The Great Divide:

An Analysis of the Divergent Treatment of Foreign-held South African Immovable Property under the Estate Duty and Capital Gains Tax Regimes

By Dr Hendri Herbst

INTRODUCTION

The sustained interest of non-resident individuals in acquiring high-value immovable property in the Republic of South Africa, whether for personal use or as a component of a global investment portfolio, presents a recurring and complex challenge for international tax and wealth advisors. The structuring of such acquisitions necessitates a sophisticated approach to manage exposure to the array of South African taxes that may be levied both during the holding period and upon exit or succession. This imperative has led to the widespread use of various ownership vehicles, among which the holding of South African immovable property by a non-resident individual through a foreign-incorporated company is a prevalent and compelling strategy.

This structure, however, gives rise to a profound legislative divergence – a “Great Divide” – in its treatment under South Africa’s principal fiscal statutes. On one hand, the Estate Duty Act 45 of 1955 (“the Act” / “Estate Duty Act”), as it is currently legislated, meticulously respects the integrity of the foreign corporate structure, thereby effectively sheltering the underlying immovable property from the ambit of South African estate duty upon the death of the non-resident shareholder. On the other hand, the Income Tax Act 58 of 1962 (“Income Tax Act”), through the specific and targeted mechanisms of its Eighth Schedule, systematically pierces that same corporate veil to impose Capital Gains Tax (CGT) on any disposal, or deemed disposal, of the shares in that foreign company.

This article provides a definitive, technical analysis of this legislative anomaly. It will demonstrate that while the Estate Duty Act upholds the separate legal personality of the foreign company, the Income Tax Act adopts a substance-over-form approach, deeming an interest in the foreign company to be an interest in the underlying South African land. This analysis will dissect the precise statutory mechanics that create this divergence, explore its historical and policy context, and critically evaluate its profound implications for structuring, lifetime exit strategies, and, most importantly, the often-overlooked tax consequences that crystallise upon the death of the ultimate beneficial owner.

THE ESTATE DUTY SHELTER: UPHOLDING THE CORPORATE VEIL

The foundation for the non-applicability of South African estate duty to shares in a foreign company holding local immovable property rests on a series of precise, interlocking provisions within the Estate Duty Act. The analysis begins with the Act’s core jurisdictional principles and culminates in a specific statutory exclusion that is both robust and multi-layered.

A. The Principle of Territoriality for Non-Ordinarily Resident Deceased

A fundamental distinction within the Act is drawn between individuals who are “ordinarily resident” in the Republic at the time of their death and those who are not. For persons ordinarily resident, estate duty is levied on their worldwide property. However, for individuals who are not ordinarily resident in South Africa – the focus of this analysis – the tax base is significantly narrower. Estate duty is chargeable only on their South African property. This principle of territoriality, or source-based taxation for non-residents, is a cornerstone of estate planning for foreign nationals with assets in the Republic.

The Act’s legislative architecture reinforces this principle. Section 3(2) provides an exceptionally broad definition of “property,” encompassing “any right in or to property, movable or immovable, corporeal or incorporeal”. This definition is, however, immediately and significantly qualified by a series of specific exclusions for non-ordinarily resident deceased persons, enumerated in paragraphs (c) through (h) of the same subsection. These exclusions effectively remove from the dutiable estate assets such as immovable property situated outside the Republic, movable property physically situated outside the Republic, and debts not enforceable in South African courts. This structure – a broad initial definition followed by specific territorial exclusions – places the analytical burden squarely on determining the legal location, or situs, of an asset for estate duty purposes.

B. A Forensic Examination of the Asset: Shares, Not Property

A cornerstone of this analysis, and a principle that cannot be overemphasised, is the precise characterisation of the asset owned by the deceased non-resident individual. Where a foreign company is interposed to hold the South African immovable property, the asset directly owned by the deceased shareholder is not the land itself, but the shares in that foreign company. The doctrine of separate legal personality, a fundamental tenet of corporate law, dictates that a company is a distinct legal entity, separate from its shareholders. The company owns its assets – the South African immovable property – while the shareholders own the shares, which represent their interest in the company.

