A Guide to SARS s Urban Development Zone Tax Incentive

Transcription

1 A Guide to SARS s Urban Development Zone Tax Incentive This is just a general summary of relevant UDZ information for investors buying into sectional-title developments. It is not meant to delve into the precise technical and legal detail that is often associated with taxation and should, therefore, not be used as a legal reference. For further legal reference please consult The Income Tax Act, No. 58 of 1962(section 13quat) and your tax consultant. INTRODUCTION In 2003, the Minister of Finance, Mr. Trevor Manuel, announced the introduction of a tax incentive that will encourage investment for certain specified urban development zones. The core objectives of this incentive are: to respond to the problem of dereliction and dilapidation in South Africa s large cities; and to promote urban renewal and development through private sector investment in the construction and improvement of buildings. This incentive, falling under section 13quat of the Income Tax Act (Act No. 58 of 1962), comes in the form of an accelerated depreciation allowance for the construction of new buildings and improvements in specified urban development zones. Without this incentive, these costs may not be depreciated and properties would only be entitled to depreciation of only 2 or 5 per cent per annum (depending on the nature of the buildings and the improvements involved). Page 1 of 10

2 NATURE OF THE INCENTIVE The incentive provides investors with a tax write-off for the cost of the improvement or building over time before actual sale (and without regard to the write off for accounting purposes). The tax write-off period depends on whether the construction relates to an improvement of an existing building (or part thereof) versus a new building (or extension or addition to a new building). The purpose of this enhanced incentive (beyond the 17-year write-off above) is to maintain structures considered worthy of retention and to maximise the use of all the sunken capital of existing buildings. In order to qualify for the 5-year write-off, investors must preserve a substantial part of the building s existing structural or exterior framework (i.e., all the 4 walls or all the steel frameworks of the existing building). In addition, extensions or additions to an existing building may fall within the 5-year write-off (as opposed to the 17-year write-off) if merely incidental to the improvement. The UDZ allowance will be allowed as follows: In respect of the erection or extension of or addition to a building or part of a building or the purchase of such a building or part of a building from a developer, over a period of 17 years (therefore, 20% of the cost in the first year of assessment and 5% of the cost in each of the successive 16 years of assessment). In respect of the improvement of an existing building or part of a building or the purchase of such an existing building or part of a building from a developer, over a period of 5 years (therefore, 20% of the cost in the first year of assessment and 20% of the cost in each of the 4 successive years of assessment). HOW DOES THE INCENTIVE REDUCE MY TAX? If an owner-first purchaser qualifies for the tax incentive, the 17-year write-off of costs incurred by the owner-first purchaser are deductible against the entire taxable income of the owner-first purchaser. No ring fencing applies. In other words, writeoffs for one building can be setoff against any other income of the owner-first purchaser, regardless of whether that income relates to the building or the line of business to which that building relates. Any excess losses that cannot be fully set-off within a year are carried forward indefinitely. These excess losses can be setoff in later years until fully absorbed. New Buildings An owner-first purchaser who purchases a newly constructed building (or part thereof), including extensions or additions from a bona fide developer is deemed to have incurred 55 percent of the purchase price. The owner-first purchaser will receive a 17-year write-off for the 55%once the building is brought into use. This write-off allows for a deduction of 20%for the first year in which the building is brought into use and an annual deduction of 5% for each of the following 16 years. Example. Facts: A developer purchases vacant land for R5 million and constructs a new sectional-title development on the land. The development costs R10 million. The owner first-purchaser incurs costs of R1 million for each unit bought from the developer. Page 2 of 10

3 Result. The owner-first purchaser s deductible amount is 55 percent of R1 million (i.e., R ). In the first year that the building is brought into use, the allowance will be 20% of the R (i.e.: R ). Thereafter, the owner-first purchaser can deduct 5% (or R27 500) of the balance of the deemed costs for each of the next 16 years (i.e: the remaining R over a 16-year period). The land may never be depreciated. WHAT HAPPENS WHEN A PERSON SELLS A UDZ BUILDING? Where a person that claimed a deduction for a UDZ allowance sells the building in respect of which the UDZ allowance was claimed, such person will from the year of assessment following the year of assessment during which the person sold the building or part of the building, no longer qualify for a UDZ allowance in respect of such building or part of the building. All deductions that were previously allowed in respect of UDZ allowances, will, furthermore, be subject to the recoupment provisions contained in section 8(4)(a) of the Act. Such person will, furthermore, be subject to taxation on any capital gain made on the disposal of the UDZ building. WHAT HAPPENS WHEN A PERSON CEASES TO USE A BUILDING SOLELY FOR PURPOSES OF TRADE? Where a person that claimed a deduction for a UDZ allowance ceases to use the UDZ building or part of a building in respect of which the UDZ allowance was claimed solely for purposes of trade, such person will from the year of assessment following the year of assessment during which the person ceased to use the building or part of the building solely for purposes of trade, no longer qualify for any UDZ allowances in respect of the costs incurred in respect of such building or part of such building. WHAT REQUIREMENTS MUST A PERSON COMPLY WITH TO QUALIFY FOR THE UDZ ALLOWANCE? i) Building Requirement (1) A bona fide developer must improve or construct an entire building or at least (if not the entire building) a 1000m² area. For instance, assume a bona fide developer can purchase ten flats of 100m² each in the same block of flats, refurbish them, and then sell them off individually to owner-first purchasers. In this circumstance, the individual owner-first purchasers will be able to claim the allowance. In addition, if a developer has improved a building (or part thereof) the developer must incur expenditure equal to at least 20% of the purchase price paid by the taxpayer. (2) The developer must not have claimed any UDZ allowance in respect of that building (or part thereof). (3) Any owner-first purchaser must purchase the building (or part thereof) directly from a bona fide developer that has built the building. The agreement to purchase must have been concluded on after 8 November (4) The bona fide developer must not use the building (or part thereof) for purposes of his/her trade. This requirement stands in contrast to the owner-first purchaser who must use the purchased building(s) for purposes of his/her trade Page 3 of 10

