Valuing a usufruct for estate duty purposes may incur a greater tax liability than disposing of it while the usufructuary is alive and paying donations tax, transfer duty and CGT

When a usufruct ceases, it can have serious estate duty consequences for a deceased usufructuary. For this reason, amongst others, most planners nowadays shun the usufruct and use an inter vivos trust for estate planning. This article explores one of the options open to an aged usufructuary staring down the barrel of the estate duty gun.

At the heart of the problem is s 5(1)(b) of the Estate Duty Act 45 of 1955. It states that a usufruct ceasing on a person’s death should be valued by capitalizing the right of enjoyment at 12% a year over the life of the person who becomes entitled to the right of enjoyment, or if the right is for a lesser period, over that lesser period. Under s 5(2), the Commissioner can approve a rate lower than 12% if satisfied that the property cannot reasonably be expected to produce a yield of 12%.

Typically, the bare dominium holder will be a family trust which is deemed to have a life expectancy of 50 years. The annual right of enjoyment of property with a market value of ZAR 100 at 12% is ZAR 12 (R100 × 12%). The value of a usufruct over 50 years is then determined by multiplying the annual right of enjoyment by the factor in Table B2 which is 8.3045 = ZAR 99.65.

The present value of ZAR 12 a year for 50 years can also be determined using Excel:

= PV(0.12,50,-12)

= ZAR 99.65

In effect, the inclusion for estate duty purposes is virtually equal to the full market value of the property. Estate duty is payable at the rate of 20% of the dutiable amount of the estate that does not exceed ZAR 30-million and 25% on any amount exceeding that figure (persons dying on or after 1 March 2018).

To avoid this outcome, the usufructuary could sell or donate the usufruct to the bare dominium holder during his or her lifetime. This option will have donations tax, capital gains tax and transfer duty (assuming a usufruct over immoveable property) implications, which would not have arisen on death. On death there would be no: 

• donations tax, since the deceased has not disposed of property;
• transfer duty, since nothing is acquired by the bare dominium holder; nor
• capital gains tax, because the expiry of the usufruct would not give rise to any proceeds.

A comparison therefore needs to be made between the estate duty that would become payable and the aggregate of any donations tax, transfer duty and capital gains tax. If the aggregate of the three taxes is less than the estate duty, the usufructuary should consider disposing of the usufruct to the bare dominium holder, either for consideration or as a donation. Whether the usufruct should be sold or donated would depend on a number of factors such as the relative rates of donations tax and estate duty and the availability of the donations tax exemption when s 7C applies to an interest-free loan. 

Donation’s tax

Since a usufruct is a highly personal right, it may not be disposed of to anyone other than the bare dominium holder. The usufructuary could dispose of the usufruct to the bare dominium holder for consideration or as a donation. If sold for consideration on an interest-free or low-interest loan account, there could be continuing donations tax implications under s 7C in relation to the failure to charge interest at less than the official rate of interest as long as the loan remains outstanding. The balance of the loan still outstanding at the time of death would be included in the person’s estate for estate duty purposes.

Should the usufruct be donated, the donation could attract donations tax. In this regard, s 62(1)(a) provides that the donation must be valued by capitalizing at 12% the annual right of enjoyment over the donor’s life expectancy, or if held for a lesser period, over that period. Under s 62(2) the Commissioner can accept a lower yield, if satisfied that the property cannot reasonably be expected to produce a yield of 12%. The life expectancy tables used for estate duty purposes are also used for donations tax purposes.

Thus, if the property had a market value of ZAR 100, the annual right of enjoyment at 12% would be equal to ZAR 12. If the usufructuary was aged 90 or above, his or her life expectancy would be 4.3 years with a present value factor of 3.21438. Thus, ZAR 12 × 3.21438 = ZAR 38.57. Or, using Excel: = PV(0.12,4.3,-12) = ZAR 38.57.

This value is substantially lower than the value determined for estate duty purposes. In addition, the donor would be able to use the annual donations tax exemption of ZAR 100 000.

The rate of donations tax is 20% on the cumulative value since 1 March 2018 of all taxable donations up to ZAR 30-million, and above that amount at 25%.

