The Pitfalls of Owning Stock in a Real Estate Company

NORMALLY, the disposal of any equity investment in a company will not incur any income tax since it will be a capital transaction. However, if you hold shares in a company that primarily owns real estate, Real Estate Gains Tax (RPGT) will be triggered on the disposal of those shares.

Many taxpayers may not be aware of the implications of holding such shares and may be subject to surprises when selling due to how the acquisition price, disposal price and change in the nature of halfway through the acquisition are determined by this single piece of legislation in Article 34A of the RPGT Act.

Understand the basic rules

Whenever a taxpayer buys shares in a controlled company, he must determine if the company is a real estate company (PRC) and if it is a PRC share, then it remains forever a PRC share notwithstanding the fact that the company may have subsequently ceased to be PRC. Anytime the RPC share is sold, RPGT will be taxed.

A company becomes a PRC when it meets the test of 75% of total tangible assets and this will be triggered when at any time the company owns real estate and PRC shares whose market value exceeds 75% of total assets tangible assets of the company. Total property, plant and equipment includes cash, trade receivables, fixed assets, excluding intangible assets such as intellectual property and goodwill. The determination of the acquisition price by the taxpayer is based on the number of shares acquired divided by the total number of shares issued by the company, and this fraction will be multiplied by the market value of the buildings and shares of buildings held by the business.

The sale price of the shares does not follow the normal sale rules of the RPGT law. For this purpose, the sale price will be the consideration received. Legal fees and other costs related to the acquisition and disposal of shares will not be taken into account.

The capital loss on the sale of RPC shares cannot be carried forward.

Where are the problems?

Taxpayers need to keep an eye on their investments because at the time of acquisition the company may not be a PRC but subsequently it could become a PRC. At this stage, the shareholder must determine his acquisition price, which will be proportional to the market value of the property acquired by the company. Obtaining the acquisition price afterwards can be a problem.

Bonus issues and rights issues are another issue. The interpretation adopted by the Inland Revenue Board (IRB) and taxpayers may be different. The IRB considers free shares to have no cost and in the case of the rights issue the cost will be the value paid for the rights issue. This may not be in accordance with the law as there is a school of thought which supports the idea that the initial costs paid for the acquisition of the shares should be shared proportionately between the original shares and the issuance of bonuses on the based on the reasoning that the bonus shares are issued on the basis of the original shares and the free issue should not dilute the existing shareholdings.

Likewise, the question of whether the price paid for the rights issue is the cost of the rights issue or whether the costs should be clubbed with the original shares and shared proportionately.

If the taxpayer has purchased shares in installments over a period of time in a PRC corporation, the allocation of disposal proceeds is another issue. It is not clear whether the sale proceeds should be allocated according to the number of shares acquired or the acquisition price of the shares. The IRB tends to use a number of shares, which can result in an uneven distribution of the transfer price and could lead to significant liability for the RPGT. It does not reflect the commercial reality of the transaction.

Recently, the IRB attempted to include the occasional sale of PRC shares in income tax where taxpayers dealing in real estate are investigated on the grounds that the sale of the shares of PRC is also an integral part of the taxpayer’s business. Activities. This is incorrect because Section 34A of the RPGT Act makes it clear that once a share is a CPR share, it remains a CPR and any disposal of such shares will be subject to CPR.

This the article is written by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).