Tanya Jacobs
Estate duty - the satirical culmination of the age old adage of death and taxes. Many have attempted to circumvent payment of this tax through complex and creative structures, such as splitting property between a trust and the surviving spouse. Some of these structures often entailed costly or restrictive repercussions for the beneficiaries and even the person doing the planning.
Thrifty planners started looking for a less costly way to pass property across generations and utilise tax and duty savings for maximum benefit. Enter the ‘usufruct’. The concept has been around for a long time and can be traced back centuries. The English word usufruct derives from the Latin words usus and fructus, nouns meaning ‘use’ and ‘enjoyment’.
A usufruct originates from civil law, where it is a real right of limited duration held over the property of another. The holder of a usufruct, known as the usufructuary, has the right to use and enjoy the property, as well as the right to receive profits from the fruits of the property. ‘Fruits’ should be understood as referring to any replaceable commodity on the property, including amongst others – actual fruits, livestock and even rental payments derived from the property.
Example: A husband leaves his farm to his trust with a usufruct to his wife, thereby ensuring that she receives the right of use and enjoyment over the property without her actually having to run the farm.
Who owns it anyway?
A usufruct grants the holder the right of use of the property, for the rest of their life or a defined period, but not ownership. The ownership still resides with the original owner and their portion is now known as the ‘bare dominium’. A responsibility is placed on the usufructuary to preserve the property for the ultimate owner.
What are the caveats?
Usufructs can have serious consequences when it comes to Capital Gains Tax, so any legal process one intends following needs to be investigated and advised upon by a trained professional. One may not be immediately concerned with the legal implications, but a qualified person will be able to give advice as to what will happen years into the future, if for instance one intends on selling the property.
Where a usufruct is granted, the value is calculated by capitalising the annual yield on the property at 12% over the life expectancy of the usufructuary, which is then deducted from the market value of the property asset to determine the bare dominium value. This bare dominium value will be the base cost when the asset is disposed of by the bare dominium owner. The increased capital gains tax liability will then be taxed at the trust’s increased rate, currently an effective rate of 20%, when using the trust example above. If there is a one year rollover, there is a further part disposal and then the base cost is reduced.
If a financial institution holds a mortgage bond over your property, they are unlikely to agree to the registration of a usufruct. You will need to settle your bond first.
Another aspect that must be borne in mind is that the usufructuary usually has a responsibility to maintain the property for the bare dominium owners as well as pay the rates and taxes. In practice this is difficult to monitor and control in a situation where the usufructuary does not duly exercise their responsibility i.e. to pay for rates and taxes relating to the property which leads to disputes between usufructuary holders and bare dominium owners.
The “one year roll-over” explained
A direct bequest to a trust will attract estate duty on the full value of the asset/s in the estate. On the other hand, a deduction is allowed in respect of bequests to a surviving spouse which will not attract estate duty. It is to be noted that on the spouse’s death, the full amount inherited plus any growth will attract estate duty within the spouse’s estate. By using what has become known as the “one year roll-over”, estate duty and capital gains tax can be limited in both the estates. This is how it works:
- A husband bequeaths his estate to a trust (testamentary or inter vivos).
- The bequest is subject to a usufruct in favour of his wife.
- On her death the usufruct terminates, and the trust becomes the full owner of assets, for the
benefit of their children.
- By allowing the usufruct to continue for one year after the wife’s death, the amount of the value of
the usufructuary right in her estate can be reduced.
This technique reduces the overall estate duty liability. Nonetheless, this method may be regarded as rather aggressive, and as such it may be curtailed by SARS at some stage.
Important Cautionary:
The use of a usufruct with a one year rollover has been the subject of attention on the part of SARS recently. Yet to date, SARS has not been able to draft effective amendments to the Estate Duty Act to prevent this estate planning arrangement. The rollover construction is therefore not without its risks.
CONCLUSION
The ability to save tax and duty in the short term needs to be weighed against the longer term tax position taking into account the future growth on assets, protection against creditors and possible changes in legislation. Where these additional factors have not been taken into account the purpose and intended outcome of utilising a usufruct may fail. Therefore, when sourcing estate planning and will drafting services, ensure that the advisor is up to date with issues like these and can explain the possible ramifications.
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