In the current tough economic times heightened by the COVID-19 pandemic, companies are considering alternative funding arrangements for their businesses and activities. These arrangements minimise their cash flow obligations to third parties in the short term, while also ensuring that they comply with the relevant tax legislation and utilise it to their advantage. One option that is common practice is the creation of a loan account by a debtor in favour of a creditor.
Often shareholders have a loan account with the company and loan accounts are especially prevalent between group companies. However, not much judicial thought has previously been given to the tax effect of crediting such company loan accounts.
The South African Revenue Service (“SARS”) constantly re-evaluates the tax consequences of various financial arrangements companies enter into and this is one of those situations. Careful consideration should be given as these types of loan transactions as they have tax implications for both the lender and the borrower.
Case Law
In the Tax Court case of Claremont Library Development Company (Pty) Ltd v Commissioner for the South African Revenue Service[1], the Court had to consider the question of whether crediting a loan account constitutes “payment” of full consideration for purposes of Section 22(3) of the Value-Added Tax Act No 89 of 1991 (the “VAT Act”).
Section 22(3) of the VAT Act provides that where a vendor has claimed an input tax deduction in respect of the acquisition of a taxable supply but has not made payment of the full consideration in respect of such supply within 12 months, that vendor shall be liable to account for deemed output tax equal to the tax fraction of the outstanding amount not paid.
This Section is aimed at preventing deliberate manipulation to create a tax benefit and does not aim to influence bona fide transactions between companies within a group in circumstances in which there is no loss to the fiscus.
Let’s illustrate this with the facts of the case:
The taxpayer, CLDC, concluded an agreement with its the sole shareholder and holding company, Corevest, in terms of which Corevest would develop residential and commercial property on land owned by the taxpayer. Corevest funded the taxpayer’s cash-flow requirements on loan account via inter-company shareholder loans to avoid external finance having to be obtained.
Corevest issued a tax invoice to CLDC in respect of part of the development of the residential component of the development and the taxpayer claimed an input tax deduction in respect of the VAT. CLDC paid the input VAT it received from SARS to Corevest, which in turn paid this amount to SARS. The remaining liability due to Corevest in terms of the invoice was credited to Corevest’s loan account in the taxpayer’s books in accordance with the funding arrangement between the parties. After SARS conducted an audit, four years after the invoice was raised, it alleged that the requirements of Section 22(3) of the VAT Act had not been met.
CLDC appealed against the SARS assessment, as SARS had claimed that the recording of the amount in the loan account of Corevest did not constitute “payment” of the consideration in that it remained a debt on the books.
CLDC relied on the decision of the Supreme Court of Appeal in the case of Commissioner SARS v Scribante Construction (Pty) Ltd[2], in which a dividend declared as interest, which was credited to shareholders’ loan accounts with the company, was found to constitute a payment by the company to the shareholders and as an actual deposit. It also relied on the historic case of Commissioner for Inland Revenue v Guiseppe Brollo Properties (Pty) Ltd[3] in terms of which the enquiry turns on the overriding purpose of the loan account liability incurred.
The Tax Court held that, on the facts before it, there was no deliberate manipulation in creating a bad debt with a view to creating a tax benefit either by the taxpayer or Corevest – the purpose of the loan liability incurred by CLDC was to discharge the debt owed to Corevest. In light of this, the Court found that the crediting of Corevest’s loan account by the taxpayer in the context of the funding arrangement between the two parties amounted to payment of “consideration” in relation to the supply of goods and services invoiced as there was no reason as to why an obligation under an invoice may not be discharged through the creation of another liability such as a loan account. CLDC was accordingly not required to account for deemed output tax in terms of Section 22(3) of the VAT Act.
The Court further held that if a receipt or accrual arises from a detailed commercial transaction, the transaction in its entirety must be considered from a commercial perspective as opposed to breaking it into component parts or subjecting it to narrow legal scrutiny.
It appears that the Court’s decision was also strongly influenced by the fact that no loss was incurred by the fiscus.
Conclusion
Irrespective that this judgement deals with a transaction between group companies that is now specifically provided for by Section 22(3A) of the VAT Act, it remains that the principles may be applied to transactions between non-group companies or other parties that enter into these types of transactions, or make payments of consideration, on loan account.
Parties to this type of transaction should ensure that there is a professionally drafted written agreement in place that clearly states that the obligation under the specific invoice will be discharged through the creation of a loan account or that it will be set off against a loan account. It is also advisable to obtain the advice of a tax consultant or professional when entering into such arrangement.
[1] (VAT1247) [2016] ZATC 6 (5 September 2016)
[2] (026/2001) [2002] ZASCA 161 (14 May 2002)
[3] (392/92) [1993] ZASCA 197; 1994 (2) SA 147 (AD); (1 December 1993)