Prior to the introduction of section 12N, section 11(g) of the Act regulated any deductions related to leasehold improvements. This section provided that a lessee could deduct the cost of improvements actually incurred from the date such improvements were completed, to the extent that the lessee had an obligation to effect the improvements and that the land or building to which the improvements were made, was used in the production of the lessee’s income.

In general, a leasehold improvement allowance cannot be claimed where such an amount does not constitute “gross income” as defined in the hands of the lessor. Accordingly, if the lessor is an entity which is exempt from tax, no amount will be included in the taxable income of the lessor and the lessee will not qualify for an allowance in respect of the leasehold improvements.

Both sections 13quat and 13quin of the Act require the taxpayer claiming the allowance in terms of these sections, to be the owner of the building. This qualifying criterion of ownership creates practical problems for development partnerships undertaken with Government. Increasingly in urban development transactions, municipalities are not prepared to sell the land to the developer, but wish to retain the land and require leasehold improvements to be effected by the developer as lessee.

Section 11(g)(v) however provided for an exception where the land is owned by any sphere of Government, and the right of use or occupation is at least 20 years. In accordance with this provision, even though private sector developers were not able to avail themselves of the tax incentive provided for in section 13quat and 13quin, these taxpayers were still able to claim an allowance where they affected improvements to state owned buildings.

This exception to the general rule was deleted from section 11(g)(v) and replaced by the new section 12N of the Act. This section has the effect of deeming the lessee to be the owner of the property, which will allow the lessee to qualify for certain capital allowances (e.g. sections 13quat and 13quin), to which it would otherwise not be entitled. Although this section provides for a beneficial capital allowance regime, there are a number of stringent requirements that a lessee must satisfy before it can qualify for such deductions.

The obstacle for lessees, and in particular property developers, is found in section 12N(3), which provides that the section (12N) does not apply to taxpayers who grant the right of use or occupation of the land or building to another party unless such a person is part of the same group of companies as the lessee.

The exclusion therefore has the effect that a developer will be precluded from applying this section and will therefore not be able to avail of any capital allowances in terms of the Act, since the application of section 11D, 12D, 12F, 12I, 13, 13bis, 13ter, 13quat, 13quin, 13sex and 36 are subject to section 12N in leasehold improvement context.

The Legislature was clear in the Explanatory Memorandum to the 2010 Taxation Laws Amendment Bill, that section 12N was introduced in an attempt to combat tax avoidance through the artificial shifting of depreciation allowances from exempt entities to taxpayers. Section 12N is further intended to restrict the application of the section to entities that occupy the buildings themselves, or use the buildings for group companies. This restriction effectively excludes property developers who will use the property for purposes of their own trade.

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In addition to the restrictions, section 12N also excludes property developers from claiming allowances to which they were previously entitled - it is not clear why property developers are specifically excluded from the scope of section 12N.

Although the Legislature’s intention to curb misuse and abuse of the section 12N allowances is acknowledged, it is submitted that restrictions contained within the section to achieve this goal are unnecessarily wide and may have the effect deterring developers from participating in public private partnerships with Government, or from pursuing developments on Government land.