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Frequently Asked QuestionsWhat requirements must a person meet to qualify for the UDZ allowance?
The requirements outlined below from A-F must be fulfilled in order to qualify for the UDZ allowance: A. Building requirement To be able to qualify for a UDZ allowance, a person must have: 1. erected an entire new commercial or residential building; 2. extended, added to or improved an entire existing commercial or residential building or part of such a building representing a floor area of at least 1 000 m²; or 3. purchased a commercial or residential building or part of a commercial or residential building directly from a developer that complies with all 3 of the following requirements: a. The developer erected, extended, added to or improved the building or part of the building representing a floor area of at least 1 000 m². b. The developer did not claim any UDZ allowance in respect of the building or that part of the building. c. In the case of the improvement of a building or part of a building, the developer has incurred expenditure in respect of these improvements which is equal to at least 20 per cent of the purchase price paid by the person in respect of the building or part of the building. The definition of a ‘Developer’ For the purposes of the UDZ allowance, a “developer” is defined in section 13quat as a person that “erects, extends, adds to or improves a building or part with the sole purpose of disposing of that building or part thereof immediately after completion of that erection, extension, addition or improvement; and does not use the building or part which is to be disposed of for purposes of his or her trade in any other manner;” B. Dates requirement To be able to qualify for a UDZ allowance in eThekwini, the erection, extension or improvement of the building must have commenced on or after the 10th of December 2004. Where the building or part of the building was purchased from a developer, the purchase agreement must have been concluded on or after 8 November 2005. Furthermore the building or part of the building for which the incentive is claimed must have been brought to use solely for purposes of trade on or before 31 March 2009. C. Owner requirement To be able to qualify for a UDZ allowance the building in question must be owned by the person or body claiming the allowance. A lessee that constructed or improved a building or part of a building on leased property will, therefore, not be able to qualify for a UDZ allowance in respect of that building. D. Trade requirement To qualify for the UDZ allowance, the building must be constructed and used solely for the purposes of trade, and the allowance cannot be claimed until the building is brought into use for the purposes of trade. The building must be brought into use for trade on or before 31 March 2009. E. Urban Development Zone requirement To be able to qualify for a UDZ allowance, it is necessary that the building is located within a defined UDZ. The UDZ area for eThekwini Municipality recommended by Council and promulgated by the Minister of Finance consists of the greater CBD described as follows: The area bounded by Bell Street in the south through to Shepstone Rd, Victoria Embankment, Alexandra Street, Berea Road, Carters Ave, Canongate Road, Warwick Ave, Centenary Road, Carlisle Road, First Ave, Stamford Hill Road, Croydon Road. Walter Gilbert Road, Cobham Road, Old Fort Road, NMR Ave, Somtseu Ave, Stanger Str, Argyle Road, NMR Ave and Walter Gilbert Rd in the north. To be able to qualify for the UDZ allowance it is necessary that the person claiming the allowance has obtained certain documentation from the relevant municipality. These include: 1. A location certificate: a certificate that confirms that the building or part of a building that was constructed, improved or purchased from a developer is located within an approved Urban Development Zone. 2. A certificate of occupancy in respect of the building or part of the building that was constructed improved or purchased. 3. If the building or part of the building was purchased from a developer that constructed or improved the building, a certificate (UDZ 3 form available on SARS website) must be provided. The certificate confirms that: a) the erection, extension, addition to or improvement of the building was commenced by the developer on or after 10 December 2004 b) the construction or improvement by the developer covers the entire building or at least a floor area of 1 000 m²; c) the developer has not claimed any UDZ allowance in respect of the building or that part of the building; and d) in the case of the improvement of a building or part of a building, the developer has incurred expenditure in respect of those improvements which is equal to at least 20 per cent of the purchase price paid by the taxpayer in respect of the building or part of the building. These documentation must, together with the relevant SARS form be submitted with the person’s relevant return of income when a UDZ allowance is claimed. When does the tax incentive take effect?The incentive takes effect as each Urban Development Zone is published. This means that for each municipality, the incentive will only be effective once the selected Urban Development Zone is published in the Government Gazette. eThekwini’s UDZ took effect on the 10th December 2004, Government Gazette No.27077. In more specific terms, the effective date is linked to the contract and to the construction. First, all the relevant parties must sign the construction contract on or after the date of gazetting. Second, the construction must also commence on or after that date. Projects