About a year ago I wrote an article about certain changes to the Transfer Duty Act that affect speculators in property.
The effect of the changes can be illustrated as follows:
You sign a purchase agreement to buy a property for R400 000. Before the property is transferred into your name, you find someone else who wants to buy the property for R500 000.
You cancel the first transaction in favour of the new purchaser, who pays you a cancellation fee of R100 000 and pays the original purchase price (R400 000) to the seller.
You retained a portion of the purchase price - that is, you did not cancel the first agreement so that you did not receive a financial benefit - and so you will pay transfer duty on the full purchase price (R400 000) set out in your original purchase agreement.
In addition, the new buyer will pay transfer duty on the purchase price and the cancellation fee - that's a total of R500 000!
Clearly, in this scenario the seller is not a registered value added tax (VAT) vendor because he or she is not a property developer or trader. In addition, the property is residential rather than commercial. Where a seller is registered for VAT, he or she must levy VAT on the sale of the property and, because VAT is raised, no transfer duty is payable.
But how does the legislation apply in the following scenario?
You purchase a property from a property developer (who is registered for VAT) for R456 000 (that is, R400 000 plus 14 percent VAT of R56 000).
However, before taking transfer, you find another purchaser who is willing to pay R570 000 (R500 000 plus VAT). The purchaser approaches the developer to cancel the sale to you and to rather sell the property to him/her.
In terms of the arrangement, the developer agrees to give you R100 000 as a cancellation fee.
This scenario raises the following questions:
- Is this legal?
- Would the cancellation fee you receive be subject to income tax or capital gains tax (CGT)?
Firstly, I do not believe there is anything in law to prevent you entering into such an arrangement (in other words, it is not illegal).
But what about the VAT and transfer duty consequences?
As a result of the original agreement being cancelled, the property developer will not have "supplied" property to you. Consequently, VAT will not be levied on the original sale.
However, because we are dealing with fixed property that is subject to transfer duty, we must still look at whether or not there are any transfer duty implications.
According to the legislation that came into effect on December 22, 2003, because you have not "relinquished all rights" and have received some "consideration arising from such cancellation" (that is, the R100 000 cancellation fee), you would be liable for transfer duty on the R400 000 reflected in the cancelled sale agreement (this would not be exempt from transfer duty because VAT was not paid instead).
The developer will still charge the buyer R570 000, and will pay VAT of R70 000 to the South African Revenue Service (SARS).
Will you pay income tax on the R100 000 cancellation fee? Very likely. If SARS believes that you entered into the arrangement for the purposes of making a profit, you will be liable for income tax on the amount you receive.
If you can demonstrate that you withdrew from the contract for another reason - for example, it was always your intention to take the property but the purchaser approached you with an offer you couldn't refuse, and consequently, the cancellation fee is just a lucky gain - you will be viewed as having disposed of your right in the property in return for the cancellation fee. In this case, you will be able to pay CGT on the amount, which is effectively lower than the income tax you would be liable for if you had to pay that tax.
It is important to remember that the onus of proving your intention lies with you, and proving your intention may be difficult without supporting evidence (for example, documents). SARS will assume the worst unless you can prove otherwise.
- Deborah Tickle is a tax partner at KPMG.