The term “consideration” is widely defined in section 1(1) of the Value-Added Tax Act 89 of 1991 (VAT Act) to mean any payment made or to be made, whether in money or otherwise, or any act or forbearance, in respect of, in response to, or for the inducement of, the supply of any goods or services, whether by that person or any other person.
Where a business is transferred as a going concern which qualifies for the zero rate in terms of section 11(1)(e) of the VAT Act, or if the business transferred falls outside the scope of VAT under section 8(25), it may not be considered important to determine whether the assumption of the liabilities forms part of the consideration payable. In this case, the VAT on the assumption of the liabilities as part of the business acquisition will generally follow the VAT status of the consideration payable for the business. However, it is critical to determine whether the assumption of the liabilities forms part of the consideration payable if the transaction does not qualify for zero rating, or for the exclusion under section 8(25).
The VAT consequences of the assumption of the more common types of liabilities which are generally assumed as part of a business acquisition are discussed below.
The purchaser may agree with the seller that the purchaser will assume the seller’s contractual liability to make payment of amounts owing to trade creditors at the date of the transfer of the business. The parties agree that the purchase price for the business payable to the seller will be reduced by the amount owing to the trade creditors. These liabilities exist independently of the business assets that are being disposed of.
The consideration paid for the business in this case comprises of two parts, (i) the consideration paid to the seller for the business and (ii) the amounts paid to the trade creditors to settle the amounts owing by the seller and to relieve the seller of its liabilities. The amount of consideration on which VAT is payable is the aggregate of the two, as they both form part of the monetary consideration payable in respect of the supply of the business.
The purchaser and the seller may agree that the purchaser will honour the seller’s warranty obligations for goods sold prior to the transfer of the business. In this case the amount payable by the purchaser is not known at the time the business is transferred. The parties agree that the purchase consideration will be reduced by an agreed amount, determined on some basis as an estimate of the warranty claims that are expected to be made.
The undertaking by the purchaser to settle the seller’s warranty obligations that arise after the effective date of the transfer of the business comprises non-monetary consideration for the supply of the business. The value placed on this obligation by the parties acting at arm’s length and by which the purchase price for the business is reduced, forms part of the consideration payable for the business. VAT is therefore payable on the actual amount paid by the purchaser to the seller plus the value placed on the warranty obligations assumed by the purchaser.
Certain liabilities may be imposed by statute, in which case the purchaser assumes the liability as a consequence of purchasing the business. Where a statute imposes an obligation on the owner of the business, the seller is released from the liability when the business is transferred, and the purchaser assumes the statutory liability.
A typical example of such an obligation is provided in Interpretation Note 94 (IN 94), citing a judgment by the Supreme Court of Canada, where the appellant disposed of its right to harvest timber and the buyer assumed the appellant’s statutory obligation to reforest the land on which it had previously felled timber. The issue was whether the value of the assumed liabilities comprised part of the consideration received for the disposal of the right to timber. The court held that the reforestation obligation was simply a future cost tied to the forest tenures that depressed the value of the assets and was not a separate obligation, and therefore it did not comprise consideration for the sale.
Although IN 94 deals with the income tax implications of contingent liabilities assumed in the acquisition of a business, the same principles regarding statutory obligations equally apply in a VAT context. If a liability is imposed by a statute on the operator of the business, the liability reduces the value of the business. The liability assumed by the purchaser is embedded in the business acquired. In these circumstances the purchaser does not assume the liability in terms of a contractual arrangement between the supplier and the purchaser, but as a consequence of the operation of a particular statute. Accordingly, the assumption of a statutory obligation does not form part of the consideration paid to the supplier for acquiring the business.
Payment made for assumption of a liability
The above scenarios must be distinguished from the situation where a person who has an existing or future liability pays another person to assume that liability. As an example, a company may have an existing third-party claim against it, or have contingent warranty claims in respect of goods manufactured. The liability in this scenario comprises a “debt security”, and the transfer thereof to another person is a financial service in terms of section 2(1)(c) of the VAT Act, which is exempt from VAT in terms of section 12(a). A “debt security” is defined in section 2(2)(iii) to include an obligation or liability to pay money that is or is to be owing by any person. It therefore includes current liabilities as well as liabilities that may arise in the future.
Consequently, a person who receives a payment as consideration for the assumption of another person’s current or future liability is not liable to account for VAT on the payment, because it is exempt from VAT.
The VAT consequences of the assumption of liabilities depend on the nature of the specific liabilities and on the nature of the transaction under which the liabilities are assumed. In some instances, the assumption of liabilities is standard rated and sometimes it may form part of a zero-rated transaction. The assumption of certain liabilities may fall outside the scope of VAT, and in other instances it could be exempt from VAT. Each scenario must therefore be considered on its own merits and on the relevant facts.