The section 11(g) leasehold improvement allowance – opportunities, risks and practical consideration

By Brigitte Zegwaard, Senior Manager

In the commercial property world, it’s not unusual for lessors to enhance (“sweeten”) a lease agreement by offering the lessees a tenant installation allowance at the commencement of the lease agreement, or by permitting the lessee to make improvements to the leased property. The appeal for lessees is clear: under the right conditions, improvements to leasehold property by the lessee can unlock valuable tax deductions, even though the lessee is not the owner of the improvements.

Section 11(g) of the Income Tax Act No. 58 of 1962 (“the ITA”) allows a lessee to claim a leasehold improvement allowance—commonly known as the “s11(g) allowance”, provided certain requirements are met. In August 2023, SARS issued version 2 of Interpretation Note 110 setting out its view on, among other things, the interpretation of section 11(g). The following are the key requirements of this provision:

Contractual Obligation – The lessee must be legally obliged under the lease agreement to carry out improvements on land or buildings granted for their use or occupation.
Value Cap – The total allowances cannot exceed the cost of the improvements or the value specified in the lease agreement.
Fair Value Default – If no value is stipulated in the lease, the allowance is capped at the fair and reasonable value of the improvements.
Spread Over Time – The deduction must be spread over the period of the lessee’s use or occupation, commencing from the date the improvements are completed, to the shorter of the lease period or 25 years, and be apportioned for part years.
Completion Requirement – The allowance is claimable only from the date the improvements are completed and if the property is used to generate “income” (i.e. gross income less exempt income) in the hands of the lessee.
Lessor’s Income Inclusion – The value of the improvements must constitute “income” in the hands of the lessor.
Termination Loss – If the lease ends early, any un-deducted balance may be claimed as a deduction in the year that the lease ends.

While these rules appear straightforward, complications often arise in practice—particularly where the amount spent differs from the “contract amount” stated in the lease.

Spending More – If the lessee spends more than the contract amount, the allowance is capped at the contract amount. The excess may still qualify for a deduction under other building or other capital allowance provisions if the requirements of those provisions are met. The lessor includes only the contract amount in their income.
Spending Less – If actual expenditure is below the contract amount, the allowance is based on actual spend, but the lessor is still taxed on the full contract amount.

The Contractual Obligation Trap
The allowance is only available if there is a clear contractual obligation to effect the improvements. Vague and poorly drafted lease agreements can cause major problems. In practice, most leases do not oblige the tenant to effect improvements but merely grant them the right to do so.

A common mistake is treating the existence of a tenant installation allowance — a cash contribution from the lessor at the commencement of the lease agreement — as evidence of a contractual obligation to improve the property. Without a legally enforceable requirement to perform the improvements, the claim fails, leaving the lessee without the s11(g) deduction.

Compliance Risks
The s11(g) allowance is claimed in a separate section of the corporate tax return (ITR14). If claimed incorrectly, SARS may argue there was material non-disclosure, misrepresentation, or fraud — removing the usual prescription protection and leaving the assessment open to re-assessment after the normal three-year period.

Another key risk is that the lessor’s income status matters: if the lessor is a tax-exempt entity, the lessee cannot claim the allowance, even if there is the clear contractual obligation to effect the improvements. This information may not always be readily available — and some lessors may be reluctant to share it with the lessee.

Financial Consequences of Non-Compliance
If SARS disallows an s11(g) claim, the lessee could face:

Understatement penalties – ranging from 10% up to 200% of the understated tax;
Under-estimation of provisional tax penalties – 20% of the shortfall if provisional tax estimates are significantly below actual taxable income; and
Interest charges – on the underpaid provisional tax.

The combined effect can be substantial.

Claiming expenditure under the correct provisions
Items such as furniture and fittings, office equipment and plant and machinery which do not affix to the building and thus do not qualify for the section 11(g) allowance, may qualify for the wear-and-tear allowances (where the requirements are met). Alternatively, certain expenses may qualify for deduction as expenditure on repairs. Each case must be assessed individually; there is no one-size-fits-all solution.

Conclusion
Leasehold improvements can be a valuable tax opportunity, but only when the lease agreement, expenditure, and tax treatment align with the strict requirements of section 11(g). Businesses should seek expert tax advice before signing a lease to confirm eligibility and avoid unexpected costs. Ongoing monitoring of legislative changes and maintaining accurate documentation are equally important to safeguard the deduction and ensure compliance.