An Option to Save on Estate Duty? Understanding a Complex Strategy

We all hope to leave a meaningful legacy for our loved ones, and part of that involves planning how our assets will be passed on. One significant factor in South Africa is Estate Duty – a tax calculated on the value of the estate you leave behind. Careful planning aims to manage this legally and effectively.

A complex idea sometimes discussed involves using an "option contract" to potentially "peg" the value of certain assets for Estate Duty purposes. While theoretically interesting, it's a strategy that comes with considerable legal uncertainty and practical risks.

How the "Option" Idea Works

Let's say you own a valuable asset expected to grow significantly, like a farm or business property. The strategy involves these steps:

1. You grant a trusted person (perhaps a family member) a formal legal agreement – an "option."

2. This option gives them the right to buy that specific asset from your estate after you pass away.

3. The crucial part is that the purchase price is fixed in the option agreement now, based on today's values or a set formula, even though the actual sale might happen much later.

The Theory: Why It Might Be Possible

The main goal is to manage the Estate Duty liability. Normally, duty is based on the asset's market value at the date of death. If the farm is worth much more then than when the option was granted, the duty could be substantial.

The hope with this strategy is that Estate Duty will only be calculated on the lower, pre-agreed option price. The legal argument hinges on Section 4(b) of the Estate Duty Act. Proponents argue that the binding option contract creates a legal obligation or a "debt due by the deceased" against the asset. This "debt" (the estate's legal requirement to sell at the agreed price if the option is exercised) is then argued to be deductible, effectively reducing the asset's value included in the estate down to the option price for duty purposes.

Supporters might point to principles from certain court cases, like Myer v CIR, suggesting that obligations entered into before death can sometimes impact the estate's liabilities. The theory relies on the option being viewed as a firm obligation established during the owner's lifetime.

The Reality Check: Significant Hurdles and Pitfalls

Despite the theory, this strategy faces major challenges:

• SARS Opposition is Likely: It's highly probable that SARS will contest this interpretation. Their stance is often that assets should be valued at their full market value at death for Estate Duty, viewing the option price as irrelevant for this purpose. A challenge from SARS can lead to disputes and potentially litigation.

• Legal Uncertainty Persists: South African courts have not provided a clear, final confirmation that this specific strategy works. In fact, important cases like CIR v Estate Kirsh and Estate Robottom v CIR have dealt with situations where pre-agreed prices for assets triggered upon death were not accepted for Estate Duty valuation, with the courts favouring market value. Successfully using the option strategy might require arguing that these precedents don't apply or were wrongly decided – a difficult legal position.

• Complexity: This isn't a simple agreement. It requires meticulous legal drafting to even stand a chance of aligning with the theoretical arguments. Errors could be costly.

• Other Tax Considerations:

  • Donations Tax: If the option price is deemed "inadequate" compared to the market value when the option is granted, SARS could potentially levy Donations Tax on the difference.   

  • Capital Gains Tax (CGT): CGT is calculated based on the market value at the date of death for the deceased's final tax return. The later sale by the estate at the lower option price usually results in a capital loss for the estate itself, which may or may not be usable. The strategy doesn't avoid the CGT based on market value at death.

    
    

Conclusion: Expert Guidance is Essential

While the option strategy offers a theoretical argument for reducing Estate Duty based on specific interpretations of the law, its practical application is fraught with legal uncertainty and high risk of challenge by SARS.

This is complex territory requiring sophisticated planning. It is absolutely essential to consult

with a qualified CFP® Estate Planner before considering such a strategy. They can help you understand the intricate legal arguments, the substantial risks involved, the stance of SARS, and explore more reliable and legally certain estate planning solutions tailored to your specific financial situation and goals.