South Africa: VAT on indemnity payments not deductible (court decision)

The Supreme Court of Appeal found that the loan cover was supplied for no consideration.

The Supreme Court of Appeal found that the loan cover was supplied for no consideration.

The Supreme Court of Appeal held that value added tax (VAT) in respect of indemnity payments—made by the taxpayer relating to loan cover payments made for its unsecured lending business—was not deductible. 

The case is: Commissioner for South African Revenue Service v. Capitec Bank Limited (Case no. 94/2021) [2022] ZASCA 97 (21 June 2022)

Background

The VAT law allows a vendor to deduct VAT equal to the tax fraction of any payment made by the vendor to indemnify another person in terms of any contract or insurance. However, it requires that the contract of insurance is a taxable supply (i.e., a supply on which VAT is chargeable, either at the zero or standard rate). This requires that the insurance activity be an “enterprise” activity in terms of which services are supplied to any person for consideration.

Summary

The facts of the case were as follows:

  • As part of the provision of credit to customers, the taxpayer provided loan cover, the proceeds of which were applied to settle or reduce the outstanding loan amount due to the taxpayer in the event of the customer’s death or retrenchment.
  • No additional charge was levied for the loan cover provided to customers in addition to the monthly service fee and interest.
  • Loan cover was underwritten by a third-party insurer and the taxpayer may claim under its policy on account of the death or retrenchment of the borrower.
  • The taxpayer essentially insured itself against the unpaid amount, resulting in the loan being paid in full and the taxpayer not suffering a loss of credit.
  • The taxpayer made VAT deductions calculated on the tax fraction of payments made under the loan cover on the basis that the loan cover was taxable through other taxable fees it charged customers.

The principal question in the case was whether the loan cover supplied was an enterprise activity and, in turn, a taxable supply. If so, deduction of VAT would be permitted.

The Tax Court held that the fee income, which is charged over and above the interest charge, is part of the consideration payable for the provision of credit and that the loan cover promotes and is made in the course of the enterprise which includes making of taxable supplies. The Tax Court thus held that the VAT was deductible.

However, the Supreme Court of Appeal found, after a review of the loan agreements entered into with customers, that the loan cover was, in fact, supplied for no consideration. These agreements stated that no credit life insurance or optional insurance is charged. An extract from the agreement confirms that the charge is included in the interest rate charged. Given that the industry of granting credit is regulated, the taxpayer could only charge fees in terms of National Credit Act provisions and therefore could not bundle with regulated fees. Since there is no consideration, the supply of loan cover could not be said to be an enterprise activity. The Supreme Court of Appeal thus held that the loan cover was supplied in the course of making exempt supplies since the policies ensured recovery of the credit given to its customers, and the VAT deduction is not permitted. 

KPMG observation

The classification of an activity as an “enterprise” activity needs to be carefully evaluated. The regulatory nature of the industry within which a vendor operates needs to also be taken into account. The downfall for the taxpayer in this case was essentially that the fees charged under credit arrangements are highly regulated and therefore could not be argued that consideration was received.

Read a June 2022 report [PDF 230 KB] prepared by the KPMG member firm in South Africa

 

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