A FRAMEWORK FOR WEALTH TRANSFER TAXATION IN SOUTH AFRICA ELZETTE MULLER DOCTOR LEGUM. in the FACULTY OF LAW UNIVERSITY OF PRETORIA

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1 A FRAMEWORK FOR WEALTH TRANSFER TAXATION IN SOUTH AFRICA by ELZETTE MULLER submitted in partial fulfillment of the requirements for the degree DOCTOR LEGUM in the FACULTY OF LAW UNIVERSITY OF PRETORIA PROMOTOR: PROF RCD FRANZSEN Pretoria April 2010 University of Pretoria

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3 TABLE OF CONTENTS CHAPTER 1: INTRODUCTION BACKGROUND AND PURPOSE OF STUDY EXPOSITION LIMITATION OF SCOPE...7 CHAPTER 2: THE HISTORICAL DEVELOPMENT, OBJECTIVES AND POLICY CONSIDERATIONS OF TAXATION IN GENERAL INTRODUCTION A GENERAL ORIENTATION TO TAXATION AND AN OVERVIEW OF THE TAXATION OF INCOME, WEALTH AND CONSUMPTION General Orientation The Origin, Historical Development and Theoretical Basis of Taxation Description of Taxation The Development of the Various Tax Bases The Taxation of Income The Income Tax: Various Approaches Comprehensive Income Tax The Taxation of Wealth Property Taxation Transfer Taxation Property Transfer Taxes Wealth Transfer Taxes Net Increase in Wealth Taxation Net Wealth Taxes...26 i

4 Capital Gains Taxes The Taxation of Consumption Taxes on Goods and Services Personal (Direct) Consumption Tax Miscellaneous Taxes Tax Systems: A Mix of Various Taxes OBJECTIVES OF TAXATION Revenue Socio-economic Objectives Redistribution of Resources Economic Growth Reprising TAX POLICY CONSIDERATIONS General The Canons of Taxation The First Canon: Equity The Benefit Principle The Ability-to-Pay Principle: Horizontal Equity and Vertical Equity Equity through Objectives: A Better Approach? The Second Canon: Certainty and Simplicity The Third Canon: Convenience The Fourth Canon: Cost Effectiveness and Efficiency Collection Costs Dead-Weight Market Costs and Neutrality Unproductive Costs Other Considerations Principles in Conflict Constitutional Considerations: A South African Perspective The Constitutional Transformation The Power to Impose Taxes...58 ii

5 Substantive Limitations The Bill of Rights Right to Property Right to Equality Procedural Limitations The Power to Collect Taxes CONCLUSIONS...63 CHAPTER 3: THE HISTORICAL DEVELOPMENT OF THE TAXATION OF WEALTH TRANSFERS INTRODUCTION THE INTERNATIONAL HISTORICAL DEVELOPMENT OF WEALTH TRANSFER TAXATION IN SELECTED COUNTRIES: A BRIEF OVERVIEW The Ancient Civilisations and the Roman Empire The Middle Ages The Modern Era (from 1500 CE) Recent International Developments: A Tendency of Decline? THE HISTORICAL DEVELOPMENT OF WEALTH TRANSFER TAXATION IN SOUTH AFRICA: A BRIEF OVERVIEW Income Taxation Wealth Transfer Taxation Pre-Union Legislation National Legislation Death Duties ( ) Donations Tax and Estate Duty (1955-) The Tax Law Reform Commissions Comprehensive Income Tax and Comprehensive Consumption Tax Capital Gains Taxation CONCLUSIONS...96 iii

6 CHAPTER 4: THE CONCEPTUAL JUSTIFICATION FOR THE TAXATION OF WEALTH TRANSFERS INTRODUCTION THE FUNDAMENTAL PHILOSOPHICAL DEBATE: THE LEGITIMACY OF RESTRICTIONS ON INHERITANCES THE OBJECTIVES DEBATE Revenue Redistribution of Resources THE TAX POLICY DEBATE The First Canon: Equity Ability-to-Pay Capital Gains Tax Equity Requires Recipient-based Taxation (In the Form of A Recipient-based Wealth Transfer Tax or Inclusion in the Income Tax Base) Progressivity (A Function of Vertical Equity) Inequity through Special Provisions Inequity through Increased Consumption Estate Planning: Cause for Inequity The Second Canon: Certainty and Simplicity The Third Canon: Convenience The Fourth Canon: Cost Effectiveness and Efficiency (The Economic Arguments) Collection Costs Deadweight Costs: Market Distortions on Micro-economic and Macro-economic Level Unproductive Costs POLITICAL CONSIDERATIONS iv

