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South Africa: Application of VAT on Certain Government Grants
Government grants may carry value added tax (VAT) charges at different rates or not at all. The correct categorization can directly affect a vendor’s VAT bottom line.
Background
South Africa’s VAT Act defines a grant to include any appropriation, grant in aid, subsidy or contribution transferred, granted or paid to a vendor by the government. This excludes a payment made for the supply of any goods or services to the government.
A vendor receiving a grant is deemed to supply a service to the government if the vendor applies the grant to make taxable supplies. When the vendor is not a designated entity, the vendor may “zero-rate” the supply. The term “designated entity” mainly includes vendors such as the government or related entities.
When the vendor is a designated entity, output tax must be declared to the South African Revenue Services, calculated by using the tax fraction (14/114). When a vendor receives a grant and does not apply it to make taxable supplies (e.g., providing interest bearing loans) the vendor will not be deemed to supply a service to the government, and the payment would fall outside the scope of VAT.
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Government Grants
Vendors receiving grant funding from the government which cannot be attributed to either taxable or exempt supplies need to determine the extent to which the grant is applied to make taxable supplies. The government usually provides grants with a specific purpose in mind; therefore, vendors would in most circumstances be able to determine the use of the grant.
The VAT treatment of grants can be illustrated by the following example.
Company ABC, not a designated entity, is a construction company making taxable supplies. ABC generates income from its construction activities amounting to R10 million. ABC receives a R1 million grant from the government to provide interest bearing loans to certain of its BEE subcontractors. ABC also receives a grant of R2 million to upgrade buildings in certain areas (not government services).
ABC’s income can be categorized as follows:
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Nature of Income |
Amount |
VAT Treatment |
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Construction income |
R10 million |
Taxable at 14% |
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Deemed supply - upgrade of buildings |
R2 million |
Taxable at 0% |
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Funding received - to provide loan funding |
R1 million |
Not taxable |
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Interest earned - from loan funding |
|
Exempt |
Because ABC makes taxable and exempt supplies, it may be required to apportion input tax on expenses incurred which cannot directly be attributed to either. The pre-approved standard method of apportionment (namely the turnover method) would include all of the listed categories of income. When the facts suggest that this method of apportionment is not equitable, a vendor may apply to the South African Revenue Services to use an alternative method.
KPMG Observation
Vendors need to bear in mind that VAT on expenses incurred which is directly attributable to the provision of exempt supplies, such as providing credit, cannot be claimed as input tax deductions which renders it a final cost.
This discussion is a very high-level synopsis of the VAT effect which government grants may have on a vendor. Although a vendor may benefit from the zero-rate, the vendor may not be able to recover full input tax on certain expenses.
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For more information, contact a tax professional with KPMG in South Africa:
Willem Bam, +27 (0) 11 647 7643, willem.bam@kpmg.co.za
Ferdie Schneider, +27 (0) 11 647 8686,
ferdie.schneider@kpmg.co.za
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