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Many taxpayers hold their residences in a company (including a close corporation) or a trust. Historically, they used this mechanism to obtain certain benefits, on estate duty and transfer duty for example.
During 2002, taxpayers were given an opportunity to transfer their residences out of their companies or trusts into their own names free of capital gains tax (CGT), secondary tax on companies (STC) and transfer duties. At the time, this relief was available only to natural persons and special trusts. Many taxpayers failed to make use of this opportunity.
The tax laws subsequently changed, and it became extremely costly for a company or a trust to dispose of a residence. In 2009, taxpayers were given another opportunity, when the relief period was extended to apply to all residences disposed of by a company or a trust on or after February 11, 2009 but before September 30, 2010. (For articles on the rules that apply to this period, see Personal Finance magazine’s second quarter 2010 and fourth quarter 2009 issues.)
More recently, the Taxation Laws Amendment Act of 2010 (promulgated on November 2, 2010) provided taxpayers with a further opportunity to qualify for the relief and widened the ambit. That said, new conditions were imposed – most notably that the company or trust must terminate its existence after the disposal of the residence to qualify for the relief.
In a nutshell, the new rules provide that if the residence is held in a company or a trust, that entity now has until December 31, 2012 to dispose of the residence and, provided certain criteria are met, no CGT and STC will be payable by the entity and no transfer duties will be payable by the purchaser in respect of the disposal. The new relief measures came into effect on October 1, 2010 and apply to all residences disposed of on or after that date.
This article sets out the requirements that must be met to qualify for the new relief and illustrates by way of examples the tax consequences that will follow where the relief applies.
What requirements must be met?
All of the following four requirements must be met to qualify for the relief:
1. There must be a disposal of “an interest” in a “residence” by a company or a trust. A person is regarded as having “an interest” in a residence where that person has a real or statutory right or the right of use (or occupation) in the residence. An interest in a residence also includes a share owned directly in a share block company.
A “residence” is any structure, including a boat, caravan and mobile home, that is used as a place of residence by a natural person and includes any appurtenance (accessory, object or piece of equipment) belonging to it.
Vacant land does not constitute a “residence” and will not qualify for the relief. Similarly, any other assets disposed of by the company or trust will not qualify for the relief.
2. The disposal must occur on or after October 1, 2010 but on or before December 31, 2012. The date of disposal (and not the date of registration in the Deeds Office) is important, because it determines whether the new or the “old” (and more limited) rules apply.
Disposals that occurred between February 11, 2009 and September 30, 2010 could still qualify for the relief if the agreement of sale was subject to suspensive conditions that are fulfilled only on or after October 1, 2010.
For example, Company X sold the residence to its sole shareholder on August 15, 2010 and the agreement of sale was made subject to the shareholder obtaining a mortgage loan from the bank. If the shareholder secured the mortgage loan only on November 18, 2010, the disposal will qualify for the new relief, even though the agreement was signed before October 1, 2010.
3. During the period February 11, 2009 to the date of disposal of the residence on or before December 31, 2012, the residence must:
* Be used mainly (that is, more than half the floor area) for domestic purposes by natural persons who are connected persons in relation to the company or trust (for example, they must be shareholders of the company or beneficiaries of the trust); and
* These natural persons must have ordinarily resided in the residence.
Note that “non-domestic” use of a residence includes renting a portion to another person or using part of it as a home office or for business purposes.
It is unlikely that the tax relief will apply to disposals of holiday homes held by a company or a trust, because these residences are generally not used mainly for domestic purposes. That said, if you can prove to the South African Revenue Service (SARS) that your holiday home has indeed been used mainly for domestic purposes, the relief may also apply to the disposal of the holiday home, provided the other requirements for relief are met.
4. Within six months of the date of disposal of the residence, the company or trust must take certain steps to terminate its existence, namely:
* In the case of a company, it must have taken steps to liquidate, wind up or deregister. This does not mean that the company must actually be terminated within six months; it means that it must have initiated the appropriate steps.
There are very specific steps that must be taken to terminate the existence of a company, so it is important that the company ensures it is in a position to implement these steps within the six-month period before it disposes of the residence.
Examples of the steps that must be taken are: a special resolution must be lodged with the relevant parties; all outstanding returns must be submitted to SARS or an extension must be obtained; in the case of liquidation or winding up, the relevant assets must be disposed of; and in the case of deregistration, the relevant written statement must be lodged with the appropriate parties.
