Taxing Matters – Disposal of a Primary Residence from a Company or Trust to Individuals

Those taxpayers who have not taken advantage of the Receiver of Revenue’s window period in which to transfer their primary residence out of a company (which includes a close corporation) or trust without tax or penalty have been granted another opportunity.

Historically, some individuals acquired their residence in a company or trust, primarily to avoid transfer duty. Since the introduction of capital gains tax (“CGT”) and transfer duty on the disposal of shares in residential property companies and beneficial interests in trusts, the advantages of these residential property holding entities have to a large extent diminished, coupled with the fact that the primary residence exclusion from CGT is only available to individuals.

During 2002, there was a two– year window period and in 2009 a restored window period, contained in paragraph 51 of the Eighth Schedule to the Income Tax Act No. 58 of 1962 (“the Act”), whereby relief was granted to taxpayers to encourage them to transfer their residential properties out of companies or trusts with no CGT, transfer duty or secondary tax on companies (“STC”) consequences.

Paragraph 51A has now been introduced into the Eighth Schedule to the Act and caters for the disposal of a residence by a company, or trust to an individual, between 1 October 2010 and 31 December 2012, free of CGT, STC and transfer duty.
The CGT and transfer duty consequences are effectively postponed until the ultimate disposal of the residence by the individual at a future date (“rollover relief”).The most significant difference between paragraph 51 and paragraph 51A is that multi–tiered structures are now catered for in paragraph 51A.

Requirements
The following requirements must be met in order for the company or trust to qualify for the rollover relief:
The disposal of the residence must take place on or before 31 December 2012;
The individual acquiring the residence must be a connected person in relation to the company or the trust; must have ordinarily resided in the residence; and must have used the residence mainly for domestic purposes (“qualifying individual”) during the period commencing on 11 February 2009 and ending on the date of the disposal (“the qualifying period”). Without going into detail with regards to the definition of a connected person per section 1 of the Act, broadly speaking, a connected person in the context of this paragraph is¹:

in relation to company –
any 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

in relation to a trust –
any beneficiary of such trust or any relative of the beneficiary of the trust

in relation to a close corporation –
any member or relative of such member.

Within six months of the date of disposal:
certain prescribed steps must be taken to wind up, liquidate or deregister the company (“terminate”); or
in the case of a trust, the founder, trustees and beneficiaries of that trust must have agreed in writing to the revocation of the trust, or an application must be submitted to a competent court for the revocation of the trust.

It is interesting to note that –
The term residence excludes vacant land.

Unlike paragraph 51, there is no limitation/restriction on the size of the land on which the residence is situated.
Common property associated with a sectional title unit or an interest in a share block company is not excluded from paragraph 51A. The common property will be owned jointly by the sectional title unit holders.

The residence may only be disposed of to an individual. Therefore the residence may not be disposed of to a deceased estate. However, in situations where the individual passed away after acquiring the residence under an unconditional agreement, but before the residence is registered in his/her name, the rollover relief will apply.

The qualifying residence must be utilised mainly for domestic purposes. The term “mainly” is not defined, but according to case law is determined on a floor–area basis which needs to exceed 50 per cent in respect of domestic use.

Temporary absences such as vacations or business trips will be ignored when determining whether the individual ordinarily resided in the residence. However, the disposal of a holiday home will not qualify for rollover relief.

Other assets which need to be disposed of prior to the company or trust being terminated may result in tax implications for the company/trust.

CGT implications for the company and/or trust
The company and/or trust is deemed to have disposed of the residence at its base cost. Therefore, there are no CGT consequences upon disposal of the residence.

CGT implications for the person acquiring the residence from a company
In the case where the company owned the residence prior to the shareholders obtaining their shareholding in the company, and 90 per cent and more of the market value of the assets of the company, during the qualifying period, is attributable to the residence, the person acquiring the residence:

must disregard the disposal of the shares held in the property company (i.e. there are no CGT consequences upon termination of the company and the consequent disposal of the shares by the shareholder); and
will be deemed to have acquired the residence for a base cost equal to the cost of the shares, as at the date of acquisition of those shares, plus the cost of any improvements effected in respect of the residence subsequent to the date of the acquisition of the shares.

In all other cases i.e. where the aforementioned requirements are not met, for example where the shareholders acquired their shares before the company acquired the residence, the person acquiring the residence:

must disregard the disposal of the shares held in the property company (i.e. there are no CGT consequences upon termination of the company and the consequent disposal of the shares by the shareholder); and

will be deemed to be one and the same person with respect to –
the date of acquisition of the residence by that company;
the amount and date of incurral of any expenditure allowable in determining the base cost of the residence for CGT purposes; and
any valuation done in respect of that residence for CGT purposes.

CGT implications for the person acquiring the residence from a trust
The person acquiring the residence will be deemed to be one and the same person with regards to –

the date of acquisition of the residence by that trust;
the amount and date of incurral of any expenditure allowable in determining the base cost of the residence for CGT purposes; and any valuation done in respect of that residence for CGT purposes.

STC exemption
In order to qualify for an exemption from STC upon disposal of the residence and termination of the company, the residence must be distributed as a dividend in specie.
Therefore, should the residence be disposed of by way of a sale, any distribution of the resulting profit will not qualify for an exemption from STC.

Transfer duty implications
No transfer duty shall be payable in respect of any acquisition of a residence contemplated in paragraph 51A of the Eighth Schedule to the Act.

Approach with respect to multi–tiered structures
In the case of multi-tiered structures, the residence must ultimately be disposed of to a qualifying individual on or before 31 December 2012. In addition, all persons i.e. company’s and trusts forming part of the mult-tiered structure must be terminated within six months of the respective disposals.
Therefore in the above illustration, Company A must be terminated and Trust B must be revoked within six months of their respective disposals.

Considerations and Conclusion
The possible tax implications must be considered where the acquisition of the residence was funded by a loan extended by a shareholder/beneficiary and such loans are waived as a result of the disposal of the residence and termination of the company or trust.

Trust deeds may need to be amended where for example an individual who is related to a beneficiary of the trust but is themselves not a beneficiary, ordinarily resided in a residence, owned by such trust, and the residence is to be distributed to them.

The implications where there is more than one shareholder in a company owning the residence must be considered. There are conflicting views as to whether or not it is permissible for a company to declare a dividend to a single shareholder as opposed to all shareholders within a particular class and what the attendant tax implications may be.

Although the Act does not prescribe how the residence should be disposed of by the company or trust, for example, whether by way of a distribution or sale, it must be borne in mind that a company will not qualify for an STC or dividends tax exemption unless the residence is distributed as a dividend in specie.

Finally, although the rollover relief is beneficial for a person wanting to transfer their primary residence into their own hands to, amongst other reasons, qualify for the primary residence exclusion, it is important to note that this relief might not be beneficial to trusts or companies that own other significant assets, as the rollover relief is not applicable to the disposal of any other assets. Therefore, the consequent tax liability arising as a result of terminating the company or trust which has other high growth assets must be weighed up against the benefit of holding the residence in the name of the individual.

1. 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.

TAXtalk: www.taxtalk.co.za

Print Friendly, PDF & Email
Short URL to this article: http://tinyurl.com/8wuge5c

All material subject to our Legal Disclaimers.

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.