South Africa: VAT: Looming Triple Jeopardy For South African Banks, SARB And SA Mint Acquiring (refined) Second-hand Gold

Gold is gold wherever in the world you buy it. Except if you buy it in South Africa and you happen to be a South African registered bank, the South African Reserve Bank ("SARB") or the South African Mint Company (Proprietary) Limited, then you could find yourself paying 15% more in VAT depending on whom you buy your gold from.

By its very nature, gold is virtually indestructible and lends itself well to recycling. This means that all gold ever mined is still available above ground in one form or another. Its properties are universal such that each 1oz of gold, in whichever form it may be contained, is 100% interchangeable with any other 1oz of gold. This is most evident when gold is refined into a bullion bar with a purity in excess of 99.5% (ie, pure gold). Bullion bars are often the subject of location swaps commonly occurring between the world's bullion banks whilst the physical gold bars themselves don't exchange hands.

Why then is it that when a bank, SARB or SA Mint acquires gold in South Africa from a mine the purchase qualifies to be zero-rated (taxed at a VAT rate of 0%) but when these same purchasers acquire gold from anyone else, such as another local bank or a second-hand gold refinery, the price is 15% higher as a result of VAT? Based on a recent judgment the answer, it would appear, depends on where the gold originates from.

Zero-rating of gold

Section 11(1)(f) provides that a transaction may be zero-rated if the supply is to a bank, SARB or SA Mint "of gold in the form of bars, blank coins, ingots, buttons, wire, plate or granules or in solution, which has not undergone any manufacturing process other than the refining thereof or the manufacture or production of such bars, blank coins, ingots, buttons, wire, plate, granules or solution;".

Taken at face value, this provision zero rates a supply of gold in any one of the eight prescribed forms to one of the three listed recipients.

Game-changing judgment

In a recent judgment of the High Court of South Africa, Gauteng Division, Pretoria in the matter of Lueven Metals (Pty) Ltd v CSARS (31356/2021) [2022] ZAGPPHC 325 (19 May 2022), the court held that secondary refined and previously manufactured gold supplied to a bank, SARB or SA Mint does not qualify for zero rating under section 11(1)(f) of the VAT Act.

The vendor, Lueven Metals (Pty) Ltd, is a second-hand gold refinery incorporated in South Africa. It was common cause that Lueven produced gold bullion bars from second-hand gold material (e.g., jewellery and scrap gold) for sale to Absa Bank Limited. It acquired second-hand gold which it partly refined in-house to produce gold bars with a purity below 99.5% ("lesser pure bars").

Lueven deposited the lesser pure bars at Rand Refinery Limited ("Rand Refinery") for further refining, on its behalf, to produce pure gold bullion bars that meet the Good Delivery standards of the London Bullion Market Association ("LBMA"). Lueven itself is not LBMA accredited. Rand Refinery, acting as its agent, then delivered the gold bullion bars to Absa on Lueven's behalf which Lueven zero-rated in terms of section 11(1)(f) of the VAT Act.

At the heart of the dispute was whether the phrase "which has not undergone any manufacturing process other than the refining thereof or the manufacture or production" (hereinafter referred to as "the restrictive phrase") precludes gold originating from secondary sources from being zero rated when it is supplied as a refined bullion bar to a bank, SARB or SA Mint. The Court was of the view that it does and made a declaratory order to that effect against the taxpayer.

Which gold?

But were the parties to the dispute referring to the same gold? Section 11(1)(f) refers to gold in eight prescribed forms, then uses the pronoun "which" before proceeding with the restrictive phrase.

The restrictive phrase bears a different meaning depending on whether one has in mind the gold sourced by the taxpayer (being secondary, unrefined gold which goes into the making of the final gold product), or the final gold product supplied to one of the listed recipients (being newly refined gold in one of the eight prescribed forms). It then becomes clear that there is a fundamental difference in VAT treatment depending on the kind of gold one believes the restrictive phrase applies to.

The VAT treatment of a transaction depends on the type of goods or services supplied. For example, the supply of financial services is exempt from VAT whereas the supply of management services is taxable. When determining the VAT treatment of a supply, one does not consider the nature of any goods or services acquired to make that supply. The vendor therefore contended that the gold "which" may not have undergone any process of manufacture is the gold in one of the eight prescribed forms referred to in the section – that gold and, therefore, that section 11(1)(f) is a form preserving section.

SARS on the other hand contended that (any) gold "which" has previously been subjected to any manufacturing process at any time in the past (e.g., scrap jewellery, or bars containing scrap gold) will not qualify for zero-rating and that the language of the section is clear.

Who benefits from zero-rating?

The nail in the coffin for the vendor appears to have been SARS' contention that the policy rationale behind the section is to benefit the mining industry; thus that the only gold capable of qualifying for zero rating under this section is newly mined gold. However, no evidence was proffered for such contention.

