Estate planning is not necessarily the most enticing of prospects given the scenarios that it requires you to confront – typically these will be incapacity, death, and taxation. However, the coronavirus pandemic is a timely reminder that this is a very necessary exercise that should not be delayed.

My advice is to take advantage of this time to address your estate planning now. It is a process that will give you comfort that you have provided properly for your dependents and – ironically given the current state of the global uncertainty – it should leave you with the feeling of being in control again.

The benefits of estate planning

Hope for the best, but prepare for the worst. A detailed estate plan with supporting documents can prove invaluable in times of emergency and can save, not just your family but also business partners or co-investors, a huge amount of stress at a time when emotions will be running high.

Estate planning is so much more than just creating a will. It is also ensuring that there is sufficient liquidity to meet your estate’s financial obligations in the event of your incapacity (through income protection policies) or upon your death (often through life insurance). In both cases, the objective is to eliminate uncertainties and financial hardship.

Many estates around the world, not just in South Africa, are rich in assets but lack the liquidity required to sustain borrowings or settle liabilities in the short term and this can result in difficult financial situations and tough choices for dependents. Unless your estate is cash-rich and debt-free, it is essential to incorporate financial planning into your estate planning to ensure a smooth continuation of a business and/or assets staying within family ownership.

When you structure your finances and assets, attention should be paid to minimise the number of taxes including donation tax (currently levied at 20%), estate duty (currently levied at 20% on estates valued above ZAR3.5 million and 25% on estates valued above ZAR30 million) and capital gains tax (40% of the gain is included in your taxable income after deducting the annual exemption). You can also minimise the potential costs of executor fees by placing assets into the trust.

The maximum rate that an executor in South Africa can charge is 3.5% of the value of the estate and 6% of the income earned by the assets from the date of the person’s death until the estate is distributed. Any restructuring that reduces the amount of your final estate that is subject to probate may, therefore, increase the amount that your heirs inherit – and in South Africa, there is no tax payable by a person who receives an inheritance.

Many South Africans also have assets in more than one country. In most cases, the foreign country will also have the authority to levy taxes on your estate if you own property that is situated there. This could mean that your estate may be subject to double taxation and another probate procedure.

The foreign country may also have ‘forced heirship’ rules that stipulate the proportion of your estate that must be left to certain family members. Careful estate planning will be required to avoid the prospect of double taxation or forced heirship applying to any part of your estate.

Families are often more complex structures in the modern era. People may have multiple marriages or have children from different relationships, both in or out of marriage. A carefully thought through estate plan will allow you to protect your loved ones from legal battles or financial uncertainty when you are no longer around to determine or assist in these matters. Again, this can often best be achieved by transferring assets into trusts. It is even possible to arrange for generation-skipping asset transfers through the use of trusts.

The role of trusts in estate planning for South Africans residents

Trusts were first introduced into the South African legal system through English law with the primary purpose of protecting assets, but in recent years South African trusts have also became popular as vehicles to assist in the reduction of estate duty and other taxes through ‘estate pegging’ or ‘income splitting’.

As of 1 March 2017, however, the approach to setting up trusts changed again with the introduction of section 7C to our Income Tax Act, an anti-avoidance provision that applied retrospectively to South African trusts.

The aim of section 7C was to prevent potential estate duty avoidance where the settlor of a trust ‘sold’ a growth asset to a trust in return for an interest-free or low interest-bearing loan that did not grow in value. When the settlor passed away, it was the loan rather than the asset that was subject estate duty and executor fees. With a low interest-bearing loan, the ‘seller’ also avoided personal income tax on the interest that was not charged.

Section 7C, therefore, deems any interest foregone in respect of a loan made to a trust to be an ongoing annual donation by the settlor and subject to donations tax, which is charged at a rate of 20% in South Africa. The interest foregone is determined as the difference between the interested charged by the lender and the interest that would have been payable by the trust had the interest been charged at the official rate of interest as defined in the 7th Schedule to the Income Tax Act. To complicate matters more, this rate is variable.

Meanwhile, attribution and transfer pricing rules apply in respect of funding offshore trusts through loans. These rules essentially require an individual to charge an arm’s length rate of interest when a loan is made to an offshore trust. Factors in determining this market-related interest rate include the principal amount loaned, the duration of the loan agreement, the terms of the loan, the currency in which the loan is denominated and whether comparable loans exist between unrelated parties.

If a market-related interest rate is charged, the lender is taxed on the actual foreign interest accrued at his/her applicable marginal rate of income tax in South Africa. If a below market-related interest rate is charged, the difference may be treated as a donation made to the offshore trust and be taxable at a flat rate of 20% (after taking into account the annual ZAR100,000 donation tax exemption).

The value of setting up a trust

As a result of these changes, trusts no longer offer the same tax benefits and funding them is no longer as straightforward. However, they are still one of the most secure ways to protect your assets and ensure that your wealth can be preserved for future generations.

Trusts can still play an essential part in estate planning if your intention is to:

  • Protect your assets and preserve a legacy for future generations;
  • Protect your assets and those of your beneficiaries from the claims of creditors;
  • Protect your assets and those of your beneficiaries from claims as a result of potential relationship breakdowns;
  • Look after the needs of minor or disabled beneficiaries (special trusts);
  • Ensure that all your beneficiaries can benefit from an asset that cannot be easily subdivided, such as holiday houses or farms;
  • Separate personal capital assets from business and trading assets;
  • Provide for dependents and relatives who are incapable of managing their money or taking care of their own affairs.

To create a valid trust, it is extremely important that the settlor of the trust has the intention to transfer ownership of his/her assets to the trustees of the trust. If there is any uncertainty around this aspect, the trust will fail and the assets will still be regarded as belonging to the settlor. This is what is known as a ‘sham’ trust.

Where a settlor has extensive reserved powers notwithstanding the terms of the trust and continues to treat the trust assets as if they were his/her own, then it may be that the trust will be set aside if challenged in court. This would have a devastating impact on any estate plan.

Reviewing your estate plan

Although the current situation may make a face-to-face meeting with your lawyer or financial adviser impossible, new technologies mean there are plenty of other options available – telephone, email, video conferencing. There is no excuse!

Estate planning should really take place at least on an annual basis. This involves reviewing and ‘stress testing’ your existing plans and making any alterations based on income/asset growth or declines or changing personal or business circumstances. If your estate is subject to frequent asset acquisitions or disposals, it may be advisable to update your estate plan more regularly.

Privacy and estate planning

A final comment: Estate planning is generally regarded as a very private concern, especially by older generations, and there may be many good personal and commercial reasons to keep matters confidential. However, it is also essential to avoid any unnecessary uncertainty, unhappiness, anger or resentment among your close family members or business partners.

Our advice is to discuss your estate plan with your close family members or, at the very least, your spouse or partner. After all, it is their future that you are planning for. If you are involved in a business on a management and ownership level, it is also, of course, essential to keep your business partners up to date with all relevant planning.

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