Holiday Homes Portal News

Fractional Ownership: New tax implications

Date: 13/01/2010
Article source: Fractional Ownership

Outright ownership of a second home on a golf course or in some other luxury destination has moved beyond the vast majority. This has brought about the upswing in fractional ownership through which individuals can own a fraction or part of that dream.

Legally, fractional ownership normally takes two forms. It can be achieved through the purchaser acquiring a stake in a company which owns the property, or through the purchaser holding an undivided share in the property. The first method has been targeted in the latest set of tax amendments by the South African Revenue Services (SARS).

Ordinarily, VAT is charged where there is a supply of goods or services made by a vendor. The definition of "goods" in the VAT Act includes "immovable property". Immovable property is again defined as including "any share in a share block company which confers a right to or an interest in the use of immovable property". Therefore, where a sale of a share in a share block company takes place, it is subject to VAT if the seller is a vendor.

Most developers would be VAT registered as they are supplying goods, and carrying on a trade, with throughput which would exceed the registration threshold of R1m.

Transfer duty on the other hand taxes the acquisition of immovable property which is NOT subject to VAT. Transfer duty also applies to the acquisition of shares in companies mainly consisting of immovable property dedicated to residential use – a "residential property company". The fair value of the immovable property in that company must comprise more than 50% of the aggregate fair market value of all assets held by that company for transfer duty to apply to such a company. Residential property would include normal houses, holiday homes and similar abodes.

So it would appear that one was either caught under VAT or under transfer duty, and clever structuring through a corporate structure would not help. But a gap was found.

Tax expert Grant Bayne explains: "A sale of a share in a share block company could escape transfer duty under certain conditions. An example of this is where a share in a share block company is sold by a non-vendor shareholder. As the seller is not a vendor, the sale falls outside of the VAT net. The sale of the share also falls outside the Transfer Duty Act if the company is not a residential property company.

"This loophole could have arisen where shares in certain companies are offered as fractional ownership. The companies are constructed in such a way that they don't fall under the definition of a residential property company. The sale by the developer will be subject to VAT as fixed property, but any subsequent sales would have fallen outside the Transfer Duty where the fractional ownership is, for example, in respect of an apartment block, hotel or structure of five units or more."

This loophole has now been closed. Bayne goes on: "Where one acquires a stake in a company holding immovable property, the purchaser of the shares would have a right to use the property for certain periods. This would be a right granted in the shareholder agreement (or whatever the document is called by the relevant developer). It is the granting of this right of use that brings the scheme into the ambit of the Share Blocks Control Act."

A "Share Block Scheme" is defined in the Share Blocks Control Act as "any scheme in terms of which a share confers a right to or an interest in the use of immovable property".

"This leaves very little doubt that the definition includes fractional ownership where it is held through a company structure. There is also little room to structure differently as the ultimate aim is the use of that dream home on the golf course, or by the sea. It is that "use of immovable property" which is being bought. Just in case you wish to argue otherwise, the Share Blocks Control Act goes further and states:

"For the purposes of this Act a company shall be presumed to operate a share block scheme if any share of the company confers a right to or an interest in the use of immovable property or any part of immovable property".

So how does this affect us when considering the latest changes in the Revenue Laws Amendment Act? The amendment to the Transfer Duty Act now incorporates a share in a share block company as defined in the Share Blocks Control Act, 1980 (Act No. 59 of 1980).

Says Bayne: SARS provides a good conclusion:

"A share in a share block company is economically equivalent to a direct interest in immovable property and should be treated as such for purposes of the Transfer Duty. This treatment should apply regardless of the nature and percentage of immovable property held by the company. Once applicable, the fair value of the share block company will be measured without regard to liabilities, and the seller will become jointly liable for any unpaid transfer duty. Both these requirements are consistent with the rules for residential property companies.

A company that is not registered in terms of the Share Blocks Control Act can also be caught by this proposal if deemed to be a share block by virtue of section 4 of the Act (due to the conferral of a right to or an interest in the use of immovable property).

The net impact of these changes is to ensure that shares in a share block company block are treated like sectional title interests. The sale by the developer will trigger VAT; subsequent transfers will be subject to the Transfer Duty."