VAT im­pli­ca­tions of lease­hold im­prove­ments

Business Day - Business Law and Tax Review - - BUSINESS LAW & TAX REVIEW - Ferdie Sch­nei­der

These have very spe­cific con­se­quences for the lessor and the lessee, specif­i­cally with re­gards to the VAT time and value of sup­ply rules

THE South African Rev­enue Ser­vice (SARS) re­cently pub­lished a draft in­ter­pre­ta­tion note on the Value Added Tax (VAT) time and value of sup­ply rules which ap­ply to lease­hold im­prove­ments, but with­out ad­dress­ing barter type trans­ac­tions where ei­ther the lease pre­mi­ums or the lease­hold im­prove­ments are sup­plied at a value other than the open mar­ket value.

The VAT im­pli­ca­tions of lease­hold im­prove­ments can be in­ter­est­ing as they have very spe­cific con­se­quences for the lessor and the lessee, specif­i­cally with re­gards to the VAT time and value of sup­ply rules.

An un­der­stand­ing of ac­ces­sio is nec­es­sary to un­der­stand the ef­fects of lease­hold im­prove­ments and the VAT con­se­quences thereof. The con­cept of ac­ces­sio has its ori­gin in an­cient Ro­man prop­erty law which de­ter­mined own­er­ship, amongst oth­ers, of goods which re­lated to other goods, where it could be con­sid­ered that one good is the prin­ci­pal good and the other an ad­di­tion or ac­ces­sion to the prin­ci­pal good. The owner of the prin­ci­pal good usu­ally be­came the owner of the ac­ces­sion. The strong­est kind of ac­ces­sio is ac­ces­sion which arises as a re­sult of the ac­ces­sion of a good to land. Where a build­ing or struc­ture is erected on land, the build­ing would gen­er­ally ac­cede to the land (un­less it is move­able in na­ture) and, as a re­sult, be­come the prop­erty of the land owner. As a re­sult, lease­hold im­prove­ments ef­fected un­der a lease agree­ment by the lessee which per­ma­nently ac­cedes to the land or build­ings be­come the prop­erty of the land owner. The use of the im­prove­ment will only pass to the land owner or lessor on ter­mi­na­tion of the lease.

The VAT con­se­quences of the sup­ply of the use of the prop­erty made avail­able by the lessor to the lessee and lease­hold im­prove­ments ef­fected by the lessee to the prop­erty of the lessor or land owner can be an­a­lysed based on the con­cept of ac­ces­sio.

The VAT Act deems the sup­ply of use of prop­erty in terms of a rental agree­ment to be a sup­ply of goods. The VAT time of sup­ply rule in re­spect of the sup­ply of use of prop­erty is fairly straight­for­ward. The VAT Act deems goods sup­plied un­der a rental agree­ment which pro­vides for pe­ri­odic pay­ments to be suc­ces­sively sup­plied for suc­ces­sive parts of the pe­riod of agree­ment and each suc­ces­sive sup­ply is deemed to take place when the pay­ment be­comes due or is re­ceived, which­ever is the ear­lier.

The VAT value of sup­ply rule ap­pli­ca­ble to the sup­ply of use of prop­erty can be trick­ier. The gen­eral VAT value rule deems the value of the sup­ply of the use of prop­erty to be the amount of con­sid­er­a­tion paid for the use of the prop­erty. The term “con­sid­er­a­tion” (which in­cludes VAT) in­cludes pay­ment made or to be made, in money or oth­er­wise, or any act or for­bear­ance, whether vol­un­tary or not, in re­spect of, in re­sponse to, or for the in­duce­ment of a sup­ply.

The VAT Act fur­ther de­ter­mines that the value of the con­sid­er­a­tion shall be the amount of money (lease pre­mi­ums) to the ex­tent that the con­sid­er­a­tion is con­sid­er­a­tion in money; and the open mar­ket value of the con­sid­er­a­tion to the ex­tent that the con­sid­er­a­tion is not in money. Where the lessor and lessee agree open mar­ket value lease pre­mi­ums with­out any other obli­ga­tions aris­ing for the lessee, the value of the con­sid­er­a­tion would be the lease pre­mi­ums. Where the lessor and lessee agree that, in ad­di­tion to the lease pre­mi­ums, the lessee un­der­takes to ef­fect lease­hold im­prove­ments, the con­sid­er­a­tion for the use of prop­erty changes from a straight for­ward “con­sid­er­a­tion in money” sce­nario to a sit­u­a­tion which in­cludes part “con­sid­er­a­tion in money” (that is the lease pre­mi­ums agreed) and part “not con­sid­er­a­tion in money” (that is the lease­hold im­prove­ments).

The lessor re­ceives lease pre­mi­ums and lease­hold im­prove­ments in ex­change for the sup­ply of the use of the prop­erty (a typ­i­cal barter trans­ac­tion). The lessor then needs to de­ter­mine (pre­sum­ably by val­u­a­tion) the open mar­ket value of the lease­hold im­prove­ments which, to­gether with the lease pre­mi­ums, con­sti­tute the con­sid­er­a­tion for the sup­ply of the use of the prop­erty pro­vided by the lessor to the lessee.

