", when used in
this framework, is that part of an estate remaining after bequests,
legacies and the payment of estate liabilities and administration
costs.
It was clear in the will that it was the intention of the testatrix
that her claim (the debt), was to form part of the residue in the
estate and it was not separately bequeathed to the trust as a
legacy. The financial statements of the trust reflected the loan as
payable to the deceased on demand and the trust was always
financially able to repay the loan on demand before her death. The
will was a joint will and the debt was due by the trust to the
deceased and not to her husband.
The deceased and the testator had jointly disposed of the residue
of their estates in the joint will which was an indication that,
other than those household possessions specifically referred to in
the will, they had no bequests in mind to either the trust or any
other person. It was not the intention of the deceased to
specifically bequeath the debt to the trust and therefore the claim
of the deceased of her loan account simply formed part of the
residue of the estate. It was not her intention to dispose of this
claim in favour of the trust for no consideration.
The court held that the judgment in ITC 1793 found no
application to the facts in case ITC 1835. It had to be considered
whether the method employed by the executor in the winding up of
the estate (where the claim was not recovered from the trust but
merely awarded to it as the sole residuary heir to the estate),
brought this "award" within the parameters of paragraph
12(5) of the Eighth Schedule.
The true question which arose for purposes of paragraph 12(5) of
the Eighth Schedule was whether the creditor intended to discharge
a debt for no consideration. The court held that the determining
factor was the intention of the creditor, whereby she disposed of a
debt, and not the subsequent manner in which that creditor's
estate was administered. It was clear that the intention of the
deceased was not to discharge the debt for no consideration. The
appeal was accordingly allowed and the Commissioner's
assessment for payment of CGT on the full amount of the debt was
set aside.
Ultimately the difference between the two cases was is that in ITC
1793 the deceased's provision in her will discharging the
trust's debt constituted a deemed disposal and, therefore, a
CGT event, but in ITC 1835 it was not the intention of the deceased
to discharge the trust's debt for no consideration.
The lesson to testators is not to waive payment of a debt in your
will when in fact it is intended to fall into the free residue. A
waiver would amount to a donation and have an unwanted tax
implication for the debtor. Testators need to use terminology
correctly and wills should be drawn or revised by an expert.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.