1804. Bequest of loan to a trust
January 2010 - Issue 125
Paragraph 12(5) of the Eighth Schedule to the Income Tax Act No. 58 of 1962, as amended (the Act), was introduced to deal specifically with the scenario where a debt owed by a debtor to a creditor is reduced or discharged by the creditor for no consideration, or for a consideration which is less than the amount by which the face value of the debt is reduced or discharged. In these circumstances, the debtor is liable for CGT on an amount equal to the extent to which the debtor has been relieved of his obligations. The debtor is deemed to have acquired a claim to so much of the debt as is reduced or discharged for no consideration and to have disposed of the claim for proceeds equal to the reduction or discharge.
The Kimberley Tax Court in ITC 1835  (71 SATC 105) had to consider whether a debt owed to a deceased estate had been discharged for no consideration and hence subject to capital gains tax on the value of such claim in terms of paragraph 12(5) of the Eighth Schedule to the Act.
The facts of the case were that the taxpayer, being the XXX inter vivos trust, was the sole heir of the residue of the estate of the testatrix and her husband who had executed a joint will on 16 March 1992, the residue being subject to a usufruct in favour of the survivor of them for the duration of their life and thereafter to their son for a year. The testatrix died on 10 June 2003 and her surviving spouse was still alive. The joint will also provided that the first-dying spouse would bequeath various assets, such as household possessions, to the survivor of them and the residue of the estate of the first-dying was left to the XXX trust subject to the usufruct. The taxpayer, at the time of the testatrix’s death, was indebted to her on a loan account in the sum of R539 189 which fell into the residue of the estate.
It was common cause that the executor in the estate did not demand or receive payment of the aforesaid claim from the taxpayer for purposes of winding up of the estate of the testatrix but, rather in the Liquidation and Distribution Account this debt was reflected as a claim awarded to the taxpayer as the sole heir to the residue of the estate. The Liquidation and Distribution account was finalized on 16 February 2004 and the estate was wound up in terms thereof shortly thereafter.
The respondent, being the Commissioner for SARS, subsequently issued a notice of assessment on appellant imposing capital gains tax on the trust in terms of paragraph 12(5) of the Eighth Schedule to the Act and section 26A thereof in respect of the aforesaid amount of R539 189.
The respondent contended that, in terms of the joint will, the debt owed by the taxpayer to the testatrix had been discharged for no consideration and that the taxpayer had acquired that claim for no consideration as contemplated in paragraph 12(5) of the Eighth Schedule and therefore the taxpayer was liable for payment of capital gains tax on the value of such claim. The respondent relied on the decision of Bertelsmann J in ITC 1793  (67 SATC 256) in which it was found that a trust was liable for payment of tax on a bequest made to it by a testatrix in her will.
The taxpayer contended that the wording of the will in this case differed fundamentally from the wording of the will in ITC 1793 supra and that the case was therefore to be distinguished from the present matter and that the solution at hand was to be found in the wording of the will and not in the method employed by the executor in winding up the estate.
The respondent conceded that, had the executor demanded and received payment of the debt due by appellant to the estate, capital gains tax would not have been payable on the amount of R539 189 inherited by the appellant as part of the residue of the estate.
Paragraph 12(5) provides that where a debt owed by a person to a creditor is reduced or discharged by that creditor for no consideration or for a consideration which is less than the amount by which the face value of the debt is so reduced or discharged, then a deemed capital gain will arise.
Section 26A of the Act provides that there shall be included in the taxable income of a person for a year of assessment the taxable capital gain of that person for that year of assessment as determined in terms of the Eighth Schedule to the Act.
In deciding the matter, Lacock J, stated that there could be no doubt that a court in construing a will had to ascertain the intention of the testator/testatrix from the words used in the will and, furthermore, a court is not to consider the wording of a will in vacuo but is to consider the wording thereof whilst placing itself as far as possible in the position of the testator/testatrix at the time of the execution of the will.
Lacock J, held that the intention of the testators was clear, namely, that the residue of the estate was bequeathed to the taxpayer as the sole heir thereof, subject to the usufruct in favour of the surviving spouse and the son and the meaning of the word ‘residue’ is well known when used in the context of a testamentary disposition. The term generally connotes that portion of the estate that remains after provision is made for direct bequests and legacies, as well as the payment of estate liabilities and administration costs.
It was therefore clear from the wording of the will that it was the intention of the testatrix that her claim against the appellant, that is her loan account, was to form part of the residue in the estate and this claim was not separately bequeathed to the taxpayer as a legacy.
Furthermore, as reflected in the financial statements of appellant, the loan in question was payable to the testatrix on demand and the taxpayer was at all times financially able and in a position to repay the loan had the testatrix demanded payment thereof before her death. Moreover, the testatrix was therefore, before her death, entitled to demand payment of the loan account or a portion thereof and there was nothing indicative thereof that the indebtedness of appellant was to remain a definite or fixed sum of money or could not be recovered, it could have varied from time to time or could even have been settled.
The court further stated that the will was a joint will of the testatrix and her husband and the relevant debt was due by the taxpayer to the testatrix and not to her husband and the testators had jointly disposed of the residue of their estate in the joint will and this was indicative of the fact that they had no bequests in mind of any of their individual or separate assets to either appellant or any person, other than those household possessions specifically referred to in the will.
It was not the intention of the testatrix to specifically bequeath the claim in issue to the appellant and thus the claim of the testatrix under her loan account formed part of the residue of the estate, and that it was not her intention to dispose of this claim in favour of the taxpayer for no consideration as contemplated in paragraph 12(5) of the Eighth Schedule to the Act.
The court held that the judgment in ITC 1793  (67 SATC 256) therefore found no application to the facts in this matter.
It remained to be considered whether the method employed by the executor in the winding up of the estate whereby the relevant claim was not recovered from the taxpayer but merely awarded to the taxpayer as the sole residuary heir to the estate, brought this ‘award’ within the purview of paragraph 12(5) of the Eighth Schedule to the Act and the answer to this question had to be found in the wording of paragraph 12(5) of the Eighth Schedule itself.
What was required in terms of paragraph 12(5) was an act by a creditor whereby he/she consciously intended to discharge a debt for no consideration and the determining factor was the intention of the creditor whereby he/she disposed of a debt or an asset, and not the subsequent manner in which that creditor’s estate may be administered. Moreover, it was clear that the intention of the testatrix was not to discharge the debt for no consideration.
In the result the appeal was allowed and the respondent’s assessment for payment of capital gains tax on the amount of R539 189 was set aside.
The important distinguishing factor between ITC 1835 and ITC 1793 supra, is that in ITC 1793 the testatrix’s provision in her will discharging the trust’s debt constituted a deemed disposal in terms of paragraph 12(5) of the Eighth Schedule whereas, in ITC 1835 the court found that it was not the intention of the testatrix to specifically bequeath her claim to the trust and to discharge the debt for no consideration.
It is therefore important that wills containing bequests of loan accounts to a trust be amended accordingly to avoid the problem encountered in ITC 1793.
Edward Nathan Sonnenbergs