Avoid Dividend Taxes
01 November 2009
Posted by: Author: David Warneke
Avoid Dividend Taxes
There’s a window of opportunity to deregister your company without becoming liable for dividend taxes
The impending implementation of a dividends tax will mean that the current exemption regarding pre-2001 embedded value will fall away.If your company or close corporation holds an asset with pre-2001embedded value it would be wise to take note of the fact that the existing exemption from STC on deregistration will fall away with the introduction of the dividends tax.
Consider the following example:You own all the shares in your company. These shares were acquired in 1991 for R100, as the company was a ‘shelf company' with no assets at the time. After you acquired the shares, the company purchased a property (also in 1991) for R1 million, using100% bond finance—this is the company's only asset. The property was valued at R3 million for CGT purposes as at October 2001, and its current market value is R5 million.Your shares in the company were therefore valued at R2 million for CGT purposes as at October 2001.
This is represented by the value of the property at that date,R3 million, less (say) R1 million still outstanding on the bond.The R2 million increase in the value of the property between the date of its purchase in 1991 and October 2001 is what I refer to as‘pre 2001 embedded value’.As the Income Tax Act presently allows, if the company sells its asset for its market value of R5 million and is deregistered now,there will be no STC on the resulting dividend to the extent that this dividend represents the pre 2001 embedded value of assets in the company.
STC will be calculated only on the post-2001 increase in value of the property from R3 million to R5 million, and will amount to approximately R200 000. STC is at the rate of 10% of the amount of a dividend declared. The saving in STC due to the exemption on the‘embedded value’ portion of the dividend is thus R200 000, being 10% of the pre-2001 increase in value from R1 million to R3 million.
However, things are about to change, probably towards the end of 2010 or in early 2011, when the new dividends tax is introduced.The current exemption regarding pre-2001 embedded value will fall away. Thereafter, the full increase in value of the property will become subject to the dividends tax, which would amount to R400 000 (10% of R5 million proceeds, less R1 million cost).I would strongly advise companies or close corporations that hold assets with pre 2001 embedded value to contact their tax advisers to discuss whether or not it would be worthwhile to deregister the company prior to the introduction of the new dividends tax.
Bear in mind that it may not be necessary to sell the underlying asset to an outside party—one could, for example, transfer the asset to another existing entity, or set one up for this purpose.If the asset is commercial property, the transaction could be zero-rated from a VAT perspective.Please also bear in mind that the pre-2001 embedded value does not have to be represented by property—it could, for example, be represented by an increase in the value of shares or other assets held by the company.
It should be noted that the above example is simplified to the extent that it does not consider the CGT implications in the company's or shareholder's hands, which may or may not make a difference to the decision.
Source: By David Warneke (Tax breaks)