How tax hikes will impact your estate planning
Tax announcements revealed in the 2018 budget will have wide-ranging implications for the administration of deceased estates and trusts, including higher costs.
Former finance minister Malusi Gigaba announced in February that Value-Added Tax (VAT) would rise by one percentage point to 15% from April 1, 2018. Estate duty increased from 20% to 25% for estates of R30 million or more on March 1, 2018.
1. The VAT hike
Louis van Vuren, CEO of the Fiduciary Institute of Southern Africa (FISA), says most professional executors and trustees are registered VAT vendors and will charge 15% VAT on their fees.
Together with Master’s fees, that were increased for the first time since 1986 on January 1, 2018, this could result in quite a substantial increase in administration costs. Master’s fees were previously capped at R600 where the estate value was just over R200 000, but currently a maximum fee of R7 000 is levied once the estate value reaches R3.6 million.
With regards to the administration of a deceased estate, the VAT hike will result in an increase in the effective maximum executor’s fee from 3.99% (3.5% plus VAT at 14%) to 4.025% (3.5% plus VAT at 15%) or a rand amount increase of R350 for every R1 million of gross estate value, Van Vuren explains.
It will also lead to an increase in the cost of all services rendered to the deceased estate by other professionals. This may include attorney’s fees for the transfer of fixed property, valuation fees on fixed properties by sworn appraisers, accountant’s fees for the valuation of unlisted companies for estate duty purposes, tax compliance fees for the deceased’s last tax return and any possible tax return in the estate, he notes.
A back-of-the-envelope calculation suggests that an estate of R5 million, which includes a fixed property of R3 million, will incur roughly R10 000 in additional costs as a result of the VAT and Master’s fee hikes.
As far as trust administration is concerned, most professional trustees charge a trustee fee of between 1% and 1.3% of the trust capital each year. If the trustee fee is 1%, a trust with R5 million of assets will therefore attract R500 more in fees purely as a result of the VAT hike, Van Vuren says.
2. The estate duty hike
The wisdom of the piecemeal introduction of some of the Davis Tax Committee’s recommendations on estate duty has to be questioned, Van Vuren says.
While the committee previously recommended that the estate duty rate should be increased from 20% to 25% where the dutiable value of the estate exceeds R30 million, it also proposed that the “primary abatement” – the portion of a net estate free from estate duty – be increased to R15 million (currently R3.5 million), that the spousal exemption should be withdrawn (currently, amounts inherited by a spouse are free from estate duty) and that the unlimited inter-spousal exemption within the donations tax system should be reconsidered. National Treasury only adopted the first proposal.
Estate duty and donations tax only contribute a few drops to the tax bucket, yet the fractured introduction of tax recommendations will make the estate duty system and estate planning even more complex than it already is, Van Vuren says.
He says there is still no donations tax payable on donations between spouses – and neither should there be.
“With the very liberal definition of ‘spouse’ used in tax legislation the argument that this concession [the inter-spousal exemption] is unconstitutional, is tenuous at best. With the higher estate duty level proposed for dutiable estates over R30 million, the incentive to ensure a more equal distribution of wealth between spouses by donations becomes stronger,” he says.
The Budget also proposed that the “official rate of interest” – currently the repo rate plus 100 basis points (7.75%) – be increased to a level closer to the prime rate of interest (currently 10.25%). Treasury argues that since interest rates lower than prime have become uncommon, this change would allow the benefit of lower rates to be measured with reference to a rate that approximates the rate offered by commercial banks to low-risk clients.
This is, in itself, a fallacious argument, Van Vuren says. The prime rate takes into consideration the interest rate margin that banks charge as an income stream to cover costs and deliver profit. In a loan between connected persons (family etc.) this interest rate margin is inappropriate and a better yardstick would be low risk deposit rates or money market yields.
Among other things, the official rate of interest is used to calculate donations tax on low or no-interest loans to trusts by “connected persons” (usually the founder, trustees or beneficiaries of the trust). These loans are commonly used as an estate planning tool where taxpayers move wealth generating assets to a trust whilst simultaneously extending an interest-free or low-interest loan to the trust to finance the transaction. This allows the assets to grow in value outside the estate of the original owner, effectively reducing estate duty income for government.
Van Vuren says even despite the interest rate proposal, the case for moving growth assets to a trust could become stronger as a result of the higher estate duty rate.
“Even at an official rate of 8.75% it could still make sense for a wealthy individual with, let’s say, a R50 million dutiable estate to move R20 million into a trust. The discounted present value of the annual donations tax at 6% inflation over a 10-year term will be R2.73 million.”
“However, if one assumes growth of just 3% more than inflation on the assets in the trust over the same ten-year term, the present value of your future estate duty saving at the new rate of 25% will be in excess of R6.6 million. Obviously, the earlier payment of capital gains tax [CGT] on transfer to the trust will also be an immediate cost, but will in turn reduce CGT in the trust on the assets transferred.”
“The message is that, unintentionally, the proposed increase in estate duty could open a window for seriously wealthy persons to avoid estate duty and save tax overall.”
- The Fiduciary Institute of Southern Africa (FISA) sponsored this content.