The objective of this blog is to understand the difference between input and output VAT on operating leases in South Africa, and the tax treatment on these leases. Tax is easier to understand with examples, so let's jump straight into it (VAT of 15% is assumed):
A company enters into an operating lease agreement for a used excavator costing R500,000. The machine has an economic life of 10 years and the lease runs for 3 years. Lease payments of R20,787 (R18,076 lease plus R2,711 VAT) are payable monthly in arrears. The interest rate on the lease is 18% per annum. This is an operating lease because the risks of ownership effectively stay with the lessor. The agreement is therefore a normal rental agreement for VAT purposes. It follows that the lessee will not be able to claim the full input VAT upfront. The input VAT can be claimed on each payment, based on each rental payment’s amount.
For income tax purposes, the agreement remains a lease agreement and the lessee will be allowed to claim the rental payments as a tax deduction in terms of section 11(a). The monthly lease payment must be reduced with the VAT relating to that payment in order to calculate the deduction for the rental payment under section 11(a) of the Income Tax Act. The section 11(a) deduction to lessee in the first year is therefore R20,787 x 12 x 100/115 = R216,908.
Based on the information in the example above, the lessee would then recognize the following entry on a monthly basis:
Debit: Lease expense (P/L) R18,076
Debit: Input VAT (R20,77 x 15/115) R2,711
Credit: Bank R20,787
Input versus Output VAT
Output VAT is VAT which you must calculate and collect when you sell goods and services, provided that you are registered in the VAT Register.
Input VAT is VAT which is included in the price when you purchase vatable goods or services for your business.
If you are registered for VAT, you will be able to deduct input VAT against output VAT in your VAT return.
Example calculation of output and input VAT
Company A, which is registered in the VAT Register, is the lessor of the abovementioned excavator. It purchases the machine for R500,000, including VAT. During the same period (one financial year), the company rents out the excavator for R18,076 excluding VAT.
In the tax return for VAT, it must deduct input VAT from output VAT.
Excavator purchased for R500,000 including VAT
VAT: R500,000 x 15/115 = R65,217
Input VAT R65,217
Annual rentals received of R216,912 (R18,076 X 12) excluding VAT
VAT: R216,912 x 15/100 = R32,536
Output VAT: R32,536
Company A will receive a VAT refund of R32,681
R65,217 minus R32,536 = R32,681
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