TIME FOR ESTATE DUTY TO GO?

The days of estate duty may be numbered according to Nicolene Schoeman of Schoeman Attorneys and an article by Barry Ger, Cape Town-based tax consultant, in the May issue of De Rebus, the SA attorneys’ journal published by the Law Society of South Africa (LSSA). His opinion is echoed by several other media reports. In fact, many people’s hopes that this tax was finally on its way out rose significantly during this year’s budget speech.

Estate duty: brief background

Imposed in terms of the Estate Duty Act 45 of 1955 as amended, estate duty is a tax levied at 20%. It is payable in respect of all property (and property deemed to be property) held by a deceased person at the date of his or her death.

In respect of property deemed to be property, the law denotes that even property not actually held by the deceased at death – in other words: some insurance policies – are also deemed to be included in his or her estate as part of the dutiable amount on which the tax is raised.

The tax is subject to a R3 500 000.00 exemption or abatement, which can be increased to R7 000 000.00 if the deceased person was predeceased by a spouse who did not use their abatement.

Ironically, writes Ger, wealthy people are reluctant to pay this tax even with their substantial means. They often engage in expensive and elaborate ownership structures to avoid it. As a result, estate duty contributes a relatively small amount of revenue to the fiscus through SARS and the costs involved in collecting estate duty are high.

Ger also states that he thinks this is the reason behind proposals to abolish the tax. Estate duty presents a number of other problems. For example:

• Assets owned by a deceased person in an offshore jurisdiction could be subject to local estate duty as well as any other duty imposed in the foreign country
• Assets that form part of the dutiable estate compromise income or assets already subjected to income tax during the deceased person’s lifetime
• Worst of all, estate duty overlaps in many ways with capital gains tax (CGT).

For these reasons, the fiscus is considering a new inheritance tax that is common to some other jurisdictions. Alternatively, it will make certain amendments to the CGT provisions. These are still rather unclear and, at this point, amount to little more than speculation.

Therefore, clients are urged to consult suitably qualified attorneys for advice on appropriate estate planning strategies and updates on any relevant developments.

Please take note that it is of the utmost importance that any estate planning strategy is implemented with a legally valid and updated will.

 

IS FIXED PROPERTY IN A TRUST STILL VIABLE?

Gerrie Vosser examines the tax and costs related to different scenarios in order to determine whether it is still a feasible option to hold fixed property in a trust.

For many years the high transfer duty rate applying to trusts made it less attractive to purchase fixed properties in trust, a situation that changed, quite unexpectedly, for the better when on 23 February 2011 the transfer duty rate for trusts was adjusted downwards to the same more favourable rate as those for natural persons. However, just as unexpectedly, in the 2012 budget capital gains tax (CGT) inclusion rates were increased, resulting in trusts now being exposed to a maximum effective CGT rate of 26.7% compared to those of 18.6% and 13.3% for private companies and private individuals respectively.

Concerns have subsequently been raised that ownership of fixed property in trust as a way to create, protect, utilise and transfer wealth may have been dealt a crippling blow. However, these concerns turn out to be unjustified when various fixed property ownership options are analysed from an integrated, multi-disciplinary point of view.

Optimal ownership of investment property

Consider the example of an investment property, fully paid, currently worth R 1 000 000 (use this as base cost for CGT) with a projected annual capital growth rate of 10% and a current annual rental income of R 72 000 (net of cost). The following comparative tax and cost analysis of various ownership options shows a trust to be the optimal ownership choice:

Personal ownership

Property owned by Joe Bloggs, successful business person and subject to an income tax rate of 40%, married out of community of property to Jill, an unemployed housewife, with two children approaching their teens and Jill’s mother financially dependent on the Bloggs. (Even without the investment property of R 1 000 000, the net value of Joe and Jill’s combined estate and life assurance already exceeds R 7 000 000.)  

Private company

Property owned by a private company the shares of which are held by Joe.

Family trust

Property owned by a fully discretionary family trust with a personalised beneficiary base.

