Purchasing Property as a Going Concern

By Liad Hadar, Director at Hadar Incorporated, Specialist Property Law Firm
This article first appeared in Asset Magazine’s November 2023 edition

In the realm of property transactions, smart purchasers are always on the lookout for opportunities to maximize returns and minimize costs.

One avenue to explore to reduce costs, whilst protecting and bolstering cashflow, is the purchase of a property as a going concern, a legal mechanism that can bring significant financial benefits. These benefits arise mainly from the tax savings in such transactions as opposed to those of standard property transactions.

In this article, I delve into the concept of acquiring property as a going concern and the potential advantages it offers, particularly in terms of Value Added Tax (VAT) exemptions. I explain what the requirements for such transactions and warn of the importance of approaching these transactions carefully to avoid any pitfalls.

Understanding the Going Concern Principle

When purchasing a property as a going concern, the essence lies in the continuous operation of a business or trade within the premises upon which the property is situated. This approach applies to properties that are already income generating and actively used for commercial purposes – simple examples being a hotel, a retail shopping centre or an commercial office building.

In essence, by acquiring such this class of property, the purchaser steps into the shoes of the seller (upon registration of transfer) seamlessly continuing the operations without interrupting the flow of business.

The VAT Implication

In standard property transactions, the sale of a property attracts VAT at the current rate of 15% (to be added to the purchase price). However, when buying a property as a going concern, a unique VAT advantage emerges. Section 11(1)(e) of the Value Added Tax Act 89 of 1991 allows for the transaction to be “zero VAT rated” which, in other words, means subject to zero percent VAT. In simple terms, no VAT is payable by the purchaser and it effectively saves the additional 15% of the purchase price that would have been paid but for such exemption.

This exemption can result in substantial cost savings for the purchaser, making a transaction and its expected returns a more attractive option.

Qualifying for the VAT Exemption

For a property purchase to qualify as a going concern, certain criteria must be met. These criteria include:

  • The property constitutes an “enterprise” as defined in the VAT Act;
  • The enterprise is being disposed of as a going concern;
  • The parties have agreed (clearly) in writing that at the date of conclusion of the sale agreement, the enterprise will be an income earning activity on the date of transfer from the seller to the purchaser;
  • All the assets of such enterprise necessary for the continued operation of the enterprise are being sold;
  • Both the seller and purchaser are registered VAT vendors.

Benefits of Purchasing as a Going Concern

As above, the most significant advantage of purchasing a property as a going concern is the substantial VAT savings. By not having to pay VAT on the property’s purchase price. For example, if a purchaser is acquiring a substantial retail shopping centre for R100 000 000.00, it is saving R15 000 000.00 which it can use for other purposes.

This saving can significantly impact the purchaser’s cash flow whilst also making the transaction a more attractive consideration on a calculation of the internal rate of return of such acquisition.

The funds saved by not paying VAT can be used, amongst other things, for additional capital to be reinvested in the property and further drive up its value with a revamp or important upgrades.

The other benefit is that acquiring a property as a going concern means that the existing business operations remain largely uninterrupted. This continuity can be a valuable asset, as you can start generating income from day one.

The (Huge) Importance of Due Diligence

While the prospect of VAT savings is exciting, given the nature of such transactions, it is crucial for purchasers to conduct a thorough due diligence before purchasing a property as a going concern. This includes:

  • Reviewing the financial records of the business to ensure it is operating profitably and does not carry any hidden or substantial liabilities;
  • Assessing existing lease agreements with current tenants and understanding their implications;
  • Ensuring that the property adheres to all relevant regulations, such as zoning and other regulatory requirements.

Potential Pitfalls and Considerations

Whilst purchasing a property as a going concern offers numerous benefits, one must be aware of potential challenges and considerations. Such potential issues can be checked in the aforementioned due diligence process. Things to consider are:

  • The seller must be compliant with all tax and legal obligations. Any non-compliance issues could impact the transaction’s eligibility for VAT exemption;
  • Ensure that all agreements and documents clearly reflect the going concern nature of the transaction. This documentation is essential for tax authorities and potential disputes.
  • The purchaser must confirm their eligibility for VAT exemption, as well as that of the transaction itself, as any incorrect claims can lead to fines and interest charges.
  • As the new owner, you assume all liabilities and obligations of the business. It’s vital to assess these potential risks as you becoming liable for them.

Conclusion

Purchasing a property as a going concern and benefiting from VAT exemptions is an enticing proposition for investors in the South African property market.

It provides an opportunity to save on VAT costs, which, amongst other things, enhances cash flow, provides a better return on investments and maintains business continuity. It is however a potentially complex exercise which requires careful consideration, correct and expert legal drafting, thorough due diligence and proper documentation.

Before embarking on a going concern transaction, it is advisable to seek guidance from legal and financial professionals who specialize in Property Law. With the right support and a well-executed strategy, purchasers can unlock the full potential of this opportunity and benefit greatly.