Louis Marais and Partners Chartered Accountants (S.A.)

Since the increase of the compulsory value-added tax (VAT) registration threshold from R300 000 to R1 million with effect from 1 March 2009, a number of vendors are considering deregistering from VAT. If the total value of taxable supplies made by the vendor during the preceding 12 months did not exceed R1 million and there are no reasonable grounds for believing that a vendor’s taxable supplies during the next 12 months will exceed R1 million, the vendor is not obliged to be registered for VAT and may voluntarily deregister.

However, a vendor should be well advised of the VAT and income tax consequences that arise from a VAT deregistration. The adverse consequences could be substantial and could well convince the vendor not to deregister for VAT.

VAT consequences

When a person deregisters from being a VAT vendor, the person could be liable for what is colloquially referred to as exit VAT. The rationale behind the exit VAT is that the vendor was most likely entitled to an input tax credit when these goods and services were acquired. The relevant sections of the Value-Added Tax Act 89 of 1991(the Act) that provide for the exit VAT are ss 8(2) and 10(5).

Section 8(2) deems a person who ceases to be a vendor to have made a supply of any goods or rights capable of cession, assignment or surrender, which forms part of the person’s enterprise. This supply is deemed to take place immediately before the person ceased to be a vendor. Section 10(5) of the Act provides that this supply is deemed to be made for consideration in money equal to the lesser of the cost to the vendor of acquisition, manufacture, assembly or construction of the goods and the open market value of the supply.
Certain goods that a vendor might have on hand at the time of deregistration need to be considered:

Goods in respect of which an input tax credit was denied

Goods in respect of which an input tax credit was denied on acquisition in terms of s 17(2) of the Act (or in respect of which an input tax credit would have been denied had the VAT Act been effective at the date of acquisition) are not deemed to be supplied by the vendor on deregistration (s 8(2) of the Act). These goods are generally motor cars and goods acquired by the vendor for entertainment purposes.

Goods acquired before the commencement date of the Act

The goods that the vendor acquired before the commencement date of the Act are nevertheless subject to the exit VAT on deregistration. This is the case irrespective of whether the vendor became entitled to an input tax credit in respect of these goods (the vendor would have been entitled to an input tax credit in respect of these goods only if they were used prior to the commencement date for purposes of making non-taxable supplies and subsequent to the commencement date the vendor applied the goods for purposes of making taxable supplies – see ss 18(4)(a) and 18(5) of the Act).

Goods acquired in respect of which a partial input tax credit was claimed

If a vendor acquired goods that were applied partially in the making of taxable supplies, the vendor would have been entitled to a partial input tax credit on acquisition of these goods (ss 16(3) and 17(1) of the Act). When these goods are deemed to be supplied by the vendor on deregistration, the vendor becomes entitled to an input tax credit to the extent that the goods were applied in the making of non-taxable supplies (s 16(3)(h) of the Act).
This input tax credit is based on the lesser of the adjusted cost (including VAT) of the goods and the open market value of the goods at the time of deregistration. If these goods consist of fixed property, the sum of this input tax credit and all previous input tax credits allowed in respect of the fixed property may not exceed the transfer duty that was payable on acquisition of the fixed property (s 16(3)(h)(i) of the Act).

Outstanding debtors on the date of deregistration

Outstanding debtors on the date of deregistration would qualify as a ‘right capable of assignment, cession or surrender’ and as such are also deemed to be supplied in terms of s 8(2). The supply of debtors, however, qualifies as a supply of a financial service (s 2(1)(c) of the Act), which is an exempt supply (s12(a) of the Act).

The outstanding debtors on the date of deregistration would therefore not attract exit VAT. If the vendor is registered on the cash basis, the supply of its debtors would not qualify as a financial service (s 2(4)(a) of the Act). In such a case, the outstanding debtors on the date of deregistration would attract exit VAT.

Outstanding creditors on the date of deregistration

If a vendor that is registered on the invoice basis has claimed an input tax credit in respect of the acquisition of goods on credit and deregisters within 12 months after the tax period within which the input tax credit was claimed and the vendor has not paid the full consideration to the supplier at the time of deregistration, the vendor has to account for the output VAT in relation to the unpaid portion (s 22(3)).

The result of this could be that the vendor has to account for double output VAT on the same amount. This will be the case if the goods that the vendor acquired on credit are still on hand at the time of deregistration and the consideration in respect of the acquisition of the goods has not been paid at that time. On deregistration the vendor has to account for exit VAT on the goods (in terms of s 8(2) of the Act) and the vendor has to account for output VAT on the unpaid portion of the consideration (s 22(3) of the Act).

Diesel or biodiesel

One of the requirements that must be complied with before a person can register as a participant in the Diesel Refund Scheme, is that the person must be registered for VAT purposes. When such person deregisters for VAT, he also has to deregister from the Diesel Refund Scheme.

