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Clarification of relief measures available for the disposal of a residence by a company, close corporation or trust In 2010 SARS introduced paragraph 51A of the Eighth Schedule to the Income Tax Act 58 of 1962 (“the Act”), which provides for a window period within which residences can be transferred out of companies, close corporations (CC’s) and trusts free of certain tax implications. The intention with the introduction of this paragraph, which replaced the existing relief available under paragraph 51 of the Eighth Schedule, was to, firstly, widen the scope of these relief measures and to, secondly, impose certain further conditions. Paragraph 51A caters for disposals between 1 October 2010 and 31 December 2012 (“the qualifying period”). If the requirements set out in paragraph 51A are met, the disposal of the residence to an individual will not give rise to capital gains tax (“CGT”), transfer duty or dividends tax (“DT”) consequences. The tax consequences are in certain circumstances postponed until the ultimate disposal of the residence by the individual at a future date (“the relief measures”). Before looking at the requirements and implications of the relief measures we will first look at the benefits of holding the residence directly and why a company/Close Corporation (“CC”) or trust was used to hold a residence historically and whether these reasons are still relevant.
What are the benefits of holding the residence directly? Firstly, an individual who intends to use or continue to use the transferred residence as his primary residence would qualify for the primary residence exemption upon disposal of the residence, which includes a disposal as a result of death. This primary residence exclusion is not applicable to companies, CC’s or trusts. •
Briefly, the primary residence exemption either exempts the first R2 million of any capital gain/loss realised on disposal of the residence; or
•
Where the proceeds are less than or equal to R2 million, the full gain/loss is exempt.
Secondly, an individual qualifies for a CGT rebate on death equal to R300,000 of the capital gain realised on death which could be used to reduce any capital gain arising as a result of the disposal of the transferred residence (for example a holiday home) on death. Thirdly, an individual’s CGT inclusion rate applicable to capital gains is, for the most part, lower than that of a company/CC or trust. Person
Effective CGT rates
Individual
13.32%
Company/CC
18.65%
Trust
26.64%
Notes N1 N2
N1. Assuming a maximum marginal rate of 40% N2. This rate can be reduced to 13.32% provided it is attributed or vested in a resident beneficiary
Finally, where a company/CC disposes of a residence and then distributes the capital profit to the shareholders/members there is DT of 15% on such a distribution. Clearly there is no such tax implication where the residence is held directly by the individual.
Why use a company, CC or trust to own a residence? There were a number of reasons why companies, CC’s and trusts were used to hold a residence, some of which are still valid. However due to various legislative amendments over the years some of these reasons are no longer applicable. Some of these reasons are: •
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Historically it was possible to avoid transfer duty by acquiring the shares/membership interest in a company/ CC or acquiring a beneficial interest in a trust. Due to an amendment to the Transfer Duty Act, 40 of 1949 in 2002 this is no longer possible. Historically there was no CGT and the distribution of a
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•
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capital profit by a company/CC in anticipation of windingup was exempt from secondary tax on companies. In 2002 this exemption was limited to the distribution of pre-1 October 2001 capital profits and w.e.f 1 January 2011 it was completely removed with the introduction of a new dividend definition. The reduction or elimination of estate duty. Although this reason is still valid, it is important to note that the legislation pertaining to the imposition of estate duty has undergone a number of changes which have resulted, to an extent, in a reduction of the liability to estate duty. These changes include: – A significant increase in the estate duty rebate from R1,5 million (prior to March 2006) to R3,5 million. – The estate duty rebate was increased as a result of the ability to roll-over any portion of the rebate not utilised by one spouse to the surviving spouse resulting in a possible maximum estate duty rebate of R7 million for the surviving spouse. – Finally, the Commissioner has also introduced a successive deaths rebate which reduces the rate of estate duty on a sliding scale if the person who inherited the property from the deceased dies within up to 10 years from the date of death of the first deceased. Protection from creditors. Death creates a CGT event. This is a very valid reason for maintaining a residence in a trust, for example a holiday home which would not qualify for the primary residence exclusion.
