Leasehold improvements – Tax Deduction

Taxpayers who rent their business premises often erect improvements to the premises and the cost of this can be quite substantial. A tax benefit in the form a deduction for such costs assists in alleviating the burden placed on a business. In this article, we investigate some of the requirements for claiming a deduction for leasehold improvements in terms of the so called leasehold improvement allowance.

Improvements used in the production of income/income is derived therefrom

The improvements must be used to generate income or income must be derived therefrom. A typical example of where improvements are used in the production of income is where the improvements are rented to third parties in terms of a sub-lease agreement. An example of where income is derived from the leasehold improvement is where the lessee uses the improvements in its office or erects a building on leased land to be used as the office of the lessee.

Obligation to effect improvements

The leasehold improvement allowance is only available to the lessee where there is an obligation on the lessee to affect the improvements in terms of the lease agreement. Where the lessee merely has an option to effect improvements to the leased premises or does so on its own accord, the leasehold improvement allowance is not available, despite the improvements possibly being used in the production of income. Where there is no obligation to affect the improvements, taxpayers may be tempted to seek relief in the form of a wear and tear allowance. However, for a taxpayer to claim a wear and tear allowance, the taxpayer must be the owner of the leasehold improvement. Depending on the type of improvement, it may be very difficult for a taxpayer to prove ownership in the improvements as improvements to land owned by another also becomes the property of the owner and is therefore typically not owned by the lessee.

Included in the lessor’s gross income

A further requirement is that the lessor must be required to include the value of the improvements in its income for tax purposes. It should however be noted that it is not a requirement for the lessee to ensure that the lessor actually does include the value in its income but rather merely that the lessor must be required to include the value in its income. Where the lessor is exempt from tax, the lessor will not be required to include the value of the improvements in its income and therefore, no allowance will be available to the lessee where the lessor is exempt from tax. A typical example where the lessee will not be entitled to the leasehold improvement allowance is where the lessor is the South African Government. In terms of section 10(1)(a) of the Act, receipts and accruals of the Government are exempt from tax and hence there will be no inclusion in income as is required. Lessees who find themselves in these situations may however seek relief in terms of section 12N of the Act that deems lessees the owner of improvements in certain instances.

Where the requirements for claiming a tax deduction in the form of a leasehold improvement allowance are satisfied, the lessee may be entitled to the allowance. Care should however also be taken to ensure the amount of the allowance claimed is in line with the legislation. Incorrectly claiming the allowance or claiming too much as an allowance may lead to severe penalties.  Taxpayers will be well advised to seek assistance from an expert to ensure that the allowance is available and does in fact alleviate the cost of the improvements rather than add further costs in the form of penalties.

Author: N Theron