A recent Supreme Court of Appeal judgement will have adverse value-added tax (VAT) consequences for companies that render a single supply of goods/services made up of more than one component of goods or services.
The judgement may have dire consequences for lower income households as well as the broader consumer market of South Africa considering the current economic climate. Goods which are currently zero-rated under the VAT Act may increase in price further adding to the burden of many households that are struggling to make ends meet.
The case in issue involved Diageo South Africa Ltd, a vendor that manufactured and distributed alcoholic drinks in South Africa under various brands, such as Captain Morgan and Bells. Diageo entered into an exclusive rights distribution agreement with foreign brand owners, which included amongst other things, the rights to use the foreign brand owners’ trademarks, intellectual property, equipment, packages and labels in South Africa. Further to this, Diageo was responsible for the advertising and promotion (‘A&P) of the foreign brand owners’ products in South Africa. The foreign brand owners did not perform or undertake the A&P activities themselves but appointed Diageo to render these services for a fee.
The A&P activities comprised advertising in different media, as well as marketing and brand building activities. As part of the service, Diageo provided promotional products to customers. The promotional products were given away free of charge to third parties for use of consumption in South Africa.
The tax invoice issued by Diageo to the foreign brand owners reflected a fee for services rendered. Although the fee charged by Diageo was calculated with reference to the annual amount spent on the A&P activities, no differentiation was made on the tax invoice between the services rendered to the foreign brand owners and goods consumed in South Africa. Diageo levied VAT at the zero rate on the A&P services supplied by it to the foreign brand owners.
The Commissioner for the South African Revenue Service (‘SARS’), however, was of the view that section 8(15) of the VAT Act applied and deemed Diageo to have made separate supplies of zero-rated A&P services and standard rated goods (i.e. promotional products that were not exported but consumed in South Africa).
SARS assessed Diageo for additional output tax amounting to R14 million on the goods component of the supply of the A&P services.
Diageo challenged the additional assessments in the Cape Town Tax Court on the basis that it had made a single supply of zero-rated A&P services and not a separate supply of both goods and services.
The Tax Court evaluated the nature of the supply made by Diageo. It concluded that the Commissioner’s application of section 8(15) was correct and dismissed the appeal and gave judgement in favour of SARS. Diageo appealed against the Tax Court decision directly to the Supreme Court of Appeal (‘SCA’).
Relying on foreign authorities, Diageo argued that section 8(15) can only apply if a vendor makes “‘separate dissociable supplies of both goods and services’ or supplies that are ‘economically divisible, independent and hence dissociable’ and which constitute ‘an end in itself’, not a means to achieve that end”.
Diageo also submitted that its sole contractual obligation was to provide a service and not to supply goods. The fact that it used goods and incurred expenditure for the purposes of rendering the A&P services to the foreign brand owners did not mean that it supplied both goods and services.
SARS argued that the provisions of section 8(15) of the VAT Act applied as Diageo issued an invoice to the foreign brand owners for a single supply which comprised both goods and services.
The SCA was unpersuaded by Diageo’s argument, in particular its reliance on foreign authorities. It stated that such reliance was unhelpful as these authorities do not deal with the interpretation of statutory provisions that are the equivalent of an apportionment provision as contained in the legislation.
The SCA held in favour of SARS stating that the single supply of A&P services by Diageo consisted of both goods and services that were distinct and clearly identifiable from each other.
Accordingly, Diageo was held liable for the output tax adjustments.
The impact of the Supreme Court of Appeal judgement
The impact of the judgement is far-reaching, and the following should be considered:
? When is a single supply of goods or services or of goods and services regarded as divisible components that are distinct and clearly identifiable from each other for purposes of section 8(15).
? South Africa does not have a refund mechanism that allows foreign businesses to recover VAT charged under similar circumstances. This creates tax disparity between local and foreign businesses as the additional VAT ultimately becomes a cost for foreign businesses.
? The appropriate use of foreign jurisprudence. It is evident from this appeal that vendors should be careful when placing reliance on foreign authorities in making tax decisions, as the courts are hesitant to accept principles in circumstances where there is no clear correlation to the provisions in the South Africa legislation.
The implications of the judgement
The SCA judgement is important for supplies to non-residents and where zero-rated food products are supplied. The judgement raises the question as to whether, for example, a container of milk or loaf of brown bread supplied by a manufacturer to a retailer should be split between the supply of the actual product, i.e. the milk or bread, and the other components, for example the packaging or transport.
The reality of the conclusions reached is that where, for example, packaged or delivered goods are supplied, the vendor is required to split the supply between the various components, should different rates of tax be applicable to the constituent parts. The product will continue to enjoy the benefits of zero-rating but the portion of the price relating to the packaging and transport will now be subject to VAT at 15%.
The purpose of zero-rating the supply of basic foodstuffs is to alleviate the tax burden placed on lower income households. By adding VAT to certain components will increase prices, and significantly add administration costs and create other impracticalities. Separating a supply, such as a zero-rated foodstuff, into its individual components and then charging VAT on certain of those components would result in a commercially unreal outcome. The impact of this judgement may possibly have immense consequences for lower income households as well as the broader consumer market of South Africa.
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