As such, the vendor must account for any stock of unused diesel held at the date of deregistration. If a diesel refund in regard to that stock has previously been claimed (or offset against any output tax liability), the amount must be repaid to South African Revenue Service (SARS) during the deregistration process.

Income tax consequences

If a taxpayer is a VAT vendor, the cost of all assets acquired or the amount of any expenditure incurred is exclusive of VAT for income tax purposes if the vendor was entitled to an input tax credit in respect of such cost or amount (s 23C(1) of the Income Tax Act 58 of 1962). Any capital allowance in respect of the asset or deduction in respect of the expenditure incurred would therefore be based on the amount exclusive of VAT.

There is no provision in the Income Tax Act that provides that the taxpayer must increase the cost of an asset acquired with the amount of the exit VAT where the person deregisters from VAT subsequent to the acquisition of the asset. I, however, submit that the amount of exit VAT may qualify for a deduction from the taxpayer’s income in the year of assessment in which it is incurred in terms of s 11(a) of the Income Tax Act. This section provides that expenses or losses actually incurred in the production of income and that are not of a capital nature, may be deducted from the taxpayer’s income.

The ‘in the production of income’ and ‘not of a capital nature’ requirements of s 11(a) need to be considered. With regard to the ‘in the production of income’ requirement, it has been held that

‘… all expenses attached to the performance of a business operation bona fide performed for the purpose of earning income are deductible whether such expenses are necessary for its performance or attached to it by chance or are bona fide incurred for the more efficient performance of such operation provided they are so closely connected with it that they may be regarded as part of the cost of performing it’ (Port Elizabeth Electric Tramway Co Ltd v Commissioner for Inland Revenue, 1936 CPD 241 at 246).

I submit that one should at least be able to argue that the exit VAT incurred by a taxpayer is attached by chance to the performance of its business operation. The ‘risk’ of incurring an exit VAT expense should be reasonably incidental to any vendor’s trade (see Commissioner of Taxes v Rendle 1965 (1) SA 59 (SRA)).

With regard to the ‘not of a capital nature’ requirement of s 11(a), I submit that the exit VAT incurred neither creates nor preserves a capital asset in the taxpayer’s hands. Such expense forms part of the cost of performing the taxpayer’s income-earning operations as opposed to the cost of establishing or improving or adding to the taxpayer’s income-earning plant or machinery (see New State Areas Ltd v Commissioner for Inland Revenue 1946 AD 610 at 620; BP Southern Africa (Pty) Ltd v CSARS 69 SATC 79 (SCA)). The exit VAT should therefore not be of a capital nature.

Section 22(3)(a) of the Income Tax Act may provide for an adjustment of the cost of trading stock. This section provides that any ‘further costs incurred’
‘in getting such trading stock into its then existing condition and location’ are added to the acquisition cost of such trading stock. This section provides that these ‘further costs’ are ‘such costs as in terms of any generally accepted accounting practice approved by the Commissioner should be included in the valuation of such trading stock’.

I submit that the person will in terms of IAS 2 increase the cost price of trading stock with the amount of the exit VAT on the trading stock for accounting purposes. I therefore submit that the exit VAT in the case of trading stock should be added to the cost price of trading stock. The person would then effectively claim only the amount of exit VAT as an income tax deduction in the year of assessment when the trading stock is disposed of.
Recent legislative amendments regarding VAT deregistrations
Section 8(2C) was inserted in the Act with effect from 1 March 2009. This section provides that where a person deregisters from VAT for the sole reason that the person has registered as a micro business, the amount of exit VAT must be paid in six equal monthly instalments (or in so many monthly instalments as the commissioner may allow).

Section 10(5A) was also inserted into the Act with effect from 1 March 2009 and provides that where a person deregisters from VAT because of a micro-business registration, the deemed consideration for the person’s deemed supply in terms of s 8(2) is reduced by R100 000.

Section 8(2D), which was inserted into the Act with effect from 1 March 2009, provides that where a vendor deregisters from VAT because the total value of taxable supplies made by the vendor during the preceding 12 months did not exceed R1 million, the exit VAT must be paid in six equal monthly instalments (or in so many monthly instalments as the commissioner may allow). However, for this concession to apply, the vendor had to deregister from VAT before 30 June 2009.

Procedure to be followed to deregister from VAT

The procedure that must be followed in order to deregister from VAT is to submit a completed VAT123 form at the SARS branch office where the vendor is registered. A vendor will be deregistered only if all outstanding liabilities or obligations incurred under the VAT Act have been settled or resolved.
Once SARS receives the VAT123 form, the process of VAT cancellation will commence and the vendor’s VAT registration status will be suspended from an effective date. However, the vendor must still charge, collect and account for VAT until informed by SARS of the vendor’s VAT deregistration status.

Conclusion

Although it can be argued that the exit VAT payable on deregistering from VAT may be deducted from a person’s income for income tax purposes, the cost of such deregistration may be substantial and a vendor should be advised accordingly.