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Important CGT Implication when concluding a rental lease for business premises

30 April 2014   (0 Comments)
Posted by: Author: Simangele Mzizi
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Author: Simangele Mzizi (FSP Business)

Business owners neglect to consider the Capital Gains Tax (CGT) consequences before signing a lease agreement for the rental of business premises. Failing to do so will have a significant effect on the tax cost of business operations.

Simangele Mzizi developed a practical example on the CGT implications entering into a lease agreement to rent business premises:

Example - Fast Food Enterprise

Mr Smith is the owner of a fast food business, which carries on its trade as a sole proprietor. On 1 March2006, Mr Smith enters into a five-year lease for the rental of business premises ending 28 February 2011.

Mr Smith improves the premises voluntarily with the consent of and ultimately for the benefit of the landlord. He spends R200 000 on improvements. The R200 000 is spent in year one.

CGT consequences

Capital Gains Tax: 

On termination date (28 February 2011) of the lease, the transaction result in a disposal for CGT purposes.¹

The CGT consequences for Mr Smith are as follows:

Proceeds:                                                         R nil (No receipt or accrual to Mr Smith)

Less:                                                                 Base cost R200 000 (Cost of improvements)

                                                                          Capital gain/ (loss) R (200 000)

The result is that Mr Smith will incur a capital loss of R200 000 on the termination of the lease, five years after he incurred the expense. However, a capital loss can't be offset against taxable income.

In addition, Mr Smith will not be allowed to deduct the cost of the improvements for income tax purposes because the improvements don't qualify for a deduction since there's no contractual obligation to effect improvements and he is not allowed to claim a wear and tear allowance on qualifying assets if he's not the owner of the assets. 

The effect is that if you're entering into a lease agreement for the rental of business premises, make sure you consider the CGT implications of your decision. 

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References:

¹ Paragraph 11(1) (b) of the Eighth Schedule of the Income Tax Act No. 58 of 1962.



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