Author: Carmen Moss-Holdstock (SNG)
In general, South Africa imposes VAT at the standard rate of 14 per cent on the supply of goods or services on a destination basis, that is, VAT is borne by the final consumer of goods or services within the country. The primary mechanism to ensure that only local consumption is taxed in SA is through the zero rating (0 per cent) of goods and services exported from SA and the levying of VAT on the importation of goods and certain services.
The concept of “contract manufacturing” is not necessarily a new concept, however, depending on the factual circumstances of each case, it can still prove to be a rather tricky and difficult area when applying the relevant sections of the Value-Added Tax Act, 1991 (VAT Act).
This is best illustrated by way of example. Two scenarios are considered:
- the one involving a customer located in SA (SA Customer) and
- the other involving a customer located outside SA (Foreign Customer).
Both customers are car manufacturing companies. In both instances, the Foreign Customer and the SA Customer will place an order for the manufacturing of certain parts with a company which is located outside SA (Foreign Supplier). Foreign Supplier in turn subcontracts the manufacturing of the parts to an external supplier situated in SA (SA ManCo). In order to manufacture the parts, SA ManCo must design and manufacture the necessary tooling (e.g. jigs, templates, dies, etc.) for which it charges a separate fee to Foreign Supplier. Legal ownership of the tooling is either transferred directly to the Foreign Customer or SA Customer once manufactured by SA ManCo, or ownership is firstly transferred to Foreign Supplier who subsequently transfers ownership to Foreign Customer or SA Customer. In either case, ownership of the tooling is transferred by SA ManCo to a third party.
While the parts are exported by SA ManCo during the period of the supply agreement, the tooling, which is ultimately owned by Foreign Customer or SA Customer, remains indefinitely in SA with the SA ManCo for the purpose of the ongoing supply of the requisite parts.
What then are the SA VAT implications that arise in consequence of the manner in which the contract manufacturing arrangement is structured?
The answer to this question depends in the first instance on the nature of the supply, that is, whether it is a supply of goods or services? Allied to this determination is the issue of whether the supply of the parts and tooling is a separate supply of the two elements of the transaction or a composite supply of the parts and the tooling? Once it has been determined whether the supply by SA ManCo to Foreign Supplier is of goods or services, and whether the supply is of two separate items, it then needs to be determined whether the relevant supply falls within the ambit of one or other of the zero-rating provisions in the VAT Act.
The VAT implications arising from the supply of the tooling and the parts to Foreign Supplier by SA ManCo for onward supply to Foreign Customer: A supply of goods vs a supply of services
While SA ManCo undertakes the manufacture of the parts on behalf of Foreign Supplier, it is submitted that the real subject matter of the transaction is one of a supply of goods, both in relation to the parts and the tooling. The materials necessary to manufacture the parts and tooling are acquired by SA ManCo as principal, and not agent on behalf of Foreign Supplier. In essence therefore, it cannot be said that SA ManCo has rendered manufacturing services to Foreign Supplier in relation to materials belonging to Foreign Supplier.
As noted above, VAT must generally be accounted for at the standard rate of 14 per cent on the value of all taxable supplies of goods made by a vendor. Such a supply may however be zero rated if the goods are “exported” from SA as contemplated in section 11(1)(a) of the VAT Act. Goods are treated as “exported” if they are consigned or delivered by the supplier (SA ManCo in this instance) to the recipient of the supply (Foreign Supplier) at an address outside SA (a so-called direct export), or the recipient (Foreign Supplier) takes possession of the goods in SA but the goods are subsequently removed from SA in compliance with the prescribed export incentive scheme (a so-called indirect export). In both instances, substantial documentary proof is required that the goods have in fact left the country. Time limits also apply.
Importantly, in the case of a direct export it is that the supplier of the goods (SA ManCo) who must be contractually responsible for and in control of the export of the goods. By contrast, it is the recipient of the supply (Foreign Supplier) in the case of an indirect export who is responsible for and in control of the export – albeit that the local supplier (SA ManCo) must be in the possession of the necessary export documentation within the stipulated time limits in order to be able to claim the benefit of zero rating.
Provided the parts and tooling are “exported” from SA to Foreign Supplier as contemplated in VAT Act, SA ManCo may zero rate the supply. However, while the parts destined for Foreign Customer will be consigned or delivered by SA ManCo to Foreign Supplier and therefore will constitute a direct “export”, the tooling will remain in SA and cannot therefore be said to have been “exported” – notwithstanding that ownership of the tooling is transferred to either Foreign Supplier or to Foreign Customer.
The issue then arises as to whether the relevant supply (relating to the parts and tooling which are the subject matter of a single contract) forms a single, composite supply, or a separate supply of the parts and tooling. The importance of the distinction lies in the fact that if the supply is a composite supply of goods consisting of both the parts and tooling, the fact that the tooling remains in SA will mean that the supplies by SA ManCo cannot be zero rated as “the goods” are required to be removed from SA to qualify for zero rating. However, if the supply by SA ManCo consists of a separate supply of parts and of tooling, then at least the parts are exported and the supply thereof will be zero rated. The supply of the tooling will be standard rated as the tooling will not have been removed from SA as required under both the direct and indirect export regimes.
The European Court of Justice (ECJ) had held that in deciding whether a supply is a composite supply one must have regard to whether the supply comprise a single supply from an economic perspective. It would seem that the court places much reliance on whether the elements making up the supply are in essence principal supplies in their own right, that is, are independent of one another (separate supplies), or whether certain elements are merely ancillary to an identifiable principal supply (single composite supply). Unfortunately no judicial guidance has been provided in SA to date.