Requirements of paragraph 51A The following requirements must be met to qualify for the relief contained in paragraph 51A: • •
•
The disposal of the interest in the residence must take place between 1 October 2010 and 31 December 2012; Within six months of the date of disposal: – In the case of a company/CC, certain prescribed steps must be taken to wind up, liquidate or deregister (“terminate”); or – In the case of a trust, steps must be taken to terminate the trust. The residence must have been mainly used for domestic purposes, during the period commencing on 11 February 2009 and ending on the date of disposal, by connected person/s in relation to the company/CC or the trust at the time of the disposal (“qualifying individual”). Without going into detail on the definition of a connected person per section 1 of the Act, broadly speaking, a connected person in the context of this paragraph is: – In relation to company – Any individual shareholder, who individually or jointly, with any other connected person, holds at least 20 per cent of the company’s equity share capital or voting rights. • For example, Mr X holds 99% in a company and Mrs X holds 1%. As Mrs X is a connected person (spouse) in relation to Mr X who holds 99% and she holds a 1% interest she will also be a connected person in relation to the company as she jointly
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holds 20% of the company’s equity share capital. However, it is important to note that in the case of a company a spouse/relative of a shareholder is not necessarily a connected person in relation to a company if such spouse/relative does not also hold any shares in the company. For example, using the facts as set out in the aforementioned example, except that Mr X holds 100% of the company. Mrs X is not a connected person in relation to the company as she does not hold, individually/jointly any equity shares in the company. In relation to a CC – Any member or relative of such member. The connected person definition in relation to a CC is much broader than that of a company. In relation to a trust – Any beneficiary of such trust or any relative of the beneficiary of the trust, the connected person definition in relation to a trust is much broader than that of a company.
(It is important to note that the definition of “connected person” is very broad and complex and although we have listed certain of the inclusions under the “connected person” definition, this list is not exhaustive)
What is an interest in a residence? Vacant land does not qualify, however the disposal of a share in a share block company by a company, CC or trust would qualify. There is no limitation/restriction in respect of the size of the land on which the residence is situated. The only requirement is that the residence situated on the land must have been mainly used for domestic purposes. For example, where a residence is situated on a plot which comprises three hectares and two-thirds of the plot is used for domestic purposes and a third of the plot has a cottage on it which is rented out, the full three hectares will qualify for the relief measures as it is mainly used for domestic purposes. However, where a farmhouse is situated on 500 hectares and only one hectare is used mainly for domestic purposes and the rest is used for farming purposes then the disposal of the 500 hectares would not qualify for the relief measures.
Disposal on or before 31 December 2012 The time of disposal of the residence is not defined in paragraph 51A and therefore one would have to apply the general principles contained in paragraph 13 of the Eighth Schedule to the Act dealing with the time of disposal of assets. Where the residence is disposed of in terms of an agreement of sale which is not subject to any suspensive conditions then the time of the disposal is the date of conclusion of the agreement. However where the agreement of sale is subject to a suspensive condition then the time of disposal is the date of fulfillment of the conditions.
Where the residence is distributed by a company/CC as a dividend in specie the time of disposal is the date of distribution which means the date of payment of the distribution by the directors, except where the distribution is made: • By a company subject to the condition that it be payable to a shareholder of the company registered in that company’s share register on a specified date, in which case it must be that date; • By a company to a shareholder of that company otherwise than by way of a formal declaration of a dividend, in which case it must be the date on which the shareholder became entitled to that distribution; or • By the liquidator of a company to a shareholder of that company in the course of the winding up or liquidation of that company, in which case it must be the date on which the shareholder became entitled to that distribution. Where the residence is distributed by a trust to a beneficiary the time of disposal would be the date of vesting of the residence in the beneficiary. It is important to note that the date of registration in the deeds office is not relevant. Therefore, provided the timing provisions set out above are complied with the fact that the residence is only registered in the deed’s office in a qualifying individual’s name after 31 December 2012 does not mean that the provisions of paragraph 51A have not been complied with.
