Estate Duty – The Donation of Limited Interests

Following on the example in the last edition of Finance Matters, Estate Duty savings as opposed to Estate Duty deferment can actually be achieved with the utilisation of limited interests.

In the last edition, I covered the use of usufructs as an effective means of protecting assets for future beneficiaries and also highlighted the associated benefits of this type of disposition due to the deferment of the Estate Duty liability. As indicated by the example, no savings are actually achieved in the long term because of the value included in the estate of the usufructuary when the usufruct terminates. Using exactly the same example, however, if the usufructuary were to donate his usufruct to the bare dominium holder during his lifetime, the eventual estate duty liability could be significantly less.

The simple reason for this is that when a person has a usufruct over certain property when he or she dies, the value of the terminating usufruct is calculated taking into account the annual value of the property (i.e. market value x 12%) over the life expectancy of the beneficiary who is often much younger whereas when a usufruct is donated, the value of the donation is calculated taking into account the annual value of the property over the life expectancy of the donor.

By way of an example, and taking into account the same circumstances as those referred to in my previous newsletter, the calculations on death versus donation would differ as follows:

Facts:

  • The surviving spouse enjoying a usufruct over the affected property is a female aged 90 next birthday.
  • The son to whom the usufruct passes or is donated is a male aged 50 next birthday.
  • The property (or asset) has a market value of R3 Million at the time of donation or passing.

Where the surviving spouse passes away and the usufruct over the property passes to her son, the value of the ceasing usufruct would equate to R2.737 Million (and based on the example in the previous newsletter would be limited to R2,642 Million).

If on the other hand, the surviving spouse referred to above donated the usufruct to her son just before she passed away, the value of the donation would only equate to R1, 076 Million.

As can be seen, the estate of the surviving spouse will be reduced by R1,566 Million thus saving estate duty of around R313 000 (if the full value was dutiable) while the donations tax payable on the donation (being roughly R195 000) would also have the effect of reducing the estate for estate duty purposes.

Although the above example refers to a situation where an existing usufruct is donated (purely because it follows on the testamentary usufruct used as an example in my previous newsletter), there is no reason why existing assets cannot be made subject to a usufruct and the usufruct subsequently donated.

Although these estate planning mechanisms are reasonably simple to establish and implement, it is very important to ensure that the services of a specialist are enlisted because there are significant risks if incorrect procedures and processes are followed. As an example, the sale of the usufruct as opposed to the donation of a usufruct could attract income tax as opposed to donations tax. There are also continual legislative changes that could impact on various estate planning techniques.

Credits / Sources:
Estate Duty – The Donation of Limited Interests – Peter Hewett – Old Mutual Private Wealth

Article by: Peter Hewett - Telephone: 011 322 6300 - phewett@oldmutual.com