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27 Sep 2016

THE DAVIS COMMISSION AND PROPOSED ATTACKS ON TRUSTS AND THE WEALTHY

As mentioned in our Newsflash which followed on the Budget Speech of our Finance Minister for this 2016 Tax Year, the Government was planning to ‘turn its guns’ onto Trusts.  To cut a long story short the Government was plainly of the view (with some justification) that Trusts were being used to unfairly reduce Income Tax and Estate Duty (death tax) burdens on taxpayers.

The first salvo has been presented to us in draft legislation intended to become law as of 1st March 2017.  This first salvo addresses the matter of loans made to Trusts by “connected” entities.  In this regard and by way of a very simple example, if I were to establish a Trust for myself today, it will be a very impoverished Trust.  Although like any newborn, it will exist, it will (save for something very nominal) have no wealth at all.  If it accordingly wishes to say, buy a house, it would have to borrow money and the most obvious person to ask for such loan would be me.  If I agree to lend it the money it would owe that money to me until it is repaid.  I would be said to have a loan account in the books of account of the Trust.  For reasons that are fairly obvious, such loans do not normally stipulate for interest to be payable.  It would, after all, be somewhat silly for me to burden my own Trust with an interest bill.  It would effectively amount to me charging myself interest!  The new Tax Law proposed by SARS stipulates that even though I might not wish to charge my Trust interest, interest is deemed to accrue on such loans (existing ones and future ones) at a market-related rate.  I will, in other words, be obliged to declare such income in my personal tax return and pay tax on it!  To add insult to injury, the law requires my Trust to actually pay that interest to me within a period of three years of the interest accruing, failing which the law will assume that I have donated that interest to the Trust and Donations Tax of 20% will be levied!

The genesis of the abovementioned amendment to the Tax Laws is to be found in the recommendations of a Commission of Enquiry which is currently being conducted at the instance of our Government under the stewardship of Judge D Davis.  That Commission was asked to review all Tax Laws and make recommendations to the Government.  Sadly for those of us who are heavily committed and invested in Trusts or those of us who have fairly significant financial means, Judge Davis has not, by any means, finished looking at Tax Laws and has made a whole host of other suggestions to the Government.  Whether they will all become law is of course debatable but bearing in mind our Government’s determination to close the gap between the ‘haves’ and the ‘have nots’, I am personally of the view that all of the recommendations will be implemented in one way or another and probably as aggressively as possible.

Herewith then a view of Judge Davis’ further thoughts (in no particular order):

  • Estate Duty – As the law now stands if I die, Estate Duty (death tax) is payable at the rate of 20% on the value of my estate over and above R3.5 Million.  It is proposed that :
    • Nominating one’s spouse as beneficiary of one’s estate will no longer postpone the implementation of the Estate Duty.  In this regard and in terms of the law as it stands, the implementation of Estate Duty is postponed until my spouse’s death in respect of anything which I leave to my spouse in my Will.  In other words if I die today and if my estate is worth more than R3.5 Million, Estate Duty will be payable by my Executor.  If on the other hand I left my estate to my spouse, the Estate Duty will not be payable now.  It will only become payable when my spouse dies.  The idea behind the current law is to ensure that me passing away does not affect the standard of living of the spouse who survives me.
    • The threshold for Estate Duty should be raised from R3.5 Million to R15 Million.  That would seem to put Estate Duty issues beyond the concerns of most people but I am personally of the view that our Government will seize the idea of reviewing the threshold, but set it much lower!
    • Estate Duty will be raised from 20% to 25% for estates having a value in excess of R30 Million. This amendment also seems to put the issue of Estate Duty beyond the concerns of most people but I am personally of the view that our Government will seize the idea of reviewing the percentage but set the threshold much lower!  It should be noted that if Estate Duty increases Donations Tax will increase by the same amount as the two taxes are always the same.
  • Donations Tax – As the law now stands and barring a certain nominal permitted amounts, any donation made by a taxpayer is subject to Donations Tax of 20%.  This does not however apply to donations between spouses which are permitted without any tax consequence.   Judge Davis proposes that this privilege will be removed and that save for a few fairly insignificant exceptions, this privilege will be ended and donations between spouses will be subjected to Donations Tax.  As already intimated under the topic of Estate Duty, I predict that Estate Duty will be raised and that Donations Tax will accordingly be likewise raised.
  • Capital Gains Tax – As the law now stands if I die I am deemed to have sold all my assets for their market value and if that results in me having made a deemed capital gain (profit), Capital Gains Tax will apply to that profit.  In very similar fashion to Estate Duty the implementation of this tax is currently postponed to the date of the death of my spouse in respect of assets which I leave to my spouse.  Judge Davis proposes that this postponement of tax be removed but that the threshold for payment of this tax be raised from R300 000 to R1 Million.
  • Trusts – Judge Davis has recommended to the Government that the ‘first salvo’ against Trusts dealing with interest on loan accounts should be broadened and that if no interest is charged on such loans, all the assets of my Trust should be deemed to belong to me at the time of my death and be exposed to Estate Duty.  In other words that the Government be entitled to effectively ignore the existence of the Trust completely.  In addition to this Judge Davis has recommended that the ‘flow-through principle’ should be blocked and only allowed in very limited circumstances.  In this regard and as the law stands, Trustees can decide to pass on to Beneficiaries of the Trust, pre-tax income where the tax will then be payable by the Beneficiaries.  This is done quite regularly to benefit from the difference between individual and Trust tax rates.