Domestic use requirement It has been held by our courts that the word “mainly” prescribes a purely quantitative standard of more than 50%. The difficulty comes in measuring this 50%. SARS has proposed that a time basis or a floor-area basis could be used as a basis for measurement. The time basis could be used in the case of a holiday home for example where a holiday home has been let out for two months of the year and used by a qualifying individual for domestic purposes for three months of the year. In such a case it could be argued that it has been used mainly for domestic purposes i.e. 60% of the time. The floor-area basis would be relevant where a part of a primary residence is used for trade purposes for example Mr X’s home which he uses for domestic purposes comprises 200 square meters. He rents out a granny flat adjacent to his home which comprises 80 square meters. Based on a floor-area basis the residence of Mr X is mainly used for domestic purposes (71%). Finally, the use of the residence after 11 February 2009 mainly for domestic purposes would not qualify under paragraph 51A.
Connected person requirement The individual who used the residence for domestic purposes must be a connected person in relation to the company, CC or trust. However, this person need only be connected to the company, CC or trust as at the date of disposal and not necessarily from 11 February 2009 but this person must have used the residence for domestic purposes from 11 February 2009. For example, after 11 February 2009 Mrs X becomes the spouse of Mr X, a beneficiary of a trust which owns a residence. However
Mrs X has lived in the house with Mr X since 11 February 2009. Therefore, subject to the provisions of the trust deed the residence can be transferred to Mrs X or Mrs X and Mr X in terms of paragraph 51A.
What steps must be taken within six months? The prescribed steps do not require termination of the company, CC or trust within the six month period. Paragraph 51A merely requires that certain steps are taken within six months from the date of disposal of the residence in order to terminate the entity. In the case of a company (the steps in respect of a CC are the same) the following prescribed steps must be taken within the six month period: Liquidation
Deregistration
Lodge a resolution as required by the Companies Act
Lodge a request for the company’s deregistration in the prescribed manner and form to the CIPC i.t.o the Companies Act. This requires that the company/CC no longer has any assets/liabilities
Dispose of all assets and settle all liabilities except for assets required to satisfy any liabilities to Government and administration costs Submit a copy of the resolution to SARS
Submit a copy of the resolution to SARS
Submit all outstanding returns or information to SARS or obtain the necessary extension from SARS. This must be done by the end of the six-month period.
Submit all outstanding returns or information to SARS or obtain the necessary extension from SARS. This must be done by the end of the six-month period.
In the case of a trust, the steps to be taken would depend on the trust deed. There is usually a termination clause within a trust deed which prescribes the steps which need to be taken in order to terminate the trust.
What are the tax implications for the company/CC? CGT If the requirements of paragraph 51A are met then the company/ CC will be deemed to have disposed of the residence for an amount equal to the base cost of the residence for that company/ CC. Hence there are no CGT consequences for the company/CC.
Dividends tax Where the residence is disposed of by the company/CC to a shareholder/member as a dividend in specie and the requirements of paragraph 51A are met there is an exemption from DT. Where the residence is disposed of by the company/CC to a shareholder/member in terms of an agreement of sale for an amount which is less than the market value of the residence, this
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disposal would also qualify as a dividend in specie and would also qualify for a DT exemption. However, please note the possible donations tax implications of such a disposal which we have addressed below. Where the residence is disposed of by the company/CC to a shareholder/member in terms of an agreement of sale for an amount which is equal to the market value of the residence, clearly there are no DT implications on such transaction as it is not a distribution of a dividend but rather a sale of an asset. However, the distribution of the proceeds arising as a result of this disposal whether it be a distribution of cash or a loan receivable will be subject to DT as it does not qualify as a distribution of the residence as a dividend in specie.
between the consideration payable of R1 million and the market value of the residence of R2.5 million) which will be subject to donations tax of R300,000.
Other tax consequences There is no tax relief for the company/CC where any assets other than the residence are also disposed of as a result of the termination of the company/CC in order to comply with the requirements of paragraph 51A.
What are the tax implications for the trust?
