In a bold move, the South African Revenue Service (Sars) appealed an adverse Tax Court decision directly to the Supreme Court of Appeal (SCA), which overturned the Tax Court decision with costs, including the costs of two counsel.
The SCA judgment was handed down on 21 June.
The matter involved a notional input tax deduction of R71.5 million claimed by Capitec in its November 2017 value-added tax (Vat) return relating to its unsecured lending business.
Capitec conducts business as a retail bank, and provides banking services such as savings and credit card facilities, as well as unsecured loans to customers.
It provides loan cover to its customers that will cover the outstanding loan in the event of the customer’s death or retrenchment, at no charge.
Under the insurance policies with insurance providers, Capitec paid the premiums on the loan cover, and became entitled to the benefits if the customer’s loan was not repaid.
From November 2014 to November 2015, Capitec received payouts and made corresponding payments in respect of the loan cover in the amount of R582.4 million. Capitec claimed the R71.5 million tax fraction of the total insurance payouts as a notional tax input.
Sars disallowed the deduction and also levied a 10% late payment penalty for the resultant understatement of Capitec’s Vat liability.
The SCA had to determine whether the loan cover was a taxable supply; that is, whether it was supplied in the course or furtherance of an enterprise.
Sars was of the view that the loan cover did not constitute a ‘taxable supply’, but an ‘exempt supply’, for the reason that the loan cover was supplied at no charge in the course of Capitec’s business of providing credit to its customers.
Capitec contended that although it does not charge a distinct fee for the loan cover, it was integral to its unsecured lending business which generated both interest income and fee income.
The Vat Act provides for a deduction of the tax fraction of any payment made to indemnify another person in terms of any contract of insurance, provided the supply of that contract of insurance is a ‘taxable supply’. A taxable supply means any supply of goods or services that is chargeable with tax.
Vat is to be levied on the supply by any vendor of goods or services in carrying on an enterprise.
The Vat Act further provides that the making of exempt supplies is excluded from qualifying as an enterprise activity, and the supply of any financial services is exempt from Vat.
The SCA was impressed with the argument put forward by Sars’s counsel on the “matching principle”, that is, that the Vat collected by the vendor on the outgoing supply must be matched with the Vat input tax levied on the incoming supply.
The SCA agreed with Capitec’s counsel that “because the loan cover was supplied as part and parcel of the credit offering business, there was thus a direct link between the supply of the loan cover and the credit supply”, but found that Capitec is in the business of providing credit, which is an exempt supply, and is not in the business of providing insurance.
The SCA referred to the Commissioner for the South African Revenue Service v Tourvest Financial Services, in which the court discussed the apportionment of tax paid on goods and services acquired between taxable supplies and exempt supplies, and reasoned that “only the part attributable to the taxable supply may be deducted as input tax”.
The SCA opined that where a vendor carries on the business of providing financial services, that remains its main business.
The earning of taxable fees, a minor part of Capitec’s business, may be carved out as such and the Vat input claimed accordingly.
However, as Capitec does not charge its clients for credit insurance, the supply of the loan cover does not qualify as an ‘enterprise’ under the Vat Act, and supplies made for no consideration do not qualify as conducting the activity of an enterprise, and do not qualify as a taxable supply.
Capitec was allowed an input tax deduction in respect of the premiums paid to the insurance company Guardrisk, and was required to pay output tax on the indemnity payment it received from Guardrisk.
Hence, both the input tax deduction and the output tax were accounted for in Capitec’s books.
The additional notional input tax deduction
The SCA found that:
- Capitec “wants to treat that same deemed supply as a new notional input tax deduction”.
- “This will leave the books of Capitec skewed, as this would result in there being deductions of input tax without any corresponding output tax”.
- Capitec did not apportion the deduction in its tax return, had not raised the issue of a mixed tax supply in the Tax Court, nor did it plead apportionment as a ground of objection to Sars’s assessment or ground of appeal. Therefore, “there would be no basis to allow an apportionment and SARS was correct to disallow Capitec’s deduction of the whole amount”.
- Capitec had reasonable grounds to claim the deduction, and had obtained a favourable opinion from a senior counsel, and that the only way Capitec could test the issue was to claim the deduction in its tax return. The SCA remitted the penalty.
Appealing directly to the SCA on a complex matter is a strategic move on Sars’s part, considering a number of recent poor high court judgments.