Author : Ruaan van Eeden, Director, and Carmen Moss-Holdstock, Assoc
VAT considerations in relation to the disposal of leased commercial property
Cliffe Dekker Hofmeyr – Published 22 Nov 2012
Subject to various conditions being met, an enterprise (or part of it capable of separate operation), that is disposed of as a going concern to a registered vendor, may be subject to Value-Added Tax (VAT) at the zero rate. Where leased commercial property is being disposed of as a going concern, particular care must be taken by the person making the supply to ensure that the correct VAT rate is applied.
For purposes of this article we will briefly discuss two scenarios:
- The disposal of a commercial letting enterprise by a vendor (fixed property together with lease agreements); and
- The disposal of a commercial property by a vendor to its only tenant that will continue the letting enterprise.
The zero rating provisions for the disposal of an enterprise as a going concern are contained in s11(1)(e) of the Value-Added Tax Act, No 89 of 1991 (VAT Act), read with Interpretation Note 57 (IN57). Essentially, for a disposal to qualify for the zero rate of VAT, the following requirements must be met:
- The parties must agree in writing that the enterprise is disposed of as a going concern.
- The supplier and recipient must be registered vendors.
- The supply must be of an enterprise or part of an enterprise capable of separate operation.
- The supplier and the recipient must, at the time of concluding the agreement, agree in writing that the enterprise (or part thereof) will be an income earning activity on transfer.
- The assets necessary for the carrying on of the enterprise must be disposed of.
- The supplier and the recipient must agree in writing that the consideration for the supply is inclusive of tax at the rate of 0%.
For purposes of discussing the two scenarios above, the focus will be on the transfer of assets necessary for the carrying on of the enterprise, in other words, what would be required to zero rate a transaction with reference to commercial letting enterprises.
In terms of IN57, the view of the South African Revenue Service (SARS) is that the mere transfer of an asset is not enough to fall within the zero rating provisions of s11(1)(e) of the VAT Act. More specifically, in relation to the disposal of a commercial letting enterprise, it is SARS’ view that the fixed property must be disposed of, together with the lease agreement in order to fall within the zero rating provisions. The aforementioned disposals of commercial letting enterprises must also pass the additional test relating to level of occupancy. SARS’ view is that an occupancy level of at least 50% is required, which is consistent with the approach followed in other jurisdictions, such as New Zealand.
The 50% occupancy level is however not set in stone,as one would need to consider the current market conditions in which the disposal is made. One may face a scenario, in an economic slowdown that occupancy rates of less than 50% may be acceptable – it should therefore not be a hindrance in applying the zero rate of VAT in such a scenario.
In practice, it is not uncommon for a tenant (being the only tenant) to enter into an agreement for the purchase of commercial property from its current owner. SARS’ view, in the aforementioned scenario, is that this type of transaction does not constitute the disposal of a going concern for purposes of the s11(1)(e) of the VAT Act. In VAT Guide 409 for Fixed Property and Construction various income activities are listed that would not qualify as the transfer of an income earning activity – more specifically it is SARS’ view that where a lease is extinguished where a commercial property is sold to a tenant, it does not constitute the sale of a going concern. In other words, it is SARS’ view that not all the assets, that is fixed property including lease, have been transferred as part of the enterprise disposal.
A slightly more complex situation arises where a lessee has entered into a sub-letting arrangement and intends to purchase the commercial property outright from the current owner. The lessee technically (but not in a legal sense) steps into the shoes of the owner upon the transfer of the commercial property and will continue the letting enterprise and make taxable supplies subject to VAT at the standard rate. Even though a commercial letting enterprise appears to continue unhindered where the lessee now becomes the outright owner, it is debatable whether the zero rating will apply to the disposal of the property. An argument that counts against zero rating this type of transaction is that the lease between the owner and the lessee terminates on disposal and that the sub-letting agreements, which the lessee has in place with its tenants, do not form part of the assets necessary for the carrying on of the lessor’s enterprise. In such a scenario the standard rate would likely apply to the disposal, however, the recipient would be able to claim input tax where the property will be used in the course of making taxable supplies.
As can be gleaned from above, when parties are concluding agreements for the transfer of a commercial letting enterprise as a going concern and applying the zero rating provisions, there are various factors that need to be taken into account from a VAT perspective. The dragon is in the detail.
Written by Ruaan van Eeden, Director, and Carmen Moss-Holdstock, Associate, Tax, Cliffe Dekker Hofmeyr
Edited by: Creamer Media Reporter