VAT AND RENTAL POOLS

Owners go to arbitration to get properties out of Cape Royale rental pool

A battle between disgruntled investors and the company that manages their properties highlights the issues that can arise when you put your property in a rental pool.

The owners of 17 units in Cape Royale Luxury Hotel & Spa, a fivestar hotel in Cape Town, have started arbitration proceedings to cancel their agreements with the company that manages the rental pool, on the grounds of alleged breach of contract – and they are claiming damages.

The company that manages the rental pool is Cape Royale Luxury Residence. In terms of the rental pool agreement between the owners and the developer, disputes between parties to the agreement must be referred to an arbitrator.

Earlier this year, the hotel’s body corporate was placed under administration after the High Court found that trustees Paschal Phelan and Bettina Heiberg had failed to fulfil their fiduciary duties to the body corporate. Judge Vincent Saldanha found that Phelan, in his capacity as chairman of the body corporate, had also failed to ensure that his interests – in the development company and in Cape Royale Luxury Residence – did not compromise or affect his financial duties to the body corporate.

Phelan is the sole director of Cape Royale Luxury Residence, according to a search on the LexisNexis Risk Management website this week.

The administration order was handed down in response to an application by an owner who has a unit in the hotel’s rental pool.

The owner claimed that the trustees were guilty of gross neglect and incompetence in the management of the body corporate’s financial and general affairs.

Nolands Forensics was appointed as the administrator until May 30 next year, when it must file a report to the High Court for its period of administration, as well as for the financial years 2009 to 2012.

The hotel has about 130 units, 82 of which are in the rental pool.

Owners of units in a rental pool have a right of occupation for only part of the year, while for the rest of the year their units are let to tourists and business people on a short-term basis. The net income is divided between the owners. An owner’s percentage of the total income is based on a formula and is paid after the deduction of the levy and the rental pool costs.

The 16 claimants say they are entitled to cancel their rental pool agreements and claim damages from the rental pool management company because of the following alleged breaches of the agreement:

◆ The management company has failed to provide owners with audited financial statements for the rental pool;

◆ There has been incorrect accounting of the net rental income;

◆ The rental pool income has been divided incorrectly, because the units in the rental pool have been valued incorrectly;

◆ The management company failed to register the rental pool in accordance with directives issued by the South African Revenue Service (SARS); and

◆ The management company has failed to repay input VAT to owners (see “VAT and rental pools”, right).

A five-year forecast sent to owners, dated February 2009, projected a net rental income of R26.5 million for 2011, after management and performance fees. But the actual rental pool return for 2011 was R5.4 million, according to a spreadsheet sent by Elmarie van Loggerenberg, financial manager of Cape Royale, to one of the owners.

In a letter that was sent to another former owner, dated September 1, 2010, Nathan Schmidt, managing director of Phelan Holdings Hospitality Group, gave the rental pool income for the second quarter of 2010 as R57 308 in April, minus R255 412 in May, and R2 312 120 in June. For the second quarter, the former owner received R23 530 (before the deduction of his body corporate levy), so he earned about R7 800 a month in that quarter. He paid R3.2 million for the unit.

In its plea to the claims, Cape Royale Luxury Residence denies each of the alleged breaches of the agreement. It also denies that it is responsible for the incorrect accounting of the net rental income.

Cape Royale Luxury Residence further claims that the unhappy owners’ purported cancellation of the rental pool agreements is unlawful and amounts to repudiation, thereby entitling the company to cancel the agreements.

It says that “despite the claimants’ repudiation of the rental pool agreements and the management company’s acceptance thereof and its cancellation of the agreement, the claimants are not entitled to withdraw their units from the rental pool until March 2014”. When you buy property from a developer, instead of paying transfer duty to the South African Revenue Service (SARS), you pay value-added tax (VAT) to the developer. The developer, as a VAT-registered vendor, pays it over to SARS as output tax.

If you place the property in a rental pool, the rental pool has the right to claim, on your behalf, your VAT back from SARS. This is input VAT. This refund should be paid back to you

And, “as a consequence of the termination of the agreements, the claimants are all liable to pay SARS any VAT or other taxes owed by virtue of the termination of the rental pool agreements”.

In response to questions relating to the rental pool, Lilly le Roux, inhouse legal counsel for Solar Capital, said Phelan was “not available”.

According to Companies and Intellectual Property Commission records, Phelan is the sole director of Solar Capital, which has been awarded a R13-billion state tender to build one of the world’s largest solar farms in the Northern Cape.

Phelan and Solar Capital are within a reasonable period of time after the date of transfer.

Since the rental pool operates as a business on behalf of the owners, it needs to be registered as a VAT vendor. The rental pool is also obliged to pay tax (output VAT) on income collected by the rental pool through the leasing of units.

When a property that is in the rental pool is sold and the new owner elects to leave it in the rental pool, that sale is exempt from VAT. suing Independent Newspapers for defamation arising from an article about Solar Capital.

Yesterday, Phelan’s attorney, Basil de Sousa, said that “to seek comment from our client on allegations of breach (all of which have been denied in the pleadings filed in the arbitration proceedings) is both inappropriate and untimely, and will indeed be prejudicial to the parties in the arbitration”.

Allegations of breach can be properly vented and dealt with at the arbitration hearing only, he says.

The arbitration hearing is set for April 7 next year. The arbitrator is Advocate Les Rose-Innes SC.