South Africa: Estate Planning

Last Updated: 7 June 2010
Article by Roger Green

As at the 1st April 2010 the relevant rates of tax were as follows:

Estate Duty – Estate duty is payable at the rate of 20% of the net value of assets in the estate in excess of the sum of R3 500 000,00. Estate duty is not payable on assets bequeathed to a surviving spouse. If the estate of a spouse does not utilise the whole of the abatement of R3 500 000,00, the estate of the last dying of the spouses may have the benefit of the unused portion of the abatement. Spouses therefore can enjoy a combined abatement of R7 000 000,00.

Capital Gains - Capital gains in a trust or company are taxed at the rate of 20% or 14% as opposed to up to a maximum of 10% in the hands of a natural person. A person who dies is deemed to have disposed of his or her assets for an amount equal to the market value of those assets at the date of death. The capital gain is taxed to the extent that it exceeds R120 000,00, subject to the proviso that assets transferred to a surviving spouse are treated as having been disposed of for an amount equal to the base cost of the assets. Accordingly the assessment of the capital gain and payment of tax on the capital gain is deferred until the death of the surviving spouse.

In the case of a natural person capital gains in any tax year up to a maximum of R17 500,00 are free of tax.

Donations - Donations of up to R100 000,00 a year are free of donations tax. Donations in excess of this amount, other than donations between spouses, attract tax at the rate of 20%.

Trusts - A trust pays income tax at a flat rate of 40%. The conduit principle applies to income, including capital gains, passed on by a trust to a beneficiary, so, subject to certain anti-avoidance rules, the income or capital gain passed on is taxed in the hands of the beneficiary and not in the hands of the trust.

The Estate Plan

In a growing economy aided by an inflationary environment the value of investments is likely to increase over time. The principal object of an estate plan is to "freeze" the value of an estate and thereby reduce or eliminate estate duty. A convenient means of achieving this objective is for the estate planner to transfer investments which are likely to increase in value with the passage of time to a trust created for the benefit of his descendants.

Trusts

1. A trust is brought into existence as a result of a contract between a donor and the trustees. The beneficiaries of a trust are designated in a deed of trust. A distinction is made between income beneficiaries and capital beneficiaries. The estate planner may be a trustee but if the estate planner is a beneficiary as well, it will be necessary to appoint at least one independent trustee. The powers accorded to the trustees in the deed of trust should be such to enable the trustees to take full advantage of the tax planning opportunities afforded by a trust. The principal beneficiaries of the trust will be the descendants of the estate planner, including or excluding spouses.

2. Under normal circumstances the estate planner will wish to avoid the payment of donations tax. He will therefore donate only a nominal sum to the trust. The estate planner will lend money to the trust to enable it to purchase assets or, alternatively, the estate planner will sell assets to the trust. The purchase price will be a debt owing by the trust to the estate planner on loan account. Depending upon the requirements of the estate planner the loan may be free of interest or it may attract interest. If interest is charged the rate of interest should not exceed a market related rate.

3. The trust deed should contain a stipulation that the trustees can lend money to the beneficiaries, including the estate planner, with or without interest.

4. The estate planner may be both an income and a capital beneficiary. In some cases, the estate planner and his or her spouse will be income beneficiaries only. If the estate planner and/or his spouse are to be capital beneficiary, two independent trustees should be appointed to achieve a divestment of control of the assets in the trust.

5. The loan account of the estate planner in the trust will be reduced over time by payments made to the estate planner by the trustees. Upon the estate planner's death the growth which will have taken place in the value of the assets held by the trust will not attract estate duty. There will also be no taxable capital gain if the assets in the trust are not realised.

6. There can be a saving in income tax if taxable income of the trust is distributed amongst beneficiaries who have little or no other sources of taxable income such as grandchildren or a spouse who is a housewife. Income distributed to a beneficiary may be lent back to the trust and credited to a loan account. If the exemption on interest is included, the current thresholds below which no income tax is payable are R79 300,00 per annum for persons under the age of 65 years and R120 528,00 per annum for persons over the age of 65 years. Any income distributed over and above these amounts up to the sum of R140 000,00 will attract income tax at the rate of 18% only. The trustees should avoid distributing income to the estate planner's minor children as income distributed to those children will attract income tax in the hands of the estate planner. Income may be distributed to those of the estate planner's children who have attained their majority, grandchildren and charitable, educational or religious institutions if they are included as beneficiaries.

7. The estate planner should not release the trust from liability for any debt owed to him. The reason being that the release of the trust from liability will give rise to a taxable capital gain. It is preferable to donate a sum of money to the trust to enable the trust to make a payment in reduction of the estate planner's loan account.

8. The transfer of assets to a trust does not mean the estate planner is no longer possessed of assets. The estate planner is a creditor of the trust by virtue of holding a loan account in the trust which will be an asset in the estate of the estate planner. It is unwise to bequeath the loan account to the trust as the bequest will give rise to a liability for tax on a capital gain equal to the amount of the loan at a rate of 20%. The loan account should rather be bequeathed to the estate planner's heirs. Alternatively an unrelated sum of money can be bequeathed to the trust to enable the trust to repay the loan account.

9. If a trust disposes of assets and makes a capital gain, the trustees may, subject to certain anti-avoidance rules, award the capital gain to capital beneficiaries to enable the gain to be taxed in the hands of the beneficiaries at a rate up to 10% as opposed to 20% in the hands of the trust. The beneficiaries can lend the proceeds back to the trust to provide for continued investment by the trust.

10. Caution should be exercised if a beneficiary of a trust is a non-resident for tax purposes. Income credited or paid to such a beneficiary may need to be included in the world-wide income of the non-resident beneficiary. A capital gain in a trust should not be awarded to a non-resident beneficiary as the trust will remain liable for the payment of income tax.

11. The vesting in a beneficiary of an asset in a trust will give rise to capital gains tax in the hands of the beneficiary. The distribution of cash to a capital beneficiary either during the existence of the trust or on termination of the trust will not give rise to the payment of tax as the tax would have been paid on disposal of the assets by the trust.

Primary Residence

The home in which an estate planner lives should be registered in the name of the estate planner or his or her spouse. On the sale of the property the first R1 500 000,00 of any capital gain will be exempt from capital gains tax. There is an automatic exclusion if the property is sold for less than R2 000 000,00. This exemption does not apply if the property is owned by a legal entity. There are instances however when it might be preferable to acquire a home through a trust.

Planning

The above are only some of the considerations an estate planner should take into account. Each estate plan needs to be carefully tailored to meet the individual needs and circumstances of the estate planner.

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.

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