By Christelle Elleraey Esterhuizen – Thesis presented in partial fulfilment of the requirements for the degree MComm (Taxation) at the University of Stellenbosch.
INCOME TAX NATURE OF REIMBURSEMENTS RELATING TO
LEASEHOLD IMPROVEMENTS
C E Esterhuizen
B Comm (Law) LLB
Senior Consultant to PricewaterhouseCoopers Tax Services
Summary
It is becoming increasingly common for lessees to receive contributions from
lessors towards leasehold improvements costs. A lessee will be entitled to
claim an allowance in terms of section 11(g), where expenditure has actually
been incurred in pursuance of an obligation in terms of a lease agreement,
and the property is used for the production of income. Obstacles arise where
the lessee either receives a payment or benefit, in cash or otherwise from the
lessor, either as consideration for the lessee to effect the improvements or as
inducement for the lessee to enter into the lease agreement. The nature of
these payments or benefits received by the lessee for income tax purposes
needs to be assessed with reference to the general principles laid down by
the South African courts in respect of the gross income definition and
international case law dealing with the income tax treatment of similar
payments made by the lessor to the lessee. Factors also need to be identified,
which should be taken into account to assess the income tax nature of these
payments or benefits. The terms of the agreement in terms of which such
payments or benefits are made should clearly state the purpose thereof, and
a conclusive answer will depend on the particular circumstances and facts of
each case. The interaction between a payment or benefit received by a lessee
and the availability of a leasehold improvements allowance in terms of section
11(g) is a complex matter and it remains to be seen how South African courts
will deal with these issues.
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INCOME TAX NATURE OF REIMBURSEMENTS RELATING TO LEASEHOLD IMPROVEMENTS
1. Introduction
Taxpayers are often faced with the choice of buying or leasing property to
carry on their business operations. Many factors may influence this decision
and each option has its own benefits and disadvantages. Where a taxpayer
decides to lease property, such property is often not suitable and
improvements are required to convert and equip the property to a suitable
condition prior to commencing business operations. Depending on the
financial position of the lessee and lessor and the nature of the improvements,
the parties will decide who will be responsible for effecting the improvements
and incurring the related costs.
There is an increasing tendency that lease agreements place contractual
obligations on lessors to make payments or grant benefits to lessees, either
as reimbursement for the improvements effected or as inducement for
entering into the lease agreement. This article will focus on instances where a
lessee is responsible for effecting improvements to the leased property, and
will consider the circumstances where the lessor remunerates the lessee in
cash or otherwise.
The amounts payable to the lessee may be in the form of:
· A rent inducement payment;
· Reimbursement of the leasehold improvements expenditure through a
tenant installation allowance; and
· Granting of the free right of use of the leased property until all the
leasehold improvements expenditure have been recovered by the lessee.
These payments and benefits cause many uncertainties, not only with regard
to the income tax nature thereof, but also with regard to the availability of the
leasehold improvements allowance in terms of section 11(g).
The writer could not find any South African case law that deals with these
issues simultaneously, nor could South African case law be found that deals
with the income tax treatment of these payments or benefits in the hands of
the lessee. There is however international case law which deals with the
nature of rent inducement payments in the hands of the lessee.
Not many commentators and tax experts have expressed their views on the
potential income tax implications of these payments or benefits receivable by
a lessee. There are however articles by, amongst others, Clegg, D.,
Meyerowitz, S.C. and Croome, B.