It is the long-standing practice of traders and service providers to grant customers extended payment terms for the goods or services they supply as a means to enhance turnover. Where the credit provided is interest-free, the question that arises is whether the provision of such credit impacts on the entitlement of the supplier to claim input tax for value added tax (“VAT”) purposes.
Assuming the supplier is a registered VAT vendor and the goods or services are not specifically exempt from VAT, the supplier is required to levy and account for VAT on the consideration for the goods or services supplied on credit. In some instances, the South African Revenue Service (“SARS”) has contended that by granting the interest-free credit, the supplier is supplying a financial service. SARS contends that such supplier is making both taxable and exempt supplies, and may require the vendor to apportion its input tax deductions accordingly.
Section 12(a) of the Value-Added Tax Act, 1991 (the “VAT Act“) exempts the supply of any financial services from VAT. The activities which are considered to be “financial services” for this purpose are defined in section 2 of the VAT Act. Section 2(1)(f) includes in the ambit of a financial service, the activity involving the provision by any person of credit under an agreement, by which money or money’s worth is provided to another person who agrees to pay, in the future, a sum exceeding in the aggregate the amount of such money or money’s worth.
The VAT Act is clear as to the activity involving the provision of credit which is considered to be an exempt financial service. Firstly, there must be an agreement in terms of which money or money’s worth is provided. Secondly, the person to whom the money or money’s worth is provided must, in terms of the agreement, assume an obligation to pay, in the future, a sum or sums exceeding in aggregate the money or money’s worth that was provided.
The first requirement will normally be met, as the supplier will enter into an agreement with the customer which will govern the repayment terms and conditions. Although the supplier will not supply a sum of money to the customer, the credit amount is considered to be “money’s worth” which is provided.
However, the second requirement is not complied with because the customer does not agree to pay in the future sums exceeding the money’s worth that was provided in terms of the credit agreement. The activity of granting interest-free credit is therefore not a financial service as contemplated in section 2(1)(f).
The terms and conditions under which the credit is granted may stipulate that the supplier is entitled to levy interest if the customer does not make the agreed payments within the interest-free period. Such a provision entitles the supplier to claim interest from the customer if the customer defaults, but cannot be construed to be an agreement in terms of which credit is provided where the customer now agrees to make payment of sums exceeding the money’s worth provided. There is, firstly, no agreement in terms of which the credit terms are extended beyond what was already agreed, and secondly, the interest charged is a penalty amount payable because the customer is in default, and is not consideration for the provision of credit under any agreement.
Section 2(1)(c) of the VAT Act also includes the activity involving the issue, allotment, drawing, acceptance, endorsement or transfer of ownership of a debt security as a financial service. A ”debt security” is defined to mean an interest in or right to be paid money. A debt security generally includes financial instruments such as bonds, promissory notes and debentures, and may also include book debts.
The supply of goods or services on credit is, however, not considered to be the issue or allotment of a debt security as contemplated by section 2(1)(c). The supplier’s right to be paid money arises from the supply of the goods or services, and not from the creation or issuing of a debt instrument evidencing a debt obligation. A book debt would comprise a debt security after the debt is established through the supply of goods or services on credit. Any subsequent trade in the book debt will be exempt from VAT being the transfer of ownership of a debt security.
The main purpose of interest free-credit sales is to make products more affordable for consumers and to drive sales. It also allows the supplier to monitor consumer behavior and to communicate regularly with customers regarding new products and special offerings, thereby driving sales further. The supply of goods or services on interest-free credit therefore forms an integral part of such sales, and does not comprise a separate, stand-alone activity. SARS acknowledges in its VAT Interpretation Note 70, that where a supply is made by a vendor for no consideration in the context of a business activity or enterprise, then such supply is regarded to be a taxable supply in the course or furtherance of the enterprise. The granting of the interest-free credit in this context, is therefore not a non-enterprise activity, as was held in K C M v Commissioner of South African Revenue Services (unreported case no. VAT 711, 14 August 2009), where the organisation provided publications for no consideration, and which was ruled to be a gratuitous disposition.
As the granting of interest-free credit is not an exempt financial service and forms an integral part of the taxable enterprise activities of the supplier, there is no basis upon which the taxable expenses incurred in relation thereto should be apportioned.
VATCOM, a committee that was established to consider comments and recommendations on the VAT Bill when VAT was introduced in South Africa in 1991, considered the granting of interest-free credit and stated that it does not fall within section 2(1)(f) and is therefore not a financial service. VATCOM further stated that the provision of credit for no consideration is a taxable supply and no apportionment of input tax would be required (VATCOM report, comment regarding clause 2(1)(f), page 83). The statement that the provision of interest-free credit would not require apportionment is repeated in VATCOM’s comments to clause 2(1)(ℓ)) (refer page 84).
In conclusion, the supply of interest-free credit is not a financial service which is exempt from VAT in terms of section 12(a), but it is a taxable supply, albeit for no consideration, which forms an integral part of the supplier’s taxable enterprise activities. No apportionment of input tax should therefore be required for vendors supplying goods or services on extended interest-free credit terms.