South Africa’s Tax Court issued a decision addressing the rule under section 17(1) of the VAT Act, 1991 concerning retroactive (retrospective) application of an approval by the South African Revenue Service (SARS) of an alternative method of apportionment for value added tax (VAT) purposes.
The case is: Case No: VAT2063 (15 November 2019)
Section 17(1) generally provides that vendors must use an apportionment method approved by the Commissioner. The only pre-approved method is the standard turnover-based method; this method determines the extent to which the VAT incurred on dual-purpose expenses can be claimed as input tax, by expressing the total value of taxable supplies as a percentage of total receipts or accruals.
Unlike most turnover-based methods used in other jurisdictions concerning VAT or goods and services tax (GST), the standard turnover-based method in South Africa includes income in respect of which no supplies have been made—such as dividend income—as well as passive income which requires no or insignificant usage of taxable resources—such as interest earned from a call account.
However, the South Africa rule provides that a vendor may only use the standard turnover-based method, if the method is fair and reasonable. Failing that, the vendor must apply to SARS to use an “alternative method” that is also fair and reasonable. In this regard, the statute provides that when an apportionment method has been approved by the Commissioner, the method may only be changed from a future tax period, or from a date that the Commissioner may consider equitable, provided that this date must fall, in the case of a vendor that is a taxpayer for income tax purposes, within the year of assessment during which the application for the alternative method has been made. In other words, if a vendor applies to the Commissioner for approval to use an alternative method, SARS may approve the method with retroactive effect, but at best, from the first day of the financial year in which the application was made. For example, SARS may at best make the ruling effective from 1 March in relation to a vendor with a February year-end that applies for an alternative apportionment method in December.
Some of the most common difficulties that occur include that many vendors are unaware that they are required to apply an apportionment method approved by SARS, in order to determine the extent of VAT incurred on dual expenses (i.e., overhead costs) if their non-taxable receipts and accruals, such as dividends, interest, and such items represent more than 5% of total receipts or accruals.
Another common mistake is that vendors apply a method which they believe is equitable, which may be based on floor space or head count but such methods have not been approved by SARS. By the time the vendors are made aware of the fact that they were required to use the standard turnover-based method, it most often happens that the vendor has a five-year retroactive VAT liability, including penalties and interest. In these circumstances, the vendors often apply for the use of an alternative method, in which case the Commissioner generally approves the method with retroactive effect, but limited to the first day of the financial year in which the application was filed—hence, still leaving the vendor obligated to use the standard turnover basis for the period before the effective date of the ruling.
Tax Court case
Many vendors have argued that since SARS has accepted that the standard turnover-based method does not yield equitable results, as is evident from the approval of an alternative method, SARS cannot raise assessments in respect of historic years when the vendor was required to use the standard turnover-based method.
The facts in the Tax Court case mirror this situation. The court found that a sensible interpretation of section 17(1)(iii) is not one that would allow the taxpayer to have its ruling to use an alternative apportionment method applied retroactively beyond the period envisaged in that section.
The court further stated that an interpretation that would serve to condone the taxpayer’s tardiness in seeking a timely private ruling in respect of historic years, “strained” the context and purpose of the section. The court further held that despite the fact that SARS approved an alternative method, since the standard turnover-based method did not yield an equitable result, the provisions of section 17(1)(iii) expressly preclude the Commissioner from issuing a ruling that had an effect from an earlier date.
The taxpayer was thus directed to apply the standard turnover-basis of apportionment in respect of the years preceding the effective date of the ruling approving an alternative method.
Read a November 2019 report [PDF 332 KB] prepared by the KPMG member firm in South Africa
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