VAT: New and Improved Standard Turnover-Based Apportionment Method

01 March 2024
VAT
PWC

SARS published Issue 3 of Binding General Ruling No. 16 (“BGR 16”) at the end of 2023. This version updates the standard turnover-based method of apportionment to make it fair and reasonable by limiting the inclusion of income streams that distorted the method before. We explore the amendments to this new version of the BGR 16 and what it means for you in more detail in this article.

Introduction

SARS’ Issue 3 of binding general ruling (“BGR”) 16, published on 27 November 2023, sets out the updated standard turnover-based method (“STBM”) of apportionment. This method is applicable to vendors that are not in possession of an approved alternative method of apportionment.

Background

Every vendor is entitled to deduct the VAT that it incurs on the acquisition of goods or services as input tax, provided that the acquisition is made for purposes of use, consumption or supply in the course of making taxable supplies. The deduction of input tax is further regulated by section 16(3)1 read with section 16(2), which provides for certain documentary and other requirements to be met before the deduction is made.

The issue of apportionment arises in instances where a vendor acquires goods or services which are partly used for taxable purposes and partly for other purposes. Such expenses are commonly referred to as “mixed expenses”2 and the VAT paid in respect of these expenses must be apportioned.

Section 17(1) provides that a vendor may only deduct the VAT incurred on mixed expenses to the extent that they are used, consumed or supplied for taxable purposes. To achieve this, section 17(1) requires the vendor to make any such deduction of VAT on mixed expenses by applying an apportionment method approved by the Commissioner for SARS in a private or general binding ruling.

In line with this requirement, SARS published BGR 16, which sets out a default method of apportionment to be used by vendors in determining the extent of input tax that may be deducted on mixed expenses as contemplated in section 17(1).

Vendors can use this standard approved method if it is fair and reasonable to the vendor’s business activities. If not, the vendor must request approval of an alternative method.

Discussion

When it was first published, and previously updated, the STBM only allowed for a limited number of exclusions and adjustments to the formula in order to determine the apportionment ratio for deducting input tax on mixed expenses. As a result of this, combined with many instances of vendors being unaware of the need to apply a separate method, the previous versions of the STBM did not yield a fair and reasonable result in many cases.

Section 17(1) contains certain provisos, one of which sets out that SARS can only approve an alternative apportionment method for a vendor with effect from the beginning of the financial year within which such vendor applied to SARS and requested approval for the alternative method.

Not applying within this deadline results in vendors having to apply the STBM to its mixed expenses even though it is not fair and reasonable, taking into account its business activities.

This principle was tested in the Supreme Court of Appeal (“SCA”) case of Mukuru Africa (Pty) Ltd vs CSARS3 (“Mukuru case”). This case dealt with the retrospective effect of an approved alternative method of apportionment and whether the STBM as set out in BGR 16 was a default method applicable in the absence of an approved alternative method of apportionment.

The SCA held in the Mukuru case that an alternative apportionment method cannot be approved by SARS with retrospective effect but only with effect from the year of assessment in which the taxpayer applied for the alternative method.

It further held that the only method that can be used by a vendor in the absence of another approved method is the STBM as set out in BGR 16.

The older versions of the STBM did not provide for an appropriate input tax recovery ratio, as it required the inclusion of income streams that were distortive in nature.

The application of the law in the above manner therefore has a detrimental impact on a vendor’s entitlement to deduct input tax where an application for approval of an alternative method is made late, or not at all. Considering the above events and outcome, SARS has now published a revised version of BGR 16 which allows for various exclusions, adjustments and notes to the method. We discuss these in more detail below.

BGR 16 Issue 3

After publishing it in draft and following a period for the public to comment, SARS published the updated BGR 16 (Issue 3) on 27 November 2023. Issue 3 of the ruling is more comprehensive in its approach to the limitation of income in the formula and is effectively aimed at achieving an apportionment ratio which is fair and reasonable. We discuss the main exclusions and limitations below.

Exclusions and Adjustments

In terms of the new BGR 16, the following amounts of income can be excluded from or limited in the formula:

Foreign exchange differences

The above amounts can be excluded from exempt income in the formula, except to the extent that it involves any hedging activities. SARS considers hedging activities as a form of trading in financial assets which includes the use of certain resources to effect such transactions.

SARS is therefore of the view that these activities must be reflected in the method and, accordingly, foreign exchange differences must be included in the denominator of the STBM where hedging is involved.

Accounting entries

SARS acknowledges that due to International Financial Reporting Standards (“IFRS”), vendors are required to make certain accounting adjustments. As these accounting adjustments do not give rise to actual income, provision is made for these accounting adjustments to be excluded from the STBM.

The sale of capital assets

SARS accepts that receipts from the sale of capital assets can be excluded. This is on the basis that vendors are generally not in the business of selling capital assets on an ongoing basis and the inclusion will be distortive due to their extraordinary nature and value. It is important to ensure that the exclusion relates to a capital asset as envisaged in the BGR 16.

