South Africa: To Bequeath Or Not

Last Updated: 21 February 2012
Article by Lesley Maman

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.

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