Estate duty is levied on the “property of that person as at the date of his death”. Consequently, the dutiable asset in the deceased’s hands is their shareholding in the foreign company, not the underlying real estate. This distinction is paramount, as the situs rules applicable to shares differ fundamentally from those applicable to immovable property.

C. The Crux of the Matter: A Meticulous Interpretation of the Section 3(2)(g) Exclusion

The determination of whether shares in a foreign company constitute South African property for estate duty purposes in the hands of a non-resident deceased hinges on a meticulous interpretation of Section 3(2)(g) of the Act. This provision directly addresses and excludes such shares under specific conditions, providing a powerful tool for estate planning. The analysis of this subsection proceeds along two distinct, yet complementary, interpretative paths, both of which lead to the same conclusion of being non-dutiable.

1. Primary Interpretation: The “Body Corporate which is not a Company” Test (s3(2)(g)(i))

The first and most direct route to exclusion is found in Section 3(2)(g)(i). For a deceased who was not ordinarily resident in the Republic, the definition of “property” does not include “any stocks or shares held by him in a body corporate which is not a company”. The application of this test requires satisfying two conditions. First, the deceased shareholder must not have been ordinarily resident in the Republic at the date of death, a common fact pattern for these structures. Second, the foreign entity must qualify as a “body corporate which is not a company” for the purposes of the Act.

The definition of “company” in Section 1(1) of the Act is therefore critical. It includes not only entities incorporated or registered under South African law but also any association which, although not so incorporated, “carries on business or has an office or place of business or maintains a share transfer register in the Republic”. A foreign corporate entity that is structured solely to hold a personal-use asset for its shareholders and does not conduct active business, have a place of business, or maintain a share transfer register in South Africa would fail to meet this definition. It would thus be classified as a “body corporate which is not a company” under the Act. Consequently, its shares, when held by a non-resident deceased, are unequivocally excluded from the definition of “property” under Section 3(2)(g)(i). The integrity of this position is therefore contingent on the passive nature of the holding structure; the intended use as a “buy & hold” personal asset is crucial to satisfying this primary test.

2. Alternative Interpretation: The “Registration of Transfer” Test (s3(2)(g)(ii))

The Act provides a robust fallback position should the foreign entity, for any reason, be deemed to be “a company” under the South African definition. This might occur, for example, if the use of the property were to change from personal to commercial, potentially constituting the “carrying on of business” in the Republic. In such a scenario, the analysis shifts to Section 3(2)(g)(ii).

This subsection excludes from the definition of “property” any stocks or shares held by a non-resident deceased in “a company, provided any transfer whereby any change of ownership in such stocks or shares is recorded is not required to be registered in the Republic”. The legal formalities and procedures for effecting a transfer of shares in a foreign company are governed exclusively by the laws of its jurisdiction of incorporation. The share register would be located and maintained in its jurisdiction of incorporation, not South Africa. Crucially, there is no provision in South African law that compels the registration in South Africa of a share transfer in a foreign company between two non-residents for that transfer to be legally effective. Therefore, even if the foreign entity were to be considered “a company” under the Act, the shares held by the non-resident deceased would still be excluded from their South African dutiable estate because the transfer of those shares upon death would not require registration in the Republic. This dual-layered statutory protection makes the exclusion particularly resilient to challenge.

D. The Legislative Divergence Part 1: The Critical Absence of an Estate Duty “Look-Through”

A pivotal question is whether the South African Revenue Service (SARS) could disregard the separate legal personality of the foreign company and attribute a South African situs to the shares based on the location of the company’s underlying assets. This is often referred to as a “look-through” or “substance-over-form” approach. As will be demonstrated in the subsequent section, the Income Tax Act contains explicit provisions to do precisely this for CGT purposes.

However, the Estate Duty Act currently contains no equivalent explicit “look-through” provision. The statutory tests in Section 3(2)(g) focus entirely on the nature of the corporate body and the location of its share transfer register, not on the location or nature of its underlying assets. The general legal principle is to respect the separate legal personality of a company, and in the absence of a specific statutory provision to the contrary, the Act adheres to this principle. The shareholder owns the shares, and the company owns the land; the situs of each is determined independently.

