I currently own a home which I consider my primary residence. I want to invest in an investment property and to purchase this property using another vehicle, such as setting up a company for tax purposes. With regards to the company can it just be a shelf company or does the company have to trade?
In terms of using a company structure for the property, you may use either an actively trading company or a so-called ‘shelf company’. Should you use a shelf company to purchase an investment property, we can assume that the property will be generating a rental income. As such, the company will be deemed an active trading company. Keep in mind that, if you use or purchase a shelf company for the purpose of housing your investment property, you will need to complete any outstanding tax returns in respect of the company as is required by Sars, even if it is a nil return for each year. These outstanding returns may sometimes incur administrative penalties for non-submission, or interest on outstanding tax liabilities, so be sure to do your homework before using such a company.
When assessing the benefit of using the company structure for tax purposes, it is important to run a thorough analysis of the potential costs and benefits of doing so. Bear in mind, when holding investment property in your personal capacity, only the net income from the property is included in your taxable income. Items such as interest on the bond, insurance, rental agent fees, maintenance, municipal rates, etc, are all deductible costs to the rental income from the property.
Therefore, only the net income after the deduction of all allowable costs is then added to your personal taxable income and taxed at your marginal rate.
Depending on the level of your personal earnings and taxable income, using a company structure may have some tax benefits, depending on your taxable income and the expected net taxable income from the rental property. However, since the nature of the income for the company would derive solely from rental income from immovable property, the company would not meet the qualification requirements for the small business corporation tax table, as the rental income would be greater than 20% of the company’s total income. Therefore, the net income after allowable costs would be taxed at the current corporate tax rate of 28%.
For you to receive any of the income in your personal capacity, you would need to draw either an income or distribute dividends from the company. Remuneration taken as income is added to your personal taxable income and taxed at your marginal tax. This income would, however, be an allowable tax deduction for the company.
Another option would be to distribute a dividend from the profit after business tax. This dividend is then taxed at the flat dividend withholding tax rate of 20%. When drawing dividend income, you need to be aware of the net effective rate of tax as you are effectively paying both corporate and dividend tax to receive the net income.
As an example, if the company generates a net profit of R100 it would be liable to pay the corporate tax of 28%. After the deduction of the corporate tax, the remaining R72 is then available to distribute as a dividend. Assuming the full amount is distributed, this dividend is taxed at 20%, leaving you a net income of R57.60. This is an effective tax rate of 42.4%.
Therefore, if your personal taxable income is already in the 45% tax bracket, a company structure may be favourable as a more efficient tax vehicle.
If you are in any of the lower-income brackets, you may wish to reconsider the use of a company for this purpose.
Another point to consider is the future capital gains tax (CGT) implications. As this would be an investment property, the full capital gain on the future sale of the property would be included for CGT. If you own the property in your personal capacity, you can make use of your annual R40 000 CGT exclusion and the maximum effective rate of CGT you currently pay as an individual is 18%. Within a company structure, there is no annual exclusion and the maximum effective CGT rate increases to 22.4%.
In answering this, please note that I have made certain assumptions and the appropriate answer will depend heavily on your personal circumstances. I, therefore, encourage you to seek advice from a chartered accountant or CFP® professional who will be able to assist you in assessing the tax consequences more thoroughly.