In the current tough economic times, it is common for companies to consider alternative funding arrangements to fund their activities, which minimise their cash flow obligations to third parties in the short term, while also ensuring that they comply with the relevant tax legislation and utilise it to their advantage. One option to consider in this regard, is the creation of a loan account by a debtor in favour of a creditor. In CLDC v The Commissioner for the South African Revenue Service (VAT1247)  ZATC 6 (5 September 2016), handed down by the Tax Court on 5 September 2016, the court had to deal with this issue and specifically the consequences of s22(3) of the Value-Added Tax Act. No 89 of 1991 (VAT Act).
The taxpayer, CLDC, concluded an agreement with its wholly owned subsidiary, C in terms of which C would develop land owned by the taxpayer. C funded the taxpayer’s cash-flow requirements on loan account via inter-company shareholder loans to avoid external finance having to be obtained. C issued a tax invoice to the taxpayer in respect of part of the development. The taxpayer subsequently claimed an input tax deduction in respect of the VAT, which amounted to approximately R10 million. The taxpayer paid the input VAT it received from South African Revenue Service (SARS) to C, which in turn paid this amount to SARS. The remaining liability due to C in terms of the invoice, approximately R72 million, was credited to C’s loan account in the taxpayer’s books in accordance with the funding arrangement between the parties. After SARS conducted an audit in 2013, four years after the invoice was raised, it alleged that the requirements of s22(3) of the VAT Act had not been met.
The Tax Court explained that in terms of s22(3) of the VAT Act, where a vendor has claimed an input tax deduction on the basis of a tax invoice, but has not made payment of the relevant consideration within a period of 12 months, the transaction is effectively reversed. The result is that the benefit of the input tax previously deducted is counteracted because the consideration has not been paid. The court stated that the question in the current matter was whether, having regard to the provisions of s22(3), the crediting of a loan account constitutes payment of full “consideration” within a period of 12 months after the taxpayer claimed an input tax deduction for the VAT component of the invoice raised by C as a related company or not.
In ascertaining whether the crediting of the loan account constituted “payment made…in respect of” and “in response to…the supply” of the “goods and services”, in terms of the definition of consideration in s1 of the VAT Act, the court first referred to the decision in Commissioner, South African Revenue Service v Capstone 556 (Pty) Ltd 2016 (4) SA 341 (SCA), where it was held that if a receipt or accrual arises from a detailed commercial transaction, the transaction in its entirety must be considered from a commercial perspective as opposed to breaking it into component parts or subjecting it to narrow legal scrutiny.
The court explained that in terms of the funding arrangement between the taxpayer and C, had C’s loan account not been credited in the manner it was, C would have been required to advance funds to the taxpayer to settle its own invoice and could not have sued the taxpayer in the event of non-payment nor claim the amount in question as a bad debt for VAT or other tax purposes. It follows that both C and the taxpayer did not expect that C would be paid in cash for the relevant supply. What the parties contemplated was that the invoice would be settled by crediting the loan account of C in the taxpayer’s books as its wholly-owned subsidiary. This argument was corroborated by the evidence of the taxpayer’s managing director, and the auditor of the taxpayer and C. According to the court, crediting the loan account did not extinguish the taxpayer’s liability to C, but simply changed the liability from a current liability to a long-term liability in the taxpayer’s books.
The court referred to the decision in Commissioner for Inland Revenue v Guiseppe Brollo Properties (Pty) Ltd 1994 (2) SA 147 (A) and stated that what had to be considered, was the “overriding purpose” for which the loan account liability was incurred. The taxpayer provided undisputed evidence that the purpose of incurring the loan liability was to discharge the invoice debt. The result: what was owing by the taxpayer under the loan account was a different “animal” to what was owing under the invoice. The definition of consideration in s1 of the VAT Act includes “any payment made or to be made” whether “in money or otherwise, or any act or forbearance”. The court held that, as long as payment amounts to the discharge of an obligation to another, there is no reason why an obligation under an invoice may not be discharged through the creation of another liability such as one under a loan. Simply put, “the effect is to discharge one obligation through another”.
The court referred to the explanatory memorandum to the Taxation Laws Amendment Bill, 1996, which states that the purpose of s22 of the VAT Act was to prevent prejudice being suffered by the fiscus, as prior to the amendment it was possible to deliberately create bad debts with a view to create a tax benefit. According to the court, the intention of s22(3) was to prevent such deliberate manipulation and not to prevent an invoice from being considered paid through the creation of a loan account liability where a funding arrangement exists between companies within the same group. On the facts before the court, there was no such deliberate manipulation in creating a bad debt with a view to creating a tax benefit either by the taxpayer or C. In light of this, the court found that the crediting of C’s loan account by the taxpayer in the context of the funding arrangement between the two companies amounted to payment of “consideration” in relation to the supply of goods and services invoiced.
The court’s endorsement and application of the decision in Capstone, is likely to be welcomed by many within the tax community. The application of the principles laid down in Capstone further entrenches the interpretative approach to tax legislation in terms of which the legislation should be interpreted from a commercial perspective. We discussed the Capstone decision in greater detail in our Tax and Exchange Control Alert of 11 March 2016 (Capital v revenue: The taxpayer prevails).
It is important to take note, however, that subsequent to the use of the funding arrangement by C and the taxpayer, s22(3A) of the VAT Act was introduced in 2012, which expressly states that the provisions of s22(3) are not applicable in respect of a taxable supply made by a vendor to another vendor who is a member of the same group of companies. The court also acknowledged that the funding arrangement would not have been permissible had s22(3A) already been in effect. It appears that the court’s decision was strongly influenced by the fact that no loss was incurred by the fiscus.