The tax implications for ‘out of scope activities’
Case acknowledges that a vendor may, as a result of the legal vehicle in which it operates, have certain statutory obligations towards its shareholders
VAT Case No 382 was heard on June 13, following a dispute between the South African Revenue Service (SARS) and XYZ (a local company), namely whether (i) certain services acquired by XYZ from a foreign supplier were subject to Value-Added Tax (VAT) on imported services; and (ii) whether XYZ could claim the VAT incurred on certain local services as input tax deductions.
XYZ’s shares were linked to depository receipts which represented an interest in shares issued by ABC (a Swiss company). A share in XYZ and a depository receipt constituted a “linked unit”. The linked units were listed on the JSE, the London Stock Exchange (LSE) and the Swiss Exchange (SWX).
XYZ’s main trading activities consisted of mining and selling of diamonds. ABC and its subsidiaries owned diamond mining interests elsewhere in the world. XYZ’s subsidiaries operated diamond businesses and held shares in DEF (a UK company) whose shares are listed on the JSE, LSE and the SWX. GHI, a company in the XYZ group, also held DEF shares.
The XYZ linked unit holders included DEF, KLM (a Luxembourg company) and DSW (a Botswana company) which held a combined stake of 39,8% in XYZ. The remaining 60,2% were held by institutional and other investors.
DEF, KLM and DSW proposed (as a consortium) that XYZ enter into a transaction to eliminate the interests of the other unit holders (the 60,2%) in XYZ and create a new Luxembourg company, BCD, which would become the holding company of both XYZ and ABC.
The boards of XYZ and ABC companies established an Independent Committee of Directors (ICD) to advise them on whether the consortium’s offer was fair and reasonable to independent unit holders and to assist in negotiations with the consortium. The ICD was authorised to consult with NMR (a UK company) as independent financial advisors. At the same time, various advisers in SA were appointed. NMR considered the consortium’s final offer fair and reasonable. The ICD advised the boards that the offer was fair and reasonable and the boards, in turn, advised the other unit holders.
In terms of the final offer the other unit holders’ shareholding would be eliminated through a distribution to them of all XYZ’s DEF shares, and additional DEF shares and cash. The transaction was implemented through a scheme of arrangement pursuant to section 311 of the Companies Act. The scheme effectively constituted a buy-back leg and a cancellation leg. In terms of the buy-back leg, XYZ acquired 1% of the shares in XYZ of all unit holders (including the consortium) in consideration for DEF shares and a dividend per share attributable to the DEF shares. In terms of the cancellation leg, the balance of the shares in XYZ held by other unit holders were cancelled in consideration for cash and a further allocation of DEF shares.
NMR issued invoices to XYZ and ABC for services rendered in connection with the transaction. SARS assessed XYZ for imported services VAT on the NMR services.
The local suppliers also issued invoices to XYZ for services rendered in connection with the transaction. XYZ claimed the VAT incurred as input tax deductions. SARS disallowed the input tax deductions.
XYZ objected against these assessments and SARS disallowed the objections.
XYZ contended that the services did not constitute “imported services” as: (i) imported services are utilised otherwise than for the purpose of making taxable supplies; (ii) NMR’s services were consumed for the purpose of making taxable supplies; (iii) a supply is a taxable supply if it is made “in the course or furtherance of its enterprise”; (iv) given that XYZ was a public company and conducted its operation within a particular regulated framework the legally mandated advice formed part of the furtherance of its enterprise.
XYZ argued, in the alternative, that NMR’s services, to a significant extent, were utilised and consumed outside the Republic and could not constitute imported services, even if the services were utilised or consumed “otherwise” than in the course of making taxable supplies.
SARS argued that although XYZ may have supplied a service to its shareholders it was not made in the course or furtherance of its enterprise of extracting diamonds. Therefore, NMR’s services could not be said to be consumed for the purpose of making taxable supplies.
SARS argued, in the alternative, that XYZ was involved in three classes of business, namely: (i) extracting and selling diamonds; (ii) holding shares in subsidiary companies; and (iii) holding shares in listed companies. If it was accepted that XYZ chose the corporate form to conduct these three businesses, then the “NMR overheads” were also incurred in the course and furtherance of XYZ’s business of owning subsidiaries and listed investments.
SARS argued that the services were consumed where XYZ resided and carried on business. As XYZ only carried on business in SA, the consumption of the services took place in the country and XYZ should be subject to VAT on imported services.
The court found that while NMR’s services were not directly linked to its mining operations, XYZ was legally obliged to engage such services as a result of the proposed offer.
It was also held that a supply of a financial service to a non-resident, other than in the course of an enterprise making taxable supplies, is not a zero rated supply.
Some local fees were invoiced in globular format. Some work related to the fiduciary obligations of the board to give advice to the shareholders and stood on a similar footing to the NMR services. As a result, the services led to the making of taxable and non-taxable supplies, which necessitates an apportionment or allocation to determine the extent to which the services related directly to the scheme of arrangement (taxable) and to the transfer of shares (exempt or non-enterprise). As it was not possible to determine whether apportionment or allocation applies, the assessment, with regard to these fees, was referred back to SARS for reconsideration.
VAT Case 382 seems to acknowledge that a vendor may, as a result of the legal vehicle in which it operates, have certain statutory obligations towards its shareholders, such as the provision of advice, which would constitute an activity performed in the course or furtherance of its enterprise. As a result, it may claim VAT on related expenses incurred as input tax deductions and will not be liable for VAT on related imported services. The case also addresses the concept (not so often explored in the South African VAT context) of so-called “outside of scope” activities or supplies and seems to regard VAT on related expenses as non-deductible. Although not crystal clear, it would seem from the facts that XYZ distributed DEF shares which it did not own directly, but which were owned by other XYZ group companies, and that these activities constituted “out of scope activities” of which the tax was found to be non-deductible.
Ferdie Schneider is a partner at KPMG Services.