UDZguide 11/08/2008

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A Guide to SARS’s Urban Development Zone Tax

Incentive

This is just a general summary of relevant UDZ information for investors buying into sectional-title developments. It is not meant

to delve into the precise technical and legal detail that is often associated with taxation and should, therefore, not be used as a

legal reference. For further legal reference please consult The Income Tax Act, No. 58 of 1962(section 13quat) and your tax

consultant.

INTRODUCTION

In 2003, the Minister of Finance, Mr. Trevor Manuel, announced the introduction of

a tax incentive that will encourage investment for certain specified urban

development zones.

The core objectives of this incentive are:

• to respond to the problem of dereliction and dilapidation in South

Africa’s large cities; and

• to promote urban renewal and development through private sector

investment in the construction and improvement of buildings.

This incentive, falling under section 13quat of the Income Tax Act (Act No. 58 of

1962), comes in the form of an accelerated depreciation allowance for the

construction of new buildings and improvements in specified urban development

zones. Without this incentive, these costs may not be depreciated and properties

would only be entitled to depreciation of only 2 or 5 per cent per annum (depending

on the nature of the buildings and the improvements involved).

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NATURE OF THE INCENTIVE

The incentive provides investors with a tax write-off for the cost of the improvement

or building over time before actual sale (and without regard to the write off for

accounting purposes). The tax write-off period depends on whether the construction

relates to an improvement of an existing building (or part thereof) versus a new

building (or extension or addition to a new building). The purpose of this enhanced

incentive (beyond the 17-year write-off above) is to maintain structures considered

worthy of retention and to maximise the use of all the sunken capital of existing

buildings. In order to qualify for the 5-year write-off, 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 addition,

extensions or additions to an existing building may fall within the 5-year write-off (as

opposed to the 17-year write-off) if merely incidental to the improvement.

The UDZ allowance will be allowed as follows:

• In respect of the erection or extension of or addition to a building or part of a

building or the purchase of such a building or part of a building from a developer,

over a period of 17 years (therefore, 20% of the cost in the first year of assessment

and 5% of the cost in each of the successive 16 years of assessment).

• In respect of the improvement of an existing building or part of a building or the

purchase of such an existing building or part of a building from a developer, over a

period of 5 years (therefore, 20% of the cost in the first year of assessment and 20%

of the cost in each of the 4 successive years of assessment).

HOW DOES THE INCENTIVE REDUCE MY TAX?

If an owner-first purchaser qualifies for the tax incentive, the 17-year write-off of

costs incurred by the owner-first purchaser are deductible against the entire taxable

income of the owner-first purchaser. No ring fencing applies. In other words, write-

offs for one building can be setoff against any other income of the owner-first

purchaser, regardless of whether that income relates to the building or the line of

business to which that building relates. Any excess losses that cannot be fully set-off

within a year are carried forward indefinitely. These excess losses can be setoff in

later years until fully absorbed.

New Buildings

An owner-first purchaser who purchases a newly constructed building (or part

thereof), including extensions or additions from a bona fide developer is deemed to

have incurred 55 percent of the purchase price. The owner-first purchaser will

receive a 17-year write-off for the 55%once the building is brought into use. This

write-off allows for a deduction of 20%for the first year in which the building is

brought into use and an annual deduction of 5% for each of the following 16 years.

Example. Facts: A developer purchases vacant land for R5 million and

constructs a new sectional-title development on the land. The development

costs R10 million. The owner first-purchaser incurs costs of R1 million for

each unit bought from the developer.

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Result. The owner-first purchaser’s deductible amount is 55 percent of R1

million (i.e., R550 000). In the first year that the building is brought into use,

the allowance will be 20% of the R550 000 (i.e.: R110 000). Thereafter, the

owner-first purchaser can deduct 5% (or R27 500) of the balance of the

deemed costs for each of the next 16 years (i.e: the remaining R440 000 over

a 16-year period). The land may never be depreciated.

WHAT HAPPENS WHEN A PERSON SELLS A UDZ BUILDING?

Where a person that claimed a deduction for a UDZ allowance sells the building in

respect of which the UDZ allowance was claimed, such person will from the year of

assessment following the year of assessment 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 subject to the recoupment

provisions contained in section 8(4)(a) of the Act. Such person will, furthermore, be

subject to taxation on any capital gain made on the disposal of the UDZ building.

WHAT HAPPENS WHEN A PERSON CEASES TO USE A BUILDING SOLELY FOR

PURPOSES OF TRADE?

Where a person that claimed a deduction for a UDZ allowance ceases to use the UDZ

building or part of a building in respect of which the UDZ allowance was claimed

solely for purposes of trade, such person 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 any UDZ allowances in

respect of the costs incurred in respect of such building or part of such building.

