The introduction of capital gains tax ("CGT") from 1 October, 2001 will have far-reaching implications for taxpayers. Commercial property will be treated as any other asset for CGT purposes. There are no special relief provisions in respect of these assets.

Property held in various entities Commercial properties are generally held in companies, close corporations or trusts and sometimes in individuals' own hands. The tax implications relating to each may vary significantly. The question that arises is what form a disposal should take, when the property is located within such an entity.

Disposal of property by a trust: Where property is disposed of by a trust, the capital gain will accrue to the trust, which will be liable for the CGT. The rates at which gains will be taxed in trusts are listed in the panel below right. The trust may thereafter distribute the capital gain to a beneficiary who is a resident. In this instance, if such distribution is made in the same tax year, the trust will disregard the capital gain and the gain will be treated as a gain of the beneficiary, which may give rise to a lower effective tax liability. Bear in mind that, if the capital gain is distributed to the beneficiary, then the trust will no longer have the money available to acquire a new property. In such a situation it is possible for the beneficiary to lend the money back to the trust. However, all the usual income tax considerations in respect of loans to trusts will then have to be considered; it would be advisable to seek advice before embarking on a specific route.

 
Disposal of property by a company or close corporation: If a company or a close corporation disposes of a property then the capital gain or loss will be subject to CGT in the company or close corporation. Any subsequent distribution of the capital gain by the company or close corporation that constitutes a dividend will be subject to STC at 12,5%, unless the distribution arises on deregistration or liquidation.

Disposal of property by an individual: Where an individual disposes of property, the capital gain or loss will be subject to CGT in the individual's hands at the rates listed below.

Capital versus revenue: Taxpayers must remember that where an amount is subject to income tax it will not also be subject to CGT. Therefore, when a revenue asset is disposed of, the gain on the disposal will not give rise to CGT, but will be subject to normal income tax. However, it will be beneficial for a taxpayer if the amount is capital since the effective tax rate on the gain will be lower than on taxable income. For example, the income tax rate for a company is 30%, while the effective rate of tax in a company in respect of a capital gain is 15%.

Base cost in respect of commercial property: The option of performing a valuation in respect of an asset only exists where the asset was acquired before and is not disposed of on 1 October 2001 (i.e. a pre-valuation date asset). For all assets that are not pre-valuation date assets, the base cost as determined in the CGT legislation must be used. There are different methods of determining the base cost of pre-valuation date assets. It is important to use the correct method when the asset is disposed of.

This legislation specifically states which amounts may be taken into account in order to establish the base cost of an asset. The base cost of commercial properties will consist of expenditure actually incurred in respect of the acquisition, creation or disposal of the asset, including costs such as stamp and transfer duty, certain amounts of donations tax paid, expenditure incurred to acquire an option to purchase the asset, as well as the cost of obtaining a valuation for CGT purposes. In addition, expenditure actually incurred to improve the asset or to establish, maintain or defend a legal title to the asset will also be added to the base cost of commercial property. Any amount of VAT paid by the taxpayer in respect of the property that can not be claimed as an input credit will also be added to the base cost of the asset. Remember that taxpayers will be required to retain original documentation to support these amounts. Examples of the documentation that Revenue has in mind are invoices, paid cheques, contracts of purchase and sale, as well as any correspondence in respect of the amounts. Taxpayers will have to retain the documents for four years after the date on which the Commissioner receives the tax return reflecting the capital gain or loss in respect of the asset to which they relate.

Leasehold improvements: A taxpayer may not include any amount in the base cost of an asset where someone else incurred the amount. Therefore, where a lessee effected leasehold improvements to a property before 1 October 2001, it will be necessary for the lessor (owner) to obtain a valuation of the property so as to include the value of the improvements in the base cost of the property. Leasehold improvements effected by a lessee after 1 October 2001 may not be included in the base cost of the asset.

Cascading: In a group with a vertical holding structure, there is a risk that CGT may give rise to a "cascading" tax effect. Assume a scenario where A holds all the shares in B Co and B Co holds all the shares in C Co, which owns property. The group holds no other assets. If the property increases in value, then the value of the C Co shares held by B Co will increase and, therefore, the value of the B Co shares held by A will also increase. If A sells the B Co shares then A will also increase. If A sells the B Co shares then A will realise a capital gain equal to the growth in the underlying property held by C Co. If B Co then sells the C Co shares, then B Co will realize a capital gain equal to the increase in the value of the underlying property owned by C Co. When C Co sells the property, C Co will realise a capital gain equal to the increase in the value of the property. This example shows the increase in one asset being subjected to CGT three times. The more entities there are in the chain the greater the cascading effect will be. A possible way of preventing this from happening will be to sell the property held by C Co first. C Co will then realise a capital gain. The amount of the gain can then be distributed through the group into A's hands and the subsequent sales of shares will not include any amount relating to the capital gain on the property. It should be noted that STC of 12,5% will, however, be payable on the declaration of the ultimate dividend. In situations such as this it will be wise to obtain appropriate advice before embarking on a specific course of action.

The choice between selling assets or shares: Where a taxpayer owns a company or close corporation, which owns a property, and wishes to dispose of the asset, it is necessary to consider the different implications arising from the sale of the property by the entity and the sale of the shares or members' interest. If the taxpayer, for example, is an individual and sells the shares, then the capital gain or loss arising from the sale will be subject to CGT at the individual rate of tax, which would mean that the maximum effective rate of tax would be 10% (25% x 40%). Should the company or close corporation sell the property, then the capital gain or loss will be subject to the corporate rate of tax, which means that the effective rate of tax would be 15% (50% x 30%). In addition, any amount distributed by the company to the taxpayer in the form of a dividend may attract STC at 12,5% in the company. The choice of action will depend on the circumstances of both the taxpayer and the purchaser.

Purchasing property: Where a group of companies holds various properties and intends to purchase further properties, it will be wise to establish which of the properties owned may give rise to capital losses in the future. If the entities holding such properties do not hold other assets that will give rise to capital gains, then the capital losses will not be utilised and will be of no benefit to the entity or the group, since capital losses, like assessed losses, may not be transferred between taxpayers. When new purchases are made, it will, therefore, be wise to consider placing such properties in those entities where potential unutilised losses may lie.

Obtaining a valuation: If you own commercial property at 1 October 2001, the question of obtaining a valuation for that property arises. It is generally suggested that valuations should be obtained wherever possible, since this will give the taxpayer an additional option to consider when determining a capital gain or loss on disposal of an asset. If it is decided to obtain a valuation, then the valuation must be performed within the two years starting on 1 October 2001. Although the valuation need not be performed on 1 October 2001, the value reflected in the valuation should be the market value of the property as at 1 October 2001. Therefore, if improvements are effected to the property after 1 October 2001, but before the date on which the valuation is performed, then the valuer should disregard any increase in the value of the property arising from the improvements. The CGT legislation does not prescribe who should perform a valuation and it is anticipated that a valuation performed by either a registered valuer, estate agent, or even possible a Directors' valuation would be sufficient. A valuation performed by a registered valuer would probably have the most weight when having to satisfy SARS that a valuation is reasonable. Remember, however that the onus to prove that a valuation correctly reflects the value of an asset at 1 October 2001 rests with the taxpayer. If the Commissioner is not satisfied with a valuation, then the Commissioner may adjust the value of the asset. Thus, taxpayers will be well advised no to attempt to obtain valuations that do not reflect the true value of their assets.