The tax im­pli­ca­tions for ‘out of scope ac­tiv­i­ties’

Business Day - Business Law and Tax Review - - BUSINESS LAW & TAX REVIEW - Ferdie Sch­nei­der

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.

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