Extraordinary income

Extraordinary income is generally non-recurring income received due to exceptional circumstances. SARS accepts “this income would have a significant impact on the quantum of income received by a vendor without affecting the normal expenses incurred year on year. The inclusion of such income in the apportionment formula would therefore severely distort the apportionment ratio as there would be a material fluctuation from one year to another whilst the mixed expenses, and the use thereof in the vendor’s business, would have remained unchanged”. On this basis, this income is excluded. It is again very important to ensure that any amount excluded on such a basis qualifies as extraordinary income as envisaged in the BGR 16.

Specifically denied input tax

Income in relation to items for which no deduction of input tax is permissible should not be included in the apportionment ratio calculation.

Change in use adjustment

These adjustments are excluded, as it only adjusts the input tax deducted based on actual versus intended use of goods or services.

Indemnity payments

Indemnity payments received by a vendor are excluded from the formula where it relates to extraordinary income. Securities lending transactions Manufactured dividends or interest received by a vendor under a security lending arrangement must be included in the formula, limited to the difference between the prime and JIBAR lending rates applied to the manufactured dividends or interest.

Raising funds through equities or derivatives

This is regarded by SARS as extraordinary income and is excluded from the formula.

Interest

SARS accepts that interest on current or day-to-day bank accounts can be excluded, as this is not for investment purposes but rather to facilitate a vendor’s business transactions. However, interest on call accounts or other similar investment accounts must be included in the formula but limited to the difference between the prime and JIBAR lending rates.

SARS has further permitted the inclusion of net interest (that is, interest received less interest paid) to the extent that the interest is earned in respect of borrow to on-lend activities.

This equally applies to zero-rated interest earned in this manner. The formula makes further adjustments in certain other instances, for example:

where no interest is paid by the vendor in relation to its borrowing activities (e.g., using own funds);
bad debts;
interest-free funding;
financing from own funds; and
connected persons.

Investment interest is generally limited to the interest earned for the year x (prime rate – JIBAR).

Lastly, SARS requires the gross interest to be included in the formula under the following circumstances:

interest levied on debtors' accounts; and
interest levied by a retailer in respect of credit provided to facilitate the sale of its goods.

Trading in financial assets

SARS requires that a three-year moving average of the gross trading margin be included in the formula. Any negative margins must be included as an absolute value. Lastly, SARS provides for a formula to apply in splitting the gross trading margin between exempt and zero-rated amounts.

Dividends

Dividends received are now limited in the formula based on a three-year moving average of dividends received or accrued during the year × (prime rate − JIBAR).

Profit share from joint ventures or partnerships

SARS limits the inclusion of this income in the formula to a three-year moving average of the profit share received or accrued during the year, multiplied by the prime rate less JIBAR.

Debt securitisation

It is now acknowledged that including the full value of a debt sold creates a distortion. The inclusion is now limited by applying the formula of

Proceeds on the sale of debts under a securitisation transaction during the year × (prime rate − JIBAR)

However, where the debts are sold immediately after origination and before earning any interest, the interest equal to the origination fees must be included in the formula as a proxy for the exempt activity.

Notes to the formula

The BGR 16 includes Notes stating:

How the interest rates are to be used, i.e., the prime rate and JIBAR/ZARONIA rates are added;
Where the previous year’s turnover was used to determine the ratio, an adjustment must now be made within nine months from the end of the FY.

Application of the method

The new method envisaged in the BGR 16 will apply to financial years commencing on or after 1 January 2024, subject to certain exceptions. Issue 2’s method is withdrawn.

If a vendor falls under an approved industry method, the STBM in the BGR 16 cannot be used. This will equally apply to a vendor that has an alternative method approved in a VAT ruling or VAT class ruling, unless the vendor applies to SARS to request confirmation that the STBM can be applied. Such request must be in a VAT ruling and submitted before expiry of the 2024 financial year.

Practical Implications & Key Takeaway

Vendors who do not have a specifically approved alternative method or an industry-approved method are required to apply the STBM as set out in BGR 16. In comparison to its predecessor, BGR 16 now provides for a lot more interpretation in the classification and treatment of the receipts to be included in the formula. This is a very different approach from the previous version of the method and usual SARS practice. In addition, the above approach taken in the BGR affirms the self-assessment nature of the tax, and this creates additional risk for vendors.

It is likely that SARS will focus on the application of this method in its VAT audit procedures. It is therefore crucial for vendors to carefully document:

why the STBM is fair and reasonable in their particular circumstances; and
any adjustments made and the reasoning for conclusions reached regarding the inclusion of particular amounts or receipts.

It may also be prudent to obtain advice or some form of assurance to support both the vendor’s application of this method and adjustments made to certain inclusions. The above recommendations are to prevent any uncertainty and to mitigate and protect the business from potential future SARS audit assessments and the levying of understatement penalties and/or interest. The new BGR is welcomed and in our view represents a positive development for both vendors and SARS.

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VAT: New and Improved Standard Turnover-Based Apportionment Method

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