Background Shelf Company A is currently dormant. Company A will in future be used to acquire land and develop a townhouses complex on the land. The main purpose of Company A after completion of twenty townhouse units is to rent out the townhouses as reside
Important:
This answer is based on tax law year ending 28 February 2020.
Answer:
The VAT Act
The general charging section
Section 7(1)(a) of the VAT Act imposes VAT on the supply of goods or services made by a vendor in the course or furtherance of the VAT enterprise carried on by the vendor. VAT is imposed at the standard rate of (currently 15%), unless the supply qualifies to be supplied at the zero-rate in terms of section 11 of the VAT Act or is exempt from VAT in terms of section 12 of the VAT Act.
Sections dealing with “enterprise”
“Enterprise” is defined in section 1(1) of the VAT Act as any enterprise or activity which is carried on continuously or regularly in or partly in South Africa and in the course or furtherance of which goods or services are supplied to any other person for a consideration.
Proviso (v) to the definition of “enterprise” in section 1(1) of the VAT Act determines that any activity is, to the extent that it involves the making of exempt supplies, deemed not to be the carrying on of a VAT enterprise.
Section 12(c) of the VAT Act exempts from VAT the supply of a dwelling under an agreement for the letting and hiring thereof.
A “dwelling” is defined in section 1(1) of the VAT Act as any building, premises, structure, or any other place, or any part thereof, used predominantly as a place of residence or abode of any natural person or which is intended for used predominantly as a place of residence or abode of any natural person. A dwelling includes fixtures and fittings belonging thereto and enjoyed therewith. The definition of a dwelling specifically excludes property used in the supply of commercial accommodation.
Sections dealing with input tax
Section 16(3)(a)(i) of the VAT Act allows a vendor to make a deduction of input tax in respect of supplies of goods and services made to the vendor during a tax period.
“Input tax” is defined in section 1(1) of the VAT Act as, amongst others, VAT charged under section 7 of the VAT Act and payable in terms of that section by a supplier on the supply of goods or services made by the supplier to the vendor, to the extent that the vendor has acquired the goods or services for the purpose of consumption, use or supply in the course of making taxable supplies.
Application of the principles
The acquisition of the land and townhouses for renting out to tenants represents an exempt activity for VAT purposes as envisaged in section 12(c) of the VAT Act. These activities accordingly, do not form part of a VAT enterprise carried on by Company A. No input tax may be claimed in respect of the acquisition of the land and the construction of the buildings and no output tax must be accounted for on the rentals charged. If this is the only activity carried on by Company A, Company A should deregister as a VAT vendor.
Careful consideration should be given to the manner in which the townhouses are ultimately disposed of. As a general principle the disposal of assets used to make exempt supplies would not be subject to VAT, not being a supply made in the carrying on of a VAT enterprise.
The manner in which the disposal takes place may, however, be indicative of a secondary trade carried on, being the sale of the townhouses, especially if a significant number of townhouses are in the market at the same time.
If Company A already anticipates that it will sell a significant portion of the townhouses after a period of three years, this is strong evidence of a dual purpose at the outset of the transaction. Under these circumstances it would be challenging to argue successfully that the townhouses are not acquired for a dual purpose, i.e. initially to be used in an exempt activity and thereafter in a taxable activity of selling townhouses.
In summary, the onus is on the taxpayer to prove that he/she does not acquire an asset with a dual purpose. Based on the facts provided, this may be a difficult onus to dispose of.