It is common for contracting parties to enter into a settlement agreement to settle a contractual dispute. this is often the preferred route where parties want to settle a dispute expeditiously and eschew the financial and time implications of taking a matter to court. Typically, a settlement agreement would involve one party (Party A) paying another party (Party B) in full and final settlement of the dispute. A feature of settlement agreements (to ensure that the dispute is "over"), includes a clause that states that Party B, in return for the payment made by Party A, would release Party A from any and all claims Party B has against Party A.
Where both parties are VAT registered, the VAT consequences of the settlement agreement must be evaluated prior to the parties ratifying such agreement. This begs the question as to whether the payment made by Party A to Party B in order to settle the dispute, comprises "consideration" for a supply made by Party
It follows that the enquiry to determine whether VAT must be levied on a settlement amount received, is whether or not the payment of that amount is made for a supply of goods or services. This involves an interpretative exercise based on the VAT legislation and the surrounding facts and circumstances (which is often encapsulated in the settlement agreement itself). As a general matter, amounts received as compensation for losses or damages suffered are not consideration for any services supplied - these payments fall outside the VAT net. This article does not focus on these types of payments made in terms of a settlement agreement.
Is there a supply?
In line with the impositioning section 7(1)(a) of the VAT Act, there needs to be a "supply" of something (ie, goods or services) in order for the said section to be invoked. Since the South African VAT legislation was modelled on the New Zealand Goods and Services Act ("GST Act"), the principles laid down by the
The
"....Although services are defined as meaning anything which is not goods, it is still necessary for there to have been a supply of something."
"It is fundamental to the GST Act that the tax is levied on or in respect of supplies. It is not a tax on receipts or turnover; it is a tax on transactions ........."
The term "supply" is widely defined in section 1(1) of the VAT Act to include "...performance in terms of a sale, rental agreement, instalment credit agreement and all other forms of supply, whether voluntary, compulsory or by operation of law,... and any derivative of "supply" shall be construed accordingly". The term "supply" has been interpreted by the
Based on the foregoing and in consideration of a typical settlement agreement, in return for the payment of the settlement amount, Party B would surrender its right to pursue legal action against Party A. Could it be said that the surrender of a right to pursue legal action is the "supply" of services (assuming there is nothing corporeal or tangible that may connote a supply of goods)? Notwithstanding, the fact that the definition of "services" in section 1(1) of the VAT Act is of wide import and includes "...cession or surrender of any right..", as a starting point, there must be a supply.
Interestingly, the
However, in order for a forbearance to sue to qualify as a supply of services, it must be given in return for a consideration; in other words, there needs to be a nexus/connection between the supply and consideration -this requirement has also been confirmed by the
In C of IR v
The Court of Appeal noted there was an expectation among the parties that the refinery would continue to operate, but that there was no contractual obligation to that effect. The government's only recourse in the event that the refinery ceased to be operational was to stop making payments. Although the payments were intended as an inducement to keep the refinery open, they were not linked to any identifiable supply. It was held that there were no obligations between the parties as if the refining company failed to meet the conditions for payment, the only recourse to the Crown was to withhold payment. The lack of any element of reciprocity between
South African context
Based on the dictum of the SCA, it is noted that the interpretation of statutory provisions (eg, the definition of "supply"; "services"; "consideration", etc) in
In summary, in order to determine the VAT implications of a payment made in terms of a settlement agreement, one has to unpack the following:
- is there a supply made by the payee (ie, supplier) to the payor (ie, recipient)?
- is the payment received in respect of, in response to, or for the inducement of that supply?
- is the supply made in the course or furtherance of the enterprise of the supplier?
- what is being supplied?
It is manifest that the above analysis would depend on the nature of the settlement agreement and the applicable VAT provisions - the starting, as enumerated, would be to enquire: is there an underlying supply that is linked to this payment? Failure to apply one's mind to the settlement agreement, may result in a loss being realised in the hands of the payee as the payor may request a tax invoice from the payee in order to claim an input tax deduction on the payment made - this is normally when the parties scramble to determine the VAT implications of a settlement amount made; this often results in further costs being incurred and is counterintuitive as this also prolongs the settlement process. Another consideration is that the payee must properly analyse the VAT implications of a settlement agreement owing to the fact that it has to discharge its onus of proving that such amount is not subject to VAT (if that is indeed the case), when SARS enquiries as to the VAT implications of the settlement payment received - failure to do so will, most likely, result in the imposition of penalties by SARS.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
Mr
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