Usufructs: Understanding the 12% discount rate and annual right of enjoyment

It is not uncommon to see usufructs, particularly in wills. These provide one person with the use of an asset (generally a spouse) over their lifetime or a defined period and another (often a child or trust for the children)with the 'bare dominium' in the asset. At the end of the usufruct period or death of the usufructuary, it falls away and the bare dominium holder has the full use of the asset. The usufruct is an asset and has to be valued, be it for capital gains tax, donations tax, estate duty, or transfer duty purposes.

The process of determining the value of a usufruct can be quite daunting for the uninitiated. The capitalisation rate of 12%, the annual right of enjoyment of 12% or lower, life expectancy tables and tables for a fixed period can all add to the confusion. This article seeks to clear up some of the fog surrounding the subject.

The following abbreviations have been used: Income Tax Act 58 of 1962 (ITA), capital gains tax (CGT), Estate Duty Act 45 of 1955 (EDA) and Transfer Duty Act 40 of 1949 (TDA).

The present value tables

Two sets of tables are available for the purposes of determining the value of a usufruct, namely

• Table A - The Expectation of Life and the Present Value of R1 per Annum for Life Capitalised at 12 per cent over the Expectation of Life of Males and Females of Various Ages; and
• Table B - Present Value of R1 per Annum Capitalised at 12 per cent over Fixed Periods.

These tables are contained in regulations published under s 29 of the EDA and can be found in GNR 1942 GG 2533 of 23 September 1977: Valuation of annuities or of fiduciary, usufructuary or other limited interests in property in the estates of deceased persons. They can also be found in the SARS Comprehensive Guide to Capital Gains Tax (Issue 9) in 8.35.7. A quick way to get there is to search the guide for the word ‘females’ (without the quotation marks).

Table A

Table A is used for valuing a usufruct based on the person’s life expectancy. The table shows ages from 0 to 90, life expectancies for males and females of those ages and then a present value factor which is multiplied by the annual right of enjoyment.

For example, a male with an age of zero (less than one year old) has a life expectancy of 64,74 years and a present value factor of 8,32791. But a male aged one has a better life expectancy of 65,37 years and a factor of 8,32828. After that, it’s downhill all the way until age 90, when the life expectancy is 4,3 years with a factor for a male of 3,21438. According to Meyerowitz on Administration of Estates and their Taxation,¹ persons aged above 90 are to be taken as 90. This was supposed to have been included in a footnote to the Gazette but it was inadvertently omitted. Females have better life expectancies, for example, a female aged one has a life expectancy of 72,74, which is 7,37 years longer than her male counterpart of the same age.

In looking up the age, it is the age next birthday that must be used. This can be tricky to work out at a specific point in time, but fortunately there are online calculators that can be used.² It is difficult to see under what circumstances the age of zero will ever be used because a child of three months old would have an age next birthday of 1. A conceived but unborn child does not have legal personality until born³ and cannot hold a usufruct, although it can inherit under a will. Even so, its age next birthday when born would also be one.

Table B

Table B contains the present value factors for fixed periods ranging from 1 to 100.

A usufructuary that is a juristic person such as a trust or company is treated as having a life expectancy of 50 years,⁴ and the factor for 50 years is found in Table B (8,3045).

Determination of the present value factors in the tables

You might ask how the factors in the tables are determined. I am not going to attempt to explain this for table A because the life expectancies include parts of a year, which complicates matters. But the fixed period amounts are easier to explain. The mathematical formula (a polynomial) is 1/(1 + r)n + 1/(1 + r)n+1 + 1/(1 + r)n+2 and so on, in which r is the discount rate (0,12) and n is the period. Thus, for example, the present value of R1 at 12% for 1 year is 1/(1 + 0,12)1 = 0,892857 but the table rounds it up to 0,8929, and for two years 1/1,12 + 1/(1,12 × 1,12) = 0,89257 +0,797194 = 1,69005, rounded in the table to 1,690.

Using Excel

The factors in both tables can quickly be checked using Excel using the formula:

=PV(0.12,n,-1) in which 0.12 is the discount rate, n is the number of years and -1 is the annual right of enjoyment. So, to work out the factor for a life expectancy of a male aged 90:

=PV(0.12,4.3,-1)

= 3,21438, which is the same as the table A figure.

Note: 4.3 is the life expectancy of a male aged 90 next birthday.

In Excel you can expand the number of decimal places using the shortcut key ALT, H, 0 and reduce it with ALT, H, 9.

Annual right of enjoyment v discount rate

For CGT, donations tax, estate duty and transfer duty purposes the method for determining the value of a usufruct is the same. It involves capitalising, at 12% a year, the annual right of enjoyment of the asset over the usufructuary’s life expectancy, or if the right of enjoyment is for a lesser period, over that lesser period. The annual right of enjoyment of the asset is 12% of the market value of the full ownership of the asset. . If the Commissioner is satisfied that the asset cannot reasonably be expected to produce a yield of 12%, the Commissioner must prescribe the annual yield that the asset is reasonably expected to produce.

It will be observed that the rate of 12% is mentioned in two different places in the calculation and these should not be confused.

The discount rate

The discount rate is 12% and represents the rate at which the annual right of enjoyment must be discounted back to the present (‘capitalised’).⁵ It is the equivalent of the rate of inflation or time value of money and cannot be changed by SARS or the taxpayer. Thus, the present value factors in Table A and Table B must always be used as they presume a discount rate of 12%. The rate of 12% is quite high in relation to South Africa’s actual rate of inflation of around 4 to 5% and for usufructuaries wishing to dispose of their usufructs to the bare dominium holder , it reduces the annual right of enjoyment quite substantially. For example, R100 a year for two years discounted at 0% is equal to R200 but the same amounts discounted at 12% are equal to R169.

The annual right of enjoyment

The presumed annual right of enjoyment is 12% × the market value of the full ownership in the property. This valuation can be challenged in appropriate circumstances by approaching the Commissioner for a reduced percentage.⁶

In C: SARS v Klosser’s Estate,⁷ an estate duty case, the court upheld the Commissioner’s use of an annual yield of 2,5% for listed shares. The court held that the Commissioner was required to make predictions as to the future yield and that these could be based only on facts which included the yield at the time of death and in the past. The Commissioner had invited the taxpayer to provide statistics of the yield over the past three years but the taxpayer had not responded to the request. The court also rejected the taxpayer’s argument that the assets could be subject to change in future because no evidence to this effect had been adduced. In the result the court upheld the Commissioner’s use of an annual yield of 2,5% for the listed share portfolio.

This article was first published in ASA December 2023