Donations tax
CGT
There is no specific donations tax exemption for the disposal of a residence in terms of paragraph 51A, hence a person would need to determine, when availing oneself of the relief in terms of paragraph 51A, whether there are any donations tax exemptions applicable to the envisaged transaction.
If the requirements of paragraph 51A are met then the trust will be deemed to have disposed of the residence for an amount equal to the base cost of the residence for that trust. Hence there are no CGT consequences for the trust.
The distribution of the residence as a dividend in specie to a shareholder/member is not a donation. The disposal of the residence to a shareholder/member for an amount which is less than the market value of the residence will also not be subject to donations tax as it is a deemed dividend in specie distributed to the shareholder/member. However, the disposal of the residence to a connected person in relation to a shareholder/member who is not a shareholder/ member of the company/CC is different. In this case one must apply the provisions of the section 57 of the Act which provides that, where property is disposed of by a company at the instance of, for example a shareholder of a company, and that disposal would have been treated as a donation had that disposal been made by that shareholder, then that shareholder will be deemed to have donated that property. •
•
For example, Mr X holds a 100% membership interest in CC B. CC B’s only asset is a residence. Mr X and Mrs X are married and have lived in the residence owned by CC B since 11 February 2009 and used it for domestic purposes. Mr X signs a special resolution authorising CC B to dispose of all its assets (i.e. the residence) to Mrs X at cost i.e. R1 million. The residence is however worth R2.5 million. – At the instance of Mr X, as sole member of CC B, the residence is disposed of to Mrs X. – As a result of section 57 of the Act, Mr X will be regarded as having donated the residence to Mrs X. – However as Mrs X is Mr X’s spouse this donation will be exempt from donations tax. Using the same facts above, except that Mr X’s son, Brad, has been using the residence for domestic purposes from 11 February 2009, the following will apply to Mr X: – At the instance of Mr X, as sole member of CC B, the residence is disposed of to Brad. – As a result of section 57 of the Act, Mr X will be regarded as having donated the residence to Brad. – There is no exemption from donations tax in these circumstances and therefore Mr X will be deemed to have made a donation of R1.5 million (the difference
Donations tax As pointed out above there is no specific donations tax exemption for the disposal of a residence in terms of paragraph 51A. The distribution of a residence by a trust to a beneficiary of the trust in terms of the trust deed is exempt from donations tax. The disposal of the residence at below market value to beneficiary of the trust would also be exempt from donations tax and would in all likelihood be authorised by the trust deed and therefore regarded as a disposal under and in pursuance of a trust which is exempt from donations tax. However, the disposal of a residence to a connected person in relation to a beneficiary of a trust is not exempt from donations tax as it would (ordinarily) not be a disposal under and in pursuance of a trust. •
For example, Mr Y is a beneficiary of Trust A. Trust A’s only asset is a residence. Mr Y’s father and mother have lived in the residence owned by Trust A since 11 February 2009 and used it for domestic purposes. Trust A, disposes of the residence at cost i.e. R1 million to Mr Y’s father. The residence is however worth R2.5 million. – As Mr Y’s father is not a beneficiary of Trust A the disposal for inadequate consideration to Mr Y’s father is not an exempt donation as it is not disposed of under and in pursuance of a trust and therefore Trust A will be deemed to have made a donation of R1.5 million (the difference between the consideration payable of R1 million and the market value of the residence of R2.5 million) which will be subject to donations tax of R300,000.
Other tax consequences There is no tax relief for the trust where any assets other than the residence are also disposed of as a result of the termination of thetrust in order to comply with the requirements of paragraph 51A.
What are the tax implications for the qualifying individual upon acquisition of the residence from a company/CC? When answering this question paragraph 51A deals with two scenarios. • Scenario 1. This is where: – A shareholder/member acquires the residence i.e. not a connected person in relation to the company/CC who is not a shareholder/member; – All the shareholders/members acquired the shares/ membership interest after the company/CC acquired the residence; and – 90% or more of the market value of the assets of the company, from 11 February 2009 to the date of disposal is attributable to the residence. • Scenario 2: This scenario is applicable where Scenario 1 is not applicable.