* In the case of a trust, the founder, trustees and beneficiaries of the trust must have agreed in writing to revoke the trust within the six-month period or an application must be made to a competent court for the trust’s revocation within the six-month period.
Who must acquire the residence?
The new provisions do not clearly stipulate that the company or trust must dispose of the residence to a specific person in order to qualify for the relief.
It is thus not entirely clear whether, in order to qualify for the relief, the person(s) acquiring the residence from the company or trust must be a natural person who ordinarily resided in the residence from February 11, 2009 until the date of acquisition and whether that person must be a connected person in relation to the company or trust during this period.
SARS’s draft guide on the new provisions discusses this issue at length and concludes that, in order to qualify for the relief, the acquirer must meet the aforementioned requirements (see requirement 3 above). This means that a disposal of a residence to any person who is not a connected person in relation to the company or trust that disposes of the residence (for example, an unrelated third party) will not qualify for the relief. That said, the law is not entirely clear on this issue and it is recommended that specialist tax advice be sought in this regard.
What relief will you get?
This is how the following duties and taxes are affected if you meet all the requirements.
* Transfer duty. The acquirer of the residence will not be liable to pay transfer duty.
* STC. Relief will apply only if the residence is distributed as an in specie dividend. If the residence is first disposed of by the company and thereafter the profits on disposal are distributed to the shareholders as a cash dividend, the normal STC rules will apply (that is, subject to any exemptions, the dividend may be subject to STC at the rate of 10 percent). Normal STC rules will also apply to any other assets that the company distributes before its termination.
Importantly, a sale of a residence to a shareholder at less than its market value could give rise to a deemed dividend for STC purposes, which will not qualify for the relief and hence the normal STC rules would also apply in this case.
* Dividends tax. As with the STC relief, relief for dividends tax will apply only if the residence is distributed as an in specie dividend. Note that dividends tax is not yet effective.
* CGT. The company or trust is deemed to dispose of the residence at its base cost at the date of the disposal. This means that no capital gain or loss will arise on the disposal. But the relief is limited to the disposal of the residence only, and any other assets that the entity is required to dispose of prior to its termination will trigger CGT in the normal way.
* Donations tax and value-added tax. No specific relief has been granted for these taxes and the normal rules will apply.
More on CGT
How is the acquirer’s base cost of the residence determined for the purposes of CGT? If the residence is disposed of by the company to you, as a natural person and its shareholder (or as one of the shareholders), the value of the base cost of the residence in your hands will depend on when you acquired the shares in the company.
If you acquired them after the company acquired the residence, and 90 percent or more of the market value of the company’s assets (total assets and not net assets) during the period February 11, 2009 to the date of disposal is attributable to the residence, the base cost of the residence in your hands is equal to the base cost of the shares when the shares were acquired plus improvement costs incurred in respect of the residence after the acquisition of the shares.
For tax purposes, you must in this case also disregard the disposal of your shares in the company if the disposal occurred in the course of the company’s liquidation, winding-up or de-registration.
If you acquired the shares in the company before the company acquired the residence, you are deemed to acquire the residence at its base cost to the company or trust (that is, the acquisition costs paid for the residence by the company plus the cost of subsequent improvements). In this case, the cost of shares in the company is not taken into account in determining the base cost in your hands.
You must disregard the disposal of the shares in the company, if the disposal occurred in the course of the company’s liquidation, winding-up or de-registration.
If the residence is disposed of by a trust, the acquirer is deemed to acquire the residence at its base cost to the trust (that is, acquisition costs paid for the residence plus the cost of subsequent improvements).
The CGT relief described above may also apply when the company or trust disposes of the residence to another company or trust. This will, for example, apply when a trust or another company is the shareholder of the company that holds the residence. It could also apply where the residence is currently housed in a company or a trust and the seller does not wish to terminate the existence of that entity after the disposal of the residence, in which case it can dispose of the residence to another company or trust.
The CGT relief will apply if all of the four requirements referred to earlier are met and, in particular, the residence is disposed of before December 31, 2012 to one or more natural persons who are connected persons in relation to the company or trust.
Waiver of loan accounts
As noted earlier, to qualify for the relief, the existence of the company or trust must be terminated. For this to occur, all the entity’s liabilities must be discharged.
