Taxing the wealthy to death and beyond

An increase in the estate duty rate and a potential doubling of the capital gains tax rate for individuals are pitted as potential additional revenue sources to make up for increasing budget shortfalls.

This, together with recently introduced changes to the taxation of interest free loans to trusts – that devilish estate planning tool –  has the potential of filling government coffers with an additional R3 billion to R5 billion per annum.

The recommendations of the Davis Tax Committee on estate duty and donations tax is expected to feature in Finance Minister Pravin Gordhan’s budget speech later this month (February 22).

Gordhan will announce government’s plans how to collect an additional R28 billion in tax revenue on the back of an expected shortfall of R23 billion for the current tax year.

The committee has recommended an increase in taxable estates from R3.5 million to R15 million at 20%, with an additional 5% on estates worth more than R30 million.

The recommendations may bring relief for the Average Joe, but for the wealthy it may be another bitter pill to swallow.

The committee has also recommended that the roll-over relief for spouses be scrapped so that everyone – whether married or not – are taxed the same alive and in death.

The roll-over relief currently means no estate duty, donations tax or capital gains tax if the assets of the deceased are left to the surviving spouse. Taxation is only triggered on the death of the surviving member of the marriage.

Patricia Williams, tax partner at Bowmans law firm, says if this recommendation is implemented transactions between spouses will start to fall within the tax net, potentially triggering capital gains tax and donations tax.

She notes that the capital gains tax and donations tax will be applicable if there are transfers of assets between couples (living and deceased), even if the size of the estate was less than the proposed R15 million or R30 million.

“Leaving assets to one’s spouse upon death would become a very fiscally expensive choice, since these assets would be taxed upon the death of the first spouse, and then a second time upon death of the second spouse,” Williams says.

Piet Nel, head of the School of Applied Tax at the South African Institute of Tax Professionals (SAIT), says the current inclusion rates on capital gains tax present a problem.

The inclusion rate is the portion of the capital gain which is included in taxable income. In the case of individuals, it is currently 40%, and for companies and trusts 80%. The effective rate on which the portion of the gains are taxed is 16.4% for individuals, 22.4% for companies and 32.8% for trusts.

Nel says with the introduction of a tax on capital gains, inclusion rates were to be kept low to address the impact on inflation. That was why an inflation adjustment was not brought in.

The rates of estate duty and donations tax were reduced from 25% to 20% in 2001 when capital gains tax was first introduced to counter the double taxation at death (estate duty and capital gains tax).

However, since then the inclusion rates have been increased twice, yet there has been no reduction in the estate duty or donations tax rate.

“The tax on the capital gains at death and the fact that we have no inflation adjustments, makes the tax too high,” Nel says.

Cheryl Howard, MD of Talaria Wealth, says the tax-free amounts for capital gains tax and estate duty have not been adjusted for years.

Currently only estates valued below R3.5 million are excluded from estate duty and the exclusion from capital gains tax (at the year of death) has remained R300 000 since 2012.

The Davis Tax Committee states in its final estate duty report that even if the general abatement (exclusion) was increased to R7.5 million it would not represent a “complete solution”.

“It is not difficult to imagine that a taxpayer’s modest primary residence and personal effects could easily exceed R3 million, leaving but R4.5 million remaining to cover savings, investments and life insurance benefits,” the report says.

“This may be sufficient to provide for the modest maintenance of a retired widow(er) for five to ten years, but would be totally insufficient to cover the needs of a middle class family following the death of a breadwinner.”

The report refers to figures from the South African Revenue Service (Sars) which show that the value of the majority of estates (1 310 out of 1 445) is less than R15 million. Their estate duty liability amounts to R556 million of the total estate duty collection of R1.4 billion (2014-15).

“It can thus be concluded that the loss of estate duty associated with dramatically increasing the primary abatement is no cause for alarm,” the committee says.

Howard says the increase of taxable estates to R15 million will be a relief for the Average Joe, but Mr Moneybags is clearly targeted with the proposed increase in estate duty, the scrapping of the roll-over relief for couples and the taxing of interest free loans to trust.

Howard also warns that the inclusion rate for capital gains can “easily” be increased from 40% to 80%, raising the effective capital gains tax rate for individuals to the same level as trusts (32.8%).

“Trusts remain the most effective way of structuring one’s estate. However, for people with estates valued at less than R30 million it is no longer a cost-effective option because the of cost of compliance and punitive rates,” she says.

Nel says middle class people with an estate below R3.5 million have no need to do any planning to avoid estate duty. It is where the combined estate of spouses, exceeding R3.5 million that planning is required.

“The roll-over relief between spouses really gives the only relief. That is why it should not be taken away,” he says.

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