Author: Herman Viviers (North-West University)
“A dividend in specie generally constitutes a distribution made to the beneficial owner of a share in any form other than in cash”
Considering the VAT consequences for a VAT vendor who declares dividends to its shareholders, may at first appear to be simple. However, the VAT treatment seems to become more complex as soon as one tries to justify it in terms of the provisions contained within the Value-Added Tax Act (89 of 1991) (“VAT Act”). The purpose of this article is to take a closer look at the VAT consequences where a VAT vendor declares dividends (either in cash or in specie) to the beneficial owners of its shares and to justify it in terms of the provisions of the VAT Act.
In general, section 7(1)(a) of the VAT Act determines that output VAT should be levied where a vendor makes a supply of goods or services in the course or furtherance of its enterprise. The terms “supply”, “goods” and “services” referred to within section 7(1)(a) are all defined in section 1 of the VAT Act. It is therefore clear that where there is no “supply” of “goods” or “services”, no VAT output needs to be accounted for. However, section 7(1)(a) is not the only provision in the VAT Act that requires output VAT to be levied. With the distribution of a dividend in specie it needs to be considered whether a possible change in use adjustment in terms of section 18(1) of the VAT Act is required. It also needs to be considered how the VAT treatment will be affected, if at all, where the holder of shares receiving the dividend in specie is a connected person in relation to the vendor who declares it.
Dividends in cash
A “supply” is defined in section 1 of the VAT Act and includes “…all forms of supply, whether voluntary, compulsory or by operation of law…”. Thus, a vendor’s decision to declare a cash dividend to its shareholders will qualify as a supply and will in effect constitute the supply of money. Due to the fact that “money” is specifically excluded from both the definitions of “goods” and “services” as defined in section 1 of the VAT Act, no VAT effect will arise on the distribution of a cash dividend as there is neither a supply of goods nor services.
Dividends in specie
A dividend in specie generally constitutes a distribution made to the beneficial owner of a share in any form other than in cash (such as the distribution of trading stock or a capital asset). It therefore seems as if section 7(1)(a) could now take effect as it is no longer “money” which is distributed. It still needs to be determined whether the distribution of a dividend in specie does in fact constitute the supply of “goods” or “services” for VAT purposes. Neither the definitions of “goods” or “services”, as contained within section 1 of the VAT Act, deals with or make specific reference to “dividends”. This matter was resolved through Decision 329 (taken by the Commissioner of Inland Revenue, 20 September 1991) where it was indicated that dividends in specie should be treated as the “supply of goods” for VAT purposes.
However, section 7(1)(a) of the VAT Act also requires that the supply of the goods should be in the course of or furtherance of the vendor’s “enterprise”. One of the requirements to qualify as an “enterprise”, as stipulated in paragraph (a) of the definition in section 1 of the VAT Act, is that the “…goods or services are supplied…for a consideration…”. In the case of the supply of a dividend in specie, no consideration is received by the declaring vendor from the holder of shares. Therefore, it seems as if section 10(23) of the VAT Act will apply which determines that: “…where any supply is made for no consideration the value of the supply will be deemed to be nil.” As a result it seems as if no output VAT will be levied on the declaration of a dividend in specie as the value of the supply will be zero.
It is however questionable whether this position is correct as Interpretation Note: No. 70 (dated 14 March 2013) specifically dealing with “Supplies made for no consideration” is silent on, and makes no reference to, the VAT treatment of dividend in specie distributions. It is therefore submitted that the distribution of an asset as a dividend in specie could also fall within the ambit of section 10(4) of the VAT Act where the parties involved are connected persons in relation to one another, or even within the scope of section 18(1) which could be applicable irrespective of whether the parties involved are connected or not. These two provisions are considered below:
Section 10(4) of the VAT Act determines that where a taxable supply is made between connected persons for no consideration (as in the case of a the distribution of an asset as a dividend in specie) and the recipient is not entitled to claim the full input VAT on such supply made to him (either because the recipient is not a VAT vendor or is a vendor, but does not amount to at least 95 per cent taxable supplies), the value of the consideration will be deemed to be the open market value of such supply. Thus, where a dividend in specie is distributed by a vendor to its holder of shares who is not a vendor for no consideration, no output VAT will be levied, unless the holder of shares is a connected person in which case the open market value of the dividend in specie will be taxed.
Section 18(1) of the VAT Act requires an output adjustment to be made where goods were originally acquired for the purpose of the making of taxable supplies (and on which, as a result, input VAT was allowed at original acquisition) if they are subsequently applied by that vendor for a purpose other than for the said purpose. For example, where a vendor acquires an asset to be utilised in its enterprise for the making of taxable supplies and subsequently decides to distribute that asset as a dividend in specie to its holder of shares, it seems as if this would constitute a “change in use” and would require an output VAT adjustment in order to cancel out the input VAT allowed at the original acquisition. Section 10(7) of the VAT Act determines that where goods are deemed by section 18(1) to be supplied by a vendor, it will be deemed to be made for a consideration in money equal to the open market value of such supply. Therefore, output VAT would need to be levied by such a vendor distributing the asset in specie to its holder of shares on the open market value of such asset. This would be in contrast with the nil VAT effect under the supply at no consideration in terms of section 10(23) of the VAT Act as discussed above.
Therefore, irrespective of whether the parties are connected or not, there seems to be a mismatch in the VAT treatment as the distribution of an asset as a dividend in specie seems to fall within the scope of both section 10(23) and section 18(1) (read with section 10(7)) of the VAT Act. Neither of these sections mutually excludes one another, nor does it specify the order in which it should be applied.
It is clear that the VAT effect of dividends is no simple matter. VAT vendors making distributions of dividends in specie should carefully consider the circumstances under which these distributions are made, as the incorrect interpretation could result in unforeseen VAT consequences.
This article first appeared on the July/August 2015 edition on Tax Talk.