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ESTATE DUTY: PAYING LESS BY GIVING MORE

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Mr John Frith, a chartered accountant from Port Alfred has raised an interesting issue with the South African Institute of Chartered Accountants (SAICA). He pointed out that by making either the surviving spouse or a charitable institution the sole residuary heir of his estate a testator will end up paying 20% less estate duty.

The purpose of this article is to analyse the example submitted by Mr Frith, by considering specific deductions under section 4 of the Estate Duty Act No. 45 of 1955 (the Act) and the effect it may have on the calculation of estate duty.

Background
Estate duty is a tax levied in terms of the Act and collected by the Commissioner of the South African Revenue Service (the Commissioner) in respect of the estate of every person that died on or after 1 April 1955. Estate duty is currently levied at a rate of 20% of the dutiable amount of an estate.

Section 4A of the Act defines the dutiable amount of any estate as the net value of that estate, as determined in accordance with section 4 of the Act, less a so-called abatement of R3,5 million.

Whereas section 3 provides what property is included or is deemed to be included in the deceased’s estate at the time of his/her death, section 4 sets out the allowable deductions for purposes of determining the net value of the estate.

The raison d’être of a proper estate plan is inter alia to reduce or minimise estate duty and any potential capital gains tax liability. South Africa has no forced heirship rules, and the basic philosophy that taxpayers are perfectly entitled to arrange their affairs so as to pay the least amount of tax has repeatedly been confirmed by the courts. As so eloquently put by Lord President Clyde in Ayreshire Pullman Motor Services and DM Ritchie v Commissioner for Inland Revenue 14 TC 754:

“No man in this country is under the smallest obligation, moral or other, so to arrange his legal relations to his business or his property as to enable the Inland Revenue to put the largest possible shovel into his stores. The Inland Revenue is not slow – and quite rightly – to take every advantage which is open to it under the taxing statutes for the purpose of depleting the taxpayer’s pocket. And the taxpayer is, in like manner, entitled to be astute to prevent, as far as he honestly can, the depletion of his means by the Revenue.”
As a general rule, a person is fully entitled to bequeath his assets to whomsoever he/she chooses. The disposal of property by a testator generally has no effect on the amount of estate duty payable, except in two situations. By making proper use of the provisions contained in sections 4(h) and (q) a testator will save estate duty in the process.
The law
In terms of section 4 of the Act, the net value of any estate shall be determined by deducting, from the total value of all property included in the estate (as envisaged in section 3), amongst others:

• [in terms of section 4(h)] the value of any property included in the estate that has not been allowed as a deduction under any other provision of section 4 and which accrues or accrued (by way of bequest1) to –

1). any public benefit organisation2 which is exempt from tax in terms of section 10(1)(cN) of the Income Tax Act; or
2). any institution, board or body, which is exempt from tax in terms of section 10(1)(cA)(i) of the Income Tax Act, which has as its sole or principal object the carrying on of any public benefit activity3; or
3). the State or any “municipality” as defined in section 1 of the Income Tax Act;

• [in terms of section 4(q)] so much of the value of any property included in the estate which has not been allowed as a deduction under any other provision of section 4, and which accrues to the surviving spouse of the deceased: Provided that –

1). the deduction allowable shall be reduced by so much of any amount as the surviving spouse is required in terms of the will of the deceased to dispose of to any other person or trust;
2). no deduction shall be allowed in respect of any property which accrues to a trust established by the deceased for the benefit of the surviving spouse, if the trustee of such trust has a discretion to allocate such property or any income therefrom to any person other than the surviving spouse.

Bequests to charitable institutions and the surviving spouse
As indicated above, bequests made in terms of section 4(h) to certain institutions on the death of the deceased will qualify as deduction for estate duty purposes.

It is important to note, however, that the deduction applies to both monetary accruals and those accruals that may be put into money terms. For example, where a usufruct or annuity or fiduciary interest, which the deceased enjoyed at the time of his/her death, accrues to a qualifying institution that accrual will rank as a deduction when determining the net value of the estate. Similarly, where the proceeds from an insurance policy, which would otherwise have been included in the property of the deceased’s estate, were bequeathed to a qualifying institution that amount will be deductible.4

When it comes to accruals of property to a surviving spouse, a bequest needs to comply with all the requirements and provisos set out in section 4(q) to rank as a deduction. By using the provisions of section 4(q) properly, it is possible to reduce the dutiable amount relating to the estate of the first-dying spouse.

Therefore, by making specific bequests to a charitable institution or the surviving spouse, the testator will automatically reduce the estate’s liability for estate duty. When it comes to the selection of the residuary heir, Mr Frith points out that the liability for estate duty can be further reduced where the residuary heir is the surviving spouse or an approved charitable organisation.

Calculation of estate duty
Where the bequest of the residue is deductible, the quantum of such deduction is not required to be reduced by the amount of estate duty that will be payable in respect of any other bequests. In other words, the whole amount available as the residue is allowed as a deduction in determining the liability for estate duty. This seems to have been a bone of contention in the past, as the Commissioner always contended that account had to be taken of the estate duty when determining the value of the accrual to a residuary heir, i.e. the estate duty needs to be calculated first before the residue is determined.

