Companies that launch property development projects or pursue other lines of business in an area with no infrastructure (no roads, no streets, no lighting, no water main, etc) are often forced to build the necessary items of public infrastructure, because municipalities do not have enough funds. Later, to reduce the cost of managing that public infrastructure, the developer requests that the municipality should take ownership of those items and carry out their further management and maintenance. This article explores the tax implications of such activities.
The Municipalities Act states that a municipality’s functions include providing local residents with utility services as well as improving and cleaning the municipality’s administrative area, including building, refurbishing, maintaining and lighting the streets, roads and squares. So it makes perfect sense to transfer any items of public infrastructure built with private-sector money to the municipality for their further management.
Initial questions arise when it comes to legally documenting the transfer of the public infrastructure item to the municipality, because there is no legal form of transaction that would precisely reflect the intentions of the parties and lead to public infrastructure items built by the private sector being passed to the municipality for their further management and maintenance. Since municipalities are not prepared to reimburse the cost of building such public infrastructure, these items are transferred to municipalities without consideration under a deed of gift. However, generosity is not a motive for such private-sector activities: a gift is the only form of transaction that provides for the transfer of an asset without consideration.
Also, the corporate income tax (CIT) and value added tax (VAT) legislation is silent about how public infrastructure development costs should be recorded in the company’s books.
Since the company has invested in public infrastructure items for commercial and not personal reasons, in practice accounting for the cost of developing a public infrastructure item depends on the company’s line of business. These costs are either accrued in inventories under current assets if the company’s core business activity is property development and disposal, or in PPE (with depreciation being included in the value of services rendered) if a public infrastructure item has been built for the company’s own business that is not property sales (e.g. a logistics centre or a shop). Any input VAT paid on the construction of a public infrastructure item is deductible, even though the infrastructure can be used by the public and no consideration has been received for that use.
What are the VAT and CIT implications if a public infrastructure item is transferred to the municipality without consideration (i.e. donated)?
The SRS has not reached a consensus on whether the gift of a public infrastructure item to the municipality in these situations qualifies as a deemed taxable supply (personal consumption) within the meaning of the VAT Act. In our view, if we evaluate the economic substance of the transaction, it is not a deemed taxable supply and should not attract VAT (if the company has invested in a property that qualifies as “used” at the time of transfer to the municipality, the supply should not be recorded as exempt, either).
Passing the public infrastructure item to the municipality raises the next question: Does the deducted input VAT need adjusting? In our view, it does not matter that a public infrastructure item is transferred to the municipality without consideration, because the transfer to the municipality for further management and maintenance does not restrict its further use and does not change its significance in the company’s business. Accordingly, the deducted input VAT needs no adjusting. The SRS has mostly agreed with this view.