Cumulative total taxation

The following chart represents the cumulative total tax, that is, income tax, CGT, estate duty and donations tax (the latter relates to Comparison 3a only) over the course of each scenario for all 4 comparisons.

Figure 1 – Cumulative total taxation

Discussion

The cumulative total tax amounts at the end of the various scenarios (in Year 50) do not seem to differ greatly between the scenarios with roughly only a R20 million variance between all scenarios after a period of 50 years (ranging from about R120 million to R140 million). The timing of the tax events at each of the major events will however have an effect on the capital value retained, as will be seen in the charts to follow (Figure 3). The sudden increases in cumulative tax seen in the various line graphs coincide with a significant tax event in each scenario, for instance, estate duty and CGT on the death of the founder or spouse or CGT payable due to a restructuring. When the capital value is decreased due to a major tax event, the investment income generated in the following year

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

(calculated as a percentage of the capital value at the start of each year464_{) will be reduced}

which will result in less income tax due annually. This can be seen as a decreased slope in certain line graphs after the occurrence of a significant tax event compared to other line graphs.

As the capital is allowed to grow over the years following such an event, the taxable income generated each year will gradually increase as will the income tax due. This can be seen as a gradually increasing slope in each line graph in the above chart over a period of time.

Year 30: In Year 30 (death of founder) all the personal estate line graphs for Comparisons 2, 3a and 3b see an increase as a result of estate duty due in the founder’s estate because of the suggested repeal of the s 4 (q) estate duty deduction (with regard to inter-spousal bequests)465_{. The only personal estate scenario that does not see an increase in taxes in this}

year is that of Comparison 1 due to the s 4 (q) deduction still in place per current legislation.

The only trust scenario that has a major tax event on the death of the founder is the one in Comparison 3b due to the treatment of the trust assets as deemed property in the estate of the founder. In the trust scenarios, the death of the founder could possibly result in a minor increase in total taxes in that year as a result of estate duty due on the portion of any remaining loan account of the founder that exceeds the s 4A abatement amount applicable to each scenario. The only trust scenario that will have a minor estate duty on the death of the founder is that of the baseline Comparison 1 as a result of the remaining loan account exceeding the R3,5 million estate duty abatement per current legislation. In all the other trust scenarios, the remaining loan account will fall below the increased s 4A abatements (R6 million and R15 million in Comparison 2 and in Comparisons 3a and 3b respectively) and therefore no estate duty will be due on the founder’s loan account in these scenarios.

Year 35: The major tax event in Year 35 will only affect the trust scenarios as this is the CGT due as a result of restructuring the trust by distributing two thirds of the trust assets to the two adult children (one third each) in order for them to set up their own trusts. The extent of the tax event will however vary as the tax payable will depend on the value of the trust assets at the end of Year 35. As can be seen, the amount of CGT paid by the trust in Comparison 3b is markedly less than that paid in the other trusts as the trust in this scenario already had a major tax event as a result of the death of the founder in Year 30 (estate duty) which would have depleted the capital value on which CGT will be

464 _{Refer assumptions per Table 3 in chapter 5.1.7} 465 _{See discussion under chapter 4.4}

calculated in Year 35. The tax event in Comparison 2 (the DTC’s First Report’s recommendations, which repealed the conduit principle) is also greater than that in the other trust scenarios due to the higher capital gains inclusion rate applicable to trusts which applies to the CGT calculation in this scenario.

Year 40: Year 40 shows a significant tax event for all the personal estate scenarios as a result of estate duty and CGT due on the death of the surviving spouse. Even though the total cumulative tax paid by all the personal estate scenarios are very similar at this point (about R90 million), the real difference will be seen in the effect on the capital value in the charts to follow (Figure 3). In the trusts, a relatively minor tax event occurs in this year as the remaining assets in the original trust (Trust 1) is distributed to the two living

beneficiaries which triggers CGT.

Year 50: The exit event in Year 50 will attract more CGT in scenarios where the capital value that has been achieved at the end of Year 50 is greater. It can therefore be seen that the extent of the increase in cumulative taxes in that year is lower for the personal estate scenarios than for the trust scenarios where higher capital values have been achieved. Conclusion

Even though the initial recommendations in the DTC’s First Report with regard to the repeal of the conduit principle was expected to be punitive for the trust scenario, it seems as if such recommendations, if implemented, would not have resulted in significantly more tax to be collected over the lifetime of a typical trust compared to that collected from trust assets held under current legislation. The reason for this is that the capital gains on a complete exit event (sale of all assets in a trust) under current legislation would have resulted in a significant amount of CGT payable due to the increased capital growth that had been achieved in a trust over several years. As mentioned in some of the

commentaries by professional bodies to the DTC’s First Report in chapter 4.8, the restructuring of trust assets to cater for the needs of next generations is a fairly common occurrence466 _{and if trust assets are allowed to grow in a trust without the interference of}

punitive income taxes, the CGT payable at the time of such a restructuring is likely to be significant.

466 _{FISA 2015:4 (para 2.6.2)}