The Taxation Laws Amendment Act, 2010 includes the final version of the provision introduced last year, providing for the transfer of residential properties from trusts or companies to natural persons connected with the entities, at base cost to the entity in each case. This version, in paragraph 51A of the Eighth Schedule to the Income Tax Act, is far more inclusive than its predecessor, but the unfortunate aspect is that it requires the termination of the trust or company after the disposal.
The requirements for this concession to apply may be summarised by means of five questions, each of which must be answered in the affirmative:
- Has the entity disposed of an interest in a residence before 31 December 2012?
- Has the residence been used mainly for domestic purposes during (note: not throughout) the period from 11 February 2009 to the date of disposal?
- Did the occupants of the residence ordinarily reside there?
- Are the occupants connected persons in relation to the entity?
- Have steps been taken within six months of the disposal to terminate the existence of the entity?
If all these conditions are in place, the recipient of the disposal is deemed to have held the property since the entity acquired it, and at the same cost. If the entity is a company and the current shareholder acquired the shares after the company acquired the property, the base cost of the property is deemed to be that of the shares.
Consider a typical situation: a house is registered in the name of a company and the shareholders, being the spouses, ordinarily reside in it. All the above conditions are met. This would be the case even if one spouse was the sole shareholder, because the other spouse would be a connected person in relation to the company through his/her relationship with the shareholder. The recipient of the house need not be a person who was residing in it; in fact, the options for a company to distribute an asset are limited to shareholders, because paragraph 51A does not override the provisions of the Companies Act. It follows that the house may only be distributed by way of dividend, which means that the only possible recipients are the shareholders. If the children of the shareholders ordinarily reside in the house, the disposal may take place to the shareholders because they are connected persons in relation to the shareholders.
In much the same way, a trust that owns a residential property may distribute it, but only to a beneficiary of the trust. Here too, the person who occupies the property need not be the recipient, but must be a connected person in relation to the trust.
Two common situations exist in these circumstances, both of which have attracted enquiries as to whether the provisions apply: where the share capital of a company is held by a trust and the company owns the property; and where the residence is a holiday home.
In the first instance, there will be two applications of the five questions, one for the disposal to the trust and one for the further disposal to a beneficiary of the trust. Firstly, if the occupants are beneficiaries of the trust and ordinarily reside in the property, then they are connected persons in relation to the company, because the company is a connected person in relation to the trust by virtue of the trust’s shareholding. Therefore the company may distribute the property to the trust as a dividend. Secondly, once the property is owned by the trust, the five questions are applied at that level of ownership and the answers are all in the affirmative as regards the disposal of the property to a beneficiary.
Sadly, in most instances a holiday home will not be amenable to disposal in terms of paragraph 51A, because it is unlikely to provide an affirmative answer to question 3 regarding whether the occupants ordinarily resided there.
One final point to bear in mind is that the use of this provision might not be attractive if the entity holds other assets as well, because these would have to be disposed of in the course of the compulsory termination of the existence of the trust or company, which might well lead to CGT consequences.
The lesson is clear: do not rush into the application of paragraph 51A without careful advice and consideration.