As the lease­hold im­prove­ments will usu­ally only pass to the land owner or lessor on ter­mi­na­tion of the lease this di­min­ish­ing ef­fect on the open mar­ket value of the lease­hold im­prove­ments in the hands of the lessor would need to be taken into ac­count in de­ter­min­ing the value of this com­po­nent of the con­sid­er­a­tion. Where it can be demon­strated that the value of the lease­hold im­prove­ments would, in ef­fect, be re­duced to nil or con­sumed in full by the lessee over the du­ra­tion of the lease, it is ar­guable that no value should be at­tached to this com­po­nent of the con­sid­er­a­tion. The com­bined con­sid­er­a­tion sum is then the value for VAT pur­poses.

The VAT value of sup­ply rule ap­pli­ca­ble to “con­nected per­sons” (as de­fined) pro­vides that where (i) a sup­ply is made for no con­sid­er­a­tion or for a con­sid­er­a­tion which is less than the open mar­ket value; (ii) the sup­plier and re­cip­i­ent are con­nected per­sons; and (iii) if a con­sid­er­a­tion equal to the open mar­ket value had been paid by the re­cip­i­ent, he would not have been en­ti­tled to a full in­put tax de­duc­tion, the con­sid­er­a­tion in money for the sup­ply is deemed to be the open mar­ket value of the sup­ply.

Lease­hold im­prove­ments ef­fected by a lessee on the land or prop­erty of a lessor con­sti­tute a sup­ply for VAT pur­poses from the lessee to the lessor.

The gen­eral VAT time of sup­ply rule de­ter­mines that the time of sup­ply is the ear­lier of the time that an in­voice is is­sued or when pay­ment of con­sid­er­a­tion is re­ceived by the re­cip­i­ent. Gen­er­ally, the VAT time of sup­ply will not be trig­gered if no in­voice has been is­sued and no pay­ment is made for the lease­hold im­prove­ments, ir­re­spec­tive of whether an obli­ga­tion ex­ists to ef­fect the im­prove­ments. The lessee will then not be obliged to ac­count for out­put tax and the lessor will not be en­ti­tled to an in­put tax de­duc­tion in re­spect of the im­prove­ments. How­ever, as the term “con­sid­er­a­tion” in­cludes “any act or for­bear­ance” in re­spect of, in re­sponse to, or for the in­duce­ment of a sup­ply, a re­duc­tion in lease pre­mi­ums agreed by the lessor in lieu of lease­hold im­prove­ments to be ef­fected could ar­guably con­sti­tute pay­ment of con­sid­er­a­tion and trig­ger the VAT time of sup­ply. Al­ter­na­tively, the lease agree­ment could de­ter­mine or im­ply that the lease­hold im­prove­ments to be ef­fected re­sults in or ef­fects re­duced lease pre­mi­ums payable and could con­sti­tute “a doc­u­ment no­ti­fy­ing an obli­ga­tion to make pay­ment”, which could trig­ger the VAT time of sup­ply. The ac­tual pay­ment of con­sid­er­a­tion by the lessor to the lessee as con­sid­er­a­tion for the im­prove­ments will also trig­ger the VAT time of sup­ply.

The VAT value of the sup­ply of the lease­hold im­prove­ments will usu­ally be the con­sid­er­a­tion paid by the lessor where the lessor and lessee agree the open mar­ket value con­sid­er­a­tion.

Where the lessor and lessee agree that the lessee un­der­takes to ef­fect lease­hold im­prove­ments, in ex­change for ac­tual pay­ment and re­duced lease pre­mi­ums payable, the con­sid­er­a­tion for the lease­hold im­prove­ments changes from a straight for­ward “con­sid­er­a­tion in money” sce­nario to a sit­u­a­tion which in­cludes part “con­sid­er­a­tion in money” (that is ac­tual pay­ment agreed for the im­prove­ments) and part “not con­sid­er­a­tion in money” (that is the re­duced lease pre­mi­ums agreed).

The lessee re­ceives ac­tual pay­ment for the lease­hold im­prove­ments and pays re­duced lease pre­mi­ums (again a typ­i­cal barter trans­ac­tion). The lessee then ar­guably needs to de­ter­mine the net present value of the re­duc­tion in lease pre­mi­ums which, to­gether with the ac­tual pay­ment re­ceived for ef­fect­ing the lease­hold im­prove­ments, con­sti­tute the con­sid­er­a­tion for the sup­ply of the lease­hold im­prove­ments by the lessee to the lessor. Where the lessee and lessor are con­nected per­sons, the con­nected per­sons’ VAT value rule will ap­ply.

The in­tri­ca­cies of VAT on lease­hold im­prove­ments could po­ten­tially im­pact the lessor and lessee and need to be care­fully ar­tic­u­lated and man­aged to avoid un­nec­es­sary VAT costs. Also, the very spe­cific in­come tax pro­vi­sions need to be man­aged care­fully.

Ferdie Sch­nei­der is tax part­ner in the value-added tax di­vi­sion at KPMG.

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