7 4.6 CONCLUSIONS CHAPTER 5: A CONTEMPORARY OVERVIEW OF DONATIONS TAX IN SOUTH AFRICA INTRODUCTION TAX BASE Donations and Deemed Donations Jurisdictional Basis Residency Location of Assets Double Taxation Object of Taxation: Property VALUATION General Rule Usufructuary, Fiduciary or Other Like Interests Annuities Bare Dominium TAXPAYER AND PAYMENT OF THE TAX RELIEF MECHANISMS Consideration: Deemed Donations Preferential Valuation: Agricultural Property Exemptions TREATMENT OF TRUSTS A Brief Historic Overview and Classification of Trusts The Origin and Development of Trusts No Rule against Perpetuities The Personification of Trusts for Purposes of Income Tax and Capital Gains Tax Ownership Trusts and Bewind Trusts A Donation to a Trust: The Common-Law Position v

8 5.6.3 Trusts and Donations Tax GENERAL ANTI-AVOIDANCE RULE CAPITAL GAINS TAX Capital Gains Tax Consequences Interaction with Donations Tax CONCLUSIONS CHAPTER 6: A CONTEMPORARY OVERVIEW OF ESTATE DUTY IN SOUTH AFRICA INTRODUCTION AND BROAD OVERVIEW OF ESTATE DUTY TAX BASE The Estate of Every Person Jurisdictional Basis Residency Location of Assets Double Taxation Object of Taxation: Property Property Deemed Property Domestic Life Insurance Policies upon the Life of the Deceased Retirement Benefits Property Donated under a Donatio Mortis Causa / No Benefit until Death Accrual Claims Property which the Deceased was Competent to Dispose of for his or her Own Benefit or for the Benefit of his or her Estate (Section 3(3)(d) Deemed Property) VALUATION vi

9 6.3.1 Stocks or Shares Not Quoted on Stock Exchange: Special Rule Property Realised During the Liquidation and Distribution Process Unrealised Property The General Rule Usufructuary, Fiduciary or Other Like Interests Annuities Annuities Charged upon Property Annuities Not Charged on Property Annuities Payable under an Insurance Policy or by Any Fund Bare Dominium in Property Section 3(3)(d) Property Donations Mortis Causa TAXPAYER AND PAYMENT OF THE TAX RELIEF MECHANISMS Preferential Valuation: Agricultural Property Allowable Deductions Deductible Expenses Exemptions The Primary Rebate (s 4A) TREATMENT OF TRUSTS GENERAL ANTI-AVOIDANCE RULE CAPITAL GAINS TAX Capital Gains Tax Consequences Interaction with Estate Duty CONCLUSIONS CHAPTER 7: POLICY ISSUES AND PROBLEMATIC ASPECTS RELATING TO THE SOUTH AFRICAN WEALTH TRANSFER TAX SYSTEM INTRODUCTION vii

10 7.2 THE INTEGRATION OF THE TAXATION OF INTER VIVOS TRANSFERS AND TRANSFERS ON DEATH The Issue of Integration Current Discrepancies Different Statutes Jurisdictional Basis Double Taxation Relief Valuation Rules Exemptions General Anti-avoidance Rule TRANSFEROR-BASED TAX VERSUS RECIPIENT-BASED TAX SELECTED PROBLEM AREAS Jurisdictional Basis The Characteristics of a Donation The Treatment of Life Insurance Benefits The Treatment of Limited Interests and Bare Dominium Property General The Position of Bare Dominium Property The Creation of Limited Interests The Termination of Limited Interests The Treatment of Limited Interests under the Death Duties Act Estate Freezing Techniques General Interest-free Loans Failure to Claim Performance Preference Shares Discretionary Trusts Preferential Valuation Rules for Agricultural and/or Business Property Estate Duty Levied on Estate Duty: The Absence of Grossing-Up Rules CONCLUSIONS viii

11 CHAPTER 8: WEALTH TRANSFER TAXATION IN THE UNITED KINGDOM HISTORICAL ORIENTATION AND INTRODUCTION Historical Development Broad Overview of Inheritance Tax TAX BASE Lifetime Transfers Transfers on Death Jurisdictional Basis Domicile Location of Assets Double Taxation Object of Taxation: Property VALUATION Fair Market Value Rule TAXPAYER AND PAYMENT OF THE TAX RELIEF MECHANISMS Liabilities Preferential Valuations Business Property Agricultural Property Exempt Transfers Exemptions Applicable to both Lifetime Transfers and Transfers on Death Exemptions Applicable to Lifetime Transfers Only Exemptions Applicable to Transfers on Death Only The Nil Rate Band Roll-over Relief: Non-Agricultural Woodlands TREATMENT OF SETTLED PROPERTY (TRUSTS) Trusts: A Classification ix

