This article was first published in the fourth-quarter 2012 edition of Personal Finance magazine.
It was fairly common practice until a few years ago for individuals to purchase or place residential property in a company or trust. The reasons for using these holding structures may include a desire to protect the property from creditors or for estate planning purposes.
However, the tax consequences of holding property indirectly can be significant:
* The effective capital gains tax (CGT) rate on sale if a property is held in a company is now 18.65 percent compared with a sliding scale with a top rate of 13.32 percent for an individual. In addition, if the cash in the company is extracted rather than used to purchase another asset, dividends tax of 15 percent applies. The effective tax rate on a gain made on disposal of the property can therefore be as high as 30.85 percent.
* In a trust, the effective CGT rate is 26.64 percent.
* If the property is the main home, the primary residence exclusion of the first R2 million of the capital gain is forgone if the property is held in a company or trust.
The South African Revenue Service (SARS) has provided an opportunity to unbundle certain residential property holding structures. This opportunity expires on December 31, 2012.
In order to meet the requirements (which are set out in paragraph 51A of the 8th Schedule to the Income Tax Act):
* The residence must be used mainly for domestic purposes. This means use as a main home (primary residence), but it can also cover holiday homes, as long as the residence is used more than 50 percent for domestic purposes as opposed to, for example, letting or other business purposes. The 50-percent requirement can apply on a square-metre or time basis.
* The residence must be used by individuals who are connected persons in relation to the company or trust at the time of the disposal. The definition of “connected person” is fairly wide. It includes any relative (which is also defined) of a natural person, as well as any trust in respect of which such person, or that person’s spouse, is a beneficiary. Relatives include your spouse and any person related to you or your spouse within the third degree of consanguinity. This limits the range of relatives but would include, for example, your parents, children, nieces, nephews and cousins and those of your spouse.
You are a connected person in relation to a company if you hold either individually or together with a connected person in relation to yourself, directly or indirectly, at least 20 percent of the equity or voting rights in the company.
A company for these purposes includes a close corporation (CC). A connected person in relation to a CC includes a member or any relative of a member.
* The residence must have been used mainly for domestic purposes from February 11, 2009 to the date of disposal from the company or trust. If the property was acquired via the company or trust after February 11, 2009, the unbundling provisions will not apply.
* The disposal of the property from the company or trust must take place on or before December 31, 2012. This will require a resolution by the company or trust on or before that date. The registration of transfer of the property need not, however, take place by that date but can happen afterwards.
* The company or trust must be wound up. The wind-up need not be complete by December 31, 2012. However, steps to liquidate, wind up or deregister the company or terminate the trust must begin within six months of the disposal of the property out of the company or trust.
If these requirements are met, the property can be transferred to the relevant individuals free of transfer duty and free of dividends tax. No CGT will arise in the company or trust on disposal of the pro-perty. However, this does not mean that the gain in value will not ever get taxed.
Any capital gain that would have arisen in the company or trust gets rolled over into the relevant individual’s hands. This means that when the individual sells or otherwise disposes of the property at a future date, a capital gain that would have arisen in the company or trust will be taxed at that time.
The benefits of the lower effective CGT rate for individuals and the primary residence exclusion (if applicable) will, however, apply, so the actual tax payable will be lower.
The rollover rules differ, depending on when and how the property was acquired:
* If all of the current shareholders acquired the shares when the company already owned the property and the property comprises 90 percent or more of the market value of assets held by the company during the period February 11, 2009 to the date of disposal, the CGT consequences of disposing of the shares are ignored and the shareholder’s base cost in the property is deemed to be equal to the acquisition base cost of the shares plus the cost of any improvements made to the property.
It is important that this base cost rollover is considered very carefully. It does not allow for the valuation date value (market valuation at October 1, 2001) to be carried over, for example, and it does not take loan accounts into consideration. The capital gain that may arise on the future sale of the property by the shareholder may therefore not be the same as the capital gain that would have arisen in the company. Both calculations should be performed and compared before rushing into any restructure.
* If the above situation does not apply – for example, the current shareholders acquired their shares before the company acquired the property, or some shareholders acquired their shares before and some after the company acquired the property, or the person who acquires the property is a connected person in relation to the com-pany but not a shareholder – the CGT consequences of disposing of the shares are ignored and the base cost of the shares in the company is truly rolled over to the individual. The rollover covers the date of acquisition of the property, the amount and date of incurral of expenditure, and the market valuation effected as at October 1, 2001.
