Business Structures for Property Investors

In this Video, I chat to Taurai from M5 Property Addicts about the best business structures for Property Investors.

If the video doesn't play, please follow the Link

https://youtu.be/uggrw2egUo4

An ULTRA important Bill

On 1 December 2020, the National Assembly passed the Upgrading of Land Tenure Rights Amendment Bill.

The Bill seeks to amend two provisions of the Upgrading of Land Tenure Rights Act 112 of 1991 (“the Act” or “ULTRA”) by providing for a constitutionally permissible procedure for the determination of rights of ownership and occupation of land, to remedy the constitutional invalidity of the sections. The Act in its current form discriminates against women in respect of conversion of the land tenure rights into ownership.

Land reform comprises of three elements namely land restitution, land redistribution and land tenure. Land tenure reform relates to the securing and protection of customary and informal land rights that were left vulnerable due to previous land policies. The aforementioned Act and Bill seek to secure and officially recognise land rights held by those living on customary and informal land, and to transfer power over those rights to the land rights holders.

The aim of the Bill:

• Provide for the application for conversion and land tenure rights to ownership;
• Provide for an opportunity for interested persons to object to conversion of land tenure rights into ownership;
• Provide for the institution of inquiries to assist in the determination of land tenure rights;
• Provide for the recognition of conversions that took effect in good faith in the past.

In the transition period to democracy there were two pieces of legislation -- the Upgrading of Land Tenure and the Informal Protection of Land Rights Act (IPLRA) -- which were aimed at providing an accommodation before final legislation was passed. 

THE RAHUBE MATTER

Matshabelle Mary Rahube and Hendsrine Rahube are siblings who, with other members of their family, moved into a property known as Erf 2328 Mabopane-B. Matshabelle moved out of the property in 1973 to live with her husband but moved back in 1977 after her marriage was dissolved. She has been living there since.

In 1987, Hendsrine was issued a Permission to Occupy and, in 1990, a Deed of Grant was issued in terms of Proclamation 293 of 1962. The Deed of Grant was 'upgraded' to full ownership in 1991 in terms of s2(1) ULTRA.

In August 2009, Hendsrine instituted eviction proceedings against his sister and all other occupants of the property. It was also during this time that Matshabelle allegedly first became aware of the fact that her brother was the only registered owner of the property. The question was posed as to whether s2(1) was constitutionally valid.

The High Court of South Africa, Pretoria ruled on 26 September 2017 that s2(1) ULTRA is unconstitutional insofar as it provided for the automatic conversion of land tenure rights into full ownership, without any procedures to hear and consider competing claims. The Constitutional Court confirmed the order.

THE SENQU MUNICIPALITY MATTER

When the Act was passed in 1991, it did not apply to the former TBVC territories, and when it was made to apply to those areas in 1998, the sections dealing with communal land were excluded from the application of the Act for the Republic, those sections being section 3, section 19 and section 20. Section 25(a) was the section that indicated that the three sections were not applicable throughout the entire Republic.

This case was related to the permission to occupy, which was a right applicable to mainly communal areas. The matter involved a permission to occupy (PTO) certificate issued to Teba Property Trust in respect of a piece of land falling under Senqu Municipality in the Joe Gqabi District, Eastern Cape. The Teba Property Trust had applied to have the PTO certificate converted into ownership in terms of section 3 of ULTRA, and the municipality had rejected the application on the basis that section 3 was not applicable in the parts of the Eastern Cape which had been in the former Transkei.

The Teba Trust had then approached the court and claimed that the non-applicability of section 3 to former Transkei areas was unconstitutional, in that it violated the Trust’s right to equality and the right to equal protection of the law. The court had agreed with Teba Property Trust and ordered that the section be declared unconstitutional on the basis that the section did not apply throughout the Republic.

 

AMENDMENT OF THE ACT

Section 2

What the court had said in declaring the section unconstitutional, was that because the section stated that the conversion of the deeds of grant was automatic, it did not allow for interested persons to object to the conversions. 

Clause 1 of the Bill, which amends section 2 of the Principle Act, provides that instead of conversions occurring automatically, people are able to apply to the Minister for conversions, and once the application was received, the Minister will publish a notice of application in the Gazette to inform interested persons who may wish to object the conversion. If an objection to the conversion is made, the Minister will institute an enquiry to establish the facts around the application and the objection, with the purpose of making a determination as to whom the legitimate holder of the deed of grant is.

