Property developers develop residential property with the main purpose of selling the completed residential units in the course of making taxable supplies.
Where a property developer who is registered for VAT develops residential properties for sale, the developer is entitled to deduct the VAT incurred on the development costs as input tax and is obliged to levy VAT at the standard rate on the sale of each developed unit.
Notwithstanding a developer’s intention to sell the developed property, it often happens that in adverse market conditions the developer is unable to find a buyer at the required selling price. The developer may then opt to temporarily let the property unit and generate some cash flow until market conditions are more favourable and a suitable buyer can be found.
The leasing of residential fixed property is an exempt supply which would generally result in the input VAT incurred being denied. Consequently, the moment the units are let, the developer is regarded as having made a change in use of the unit for VAT purposes from a taxable application to an exempt application. VAT then becomes due and payable by the developer in terms of section 18(1) on the open market value of the unit as at the date on which the property is let.
A property developer could, for example, develop a townhouse at a cost of R1 150 000. The property developer would have been entitled to claim the VAT on the development cost, being R150 000 (R1 150 000 × 15/115). If the market value of the townhouse is R3 450 000 on the date that it is temporarily rented out, the property developer will have to pay output VAT of R450 000 (R3 450 000 × 15/115) on the change of use adjustment.
Section 18B
Section 18B of the VAT Act was introduced with effect from 10 January 2012. Section 18B granted temporary relief to developers who were then allowed to temporarily let residential units for a period of up to 36 months before a change in use adjustment was required. However, the temporary relief provided under section 18B ceased to apply on 1 January 2018.
Consequently, residential property developers who then, for the first time, let their properties from 1 January 2018, were once again required to perform the change in use adjustment in terms of section 18(1) on the open market value of the property when the unit was first to let as a dwelling. However, the difficulties created by the section 18(1) adjustment which existed prior to the section 18B temporary relief measures remained and developers were once again faced with cash flow difficulties resulting from the disproportionate adjustment.
Section 18D
In order to address this cash-flow inequity, a new section, Section 18D, was inserted in the VAT Act and is applicable to rental agreements entered into from 1 April 2022.
Section 18D(1) defines the term “developer” to mean a vendor who continuously or regularly constructs, extends, or substantially improves fixed property or part of a fixed property consisting of any dwelling for the purpose of disposing of that fixed property after the construction, extension, or improvement.
Section 18D only provides relief for the temporary supply of the letting of residential accommodation for a total period not exceeding 12 months. The proviso to the definition states that ‘temporarily applied’ does not apply to rental agreements which provide for a fixed rental period exceeding 12 months, in which case section 18D will not apply, but rather the provisions of section 18(1).
The principles contained in Section 18D ease the output tax liability of the developer by making the output tax adjustment on the adjusted cost and not on the open market value.
The term ‘adjusted cost’ is defined in section 1(1) and is essentially the VAT inclusive cost of the goods or services in respect of the development of the property.
For example, if a property developer developed a townhouse at a cost of R1 150 000 (and all the amounts were paid to registered VAT vendors), the property developer would have been entitled to claim the VAT on the development cost, being R150 000 (R1 150 000 × 15/115). If the market value of the townhouse was R3 450 000 on the date that the townhouse was temporarily rented out, the property developer would have to pay output VAT on the adjusted cost of R1 150 000, being R150 000 (R1 150 000 × 15/115). The output tax thus effectively reverses the input tax that was claimed by the developer in constructing the fixed property (input tax would have been allowed as the developer incurred expenses in the course of making taxable supplies). The input tax is reversed as the renting of residential accommodation does not entitle the vendor to any input tax deduction.
The time of supply for this change in use adjustment is the tax period in which the agreement for the letting and hiring of the accommodation comes into effect.
The subsequent use of the fixed property temporarily rented out could include that the fixed property is disposed of within the ‘temporarily applied’ 12-month period. The result would be a normal sales transaction where output VAT is levied on the selling price of the property, the normal time of supply rules with the disposal of fixed property applies, and the input tax adjustment is calculated by using the adjusted cost of the fixed property. The vendor can again receive the benefit of the input tax as the property is supplied while making taxable supplies.
Another scenario might be that the fixed property is permanently applied for the letting of residential accommodation. The resultant VAT consequences would be that a further change in use adjustment is required. Output VAT is levied on the open market value of the property on the date on which the agreement is signed that results in the 12-month period being exceeded, or the decision is made to permanently change the use of the property to be applied as residential accommodation. The input tax adjustment is calculated by using the adjusted cost of the fixed property.
Alternatively, the fixed property is no longer applied in supplying accommodation in a dwelling immediately after the expiry of the ‘temporarily applied’ period not exceeding 12 months. Therefore, the intention of the developer is subsequently changed back to disposing of the property, but the property is empty and on the market, waiting to be sold. No output VAT would be levied as there is no change in use adjustment and no actual supply of the property thus far. The input tax adjustment is calculated by using the adjusted cost of the fixed property. Input tax adjustment is claimed in the period when the property is no longer temporarily rented out. The input tax adjustment ensures that the vendor is again in the same position it was before the temporary renting of the fixed property that is intended to be sold, occurred.
For example, Mr X is a residential property developer who recently completed a residential development in Langenhovenpark, Bloemfontein. Due to the current market conditions, Mr X is unable to sell the residential development. The renting of residential development property is exempt from VAT. Mr X is a registered Category C VAT vendor. On 30 June 2022, Mr X entered into an agreement to temporarily rent out the property as residential accommodation for a fixed period of 12 months (1 July 2022 to 30 June 2023). The fixed property had an open market value of R2 500 000 and an adjusted cost price of R1 840 000 on the date the change in use occurred.
As a change in use of the property occurred, an output tax should be levied. The output tax should be accounted for on the date the letting and hiring of the accommodation in a dwelling comes into effect, therefore 1 July 2022. The output tax is calculated on the adjusted cost of the developer and not the open market value. An output tax of R240 000 (R1 840 000 × 15/115) should be accounted for on the VAT return submitted for the July VAT period. No VAT is levied on the rental income received as it is an exempt supply.
On 31 December 2022, therefore within the 12-month period that the fixed property is temporarily applied, Mr X received an offer to purchase the fixed property. Mr X sold the fixed property to an independent third party on 5 January 2023. The market value of the property on the date of disposal was R3 105 000 and the full amount was paid in cash on the date of registration of the property. The fixed property was registered in the Deeds Registry on 28 February 2023. The time of supply is 28 February 2023.
As the fixed property is disposed of for a consideration of R3 105 000, output tax of R405 000 (R3 105 000 × 15/115) should be accounted for. The time of supply is the date of registration of the property or when payment is received, whichever is earlier – being 28 February 2023.
Mr X is allowed to deduct an input tax on the adjusted cost of the fixed property. Therefore, Mr X can claim an additional input tax of R240 000 (R1 840 000 × 15/115). The purpose of the additional input tax is to effectively reverse the output tax adjustment that was made when Mr Chill ‘temporarily applied’ the fixed property in supplying accommodation in a dwelling.
Prepared by CORE TAX For more information contact 051-448 8188 / info@coretax.co.za