Understanding the tax implications when leasing vacant commercial land

Posted On Wednesday, 30 July 2008 02:00 Published by eProp Commercial Property News
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Lessees often enter into leases of vacant commercial or industrial land and erect buildings on the land. Tax Partner at Cameron & Prentice Chartered Accountants, David Warneke, explains the tax effects of these agreements

David WarnekeThe first important point is to ensure that the scope and value of the work is covered in the lease agreement. This is important from the point of view of the lessee’s tax (see below) but also to avoid disputes with the lessor regarding the exact type and value of improvements to be completed.
From the point of view of the lessee’s tax, section 11(g) of the Income Tax Act allows a deduction for the value of the improvements as stipulated in the lease. However there has to be an obligation on the lessee to effect improvements in terms of the lease. The lessor also has to be taxed on the value of the improvements in order for the lessee to enjoy a tax deduction under the section. The tax deduction is granted over the period of the initial lease (i.e. not including renewal periods), pro-rata from the date the improvements are completed to the end of the initial lease term, with a maximum lease term for tax spreading of 25 years.
For example say the lease requires improvements to the value of R 20 million (excl VAT), the building work commenced on 1 March 2007, was completed on 1 September 2007 and the initial lease is for a 15 year period from 1 January 2007, the deduction for the lessee’s tax year ended 28 February 2008 is as follows:

The number of months from the completion of the improvements to the end of the initial lease is 172 (14 years and 4 months). Deduction for the 2008 tax year is 6 months (1 September 2007 to 29 February 2008) divided by 172 months multiplied by R 20 million equals R 697 674.
Of course, in most cases the value of the improvements won’t exactly equal the figure in the lease. The section requires that the lessee is restricted to the actual cost of the improvements, where the cost is less than the value stipulated. This scenario is particularly tax-unfriendly as the lessor will still be taxed on the value stipulated in the lease.
On the other hand if the lessee spends more than the amount stipulated, a case has held that the lease can be amended to reflect the higher figure, provided that the amendment takes place before the improvements are completed. Where no amendment is made the lessee will only be able to deduct the amount in the lease and the lessor will be taxed on the amount in the lease. The excess spent by the lessee may qualify for a deduction under section 13(1) (if the improvements consist of a manufacturing building) i.e. the excess is deducted on the straight line basis over 20 years.
The lessor is taxed on the value of the improvements as stipulated in the lease. In practice the full value is taxed in the year the improvements are completed, subject to a discretionary allowance by SARS. The discretionary allowance effectively discounts the value of the improvements at 6 % per annum over the initial period of the lease.

Last modified on Wednesday, 21 May 2014 23:07

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