Court rulings not consistent
Revenue’s treatment of VAT incurred in share-related issues should be challenged
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