Template wills and inexperienced drafters may result in trustees having to pay 20% capital gains tax on loan accounts due by trusts to deceased estates.A recent judgement in the Special Income Tax Court considered that the drafting of a will with a clause bequeathing the residue of an estate to a particular trust amounted to the forgiveness of a debt and thus gave rise to a capital gains event.As a result, the trustees have to pay 20% CGT on the amount of the loan bequeathed to them.
The court considered that the issue is whether or not it is the intention of the creditor that the loan account owed to him is to be discharged or reduced, as required by Paragraph 12.5 of Schedule 8 to the Income Tax Act.This judgement and the one prior to it on the same topic have been criticised on the grounds that it is not the intention but rather the fact that the debt was discharged for no consideration that brings into operation paragraph 12.5.However, the judgements have not been challenged and accordingly stand.
This is unfavourable for many people in their estate planning as it has been common practice for testators to bequeath loan accounts due to them to the parties or entities who are indebted to them.The good news is that the negative outcome can be overcome by careful drafting of a will which gives effect to the testator’s wishes without necessarily forgiving the debt.
When drafting a will for a testator who is owed money by a family trust, the drafter should enquire from the testator whether his intention would be for the loan accounts to be extinguished or to be bequeathed to beneficiaries.The answer to this would depend on the testators’ personal circumstances.For example, if the surviving spouse was concerned that she may not have a right to income in a discretionary trust, the loan account could be bequeathed to her.It would become an asset in her estate which she could claim from the trustees.The same would apply to any other beneficiaries.
If this route is followed, the influencing factor would be the amount of the loan account, as one would not wish to burden a beneficiary’s estate to the extent that it would exceed R3.5 million and as a result attract estate duty.Accordingly, it would be possible to leave the loan account to a number of beneficiaries, for example a spouse and children, and thus reduce the impact of the asset on their estates.In this instance, there would be no intention that the loan be discharged for no consideration and as such paragraph 12.5 would not apply.
If circumstances are such that the testator would like the amount of the loan account to be bequeathed to the trustees, it would follow, in terms of the recent ruling, that the intention (and fact) is that the loan account is to be discharged (by set-off) for no consideration.
However, the loan account could be bequeathed to legatee A and a cash amount equal to the loan account could be bequeathed to the trust on the basis that if A demands repayment of the loan account,the trust will use the cash legacy to repay it.Paragraph 12.5 will not apply as the loan account will be discharged for full consideration.Likewise, should the trust have the necessary liquidity, the testator could detail in the will that all debts due shall be discharged in full and thereafter bequeath the residue of the estate to the trust.This too would fall outside the ambit of paragraph 12.5 as the debt would be discharged in full.
The recent judgement makes it imperative for testators to review their wills and bring about any necessary changes.
Source: By Jenny Booth (TaxTALK)