When a property developer develops residential properties for resale, the developer is entitled to deduct the VAT incurred on the development cost as input tax. The developer is then obliged to levy VAT on the sales consideration when the residential units are sold. If the developer experiences difficulty in finding buyers for the units due to adverse market or economic conditions, the developer may instead let them until the property market improves. However, the moment the developer lets the unit, VAT becomes payable on the open market value of the unit at that time. This is because the South African Revenue Service (SARS) is of the view that the temporary letting of residential units developed for resale comprises a ‘change in use’ from making taxable supplies to exempt supplies, since the letting of residential accommodation is exempt from VAT.
The Minister of Finance at the time, Mr Pravin Gordhan, stated in his budget review on 17 February 2010 that this situation is disproportionate to the exempt income received by the owners of the properties and that options will have to be investigated to determine a more reasonable method in dealing with the temporary letting of residential properties developed for resale.
Section 18B of the Value-Added Tax Act, No 89 of 1991 (VAT Act) was introduced with effect from 10 January 2012 under which residential property developers enjoyed temporary relief from the payment of VAT. Section 18B allowed developers to temporarily let the residential units for a period of up to 36 months before the VAT thereon became payable. The temporary relief was initially provided until 1 January 2015 but was subsequently extended to 1 January 2018. The relief did not apply where the property was let beyond a 36-month period, or when the property was applied permanently for letting as a dwelling or for purposes other than making taxable supplies.
The temporary relief provided for under s18B has not been extended any further and ceased to apply on 1 January 2018.
Consequently, residential property developers are now faced with the dilemma that they are required to account for VAT to SARS in the January 2018 tax period on the open market value of all the unsold residential units which they temporarily let as dwellings. The VAT is payable even though some of the units may not have been let for a full 36 months.
When the temporary relief measures were first introduced, it was recognised in the Explanatory Memorandum on the Taxation Laws Amendment Bill, 2011 that the VAT payments due upon the temporary letting of the residential units undercut the cash-flow gains otherwise associated with temporary letting and may even force certain developers into insolvency. It was further stated that s18B was introduced as a short-term measure to address the cash flow problem faced by developers, whilst a more permanent solution was being sought. However, it seems that during the six years that the temporary relief under s18B applied, no effort was made to find a permanent solution to the problem, and we merely revert back to the VAT position prior to the introduction of the temporary relief measures.
Property developers that find themselves in a cash flow squeeze as a result of s18B ceasing to apply, can approach SARS under s167 of the Tax Administration Act, No 28 of 2011 (TAA) to pay the VAT amount due in instalments over an agreed period. The developer must, in terms of s168 of the TAA, be able to satisfy SARS that it has a cash flow problem and is unable to settle the VAT in a single payment, and that its financial position is likely to improve in the short term. SARS may also request the developer to provide suitable security before it agrees to the payment of the VAT in instalments.
If the developer has paid the VAT on an unsold unit which is temporarily let and it subsequently manages to sell the unit, then VAT is payable on the total sales consideration. SARS has stated in its VAT News 14 (March 2000) that the developer may then deduct the total VAT amount previously paid. SARS also subsequently stated in its Guide for Fixed Property and Construction (VAT 409 – 2011) that the developer is entitled to deduct the total amount of VAT previously paid on the unit let in the tax period in which the unit is sold, but this statement was not repeated in subsequent VAT 409 guides. However, allowing a full deduction of the VAT previously paid seems to be in contradiction with s18(4) of the VAT Act, which provides for a deduction to be made only on the lesser of the adjusted cost or the open market value of the unit.
We can only hope that SARS and National Treasury will urgently address the problems with regard to the VAT rules concerning the change in use adjustments for property developers, which problems have already been acknowledged by the Minister of Finance back in 2010, and that a permanent solution will be introduced soon. Both the New Zealand and Australian tax authorities have successfully addressed this issue, and guidance could be drawn from them to find a suitable solution in a South African context.