Court rul­ings not con­sis­tent

Rev­enue’s treat­ment of VAT in­curred in share-re­lated is­sues should be chal­lenged

Finweek English Edition - - Creating Wealth - MARK SIL­VER

YOU WOULD HAVE THOUGHT a man­u­fac­tur­ing com­pany that in­curs ex­pen­di­ture on is­su­ing shares to raise cap­i­tal – thus fi­nanc­ing the ac­qui­si­tion of new ma­chin­ery used in or­der to pro­duce and sell more wid­gets – would be able to claim the value-added tax in­curred on such ex­pen­di­ture.

The tax­payer in a re­cent lo­cal tax court case (ITC 1744) cer­tainly thought so, but was told by the court the ex­pen­di­ture in­curred on the share is­sue was prepara­tory to the mak­ing of tax­able sup­plies and ac­cord­ingly wasn’t in­curred in the course of man­u­fac­tur­ing its prod­ucts. The court added that al­though the VAT on buy­ing the ma­chin­ery was claimable, the VAT in­curred on rais­ing the funds to buy the ma­chin­ery was not.

In sup­port of that the court re­ferred to the Euro­pean Court case of the BLP Group, which held that where a tax­able per­son uses ser­vices for an ex­empt trans­ac­tion, he’s not en­ti­tled to deduct the VAT in­curred even if the ul­ti­mate pur­pose of the trans­ac­tion is the mak­ing of tax­able sup­plies. (In this case the tax­payer sold shares in or­der to raise fi­nance and it was clear the sale of shares con­sti­tuted an ex­empt sup­ply.)

The SA Rev­enue Ser­vice has re­peat­edly re­ferred to the above cases to deny tax­pay­ers the VAT on an as­sort­ment of share-re­lated ex­pen­di­ture. Al­most 10 years af­ter the BLP case an­other Euro­pean judg­ment (the Kret­ztech­nik case), where an Aus­trian dis­trib­u­tor of med­i­cal equip­ment in­curred ex­pen­di­ture in is­su­ing shares to raise cap­i­tal to be used for fi­nanc­ing its op­er­a­tions, brought some in­ter­est­ing find­ings to the fore.

On the one hand the is­sue by a com­pany

of its shares didn’t con­sti­tute a sup­ply in the first place, let alone an ex­empt sup­ply; and on the other hand the share is­sue “was car­ried out by Kret­ztech­nik in or­der to in­crease its cap­i­tal for the ben­e­fit of its eco­nomic ac­tiv­ity in gen­eral, it must be con­sid­ered the costs of the sup­plies ac­quired by that com­pany in con­nec­tion with the op­er­a­tion con­cerned form part of its over­heads and are there­fore, as such, com­po­nent parts of the price of its prod­ucts”. Kret­ztech­nik was ac­cord­ingly en­ti­tled to claim the VAT charged on ex­penses in­curred by it for var­i­ous sup­plies in the con­text of the share is­sue.

The Kret­ztech­nik case ap­pears to con­tra­dict the find­ing of the SA case in at least two fun­da­men­tal as­pects: namely, the is­sue of shares doesn’t con­sti­tute a sup­ply and can’t ac­cord­ingly be an ex­empt sup­ply. And the costs as­so­ci­ated with rais­ing funds used to ac­quire goods and ser­vices by that ven­dor, which would in turn be used for the pur­poses of gen­er­at­ing tax­able sup­plies, form part of its over­heads and that link is suf­fi­ciently close to jus­tify the de­duc­tion of the VAT on such costs.

In an­other Euro­pean judg­ment handed down last year the tax­payer, a Ger­man in­vest­ment com­pany called Se­curenta, re­lied on the Kret­ztech­nik case in or­der to jus­tify claim­ing the VAT in­curred on share is­suere­lated ex­pen­di­ture. In the Se­curenta case the tax­payer raised cap­i­tal by the is­sue of shares and in­vested such funds in land, shares and other types of in­vest­ments.

The court dis­tin­guished the Kret­ztech­nik case on the ba­sis that in that case the tax­payer only con­ducted eco­nomic ac­tiv­i­ties. How­ever, in the Se­curenta case a large por­tion of the tax­payer’s ac­tiv­i­ties con­sti­tuted the ac­qui­si­tion and hold­ing of in­vest­ments that didn’t con­sti­tute “eco­nomic ac­tiv­i­ties”. Ac­cord­ingly, the tax­payer was only per­mit­ted to claim a por­tion of the VAT in­curred on the share is­sue-re­lated ex­pen­di­ture.

Do the above de­vel­op­ments in Europe have any im­pact on the po­si­tion in SA? While not bind­ing on other South African courts, it’s been widely ap­plied by Rev­enue. The Euro­pean court de­ci­sions have con­sid­er­able per­sua­sive au­thor­ity, as was ap­par­ent in ITC1744. It’s sub­mit­ted that at the very least the Euro­pean cases have clearly demon­strated ex­pen­di­ture in­curred by a ven­dor in or­der to raise funds to fi­nance op­er­a­tions that gen­er­ate tax­able sup­plies – al­beit prepara­tory in na­ture – isn’t nec­es­sar­ily too re­mote from that ven­dor’s tax­able sup­plies in or­der to qual­ify as an in­put tax de­duc­tion.

Where a com­pany is ex­clu­sively in­volved in man­u­fac­tur­ing and in­curs ex­pen­di­ture in rais­ing cap­i­tal to fi­nance such ac­tiv­i­ties, it is in­deed dif­fi­cult to see how such ex­pen­di­ture can be any­thing be­sides a cost com­po­nent of that en­ter­prise.

Fur­ther, in ITC1744 the court’s re­liance on the BLP case might have been mis­placed, in that the BLP case in­volved the dis­posal and not the is­sue of shares. There’s no doubt the sale of shares con­sti­tutes an ex­empt sup­ply but, as was il­lus­trated in the Kret­ztech­nik case and sub­se­quent Euro­pean rul­ings, the is­sue of shares isn’t a sup­ply and can’t con­sti­tute an in­ter­ven­ing ex­empt sup­ply.

Al­though SA law in­cludes the is­sue of a share in the def­i­ni­tion of a fi­nan­cial ser­vice, in or­der for the ex­emp­tion to ap­ply, there must be a “sup­ply” of such fi­nan­cial ser­vice. It would thus seem the de­ci­sion in ITC1744 needs to be ques­tioned in light of sub­se­quent court cases and that Rev­enue’s prac­tice of dis­al­low­ing the de­duc­tion of any VAT on ex­pen­di­ture in­curred in re­la­tion to share is­sues needs to be chal­lenged.

In fact, that chal­lenge should be ex­tended to Rev­enue’s treat­ment of the VAT in­curred on a long list of ex­pen­di­ture re­lat­ing to cor­po­rate re­struc­tures, black empowerment trans­ac­tions and share­holder-re­lated costs – par­tic­u­larly where the com­pa­nies in­volved are trad­ing com­pa­nies.

Tax di­rec­tor, Deloitte

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