WHAT REQUIREMENTS MUST A PERSON COMPLY WITH TO QUALIFY FOR THE UDZ

ALLOWANCE?

i) Building Requirement

(1) A bona fide developer must improve or construct an entire building or at least (if

not the entire building) a 1000m² area. For instance, assume a bona fide developer

can purchase ten flats of 100m² each in the same block of flats, refurbish them, and

then sell them off individually to owner-first purchasers. In this circumstance, the

individual owner-first purchasers will be able to claim the allowance. In addition, if a

developer has improved a building (or part thereof) the developer must incur

expenditure equal to at least 20% of the purchase price paid by the taxpayer.

(2) The developer must not have claimed any UDZ allowance in respect of that

building (or part thereof).

(3) Any owner-first purchaser must purchase the building (or part thereof) directly

from a bona fide developer that has built the building. The agreement to purchase

must have been concluded on after 8 November 2005.

(4) The bona fide developer must not use the building (or part thereof) for purposes

of his/her trade. This requirement stands in contrast to the owner-first purchaser

who must use the purchased building(s) for purposes of his/her trade

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ii) Trade Requirement

A person will only qualify for the UDZ allowance once a building or part of a building

that was constructed, improved or purchased directly from a developer is brought

into use solely for the purposes of that person’s trade.

The courts have interpreted the concept “trade” to be neither exhaustive nor

restrictive – it will, therefore, include any activity where a person risks something

with the object of making a profit. For example, the letting of commercial or

residential property at market prices, the carrying on of a manufacturing concern

with the object of making a profit, etc. constitutes trade.

iii) Owner Requirement

To be able to qualify for a UDZ allowance it is required that the building or part of

the building that was constructed or improved must be owned by the person

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.

iv) Trade Date Requirement

To qualify for a UDZ allowance, the building or that part of a building must have been

brought into use solely for purposes of trade on or before 31 March 2014.

v) Documentation Requirement

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. If

the building or part of the building was purchased from a developer it is,

furthermore, necessary that certain other documentation must be obtained from

such developer.

(a) The Municipality

• A certificate of confirmation issued by the municipality to that person which

confirms that the building or part of a building that was constructed,

improved or purchased from a developer is located within a UDZ within the

boundaries of that municipality (a location certificate).

• A certificate of occupancy in respect of the building or part of the building

that was constructed improved or purchased.

(b)The Developer

A certificate (UDZ 3) is available on SARS’s website

(http://www.sars.gov.za/home.asp?pid=4153&tid=60&s=forms&show=1235)

that confirms that:

• The erection, extension, addition to or improvement of the building

was commenced by the developer on or after the date of publication

of the particulars pertaining to the demarcation of the relevant area

in which the building is located, in terms of a contract formally and

finally signed by all parties thereto on after that date;

• The construction or improvement by the developer covers the

entire building or at least a floor area of 1 000 m²;

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• The developer has not claimed any UDZ allowance in respect of the

building or that part of the building; and

• 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% of the purchase price

paid by the taxpayer in respect of the building or that part of the

building.

The above documentation must, together with the relevant SARS form (see below

for more information in this regard) be submitted with the person’s relevant return

of income when a UDZ allowance is claimed.

HOW DOES A PERSON CLAIM THE UDZ ALLOWANCE?

A person claiming the UDZ allowance in respect of a year of assessment has to

submit the following documentation which can be found at:

http://www.sars.gov.za/home.asp?pid=4153&tid=60&s=forms&show=1235

with the relevant return of income:

1) UDZ 1 or UDZ 2 (whichever is applicable) with regard to each building or part of a

building in respect of which a UDZ allowance is claimed, where the following

information inter alia has to be provided:

• The total cost in respect of the construction or improvement of a building

or part of a building or where a building or part of a building was purchased

from a developer the “deemed cost” for purposes of the UDZ allowance.

• The extent to which these costs relate to any portion of the building in

respect of which a certificate of occupancy has been granted by the relevant

municipality.

• An indication whether these costs were incurred in respect of the erection

or extension of, addition to or improvement of a building.

2) A certificate of occupancy obtained from the relevant municipality

3) A location certificate obtained from the relevant municipality

4) Where a building or part of a building is purchased from a developer, a certificate

(UDZ 3) obtained from the developer that constructed or improved the building or

part of the building.

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References

• South African Revenue Service, 2006. Guide to the Urban Development Zone

Tax Incentive. [Online]. South African Revenue Service.

Available at:

http://www.sars.gov.za/home.asp?pid=4150&tid=65&s=pubs&show=812

[accessed 4 July 2008].

• The National Treasury Economic Policy and International Financial Relations

Division, Tax Policy Directorate, 2006. Urban Renewal Tax Incentive. [Online].

The National Treasury. Available at:

http://www.treasury.gov.za/legislation/mfma/urban/Urban%20Renewal%20

Tax%20Incentive%20-%20Guide%20for%20Investors.pdf

[accessed 4 July 2008]

• City of Cape Town, Planning. 2004. Urban Development Zones and the Tax

Incentive [Online]. City of Cape Town. Available at:

http://www.ydl.co.za/documents/udz_brochure_ct.pdf

[accessed 4 July 2008]