commencing before these dates fall outside of the incentive. Sectional title developmentsand buildings purchased from developers are only eligible to claim if the agreement to purchase was concluded on or after 8 November 2005. What is the nature of the incentive?The incentive provides investors with tax write-off for the cost of improvement or construction over time before actual sale (and without regard to the write-off for accounting purpose). The tax write-off period depends on whether the construction relates to an improvement of existing building or part thereof versus a new building or extension or addition to a building. As illustrated below, the incentive for improvements is more generous than for new buildings. The goal is to favor the refurbishment of existing sunken capital rather than wholesale replacement. Improvements An investor who refurbishes or improves an existing building will receive a 20 percent straight-line depreciation write-off over a 5-year period once the building is brought into use. The purpose of this enhanced incentive is to maintain structures considered worthy of retention and to maximize the use of all the sunken capital of existing buildings. In order for the 5-year write-off to take effect, investors must preserve a substantial part of the building’s existing structural or exterior framework (i.e., all the 4 walls or all the steel frameworks of the existing building). In case of addition to existing building, these may fall within the 5-year write-off (as opposed to the 17-year write-off) if additions are merely incidental to the improvement. Example 1. Facts: An investor acquires a run-down shop for R8 million. The investor then refurbishes the shop in order to conduct a viable retail business. The refurbishment costs R100 million. Result: The investor can deduct 20 percent of the refurbishment costs each of 5 years (i.e., R20 million over 5 years) once the building is brought into use. The R8 million falls outside of the UDZ incentive. New buildings (plus extensions and additions) Investors erecting a new building (or extending or adding to an existing building) receive a 17-year write-off period. This write-off allows for a deduction of 20 percent for the first year the building is brought into use and annual deductions of 5 percent for each of the subsequent 16 years. Example 2. Facts: An investor constructs a new commercial building in order to conduct a retail business after having purchased vacant land for R5 million. The new construction costs an amount of R100 million. Result: The investor can deduct a maximum of 20 percent of the construction costs in the 1st year (i.e. R20 million) the building is brought into use. Thereafter, the investor can deduct 5 percent of these costs for each of the next 16 years (i.e. R5 million per annum for the next 16 years). The land may never be depreciated. How does the incentive reduce my tax?If an investor qualifies for the tax incentive, any 5-year or 17-year write-off of costs incurred by the investor is deductible against the entire taxable income of the investor. No ring fencing applies. In other words, write-offs for one building can be set off against any other income of the investor, regardless of whether that income relates to the building or the line of the business to which that building is used for. Any excess losses that cannot be fully set off within a year are carried forward indefinitely. These excess losses can be set off in later years until fully absorbed. Example 3. Facts: An investor runs a thriving legal practice, and he acquires a run down block of flats in town, he refurbishes it and rents it out on permanent basis. The total refurbishment costs were R300 000, therefore generating a UDZ allowance of R60 000 in the first year. In 2006, the investor generates R600 000 of income in his legal practice. He also generates R80 000 of rental income in the block of flats and R60 000 of associated ongoing expenses. Result: The R60 000 Urban Development Zone write-off from the block of flats is fully deductible against the investor’s entire income, not just the net R20 000 annual profits of the block of flats. Example 4. Facts: Company X is involved in a number of trades, including an IT business. Company X erects a building for R300 million for purposes of its IT trade. Company X is eligible for a R60 million Urban Development Zone write-off during the first year of use. In that same year, no income is generated from the building, but R35 million of net income is generated from the overall IT business plus another R50 million from other businesses, resulting in a total taxable income of R85 million. Result: Company X can fully set off the R60 million of Urban Development Zone write-offs against its other income. It makes no difference that the other income does not relate to the building constructed nor falls within the same line of business. Will the purchaser of a sectional title unit be able to qualify for the UDZ allowance?The purchaser of a sectional title unit will be able to qualify for the UDZ allowance if the following requirements are complied with: a) The unit is used by the person solely for purposes of trade b) The unit is located within an Urban Development Zone c) The unit is purchased directly from a developer d) The developer has not claimed any incentive for that particular building or part of building e) The necessary documentation is submitted with the purchaser’s relevant annual return of income f) The purchaser has not sold or ceased to use the unit solely for the purposes of trade during a previous year of assessment Example 5. Facts: Developer X bought land within UDZ and constructed a twenty