The Constitutional Court in the Capitec Bank case - an Apportionment of Right and Wrong?
The Constitutional Court in the Capitec Bank case - an Apportionment of Right and Wrong?
By Edlan Jacobs, Senior Manager and Elaina Silby, Junior Consultant
On 12 April 2024 the Constitutional Court (Court) delivered its judgment in Capitec Bank Limited v Commissioner for the South African Revenue Service. In summary, Capitec Bank Ltd (Capitec) conducted a transactional banking and unsecured lending business which was its enterprise for VAT purposes, to the extent that it charged fees (a taxable supply). The standard loan agreements concluded with customers contained loan cover, which enabled the borrowers who defaulted in settling their obligation to be settled via the loan cover, up to a specified amount. The payout was dependent on the occurrence of either of two insured events, death or retrenchment. This loan cover was provided free of charge (i.e. for no consideration).
During November 2017, due to the satisfaction of the conditions of the loan cover, Capitec settled borrowers’ outstanding loan obligations to the total amount of R582 383 753. Capitec claimed a deduction of R71 520 811 in terms of section 16(3)(c) of the Value Added Tax Act (VAT Act). Section 16(3)(c) permits a deduction equal to the tax fraction of any payment made by a vendor to indemnify another person under a contract of insurance, provided that the contract of insurance is a “taxable supply”. The amount claimed represented the tax fraction of the amount settled in relation to the 14% VAT rate that applied at the time of the claim.
On 15 February 2018, SARS issued an additional assessment disallowing the deduction and imposing a late payment penalty.
The Tax Court found in favour of Capitec and upheld the appeal, concluding that it was allowed to make the deduction in full.
However, the Supreme Court of Appeal (SCA) found in favour of SARS and held that Capitec was not entitled to make any deduction in terms of section 16(3)(c) of the VAT Act.
Capitec appealed to the Constitutional Court which provided clarity in three primary respects. It confirmed that:
The Constitutional Court held that:
The clarity provided by the Court is welcomed, and the judgment is impeccable in many respects. However, with respect, the approach to apportionment taken by the Court is questionable.
The Court correctly concluded that the deduction afforded by section 16(3)(c) is not subject to the apportionment provisions of section 17(1) because it is not “input tax”, but a deduction in a class of its own (sui generis).
Despite this finding, the Court found that apportionment should apply. The Court reasoned that a deduction in full was ‘instinctively unattractive’, which was made more so by the fact that the taxable fee-earning component of Capitec’s enterprise was 5% - 13% and the rest an exempt activity (interest earning). The Court’s solution was to apportion the deduction.
It appears that the Court did not have proper regard to the purpose of section 16(3)(c), and specifically, why this unique deduction exists. The purpose is set out in the VATCOM Report, which states that a portion of the premium paid is for a service (managing the funds), and the rest is a capital contribution to pay future insurance claims. To avoid the difficulty of identifying which portion of the premium relates to managing funds and the capital contribution, the principle is that the full premium is subject to VAT, but the insurer is allowed an input credit for claims paid. The value added by a short-term insurer is represented by its gross margin (broadly-speaking, the difference between premiums collected and claims paid).
This means that where insurance is supplied for no consideration the gross margin would be negative, and any claims arising would result in a VAT refund, provided the contract of insurance is a taxable supply.
The loan cover offered by Capitec was accepted by the court to be a contract of insurance. The deduction rests on the contract of insurance being a taxable supply. This only requires that it is made in the course or furtherance of the “enterprise” and not the extent to which it furthers the enterprise. Short term insurance is wholly a taxable supply if made in the course or furtherance of an enterprise and cannot be a partially taxable supply. If Capitec had charged a premium for the insurance, it would have had to levy VAT on the entire amount, not part of it. The contract of insurance is fully taxable, unless it is a supply covered by an exemption (i.e. an exempt supply). The Court’s reasoning means that any premium charged by Capitec should be a taxable supply only to an extent (only taxable to 5%-13%), and VAT should only be charged on this portion of the premium, since the supply is in the furtherance of the exact same enterprise, only the value has changed.
Taking into account the apparent purpose of section 16(3)(c), the contract of insurance should be entirely taxable but assigned a value of zero (nil), and the deduction in respect of claims paid out should be deductible in full. Once it had been established that the insurance was in the furtherance of an enterprise and not itself an exempt supply, the deduction should have been allowed in full. If it is acknowledged that Capitec settled R582 383 753 in loans owed to it, the instinct to find this outcome unattractive is reduced (the fact that Capitec had insurance of its own does not change this).
A statute must apply to all subjects equally and its interpretation cannot vary from one factual matrix to the next. Section 16(3)(c) cannot mean one thing in the context where the consideration is nil, but then mean another where consideration is more.
The income tax cases cited by the court were interpreting provisions that required one to determine the purpose for which the expenditure had been incurred. However, the VAT deduction for payments under a contract of insurance only requires that the contract of insurance be a taxable supply.
The court stated that the contract of insurance was a mixed supply made in the course or furtherance simultaneously of an exempt activity and an “enterprise” activity, requiring one to view the supply of the contract of insurance as partly taxable and partly exempt, which is contemplated by the proviso to section 2(1).
