Capital value

The following chart represents the capital value of the investment asset over the course of each scenario for all 4 comparisons.

Figure 3 – Capital value

Discussion

The potential punitive effect of the DTC’s First Report’s recommendations and the repeal of the s 4(q) deduction for inter-spousal bequests can clearly be seen in this chart. The end-values of the accumulated wealth in the scenarios differ vastly from about R140 million in the case of holding the assets in certain personal estate scenarios (Comparisons 2, 3a and 3b) to about R300 million when holding such assets in certain trust scenarios (Comparisons 1 and 3a).

In this case study, holding the assets in a personal estate under the proposed estate duty legislation results in a reduction of the eventual wealth to more than half of what it would have been had the assets been kept in a trust under current legislation. Even if the 2016 Budget Review suggestions are implemented, whereby the trust assets are regarded as deemed property in the estate of the founder on death (Comparison 3b), it will still be

Yr 30 : Fou nde r di e s Yr 35 : T rus t re st ruct ur e d fo r chi ldr e n Yr 40 : Su rv iv ing spous e di e s Yr 50 : Sal e of al l a ss e ts

more beneficial from a capital appreciation point of view to hold the assets in a trust instead. The recommendations are therefore not likely to result in more taxpayers opting to hold assets in their personal estates but could rather result in the opposite, of more

taxpayers embracing estate planning opportunities with trusts, especially where high estate values are involved.

Note that, if no exit event occurred in Year 50, the capital value at the end of that year would have been allowed to grow at the same increasing slope seen in each line graph prior to Year 49. Therefore the actual reduction of capital that occurred in Year 50 will be greater than what is apparent from each line graph. As the exit event is deemed to occur on the last day of Year 50, the taxation related to this event was calculated using the end- value of the capital in Year 50, that is, after capital growth has been taken into account for that year (less applicable income taxes paid on income generated by the capital value as at the beginning of that year). This also applies to all other years in which a major tax event occurred.

As can clearly be seen in this chart, the capital growth achieved over time by the remaining capital value will partly recover the capital lost due to taxes but as the growth occurs off a lower base, the capital value will forever be at a comparatively diminished value.

Comparisons 1 and 3a: As it is assumed that the trust capital invested at inception of the trust is unaffected by the taxes paid by the founder on initial transfer (that is, CGT and donations tax in the case of Comparison 3a), the capital value achieved in the baseline trust scenario in Comparison 1 is nearly the same as that achieved in Comparison 3a. The capital end-value for the trust scenario of Comparison 1 will be slightly less due to the relatively small amount of estate duty paid from the cash reserves of the trust assets on the founder’s remaining loan account on his or her death in Year 30.

Comparison 2: It is only in Comparison 2 (the DTC’s First Report’s recommendations) where the capital values in the trust scenario and the personal estate scenario are relatively close to each other at the end of the 50-year test period. This is mainly the result of the higher capital gains inclusion rate applicable to trusts which is used to calculate the CGT payable in the trust scenario of this comparison as a result of the exit event in Year 50. In all the other comparisons the capital end-value achieved in the trust scenario far exceeds that achievable in the personal estate scenario.

Repeal of s 4(q): It can also be seen how the repeal of the s 4(q) deduction causes the capital value in the personal estate scenarios of Comparisons 2, 3a and 3b to be reduced for a second time in the space of 10 years on the death of the surviving spouse in Year 40.

In these scenarios, the value to which the capital is reduced in Year 40 is nearly the same lower capital value achieved in the year of the death of the founder or original owner in Year 30. Long-term wealth preservation will therefore be severely hampered in these cases by the fact that the capital value will have to recover from two major tax events in relatively quick succession of each other. This successive reduction may even result in a loss of capital in real terms468_.

Estates containing assets with lower starting values may be protected by the increased s 4A abatements recommended but as soon as an estate’s value starts to significantly exceed the abatement amounts, the founder may deem it a better option to preserve the family wealth through the use of a trust structure.

Comparison 3b: Even where trust assets are included as deemed property in the estate of the founder at his or her death, as seen in the trust scenario of Comparison 3b, the capital growth potential still far exceeds that of holding the assets in a personal estate where the assets could be subject to punitive successive estate duty payments on the death of both the founder and the surviving spouse.

Conclusion

The potential punitive effect of the repeal of the s 4(q) deduction for high-value estates is clearly indicated when comparing the effect of these recommendations on the capital value of the asset achieved over time in the various scenarios. It seems as if capital losses in real terms may be the result in certain cases which could further encourage high-net-worth individuals to make use of estate planning strategies and trusts structures. Estate values falling below the proposed increased s 4A abatements may however be protected from the effect of this proposal. Studying the effects of the various recommendations on such smaller estate values falls outside the scope of this research report.

Some of the taxation proposals with regard to trusts could also result in decreased trust capital values over a period of time as a result of taxes levied at the major tax events and deemed to be paid from cash reserves forming part of the total investment asset held in the trust.

468 _{In the assumptions used in the case studies, the capital value in the personal estate scenarios of} Comparison 3a and 3b is only about R8 million more at the end of Year 40 (R69 million) than what it was at the end of Year 30 (R61 million) (Refer Table 46 in Annexure chapter 9.3.4). Doing a time-value of money calculation (PV = 61, FV = -69, N = 10, I = ?) this amounts to an effective annual capital growth over this 10-year period of just 1.2% per year. With inflation assumed at 6% per annum, this would constitute a loss in real terms of 4.8% per annum.