In the case of the disposal of property by a trust, the beneficiary inherits all the base cost attributes of the property from the trust. The rollover covers the date of acquisition of the property, the amount and date of incurral of expenditure, and the market valuation effected as at October 1, 2001.
It is worth noting that the property can be disposed of to people who are not shareholders of the company provided they are “connected persons” as defined in relation to the company. However, this situation could give rise to donations tax, which is not covered by the tax dispensation.
The rollover rules should also be looked at very carefully, as well as the tax consequences that arise on wind-up of the company or trust. The tax dispensation does not cover other assets that may be held by the company or trust and some CGT or dividends tax may arise on wind-up in these circumstances. The tax consequences of any loan accounts held in the structure should also be considered.
Companies and CCs are required to submit annual returns to SARS and to the Companies and Intellectual Property Commission (CIPC). It is therefore definitely worth considering unbundling your property both from a tax and also an administrative point of view. However, if there are any complexities in the structure, it is worth obtaining professional advice before unbundling.
SARS has issued A Guide to the Disposal of a Residence from a Company or Trust (issue two), which has useful examples. The guide can be found on the SARS website: www.sars.gov.za
Steps required for winding up a company or CC:
* Liquidation or winding-up:
– The company must lodge a resolution authorising the winding-up in terms of section 80(2) of the Companies Act, 2008;
– The company must dispose of all assets and settle all liabilities, except for assets required to meet any liabilities to any sphere of government and administrative costs relating to the liquidation or winding-up;
– A copy of the resolution must be submitted to SARS; and
– All returns or information required to be submitted to SARS must be submitted or arrangements made for submission of outstanding returns or information.
– The company must lodge a request for deregistration to the CIPC in terms of section 82(3)(b)(ii) of the Companies Act, 2008;
– A copy of the request must be submitted to SARS; and
– All returns or information required to be submitted to SARS must be submitted or arrangements for the submission of outstanding returns or information must be made.
Trusts with property holding companies
Some residential property holding structures have been set up under trusts, with the trust holding shares in a company that owns the property. The beneficiaries may wish to take advantage of the provisions of paragraph 51A so that the property is owned directly by them so that they benefit from reduced CGT rates and exclusions should they sell the property at a future date.
Paragraph 51A applies if the property is distributed by the company to the trust and then distributed by the trust to the beneficiaries. However, in order to achieve these transactions, both the company and the trust are required to be wound up. The beneficiaries may prefer to retain the trust, for example, if there are other assets in the trust that they do not wish to be distributed. In addition, if the property is transferred twice as envisaged, although transfer duty is not applicable, registering the property twice at the Deeds Office will give rise to two sets of attorney’s fees and costs.
The SARS guide envisages a situation where the property is transferred directly from the company to the trust beneficiaries. Because the property is not received by the trust and therefore not disposed of by the trust, there is no requirement to terminate the trust. Since there is only one transfer of the property (directly from the company to the trust beneficiaries), only one registration of the property is required, thus requiring only one set of attorney’s fees.
All the requirements of paragraph 51A must be met – for example, the property must be used mainly for domestic purposes by the beneficiaries or other connected persons in relation to the beneficiaries during the period February 11, 2009 to the date of disposal. The disposal must take place before December 31, 2012 and steps to wind up the company must be taken within six months of the disposal.
The transfer of the property to the beneficiaries for no consideration or for a consideration less than the market value of the property will give rise to a dividend for tax purposes. However, the transfer should be free from dividends tax provided all the requirements of paragraph 51A are met. The transfer should also be free of transfer duty. The CGT consequences, as set out above, should apply so that
CGT is deferred and the capital gains attributes of the property are rolled over to the beneficiaries.
The company is, however, also regarded as making a donation for donations tax purposes, because it has transferred assets to persons other than its shareholder (the trust). The SARS guide, however, posits that the donation is deemed to be at the instance of the trust and, provided the trust deed authorises a distribution of such property to the beneficiaries, such distribution is exempt from donations tax. This is on the basis that a properly authorised distribution from a trust does not attract donations tax.
This mechanism may be useful in circumstances where certain property holdings within a trust structure would be more tax efficient if held directly by the beneficiaries. Bear in mind, though, that the original intention of the trust should be considered before unwinding. Consider also whether adverse consequences could arise on winding up the property holding company. Loans between the company and the trust may have to be settled or distributed before the disposal of the property in order to avoid additional taxes.
* Kari Lagler is a registered tax practitioner and independent tax consultant.