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[FAQ] VAT implications of a change from a residential to commercial property

This article is based on tax law for the year ending 28 February 2021.

Background

A trust that is registered as a VAT vendor, bought two residential properties in a coastal town. No input tax was claimed on the purchase of either properties. These two properties were used for residential purposes by the trustees/beneficiaries during holidays. One of the trustees of the trust approached the trust and enquired if he could rent one of the properties. The trustee wanted to convert the residential property to run a guest house. The trust agreed and the rental does attract VAT and output tax has been declared and paid over to SARS for the last 18 years. An offer by a third party was made to purchase the property from the trust.

Is VAT payable on the sale of the property?

Answer

The VAT Act

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 are exempt from VAT in terms of section 12 of the VAT Act.

“Goods” as defined in section 1(1) of the VAT Act specifically includes fixed property.

Sections dealing with VAT enterprise related issues

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.

Sections dealing with exempt supplies

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.

“Commercial accommodation” is defined in section 1(1) of the VAT Act as lodging or board and lodging, together with domestic goods or services, in any house, flat, apartment, room, hotel, motel, inn, guest house, boarding house, residential establishment, holiday accommodation unit, chalet, tent, caravan, camping site, house boat, or similar establishment, which is regularly or systematically supplied. It excludes a dwelling supplied in terms of an agreement for the letting or hiring thereof.

Sections dealing with change-in-use adjustments

Section 16(3)(f) of the VAT Act allows a vendor a deduction of amounts calculated in accordance with, amongst others, section 8(4) of the VAT Act.

Section 18(4)(b)(i) of the VAT Act determines that where goods or services have been supplied to or imported by a person and VAT has been charged on the supply, and no deduction of input tax has been made, such goods are deemed to be supplied to the vendor in the tax period that the vendor first uses the goods or services in a taxable activity.

Section 18(4)(c) of the VAT Act determines that where second-hand goods situated in South Africa have been supplied to a person under a sale (otherwise than in terms of a supply subject to VAT) on or after 30 September 1991, and no deduction of input tax has been made, such second-hand goods are deemed to be supplied to the vendor in the tax period that the vendor first uses the second-hand goods in a taxable activity.

Application of the principles

It is common cause that the property was physically used to supply commercial accommodation, albeit not by the trust.

A property (residential or otherwise) used by any person to supply commercial accommodation cannot be a dwelling as defined in section 1(1) of the VAT Act. The rentals charged for such property could therefore never qualify as exempt supplies as envisaged in section 12(c) of the VAT Act (in practice generally referred to as residential rentals). You indicated that the trust correctly charged VAT on the rentals and paid it over to SARS.

Prior to renting the property to the operator of the guest house, the property would not have formed part of the VAT enterprise carried on by the trust as no taxable supplies have been made with the property. The property would accordingly not have formed part of the VAT enterprise carried on by the trust.

On entering into the rental agreement with the operator of the guest house, the status of the property changed from a non-VAT enterprise asset to a VAT enterprise asset. At that point in time the trust would have been entitled to an input tax/notional input tax deduction in relation to the property based on a change in application from using the property for non-enterprise purposes to using the property for VAT enterprise purposes (section 18(4) of the VAT Act). The trust had five years within which to make the claim, failing which the claim would be permanently forfeited.

The sale of the property would be subject to VAT being a VAT enterprise asset. No transfer duty will be payable in respect of the sale. The fact that for commercial purposes the property may be classified as a residential property is irrelevant in the current enquiry.

Based on the information supplied, the sale will be subject to VAT at the standard rate of 15%.

Webinar Commentary

Refer to webinar commentary on the Trusts: A deep dive here.

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