By Barry Ger and Susan McCready

The recent Supreme Court of Appeal (SCA) tax case of Commissioner for the South African Revenue Service v De Beers Consolidated Mines Ltd [2012] 3 All SA 367 (SCA) deals with one of the most contentious issues in the laws concerning value added tax (VAT), namely the deductibility of input tax. While the case did not go well for the taxpayer concerned, it sheds light on the meaning of one of the most pivotal VAT concepts, specifically when ‘expenses can be considered to have been incurred in the course of and furtherance of a taxpayer’s enterprise’.

This article will examine the De Beers case and consider how it may affect vendors in respect of claiming input tax on their costs. Before this is done, however, it may be useful to consider some basic principles concerning VAT and, more particularly, the VAT law on which the judgment was ultimately based.

Some basic VAT principles

VAT is sometimes incorrectly said to be the simplest of the taxes. This could not be further from the truth: VAT is an extremely complex tax and – as the De Beers case demonstrates – can be a minefield for taxpayers.

As tax practitioners are aware, VAT revolves around an input/output mechanism. Essentially, once a person has been registered as a VAT vendor, he will, as a general rule, claim the VAT he incurs (ie, input tax) in respect of costs and will charge VAT (ie, output tax) on taxable supplies (ie, sales). The difference between these amounts is what is ultimately paid to the revenue authorities.

Whether the input tax on costs incurred by the vendor can be claimed (or ‘deducted’, as sometimes phrased), depends on whether these costs are incurred for the purpose of making taxable supplies. This in turn depends on whether the vendor supplies goods and services in the course or furtherance of an enterprise.

A further important VAT principle that was germane to the De Beers case was that of VAT on imported services. ‘Imported services’, in terms of the definition in the Value-Added Tax Act 89 of 1991, are services supplied by a non-resident supplier to a South African resident recipient for use or consumption in South Africa. However, they exclude those services utilised or consumed for the purpose of making taxable supplies. These services are subject to VAT (ie, so-called ‘imported services VAT’).

Facts of the De Beers case

De Beers, a listed company, carries on the business of mining and selling diamonds. In November 2000 a consortium of its shareholders made a proposal to De Beers in terms of which a new company would be established to become the holding company of De Beers as well as of a linked company. Being a listed company, De Beers was, in terms of company law, required to evaluate whether the offer was fair and reasonable in order to advise its board accordingly. De Beers contracted with a foreign financial adviser, a British merchant bank, as well as local professional advisers (two law firms and one audit and advisory firm) for advice on the reasonability of the offer in order to implement its obligations. The foreign adviser did not charge South African VAT on its fees but the local advisers did on their invoices.

De Beers claimed the VAT incurred on the local advisers’ invoices as input tax deductions, while it did not account for any VAT on ‘imported services’ charged by the foreign financial adviser.

The South African Revenue Service (SARS) disallowed the input tax deductions claimed by De Beers on the basis that the local advisers’ fees did not arise in the course and furtherance of De Beers’ enterprise. It also assessed De Beers for imported services VAT in respect of charges from the foreign financial adviser.

De Beers’ arguments

De Beers proposed that both the foreign and local advisory services were a necessary concomitancy of its mining and commercial enterprise as a public company. As these services were rendered to fulfil De Beers’ obligations as a public company, they were directly linked to its regular and continuous operations as an enterprise for VAT purposes.

In the case of the foreign services, De Beers argued that imported services VAT could not be imposed on these as they were not ‘imported services’ in terms of the definition. De Beers relied on the exclusion set out in the definition of a supply of services made by a non-resident supplier to a resident recipient for the purpose of making taxable supplies. As these expenses were so connected with its enterprise for the reasons advanced, they were necessarily incurred for the purpose of making De Beers’ taxable supplies as part of its mining enterprise.

Alternatively, De Beers argued that as the advice from the foreign adviser had been provided to De Beers in certain meetings held overseas, the advice had been consumed outside of South Africa and had not been imported in terms of the definition.

