7 June 2019 by and Tax & Exchange Control Alert

Splitting hairs… VAT Case 1558

Suppliers often make single supplies of goods or services to their customers which comprise of various component parts such as, for example, various goods purchased in a supermarket, some of which are subject to VAT at the standard rate and some of which are zero rated. Other examples include tour operators who charge a single fee for a tour package which may comprise of standard rated accommodation and zero-rated international travel, or an insurer who charges a single premium for providing insurance cover for assets located in South Africa and offshore.  

Section 8(15) of the Value-Added Tax Act, No 89 of 1991 (VAT Act) prescribes how VAT should be levied on these supplies. Section 8(15) provides that if a single supply of goods or services, or of goods and services is made, and if separate considerations had been payable, they would have been charged for in part at the standard rate and in part at the zero-rate, then each part of the supply is deemed to be a separate supply for VAT purposes. This means that the supplier only levies VAT at the standard rate on that part of the consideration of the composite supply which is attributable to the standard rated goods or services. The zero rate applies to the part of the consideration which is attributable to the zero-rated goods or services supplied.

The application of s8(15) of the VAT Act was recently considered by the Tax Court in the case of Taxpayer v The Commissioner for the South African Revenue Service (VAT1558) [2018] ZATC 3 (5 December 2018) with regard to its application to marketing services.

The facts

In this case the taxpayer manufactured and distributed various brands of alcoholic beverages in South Africa under an exclusive rights distribution agreement entered into with foreign brand owners. The taxpayer supplied marketing services to the foreign brand owners for a fee. The marketing fee was calculated with reference to the actual annual cost the taxpayer incurred on marketing the brands. The marketing included a mix of media advertising, promotions, sponsorships, and relationship marketing. It also included product sampling and tasting, product giveaways comprising of, inter alia, branded glassware, t-shirts and lanyards to raise brand awareness. The products used for product sampling and tasting were taken out of the taxpayer’s own stock and the taxpayer paid for the promotional goods purchased for marketing purposes. The taxpayer charged a single all-inclusive marketing fee to the foreign brand owners and levied VAT thereon at the rate of zero per cent. SARS levied VAT at the standard rate in terms of s8(15) on the portion of the fees which was calculated on the cost of the promotional goods incurred by the taxpayer.

The arguments

SARS argued that the portion of the marketing fee which is attributable to the promotional goods is subject to VAT at the standard rate in terms of s8(15) because the cost of such goods can be determined, they were supplied and consumed locally and were not exported.

The taxpayer argued that it had a contractual obligation to supply the marketing services, and that the distribution of promotional materials and stock tasting, although not obligatory, was undertaken not as an aim in itself, but as part of the advertising strategy employed by the taxpayer in rendering the marketing services. The foreign brand owners did not require the taxpayer to distribute promotional items or to arrange product tasting events. These were part of the marketing strategy applied by the taxpayer. The taxpayer argued further that it supplied a single marketing service to the foreign brand owners and did not make any separate supply of goods to the foreign brand owners.

The Judgment

In considering the application of s8(15) of the VAT Act, the court held that s8(15) is concerned with the notional separation of supplies if separate considerations had been payable. The court held that the determination for purposes of s8(15) of the VAT Act of whether separate considerations are notionally payable does require the economic nature and commercial reality of the transaction to be considered. The court held that there is, however, no requirement that any notional separation should avoid what may be considered to be an artificial dissection of a transaction if cognizable goods or services for which separate considerations could have been payable can be identified. The court stated that the cost of supplying the promotional goods was readily ascertainable. It did not matter that the promotional goods were not received or consumed by the foreign brand owners. The court found that the supply of the promotional goods was capable of notional separation and was accordingly deemed to be a separate supply in terms of s8(15) of the VAT Act. The portion of the marketing fee which was calculated based on the cost of the promotional goods was therefore held to be subject to VAT at the standard rate.

The implications

The judgment may have far-reaching implications for suppliers, particularly if s8(15) requires a notional separation of supplies if separate considerations had been payable, and if such notional separation does not need to avoid an artificial dissection of a transaction, as held by the Tax Court. For example, where a product containing a mixture of maize meal and wheat bran is sold, on the basis that the quantity or volume of the maize meal and the wheat bran is readily ascertainable and can be notionally separated, and that it is possible to determine the cost of each supply, it seems that in terms of the judgment in VAT Case 1558 the maize meal component should be zero rated and the wheat bran component should be subject to VAT at the standard rate.

The implications of the judgment are also evident if one considers SARS Binding General Ruling (VAT) No.38 (BGR38) regarding the VAT treatment of vegetables and fruit. The supply of unprocessed fruit and vegetables is subject to VAT at the zero rate. BGR38 provides that where any substance is added to the vegetables or fruit, whether or not separately packed in the same container, the zero rate will not apply. For example, where garlic butter is added to raw baby potatoes and they are sold as a single product in the same packaging, the zero rate does not apply due to the standard rated substance added thereto. However, if the judgment in VAT Case 1558 is applied, on the basis that one can identify two cognisable supplies which are capable of notional separation, namely the vegetables and the butter, and that one can determine the cost of the vegetables and that of the butter, only that part of the price which is attributable to the butter will be subject to VAT at the standard rate.

The judgment in VAT Case 1558 seems to contradict the judgment of the Supreme Court of Appeal (SCA) in the case of Commissioner for the South African Revenue Service v British Airways plc 2005 (4) SA 231 (SCA). The Tax Court appears to have distinguished this case from the British Airways case on the basis that in the British Airways case two vendors supplied distinct services. However, the SCA held that British Airways supplied a single international transport service and incurred the cost of passenger services provided by another supplier for its own account, and British Airways merely recovered such cost from its passengers as part of the consideration for supplying the international travel service. The SCA also stated that s8(15) does no more than apportion the rate at which the vendor is required to pay the VAT levied by s7, when the vendor has supplied different goods or services as a composite whole. According to the SCA, s8(15) does not seem to require an artificial dissection of a single supply of a single product or service, but it applies when a single supply comprises of different components, therefore to supplies such as those made by a supermarket, a tour package compiled by a tour operator or insurance cover provided for goods located locally and offshore.

We understand that the taxpayer in this case has applied for leave to appeal the judgment. Hopefully the appeal court will provide clarity regarding the application of s8(15).

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