4 ii) Trade Requirement A person will only qualify for the UDZ allowance once a building or part of a building that was constructed, improved or purchased directly from a developer is brought into use solely for the purposes of that person s trade. The courts have interpreted the concept trade to be neither exhaustive nor restrictive it will, therefore, include any activity where a person risks something with the object of making a profit. For example, the letting of commercial or residential property at market prices, the carrying on of a manufacturing concern with the object of making a profit, etc. constitutes trade. iii) Owner Requirement To be able to qualify for a UDZ allowance it is required that the building or part of the building that was constructed or improved must be owned by the person claiming the allowance. A lessee that constructed or improved a building or part of a building on leased property will, therefore, not be able to qualify for a UDZ allowance in respect of that building. iv) Trade Date Requirement To qualify for a UDZ allowance, the building or that part of a building must have been brought into use solely for purposes of trade on or before 31 March v) Documentation Requirement To be able to qualify for the UDZ allowance, it is necessary that the person claiming the allowance has obtained certain documentation from the relevant municipality. If the building or part of the building was purchased from a developer it is, furthermore, necessary that certain other documentation must be obtained from such developer. (a) The Municipality A certificate of confirmation issued by the municipality to that person which confirms that the building or part of a building that was constructed, improved or purchased from a developer is located within a UDZ within the boundaries of that municipality (a location certificate). A certificate of occupancy in respect of the building or part of the building that was constructed improved or purchased. (b)the Developer A certificate (UDZ 3) is available on SARS s website ( that confirms that: The erection, extension, addition to or improvement of the building was commenced by the developer on or after the date of publication of the particulars pertaining to the demarcation of the relevant area in which the building is located, in terms of a contract formally and finally signed by all parties thereto on after that date; The construction or improvement by the developer covers the entire building or at least a floor area of m²; Page 4 of 10

5 The developer has not claimed any UDZ allowance in respect of the building or that part of the building; and In the case of the improvement of a building or part of a building, the developer has incurred expenditure in respect of those improvements which is equal to at least 20% of the purchase price paid by the taxpayer in respect of the building or that part of the building. The above documentation must, together with the relevant SARS form (see below for more information in this regard) be submitted with the person s relevant return of income when a UDZ allowance is claimed. HOW DOES A PERSON CLAIM THE UDZ ALLOWANCE? A person claiming the UDZ allowance in respect of a year of assessment has to submit the following documentation which can be found at: with the relevant return of income: 1) UDZ 1 or UDZ 2 (whichever is applicable) with regard to each building or part of a building in respect of which a UDZ allowance is claimed, where the following information inter alia has to be provided: The total cost in respect of the construction or improvement of a building or part of a building or where a building or part of a building was purchased from a developer the deemed cost for purposes of the UDZ allowance. The extent to which these costs relate to any portion of the building in respect of which a certificate of occupancy has been granted by the relevant municipality. An indication whether these costs were incurred in respect of the erection or extension of, addition to or improvement of a building. 2) A certificate of occupancy obtained from the relevant municipality 3) A location certificate obtained from the relevant municipality 4) Where a building or part of a building is purchased from a developer, a certificate (UDZ 3) obtained from the developer that constructed or improved the building or part of the building. Page 5 of 10

6 Page 6 of 10

7 Page 7 of 10

8 Page 8 of 10

9 Page 9 of 10

10 References South African Revenue Service, Guide to the Urban Development Zone Tax Incentive. [Online]. South African Revenue Service. Available at: [accessed 4 July 2008]. The National Treasury Economic Policy and International Financial Relations Division, Tax Policy Directorate, Urban Renewal Tax Incentive. [Online]. The National Treasury. Available at: Tax%20Incentive%20-%20Guide%20for%20Investors.pdf [accessed 4 July 2008] City of Cape Town, Planning Urban Development Zones and the Tax Incentive [Online]. City of Cape Town. Available at: [accessed 4 July 2008] Page 10 of 10