This process that the Department was introducing to the Bill was to deal with ensuring that the conversion was no longer automatic, and provisions were made for persons who wished to object, to have that opportunity.

Section 14A

Clause 3 of the Bill inserts a new section 14A, which gives effect to the court order which indicated that conversions which had taken place in the past in terms of the Act should be allowed to continue, and that those that took place in favour of women should also stand. The amendment to the Act should not undo the conversion which had taken place in good faith and in favour of women.

The insertion also indicated that people who had been prejudiced by conversions would be free to approach the courts to challenge those conversions.

Section 25A

This is the section dealing with the application of the Act and which had excluded section 3, section 19 and section 20 from being applicable to the entire Republic. 

 

COMMENTARY

Whilst the intentions of the Bill are not only noble but actually essential (to comply with the Court Orders), this has not rendered the Bill immune from criticism.

The first issue has been procedural.  The failure of the legislators to address the issues raised by the Constitutional Court in 2018.  This created unnecessary urgency in passing the legislation.  Concerns have therefore been raised about the level of public participation and this has been exacerbated by the arrival of COVID-19.

The second issue relates to implementation and unintended consequences.  The uncertainty is created by the retrospective nature of the Constitutional Court’s decision and the legislation.  In many instances where the tenure of properties was upgraded, the properties have been sold, mortgaged or inherited.  Any uncertainty regarding the rights of future owners is a totally undesired outcome.

Thirdly, the Ingonyama Trust wants the Bill NOT to apply to “traditional land”. The Trust is the biggest landowner in KwaZulu-Natal and the Zulu monarch Goodwill Zwelithini is the sole trustee.

The South African think tank the Free Market Foundation (FMF) has, while praising the elimination of gender discrimination in the ULTRA Amendment Bill, sharply criticised other aspects of the proposed legislation. In particular, the FMF cited the excessive discretionary powers the Bill will give to the responsible Minister and that it amounted to land dispossession. The first clause of the amendment bill will remove the automatic conversion of land tenure rights into ownership of that land. Instead, people will have to apply for that tenure to be turned into ownership. The Minister would have the power to decline such applications, as well as approve them. The FMF described this discretionary power as “extreme” and completely out of place in a democracy.

Some entities have also lumped this Bill in with the proposed Expropriation legislation and labelled it as a further erosion of property rights.  In my opinion, this seems to be a bit of a stretch. 

CONCLUSION

Land ownership is an emotive issue in South Africa.  However, gender discrimination (with gender-based violence at its extreme) is also rife in South Africa.  Therefore, all efforts to uplift women and alleviate their plight should be applauded.  If this can be achieved through land ownership, then we can only hope that the implementation of this Bill achieves that goal.

PROPERTY INVESTMENT - START AT THE BEGINNING!

"The most important aspect of making money out of property is preserving and protecting both the property and the wealth that is created.

Far too many property investors rush into buying properties without first getting a suitable property investment structure in place. Without a suitable property investment structure you are exposed and vulnerable to creditors who can ruthlessly take away everything you have gained." - Jason Lee

 

The importance of choosing the correct business entity for the right type of investment (before making the investment) cannot be over-emphasised. This decision determines the protection, method of succession (passing the investment onto future generations at death), style of ownership (management / administration / flexibility) and tax treatment that the investor will enjoy or be obligated to by that investment.

You could probably buy property in your name if you only want to own one property. People are often advised to buy their primary residence in their name due to the capital gains exemption. But if you want to build a property portfolio (aka the best way to build wealth), you need to have a proper structure in place.

I will therefore only consider Companies and Trusts as viable options in this Blog Post.  

[Close Corporations are being phased out but since there are still a few floating about, my comments on Companies would apply in the same way to Close Corporations.]

I will discuss each entity by referring to each of the aspects that I have already mentioned.

  

TRUSTS

When you buy property in a Trust, it is possible to build a much bigger portfolio than you would be able to in your name. Trusts are mostly more suited for more passive/holding investments (e.g. holding a trading company’s shareholding). They are also more suited to Family investments with a common goal.