Tax & Cost	Investment property ownership options
	Personal ownership	Private company	Family trust
Scenario one: Situation at Joe’s death 10 years later, property then worth R 2 593 700
Capital gains tax Maximum effective rate Capital gains tax	13.3% R 211 962	18.6% R 296 428	NA R 0
Executor’s fee @ 3.5% + VAT Gross value in estate Executor’s fee	R 2 593 700 R 103 489	R 2 297 272 R 91 661	R 0
Estate duty @ 20% Dutiable amount Estate duty	R 2 278 249 R 455 650	R 2 205 611 R 441 122	NA R 0
Total tax & cost	R 771 101	R 829 211	R 0
Clearly, Joe’s dependents would have been much better off with the investment property in trust.
Scenario two: Joe bequeaths the property/private company to a trust after 10 years
Transfer duty Transfer fee Secondary transfer tax @ 0.25%	R 124 496 R 24 000 NA	R 124 496 NA R 5 432	NA NA NA
Total tax & cost	R 148 496	R 129 928	R 0
Original ownership in trust would have prevented these costs associated with a bequest to a trust.
Scenario three: Income tax during the 10 year period
Income tax rate	40%	28%	0%
Income tax liability	R 288 000	R 201 600	R 0
Dividend withholding tax @ 15%	NA	R 77 760	NA
Total tax liability	R 288 000	R 279 360	R 0
Using the conduit principle, trust gross income is distributed to two non-income earning Bloggs family members resulting in no income tax having to be paid. A trust is the best option again.
Scenario four: Liquidation of property after 10 years during Joe’s lifetime
Capital gains tax Dividend tax @ 15%	R 207 972 NA	R 296 428 R 344 591	R 42 573 NA
Total expense	R 207 972	R 641 019	R 42 573
Again, using the conduit principle with trust gross income distributed to four non-income earning Bloggs family members, there is a total CGT liability of only R 42 573. A trust, yet again, proves the best option. (The effects on the personal estates of the beneficiaries need to be carefully considered and managed.)

In suitable circumstances and from a tax and cost point of view, a properly structured and professionally used discretionary trust without doubt still provides the optimal ownership solution for an investment property.

Remember however that tax benefits should never be the primary reason for establishing and using a trust. Tax legislation may change for the worse; and personal circumstances may change and neutralise potential tax benefits. Remember too that the planning, drafting and upgrading of trust deeds, as well as the management and administration of trusts requires multi-disciplinary professional skills. Members of the public are advised to seek out a practitioner who is a member of the Fiduciary Institute of South Africa (FISA), who are bound by a code of ethics to adhere to a high professional standard.

 

 

ESCAPING THE HIGHER CAPITALS GAINS TAX RATE

By Barry Ger, senior manager for corporate tax at KPMG

01 April 2012

 A window of opportunity opens for some companies.

 If your company is thinking of selling any capital assets and its year end is not February  or March there may be a window of opportunity to do it at the lower effective tax rate for a short while.

In his Budget Speech on February 22 2012, Finance Minister Pravin Gordhan announced increases to the capital gains tax (CGT) rates. Companies, trust and individuals would now be paying 18.6% (previously 14%), 26.7% (previously 20%) and a maximum of 13.3% (previously a maximum of 10%)  respectively of any capital gain that arises in their hands from the sale of their assets over to the South African Revenue Service (SARS).

In a new tax bill released on March 13 2012, it has been proposed that these new rates will take effect from tax years beginning from March 1 2012. The tax years of individuals and trusts perennially begin on March 1 anyway so for them the new rates apply already. The tax years of companies, on the other hand, have a multitude of different starting dates which means that some companies, specifically those with tax years that do not begin in March, have a short period in which they can still benefit from the lower rates. This period is, of course, longest for companies with tax years that commence much later in the calendar year or even in the next year. Companies with January 31 financial year ends, for example, will have almost 11 Months, until February 1 2013, to dispose of their assets before the new 18.6% rate kicks in.

The question arises though whether a company that makes use of this opportunity and sells off many of its high value assets before the end of its current tax year would be investigated by Sars for tax avoidance. The answer to this is probably not. Provided the company has primarily a commercial (but non -tax related) reason for making such disposals, it is unlikely Sars would be able to make such a claim stick.

It would be the height of foolishness, of course, for companies to rush off to sell their assets so as to take advantage of the lower rate.  The tax tail should never wag the commercial dog.   However, for those who were contemplating a sell-off anyway, the looming increase in CGT rates would no doubt spur them to make such decisions sooner rather than later.

 

BUYING YOUR PROPERTY IN A TRUST: IS IT REALLY WORTH IT?

To buy or not to buy, that is the question.

