The Cape Town tax court recently granted a punitive cost order against the South African Revenue Service (Sars) in a value-added tax (Vat) case, a move that is considered quite uncommon in the tax court.
The court considered Sars’s approach in the case to be “grossly unreasonable” in terms of the provisions of the Tax Administration Act.
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The case stems from an appeal to the court by Ken, a destination management company in the tourism industry, against additional Vat assessments. Ken objected to the assessments, but its objection was disallowed. It then successfully appealed to the tax court.
Ken was founded in 1997 by two Dutch nationals, called Mr and Ms Clean in court papers, who operated as local agents for foreign tour operators. They served as the “eyes and ears” of several foreign tour operators and assisted them in structuring tour packages for marketing and sale to the operator’s clients, all foreign tourists.
Ken never marketed, sold or operated any tourism assets and never dealt with the foreign tourists directly. They only acted as a conduit for the foreign tour operators. Sars argued that Ken was supplying tourism services and charged a “mark-up” for its services in the form of commissions.
Agent or agency?
Gerhard Badenhorst, tax director at Cliffe Dekker Hofmeyr, says in a tax exchange control alert the terms “agent” or “agency” are not defined in the Vat Act. However, Sars has issued an interpretation note (2016) in which it accepts that the common law relationship between the principal (the supplier of the service) and the agent prescribes the Vat consequences of the legal relationship.
“The general Vat rule is that where a person, acting as an agent, supplies goods or services on behalf of a principal to a third party, the supply is deemed to be made by the principal and not the agent.”
Where a third-party supplier makes a supply to an agent acting on behalf of a principal, that supply is deemed to be made to the principal. In these instances, the principal and not the agent must account for Vat on the supplies.
Ken argued that it rendered a tourism package assembly service to tour operators outside of South Africa.
In terms of the Vat Act the service is zero rated. It has consistently only claimed Vat on its commission income.
Sars maintained that Ken provided a supply of tour packages and services to non-resident tourists and foreign tour operators and that Vat should have been levied at a standard rate on the commissions Ken charged the operators and the costs of the tourism services paid by the operators.
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In the hearing before the court, more than 4 000 pages were introduced as evidence. The only witness was Ms Clean, who acted as Ken’s public officer for tax purposes. The court described her as a “forthright, candid and impressive” witness.
She was at pains to explain that they did not assemble the packages, but they only assisted the operators to assemble it. When there was an emergency while the foreign tourists were travelling in SA, Ken only acted as a conduit between the local suppliers, the tour operators and the tourists.
They negotiated on behalf of the tour operators but their invoices never separated the costs of the local tourism suppliers and their own commissions to the operators. This was standard practice in the industry, mainly because the agents did not want to give their competitors the opportunity to undercut their rates.
Sars described the commissions charged by Ken as a “mark-up” on the costs of the local suppliers’ charges.
The court found there was no clear legal distinction between a “mark-up” and a “commission”, and the debate was consequently one of semantics.
Ken’s accountant confirmed its invoicing practice in 2005 with Sars when it implemented an automated tour plan system. Sars had no problem then with the fact that the commissions were not indicated separately.
The tax court found that Sars failed to explain why its approval in 2005 of Ken’s approach to invoicing was now mistaken or misplaced. “Whilst Sars is not bound by such approval, one would have expected some rational indication for its subsequent departure from the stance previously adopted by (presumably sentient) Sars officials in approving the invoice layout.”
The court found that the approach adopted by Sars in issuing the additional assessments was inconsistent with the approach it adopted in 2005, its own criteria to distinguish between an agent and a principal set out in its interpretation note, and the evidence in the case.
Badenhorst says the court took a “dim view” of Sars’s approach in raising the assessments. A commentator close to the case described the judgment as solid in terms of the facts and its interpretation of tourism industry practices.
The decision has a wider application as Sars has issued several additional assessments in similar tourism businesses.
This has created uncertainty and risks in an industry heavily affected and still recovering from the Covid-19 travel restrictions.
Sars still has time to appeal the decision.