I wish to make an interest-free loan of R500 000 to each of my two children. They would pay me a set monthly income and need not pay the capital back to the estate upon my death as they would in any case inherit the money in terms of my will.
I understand that the capital loaned to them will remain an asset in my estate for estate duty purposes, but have read that I could avoid executor’s fees by making these loans.
The income earned and paid to me by them would of course be taxed in their hands and they are aware of this.
Could you please clarify the executor’s fee position?
* This article was first published in June and has been republished because the advisor, Brian Butchart, has made slight amendments to his answer. He apologises for any confusion that may have been caused.
Dear Moneyweb reader,
In order to address your query please allow me to clarify a few points raised in your question.
You mention an interest-free loan to each of your two children. Although we are aware of interest-free loans historically used to facilitate loans to family members, for tax and estate planning purposes, this practice may be subject to scrutiny from Sars.
You also mention your children paying a set monthly income to you, which I assume is for the purpose of paying back the capital and any outstanding loan on your demise will be bequeathed to your children.
Sections 54 to 64 of the Income Tax Act, 1962 states Donations Tax is tax payable at a flat rate of 20% on the value of property disposed of by donation. Section 58 specifically states a donation includes property disposed of for an inadequate consideration.
Therefore in order to ensure the capital loans are not deemed to be donations and in order to avoid falling foul of Section 58, a loan account for each child should be established with an applicable interest rate which will be more acceptable to Sars.
You will then be liable for the income tax on the interest earned, according to the prescribed interest rate in your loan agreement.
Each individual is however entitled to give away R100 000 annually, free of any Donations Tax implications. You can therefore reduce these loan accounts by R100 000 per annum reducing the loans to nil over ten years and shortened to five years between yourself and your spouse. This together with any capital repayments from your children reduces the interest and income tax annually as the loan capital reduces .
Any outstanding loan accounts at date of death regardless of the bequest to your children will be included in the Liquidation account as a claim in favour of the estate – it can be noted in the Liquidation and Distribution account next to the loan entry that the outstanding loan values are bequest to your children (Master will then ask for proof of arrangement/agreement). It will however be considered as an asset in the Liquidation account, thus triggering both executor’s fees and estate duty on the value of any outstanding loan accounts.
The executor has no right to ignore the loan, as it is the executor’s duty to account for all claims in favour of the estate.
As the executor has to deal with the loan in some way or another in all instances where the loan was still outstanding at date of death, the executor is entitled to include the amount of the loan in the total gross estate on which executor’s fees are calculated.
My response is based on certain assumptions. Although saving costs is an important consideration, equally if not more important is the appointment of an executor and the role they play in winding up of your estate. Effective estate planning and professional advice appropriate to your specific needs is valuable and should be weighed up against any costs.