VAT refund? Dont think Sars will just write out a cheque...

TAXtalk reports on the approach of the South African Revenue Service to dealing with VAT repayment claims.

Sars scrutinises VAT refund claims very carefully. Wouldn't you?

There are two types of VAT vendor, and both seem to think that submitting VAT returns where refunds are claimable will pit them in some sort of WWE tag team bout against the South African Revenue Service (SARS).

In the red corner is the paranoid vendor. This type is so convinced that Sars is going to violate them with a "gang-audit" the moment they dare to submit a VAT return where a refund is claimed, that they would rather "pad" the turnover figures or reduce their input VAT in order to "pay something" rather than claim a legitimate refund.

Such extreme caution is misguided, for SARS will seldom perform a full-blown audit unless foul play is suspected. In most cases, a VAT refund arises from the purchase of capital equipment, although it can also occur when there is a mismatch between income and expenditure (for example, stocking-up ahead of a massive price increase).

SARS' normal procedure is to contact the vendor by telephone, requesting copies of the tax invoices that have given rise to the claim. Once such invoices have been provided and SARS is satisfied that the refund claim appears legitimate, the refund is usually released without too much fuss.

Moving to the other extreme, over in the blue corner is the maverick vendor. This type is completely opposite in personality to his paranoid counterpart. Such a vendor would pad their input tax and/or reduce the turnover figures in order to reduce the amount of VAT legitimately due to SARS.

Some are so brazen about it that they even go so far as to claim refunds, thinking that SARS will meekly write out a cheque without having a bit of a closer look at things, such as in one recent tax case (ITC 1828 [2008] 70 SATC). Writing about this scheme in PricewaterhouseCoopers' monthly tax publication "Synopsis", RC Williams noted that the scheme on which the Durban Tax Court ruled was, "a high-water mark in chutzpah [and] naïveté for the taxpayer's apparent belief that obvious piffle would escape the notice of Sars assessors, and that [Sars] would meekly write out a cheque for R2.1m by way of a refund of the notional input tax on a transparently sham transaction".

Case History

The scheme in question involved the purchase of second-hand helicopter parts from a non-vendor for R15m.

In terms of sub-paragraph (b) of the definition of "input tax" contained in Section 1 of the Value-Added Tax Act, a registered vendor may claim a so-called "notional" input tax calculated as 14/114 of the purchase price of second-hand goods purchased from a non-vendor. A common and legitimate application of this principle is found in vehicle dealers who trade in second-hand vehicles, largely from private individuals who are not registered as VAT vendors.

However, in this case, the taxpayer entered into a series of convoluted transactions ultimately aimed at extinguishing any debts arising from the purchase of the helicopter spares, finally setting-off the R15m owed for the helicopter spares against the purchase price of a 30% member's interest in the vendor (a close corporation). By the time the ink had dried on all the paperwork, the corporation was left only with the claim against SARS for the refund of VAT arising from the notional input tax claimed.

SARS smelled a rat when it established that, while the taxpayer concerned was a VAT vendor since July 2005, it had not had any turnover until January 2006, the tax period for which the refund was claimed. Further investigation by SARS revealed that the parts in question were actually "useless scrap" and could not be used as aircraft spares without "a very complex and expensive process of certification and authentication".

By the time SARS had gone through the underlying transactions, it decided that enough was enough, disallowed the vendor's claim for notional input tax, and slapped on a 100% additional penalty for good measure.

Amazingly, the vendor decided to take SARS on in court. However, the Tax Court shared SARS' concern that these components were nothing more than scrap metal, totally useless as helicopter spares. It also noted the apparent lack of commercial substance in on-selling the parts for the exact same price for which they were purchased (instead of at a mark-up as one would normally expect).

But the clincher was the vendor's response to a letter from SARS, in which the vendor had indicated that the sale of the parts "resulted in a substantial profit and not zero profit as alleged". In doing so, the vendor unwittingly revealed their true intention, in that the only possible source of profit from this transaction was the refund by SARS of the notional input tax claimed, and according to the Court, this pointed to a scheme devised in order to obtain a profit in the form of a tax benefit.

The Court further pointed out that the vendor did not have the financial means to pay the R15m for the parts at the time of the transaction, and for this reason entered into the agreement for the sale of the member's interests. However, such set-off was regarded as "riddled with difficulty" in that, legally, set-off can only take place between the same parties to the transaction. The Court therefore found that the vendor did not pay the R15m for the parts, and in fact had no intention of doing so.

The case was therefore decided in favour of SARS, with the Court upholding SARS' right to deny the claim for input tax as well as to impose the 100% additional tax penalty.

According to Williams, the judgement did not reveal the basis on which the vendor had argued its objection against the assessment. In fact, the vendor had no case, and instead exposed itself further by claiming that any profit made would arise from the refunding of the notional input VAT.

Williams concluded by stating that the case was "a costly end to a clumsy attempt to pull the wool over Sars' eyes. Given the amounts of money involved, and the many suspicious circumstances, there was no realistic possibility that the various transactions could withstand scrutiny".
 

The above article is reproduced with the kind permission of TAXtalk, South Africa's leading tax publication ( www.etaxes.co.za ).

Article Added Sunday, 02 November 2008

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