By: Steven Jones
Posted: 21-AUG-06
Unless you live in one of those fabulously opulent homes featured on Top Billing each week, you have probably not given Capital Gains Tax (CGT) too much thought. The reason for this is that the first R1,5m of gains on the sale of your home is exempt from this tax.
However, many people own their home through a CC, private company, or trust. The main reason was estate planning, although at one time there was a loophole (subsequently closed by the South African Revenue Service, Sars) under which such properties could be sold without incurring transfer duty. If this is you, you may want to sit down before reading any further, because you could be in for a tax shock when you decide to sell this property.
CGT and the “window period”
When CGT was introduced, the legislation provided for an exemption on the first R1m (now R1,5m) of any gains realised on the disposal of your home, or “primary residence”. However, the catch is that this exemption is only available to individual taxpayers.
This meant that corporate homeowners faced a potentially crippling CGT bill when disposing of the underlying property in which the members resided. Recognising this potential burden, the legislature built in a 12-month “window” in which such properties could be transferred into the individual’s name without incurring any liability for CGT.
This “window” closed on September 30 2002.
Taking the pain
Of course, if you had used this window period to transfer your property into your own name, there would have been some costs – particularly if you needed to cancel and re-register your mortgage bond. However, this pales into insignificance when compared to the scenario that follows.
Suppose that you owned a property worth R500 000 when CGT was introduced in October 2001. Given the recent rises in property values, it is not inconceivable that the same property would be worth R1,5m today. If you sold this property today, and it was owned in your personal capacity, the R1m profit would have been completely exempt from CGT.
However, if the same property, which has been occupied by you and your family, was still owned by a corporate entity, the entity would have had to fork over R145 000 to Sars in the form of CGT.
Adding insult to injury
It doesn’t stop there. If you had a bond of R500 000 on the property, or had initially advanced this amount to the corporate entity, you would be left with R855 000 after you have settled your CGT account with Sars. However, this money is not actually yours – it belongs to the corporate entity.
The declaration of a dividend will solve this problem, right? Not quite. There is another sinister tax called Secondary Taxation on Companies (STC), which is levied at 12½% on any distributions made to members. The corporate entity is liable for this tax.
Normally the corporate pays the tax from its other cash resources. However, since the entity has now sold the property and wishes to distribute the entire cash amount, you would need to declare a dividend of R755 555 in order to leave sufficient cash to pay the R94 445 STC liability.
Add this to your CGT bill, and you end up with a total tax liability of R239 445 – an effective tax rate of nearly 24%. Ouch!
Avoiding this tax liability
One way of avoiding this tax liability is to simply not tell Sars that you have disposed of the property. Not a good idea. Before transfer of the property could take place, you would have had to complete and lodge a declaration for transfer duty, so Sars knows that a property has changed hands.
Furthermore, when you submit the next income tax return for the company, the property will no longer appear on the balance sheet. Alternatively, Sars can simply perform a Deeds Office search to verify the property transaction.
If you have taken the cash, Sars will be knocking on your door for the STC as well.
The penalties for tax evasion are severe – up to 200% of the tax due, not to mention interest from due date to date of payment. Sars may also decide to lay criminal charges against you. Remember that tax evasion is what eventually put Al Capone behind bars!
The other way is to simply sell the entity in its entirety. However, this strategy will not help you avoid the CGT liability, but at least the STC problem will be avoided. Unfortunately, you are probably unlikely to find anyone willing to buy your company – the primary residence exemption has been fairly well-publicised, and any astute buyer looking for a home will opt to buy the house itself.
Damage limitation
If you are about to sell the property or intend to do so within the next six months or so, it’s probably not worth incurring the expense of transferring the property into your own name.
However, if it is your intention to keep the property for some time, it may be worth your while to bite the bullet, transfer it now, and pay the relevant taxes. If you don’t, imagine what your potential CGT and STC liability will amount to in 20 years’ time, when your property could potentially be worth R12m if one assumes a doubling in value every seven years.
It is often said that ignorance of the law is no excuse. In this case, such ignorance is also expensive.