Leasehold improvements - the VAT implications

• Author: Anne Bardopoulos,Des Kruger
• Date: 01 December 2014
• DOI: 10.10520/EJC173376
• Published date: 01 December 2014
• Pages: 25-51

25

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Leasehold Improvements

THE VAT IMPLICATIONS

DES KRUGER1 • ANNE BARDOPOULOS2

ABSTRACT

The issue of how VAT must be accounted for under a leasehold-improvement

arrangement remains topical. While SARS issued a Draft Interpretation Note in

2012 which was intended to bring very necessary clarity to this issue, it was

never f‌inalised. This article considers the VAT implications of such an arrange-

ment, and concludes that under such an arrangement two supplies are made,

the one by the lessee that makes a supply of leasehold improvements to the

lessor, and one by the lessor of the right of use of the property to the lessee.

It is further argued that the two supplies themselves constitute consideration

payable by the lessee to the lessor (the improvements) and by the lessor to the

lessee (the right of use). These considerations may be explicitly provided for in

the rental agreement, but most often would be implicit. Given that the consid-

erations are not ‘consideration in money’, the value thereof must be deter-

mined in terms of section 10(3)(b), read with section 3, of the Value-Added

Tax Act 89 of 1991 (‘VAT Act’), being the open-market value of the supply.

The lessee is required to account for output tax on the date on which the

supply of the improvements is deemed to be made in terms of section 9(1)

or section 9(3)(b) of the VAT Act. If section 9(1) applies, the rental agree-

ment may constitute an ‘invoice’ that would trigger a time of supply when

the rental agreement is concluded. It is argued that ‘payment’ of the in-kind

consideration (being the value of the improvements and grant of the right

of use) would also trigger a time of supply under section 9(1) of the VAT Act,

and would similarly takes place on the date on which the rental agreement

is concluded, as it is on that date that the reciprocal obligations are extin-

guished and ‘payment’ can be said to have been made. The lessor is required

to account for output tax under section 9(3)(a) of the VAT Act on the date on

which the rental agreement is concluded on the basis that that is the date on

which ‘payment’ of the consideration (the obligation on the lessee to effect

the improvements is extinguished).

Should improvements be effected by the lessee for no consideration

(explicit or implicit), then in those circumstances the lessee will not have

made a taxable supply of the improvements, as the improvements would not

have been supplied by the lessee in the course or furtherance of its ‘enter-

prise’. The lessee would therefore not be required to account for any output

tax, but would similarly not be entitled to any input-tax relief in respect of

any goods or services acquired by the lessee for the purpose of supplying the

leasehold improvements to the lessor.

1

The views expressed by Des Kruger are his personal views and in no way represent

the views of SARS or any organisation to which he may be aff‌iliated.

2

Senior Manager, Deloitte. The views expressed by Anne Bardopoulos are her per-

sonal views and in no way represent the views of Deloitte or any organisation to

which she may be aff‌iliated.

26 VOLUME 5 • ISSUE 4 • DECEMBER 2014

Business Tax & Company Law Quarterly

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INTRODUCTION

A topical point at present is leasehold improvements and the value-

added tax (VAT) consequences pertaining thereto. There is unfortunately

currently little specif‌ic legislative or jurisprudential guidance pertaining to

this issue, unlike the income tax position, which has received both judicial3

and legislative attention.4 This article seeks to address this VAT conundrum

by assessing each aspect of such a transaction.

The South African Revenue Service (SARS) issued a Draft Interpretation

Note on VAT and leasehold improvements in April 20125 (Draft IN). The

Draft IN, which had been issued for general comment, was never f‌inalised

or issued. The Draft IN considered the VAT implications of:

• The supply of property under a rental agreement.

• Leasehold improvements effected by a lessee to the leased property with

or without —

— consideration being paid; and

— an obligation to effect improvements.

As regards the supply of the use of the property by the lessor to the lessee,

SARS merely conf‌irmed that:

• The supply of the property is deemed to be a supply of goods under

section 8(11) of the Value-Added Tax Act6 (VAT Act).

• The value of the supply is the rental payable by the lessee to the lessor.

• The time of supply is determined in accordance with section 9(3)(a) of

the VAT Act, each deemed successive supply being deemed to take place

when payment becomes due or is received, whichever is earlier.

None of these views are contestable where an explicit rental is payable

under a leasehold-improvement arrangement, but, as will become clear

from the analysis that follows, SARS fails to take into account the fact that

the value of the leasehold improvements construes implicit consideration

payable by the lessee to the lessor in lieu of, or in addition to, the explicit

rentals that may be payable to the lessor by the lessee.

SARS, with respect, also adopted a very simplistic view as regards the

position of the lessor and lessee where the lessee carries out improvements

to land belonging to the lessor. The Draft IN states that:

• A supply is made by the lessee to the lessor as a result of the change of

ownership of the improvements.

• The time of supply is the earlier of the time an invoice is issued or any

payment is made under section 9(1) of the VAT Act.

3

CIR v Butcher Bros (Pty) Ltd 1945 Ad 301, 13 SATC 24.

4

Paragraph (h) of the def‌inition of ‘gross income’ in s1, and s11(g), of the Income

Tax Act 58 of 1962 (‘the Income Tax Act’).

5

Draft Interpretation Note — Value-Added Tax: Leasehold Improvements, issued in April

2012.

6

89 of 1991.