Tax proposal has good news > Mc Murray Aldum

Tax proposal has good news

Qualifying individuals should carefully consider the provisions of the draft legislation

The recently published draft tax legislation brings some good news to individuals who own residences through a company or close corporation.
Under the proposed tax legislation, a domestic property-owning company can distribute the property to its shareholder in the course of, or in anticipation of, its liquidate tax costs. Once the property is owned directly by the individual shareholder, future tax costs arising on the sale can be significantly reduced.
Mainly for historical tax reasons, many individuals own their domestic residence indirectly through a company or close corporation. In this article, any reference to a company includes a close corporation, or to a share includes a member’s interest.
Until 2002, the sale of shares in a residential property-owning company was not subject to transfer duty, only stamp duty at a far lower rate. Since this would have reduced the tax costs when the property was eventually sold, many residential properties were owned in this manner.
The introduction of capital gains tax (CGT) brought about certain disadvantages – for one, the sale of the shares or the property itself would not have qualified for the primary residence CGT exclusion. Due to the number of residences owned in this way, representations were made to the South African Revenue Services (SARS) to allow these companies to distribute the residence to the shareholder who was an individual free of tax.
The tax legislation was amended to provide relief from CGT, transfer duty and secondary tax on companies (STG) for a period of time that ended on September 30 2002. Unfortunately, not all taxpayers took advantage of this generosity, possibly due to the fact that the transfer duty advantage remained.
At the time, residences owned through a trust could also be distributed to its beneficiaries free of tax; unfortunately, the current draft legislation does not make provision for this.
As many taxpayers have discovered, there are numerous unexpected consequences that may arise when they decide to sell their property. An informed purchaser is usually reluctant to buy the shares in the property-owning company, due in part to the tax disadvantages that could arise when the property is eventually sold and the risks of purchasing an entity with an unknown tax history. In the event that the purchaser can be convinced to purchase the shares, the shareholder will not qualify for the primary residence CGT exclusion.
The consequences is that the firm is forced to sell the property. The company will be subject to the higher CGT rate; as the effective CGT rate in a company is 14% versus 10% for an individual subject to tax at the highest marginal rate. The firm does not qualify for the primary residence exclusion either. Currently, where the sale proceeds from the disposal of a primary residence are less than R2m, the gain or loss is excluded. Should the sale proceeds exceed R2m, the first R1, 5m of capital gain or loss is excluded.
The pain does not end there. STC is imposed at a rate of 10% on the amount of dividends declared (that is, the proceeds from the sale), subject to certain exclusions.
With this in mind, qualifying taxpayers should carefully consider the provisions of the draft legislation.
The tax exemptions and exclusions apply to a “domestic residence company”. To qualify as a “domestic residence company”, its sole asset must be a “domestic residence”, being a residence used exclusively for domestic purposes. The shareholder does not need to reside there as his or her main residence, so it appears that a holiday home would also qualify, provided it is not rented out. Further, all the shares of the company must have been held by an individual alone or together with his or her spouse. The “domestic residence” must have been held by the company and the individual must have held all the shares in the company from 11 February this year to the date property is distributed.
The relief applies where the “domestic residence company” makes a distribution of, or in the course of, the liquidation, winding-up or deregistration of the company.
CGT rollover relief applies so that the company is deemed to have disposed of the property at its base cost (that is, no capital gain arises in the company) and the shareholder is treated as having acquired it at the base cost for the company. The effect is that any unrealised capital gains at the date of distribution will be taxed in the shareholder’s hands when the property is ultimately disposed of.
Taxpayers wishing to avail themselves of this relief should pay close attention to the time period in which the relief will be available. The relief will only apply in respect of distributions made between January 1 2010 and January 1 2012.
Qualifying taxpayers should not miss this opportunity next year as it is unlikely that another one will be given. It is also important to note that this is a discussion of the draft legislation, which may change once the final legislation, which may change once the final legislation is passed.