Don't be lured into what looks like a clever scheme to avoid paying transfer costs when you buy property.
Generally you pay either transfer duty or VAT when you buy property. When you buy a new property from a developer the VAT is included in the purchase price.
However, a common practice to avoid paying transfer costs involves establishing a trading entity such as a close corporation or a trust to buy a property. The trading entity is registered as a VAT vendor which allows it to claim back the VAT. In this way it pays no costs other than the purchase price of the property and legal fees.
But Deborah Tickle, tax partner at KPMG, warns that not only could this scheme be illegal, unless you are a property trader, like a developer, but you may end up paying considerably more than you bargained for.
Those who advocate this scheme to avoid taxes on second-hand properties claim that you can avoid transfer costs by paying VAT equivalent to the transfer duty and then claiming it as a refund.
The important thing to realise is that you can only claim a VAT refund when you are supplying the property for business use or are trading in property, says Tickle.
If you let the property for residential purposes or live in it yourself, you may not claim a tax refund for VAT on the purchase price of the property.
It is illegal and, if you are caught, you will be liable for the penalties and interest on the VAT, which you claimed.
When you buy a second-hand property for business letting and pay and reclaim your VAT, you must be sure you will only use the property for this purpose because if you take in a residential tenant, you will have to repay the VAT.
If you do this, the "clever scheme" might put you in a worse position than if you simply paid transfer duty, says Tickle.
This is because an amendment to the VAT Act in November 1995 limits the amount of VAT you can claim on the purchase price of a second-hand property, when its use is residential, to the amount of transfer duty which the property would usually incur.
For example, if your CC bought a second-hand property for R300 000, you could claim R14 000 as a VAT refund if you are letting it out to a business. (Remember it is limited to the transfer duty according to the November 1995 legislation).
But if the usage changes - you decide to rent it as a residence - you would be required to pay the taxman R36 842. This means the taxman will want an extra R23 000 (see calculation).
"This does not take into account the costs of forming the CC or trust and the annual costs connected to it," says Tickle.
Establishing a CC costs about R700 and a trust about R1 500. There are also annual administrative costs, for example the services of an accountant, which vary depending on the number of assets in the CC or trust. The costs of administering a CC with only one property in it could amount to about R1 000 a year.
These calculations apply to "second hand" properties.
To calculate transfer duty payable on a R300 000 property: (in the example, this would also be VAT which you could claim as a refund)
One percent of the first R60 000R600
Five percent of R190 000 (R250 000 less R60 000)R9 500
Eight percent of R50 000 (R300 000 less R250000) R4 000
Transfer duty:R14 100
To calculate the VAT portion of the R300 000 which you would have to pay to the Receiver, when the use of property changes to residential.
VAT = R300 000 x 14/114 = R300 000 x 0,123 = R36 842