On the basis of this distinction, the German tax authorities, for example, apparently treat the supply of tooling as ancillary to the supply of the parts (being the principal supply) and on this basis allow the zero rating of the tooling supplied in respect of parts exported from Germany.
While it is perhaps arguable on the basis of the approach adopted by the German tax authorities that there is a single supply of the parts and tooling, it is important to bear in mind that the “goods” must physically leave SA in order to qualify for zero rating in terms of the SA VAT Act. If one adopts the composite/single supply approach this would mean that the supply of the parts and tooling would not qualify for zero rating as the “goods” (being the parts and tooling) would not have been removed from SA.
It would seem however that there is a strong basis for arguing that the transaction is in reality a supply of parts and goods and each supply is accordingly required to be treated as such. Fortunately, even if one is able to argue that the transaction is a single/composite supply of the parts and goods, section 8(15) of the VAT Act provides that where a single supply of goods or services would, if a separate consideration been payable, charged with tax in part at the 0% and part at the standard rate, each part of the supply is treated as a separate supply.
On the basis that the export of the parts would have qualified for zero raring as the parts destined for Foreign Supplier will be dispatched from SA, while the supply of the tooling would be taxed at the standard rate, the supply of the parts and tooling fall within the ambit of section 8(15) and must be treated as separate supplies.
It follows that even if no separate charge is made for the parts and the tooling (which is not the case in scenarios postulated above), the supply of the parts will be zero rated as they will have been “exported”, while the supply of the tooling is taxable at the standard rate of 14% as the tooling will not be “exported” from SA. It is unlikely that SARS would adopt the approach of the German tax authorities and treat the supply of the tooling as forming part of the supply of the parts that are “exported”. This is the correct outcome if one considers that “consumption” of the tooling will take place in SA.
The VAT implications arising from the supply of the tooling and the parts to Foreign Supplier by SA ManCo for onward supply to SA Customer
While it is concluded above that the supply of the parts, but not the supply of the tooling, will be zero rated as the parts will be “exported” from SA, this is not true in the case of supplies by SA ManCo to Foreign Supplier if the parts are on-supplied to SA Customer. The parts will in this instance not be “exported” from SA as the parts will remain in SA and no zero rating provision applies in these circumstances.
Consideration would also need to be given to the possibility that the ongoing supply by Foreign Supplier to SA Customer results in Foreign Supplier carrying on an “enterprise” in SA – in which case Foreign Supplier would need to register for VAT in SA and account for VAT on the supplies made to SA Customer. Given that the arrangement between Foreign Supplier and SA Customer triggers a VAT liability and Foreign Supplier cannot claim input tax relief, registration as a vendor in SA may be a good position for Foreign Supplier.
The VAT implications arising from the supply of the tooling and the parts to Foreign Supplier by SA ManCo for onward supply to Foreign Customer or SA Customer: A Supply of Services?
In line with the destination based principles of the VAT Act, services which are rendered to non-residents may qualify for zero rating in terms of section 11(2) (ℓ) of the he VAT Act. The rate of zero per cent may, however, not be applied if the non-resident (Foreign Supplier) or any other person to whom the services are supplied is present in SA when the services are rendered. The zero rate may also not be applied if the services are rendered directly in respect of movable property (parts/tooling) which is located in SA when the services are supplied, unless such movable property (parts/tooling) can be said to form part of a supply by the non-resident (Foreign Supplier) to a registered vendor in SA (SA Customer) or are subsequently exported from SA to the non-resident (Foreign Supplier).
While it is concluded above that the supply is a supply of “goods”, and falls to be dealt with as such, should SA ManCo have merely contracted to manufacture the parts and tooling with material belonging to Foreign Supplier, the supply by SA ManCo would constitute a supply of services. As mentioned, a supply of services by SA ManCo to Foreign Supplier in these circumstances would only be zero rated if the parts and tooling are subsequently exported, or the parts and tooling can be said to form part of a supply by Foreign Supplier to a registered vendor (SA Customer) in SA.
Manufacturing services supplied by ManCo in relation to the parts supplied by Foreign Supplier to Foreign Customer will be zero rated as they will be exported. As regards SA Customer, the services rendered by SA ManCo in relation to those parts would not be zero rated under this provision as the parts would not be exported from SA. However, as the parts in relation to which the services are rendered by SA ManCo to Foreign Supplier form part of a supply by Foreign Supplier to SA Customer (a registered vendor), the services rendered by SA ManCo to Foreign Supplier will similarly be zero rated.
As regards the tooling, services rendered by SA ManCo in relation thereto will only be zero rated (as the tooling remains in SA) if it can be said the tooling forms part of a supply by Foreign Supplier) to a registered vendor (SA Customer) and such services are supplied to Foreign Supplier for the purpose of such supply to the registered vendor (SA Customer).
It is certainly arguably that the tooling forms part of the supply of the parts by Foreign Supplier to SA Customer and on this basis manufacturing services supplied by SA ManCo to Foreign Supplier in relation to the supply of such tooling would also be zero rated. It is not a requirement in these circumstances that the tooling must be removed from SA. The zero rating provision discussed above will obviously not be of application if the tooling is disposed of by Foreign Supplier to Foreign Customer as Foreign Customer is not a registered vendor, nor will the tooling be exported from SA.