storey office block. He sold all floors to various purchasers as sectional title units. All purchasers of the units use them solely for purposes of trade. Result: The purchasers of the units that constitute at least a 1000m2 and they meet all the requirements they will qualify for the UDZ allowance. The purchasers of the units that are less than a 1000m2 will, however, not qualify for UDZ allowances in respect of these units even though they use them for trade. What happens when a person sells a UDZ building? A person who sells a UDZ building will, from the year of assessment following the year during which the person sold the building or part of the building, no longer qualify for a UDZ allowance in respect of such building or part of the building. All deductions that were previously allowed in respect of UDZ allowances, will, furthermore, be recouped in terms of the recoupment provisions contained in section 8(4)(a) of the Income Tax Act 58 of 1962. Such person will, furthermore, be subject to taxation on any capital gain made on the disposal of the UDZ building. Example 6. Facts: Investment Company X constructed a new commercial building in order to conduct a retail business. The cost of this new construction amounted to R200m. The company claimed 30 per cent of these costs over three years of assessment (20% (R40m) in the first year and 5% (R10m) in each of the following two years). Investment Company X then sold the building for R308m. Result
The R60m recouped and the capital gains of R54 (R108 x 50%) will be included in the taxable income of Investment company X. What happens when a person ceases to use a building solely for the purposes of trade?A person who ceases to use a building or part of a building solely for purposes of trade will, from the year of assessment following the year of assessment during which the person ceased to use the building or part of the building solely for purposes of trade, no longer qualify for the UDZ allowances in respect of such building or part of such building. Example 7. On 30 April 2005 Investment Co X commenced refurbishing its building in a UDZ after the date of the publication of the particulars of the demarcated area. After completion of the refurbishment Investment Company X commenced to use it for trade on 30/09/2005. It then ceased using it solely for purposes of trade on 31 January 2006. Investment Company X has a 28 February financial year-end. Result Investment Company X complied with all the requirements and provided that the documentation requirements are complied with, will qualify for a UDZ allowance in respect of the refurbishment of the building in the 2006 year of assessment. It will, however, cease to qualify for the UDZ allowance from the 2007 year of assessment, as the company ceased to use the building solely for purposes of trade during the 2006 year of assessment. What costs does the allowance cover? The Urban Development Zone allowance covers all construction costs related to the erection, extension, addition or improvement of buildings. Finance and property acquisition costs do not fall within the incentive. Deductible costs include; water; power; sewage; access or parking for the building; drainage; security for the building (including fences, cameras and surveillance equipment); means of waste disposal, sidewalks; and landscaping (including earthworks, greenery and irrigation). The costs pertaining to the following will, for example, not be regarded as costs for purposes of the UDZ allowance: purchase price of the land, transfer duties, borrowing or financing charges and transfer and related costs. With regards to buildings purchased from developers, the amounts that will be deemed to constitute eligible costs are as follows; (a) 55% of the purchase price of the building or part of the building in case of a new building erected, extended, or added to by a developer, and (b) 30% of the purchase price of the building or part of the building, in case of a building refurbished by a developer. How do I claim the incentive on my tax return? Investors seeking a 5-year or 17-year write-off for a building within an Urban Development Zone are subject to special tax reporting obligations. More specifically, investors must provide certain additional information when filing their income tax returns. This information must be filed yearly when claiming the allowance. Failure to submit the required information results in the allowance not being available for the specific year. To satisfy this requirement, investors must firstly attach both a certificate of occupancy and a location certificate from the municipality confirming that the building is located within the area chosen by the municipality. Secondly, investors must state the total actual and estimated costs incurred by them for the erection or refurbishment of the building. Lastly, investors must provide a breakdown of erection versus improvement costs if both the 5-year and 17-year write-offs are involved. Where a building or part of a building is purchased from a developer, a purchaser has to submit a certificate (UDZ 3 form) obtained from the developer confirming that:
SARS has issued the following forms in respect of claiming the UDZ allowance:
Is there a cut-off date for claiming the incentive?The 2005 Revenue Law Amendment Bill requires that the building for which the allowance is to be claimed, be brought to use on or before 31st of March 2009. This therefore marks the end date for the incentive. However this date will not affect those who would have started the process of claiming the allowance. The process for applying for the incentive
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