It appears that there is often uncertainty whether the transfer of an interest in a partnership from one partner to another (ie either a new or existing partner) should be subject to value-added tax (VAT).
The New Zealand Inland Revenue recently released a Tax Information Bulletin (Vol 26, No. 25, June 2014) (Bulletin) relating to this issue. The Bulletin confirms that most transfers of partnership interests will not be subject to Goods and Services Tax (GST) in New Zealand because the supply will generally not be made by a registered vendor or, if the transferor is registered, the supply will not be made in the course or furtherance of that registered vendor’s enterprise. The position in South Africa is likely to be the same.
One issue which is specifically not covered in the Bulletin is the GST/VAT consequences of a final dissolution of a partnership, including the dissolution of a partnership as a result of a partner acquiring all the interests in the partnership from the other partners. The Bulletin’s failure to deal with this issue may be an indication that there is some uncertainty on the correct GST/VAT treatment in these circumstances.
Consider a scenario where two partners, namely A and B, are equal partners in a partnership that is a registered VAT vendor. A acquires B’s interest in the partnership and intends to carry on conducting the business of the partnership in its own name. As a result of the transfer of the partnership interest from B to A, the partnership will cease to exist and therefore cease to be a VAT vendor. Will the transfer of the partnership interest from B to A trigger any VAT consequences for the partnership itself?
To appreciate the potential VAT implications for the partnership, one must have regard to the following:
- S51(1) of the Value-Added Tax Act, No 89 of 1991 (VAT Act) provides that, a body of persons, whether corporate or unincorporated, which carries on an enterprise, is deemed to carry on the enterprise as a person separate from the members of such body of persons. A partnership is a body of persons, which is therefore regarded as a separate vendor for VAT registration purposes (ie separate from the partners).
- S51(2) of the VAT Act recognises that, in terms of partnership law, the introduction or withdrawal of a partner results in the dissolution of the old partnership and the creation of a new partnership, which could trigger the deemed supply rules in s8(2) of the VAT Act. To alleviate this deemed supply issue, s51(2) of the VAT Act provides that the old and the new partnership are deemed to be one and the same VAT vendor for purposes of the Act.
- However, s51(2) of the VAT Act is only applicable were a new partnership comes into being and continues to carry on the business of the old partnership as a going concern. S51(2) of the VAT Act is therefore not applicable where a partner (A) acquires the remaining interest in a partnership. In these circumstances the partnership ceases to exist as a result and no new partnership is created.
- On the basis that s51(2) of the VAT Act is not applicable, the acquisition of the partnership interest by the remaining partner would potentially trigger s8(2) of the VAT Act. In essence, s8(2) of the VAT Act provides that if a person (the partnership) ceases to be a vendor, any goods or a right capable of assignment, cession or surrender which forms part of the assets of the enterprise, will be deemed to be supplied by him in the course of his enterprise immediately before he ceased to be a vendor.
As a result of the termination of the partnership’s existence, the partnership is deemed, in terms of s8(2) of the VAT Act, to have made a supply of all of its assets in the course or furtherance of its enterprise immediately before it ceased to exist. The deemed supply could therefore trigger an output VAT liability for the partnership.
However, even though there will be a deemed supply by the partnership of all of its assets immediately before it ceases to be a vendor, it appears that there may be an argument that the partnership will be deemed to have supplied all of its assets to the remaining partner as a going concern, which qualifies as a zero-rated transaction in terms of s11(1)(e) of the VAT Act.
We note that the South African Revenue Service (SARS) previously issued the following VAT ruling:
"Ruling 320 - Sale of partner's interest in a partnership
Three partners namely A, B and C are equal partners in a partnership that is registered as a vendor.
Partners A and B wish to cease being partners of the partnership and intend selling their undivided interest in the partnership to the remaining partner C. Partner C is to continue conducting the business of the partnership as a sole proprietor. What are the VAT implications on the sale of A and B's undivided interest in the partnership if the provisions of section 51(2) cannot be applied?
The sale of the assets of the partnership to the remaining partner constitutes a taxable supply by the partnership. Section 11(1)(e) provides that the supply of an enterprise or part thereof which is capable of separate operation may be zero-rated, if the supply is made to a registered vendor and the enterprise is disposed of as a going concern. (Subject to all the requirements of sections 8(7) and 11(1)(e) read together with Practice Note No. 14 dated 20 January 1995 being met).
Where the transaction does not constitute the sale of an enterprise as a going concern and therefore not zero-rated, the provisions of section 7(1)(a) will be applicable. The vendor (partnership) has to account for output tax at the standard rate on the supply of the assets which formed part of the enterprise (other than any goods in respect of the acquisition of which a deduction of input tax under section 16(3) was denied in terms of section 17(2) or would have been denied if these sections had been applicable prior to the commencement date) upon supply to the remaining partner."
It appears that there is an argument that the deemed supply of the partnership assets to the remaining partner constitutes a taxable supply, which may be zero-rated if the supply is to a registered vendor and the enterprise is disposed of as a going concern (as contemplated in s11(1)(e) of the VAT Act). If this approach is adopted, the parties must ensure that all of the requirements of s11(1)(e) of the VAT Act are complied with and that the correct documentary proof required to substantiate the zero-rating is maintained (see SARS’s Interpretation Note 31 (Issue 3) (22 March 2013)).
However, taxpayers must be aware that the VAT Rulings were withdrawn by SARS during 2009 and are not binding on SARS. In addition, it appears from the Bulletin that, internationally, this issue requires careful consideration, which is likely to depend on the particular facts and circumstances.