Protection

I kicked-off this post with a quote from well-known property investor and author, Jason Lee.  I share his sentiment that protecting your wealth is as important as creating it.  The proper use of Trusts can create investments that are 100% creditor proof. However, please note that such protection can only be achieved over a period of time and through effective management of your Trust. 

I favour a double Trust structure as the best defence against Creditors. There are a couple of people who claim credit for this structure but, in my opinion, it stems from a book by Peter Carruthers called CrashProof your Business and developed by Rob Velosa.  Irrespective of who developed it, this structure is recommended by a vast number of the Trust experts and gurus in South Africa.

Method of Succession

• did you know that on your Death, your Estate may lose up to 55% in fees and taxes?
• did you know that these are expenses that must be paid by your heirs?
• did you know that on your Death, your assets will be frozen?

A great benefit of Trusts is that it does not form part of your estate if you are declared insolvent or pass away. There are no estate duties, capital gains tax or executor fees. No assets are frozen. You will not have this benefit if you use a company unless a trust owns your company’s shares.

Style of Ownership

Trusts are created by the Founder and managed by Trustees for the benefit of Beneficiaries.  The Founder can be both a Trustee and a Beneficiary.  There are several reasons why it is essential to have an Independent Trustee (follow the Link) and the owner cannot treat the Trust ownership of the Assets as an extension of his personal ownership.

Tax Treatment

The conduit principle that only applies to trusts is also a great mechanism to channel and split profits or capital gains to beneficiaries, which makes a trust even more tax efficient.

 

COMPANIES

Buying property in a Company makes sense if a trust owns the company, but this structure can be more expensive. Company structures are most suited where investment/business risks/liabilities are high.

Protection

Section 77 of the Companies Act prescribes certain statutory liabilities, which are placed on the directors of a company. A director of a company may be held liable for any loss, damages or costs sustained by the company as a consequence of any breach by the director of the duties contemplated.

A director of a company will, in addition, be held liable where that director:

• purports to bind the company without the requisite authority;
• acts in the name of the company in a way that is false or misleading; or
• knowingly or recklessly signs or consents to the publication of a financial statement which is false or misleading.

The Act further provides for the liability of directors, where they trade recklessly or conduct the company’s business with the intention of defrauding a creditor.

Section 214 of the Act renders a director (or any person) guilty of a criminal offence if such director / person was knowingly a party to an act or omission by a company calculated to defraud a creditor or employee of the company, or a holder of the company’s securities or with another fraudulent purpose.

In terms of both the Income Tax Act and the VAT Act, all juristic persons are required to appoint a representative taxpayer who accepts responsibility for ensuring that the company meets its tax obligations. Even though the Acts afford certain protection to these representative taxpayers, this is paltry compared to the onerous provisions of section 48(9) of the VAT Act and section 16(2C) of the Fourth Schedule to the Income Tax Act.

However, as yet no court has had the opportunity to consider these provisions; leaving one with little certainty as to how these elements will be interpreted.

Method of Succession

A company has “perpetual succession” – it survives the death/incapacity/insolvency/exit of the directors and shareholders. ... Transferring ownership and management is easy – shareholders and directors change but the company lives on.

Style of Ownership

Companies are owned by the Shareholders and managed by Directors.  The Investor can be both a Shareholder and a Director.  The South African Trust Law is not nearly as developed as its Companies Act counterpart and therefore greater legal certainty exists regarding rights and obligations surrounding Companies.

In my experience, where there are groups of people investing together, a Company is the most nimble vehicle to accommodate the entry and exit of Investors (death, insolvency, sale of shares, etc.).  A Trust is extremely cumbersome when having to cater to shifting investor demands and expectations.

Tax Treatment

And although the tax rate is lower, the conduit principle does not apply, which makes it very inefficient to move funds out of the company and benefit from your portfolio.

WHY IS THIS THE BEGINNING?

Moving assets out of one legal entity (or from a Natural Person) into another can trigger donations taxes (at 20%), deemed interest charges (at 8%, Section 7C), capital gains tax (CGT) and transfer duties.

I prefer a combination of Trusts and Companies but each individual Investor is different and should seek their own advice.

Getting things right from the start will save a lot of time, money and aggravation down the line!

Visit www.elegantcorp.co.za for a 100% FREE consultation.