Lower court decision

De Beers’ arguments largely found favour in the Tax Court. However, Davis J differed with De Beers in respect of the local advisory costs. The court found that, to the extent that the services provided related to the transfer of shares, this constituted an exempt supply and the VAT had to be apportioned.

Both SARS and De Beers appealed this decision; SARS, on the basis that none of the services were utilised or consumed for the purpose of making taxable supplies; De Beers, on the basis that all the services were so utilised or consumed.

SCA decision

Unfortunately for De Beers, the SCA largely overturned the lower court decision and dismissed De Beers’ appeal with costs.

Van Heerden and Navsa JJA were not convinced that the services were utilised as part of the ‘enterprise’ of De Beers. De Beers’ VAT enterprise was the mining, marketing and selling of diamonds. The duties imposed on a public company that is the target of a takeover bid were too far removed from the advancement of this VAT enterprise to characterise these services as being acquired for the purpose of making taxable supplies. The advisory services acquired were not directed at making De Beers’ diamond mining business better or more valuable; rather they were acquired for the benefit of the departing shareholders.

In light of this finding, the SCA could not agree that the advice obtained from the foreign adviser was integral to De Beers’ diamond mining enterprise. Unless it could be said that De Beers carried on business as an investor in shares (which it could not), the investments did not constitute an ‘enterprise’. The advice De Beers obtained from the foreign adviser was accordingly not acquired for the purpose of conducting its enterprise (ie, for the purpose of making taxable supplies).

On the matter of De Beers’ contention that the foreign advisory services had been consumed outside of South Africa, the SCA found the fact that some meetings were held overseas (two of the five meetings were held in London) could not justify the conclusion that the services were not consumed in South Africa.

What to take from the judgment?

No doubt SARS will seize on this judgment as a basis for arguing that the term ‘enterprise’ must be defined narrowly by VAT vendors.

SARS may argue that the special duties imposed on a company in the interests of its shareholder are not part and parcel of the enterprise’s activities for VAT purposes.

Does this mean that SARS should disallow VAT claims in respect of audit and legal fees incurred by companies on a regular basis?

Certainly not. There is a danger in applying this judgment too widely. In fact, even the SCA made it clear in this case that the facts of the matter were ‘unique and hardly likely to be duplicated’ and that its ‘conclusions reached [were] based on [its] curious facts’.

Most costs of complying with statutory obligations are accepted as part of the overhead costs of conducting an enterprise. These costs are, however, to be distinguished from certain services legally required of an entity in relation to activities or supplies of an isolated nature, for example the acquisition or sale of shares, or advisory services, that essentially benefit minority shareholders, rather than the business of the vendor.

Examples of the type of services that could give rise to the above VAT consequences include local or foreign advisory fees in respect of due diligences, mergers and acquisitions, group reorganisations, restructurings and certain activities in relation to raising capital (eg, bond or share issues). Much would hinge on what is considered to be the ‘enterprise’ of the taxpayer. As the court in the De Beers case noted, if the enterprise is that of an investor, then arguably the input tax may still be claimed.

A final word

Any company in need of specialist consulting on the performance of once-off or statutory obligations would be well advised to obtain a professional opinion on whether these services are incurred for the purpose of making taxable supplies and constitute the conducting of its ‘enterprise’ for VAT purposes. But, be warned, obtaining such advice may also not be considered part and parcel of conducting one’s enterprise, depending on the facts, and, accordingly, it is possible that the VAT on this advice may not be claimed as an input tax deduction.

Barry Ger BBusSc LLB BCom (Hons) (Taxation) (UCT) is a tax consultant in Cape Town.

Susan McCready CA (SA) BCom (Masters) (Taxation) (UCT) is a tax consultant in Cape Town.

 This article was first published in De Rebus in 2012 (Nov) DR 57.