Substance and form, the importance of contract terms and labels in the context of VAT law
Two recent decisions by South African courts addressed “substance over form” issues in the context of VAT controversies, ruling in both cases in favour of the tax authorities because of specific language found in the contractual agreements between the parties.
It has long been accepted in many jurisdictions, including South Africa, that a court generally should have regard to the substance of an agreement rather than its form when there is a variance between the two. This is typically applied in the case of sham transactions, where an attempt has been made to deliberately conceal the true nature of an agreement. However, the concept of substance and form may also arise in the converse situation: when the parties to an agreement in good faith attach the wrong label to their agreement, or to something in the agreement. In that context, advisors, tax authorities and courts should not hesitate to examine the true substance of the contract and ascertain the fiscal consequence that flow from that reality.
The tax consequences of labels can be demonstrated in the context of vouchers, since South African VAT law (as that of many VAT and GST jurisdictions) distinguishes between a single-purpose voucher and a multipurpose voucher. In South Africa, for VAT purposes, vouchers fall primarily into two broad categories:
- A voucher with a stated monetary value that entitles the holder to acquire goods or services: The supply of the voucher is disregarded because it is considered a medium of exchange similar to money. VAT consequences arise only when the voucher is redeemed. This is a multipurpose voucher because it can be used to acquire one or more goods or services.
- A voucher that may be exchanged for specific goods and services: The mere issue of the voucher is a taxable supply recognised when the voucher is issued, and VAT must be accounted for at that time. The subsequent surrender of the voucher for the specific goods or services is then disregarded. This is a single-purpose voucher.
The South African High Court case of Mobile Telephone Networks (Pty) Ltd v Commissioner for the South African Revenue Services highlighted the importance of labels and substance and form concepts. The taxpayer in the case provides pre-paid vouchers in ZAR denominations that provide the voucher holder to access various services and products of the taxpayer up to the value of the voucher. The taxpayer contended that
this was an “electronic wallet” that enabled customers to purchase a range of different products, such as data, music, applications or even donations to charity, and that it fell within the first category of voucher discussed above. This, the argument went, made it a multipurpose voucher akin to currency. The tax authorities, on the other hand, maintained that the voucher supplied was specifically an “airtime” voucher, and that this was the good or service supplied (that is, a single purpose) and it therefore fell within the second category of voucher discussed above.
In the context of the historical development of mobile devices, the mobile credit that consumers recharge their phones with was labelled “airtime,” because it granted the user airtime--an allocated time to make phone calls. However, this usage has evolved to allow mobile users to use this as an electronic wallet or digital currency, despite still being referred to as “airtime.”
This labelling convention appeared to be significant for the outcome of this decision, because the court held that when a consumer purchases a voucher, what it receives is “airtime,” and concluded, rightly or wrongly, that this was a single-purpose voucher for airtime. The mere issue of the airtime voucher was thus a taxable supply recognisable at the time it was issued.
Would the outcome have been different if a different label had been used, or if the court had examined the substance of what precisely an airtime voucher was in the context of modern mobile technology? However one chooses to speculate on the significance of this, it is clear that to avoid any difficulties or issues in the context of tax legislation, taxpayers and advisors should apply precise and accurate labels to all contracts and commercial instruments.
Another example in which the wording of an agreement proved significant was the South African Tax Court decision in ABC (Pty) Ltd v Commissioner for the South African Revenue Service, in which a travel agency arranged international transport on behalf of various airlines. The travel agency (the taxpayer) was paid a commission, and if it reached a certain threshold, the agency was paid an additional or supplementary commission. The taxpayer contended that this was a zero-rated supply for VAT purposes because the commissions (both ordinary and supplementary) were paid in respect of or in response to the arranging of international transport, and on that basis the entire supply was subject to VAT at the zero rate.
Conversely, the South African tax authorities took the position that the supplementary commission was not in respect of arranging international transport but rather in respect of marketing and promotional services supplied separately or in addition thereto, and argued that the contractual arrangement made this clear. The wording in the contract proved significant because it included multiple statements that the travel agency would perform marketing and promotional services. The court went as far as to say that “the language used in the three bilateral agreements is plain, clear and unambiguous.”
Again, would the outcome of this decision have been different had the parties expressly stated that the payment was made in exchange for arranging international transport? Speculation may yield varying responses; however, establishing a clear causal connection between the service of arranging international transport and the payment would have helped the taxpayer’s case under these circumstances.
These decisions provide valuable lessons for taxpayers and tax planners. Courts, tax authorities and taxpayers should examine commercial arrangements to determine the substance of an agreement, but the parties also should ensure that the form of the agreement does not vary from its substance. In other words, they should ensure that the commercial sense, as well as the real substance and purpose of a contemplated transaction, are congruent with the form. It may also be prudent for those entering into transactions to state, expressly and explicitly, their purpose in precise terms in the preamble to the agreement and throughout its various clauses.