Scenario 1: CGT consequences for the shareholder/ member
be R500 000 and not R1.5 million as it is only the base cost of the shares which rolls over to the residence and no account is taken of the loan claim of R1 million.
Scenario 2: CGT consequences for the shareholder/ member Scenario 2 is only applicable if Scenario 1 is not applicable. Examples of when Scenario 1 would not be applicable are: • •
• •
The shareholders/members acquired their shares before the company/CC acquired the residence; Some of the shareholders/members acquired their shares/ membership interest before the company/CC acquired the residence and others acquired their shares afterwards; The 90% test is not met; or The qualifying individual acquiring the residence is not a shareholder but is still a connected person in relation to the company/CC. This would be very rare in the case of a company due to the connected person definition.
If ALL of the requirements for Scenario 1 are not met then it will not apply to the disposal of the residence and the qualifying individual acquiring the residence would have to determine their tax consequences in terms of Scenario 2.
For CGT purposes upon acquisition of the residence by the qualifying individual and termination of the company/CC the qualifying individual must disregard any CGT implications upon termination of the company/CC and the base cost of the residence is rolled-over to the qualifying individual.
The 90% test is applicable to gross assets and not net assets.
•
Upon acquisition of the residence and termination of the company/CC the shareholder/member must disregard any CGT implications. The shareholder/member acquiring the residence will be deemed to have acquired the residence at a cost equal to the base cost of the shares at the date of the original acquisition by the shareholder/member plus any cost of improvements incurred by the company/CC in respect of the residence on or after that date. •
•
Therefore, for shares acquired before 1 October 2001, the shareholder/member will not be able to use the market vale method in determining the base cost of the residence in his hands. He could only avail himself of the time apportionment base cost method (“TAB method”) or 20% of the proceeds in determining the base cost of the residence upon disposal. It is important to note that in the case of Scenario 1 no cognisance is taken of the shareholders loan account. – For example, Company A owned a residence with a cost of R1 million and a market value of R1.5 million. Shareholder X funded the acquisition of the property by Company A by means of a loan account of R1 million. Shareholder X sold all the shares and the R1 million loan claim in Company A to Shareholder Y for R1.5 million i.e. R500 000 for the shares and R1 million for the loan claim. The current market value of the residence is R3 million. Shareholder Y now wishes to avail himself of the relief measures contemplated in paragraph 51A and dispose of the residence to himself. However, as the disposal of the residence would fall under Scenario 1, the base cost of the residence in the hands of Shareholder Y would
Therefore, where the residence was acquired before 1 October 2001, as the base cost of the residence for the company/CC is rolled over to the qualifying individual, he may use the market value method, the TAB method or 20% of proceeds in determining the base cost of the residence in his hands.
Other tax implications for the qualifying individual (applicable whether Scenario 1 or 2 is applicable) Provided the requirements of paragraph 51A are met, there are no transfer duty implications for the qualifying individual acquiring the residence.
What are the tax implications for the qualifying individual in relation to a trust? For CGT purposes upon acquisition of the residence by the qualifying individual and termination of the trust the qualifying individual must disregard any CGT implications and the base cost of the residence is rolled-over to the qualifying individual. •
Therefore, where the residence was acquired before 1 October 2001, as the base cost of the residence for the trust is rolled over to the qualifying individual, he may use the market value method, the TAB method or 20% of proceeds in determining the base cost of the residence in his hands.
Provided the requirements of paragraph 51A are met, there are no transfer duty implications for the qualifying individual acquiring the residence.
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Multi-tiered structures One of the main differences between paragraph 51 and paragraph 51A is that the latter caters for a residence held via multi-tiered structures. Examples of multi-tiered structures to which the relief measures could apply include: • • •
Shares in a property company held by a trust; Shares in a property company held by a holding company; Shares in a property company held by a holding company and the shares in the holding company are held by a trust.
