Tax provision for the transfer of residences out of companies and trusts not without its quirks

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Recent amendments to the Income Tax Act allowing taxpayers to transfer residences out of companies and trusts free of tax have widely been welcomed. "Although we are seeing a great deal of interest in this provision, taxpayers need to be aware of its problems", says Ilsa Groenewald, an Associate Director in the Tax division at BDO in Durban. "Although ownership of a residence in a trust structure affords advantages in terms of protection against creditors and savings in estate duty, the rate of tax payable on capital gains in a trust is a flat 26.6% rather than a maximum of 13.3% by an individual. Where the residence is acquired and disposed of by a company, dividends tax on any resulting profit at a rate of 15% will be payable in addition to capital gains tax, which is at a rate of 18.65%. So making the incorrect decision can be a costly mistake".

An individual, as opposed to a trust or company, also qualifies for a R2 million capital gains exclusion relating to gains on the disposal of a primary residence. Therefore, putting considerations of estate duty aside, taxes payable are considerably increased where residences are acquired and sold by trusts or companies compared to the tax that would be payable by individuals.

However, although the changes largely appear to be a concession to taxpayers, the changes also take away from the taxpayers at the same time. In exchange for the tax-free transfer of the residence out of a trust or company, the trust or company has to be dissolved. This would then trigger potential capital gains tax on the distribution of any other assets there may be in the trust or company, and also takes away the estate duty savings potential in a trust structure. And where multi-tier structures are involved, for example a trust holding shares in a company which holds shares in another company which holds the residence, each entity in the chain has to be dissolved.

Other complexities lie in the definitions and the detail. The amendment was enacted with the apparent aim of broadening the concession so as to apply to the transfer of holiday homes as opposed to primary residences. It requires that the residence must have been 'mainly used for domestic purposes' during the specified time frame 'by one or more natural persons who are connected persons in relation to the company or trust at the time of that disposal'.

Although at first blush the wording of the amended provision when compared with that of the previous version allows for a wider range of residences to be transferred tax-free, the current wording is capable of a multiplicity of interpretations. It is possible to interpret the phrase 'mainly used for domestic purposes' during the specified time frame 'by one or more natural persons who are connected persons in relation to the company or trust at the time of that disposal' in such a way that it is tantamount to a 'primary residence' requirement. It is also possible to interpret it in such a way that only the use by the 'natural persons who are connected persons in relation to the company or trust' is relevant to whether or not the residence qualifies for relief.

"Apart from these challenges, taxpayers should also be aware that various other complications can arise, for example where a residence is held in a company with multiple individual shareholders one needs to be aware that in terms of the Companies Act, shareholders cannot receive differential dividends from the company. In addition, in the case of a trust, a situation to avoid is that of being left with a loan from or to beneficiaries on the dissolution of the trust, as this will trigger a capital gain in the hands of the debtor. It is our advice that any taxpayer wanting to take advantage of this amendment needs to consult with a tax professional as there are numerous complexities and problems that require attention prior to making a decision", concludes Groenewald.