This legislative position is not an oversight that has gone unnoticed. The Davis Tax Committee (DTC), in its comprehensive review of the South African estate duty system between 2015 and 2016, made numerous recommendations regarding the use of trusts, inter-spousal abatements, and the primary abatement levels. Despite this wide-ranging review and the clear precedent for a “look-through” approach in the CGT legislation, the DTC did not recommend the introduction of a similar rule for estate duty on property held in corporate structures by non-residents. This legislative inaction, despite a clear opportunity for reform, suggests that the current position is either a deliberate policy choice – perhaps to encourage foreign capital investment in fixed property – or is considered a low-priority issue for lawmakers. This lends significant stability to the current interpretation and the efficacy of the structure for estate duty planning.

THE CAPITAL GAINS TAX NET: PIERCING THE CORPORATE VEIL

In stark contrast to the deference shown to the corporate form by the Estate Duty Act, the Capital Gains Tax regime, codified in the Eighth Schedule to the Income Tax Act, adopts the diametrically opposite approach. The legislation is specifically designed to pierce the corporate veil of foreign holding companies to ensure that gains arising from underlying South African immovable property do not escape the tax net.

A. The Scope of Capital Gains Tax for Non-Residents

The jurisdictional reach of South African CGT is defined in Paragraph 2 of the Eighth Schedule. While residents are subject to CGT on the disposal of their worldwide assets, the liability for non-residents is, like estate duty, territorial in nature. Paragraph 2(1)(b) provides that the Eighth Schedule applies to the disposal of the following assets of a non-resident:

• Immovable property situated in the Republic, including any “interest or right of whatever nature” of that person to or in such immovable property; and
• Any asset which is attributable to a permanent establishment of that person in the Republic.

For the purposes of the structure under review, the critical element is the expansive definition of an “interest or right” in immovable property.

B. The “Land-Rich” Doctrine: A Deep Dive into the Deeming Provision of Paragraph 2(2)

The direct counterpoint to the estate duty exclusion in Section 3(2)(g) is the deeming provision contained in Paragraph 2(2) of the Eighth Schedule. This provision explicitly extends the definition of an “interest in immovable property situated in the Republic” to include shares held in certain companies, whether those companies are resident or non-resident. This provision is commonly referred to as the “land-rich” rule.

For this deeming provision to apply and for the shares in a foreign company to be treated as South African immovable property for CGT purposes, two cumulative conditions must be met:

• The 80% Value Test: At the time of disposal of the shares, 80% or more of the market value of those shares must be attributable, directly or indirectly, to immovable property in the Republic.
• The 20% Holding Test: The non-resident person disposing of the shares, whether alone or together with any connected persons, must directly or indirectly hold at least 20% of the equity shares in that company.

In the context of a foreign company whose principal asset is South African immovable property, it will unequivocally meet the “land-rich” criteria. The entire value of the company’s shares will be attributable to South African immovable property, thus satisfying the 80% test, and the non-resident investors will typically hold a sufficient interest to satisfy the 20% test.

C. The Legislative Divergence Part 2: The Explicit CGT “Look-Through”

This provision confirms the second half of the article’s central thesis. It represents a clear and deliberate legislative design to look through the foreign corporate wrapper and tax the underlying economic gain derived from South African real estate. The Income Tax Act instructs SARS to do precisely what the Estate Duty Act does not: to disregard the foreign situs of the shares and to treat their disposal as a disposal of an interest in South African land for CGT purposes.

This is not an interpretive ambiguity or a matter of administrative practice; it is a targeted statutory anti-avoidance rule. Its introduction with the advent of CGT in 2001 was specifically intended to prevent the exact scenario of a non-resident holding SA property via a foreign company and then selling the shares in that company offshore, thereby realising the capital growth on the SA property without triggering any South African tax liability. The legislative schizophrenia is therefore complete: one Act respects the veil, the other systematically pierces it.

Exit Strategies and the Inevitable Tax on Death

The divergent tax treatment established in the preceding sections has profound practical consequences for any exit strategy, whether undertaken during the shareholder’s lifetime or occurring upon their death.

