Estate Duty Implications on Buy-and-Sell Agreements where Shares are Held in Trusts

A buy-and-sell agreement is a legal document that outlines what will happen to a business when one of the owners dies, becomes disabled or retires. It provides a framework for the transfer of ownership between the remaining partners and the estate of the departing partner. Buy-and-sell agreements protect businesses by ensuring a seamless transition of ownership and avoiding conflicts among the remaining partners. However, when shares are held in trusts, the estate duty implications of buy-and-sell agreements can be complex.

What is Estate Duty?

Estate duty, also known as inheritance tax or death tax, is a tax on the value of an estate passed on to heirs upon someone’s death. In South Africa, estate duty is levied at a rate of 20% on the taxable value of an estate above R3.5 million. This tax is paid by the estate before any distribution to the heirs.

Buy-and-sell agreements and Estate Duty

When a buy-and-sell agreement is in place, the remaining partners usually purchase the shares of the deceased partner from their estate. This means that the estate will receive a lump sum payment for the shares. However, this has estate duty implications.

When shares are held in a trust, the estate duty is calculated on the market value of the shares at the date of death, minus the outstanding loan account in favour of the estate. In other words, the estate duty is calculated on the net value of the shares.

However, if the shares are sold to the remaining partners at a higher price than the market value, the estate will receive a higher payment, but the estate duty will also be higher. The estate duty will be calculated on the full amount received for the shares, not the market value.

For example, if the market value of the shares at the date of death is R1 million and the remaining partners purchase the shares for R1.5 million, the estate duty will be calculated on R1.5 million, not R1 million. This means that the estate duty will be 20% of R1.5 million, which is R300,000. If the shares were purchased at the market value, the estate duty would have been 20% of R1 million, which is R200,000.

How to minimise Estate Duty

To minimise estate duty implications on buy-and-sell agreements where shares are held in trusts, it is important to have a clear and accurate valuation of the shares at the date of death. This will ensure that the estate duty is calculated correctly.

It is also important to structure the buy-and-sell agreement in a tax-efficient manner. For example, the agreement can be structured as a deferred payment agreement, where the purchase price is paid over a number of years, instead of a lump sum payment. This can reduce the amount of estate duty payable.

Conclusion

Buy-and-sell agreements are essential for any business to ensure a smooth transition of ownership. However, when shares are held in trusts, there are estate duty implications that need to be considered. By obtaining a correct valuation of the shares and structuring the buy-and-sell agreement in a tax-efficient manner, the estate duty implications can be minimised. It is essential to consult with a tax professional or estate planner before entering into any buy-and-sell agreement.