Time for estate duty to go?

May 1st, 2012

By Barry Ger

They say that nothing in life is certain except death and taxes, but what about taxes that arise on death? Attorneys involved in estate planning will be all too familiar with estate duty, but, unlike death, the continued existence of estate duty is not assured. In fact, hopes were high that an announcement would be made in this year’s budget speech that this tax would finally be abolished. It was a reasonable expectation. After all, Finance Minister Pravin Gordhan announced in his 2011 Budget Review that the South African revenue authorities were reviewing its effectiveness and other options were being considered. Unfortunately, nothing was ultimately said and its presence on the statute books will probably remain for at least another year. Nevertheless, many calls have been made for it to be removed. One such call is in the form of a submission from the South African Institute of Chartered Accountants to the treasury. Some of the research material set out in this submission regarding the efficacy of estate duty was relied on in the preparation of this article.

This article will examine why it has been proposed that estate duty should go and will also consider alternatives that could replace it.

The nature of estate duty

Before this can be explored, however, it may be worthwhile to consider the nature of this long-standing tax and some of the problems relating to it.

Estate duty is a tax, levied at 20%, imposed by the Estate Duty Act 45 of 1955, as amended. It is payable in respect of all property held by a deceased person at the date of his death. Even some assets not held at death, such as certain insurance policies, are deemed to fall into the ‘dutiable amount’ on which the tax is raised.

Relief from it is, however, available. The ‘dutiable amount’ may be offset by a number of deductions, which include funeral expenses, debts owed by the deceased, as well as bequests to the surviving spouse. Furthermore, the tax is subject to a R 3,5 million exemption or abatement, which can increase up to a maximum of R 7 million to the extent that one’s predeceased spouse did not use his abatement.

This means that in some instances, estate duty will not apply unless the deceased’s estate is worth more than R 7 million. It is because of this that estate duty is often thought of as only a ‘rich man’s tax’. Ironically, notwithstanding this label, rich men are loathe to pay it and with their substantial means they are able to establish elaborate and often costly ownership structures in their lifetimes for the purpose of avoiding its imposition to some extent.

It is for these reasons that estate duty contributes relatively little revenue to the fiscus and the administration involved in collecting it is cumbersome and unwieldy.

The double taxation problem

Aside from these practical difficulties with the tax, it is also theoretically problematic as it gives rise to double taxation in the following three ways.

Firstly, assets owned by a deceased person in an offshore jurisdiction could be subject to both estate duty locally as well as whatever death duty is imposed in that foreign country. Estate duty is generally not covered by the treaties South Africa has concluded with several countries that prevent double taxation because these agreements usually restrict themselves to income taxes. Although South Africa has entered into specific agreements with other countries for the avoidance of the imposition of double death duties, there are, unfortunately, only four of these.

Secondly, the assets that form part of the dutiable estate comprise income or assets that were already subject to income tax during the deceased’s lifetime. While one could quibble and note that these taxes are different, the levy of estate duty does mean that the government gets two bites from the same tax cherry.

Lastly, and most perniciously, estate duty overlaps in many ways with capital gains tax (CGT). In terms of current legislation, both estate duty and CGT are levied on death. Since 1 October 2001, the assets an individual owns on death (with some exceptions such as life insurance policies) are deemed to have been disposed of at their market value and CGT (currently at a maximum rate of 13,3%) may be imposed on the ‘gain’ that is made on this deemed disposal.

Although CGT is imposed on the appreciation in the value of the assets, whereas estate duty taxes the transfer of wealth, and although the CGT liability as a debt owing by the deceased would decrease the dutiable amount of the estate, there is still arguably double taxation on some portion of the same assets.

This can be illustrated by the following example:

Assume an individual has an asset with a market value of R 1 million on the date of his death that he bought for R 600 000. Assume too that the abatement for estate duty and annual exclusion from CGT has been exhausted and the individual is taxed at the maximum marginal income tax rate. The taxes that will be paid on death in respect of this asset would be:

CGT at an effective rate of 13,33% on a capital gain of R 400 000 = R 53 320

Estate duty at 20% on the dutiable amount of R1 million = R 200 000

The total tax on the asset is thus R 253 320. The individual is taxed twice on the increase in the asset’s value of R 400 000.

Notably, as far as I am aware, South Africa is the only country in the world that levies both CGT and estate duty on death.

Alternatives to estate duty

So what then is to be done? While estate duty can be discarded, the fiscus would demand a replacement to compensate for the consequent loss of revenue, however small this may be.

Some have advocated that a new ‘inheritance tax’ should take its place. Inheritance taxes are common in other jurisdictions. Generally, they involve the burden of the tax falling on the recipient of the wealth. This will, however, lead to a complex new tax regime that may not resolve the double taxation problems identified above.

Arguably, a far simpler solution would be to merely broaden the existing CGT regime that arises on death.

CGT is, after all, an internationally understood tax that is relatively easy to collect and administer as it is merged with income tax. Significantly, CGT is covered by most double taxation agreements between countries so there is no chance of two countries levying it on the same assets where such an agreement is in place.

Technically, CGT is also a wider tax. Unlike estate duty, taxpayers who are residents of South Africa by virtue of their physical presence in the country are covered, as are indirect interests in South African immovable property such as shares in foreign companies that hold South African property.

Furthermore, from the perspective of the fiscus, yield from CGT may exceed that of estate duty as capital gains increase over time (assuming assets increase in value from their date of acquisition).

Some implications of abolishing estate duty

Of course, adjustments would have to be made to the CGT regime to ensure a similar stream of revenue as provided for by estate duty. For example, life insurance, which is currently subject to estate duty but not CGT on death, would have to be included in a broadened CGT regime.

Also, if estate duty is abolished, it would be necessary to consider doing away with donations tax, the 20% tax levied on the value of donations made by taxpayers, for the same reasons as those cited above. Donations tax is in many ways a sister tax to estate duty as it too levies a duty on the transfer of wealth, the difference being that the transfers it targets occur before death. The problem, however, is it too intrudes on the territory of CGT, resulting in double taxation. Like death, the making of a donation is also treated as a disposal for CGT purposes that triggers both CGT and donations tax.

A final word

Clearly more research would need to be done, however it seems a case can definitely be made for the abolition of estate duty and its replacement with a wider form of CGT on death. It may, however, be necessary to wait until next year’s budget speech to see if the revenue authorities take up the call to consign estate duty to the tax scrap heap.

Barry Ger BBusSc LLB BCom (Hons) (Taxation) (UCT) is a tax consultant in Cape Town.

This article was first published in De Rebus in 2012 (May) DR 59.