A trust is a legal entity with its own distinct identity. It has the contractual capacity to acquire, hold and dispose of property and other such assets for the benefit of its nominated beneficiaries. All trusts are governed and administered in terms of the Trust Property Control Act, and formed and governed in terms of a trust deed, a written agreement concluded between the trustees and the founder of the trust.

Perhaps the most significant purpose for establishing a trust is the separation of ownership, which is often desired for reasons including asset protection, risk mitigation and limiting ones tax liability. In order for the trust to transact, a trustee(s) are duly appointed in the trust deed who are thereby authorised to act on behalf of the trust. A trustee may act on behalf of a trust provided that he has been duly appointed to act in this capacity in the trust deed, that the trust has been registered with the Master of the High Court and the Master has authorised such appointment in writing by issuing Letters of Authority to this extent. Further, the trustees’ powers to transact are set out in and may be limited by the trust deed.

There are various advantages related to purchasing property in a trust as opposed to buying it in your personal capacity of which the following are the most prominent:

A trust is a flexible vehicle, capable of catering for various changes and uncertainties occurring in one’s life over time e.g. a larger family, death, insolvency, legislative and financial changes and other circumstances.

Since the property is not registered in your name, the value of your personal estate upon death is reduced. The direct implication hereof is a reduction in your estate duty exposure. Also, should the asset value have increased over time, this growth will be excluded from your estate and the capital gains tax (“CGT”) payable on your estate is reduced accordingly. Executor’s fees pertaining to these assets will also be eliminated.

Provided that you do not establish your trust(s) with the intention of prejudicing creditors, purchasing or transferring a property into a trust helps to protect the specific asset from creditors.

It is advisable to create and operate a trust with appropriate tax advice. In this way a trust will enable you to mitigate your tax liability with specific reference to income tax, CGT, estate duty, donations tax and transfer duty.

Trusts are excellent succession planning tools as a property bought in a trust can remain in the trust indefinitely. Consequently, there is no need to transfer the property from the deceased into the name of his heir. In turn this saves on unnecessary transfer costs and CGT duty.

When finance is required to purchase a property in the current “market” the banks are less likely to grant a 100% bond to a trust and demand a deposit of up to 20% when a trust acquires a property. It appears in some instances individuals may receive up to 100% property finance.

Looking at the downside, the following count under the most burdensome disadvantages of purchasing property in a trust .

All trusts are taxed at an income tax rate of 40%. Consequently, it seems to be more favourable to buy a property in your individual capacity rather than in a trust. Here is why: CGT on the growth of the value of the property comes into play once a property is sold.

Trusts are subject to the highest inclusion rate. 66.66% of the net gain must be included in the trust’s taxable income for the year in which the property is sold. Consequently trusts are taxed at an effective rate of 26.6%. This is compared to individuals who are subject to an inclusion rate of 33.33% and a maximum effective rate of only 13.33%. However, if the profit or gains are distributed to the beneficiaries of the trust during the same tax year, the tax payable may end up being the same amount, as if a natural person is disposing of a second property.

Another downside of the trust owning the property is that the founder does not enjoy control over that property as the trust will be the legal owner of the property and the trustees will have the power to administer same.

Therefore based on the above, if administered correctly, one can benefit tremendously from the exercise of purchasing a property in a trust. It is, however, crucial to determine whether the addition of a trust to your portfolio is necessary and beneficial based on your individual needs and circumstances.

 

CAPITAL GAINS TAX LIABILITY: INCREASED RELIEF FOR INDIVIDUALS

Any person’s capital gain or loss is determined, for each asset disposed of, during the year of assessment as follows:

Proceeds                                                       xxxx

Less: Base cost                                             xxxx

                         Equals: Capital gain or loss                           xxxx

In order to calculate a taxable capital gain, the sum of all the capital gains and losses for each asset (determined separately) disposed of during the year of assessment is determined. The resulting total is then reduced by an annual exclusion for a taxpayer who is a natural person or special trust.

As of the 1^st of March 2011 this form of relief to natural persons has been increased as follows:

• The annual exclusion has been increased from R 17 500.00 to R 20 000.00 for individuals during their year of assessment.

• In the case of an individual in the year in which the individual dies, this exclusion has jumped from R 120 000.00 to R 200 000.00.

It is important for all taxpayers to be aware of their tax liabilities and also how such liability is incurred. It is for this reason, coupled with recent changes in legislation that we have decided to dedicate a portion of the next few posts to capital gains tax liability in order to keep all OMDW clients and followers updated and fully informed.