What are the potential value added tax (VAT) implications for a landlord when it accrues significant interest income but there is a decrease in rental income? This question is being asked because of the impact of the coronavirus (COVID-19) pandemic on the real estate sector in South Africa.
The property industry is a capital intensive industry, and some landlords use debt to fund the acquisition of commercial property. Within a property group, some companies may grant interest-bearing loan funding to other entities within their group in order to fund the acquisition of additional commercial properties. Due to the value of commercial property, the loan funding required to purchase commercial property could be significant. This would give rise to significant interest income for the lending companies within a property group whereas the borrowing companies would incur significant interest expenses as a result of the loan funding.
An aspect that landlords may overlook is the impact of a reduction in rent on their VAT liability (for instance, a rent reduction granted in response to the economic situation flowing from the pandemic). Landlords generally would not have a problem with regard to claiming all input VAT on the expenses they incur. If the landlord is part of a group of companies and has granted interest-bearing loan funding to another group company, that landlord could be earning significant interest income. When the landlord suddenly has a reduction in its rental income, but still accrues for the interest income, it is possible that the landlord could be faced with a VAT apportionment risk.
Taxpayers—such as commercial property landlords—that primarily generated taxable supplies are unlikely to have previously faced a need to apply VAT apportionment because the ratio of taxable supplies versus total supplies most likely exceeded 95%. When this ratio falls below 95%, these taxpayers would now be compelled to apply the standard turnover-based method of apportionment in determining the percentage of VAT which they can claim, which will result in the limitation of input VAT.
A limitation in the claiming of input VAT on expenses incurred would mean that the landlord is likely to have a higher output VAT liability than anticipated and this could result in further cash-flow constraints for the landlord. As VAT payments are made throughout the year, the cash-flow constraints could be significant for landlords.
Read a May 2020 report [PDF 114 KB] prepared by the KPMG member firm in South Africa
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