The question of whether VAT must be levied on costs that are on-charged often arises, particularly when no VAT was incurred on the cost in the first instance. The issue is most prevalent in the services industry where a consultant, for example, seeks to recover from his client certain costs that the consultant has incurred in rendering services to the client.
Where the consultant incurs costs on behalf of the client, such as the payment of an application fee or a license fee, then such fees are paid in the capacity as agent for and on behalf of the client. The recovery of the costs in these circumstances will not be subject to VAT in the hands of the consultant. The consultant will simply recover the actual cost incurred from the client without claiming any input tax and will not account for any output tax on the recovery either. This is because section 54(2) of the Value-Added Tax Act No. 89 of 1991 (the “VAT Act”) deems the supply to be made to the client directly.
The position is less clear where the consultant incurs the costs for his own account, for example VAT exempt costs for using the Gautrain to attend a meeting at the client’s premises, or zero-rated petrol costs (based on a rate per kilometre) for travelling to the client, which he seeks to recover from the client.
Section 7(1)(a) of the VAT Act levies VAT on the supply by a vendor of goods or services in the course or furtherance of an enterprise carried on by the vendor. The VAT is then, in terms of section 10(2) and 10(3) of the VAT Act, calculated at the applicable rate on the consideration received for the supply.
The term “consideration” is defined in the VAT Act to include any payment made or to be made in respect of, in response to, or for the inducement of, the supply of any goods or services. The consulting services will be a taxable supply if the consultant is a registered VAT vendor, and consequently any consideration paid in respect of or in response to the supply of the consulting services will be subject to VAT. One therefore needs to consider whether the recovery of the costs incurred constitutes consideration for the consulting services rendered, or for the on-supply of the goods or services acquired.
In the case of Commissioner, South African Revenue Service v British Airways plc 2005 (4) SA 231 the Supreme Court of Appeal (“SCA”) considered whether passenger service charges levied on an airline by an airport operator and on-charged by the airline to passengers on an international flight, comprised consideration for separate services rendered by the airline to the passengers which is subject to VAT at the standard rate of 14 per cent. The SCA held that:
“The charge that the [airports] company makes to British Airways is no more than a cost that British Airways has to bear in order to operate its carrier service, similar to those that it pays to land and park its aircraft, which it recovers from its passengers directly, rather than indirectly.”
The SCA concluded that:
“..The moneys that are recovered by British Airways are not a consideration for the supply by it of airport services simply because it does not supply them at all”.
The SCA therefore confirmed that the cost incurred by the airline and recovered from the passengers formed part of the consideration for the zero-rated international transport service supplied as opposed to being consideration for separate passenger services rendered by the airline to the passengers.
In a similar vein, SARS has previously ruled (in general written ruling 20) that where a landlord recovers a proportion of property rates incurred by him from his tenants in respect of commercial rental, the recovery of these costs by the landlord from the tenant forms part of the total rental consideration, irrespective of whether it is specified as a separate component of the rental consideration; VAT must accordingly be levied on the total rental consideration in terms of section 7(1)(a) of the VAT Act. At the time that the ruling was in effect, property rates fell outside the scope of VAT but this did not affect the recovery of such costs to be subject to VAT. SARS also previously ruled in general written ruling 76that where a company recovers travelling expenses based on a rate per kilometre from another company (and these expenses include petrol costs), the recovery of the travelling expenses constitutes consideration in respect of a taxable supply and will therefore be subject to VAT in terms of section 7(1)(a) of the VAT Act.
Although rulings 20 and 76 were withdrawn by SARS, the principles on which they were based are in line with the SCA judgment in the British Airways case. In the case of ruling 20, the landlord does not supply municipal services to the tenant for which he receives the recovery of the property rates as consideration, but the recovery of the costs forms part of the rental consideration for the property. In the case of ruling 76 the recovery of the petrol costs forms part of the consideration of the services rendered by the company and is not consideration for the supply of petrol.
Revisiting the scenario of the consultant, the cost of commuting via the Gautrain forms part of the consultants consideration for rendering the services to the client and as such is subject to VAT at the standard rate. Similarly, the recovery of the petrol costs for travelling to the client is subject to VAT at the standard rate, being part of the consideration for the consulting services rendered. The fact that the Gautrain fares or the petrol costs did not attract VAT in the hands of the consultant, is a moot point.
Service providers should therefore closely scrutinise as to whether they are properly accounting for VAT on costs recovered as part of their services rendered to clients.