This case underscores the dangers of assuming VAT deductibility without expert guidance – an expensive lesson that cost the taxpayer not only millions in disallowed claims but also legal fees. With SARS boasting an 86% litigation win rate reported in its Tax Statistics for the 2023/24 year of assessment, businesses must tread carefully or risk costly defeats in court.
The dispute is in the details
In this dispute, the taxpayer had claimed R17,495,071.81 worth of input VAT deductions between June 2012 and August 2016 under the Value Added Tax Act, No. 89 of 1991 (the Act). These input VAT deductions related to ‘entertainment expenses’ comprised of accommodation and food expenses incurred for certain employees deployed to specific fixed-term mine construction projects.
While it was common cause that ‘entertainment expenses’ broadly include the provision of food, beverages, and accommodation, section 17(2)(a) of the Act excludes input VAT deductions for ‘entertainment expenses’, except under certain limited exceptions.
The SCA had to consider whether –
- the taxpayer’s expenditure on accommodation and food fell within the exception under section 17(2)(a)(i)(bb) of the Act – which permits deductions only where entertainment is supplied to employees for a charge that covers all direct and indirect costs;
- the ‘entertainment expenses’ were involved as part of the ordinary course of the taxpayer’s business of producing taxable supplies of entertainment, as required under section 17(2)(a)(i); and
- the ‘entertainment expenses’ were incurred for employees who were “away from their usual place of work”, a condition that might have made them deductible under section 17(2)(a)(ii).
The taxpayer’s arguments
The taxpayer argued that the input VAT charged on the accommodation and food expenditure should be deductible as –
- the expenses were factored into tender pricing for the mining projects, and therefore indirectly recovered from the taxpayer’s clients;
- section 17(2)(a)(i)(bb) allowed for deductions when ‘entertainment expenses’ were charged to employees or where all direct and indirect costs were covered; and
- businesses should not bear VAT input costs where they make taxable supplies, as VAT operates under the so-called neutrality principle.
SARS’ arguments
SARS countered that the taxpayer’s claims were flawed on multiple fronts. Firstly, the expenses for food and accommodation fell squarely within the definition of “entertainment expenses” under the Act, which are expressly excluded from input VAT deductions unless specific exceptions apply.
Secondly, argument was made that the taxpayer was not engaged in the business of making taxable supplies of entertainment, meaning the claimed deductions did not qualify under the relevant provisions.
Thirdly, the taxpayer did not directly charge employees for these costs, nor did it conclusively prove that its tender pricing fully covered all direct and indirect expenses related to food and accommodation.
Lastly, SARS emphasized that the neutrality principle could not override clear statutory prohibitions, reinforcing that the Act’s restrictions on entertainment deductions serve as a legislative safeguard against potential tax abuse.
The court’s ruling
In a sweeping loss, the Supreme Court of Appeal disagreed with the taxpayer’s arguments dismissing its appeal with costs. Siding with SARS, the court found that the taxpayer’s enterprises did not involve the making of taxable supplies of entertainment, meaning the claimed input VAT did not qualify under section 17(2)(a)(i).
Further, the taxpayer had failed to prove that the ‘entertainment expenses’ were directly recouped from employees or that its tender pricing covered all direct and indirect entertainment costs. Finally, the neutrality principle did not apply where the Act expressly prohibited input VAT deductions, such that this prohibition was a clear legislative policy to prevent abuse of input VAT claims.
Legal merits or litigation?
With South African tax laws being incredibly technical and nuanced, the correct interpretation and application by taxpayers is critical to avoid unexpected tax liabilities. Similarly, taxpayer’s are cautioned to avoid overly aggressive tax advice from certain advisors in the market, and which could result in a very expensive lesson for the taxpayer.
Given SARS’ successful litigation strategy, with a high litigation win rate, enlisting the assistance of skilled tax advisors to carefully review and advise on the correct application of tax legislation on a proactive basis – and not just when disputing the matter – is of paramount importance to ensure the correct substantive application of the law and tax compliance in general.
