Authors: Wesley Grimm, Associate and Craig Miller, Director – Webber Wentzel.
The taxation of real estate investment trusts (REITs) was discussed at the recent National Treasury Workshop on the 2018 draft Taxation Laws Amendment Bill, held on 4 September 2018, in Midrand. The correct tax treatment of certain anomalies, including the taxing of commercial lease deposits, was raised.
Commercial lessors typically hold significant deposits from tenants, both in number and value. A view has emerged among certain officials at SARS that commercial tenant deposits comprise gross income where such amounts are not deposited into a separate bank account.
It is trite law that a taxpayer may not be subject to tax on amounts received by them for the benefit of another. Though commercial lessors receive tenant deposits, such deposits are not received by them on their own behalf and for their own benefit.
In the case of Omnia Fertilizer Limited v CSARS 65 SATC 159, the court held that the accounting treatment of amounts by a taxpayer evidences the intention of the taxpayer. Factually, where commercial lessors treat tenant deposits as a liability for accounting purposes they do not intend to receive such amounts on their own behalf and for their own benefit within the meaning of gross income. This is supported by the fact that lessees reflect deposits paid by them as assets in their financial statements.
In essence, not every obtaining of physical control over money or money’s worth (ie an asset with a monetary value) constitutes a receipt for the purposes of the definition of gross income. Money obtained and banked by someone (as agent or trustee for another) does not receive that money as gross income ie tenant deposits are not “received by” commercial lessors within the meaning of gross income. Rather, tenant deposits are provided by lessees to commercial lessors as security for the fulfilment by tenants of all their obligations. A tenant deposit, so received, does not belong to the commercial lessor; ownership remains vested in the lessee and must be refunded to the lessee in terms of the relevant lease agreement.
In Pyott v CIR 1945 AD 128, the amounts received by the taxpayer were set aside as a provision for allowances on containers returnable to Pyott, but the deposit amounts were not deposited into a separate trust account and were utilised for the general purposes of the business. By contrast, tenant deposits received by commercial lessors are meticulously recorded and kept separate, often in call accounts. SARS’ purported reliance on the Pyott case is for this, and other reasons, therefore factually incorrect. It is not disputed that where deposits are available to a taxpayer, to do with it as it pleases, then such deposits would, and should, be included in that taxpayer’s gross income and may, consequently, be subject to income tax as the deposits are received by that taxpayer for its own benefit.
In MP Finance Group CC (in liquidation) v CSARS 2007 SCA 71, the Court held that an amount will be “received by“a taxpayer for the purposes of the definition of gross income if it has intended to receive such amount for its own benefit (our emphasis). Upon receipt, commercial lessors have no intention to receive the tenant deposits for their own benefit for the ordinary purposes of their business. When the deposit, or a portion thereof, is applied by a commercial lessor it would only constitute gross income in the commercial lessor’s hands at that point in time.
In Special Board Decision No. 166 (Germiston Special Board), dated 18 March 2002, similarly to the decision in C v COT 46 SATC 57 individual lessors received rental deposits, which were reflected as current liabilities and refundable upon the expiry of the respective leases. The lessors in that case were entitled to deduct from the deposits to be refunded any amounts owing to them by the respective lessees at the end of the lease period. The board held that there was no contingency attached to the taxpayer’s obligation to refund the deposits. The mere fact that lessors may apply the right of set-off did not render the taxpayer’s obligation to repay the deposits conditional and, by extension, could not cause the deposits to be included in the lessor’s gross income. This feature alone, so it was held, was enough to distinguish the case from those like Pyott.
The inescapable conclusion is that commercial lessees intend to deposit money with commercial lessors in such a way that the deposits should be kept separate from the commercial lessors’ own funds. This is consistent with the view expressed by SARS on its website on the page titled Tax on Rental Income, which we agree with and which is repeated below:
“The receipt or accrual of a rental deposit by a lessor need not be included in the lessor’s gross income at the stage of receipt or accrual if there is an unconditional obligation on the lessor to refund the deposit at a later stage. It will only become gross income when the deposit is applied by the lessor…“
For SARS to seek to impute different legal consequences to commercial lease agreements, other than what was expressly agreed between the parties, undermines the sacrosanct principle of legal certainty. Commercial lessors and lessees are agreed, in fact and in law, as to the treatment of the tenant deposits and SARS may not unilaterally re-imagine the legal effect of the terms of the lease agreements (CSARS v Cape Consumers Proprietary Limited 61 SATC 91).
Commercial tenant deposits are akin to a loan with a definite and unconditional liability to refund it to the relevant lessee. Consequently, such deposits should not be included in commercial lessors’ gross income because there is an absence of a beneficial receipt by commercial lessors and such deposits are received on capital account.
National Treasury stated that it hopes to clarify the taxation of REITs, including anomalies in relation to taxing commercial tenant deposits, in the 2019 legislative cycle.