There is no limit to the number of entities within a chain which may qualify for the relief measures provided that the residence is ultimately disposed of to a qualifying individual, within six months from the date of the disposal of that residence. In addition, all entities that form part of the multi-tiered structure which have participated in the disposal of the residence, as contemplated in paragraph 51A, must be terminated within six months of the respective disposals.
value of R2.2 million on the date of disposal the residence is the only asset of Company A. The acquisition of the residence was funded by a loan extended by Trust B to Company A of R1 million which is still due in full to Trust B. In terms of a special resolution the trustees of Trust B authorise Company A to dispose of the residence to a beneficiary of Trust B at cost i.e. R1 million. The purchase price is settled by means of a loan account raised in favour of the beneficiary. Hence after the disposal of the residence to the beneficiary Company A has a loan payable to Trust B of R1 million and a loan receivable from the beneficiary of R1 million. Assuming all the requirements of paragraph 51A are met the tax implications are as follows: • • • •
Due to confusion with regards to the interpretation of the provisions of paragraph 51A and the application to multitiered structures, the view was initially held that in order for the residence to ultimately land up in the hands of a qualifying individual all the entities within the chain had to be terminated. This narrow interpretation of paragraph 51A would however have resulted in significant tax leakage especially where a trust held the shares in a property company as well as various other growth assets. However, since the release of Issue 2 of SARS’s Guide to the Disposal of a Residence from a Company or Trust (“the SARS Guide”) SARS has accepted that the legislation is wide enough so that all the entities within a chain need not be terminated provided these entities did not participate in the disposal of the residence.
•
Consider the following structure, by way of example:
•
Trust B
100%
Company A (Holds Residence)
Residence
Before the release of the SARS Guide in order for paragraph 51A to apply to the disposal of the residence to a beneficiary of Trust B, Company A and Trust B had to be terminated. However, SARS has now accepted that the wording of paragraph 51A is wide enough to allow for the disposal of the residence by Company A directly to a beneficiary of Trust B or any other qualifying individual. Therefore, the residence does not necessarily first have to be distributed to Trust B which then vests it in a beneficiary resulting in Company A and Trust B having to be terminated. The benefit of this allowance is that Trust A which may hold other high growth assets as well as the shares in Company A will not be subject to tax consequences in respect of these other assets upon termination.
Tax considerations in respect of multi-tiered structures Using the above mentioned example, assume the residence owned by Company A has a cost of R1 million and a market
The disposal of the residence to the beneficiary is not subject to CGT in the hands of the beneficiary or Company A. The beneficiary is deemed to have acquired the residence at a base cost of R1 million. The disposal of the residence at cost would qualify as a distribution of the residence as a dividend in specie and therefore there will be no DT implications for Company A. There will be no transfer duty implications for the beneficiary as the disposal complies with the requirements of paragraph 51A. As the disposal of the residence at cost has been made at the instance of Trust B as shareholder of Company A, Trust B will be deemed to have made a donation of R1.2 million to the beneficiary. However, as the acquirer of the residence is a beneficiary of Trust B, the disposal of the residence is made under and in pursuance of Trust B and therefore it is exempt from donations tax. – It is important to note that this would not necessarily be the case if the residence was disposed of at cost to the beneficiary’s spouse who is not a beneficiary of the trust (it would however depend on the provisions of the trust deed). – This would give rise to donations tax of R240,000 in the hands of Trust B. Finally, in order to terminate the existence of Company A, the loan receivable of R1 million from the beneficiary will be ceded to Trust B in settlement of the debt due to by Company A in the amount of R1 million.
Assuming the facts set out above are the same except that the residence is disposed of to the beneficiary’s spouse (“the spouse”), on loan account, at market value i.e. R2.2 million, the tax implications are as follows: • • • • • •
The disposal of the residence to the spouse is not subject to CGT in the hands of the spouse or Company A. The spouse is deemed to have acquired the residence at a base cost of R1 million. There are no DT implications as the residence was disposed of at market value. There will be no transfer duty implications for the spouse as the disposal complies with the requirements of paragraph 51A. There are no donations tax implications for Trust B as the disposal of the residence is at market value. Finally, in order to terminate the existence of Company A, the following will have to take place: – Firstly, R1 million of the loan receivable from the spouse will be ceded to Trust B in settlement of the debt due to by Company A in the amount of R1 million.
