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FAQs: Lessors and Lessees
If your CGT question is not dealt with in this list of FAQ's, please address your query to cgt@sars.gov.za
1. Are amounts received by a lessee from a lessor subject to CGT?
Whether an amount paid by a lessor to a lessee is subject to CGT would depend on the capital or revenue nature of the payment. A capital payment that would be subject to CGT would include a payment by a lessor to a lessee in exchange for the early termination of a lease (ITC 175 (1930) 5 SATC 180 (U)). On the other hand, refunds of rent, compensation for loss of future rental income and annuities are taxed as ordinary income and are not subject to CGT.
In the case of a payment for the early termination of a lease, the lessee gives up the right in the lease (an asset) in exchange for proceeds. In terms of para 11(1)(b) of the Eighth Schedule there would be a disposal. That provision includes in the meaning of disposal:
(b) the forfeiture, termination, redemption, cancellation, surrender, discharge, relinquishment, release, waiver, renunciation, expiry or abandonment of an asset.
Unless the lessee had paid a lease premium (something over and above rent) for the lease rights, the asset disposed of would have a zero base cost. Where the lease existed at valuation date, the lease rights may have a market value for the purpose of determining the valuation date value of the lease. This would depend, for example, on whether the lease rentals per the lease agreement are less than a projected market related rental for the property. Lease rights under long-term leases at a favourable rental are more likely to give rise to a market value on valuation date than short-term leases. It should be noted, however, that paragraphs 26 and 27 may operate to disallow capital losses resulting from the adoption of a base cost determined on the basis of market value. Where a lease was taken out for a non-trade purpose para 15(d) would also operate to disallow the loss.
2. When a lessee effects improvements on the land of a lessor, what are the CGT consequences for the lessee?
Obligatory improvements
Where the lessee is obliged to effect the improvements in terms of a lease agreement, they would usually qualify for deduction in terms of s 11(g). Since para 20(3)(a) excludes from base cost any amount which ‘is or was allowable as a deduction in determining the taxable income of that person…’ it follows that the improvements must be excluded from base cost.
Voluntary Improvements
Where the improvements are effected voluntarily, the lessee would not be entitled to any deduction under s 11(g). Neither would the lessee be able to claim them under s 11(a) since the expenditure would be of a capital nature. It follows that the expenditure would form part of base cost for CGT purposes.
The question then arises as to when the disposal of those improvements occurs. Is it when the improvements are physically effected or is it upon expiry of the lease?
Where the improvements are effected voluntarily, the lessee would not be entitled to any deduction under s 11(g). Neither would the lessee be able to claim them under s 11(a) since the expenditure would be of a capital nature. It follows that the expenditure would form part of base cost for CGT purposes.
The question then arises as to when the disposal of those improvements occurs. Is it when the improvements are physically effected or is it upon expiry of the lease? In terms of paragraph 33(3)(c) of the Eighth Schedule, there is no part disposal of the base cost of an asset in respect of 'the improving or enhancing of that asset which is leased to that person'. This means that the improvements will only be disposed of when the lease terminates.
The claiming of losses
When a lease terminates and the lessee is not compensated for the improvements, a capital loss will inevitably result. In determining whether capital losses on the termination of lease rights are allowable for CGT purposes, sight must not be lost of the following:
In the case of pre-1.10.01 assets where the valuation date value of the lease right has been determined on the basis of market value, paras 26 and 27 may operate to disallow or limit the loss.
Paragraph 15(d) provides that a capital loss on disposal of a lease must be disregarded to the extent that the lease was used for non-trade purposes.
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