Value-added Tax
1677. Fractional ownership
November 2008 – Issue 111

Fractional ownership is currently a rapidly growing global trend. It enables people to own a share in a desirable vacation property, although fractional ownership of other assets such as luxury boats is also on the rise.

Nature of fractional ownership

Fractional ownership refers to the collective ownership of an asset (usually with a high monetary value), with usage normally allocated to the joint owners or shareholders by means of an ownership usage roster, as well as dividing running costs among the shareholders or joint owners.

A common misconception is to confuse fractional ownership with timeshare. Fractional ownership confers the right of ownership and usage, whilst timeshare refers to simply owning usage time.

The purchase of a fractional interest in a luxury property can be structured as either, the sale of shares in the company owning the property or by way of joint ownership of an undivided title deed.

SARS recently issued guidelines in respect of fractional ownership structures, confirming that the supply of such rights and interests constitutes ‘fixed property’ for VAT purposes.

Consequences for developers

VAT registered developers need to account for VAT at 14% on the sale of each fraction, regardless of the nature of the fractions sold (ie. shares or undivided title deeds).

Should the vendor sell or transfer fractions to connected persons who will not be entitled to claim full input tax (e.g. family members who are not VAT registered), VAT will need to be accounted for on the open market value of the supply, regardless of the amount received.

VAT registered developers will generally be entitled to claim full input tax credits on expenses incurred in respect of fractional ownership developments. However, developers often retain fractions or shares in the development for investment purposes.

Unless the developer uses the retained fractions for the making of (other) taxable supplies, he/she may:

· either not be entitled to full input tax claims

· be required to make an output tax adjustment in the first period that the property is applied for non-taxable purposes (based on the open market value of the property at that stage).

Pooling of commercial accommodation

The supply of so-called holiday accommodation by the developer (or anyone else) will not constitute a taxable supply, unless it qualifies as ‘commercial accommodation’, as defined.

One of the requirements for commercial accommodation is that the annual income from such activity needs to exceed R60 000. To ensure satisfaction of this requirement, commercial accommodation may be supplied by way of a pooling arrangement.

Rental pool schemes allow a single person, instead of each owner in certain types of property developments, to conduct a commercial accommodation enterprise by using the property belonging to such owners.

The rental pool may be treated as a separate enterprise for VAT purposes, carried on separately from the owners. Such a rental pool scheme is then treated as a principal and not as the agent of the owners or shareholders.

Agreements regulating fractional ownership structures often state that shareholders or fractional owners’ unused use right time may be entered into a rental pool.

However, the VAT treatment of supplies made and received by the rental pool may be problematic. The VAT Act, contains a number of provisions relating to the treatment of pooling arrangements, but will only apply to rental pool schemes operated in respect of certain:

· property timesharing schemes

· sectional title schemes

· shareblock companies.

Should a pooling arrangement constitute a ‘rental pool’, the result will be that, although not legally the owner of the property, the rental pool vendor accounts for all output and input tax regarding that property as if it were the owner.

VAT implications for rental pools

Previously, limited guidelines existed regarding the VAT treatment of rental pools, with most vendors obtaining specific rulings from SARS before entering into such pooling arrangements.

SARS recently issued Draft VAT 409, Guide for Fixed Property and Construction for comment, providing an indication of its view regarding the VAT accounting required for rental pools. In terms of the proposed guidelines, issues to consider when instituting a ‘rental pool’ could include, inter alia:

· Will the developer supply the units directly to the rental pool or first to the fractional owners or shareholders, who will then on-supply unused user right time to the rental pool? Under certain circumstances, units may qualify as the sale of a going concern to the rental pool, i.e. VAT will be zero rated, which may have cash flow advantages.

· How will the private use of units forming part of the rental pool be regulated? Rental pools may be required to make annual adjustments where full input tax was claimed, but where private use was in excess of the de minimis rule (i.e. the units were used less than 95% of the time for the making of taxable supplies).

· When a shareholder or fractional owner sells his/her fraction or share, will the purchaser remain in the pool? The supply will not be subject to VAT should the purchaser decide to remain in the pool. Fractional owners or shareholders need to decide if they want to participate in the rental pool as soon as possible, as the rental pool will be permitted to claim input tax in respect of the furnishing of units by owners participating in the pooling scheme. This may, however, be difficult to administer should not all fractional owners or shareholders elect to form part of the rental pool.

· Where fractional owners or shareholders withdraw from the rental pool for reasons other than resale, the rental pool will be deemed to supply the fraction to the owners with VAT calculated at the open market value. This may lead to unforeseen cash flow implications.

Conclusion

The old Afrikaans proverb, "Goedkoop koop is duur koop", meaning that bargains often turn out to be more expensive, could easily apply to fractional ownership schemes, should potential investors not first familiarise themselves with the tax consequences of this ‘non-traditional’ form of ownership. It not only applies to VAT, but also to other taxes such as capital gains.

KPMG

VAT Act:S 1 definition of "fixed property" and "commercial accommodation",

VAT Act:S 3,

VAT Act:S 11(1)(e),

VAT Act:S 17,

VAT Act:S 18,

VAT Act:S 52

VAT Act:Draft VAT 409, Guide for Fixed Property and Construction