However, in CSARS v Estate Frith (63 SATC 77), a case in which Mr Frith was the executor, the estate challenged this form of calculation. The estate adopted the approach that the value accruing to the surviving spouse that was deductible in terms of section 4(q) was not first affected by the liability to pay estate duty. In finding in favour of the estate, the court criticised, what it called, the Commissioner’s engagement in “arithmetic or algebraic gymnastics”.

As to the method of calculating the liability for estate duty, Plewman JA, who delivered the majority judgment, said (at 83):

“The determination of the dutiable amount in the Act is to follow a process whereby one is able to establish the charge which is to be raised in the executor’s liquidation and distribution account. I find nothing in the Act to suggest that the very charge one is seeking to determine is to be used to determine itself. There is furthermore nothing in section 4(q) to suggest that it is concerned with what the surviving spouse will ultimately receive from the executor. What it is concerned with is the determination of a charge which must be made against the estate and therefore included as a charge in the account, which account will establish the sum (if it is a monetary amount) which the surviving spouse will receive. The focus is on what the surviving spouse is entitled to from the will, not his/her ultimate cash receipt. That this is so is in my view supported by the wording of the section which concerns itself with ‘the value of any property included in the estate’ (and not with the surviving spouse)…
The inherent circularity of the procedure Brand AJA’s judgment suggests would seem to me to be totally unnecessary if the relatively simple scheme of the Act is followed. The scheme of the Act is that estate duty is to be charged on a dutiable amount ‘calculated in accordance with the provisions of the Act’ (section 2(2)). What constitutes an estate for this purpose is expressly set out (section 3). The ‘net value’ of the estate is determined by making the specified deductions (which do not, in terms, include deductions of notional amounts) (section 4). Thereafter an additional abatement of R1 million is made (section 4A). The appellant’s contention thus would seem to rest on the introduction into the process of computation of a deduction which is not provided for in the Act.”

This really confirms the established principle of interpretation and that is that words should be given their ordinary grammatical meaning.

The court in Estate Frith came to the conclusion that the clear language of the Act supported the view that when determining the estate duty liability one should not take account of the ultimate cash receipt to the surviving spouse. This can be illustrated by an example provided by Mr Frith:

John has an estate with a net asset value of R4,5 million. The estate can devolve to John’s beneficiaries as follows: Either he bequeaths R3,5 million to his children and the residue to his brother. Alternatively he may bequeath R3,5 million to his children, R800 000 to his brother and the residue to his spouse. These scenarios are explained below.

Bequests in terms of the will:

Will 1

 

Will 2

 

Children

 

R3 500 000

 

R3 500 000

 

Brother

 

1 000 000

 

800 000

 

Spouse

 

(to get residue)

 

 

 

200 000

 

Net assets

 

R4 500 000

 

R4 500 000

 

 

 

Calculation of estate duty:

Will 1

 

Will 2

 

Net assets

 

R4 500 000

 

R4 500 000

 

Deduction (section 4(q))

 

 

 

200 000

 

Net value of estate

 

4 500 000

 

4 300 000

 

Section 4A abatement

 

R3 500 000

 

R3 500 000

 

Dutiable amount

 

1 000 000

 

800 000

 

Duty thereon at 20%

 

    200 000

 

160 000

 

 

Distribution to beneficiaries:

Will 1

 

Will 2

 

Children

 

R3 500 000

 

R3 500 000

 

Brother

 

800 000

 

800 000

 

Spouse

 

 

 

40 000

 

R4 300 000

 

R4 340 000

 

Based on Mr Frith’s example, it is clear that, by planning one’s estate in accordance with Will 1, above, the executor will end up paying 25% more estate duty (200/160) to the Commissioner than that payable in Will 2.

Conclusion
From the aforesaid example, it is clear that a “cash” saving of 25% can be achieved through careful estate planning. This results in an effective 20% saving in estate duty. However, it is important to note that had the testator in Mr Frith’s example bequeathed
R3,5 million to his children and the whole of the residue to the surviving spouse no estate duty would have been payable at all.

Thus, the point to be made is that with proper planning one can save on estate duty by appointing either a charitable institution or the surviving spouse as the residuary heir in a will. As one of the objectives of an estate plan is to reduce estate duty, it is of the utmost importance that due consideration be given to the provisions of all applicable fiscal statutes and that estate plans and accompanying wills be reviewed regularly.

(* SAICA and the author wish to thank Mr John Frith for his insight and contribution in the drafting of this article.)

Footnotes
1. The Taxation Laws Amendment Act 30 of 2002 inserted the words “by way of bequest”. Strangely enough it has never been recorded subsequently.
2. The Taxation Laws Amendment Act 30 of 2002 inserted “by way of bequest”. Strangely enough it has never been recorded subsequently.
As defined in section 30 of the Income Tax Act 58 of 1962 (as amended) (the Income Tax Act).
3 As defined in section 30 of the Income Tax Act.
4. Davis DM, Beneke C & Jooste RD, Estate Planning, LexisNexis, Durban at paragraph 2.5.9.

Carel Cornelissen B Proc, LLM (Corp Law), Adv Cert Tax, is a Senior Consultant (Intrnational and Corporate Tax) at KPMG.