12 8.6.2 A Brief History on the Development of the Treatment of Trusts for Wealth Transfer Tax Purposes Treatment of Trusts under the Inheritance Tax Act: The Contemporary Position General: The Meaning of Settled Property, Interest in Possession and Reversionary Interest Jurisdictional Basis Fixed Interest Trusts (Interest in Possession Trusts) Discretionary Trusts Special Trusts TREATMENT OF LIMITED INTERESTS AND BARE DOMINIUM The Position Prior to 22 March The Position of Bare Dominium The Creation of Limited Interests The Termination of Limited Interests The Position After 22 March GENERAL ANTI-AVOIDANCE RULE CAPITAL GAINS TAX Capital Gains Tax Consequences Interaction with Inheritance Tax CONCLUSIONS CHAPTER 9: WEALTH TRANSFER TAXATION IN THE NETHERLANDS HISTORICAL ORIENTATION AND INTRODUCTION Historical Development Broad Overview of Inheritance Tax and Gift Tax TAX BASE Acquisitions by virtue of Gifts Acquisitions by virtue of Inheritance Fictitious Acquisitions x

13 9.2.4 Jurisdictional Basis Residency (Woonplaats) Location of Assets Double Taxation Object of Taxation: Property VALUATION General Rule Residential Property Periodic Payments (Annuities) Usufructs Bare Dominium Fideicommissum (Tweetrapsmaking) Businesses Listed Shares TAXPAYER AND FILING OF RETURN RELIEF MECHANISMS Allowable Deductions: Liabilities and Consideration Preferential Valuations Business Property Qualified Country Estates (Landgoederen) Exemptions Exemptions Applicable to Gift Tax Exemptions Applicable to Inheritance Tax TREATMENT OF COMMON-LAW TRUSTS The Trust: An Unknown Phenomenon in the Dutch Law Fixed Trusts Discretionary Trusts The Position Prior to the APV Regime Proposals for a Solution The Introduction of a Regime for Afgezonderd Particulier Vermogen in xi

14 A Storm of Criticism TREATMENT OF LIMITED INTERESTS AND BARE DOMINIUM The Position of Bare Dominium The Creation of Limited Interests The Termination of Limited Interests The Section 10 Fiction Usufruct & Bare Dominium GENERAL ANTI-AVOIDANCE RULE INCOME TAX (CAPITAL GAINS TAX) Income Tax (Capital Gains Tax) Consequences Interaction with Inheritance Tax CONCLUSIONS CHAPTER 10: WEALTH TRANSFER TAXATION IN IRELAND HISTORICAL ORIENTATION AND INTRODUCTION Historical Development Broad Overview of CAT TAX BASE Taxable Transfers Jurisdictional Basis Residency Location of Assets Double Taxation Object of Taxation: Property VALUATION Valuation Date General Rule Unquoted Shares in Private Controlled Companies Annuities Annuities Charged on Property Annuities Not Charged on Property xii

15 Adjustment for Limited Interests TAXPAYER AND RETURN FILING RELIEF MECHANISMS Deductible Liabilities Consideration Preferential Valuations Agricultural Property Business Property Exemptions Exemptions Applicable to Both Inheritances and Gifts Exemptions Applicable to Gifts Only Exemptions Applicable to Inheritances Only The Group Thresholds Miscellaneous Reliefs TREATMENT OF SETTLEMENTS AND TRUSTS The Trust: Broad Overview and Classification The Position Prior to CATCA The Contemporary Position: CATCA The Meaning of Settlement and Discretionary Trust Fixed Trusts Discretionary Trusts TREATMENT OF LIMITED INTERESTS AND BARE DOMINIUM The Position of Bare Dominium The Creation of Limited Interests The Termination of Limited Interests GENERAL ANTI-AVOIDANCE RULE CAPITAL GAINS TAX Capital Gains Tax Consequences Interaction with CAT CONCLUSIONS xiii

16 CHAPTER 11: CONCLUSIONS AND RECOMMENDATIONS INTRODUCTION THE INTEGRATION OF THE TAXATION OF INTER VIVOS TRANSFERS AND TRANSFERS ON DEATH General Discrepancies in the South African Wealth Transfer Tax System The Level of Integration in the Countries Surveyed Conclusion and Recommendations TRANSFEROR-BASED TAX VERSUS RECIPIENT-BASED TAX General Theoretical Appeal Timing of the Tax Common Problem Areas Jurisdictional Basis The Treatment of Life Insurance Benefits The Treatment of Limited Interests and Bare Dominium Discretionary Trusts Grossing-up Rules Other Problem Issues Estate Administration Process and Administrative Issues Certainty of Law Conclusions and Recommendations BIBLIOGRAPHY..475 xiv