VAT is a consumption-based tax which means the final consumer (purchaser) bears the burden of the tax. If the purchaser is not VAT registered or cannot otherwise claim a full input tax deduction, the VAT incurred is a cost. It is therefore the purchaser who benefits from zero-rating. The impact of zerorating is best illustrated with reference to the basket of zero-rated foodstuff which is aimed at providing tax relief to the poor (not the retailers selling the goods).

In the current matter, section 11(1)(f) affords zero-rating only to banks, SARB or SA Mint as this section does not apply to any other type of purchaser.

But let's take a look at what all of this means in practice.

First jeopardy – Historic origin and burden of proof

Based on the interpretation of section 11(1)(f) as per the judgment, the only time when the origin of the gold can definitively qualify for zero-rating is if the gold is newly mined gold acquired from a mine. It would otherwise be impossible to establish whether a gold bar or any part thereof was previously subjected to any manufacturing process. In light of this judgment, banks, SARB and SA Mint will no longer be able to acquire (refined, recycled) gold on a zero-rated basis from second-hand gold refineries with peace of mind.

It matters not that newly mined gold and recycled gold could both be deposited at Rand Refinery at the same time, be co-mingled and co-refined to LBMA standards and then cast into a single gold bullion bar. As long as the supplier can prove that the gold originated from the mine from which it was extracted, it could zero rate its sale of gold (in a prescribed form) to a listed recipient.

This was not previously understood to be a condition for zero-rating and the exact requirements for the seller to discharge its burden of proof are unclear. SARS' Interpretation Note No. 31 (Issue 4) does not cast any light on this matter as it lists only a "tax invoice" as documentary proof to support zero rating under section 11(1)(f).

Second jeopardy – Residual VAT cost for the purchaser

If one takes a bank, for example, it provides a combination of VAT exempt/non-taxable supplies (eg, financial services) and other taxable supplies which means that it generally cannot claim the full amount of VAT incurred on its expenses. Banks acquire gold for various purposes, whether to hold as investments, reserves or to provide gold-backed investment products (eg, exchange-traded funds).

If the gold is acquired partly for VAT exempt/non-taxable purposes, the purchaser would not be able to claim the full amount of VAT incurred. Gold originating from secondary sources would be more expensive as any residual VAT which cannot be claimed will become a cost to the purchaser.

Residual VAT is often passed on by a vendor to its customer in the form of an inflated sales price. This gives rise to VAT cascading (i.e., VAT at 15% is levied on the VAT cost that is embedded in the sales price). The problem is compounded if the next customer in the line is another bank (or SARB or SA Mint). Based on the judgment, bank 1 would not be able to supply gold at the zero rate to bank 2 (or SARB or SA Mint) as bank 1 would not be able to prove the origin of the gold, especially if the gold is processed via Rand Refinery and thus co-mingled. This means gold can only ever be supplied once at the zero rate under section 11(1)(f), being the very first sale of newly mined gold (in a prescribed form, to a prescribed recipient).

On the other hand, if the listed recipients are able to claim the full amount of VAT incurred on their gold purchases the cash-flow impact thereof could still be significant. This could potentially distort consumer preferences and undermine the neutrality principle of a VAT system.

Parties to these gold transactions are well advised to review the terms of their agreements as regards pricing and whether it includes or excludes VAT. This will determine which party could ultimately be out of pocket if zero rating was incorrectly applied.

Third jeopardy – Domestic reverse charge regulations soon to be introduced

On 06 October 2021 South Africa's National Treasury published draft regulations (the "Regulations") to introduce a domestic reverse charge on "valuable metals" mainly relating to gold-containing material. It was proposed to come into operation on 1 June 2022, but the final Regulations have not yet been published.

The Regulations will apply to the second-hand gold industry and requires the purchaser to account for the VAT (at 15%) on the transaction rather than the supplier.

Most importantly, the Regulations do not apply to supplies contemplated in section 11(1)(f). However, in terms of the judgment, second-hand gold does not fall under section 11(1)(f) to begin with. This means that once the Regulations come into effect, banks, SARB and SA Mint would have to self-account for VAT at 15% on their local purchases of (refined) gold falling within the ambit of the Regulations.

Although the Regulations aim to remove the VAT cash-flow impact of second-hand gold supplies (to the extent that an off-setting input can be claimed by the purchaser), it will result in an unfortunate administrative burden for banks, SARB and SA Mint.

Conclusion

Whether banks, SARB or SA Mint incur VAT at 15% or could be required to self-assess such VAT on gold purchases from second-hand gold sources in future, the VAT cost of (refined) recycled gold just went up.

Gold is an expensive commodity. Any acquisition thereof is intentional and not easily substituted for a different product. The demand for gold by banks, SARB and SA Mint will likely not decrease, but they will undoubtedly think twice about the source of the gold they buy and how to be satisfied that the gold could be zero-rated.

Reviewed by Melanie Harrison, an Executive Consultant in ENSafrica's Tax department.

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.