It has often been the case in the past, for a number of reasons, where a residential property
was acquired by a company or close corporation, rather than the individual. One of the
reasons for this type of structuring in the past was the fact that the disposal of the immovable
property itself would result in transfer duty at (current) rates ranging from 3% - 13%. On the
other hand, stamp duty (as it was at that point in time) of 0.25% of the (market) value or
consideration was payable for the residential property, whichever was higher. This perceived
abuse was closed down by a change in the definition of “property” in the transfer duty
legislation insofar as residential property held by a company was concerned.
Whether an individual seller sells a residential property in his or her own name, whether
residential property shares are disposed of or whether the residential property is sold out of
the company, will result in differing capital gains tax (CGT) and tax liabilities for the seller.
Depending on the exact facts, the differing tax treatments may be material.
Assumptions: Assume the original base cost (original purchase price) of the residential
property was R2 000 000. Assume the residential property is sold for R5 000 000. This does
not take into account base cost expenditure incurred on improvements, renovations or
enhancements to the residential property with respect to scenario’s 1 and 3 below.
Scenario 1 – the individual owns the property
The capital gain on the disposal of the residential property will be R3 000 000 (R5 000 000 –
R2 000 000). If the individual meets the requirements of the “primary residence exclusion”
(i.e. the individual has ordinarily resided in the residence as his or her main residence, and
such residence has been used mainly for domestic purposes) contained in the CGT
legislation, such individual when determining his or her aggregate capital gain, must
disregard so much of the capital gain as does not exceed R2 000 000. In the current
example, this would result in an aggregate capital of R1 000 000 (R3 000 000 –
R2 000 000). Assuming that the individual is subject to the maximum effective CGT rate of
18% (40% of the gain is taxed at 45%), this results in a CGT liability of R180 000
(R1 000 000 x 18%).
Total Tax (CGT liability): R180 000
Scenario 2 – the individual owns the residential property through a company – sale of
shares
In this scenario, the individual sells his property-rich shares. This can prove a challenge if
the seller cannot prove the base cost for CGT purposes of the shares themselves (this may
or may not be the R2 million originally paid for the property by the company). This will
depend, amongst other things, on how the company was originally funded in order to acquire
the residential property or to undertake any improvements or enhancements to the property.
If the base cost of the shares (i.e. an amount of R2 000 000) can be proved, the CGT liability
will be calculated at R540 000 (R3 000 000 x 18%). The “primary residence exclusion” will
not be available as would be the case with Scenario 1.
Assuming that the original base cost of the shares cannot be proved, the ‘20% of proceeds
method’ may be used as a basis of determining base cost. This method would result in a
base cost of R1 000 000 for the shares, resulting in a capital gain in the hands of the seller
of R720 000 (R4 000 000 x 18%). Again, the “primary residence exclusion” will not be
available.
Total Tax (CGT) liability: R540 000 – R720 000 (depending on whether original base cost in
the shares themselves are able to be proved).
Scenario 3 – individual owns the residential property through a company – the
company disposes of the residential property
In this scenario, the company will be liable for CGT of R648 000 (i.e. 80% of the gain of
R3 000 000 is subject to the corporate income tax rate of 27%). Again, as with scenario 2,
the “primary residence exclusion” will not be available.
Further, however, what happens if the individual owning the shares needs his cash? If the
net proceeds from the disposal of the property after CGT are paid by the company to the
individual, this amount will be subject to the dividend withholding of 20%. An amount of
R470 400 dividends tax will accordingly be payable (R2 352 000 x 20%).
Total Tax Liability: R1 118 400 (CGT of R648 000 + dividends tax of R470 400
In conclusion, in deciding how to acquire a residential property and how to structure the
ownership of such property, depends on many factors, including commercial and financial
factors such as the cost of the property, the proving of base cost expenditure in the future,
the property’s anticipated capital growth, the level of renovation/improvement required, how
long the property will be held, the funding of the acquisition of the property itself or the
property-owning company, etc. What should not be forgotten, however, in considering the
very basic fact pattern contained in the scenario’s above, is that it is evident in the end that
sometimes the simplest solution is the best solution.
