South Africa: The Intricacy Of Claiming VAT Deductions

The entitlement of a vendor to claim a deduction of input tax or to claim a deduction of a notional amount is a central feature of the South African VAT system. In order for an amount to comprise "input tax", the amount must meet the following requirements:

• the supplier who supplied the goods or services must have charged VAT in terms of section 7 of the Value-Added Tax Act, 1991 ("VAT Act");
• the goods or services must have been supplied to the vendor claiming the amount as input tax;
• the goods or services concerned must have been acquired by the vendor (i.e, the recipient); and
• the goods or services must have been acquired wholly or partly for the purpose of consumption, use or supply in the course of making taxable supplies.

This article briefly explores some of the landmark judgments that have been handed down by the Supreme Court of Appeal ("SCA") pertaining to the claiming of an input tax deduction or a deduction of a notional amount by a vendor. What is manifest is that the judgments have put paid to the maxim that all VAT incurred on goods or services acquired is claimable in full as an input tax deduction, even in cases where a business is a fully taxable vendor; in a similar vein even in businesses that are not fully taxable, the issue of claiming an input tax deduction or claiming a deduction of a notional amount, has received closer scrutiny from the SCA.

In Commissioner for SARS v De Beers, the SCA took a practical approach and, effectively looked at the "effect" that certain local and foreign services acquired by De Beers had on the enterprise of De Beers (which was the mining, marketing and selling of diamonds). The SCA ruled against De Beers and stated that the diamond business of De Beers was not enhanced and that the enterprise was not in the least affected by whether or not De Beers acquired the foreign services and that the local services acquired, simply enabled De Beers to comply with its legal/statutory obligations. It followed that the services were not acquired for the purpose of making taxable supplies by an enterprise that mines, markets and sells diamonds. Southwood AJA, in para 51, said the following regarding the definition of "enterprise": "The primary question requires that there be clarity as to the nature of the 'enterprise' because the purpose of acquiring the services and whether they are consumed or utilised in making 'taxable supplies' can only be determined in relation to a particular 'enterprise'. What the 'enterprise' consists of is a factual question...."

In Consol Glass (Pty) Ltd v The Commissioner for the South African Revenue Service, the SCA endorsed the views of Southwood AJA by stating that it is essential in any VAT enquiry (when determining the deductibility of input tax) to identify at the outset the enterprise that the vendor is conducting. In the Consol case, the South African Revenue Service was able to convince the SCA that certain local and foreign services received by the vendor were not related to the vendor's taxable business (i.e, its enterprise which was fully taxable).

In that matter, Consol sought to substitute its foreign funding for local funding in order to mitigate its financial exposure to the volatility of the rand. In short, Consol restructured its debt to more favourable terms and the SCA viewed the concomitant service provider fees incurred, to be otherwise than for the purpose of making taxable supplies; stated differently, the SCA denied the deduction of the VAT incurred by the vendor on local service provider fees, etc., as it considered that the refinancing of the debt did not have a functional link to the making of taxable supplies by Consol i.e, the manufacture of glass containers – the re-financing of debt was undertaken to reduce Consol's debt servicing costs and was not in the course or furtherance of its enterprise.

In a more recent judgment of Commissioner for SARS v Capitec Bank Ltd, the issue before the SCA was whether Capitec was entitled to a deduction of a notional amount based on the tax fraction (i.e, ^15/115) of amounts paid in respect of loan cover provided to its customers in terms of section 16(3)(c) of the VAT Act (which it had received from its insurer and which were used to settle its customer's outstanding loan obligations due to the death or retrenchment of the affected customers). The determination of this issue was largely dependent on whether the loan cover that was provided to its customers by Capitec, was a taxable supply i.e., whether it was supplied in the course or furtherance of Capitec's enterprise. The SCA held, among other things, that Capitec was not entitled to the deduction as the loan cover did not qualify as a taxable supply because no consideration was charged and the loan cover was linked to the unsecured lending business, which is an exempt supply, supplied in the course of providing credit (which did not form part of Capitec's enterprise).

While the factual matrix applicable to the said cases was very specific, one cannot ignore that the claiming of input tax deductions or the claiming of a deduction of a notional amount has become a challenging and often contentious issue. Legislatively, the vendor claiming such a deduction bears the burden of proving that the amount is deductible.

It is evident that the Consol case aligns itself with the De Beers case in that the SCA in both cases when considering the deductibility of input tax on local services, etc, evaluated the totality of the transaction that gave rise to the acquisition of the said services – was the enterprise impacted before and after the transaction and can it be said that there is a functional link between the expenditure incurred and the making of taxable supplies?

Further, it is inferred that a vendor needs to look at the purpose as well as the effect of the services acquired to determine if there is a functional link to the making of taxable supplies (in other words, the "effect" must be demonstrable). Contentious areas associated with the claiming of input tax, or a notional amount may include but are not limited to:

• the raising of finance to effect company reorganisation transactions;
• the subsequent refinancing/restructure of the initial debt;
• the financing of capital expenditure by the raising of debt;
• legal fees to institute or defend any judicial action; and
• payments made in terms of any indemnification provided to a counterparty.

Vendors need to take heed of the stance of the SCA regarding the seemingly, parochial, determination of whether a vendor has incurred a particular amount in the course or furtherance of that vendor's enterprise before a deduction is warranted, in the circumstances – vendors need to prepare for more scrutiny by SARS in this regard.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.