When disposing of a business, it is normally not done by selling the assets comprising the business, but by selling the business as a going concern. Merely selling assets would attract VAT at the applicable rate. Selling a business as a going concern on the other hand can be structured in such a way that the transaction, from a VAT point of view, would be zero-rated. Important to note is that it is not an exemption from VAT, but applying VAT at a zero rate.
To merely state in the agreement of sale that the business is sold “as a going concern” is not sufficient. The key to the correct structuring of the agreement lies in the provisions of section 11 of the Value Added Tax Act, No 89 of 1991 (the “VAT Act”) and in particular section 11(1)(e) thereof which has the following requirements that have to be met:
1. The seller and the purchaser must both be registered as VAT vendors as defined in the VAT Act;
2. The supply (subject of the sale) must consist of an enterprise or part of an enterprise which is capable of separate operation;
3. The parties must state specifically in their agreement of sale that the supply is a going concern;
4. The parties must agree in their written agreement of sale that the enterprise will be an income earning activity on the effective date, being the date of transfer or take-over of the business;
5. All the assets necessary for carrying on the enterprise, must be disposed of to the purchaser; and
6. The parties must state in the agreement of sale that the consideration for the supply (the purchase price) includes VAT at a zero rate.
It would be prudent to ensure that a specific clause, containing all the above requirements, be included in an agreement of sale of any going concern in order to bring the transaction within the realm of a zero rated transaction.
A few additional aspects need to be pointed out to further clarify the issues raised above and in particular the interpretation thereof by SARS (S A Revenue Services).
Firstly, the definition of a “vendor” appears from section 1 of the VAT Act and not only includes a person who is already registered as such, but also a person who is required to be registered, but has not yet applied for registration. If a purchaser is therefor not registered as a vendor at the time of conclusion of the relevant agreement of sale, it would be advisable that the agreement provides for VAT at a zero rate, but subject to the purchaser being a registered vendor at the effective date.
Secondly, the enterprise must be a going concern as defined in paragraph (i) of the proviso to section 11(1)(e) and meet the criteria set out in paragraphs 4 – 6 above. A mere sale of eg. a farm property will be regarded as a supply of a capital asset and not necessarily the farming enterprise. If the all the agricultural equipment, crops and assets necessary for carrying on the farming activities are included and the parties explicitly agree that the income earning activities will be included and sold, the supply will qualify as a going concern.
Thirdly, if the asset or business sold, is merely capable of being operated as a business (in other words, a dormant business), it will not constitute an income earning activity as it is required to be an actual or current business or operation.
In the fourth instance, the seller may retain assets not necessary for carrying on the business and it is therefor possible to sell off a part of an existing business as long as such part sold, is capable of being run as an income earning activity on its own.
Fifthly, an agreement to sell a fixed property to the sole tenant thereof, does not constitute the disposal of a going concern, as it is regarded as the sale of a capital asset in view of the fact that the income earning activity (being the lease operation) ceases to exist when the tenant becomes the owner of the fixed property.
Lastly, it is not regarded as a supply of a going concern when ownership of an enterprise changes through the sale of shares in a company of the membership in a close corporation as this kind of transaction refers to “financial service” as contemplated in section 2(1)(d). Financial services are exempt in terms of section 12(a) of the VAT Act.