True to its mandate, the Davis Tax Committee (DTC) has been hard at work reviewing the South African tax system. Since its formation in 2013, it has already issued reports on small and medium enterprises (SMMEs), Base Erosion and Profit Shifting (BEPS) and VAT. It also compiled a macro analysis of the South African tax system, a World Bank study on the effective tax burden in South Africa and presented carbon tax proposals.
However, on 13 July the committee issued the “Estate Duty Report” which deals with a variety of topics sure to spark outcry and fierce debate, especially from more wealthy taxpayers. Whatever the outcome of the report may be following consultations, taxpayers will need to review their estate and tax plans to accommodate the impending changes.
The Estate Duty Report
The terms of reference the Minister of Finance extended to the DTC included an investigation of the role and continued relevance of estate duty to support a more equitable and progressive tax system, especially in the light of estate duty being abandoned in many developed countries. In this inquiry, the DTC had to consider the interaction between capital gains tax (CGT) and estate duty. The main findings and recommendations of the report are as follows
Estate Duty recommendations
In real terms, estate duty collection has declined in the 20 years and represents a mere 0,1% of total tax collections. This situation has mainly developed as result of the allowances that subject most estates to both capital gains tax (CGT) and estate duty, but only upon the death of both spouses, and thereby defers estate duty collection for many years.
To address the estate duty system’s shortfalls, the DTC considered three alternatives:
• Repealing the Estate duty Act completely, moving away from the concept of treating death as a taxation event;
• Amending the Act to achieve a simpler, more efficient and just system; or
• Replacing the existing estate duty system with a new form of wealth taxation.
The DTC based their recommendations on the following overarching principles:
• There is no prospect of capital taxes, regardless of its form, being a “silver bullet” to increase South African tax revenue substantially.
• Despite its inherent faults, the current Estate Duty Act, coupled with Donations Tax, remain the only direct tax on wealth in South Africa. Given the country’s huge disparity in wealth distribution, repealing these taxes without any replacement is hard to justify.
• With some modifications, the estate duty system could achieve many of the objectives without resorting to the drastic measure of implementing a Capital Transfer Tax (CTT).
The DTC is of the opinion that aggressive estate planning can be deterred by addressing the income tax regime for trusts (see below) without devoting substantial resources to implement a CTT or Net Wealth Tax. Such a deterrent is expected to result in increased estate duty and CGT collections, which will contribute to overall tax collections significantly but without burdening the tax system with new, complicated and administratively challenging alternative taxes.
Other proposed estate duty and related reforms include:
• Withdrawing the principle of inter-spouse estate duty exemptions and roll-overs, or subjecting these to a specific limit;
• Removing the inter-spousal donations tax exemption, which permits tax free donations of substantial cash amounts in anticipation of death.
• The donations tax exemption of any bona fide contribution made by a donor towards the maintenance of any person as the Commissioner considers being reasonable, should be made subject to various categories of expenditure and limits. For example, food, clothing, medical, education and cost-of-living expenses and possibly even the cost of a small motor vehicle could be included. This would act as a deterrent to substantial abuse.
• Increasing the existing primary estate duty abatement of R3,5 million per taxpayer to R6 million.
• Retaining the current flat rate of 20% for both estate duty and donations tax.
Recommendations in respect of trusts
The use of trusts in estate planning is well known. However, the DTC indicated that trusts are also often used as income-splitting vehicles through section 25B of the Income Tax Act, which allows trust income to vest and be taxed in the hands of a beneficiary. This despite the attribution rules of Section 7 of the Income Tax Act, which that are aimed at countering the abuse of section 25B. An additional tax avoidance measure is to escape donations tax through the transfer of assets into trusts by leaving the transfer consideration outstanding through an interest-free loan account.
To address the deficiencies of the estate duty system and the use of trusts to avoid or defer estate duty, the DTC recommended these fundamental legislative amendments:
• Maintaining the flat tax rate on trusts (currently 41%);
• Repealing the deeming provisions of Sections 7 and 25B should be repealed, in respect of RSA-resident and non-resident trust arrangements;
• Taxing trusts as separate taxpayers; and
• Not attempting to implement transfer pricing adjustments in instances where financial assistance or interest-free loans are advanced to trusts.
From an estate duty perspective, these proposals mean taxpayers wanting to make use of trusts to postponement estate duty will remain at liberty to do so. However, upon sale of the trust’s assets the gain will be taxed in the hands of the trust at a higher tax rate, thus compensating for the estate duty loss.
The DTC report, which was submitted to Minister Nene in January 2015, recognises that a repeal of the attribution provisions will have diverse and far-reaching implications. It recommends that in the interests of equity and certainty, the repealing of the attribution provisions should be announced in the 2015 National Budget Speech but only be implemented from 1 March 2016. However, no such mention was made in the 2015 Budget Speech and the report was only released for public comment in July 2015. It is therefore expected that the announcement will only be made in the 2016 Budget Speech and that the final announcement will be affected by the current consultation process.
The effect on offshore trusts
In respect of offshore trusts, sections 7(8) and 25B (2A) have previously been amended to specifically deal with the taxation consequences of offshore trusts with South African donors and beneficiaries. The DTC’s view is that there is no need to consider an additional specific offshore amnesty programme.
To address remaining difficulties in respect of offshore trusts, the DTC proposes that all distributions of offshore trusts be taxed as income in the hands of beneficiaries. In addition, the DTC recommends inserting a separate criminal offence provision in the Tax Administration Act, which could lead to criminal charges against taxpayers who fail to disclose their direct or indirect interests in foreign trust arrangements.
It will be interesting to hear the comments made by affected and interest parties to these recommendations. The reforms to estate duty and the taxation of trusts have been mooted for quite some time now and come as no surprise. The recommendations will however, have significant effects on existing trust structures and future estate planning. Please proceed with caution and contact Grant Thornton to assist in reviewing your plans.