The difficulty with this finding is that section 2(1) of the VAT Act only exempts a life insurance policy as defined, which was not the cover Capitec provided. A distinction must be established between the supply of the loan agreement and loan cover. The provision of credit, although an exempt supply, was a supply made in terms of the loan agreement, it was not the supply made under the contract of insurance. The Court’s conclusion may be premised on the fact that the insurance and the exempt supply of credit all formed part of a single contract without proper regard to each being a separate supply.
The Court concluding that the deduction requires apportionment without applying section 17(1), means that any apportionment on this basis could never benefit from the de minimis rule found in section 17 which provides that if the intended taxable use is at least 95%, it is regarded as being acquired wholly for taxable purposes (100%).
In conclusion, the case highlights the following key issues:
We understand that whenever a customer takes up a loan with Capitec, the customer is also required to open a transactional account - the free loan cover is therefore also in the furtherance of Capitec’s transactional banking business, which earns further fees (a taxable supply), potentially significantly increasing the proportion of its taxable supplies to total supplies.
An altered assessment which arises from referral back to SARS for examination is subject to objection and appeal. It will be interesting to see the method of apportionment and whether Capitec will object or appeal against the altered assessments issued by SARS.
On 12 April 2024 the Constitutional Court (Court) delivered its judgment in Capitec Bank Limited v Commissioner for the South African Revenue Service. In summary, Capitec Bank Ltd (Capitec) conducted a transactional banking and unsecured lending business which was its enterprise for VAT purposes, to the extent that it charged fees (a taxable supply). The standard loan agreements concluded with customers contained loan cover, which enabled the borrowers who defaulted in settling their obligation to be settled via the loan cover, up to a specified amount. The payout was dependent on the occurrence of either of two insured events, death or retrenchment. This loan cover was provided free of charge (i.e. for no consideration).
During November 2017, due to the satisfaction of the conditions of the loan cover, Capitec settled borrowers’ outstanding loan obligations to the total amount of R582 383 753. Capitec claimed a deduction of R71 520 811 in terms of section 16(3)(c) of the Value Added Tax Act (VAT Act). Section 16(3)(c) permits a deduction equal to the tax fraction of any payment made by a vendor to indemnify another person under a contract of insurance, provided that the contract of insurance is a “taxable supply”. The amount claimed represented the tax fraction of the amount settled in relation to the 14% VAT rate that applied at the time of the claim.
On 15 February 2018, SARS issued an additional assessment disallowing the deduction and imposing a late payment penalty.
The Tax Court found in favour of Capitec and upheld the appeal, concluding that it was allowed to make the deduction in full.
However, the Supreme Court of Appeal (SCA) found in favour of SARS and held that Capitec was not entitled to make any deduction in terms of section 16(3)(c) of the VAT Act.
Capitec appealed to the Constitutional Court which provided clarity in three primary respects. It confirmed that:
- The VAT Act contemplates supplies made for zero consideration;
- A supply made for zero consideration may constitute a “taxable supply”, as defined; and
- A supply does not lose its character once the amount relating to the supply has been capitalised (i.e. debited to the recipient’s account).
The Constitutional Court held that:
- The interest and fees were expected to cover the premium and leave a satisfactory return on Capitec’s capital. Therefore, in economic terms, the supply of the cover was not free. However, Capitec’s contracts with its customers explicitly stated that the cover was granted for no charge, and the case was approached on that basis;
- The definition of “enterprise” does not require all supplies to be made for a consideration;
- A supply, taxable or otherwise, may be made for no consideration and assigned a value of nil for any purpose relevant to the VAT Act;
- Capitec’s supply of the loan cover was not disqualified from being a “taxable supply” merely because it was supplied free of charge, and the SCA erred by disqualifying it;
- The Tesco Freetime case of the United Kingdom Upper Tribunal reflected the economic reality when supplies were made free of charge to promote the vendor’s business. Any expenses incurred by the vendor to further its enterprise, whether it charges a consideration or offers a good or service for free, will be factored into the vendor’s charge to its customers. VAT is accounted for on the totality of the payments received from customers as consideration for all the goods and services supplied to its customers;
- The loan cover was a mixed supply made in the course or furtherance of Capitec’s exempt activity of lending money at interest as well as its enterprise activity of charging fees to clients. Stated differently, the loan cover was a mixed supply that could be linked to Capitec’s enterprise of lending money and earning both interest from exempt supplies and fees from taxable supplies ;
- The unpaid fees debited by Capitec to borrowers’ accounts do not lose their character when capitalised, any more than the interest, when debited, loses its character as interest;
- Section 2(1) lists financial services which are all exempt supplies , and the proviso to section 2(1) ensures that any fee or commission charged is taxable. The section requires one to view the supply of the contract of insurance as partly taxable and partly exempt. The scheme of the VAT Act, in the present circumstances, itself suggests an apportionment; and
- In the income tax cases of Rand Selections and Nemojim , in dealing with the question whether expenditure had been incurred in the production of income, both courts found a practical solution in finding that the deduction was subject to apportionment, despite the legislation containing no apportionment provision. A similar approach is mandated in the context of section 16(3)(c) where the insurance contract is supplied only partly as a taxable supply.
