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Developers lose VAT relief

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A change to the VAT Act, which came into effect on January 1 this year, could catch residential property developers off guard

A change to the VAT Act, which came into effect on January 1 this year, could catch residential property developers off guard and facing cash-flow constraints.
Lawyers from Webber Wentzel say VAT relief given to developers in terms of Section 18b, introduced in 2011, now no longer applies.

Chris McMaster of Rabie Property Developers explains that while a project is being built, many developers sell individual units off-plan, and must then pay output VAT on the sale to the South African Revenue Service (SARS) upon completion and registration of the property.

Sometimes, however, not all the units are sold by the time the project is completed. In these cases developers could let the unsold units for up to three years without having to pay VAT on the unit. This helped developers because they still had to pay the costs of the development, such as interest on funding provided by the bank. Only having to pay the VAT when the unit was sold meant the developer had some respite.

The change in the law means that from January 1, if a developer lets an unsold unit, the output VAT (payable by the developer to SARS) on the market value of the property is immediately payable, even though the property has not yet been sold. This is because the property has undergone a “change of use” from inventory – stock the developer holds – to investment property.

McMaster gives an example based on the new VAT rate which comes into effect on April 1.

Assume a property is for sale for R3.45 million – that is R3m plus 15% VAT, which is R450 000. Assume the property cost the developer R2.5m in terms of land and materials, which he has borrowed from the bank at a rate of 10.25%. This means he has to repay the bank R21 354 in interest a month until he sells the property and recoups his costs.

Formerly, he could let the unit for up to three years and use this rent to help pay the funding interest. He would have to pay the VAT on the property to SARS only once the property was sold.

Now, however, the developer will have to pay the bank its monthly interest, and also pay the full VAT on the property – the R450 000 – as soon as he lets the property, without having a prospective buyer should he wish to let until the property is sold.

McMaster says: “If this is extrapolated over 10 unsold properties in one scheme it amounts to an interest bill of R213 542 a month and lost rental income. Alternatively, the developer will incur a cash outflow of R4.5m in VAT to SARS if he chooses to let the property.”

“The change in legislation may put strain on the developer’s cash flow position as he either has to forego rental inflows or foot the bill for an additional VAT outflow.”
McMaster said Rabie would not be affected by the change. “We tend to sell off-plan and don’t let unsold development stock. Certain developers made use of this relief and from their point of view the new dispensation would result in a drain on their cash flow.”

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