From the above it seems fairly obvious to me that Judge Davis and his Commission have finally decided that one of the best ways to “redistribute wealth” and to “undo the injustices of the past” is to tax the wealthy when they die.  After all the dead don’t complain!

If I already have a Trust and have over the years and in accordance with the law as it currently stands accumulated all the wealth in my Trust which would otherwise have been mine and thereby built up a significant loan account, what can I do to avoid the attack on Trusts which Judge Davis has initiated?  If I do nothing, there are going to be changes which will make it very expensive for me and possibly enable the Government to look right through my Trust and deem all my Trust’s assets to be mine and to be subject to the higher rates of Estate Duty which I have predicted.  The answer lies in a donation.  In other words, what I should do (as expensive as it might be) is donate my entire loan account to my Trust (in other words release my Trust from that debt) immediately and pay the Donations Tax at the current rate of 20%.  If I wait and as already intimated by Judge Davis, that Donations Tax (and Estate Duty of course) is perfectly likely to increase.  A donation now will make sure that the Government’s plan does not denude my Trust’s assets at the time of my death and enable those assets to be applied to the welfare of my wife and my children.  A bitter pill to swallow but then I suppose, like most medicines, one has to endure the bitterness to get the benefit.

Milton Koumbatis
27th September 2016

14 Sep 2016

SUGGESTED LETTER TO EXCLUDE PRIOR INTRODUCTIONS FROM SOLE MANDATES

Dear Seller

Thank you very much for giving us your open/sole mandate (delete appropriately) to find a purchaser for your property. We shall do the very best we can to see that your property is sold as soon as possible and at the best possible price.

(use the below paragraph for open mandates)

In the interim and for the record I confirm that if we introduce a willing and able purchaser to you or your property and if you sell your property to such a purchaser at any time after the introduction, commission will be payable to us at our standard commission rate which  is calculated at …… percent of the purchase price plus VAT on the results. If any of this requires clarification you are more than welcome to ask us for it.

Or

(use the below paragraph for sole mandates)

In the interim and for the record I enclose herewith for your attention a copy of the sole mandate agreement which you entered into with us.

Before closing I wish to raise with you a very important matter. In this regard and as we all anticipate we will be introducing prospective purchasers to your property from time to time. We all hope that one of them will choose to purchase your property. In the ideal world one of the purchasers so introduced will make an offer to purchase your property immediately after being introduced to it by us. This is  however not always the way things work and purchasers sometimes take time to reach the conclusion that a property which we introduced to them is the one that they want to buy. We can of course not predict how long it might take such a purchaser to make that decision.  It could be days, weeks or even months. Our concern is that you might at some stage between now and then decide to give a sole mandate to another estate agency. If you do so and if after that, one of the prospective purchasers we introduced to your property in the period before the sole mandate decides to make an offer to  you, you will not be able to accept that offer (even though the price might be right) without exposing yourself to the payment of double commission!  In this regard we would obviously expect commission as we were the agent who introduced a willing and able purchaser and the estate agency holding your sole mandate would also expect commission as the property would be sold during the period of their mandate.

To ensure that the situation described in the preceding paragraph does not happen to you we give you this simple advice. If you at any time after the date of this correspondence you decide to give a sole mandate to another estate agency, please ensure that before you do so, you obtain an agreement in writing from that agency that will serve to permit you to sell your property to a purchaser already introduced to your property by us, without having to pay the other agency any commission and to therefore only oblige you to pay commission to us. If you do not do so, the results could be very frustrating for us all, as you could find yourself prevented from accepting an offer which you otherwise would wish to accept and thereby losing out on the chance to sell your property!  Please don’t forget this advice!

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