Abstract

This article examines the scope and operation of VAT apportionment under the Value-Added Tax Act, with particular focus on selected topics, namely the treatment of capital gains, interest, dividends and distributions from trusts. BGR (binding general ruling) 16 prescribes the apportionment formula that is required to be applied where goods or services are acquired only partly for the purpose of making taxable supplies, namely the turnover-based method of apportionment. The apportionment ratio is essentially the ratio of the value of all taxable supplies to the aggregate value of (i) taxable supplies, plus (ii) exempt supplies, plus (iii) the sum of any other amounts of income derived by the vendor, whether in respect of a supply or not, in the tax period. BGR 16 nevertheless recognises that to include all amounts without taking into account their uniqueness would not result in a fair and reasonable apportionment, and the ruling accordingly provides for certain exclusions and adjustments. Specifically excluded from the apportionment formula are amounts derived in respect of the supply of capital assets because, as accepted in BGR 16, including such income would distort the apportionment ratio. BGR 16 provides useful guidelines for determining the nature of a receipt of a capital nature, with some reliance on the ‘tests’ developed by our courts in deciding whether a receipt is of a capital or revenue nature for income tax purposes. As regards interest income, BGR 16 provides for certain adjustments. Where the vendor carries on lending activities, that is, borrows money to on-lend, the ruling permits vendors to adopt the net interest approach. This approach allows the vendor to deduct interest paid from interest received prior to inclusion of the net amount of exempt income in the denominator. (The use of gross interest instead of net interest in the denominator would have reduced the vendor’s apportionment percentage.) Importantly, provision is made for situations where no interest is charged or paid, such as where moneys are lent from own resources and where loans are made between connected persons. These required adjustments are often overlooked in practice. As regards vendors who derive interest in consequence of their investment activities (whether investing in equities, cash or other financial instruments), the exempt interest need only be included on the basis of: interest received for the year x (Prime Rate — JIBAR). The rationale for this differential (Prime Rate — JIBAR), which recurs throughout BGR 16, is that it serves as a proxy for the value of the vendor’s own intermediation activity rather than the gross return on the underlying funds: JIBAR broadly approximates the cost of funding and the prime rate the rate at which funds are on-lent or invested, so the spread isolates the margin attributable to the activity that consumes the mixed-purpose resources, while excluding the underlying capital return that would otherwise overstate exempt turnover in the denominator and distort the apportionment ratio. Whilst dividends are generally not included in apportionment methods in other VAT jurisdictions, BGR 16 specifically includes dividends in the denominator (thereby reducing the apportionment percentage). BGR 16 notes that the investment activity associated with the holding of investments (whether in subsidiaries or associated companies, for example) must be fairly reflected in the apportionment formula. BGR 16 requires that dividends must be included on the basis of: a 3-year moving average of dividends received x (Prime Rate — JIBAR). Provision is also made for proxies where, for example, dividends are not received in the relevant periods, and where adjustments are required to be made to interest receipts. These proxies and their attendant effect on the apportionment are also often overlooked in practice. It is doubtful if this situation is mandated in the legislation. BGR 16 does not deal with distributions from trusts. However, in interactions with the authors of the article, SARS has indicated that it does not accept that the conduit principle applies and argues that the distributions must be dealt with on the same basis as dividend receipts, that is, ignoring the nature of the individual components of the distribution (interest, dividends or capital gains). The article motivates the position that it is strongly arguable that the conduit principle does apply and that the components of the distribution, such as capital gains, interest and dividends should fall to be dealt with on the same basis as those amounts that are individually dealt with in BGR 16.