Insights

VAT: International Trade and the unintended cost

The 2017/18 South African National Budget Expectations

As a result of the proposal all industries but in particular the Telecommunication Media Technology (TMT) and Service Industries would aversely affected by it's implementation. This amendment would ensure that supplies to non-residents who are not locally registered for VAT may be zero rated where the services are ultimately used for taxable purposes in South Africa.

Since February 2015 there has been no formal communication regarding this proposed amendment. This is unfortunate as the current situation can result in double taxation and contravenes the neutrality principle adopted by the Organisation for Economic Co-operation and Development (OECD).

Currently the VAT Act prohibits the application of the zero rate of VAT where contractually services are supplied to non-residents but there is a local beneficiary of the service. An example is as follows:

Where an SA vendor (ConsultCo) supplies advisory services to a non-resident and the non-resident subsequently supplies the services to another SA vendor (TradeCo), ConsultCo may arguably not apply the zero rate to its services to the non-resident. This means that ConsultCo must add 14% VAT to its invoice which neither the non-resident nor TradeCo can reclaim even though the services will be consumed in SA for taxable purposes. This means that the VAT element becomes an unintended and additional cost and causes cascading. However, if ConsultCo had contracted directly with TradeCo, TradeCo would be entitled to claim the 14% VAT as input tax.

Tax cascades arise when the recipient of a service cannot recover the VAT incurred on a supply received and subsequently passes this cost on to the next recipient.

The VAT Act requires revision because provisions already exist to ensure the subsequent supply of the service (i.e. from the non-resident to the local SA person) is taxed by virtue of the imported services sections. This is further regulated by transfer pricing mechanisms which ensure group companies charge appropriately for services rendered. To tax the same supply twice and exclude the recipient from making deductions goes against the very premise upon which a value-added tax system operates.

The Organisation for Economic Co-operation and Development (OECD) has adopted core principles on the application of VAT to internationally traded services and intangibles. They are:

Destination principle for determining the place of taxation: “For consumption tax purposes, internationally traded services and intangibles should be taxed according to the rules of the jurisdiction of consumption.”

Neutrality principle: “The burden of value added taxes themselves should not lie on taxable businesses except where explicitly provided for in legislation.”

How these principles are adopted in local VAT legislation is left to that country’s legislature. The OECD also advocates that with the increase in international trade, double taxation as well as non-taxation of transactions across borders should be eliminated and that countries should adopt and adhere to international guidelines to ensure equality and neutrality. This is especially relevant on the Africa continent and one would expect that this is something that the Tax Administration Forum (ATAF) will be attending to. ATAF represents the tax authorities in Africa and its mission is to provide a platform to improve the performance of tax administration which will enhance economic growth.

Clearly the above situation leads to double taxation and contravenes the neutrality principle. It is therefore proposed that the new section avoids double taxation and ensures that the correct amount of VAT is levied in terms of legislation.

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