The question that arises then is this: what is the position if a loan account was created to finance the initial acquisition of the residence and that loan account is now waived for no consideration (or for a consideration less than the face value of the loan)?
The waiver of the loan will not give rise to CGT consequences provided it is made in the course of the company’s liquidation, winding-up or de-registration, the parties (the creditor and the company) are connected persons and the amount waived does not exceed the creditor’s expenditure of the debt at the time of waiver/discharge. This latter requirement will apply where Creditor A cedes a loan with a face value of, say, R200 to Creditor B for, say, R150. Assuming the full loan of R200 is still outstanding at the date of discharge/waiver, only R150 will qualify for CGT relief. Unfortunately, no similar relief is granted in respect of loans waived in anticipation of the revocation of a trust. This means that all the loans of the trust have to be repaid.
It is important that taxpayers ensure that the disposals of residences are structured in the correct manner so that these may qualify for the relief. It is therefore advisable that any potential transaction be reviewed by a tax specialist before it is implemented.
EXAMPLE 1. DISTRIBUTION AS IN SPECIE DIVIDEND
A company distributes a residence as an in specie dividend and the shareholder waives the loan account.
The situation. Mr X is the sole shareholder of ABC (Pty) Ltd, a company that he established in 1999 and that is tax resident in South Africa.
On October 1, 2000, the company bought a residence for R700 000, which was financed by a mortgage bond. Mr X settled the bond, and a shareholder’s loan account was raised with ABC in the name of Mr X.
Mr X has lived in the house since the date of its acquisition. On June 30, 2005, he made improvements to the house amounting to R50 000.
On October 1, 2001, the market value of the house was R850 000.
ABC was placed under voluntary liquidation on October 5, 2010 and began taking steps to terminate its existence. Mr X agreed to waive the balance owing to him on his loan account of R600 000. ABC then distributed the house (with a market value of R1 million) to Mr X as a dividend in specie.
Tax implications. The transaction qualifies for the new relief, because: * The disposal of the residence took place on or after October 1, 2010;
* The residence was used mainly for domestic purposes by Mr X, a natural person and a shareholder of ABC, and he ordinarily resided in the residence during the period February 11, 2009 to October 5, 2010; and
* ABC has taken steps to liquidate within the prescribed time.
Tax consequences. The tax consequences will be:
* Mr X will not pay any transfer duty on the acquisition of the house;
* No secondary tax on companies is payable by ABC, because the house is distributed as an in specie dividend to Mr X; and
* ABC is deemed to have disposed of the residence at its base cost on the date of disposal and hence no capital gains tax (CGT) liability arises.
The residence was acquired before October 1, 2001 so the base cost will be determined as follows:
The market value (on October 1, 2001) = R850 000
The time-apportionment base cost = R681 818
20 percent x proceeds less any qualifying expenditure actually incurred = R190 000 (R1 million – R50 000)
If the market value is used as the base cost, Mr X is deemed to have acquired the residence at a base cost of R900 000 (R850 000 + R50 000).
The waiver of the outstanding loan will not give rise to CGT, because Mr X is a connected person in relation to ABC and the loan was waived in anticipation or during the course of the company's liquidation.
EXAMPLE 2. BALANCE ON LOAN ACCOUNT SETTLED
A company disposes of a residence and uses the proceeds to settle the balance on a shareholder’s loan account.
The situation. The situation is the same as in Example 1 but, instead of distributing the house to Mr X as an in specie dividend, ABC (Pty) Ltd sells the house for R1 million to an unrelated third party and the proceeds on disposal are used to settle the balance of the loan account owed to Mr X.
Tax implications. The transaction qualifies for the new relief for the same reasons as it does in Example 1.
Tax consequences. These will be:
* Mr X will not pay any transfer duty on the acquisition of the house.
* Secondary tax on companies (STC) will be payable, because the market value of the property (R1 million) exceeds the outstanding loan balance (R600 000). The excess amount will therefore constitute a dividend distributed to Mr X. The STC liability will amount to R40 000 ([R1 million – R600 000] x 10 percent = R40 000).
* A capital gain of R100 000 (R1 million – R900 000) will arise in ABC’s hands, because the company sold the asset to an unrelated party. Fifty percent of this gain will be included in the company's taxable income.
Anthea Scholtz is a director at Deloitte’s tax division.
This article was first published in the 1st quarter 2011 edition of Personal Finance magazine.