Lifetime Exit Strategies

There are two primary ways to realise the investment during the shareholder’s lifetime: a sale of the shares in the foreign company, or a sale of the property by the company itself. The choice between these options involves a trade-off between different tax rates and transactional complexities.

A critical factor is the Transfer Duty Act, which contains anti-avoidance rules for a “residential property company” – a definition that a foreign company holding a South African residential property will invariably meet. The consequence is that a sale of shares in such a company is treated as a sale of the underlying property, making the purchaser liable for transfer duty at the same rates as a direct property purchase. This neutralises a key commercial advantage of a share sale from the buyer’s perspective.

From the seller’s viewpoint, the tax outcomes differ significantly:

• Share Sale: The non-resident individual shareholder is the taxpayer. The disposal of the “land-rich” shares triggers South African CGT. The gain is taxed at the individual’s effective rate, which has a maximum of 18%. The purchaser must withhold 7.5% of the gross proceeds as an advance payment of this tax under Section 35A of the Income Tax Act.
• Property Sale: The foreign company is the taxpayer. The company pays tax on the capital gain at the corporate effective CGT rate of 21.6% – a higher rate than for individuals. The withholding tax rate is also higher, at 10% of the gross proceeds. A subsequent distribution of the after-tax proceeds to the non-resident shareholder would not attract South African Dividends Tax.

While a share sale offers a lower CGT rate for the seller, the purchaser’s obligation to pay transfer duty makes them more likely to prefer a cleaner asset deal, free from the company’s potential latent liabilities.

The Deemed Disposal on Death and the Unfunded Liability Trap

The most critical and often underestimated tax event is the death of a shareholder. Section 9HA of the Income Tax Act deems a person to have disposed of all their assets at market value on their date of death. Since the shares in the “land-rich” foreign company are considered South African property for CGT purposes, this deemed disposal triggers an immediate CGT liability in the deceased’s final tax return.

This creates a significant “unfunded liability trap.” While the structure successfully avoids estate duty, the deceased’s estate is now faced with a substantial CGT liability (at a maximum effective rate of 18%) without any cash proceeds from an actual sale. The executor is responsible for settling this tax debt, which can create a severe liquidity challenge.

A pivotal detail that exacerbates this risk is the inapplicability of inter-spousal rollover relief. South African tax law provides for a CGT deferral when an asset is bequeathed to a surviving spouse, but this relief is explicitly conditional on the surviving spouse being a South African tax resident. For non-resident families, this relief is unavailable. The death of the shareholder is therefore not a deferral event but an absolute and final taxing point. This transforms a structure designed to avoid one tax (estate duty) into one that accelerates another (CGT), a critical planning failure if not properly anticipated and funded.

CONCLUSION: A ROBUST BUT NUANCED STRATEGY

The use of a foreign company by a non-resident to hold South African immovable property remains a statutorily sound and highly effective strategy for the mitigation of South African estate duty. This conclusion is anchored in the precise wording of the specific exclusions contained in Section 3(2)(g) of the Estate Duty Act and the critical absence of any legislative “look-through” provision that would attribute the situs of the underlying property to the shares. The current legislative framework, reinforced by the lack of reform proposals from the Davis Tax Committee, provides a stable foundation for this planning.

This estate duty shelter, however, offers no protection whatsoever from South African Capital Gains Tax. The “Great Divide” in the legislation is stark. The explicit “land-rich” provisions in the Eighth Schedule to the Income Tax Act were designed for the express purpose of piercing the corporate veil, ensuring that any lifetime disposal or, critically, any deemed disposal on death, of the shares in the foreign company will trigger a CGT liability.

The final strategic imperative for advisors and their non-resident clients is the recognition that this structure, while powerful, is not a panacea. Its successful and sustainable implementation requires a nuanced, two-pronged approach. The first prong is the careful maintenance of the foreign company’s passive nature to secure the estate duty benefit. The second, and equally important, prong is to plan proactively and pragmatically for the inevitable CGT liability, particularly the unfunded liability that will crystallise on the death of a shareholder. The legislative chasm between the two tax acts creates a valuable planning opportunity, but navigating this complicated area is crucial to avoid unforeseen liabilities.