In a recent case, XYZ Co v The Commissioner for the South African Revenue Service (VAT 382), the Tax Court held that advisory services acquired from a foreign supplier in relation to an offer which unit holders in XYZ Co had received to eliminate their interests in the company, do not comprise imported services for Value-Added Tax (“VAT”) purposes. The Tax Court further held that the VAT incurred on local services acquired from legal and financial advisors in relation to the transaction, is not deductible as input tax.

The trading activities of XYZ Co involved the mining and selling of diamonds from South Africa. It received a proposal from three of its main shareholders as a consortium to acquire the interests of the remaining shareholders in the company.

The company appointed an independent foreign financial advisor to advise its board of directors as to whether the consortium’s offer was fair and reasonable. The company also appointed certain local financial and legal advisors in relation to the offer and to implement the transaction.

After having been advised that the offer was fair and reasonable, the transaction was implemented through a scheme of arrangement pursuant to section 311 of the Companies Act No. 61 of 1973. The scheme in effect involved a buy-back of certain of the shares of linked unit holders in the company and a cancellation of the balance of the remaining shares, in return for the payment of cash and shares in a subsidiary company.

The board of directors of the company which was listed on the Johannesburg, London and Swiss securities exchanges, was legally obliged to obtain proper advice on the offer and to provide the information to the holders of its linked units to enable them to reach an informed decision on the merits of the offer made by the consortium.

The South African Revenue Service (“SARS”) assessed the company on the services it acquired from the foreign financial advisor, and disallowed the VAT it claimed as input tax on the local service suppliers services.

A legal obligation was imposed upon the board of directors of the company to obtain the services of an independent financial advisor to inform the holders of the linked units in the company of the fairness of the consortium’s offer. The Tax Court therefore considered the cost in this regard to comprise an overhead cost of the company, which was acquired for the purpose of its diamond mining and selling enterprise.

The Tax Court held that the definition of “enterprise” in the VAT Act should not be limited to apply it exclusively to assets which are used directly in the making of taxable supplies, and found that the services did not comprise “imported services” because they were used and consumed by the company for the making of taxable supplies and in the course or furtherance of the company’s enterprise of mining and selling diamonds. Unfortunately, the Tax Court did not consider the question as to the location where the services were consumed or utilised, as only services consumed or utilised in South Africa comprise “imported services”.

The Tax Court differentiated the local services from the foreign services because it considered them to be incurred mainly to ensure the maximum transfer of shares and cash to unit holders, both activities of which do not comprise “enterprise” activities as defined in the VAT Act. It accepted that certain of the local legal services related to the statutory obligation to provide information and advice to its linked unit holders, but it could not determine the portion that related to this obligation.

The Court held that the VAT incurred on the local services did not comprise input tax and is therefore not deductible as such, save insofar as a certain portion of the local legal services are concerned.

The Tax Court agreed SARS counsel that the zero rating provisions of section 11(2) and the exemption provisions of section 12(a) only apply to supplies which would, in the absence of section 11 and 12, have been subject to VAT at the standard rate, i.e. supplies in the course of an enterprise.

The investment in its subsidiary company, which was distributed as part of the implementation scheme, did not comprise an enterprise activity and therefore fell outside the scope of VAT and is not zero rated, even though it may have been supplied to a non-resident.

The VAT on the local legal expenses, where the services relating to fulfilling the statutory obligation and those relating to the non-taxable activities could not be determined and was referred back to the SARS for reassessment.

We understand that both parties have appealed the judgment. Vendors should nevertheless carefully consider the VAT implications of the services they acquire from foreign suppliers and local suppliers in relation to investment activities in view of the judgment.

Written by Gerhard Badenhorst, Executive in the tax department at ENS

gbadenhorst@ens.co.za