Vital to understand estate duty changes

The Davis Tax Committee’s (DTC) proposal that the preferential estate duty regulation for bequests to spouses should be scrapped could have far-reaching implications for especially lower and middle-income earners if it is adopted.

Where an individual leaves assets to a surviving spouse, section 4(q) of the Estate Duty Act specifies that it qualifies for a deduction for estate duty purposes (subject to certain exclusions). Practically this means that if an individual leaves her entire estate to her spouse (assuming no assets accrue to third parties outside the estate) no estate duty will be levied.

The Act defines a spouse fairly broadly to not only include married couples or partners in customary unions but also partners in religious marriages and permanent same-sex and heterosexual relationships.

In its first interim report on the topic published in July, the DTC argued that the provision was unconstitutional as it discriminated on the basis of marital status and ignored the growth of the single parent family phenomenon. It said the inclusion of permanent relationships in the definition of “spouse” also opened the door to abuse.

The 2016 Budget did not provide any more detail and at this stage it is unclear whether the DTC’s recommendations would ultimately be introduced. There is no clarity on when the next version of the DTC report can be expected.

Ronel Williams, chairperson of the Fiduciary Institute of Southern Africa (Fisa), says the section 4(q) provision was originally intended to protect the surviving spouse and family members whose financial position could be adversely impacted if estate duty had to be paid from the estate of the first dying.

The intention was not to eliminate estate duty but merely to defer payment to a later stage (the death of the surviving spouse). This is referred to as the spousal rollover or deferral of estate duty.

Williams says low and middle class earners will likely bear the brunt of the changes should the proposal be implemented. Young couples in their early thirties may just be starting to build an asset base and probably won’t have enough cash-type assets to settle the estate duty, which may force them to sell some of their possessions. Similarly, older couples may not be in a position to effect life insurance to alleviate any cash shortages as a result of the estate duty liability.

Moreover, if the surviving spouse is unable to support himself with his own assets and his inheritance, he can lodge a claim against his partner’s estate in terms of the Maintenance of Surviving Spouses Act.

Williams says if the individual left her entire estate to her spouse a maintenance claim will have no impact. However, if she only left part of her estate to her spouse, the absence of section 4(q) could trigger estate duty and if the spouse lodged a maintenance claim on top of this, the pot available to the heirs could reduce substantially.

It should be noted that section 4(q) is also applicable to assets like life insurance policies that are paid to the surviving spouse outside the estate.

Life insurance policies are usually obtained to ensure the surviving spouse has immediate cash available outside the estate. If the recommendations become law, these policies would be fully taxable and could reduce the cash available to the surviving spouse substantially.

Primary abatement

Currently, the first R3.5 million of the net value of an estate is free from estate duty (the primary abatement).

To overcome the potential negative implications of the removal of section 4(q) the DTC recommended that the primary abatement be increased to R6 million. It also proposed that if the scrapping of the provision still triggered estate duty even in the face of a higher primary abatement, the surviving spouse could choose to bring forward the use of his primary abatement.

Thus, if the value of the first dying spouse’s net estate is R7 million, it would be reduced by her R6 million primary abatement, which means that estate duty would be payable on R1 million. The surviving spouse could then choose to use R1 million of his primary abatement in the estate of the first dying spouse to avoid payment of estate duty, but upon his death, his primary abatement would reduce to R5 million.

Williams says while the implementation of these recommendations would ease the pain in most instances, the scrapping of section 4(q) will still have a significant impact on many estates.

Scrapping the 4(q) provision due to its unconstitutional nature does not make sense if the surviving spouse is allowed to utilise his primary abatement at an earlier stage, as he would be entitled to do so based on his “status” as a spouse, Williams says.

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