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Selling a going concern may have VAT implications

Sonja FrankWhen buying or selling a business as a going concern, one needs to be mindful of possible output tax adjustments that may be required in terms of section 18A of the Value Added Tax Act. Failure to account for what some might call “hidden consequences” may result in severe penalties and interest.

When confronted with the sale of a business, advisors are often quick to suggest that the sale should take place as a going concern so that the buyer pays 0% VAT, thereby reducing the actual purchase price. At first glance this seems like an obvious choice. However, there are instances where the initial zero-rating may have VAT consequences that are easily overlooked.

Output tax
One such consequence is that output tax must be accounted for when the entire going concern will not be used in the course or furtherance of making taxable supplies. This will typically be the case where the vendor makes taxable and exempt supplies.

A vendor may acquire goods or services as a going concern, but with the intention of using those goods partly for purposes other than making taxable supplies, e.g. exempt supplies like the letting of residential accommodation. Section 18A of the VAT Act determines that an output tax adjustment must be made for the part that will not be used in the course or furtherance of making taxable supplies.

The adjustment is made by calculating the VAT on the cost of acquiring the going concern, multiplied by the percentage that will be used to make exempt supplies.

Let’s say a vendor has purchased a farm as a going concern for R10 million. A substantial 45% of his trading activities will entail the letting of residential accommodation on the farm. The section 18A adjustment that has to be made to output tax will be calculated as follows:

The net effect of this adjustment is that the vendor will be placed in the same position as he would have been had he paid input tax (instead of paying the zero-rated amount) on the acquisition of the properties used for exempt supplies.

This adjustment has to be made in the tax period of the acquisition of the going concern. This can create a substantial liability for the purchasing vendor, who will have to make sure that he has secured sufficient funding to be able to comply with his obligations.

Failure to account for adjustments – or so-called “hidden consequences” – may result in severe penalties and interest due to incomplete submissions of VAT returns and the subsequent underpayment of VAT. It is therefore important to always obtain proper advice from tax experts before entering into transactions such as the sale of a going concern.

For more information, please contact Estian Haupt or Sonja Frank of Exceed Tax & Advisory Services on 021 882 8140