Transfer duty

Assuming the usufructuary is not a VAT vendor, the bare dominium holder will be subject to transfer duty. Under s 2 of the Transfer Duty Act, transfer duty is payable on the value of any property acquired by any person by way of a transaction or in any other manner, or on the amount by which the value of any property is enhanced by the renunciation, on or after the said date, of an interest in or restriction upon the use or disposal of that property. 

So what must be determined is the value by which the bare dominium held by the bare dominium holder will be enhanced as a result of the acquisition of the usufruct. The enhancement relates to the estimated remaining period that the usufructuary would have enjoyed the usufruct, if he or she had not donated it to the bare dominium holder.

Transfer duty is based on the fair market value of the property. Under s 5(7) of the Transfer Duty Act, the fair value must take into account the period for which the right is likely to be enjoyed. According to the SARS Transfer Duty Guide, the same tables used for estate duty purposes must be used for transfer duty purposes. The guide indicates that the rate of 12% will be used if the rental value is unknown. On a property valued at ZAR 100, the transfer duty will be based on ZAR 38.57 for a usufructuary aged 90 or older, assuming a yield of 12%. 

Under s 2 of the Transfer Duty Act, transfer duty is payable on a sliding scale, ranging between 0% on the first ZAR 1-million and 13% on property with a value exceeding ZAR 11-million.

Capital gains tax

The sale or donation of the remaining usufruct triggers a disposal under para 11(1)(a). Since the usufructuary and the bare dominium holder are likely to be connected persons, the proceeds will be equal to the market value of the remaining usufruct under para 38. That market value is determined under para 31(1)(d) by capitalizing the right of enjoyment at 12% a year ‘over the expectation of life of the person to whom that interest was granted’.

The wording of para 31(1)(d) was probably designed with a full title holder in mind who grants a usufruct. To determine what the full title holder was disposing of, it would be necessary to look at the life expectancy of the usufructuary, because that is the value that the full title holder is disposing of. The wording also covers the situation in which the usufructuary disposes of the remaining right of enjoyment to the bare dominium holder, since the usufructuary is the person to whom the right of enjoyment was granted. 

While the usufructuary is disposing of the remaining usufruct, this represents the relinquishment of the usufruct, not the granting of the usufruct to the bare dominium holder. It would not make sense to base the market value on the life expectancy of the bare dominium holder, since that does not represent the value of what the usufructuary owns at the time of disposal.

As with donations tax, the Commissioner can approve a yield of less than 12% under para 31(2). 

If the usufruct was acquired before 1 October 2001 (valuation date), the valuation date value of the usufruct could potentially be determined using market value, time-apportionment or 20% of proceeds.

For a usufruct acquired on or after 1 October 2001, the base cost is likely to have been determined under para 38, or if earlier, by using barter or exchange principles.

A portion of the donations tax payable may qualify to be added to the base cost of the usufruct under paragraph 20(1)(c)(vii), using the formula in paragraph 22. The qualifying portion of donations tax will increase the base cost of a pre-valuation date asset when the market value or 20% of proceeds method is used to determine the valuation date value. However, when the time-apportionment method is used, it will result in a lower base cost because the qualifying portion of donations tax comprises post-CGT expenditure which triggers the proceeds formula in paragraph 30(2). Thus, the higher the post-CGT expenditure, the greater the portion of the overall gain or loss that will comprise a capital gain or loss. It is unfortunate that the fiscus did not treat the donations tax as a selling expense under paragraph 30(5), which would have prevented this problem.

Conclusion

The dutiable value for estate duty purposes of a ceasing usufruct is based on the life expectancy of the person who takes over the right of enjoyment of the property, which can result in a large estate duty liability. By contrast, the method of valuing a usufruct for donations tax, transfer duty and capital gains tax purposes is based on the life expectancy of the usufructuary. It may be more tax efficient to pay donations tax, transfer duty and CGT during the usufructuary’s lifetime than to pay estate duty on a ceasing usufruct on death.

Written by Duncan McAllister, Consultant at Webber Wentzel