Value added tax (“VAT”) is a primary form of taxation that is charged at a standard rate by the South African Revenue Service (currently 15% at the time of writing) on the supply of most goods and services.
Business enterprises are aware that VAT is raised on certain goods and services. However, many business enterprise owners do not realise that VAT is raised on transactions where businesses are sold to third parties.
In Income Tax Case No 1622 59 SATC 334 1996 the court held that in respect of sale of business agreements, the intentions of the parties are of paramount importance in the establishment of whether VAT is to be raised on the transaction at the rate of 15%, or at a rate of 0%. The Court found that this intention of each party is to be found in the written agreement entered into between them in respect of such sale.
The Construction of the Sale Agreement
The construction of the sale agreement is crucial so far as the establishment of VAT consequences is concerned.
Where the written agreement meets certain requirements, the parties to the transaction shall receive certain taxation benefits, namely, in those cases where the intention of the parties establishes that the business is sold as a going concern.
Then, instead of VAT being payable on the sales transaction at the rate of 15%, the parties obtain the benefit of the transaction being subject to a VAT rate of 0%.
This form of transaction is known as a zero-rated transaction, and such transactions are regulated in terms of section 11(e) and 18A of the Value Added Tax Act 89 of 1991 (the “VAT Act”).
When Do Sales Quality for Zero-Rating?
Essentially, in order for a sale of business as a going concern to qualify for zero-rating, the following requirements must be met:
- a written agreement must be entered into between the parties which states that, and in such statement demonstrates the aligned intention of the parties, the business is being sold as a going concern;
- the written agreement must provide that the business is intended to be, and is in fact an income-earning activity, when it is transferred from the seller to the purchaser;
- the assets, which are essential for the business’s operations, must be transferred by the seller to the purchaser in terms of the agreement of sale;
- the VAT rate of 0% on the sale of business transaction should be agreed to in writing between the parties; and
- both the seller and the purchaser must be registered for VAT as VAT vendors.
Some examples of transactions that might qualify for zero-rating include the sale of a farming operation together with the equipment necessary for running the farm, or the sale of a non-residential leasing business together with the fixed property used for the operation of such business.
The requirements to qualify for this benefit can, however, be complex. Each transaction must be considered carefully and the unique factual scenario must be carefully identified and incorporated in the written agreement.
It is recommended that before entering into a transaction of this nature, the parties should consult with an experienced commercial attorney or a registered tax practitioner.