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The balance of the loan receivable from the spouse will also have to be ceded to Trust B and will represent the distribution of a dividend which is subject to DT in the amount of R180,000.
Other considerations Waiver of loan accounts The relief measures contemplated in paragraph 51A only apply to the disposal of a residence and therefore the disposal of any other assets held by the company/CC or trust could still trigger tax consequences. Possible donations tax as well as other CGT implications should be considered. For example, the waiver of a loan account for no consideration, or for a consideration which is less than the face value of the loan will give rise to a capital gain in the company/ CC or trust under paragraph 12(5) of the Eighth Schedule to the Act. However, no CGT will arise if the loan was extended to a company and it is waived by the lender in the anticipation of the termination of the company. This exemption only applies to the extent that the amount of the lender’s expenditure does not exceed the base cost of the debt at the time the waiver takes place. Furthermore, this exemption will not apply if the company becomes a connected person in relation to the lender after the debt or any replacement debt arose, and the transactions are part of a scheme to avoid tax. In addition, please note that there is no specific CGT exclusion available where a loan is waived in anticipation of the termination of a trust. Donations tax will be payable upon the waiver of a loan by a founder/beneficiary to a trust. However no capital gain will arise if the residence could be sold to the founder/beneficiary at market value, thereby discharging the loan account. The proceeds from the disposal can then be distributed to the trust beneficiaries without triggering any CGT implications.
Differential dividends There are conflicting views as to whether or not it is permissible for a company/CC to declare a dividend to a single shareholder as opposed to all shareholders within a particular class. SARS is of the view that the distribution of the residence to a single shareholder, especially where the residence constitutes the majority of the assets of the company/CC, when there are other shareholders, may very well constitute a donation by the other shareholders for the purposes of section 57, at least to the extent that the amount exceeds the benefiting shareholder’s pari passu1 entitlement. Therefore, if a company is owned by a father and
1. Equally and without preference
son in equal shares and the residence is distributed to the father alone, 50% of the value of the residence representing the son’s shareholding in the company would constitute a donation to his father. The son would therefore be liable to pay donations tax of 20% on the value of the 50% interest in the residence which he in effect waived in favour of this father. Once again however it is important to look at the legislation governing donations tax in order to ascertain whether the donor may qualify for an exemption. This would have to be dealt with on a case by case basis. The following question is whether the disposal of the residence to a single shareholder as opposed to all shareholders within a particular class gives rise to a value shifting arrangement? Value shifting refers to the transfer of value from one person to another in a manner that does not constitute a disposal for CGT purposes. However, it appears that for value shifting to take place, there needs to be a permanent increase in the shareholders entitlement of the interest in the company. Therefore, based on the fact that the disposal of the residence will not give rise to a permanent increase in entitlement, no value shifting arrangement would arise.
Conclusion In conclusion, despite the fact that on the surface the transfer of a residence out of an entity in terms of paragraph 51A may seem attractive and fairly simple it is clear that the initial motivation for holding the residence through an entity as well as the tax implications of taking advantage of paragraph 51A must be carefully considered. As can be seen from this newsletter the legislation is far from simple and does not take into account the various other tax implications for example donations tax which may arise when taking advantage of paragraph 51A. Furthermore, there are still valid and compelling reasons why it may be more beneficial to continue to hold a residence within an entity such as a trust and not necessarily directly for example where the residence is a holiday home and would not qualify for the primary residence exclusion in any event. Finally, careful consideration should also be given before availing oneself of the relief measures where the entity holding the residence also holds other high growth assets which would result in tax implications upon termination of the entity. In the light of all these considerations we recommend that professional advice is sought before disposing of the residence in order to make an informed decision.
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Disclaimer This publication is produced for information purposes only and does not constitute formal advice. PKF cannot be held liable for any losses suffered as a result of reliance upon information contained in this publication. PKF South Africa Inc is a member of the PKF International Limited network of legally independent firms and does not accept any responsibility or liability for the actions or inactions on the part of any other individual member firm or firms.