The Davis Tax Committee releases its final report on Estate Duty

In July 2015, the Davis Tax Committee (DTC) released its first interim report on their review of Estate Duty. The report was met with widespread criticism and much commentary as it contained recommendations which would represent major changes to the tax treatment of transactions typically conducted by taxpayers in order to manage their wealth. Certain of these recommendations have already been proposed to parliament within the Taxation Laws Amendment Bill of 2016. The most notable of these is the new section 7C which effectively creates an obligation to charge interest on all loans to trusts.

On 24 August 2016, the second and final report on Estate Duty by the DTC was released. Whilst the report does relax certain of the initial recommendations, it has also created some new recommendations which, if agreed to by Government, will cause a significant change in how estate planning is approached in South Africa. The most pertinent of these recommendations are summarized and explained below:

1. Retirement Fund Abatement

Currently, contributions to retirement funds (provident, pension or retirement annuity funds) are deductible up to a limit of 27.5% of gross income and capped at a maximum of R350, 000 per year. The DTC has recommended that this maximum threshold is increased to take account of inflation.

2. Inter-spouse transactions

Tax laws currently provide relief for transactions between spouses in the following ways:

-        Donations between spouses are not subject to Donations Tax

-        Transfers of assets in respect of a divorce order are free from Capital Gains Tax and Donations Tax.

-        Bequests to a spouse on death are free from Capital Gains Tax and Estate Duty.

The DTC has indicated that such freedom of transactions between spouses is open to abuse and results in inconsistent treatment of married and single parent families. They have therefore recommended the following:

-        The concept of an “enduring benefit” should be applied to determine a reasonable level of exemption for cash inter-spouse donations.

-        The estate duty inter-spouse abatement (which means that inter-spouse bequests are free from estate duty) should be withdrawn however the primary abatement should be enhanced.

-        The Capital Gains Tax rollover provisions relating to inter-spouse bequests will be repealed however the death exemption should be enhanced.

-        Transfer of assets in terms of a divorce order will follow similar treatment to that of death.

3. Estate Duty abatement and rates

The first R3.5 million of a person’s estate is currently free from Estate Duty. It is proposed that this is substantially increased to R15 million. It is further proposed that the estate duty rate be increased to 25% of the value of an estate above R30 million. This will effectively result in the following estate duty rates:

Estate value less than R15 million                             0%

Estate value R15m – R30m                                       20% of the amount above R15m

Estate value above R30m                                          25% of the amount above R30m + R6m

4. Trusts

Trusts are definitely a focus point for the DTC and statistics indicate that only 33% of trusts are compliant. Before making recommendations on tax policy on trusts, the DTC recommended the following:

-        A comprehensive analysis of each trust should be conducted to ensure that the trust is compliant from on Income Tax and Estate Duty perspective.

-        All trust arrangements should be examined by SARS on registration of trust arrangements and upon transfer of assets into trusts.

-        The fundamentals of legislation relating to trusts should be reviewed.

-        There should be increased disclosure requirements on trusts and connected persons.

From a tax perspective, the perception of the DTC is that taxpayers are utilizing trusts primarily to reduce Income Tax or prevent Estate Duty. In order to avoid this, the DTC has recommended the following measures:

-        Where an interest-free or low-interest loan exists between a trust and a connected person, i.e. the trusts owes the connected person, the connected person will be deemed to control the trust and therefore the assets of the trust may be brought into the taxpayer’s estate for estate duty purposes.

-        All discretionary (i.e. non-vested) income whether capital or revenue, should be taxed in the trust and not in the hands of the beneficiary or any other connected person at a flat rate of 41%.

5. Further matters to be investigated

The report identified the following issues which they believe should be investigate further:

-        Possible implementation of wealth taxes.

-        Legislation relating to foreign trust structures.

-        The use of offshore retirement funds to conceal the true nature of investments.

In summary, whilst it is not clear how many of these recommendations will be implemented, it is fair to assume that the Minister of Finance will take this report seriously. This will have far-reaching consequences to taxpayers. It is undoubtedly clear that a priority is the non-compliance of trusts and therefore all taxpayers are urged to review the trusts to which they are connected in order to establish whether or not they are compliant. Many trusts hold passive investments and therefore trustees tend to neglect their obligations which will leave them open to attack with drastic consequences. Furthermore, the increased disclosure obligations and expected increased audit intensity by SARS will result in higher compliance time and therefore costs to effectively managed a trust.