South Africa: Constitutional Court Judgment For Capitec Bank Confirms Important VAT Principles

In a significant legal development, the Constitutional Court (“CC”) handed down its judgment on 12 April 2024 concerning Capitec Bank Limited's appeal against the Supreme Court of Appeal (“SCA”) ruling in Commissioner for the South African Revenue Service v Capitec Bank Limited.

Facts

Capitec provides unsecured loans to its clients and charges a once-off initiation fee, monthly fee and interest. This provision of credit is exempt from VAT in terms of section 2(1)(f) read with section 12(a) of the VAT Act. The proviso to section 2(1) provides that the provision of credit is a taxable supply to the extent that the consideration payable in respect thereof is, inter alia, any fee, commission, or similar charge.

Capitec also provides free cover to its clients in respect of unsecured loans in the event of retrenchment or death. Capitec claims a deduction in relation to the amounts paid out to clients under the loan cover in terms of section 16(3)(c). Section 16(3)(c) provides a deduction of an amount equal to the tax fraction of any payment made by a vendor to indemnify another person in terms of any contract of insurance. This deduction may only be made where the supply of the contract of insurance is a taxable supply.

CC judgment

Some of the salient aspects that the CC considered are:

• Was the loan cover provided free of charge?

Since the contracts with the borrowers explicitly stated that there was no charge, the court considered that the loan cover was provided free of charge.

• Is a “free-of-charge supply” disqualified from being a “taxable supply”?

The court said that section 10(23) is clear that any supply, whether taxable or non-taxable, may be a supply for no consideration, and it is then assigned a value of nil for any purposes relevant to the VAT Act. This must be recognised because it will affect a vendor's right to deduct input tax i.e. the VAT it had to pay in acquiring the goods which it supplied for nil consideration. In terms of section 17(1), the vendor is only entitled to a deduction as input tax to the extent that such goods were consumed, used or supplied “in the course of making taxable supplies”.

• Was the loan cover supplied exclusively in the course or furtherance of an exempt activity?

Capitec lent money to unsecured borrowers in order to earn exempt interest and taxable fees. The loan cover was a mixed supply made in the course and furtherance of Capitec's exempt activity of lending money for interest and its enterprise activity of lending money for fees. These were not in truth separate activities; there was a single activity of lending money for consideration which consisted of both interest and fees.

• The extent of the deduction permitted by section 16(3)(c) and apportionment

Perhaps, the most striking aspect of the judgment related to the issue of apportionment. Capitec's assertion was that it was entitled to deduct the full amount of the deduction offered by section 16(3)(c). The court considered the facts and said that the fee-earning component of Capitec's enterprise activity was only 5% to 13% of the whole (where the rest being an exempt activity that is, interest-earning). To allow Capitec a full deduction would disturb the scheme of the VAT Act.

In considering whether Capitec was entitled to claim a section 16(3)(c) deduction subject to the provisions of section 17 (this was never considered by the SCA or SARS as Capitec never argued that it applied), the court indicated that apportionment per section 17 would have yielded an acceptable result but in the context of the language of section 17 and the free loan cover, Capitec did not acquire any goods or services which it consumed, used or supplied to the borrowers or on which it paid VAT.

Lastly, it was considered whether Capitec was entitled to claim a section 16(3)(c) deduction, but subject to an apportionment implicit in section 16(3)(c), interpreted in the context of the scheme of the VAT Act as a whole. The court stated that section 16(3)(c) is a special “tailor-made” deduction and not “input tax”. The proviso to section 2(1) results in the supply of the contract of insurance having to be viewed partly as a taxable supply and partly as an exempt supply (in line with the judgment in Commissioner for the South African Revenue Services v Tourvest Financial Services (Pty) Ltd [2021] and the scheme of the Act does suggest apportionment in the circumstances.

Armed with two income tax judgments that considered an apportionment where the Income Tax Act did not expressly provide for an apportionment, the court, effectively, considered a practical solution to an otherwise intractable problem (i.e. disallowance of the whole deduction would produce inequity or anomaly one way or the other) – the practical solution yielding a fair and reasonable result in the circumstances.

Lastly, the court noted that, on the face of it, the appropriate apportionment could be based on the proportion that the taxable fees bore to the total consideration.

Takeaways from the judgment

The judgment is welcome news for vendors as it confirms the principles applicable to (taxable) supplies for no consideration. 

The principle of an apportionment outside the confines of section 17(1), taking account of the scheme of the VAT Act bear further consideration as to the impact on vendors that conduct a partly taxable and partly exempt enterprise and specifically whether this also opens the door for multiple methods of apportionment within a single enterprise. 

This judgement has clarified some important VAT principles while at the same time introducing a broader consideration taking account of the scheme of the VAT Act. The financial impact on vendors (including input tax that has not been claimed in the past) and also whether this judgement will result in an amendment to certain provisions of the VAT Act, will become apparent as these important principles are better understood.

Reviewed by Charles de Wet, Executive Consultant in ENS' Tax practice.

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