The clarity provided by the Court is welcomed, and the judgment is impeccable in many respects. However, with respect, the approach to apportionment taken by the Court is questionable.
The Court correctly concluded that the deduction afforded by section 16(3)(c) is not subject to the apportionment provisions of section 17(1) because it is not “input tax”, but a deduction in a class of its own (sui generis).
Despite this finding, the Court found that apportionment should apply. The Court reasoned that a deduction in full was ‘instinctively unattractive’, which was made more so by the fact that the taxable fee-earning component of Capitec’s enterprise was 5% - 13% and the rest an exempt activity (interest earning). The Court’s solution was to apportion the deduction.
It appears that the Court did not have proper regard to the purpose of section 16(3)(c), and specifically, why this unique deduction exists. The purpose is set out in the VATCOM Report, which states that a portion of the premium paid is for a service (managing the funds), and the rest is a capital contribution to pay future insurance claims. To avoid the difficulty of identifying which portion of the premium relates to managing funds and the capital contribution, the principle is that the full premium is subject to VAT, but the insurer is allowed an input credit for claims paid. The value added by a short-term insurer is represented by its gross margin (broadly-speaking, the difference between premiums collected and claims paid).
This means that where insurance is supplied for no consideration the gross margin would be negative, and any claims arising would result in a VAT refund, provided the contract of insurance is a taxable supply.
The loan cover offered by Capitec was accepted by the court to be a contract of insurance. The deduction rests on the contract of insurance being a taxable supply. This only requires that it is made in the course or furtherance of the “enterprise” and not the extent to which it furthers the enterprise. Short term insurance is wholly a taxable supply if made in the course or furtherance of an enterprise and cannot be a partially taxable supply. If Capitec had charged a premium for the insurance, it would have had to levy VAT on the entire amount, not part of it. The contract of insurance is fully taxable, unless it is a supply covered by an exemption (i.e. an exempt supply). The Court’s reasoning means that any premium charged by Capitec should be a taxable supply only to an extent (only taxable to 5%-13%), and VAT should only be charged on this portion of the premium, since the supply is in the furtherance of the exact same enterprise, only the value has changed.
Taking into account the apparent purpose of section 16(3)(c), the contract of insurance should be entirely taxable but assigned a value of zero (nil), and the deduction in respect of claims paid out should be deductible in full. Once it had been established that the insurance was in the furtherance of an enterprise and not itself an exempt supply, the deduction should have been allowed in full. If it is acknowledged that Capitec settled R582 383 753 in loans owed to it, the instinct to find this outcome unattractive is reduced (the fact that Capitec had insurance of its own does not change this).
A statute must apply to all subjects equally and its interpretation cannot vary from one factual matrix to the next. Section 16(3)(c) cannot mean one thing in the context where the consideration is nil, but then mean another where consideration is more.
The income tax cases cited by the court were interpreting provisions that required one to determine the purpose for which the expenditure had been incurred. However, the VAT deduction for payments under a contract of insurance only requires that the contract of insurance be a taxable supply.
The court stated that the contract of insurance was a mixed supply made in the course or furtherance simultaneously of an exempt activity and an “enterprise” activity, requiring one to view the supply of the contract of insurance as partly taxable and partly exempt, which is contemplated by the proviso to section 2(1).
The difficulty with this finding is that section 2(1) of the VAT Act only exempts a life insurance policy as defined, which was not the cover Capitec provided. A distinction must be established between the supply of the loan agreement and loan cover. The provision of credit, although an exempt supply, was a supply made in terms of the loan agreement, it was not the supply made under the contract of insurance. The Court’s conclusion may be premised on the fact that the insurance and the exempt supply of credit all formed part of a single contract without proper regard to each being a separate supply.
The Court concluding that the deduction requires apportionment without applying section 17(1), means that any apportionment on this basis could never benefit from the de minimis rule found in section 17 which provides that if the intended taxable use is at least 95%, it is regarded as being acquired wholly for taxable purposes (100%).
In conclusion, the case highlights the following key issues:
- Whether or not the contract of insurance was a taxable supply made for no consideration; and
- That the input tax deduction should be subject to apportionment.
- Whether the loan cover was short or long-term insurance - it was merely accepted that it was short-term insurance;
- Whether settling amounts owed to oneself constitutes payments made to indemnify ; and
- What constitutes a contract of insurance and the essentialia of such a contract. The loan cover was an accepted to be a contract of insurance, and no argument was advanced against this.
We understand that whenever a customer takes up a loan with Capitec, the customer is also required to open a transactional account - the free loan cover is therefore also in the furtherance of Capitec’s transactional banking business, which earns further fees (a taxable supply), potentially significantly increasing the proportion of its taxable supplies to total supplies.
An altered assessment which arises from referral back to SARS for examination is subject to objection and appeal. It will be interesting to see the method of apportionment and whether Capitec will object or appeal against the altered assessments issued by SARS.