Value-added tax
529. Residential property
February 1998
Value-added tax can have serious consequences for the unwary in the purchase or sale of fixed property.
Although transactions involving commercial property are not entirely uncomplicated, they pose fewer problems for potential buyers. These transactions are entered into for the purpose of business and buyers normally consult their accountants and lawyers before signing any contracts.
But what about the unsuspecting person looking to buy property for residential purposes? The average person generally consults no-one, except possibly his bank manager, before signing the contract for his dream house.
As a rule of thumb, buying residential property privately from another person who used the property as a residence, should not pose any problems. No VAT will be charged on the sale. Transfer duty will be payable.
Where, however, the property is bought from a developer, VAT will most probably be payable on the transaction since the developer’s turnover will oblige him to register as a vendor. In such transactions no transfer duty is payable.
Problem transactions
The type of transactions which are likely to cause problems are:
Home businesses
A house is purchased from an individual who is registered for VAT and operates his business from home. If the seller originally claimed an input tax credit in respect of the property, the sale of the property will be subject to VAT. Depending on the stipulations in the sale agreement, an unsuspecting buyer could end up incurring unnecessary costs. If the agreement provides the seller with sufficient recourse, the buyer may even end up paying an additional purchase price, being the VAT payable by the seller on the sale price.
It is therefore important that a potential buyer ensures that the agreement stipulates that the selling price is inclusive of VAT in the event of VAT becoming payable for whatever reason.
Corporate ownership
Membership or a shareholding is acquired in a close corporation or company that holds the property as its only asset.
Over the years some people have structured their affairs so as to obtain maximum VAT benefits by forming a company or close corporation to acquire the property. The entity then claims the input tax on the acquisition based on the fact that the property is either constituted as "trading stock" or a "commercial rental establishment" e.g. a guest house.
To promote the sale of the property, potential purchasers are offered shares or membership in these entities instead of direct ownership of the property itself. The purchaser is only liable for stamp duty, thus effectively reducing the cost of the property.
The purchaser buys the shares, completely unaware of the VAT implications of the transaction. Because the property will not now be used to make taxable supplies, the purchaser applies to have the entity deregistered for VAT. It is only at this stage that he becomes aware of the provisions of section 8(2) of the VAT Act which require him to pay VAT upon cancellation of the registration.
If the property was originally held as trading stock in the entity, the whole transaction can become a nightmare with further adverse tax consequences as the following scenario illustrates.
The new purchaser, aware of the "penalty" upon deregistering, decides to keep the entity alive for VAT purposes and simply to submit nil VAT returns. At a future date he receives an offer to purchase from another party. This person does not want membership or shares, but the property itself. The seller will have to account for the output tax on the full selling price since an asset that formed part of the enterprise has been disposed of.
Unfortunately this is not where it ends. Inland Revenue may want income tax on the profit the company made on the sale, since the property was held as trading stock. Profits realised on the sale of trading stock constitute revenue profits which are subject to income tax.
Editorial comment :
Although the property was originally acquired as trading stock, the intention for holding the properly may change to one of investment e.g. to be held for personal residential purposes or to be held for use as a commercial rental establishment
If the intention changed to the holding for personal residential purposes (and this can be proved), then, at the time of the change, the entity should have deregistered for VAT, stopped completing nil VAT returns and paid output tax on the then market value of the property. In such a case, the proceeds on the eventual sale of the property would not be subject to VAT nor the profit subject to income tax.
If the intention changed to the holding for use as a commercial rental establishment (and this can be proved), then, at the time of the change, there are no VAT or tax implications as the property is still held as part of a VAT registered enterprise. In such a case, the proceeds on the eventual sale of the property would still give rise to the payment of output tax, but the profit would probably be classified as being of a capital nature and thus not subject to income tax.
Partial business use
The residential property is to be used partly for business. Careful consideration should be given to the VAT implications before summarily deciding to use a residence partly for business. The most important factor to keep in mind is that when the property is sold eventually, VAT must be paid on the full selling price. The seller will then be able to claim as an input credit any portion of VAT not previously allowed as an input.
Illustration
Mr A is registered for VAT. He bought a house in January 1994 for R300 000 from a non-vendor and paid transfer duty of R14 100. He works from home and accordingly claimed a notional input in respect of the portion (25%) of the property used for business purposes. Notional input tax in respect of fixed property is limited to the transfer duty paid.
In July 1997 he is made an offer of R600 000 and he decides to sell the property. The price (unless otherwise negotiated with the purchaser) is deemed to be inclusive of VAT. What are the VAT implications?
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Input tax claimed in respect of business portion: |
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Output tax payable on selling price: |
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Input in respect of portion previously not claimed: |
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Net VAT payable: |
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Net capital profit: R300 000 - R73 684 = R226 316 |
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If no VAT had to be charged on the sale of the property Mr A’s net capital profit would have been R285 900. |
Therefore, caveat emptor, and remember that it is probably worth checking the facts and consequences with your business consultant before purchasing residential property.
BDO Spencer Steward
Definition "goods" S1 VAT Act
Definition "gross income" S1 IT Act
