Can you bypass Estate Duty through the use of a trust?

Estate Duty is a material ‘death tax’ that very few people take cognisance of. Luckily, in terms of Section 4(q) of the Estate Duty Act, but subject to its strict requirements, relief is provided to surviving ‘spouses’ who may have contributed to the accumulation of their assets, by allowing a deduction of the value of all property, which accrues to the surviving spouse, from the gross estate of the deceased. No Estate Duty is therefore payable on qualifying assets. This provides some relief for surviving ‘spouses’ who may end up having to part with assets they used to share with their spouses, just to pay Sar’s tax bill. The definition of ‘spouse’ for this purpose includes a permanent life partner and not only a legal spouse in terms of the Marriage Act or the Civil Union Act. People are advised that this deduction can also be applied when a trust is set up to basically avoid/bypass Estate Duty. Such a structure is commonly referred to as a “Widow’s Trust”. Section 4(q) was however cleverly crafted by Sars and people will be ill-advised to take such advice, which may leave you ‘out-of-pocket’ upon your spouse’s death if you have not made provision for this tax. The purpose of this section is only to postpone the payment of Estate Duty and not the avoidance thereof.
 
When the section is carefully analysed, the following is important to successfully utilise this ‘rollover’ (postponement) of the Estate Duty obligation until the surviving spouse’s death:
·       The phrase “accrues to the surviving spouse” means that the surviving ‘spouse’ may receive the assets either in terms of the deceased’s will, or through intestate succession.
·       The phrase also means that it is not only limited to property bequeathed to the surviving ‘spouse’ in the deceased’s will, but any other property that accrues to the surviving ‘spouse’ on the deceased’s death, such as the proceeds of life insurance payable to the ‘spouse’ as beneficiary, or any annuities that may accrue to the surviving ‘spouse’.
·       It only applies to amounts, which the surviving ‘spouse’ is not required in terms of the will of the deceased to be disposed of to any other person or trust. The assets will therefore have to be held by the surviving spouse after the estate is wound up. If the spouse was allowed to dispose of the assets to a third party, Sars would be out-of-pocket with the relevant Estate Duty and would never recover it.
·       Assets may be transferred to a trust, subject to specific requirements to avoid a situation where the assets are ‘absorbed’ by the trust without paying Estate Duty upon the death of the surviving ‘spouse’. The first part of the section states that the assets have to “accrue to the surviving spouse” – they have to become ‘due to them’ and no one else, including the trust or other beneficiaries. The only type of trust that can apply in this instance is a bewind trust – where the assets are held in the name of the ‘spouse’ (the beneficiary), but the assets are controlled and managed by the trustees. The last part of the section however refers to “property which accrues to a trust” as long as the trustees do not have any “discretion to allocate such property or income therefrom to any person other than the surviving spouse”. This wording suggests the possibility of a vesting trust where the assets are held in the names of the trustees, but they ‘vest’ in the surviving ‘spouse’ (the beneficiary). In both instances the assets fall into the estate of the surviving ‘spouse’ (as beneficiary) – as intended by Sars – and all income and capital gains accrue to, and are taxed in the hands of, the surviving spouse (as beneficiary).

The following is clear from the wording:
o   The trust may be registered during the lifetime of the deceased (an inter vivos trust) or upon their death (a testamentary trust). It may however be a challenge to get the wording of an inter vivos trust in line with these requirements.
o   The trustees are not allowed to be afforded any discretion in the trust instrument regarding both the assets as well as income generated by such assets. If other assets are mingled with assets accrued to the surviving ‘spouse’, the trust instrument will have to be carefully  crafted to separate these assets from the rest, which may be subject to the discretionary powers afforded to trustees in a typical discretionary trust. Our law allows a combination of vested and discretionary rights in the same trust.
o   An asset consists of its ‘bare value’ plus the value of its ‘right of use’, which has separate values. A formula is applied by Sars to calculate the two components of the asset. The beneficiary cannot only be allowed to receive the income but not getting access to the capital ever, in terms of these “Widow Trusts”, to qualify for a full deduction of the asset value from the deceased’s estate – only the portion of the total value of the asset allocated to the surviving ‘spouse’ may be allowed as a deduction.
o   The section only applies to assets actually held by the deceased upon their death, and no other assumed assets – which may give more favourable values – may be used in stead in the calculation of the value of the ‘right of use’ of those assets.
o   When calculating the ‘right of use’ of an asset, future income projections that may be better than its historical lower performance may be used, as long as they are reasonable.
o   The section also makes it clear that the asset and/or the income thereon has to be (automatically) allocated (either outright owned by them or by the trust, but vested in them) to the surviving ‘spouse’ – with the result that they get taxed on the related income and capital gains and the asset forms part of their estates for Estate Duty purposes (as intended by Sars) – without allowing any discretion to the trustees.
Any incorrect advise may have dire consequences, which may leave a large cash flow gap (20% to 25% of such assets) if Sars disallows a Section 4(q) Estate Duty ‘rollover’.