The rapid evolution of information technology has resulted in the formation of a global economy. At the touch of a button, clients can move funds to and from virtually anywhere in the world. Financial service providers now compete globally for market share and clients. Fierce competition in the market and investors insatiable need for higher returns has resulted in the creation of various financial arrangements which seek to exploit certain aspects of the financial system. Increased regulation of the industry has paved the way for institutions to create complex structures in order to circumvent such regulations or exploit their deficiencies and deliver enhanced returns to their shareholders.
Applying a (for the most part) rules based VAT, that has largely remained unchanged, to this new environment is as fascinating as it is difficult. This report, through its various chapters seeks to provide basic submissions on the effects and treatment of the VAT on some of the more common financial transactions and a select few complex transactions. Chapter 1 – The Exempting of Financial Services, puts forward the current legal framework in which financial services are evaluated with respect to VAT. It highlights the basic operations of the VAT Act with regard to financial services and looks to the reasons provided by VATCOM for the exemption of financial services (noting that while in theory VAT could be applied to financial services, they were exempt due to practical limitations). The idea of taxable fee based financial services versus non fee based exempt financial services is introduced and sets the backdrop on which the following chapters will build. Chapter 2- The Meaning of the Word Fee, proposes an interpretation of the word ‘fee’ and submits that this is crucial in determining if a financial service is subject to VAT. The word ‘fee’ is not defined in the VAT Act and the discussion seeks to attach meaning to the word by following the South African statutory interpretation approach. The submission is made that there are three key characteristics of a fee transaction, the first of which would require the payment of money from one party to another in accordance with an
108 | P a g e agreement between the two parties. The second is that money must be transferred in return for ‘something’ and the third is that ‘something’ must be identifiable as a service rendered to the payer.
Chapter 3 – Common Financial Services Provided examines commonly encountered financial services and the VAT consequences thereof. The chapter describes the appropriate sections of the VAT Act and concludes on each service discussed.
Chapter 4 - Input Tax introduces the concept of input tax within the realm of financial services. It examines the requirements of vendors with regard to calculating their input tax entitlement. Input tax relating specifically to financial service providers is also discussed.
Chapter 5- VAT in a Web of Transitions, deals with a recent court decision regarding VAT within a ‘web of transactions’. Financial institutions often bundle multiple services into one transaction. Often such services are a mix of taxable and exempt supplies. The chapter highlights the court’s approach to the application of VAT with respect to a ‘web of transactions’ and the need to determine the economic substance of the arrangement rather than strict application of the VAT Act to the legal form.
Chapter 6- Complex Financial Arrangments, tests some of the less common financial arrangements against the provisions of the VAT Act and relevant law. These arrangements are uncommon and often only occur between financial service providers or with selected clients. The chapter selects limited (and simplified) examples to illustrate the types of transactions and their basic operation. The chapter makes submissions based on these simplified examples. It is submitted that trough the analysis of these transactions a general approach to complex financial arrangements is established; the economic substance of the arrangement must be determined before application of the VAT Act to the legal form. Application of the VAT Act to the legal form should only be
109 | P a g e done (it is submitted) once it has been established that the legal form represents the economic substance.
Chapter 7- 21st Century Financial Services, deals with ‘twenty-first century’ ( or ‘high-
tech’) financial instruments but limits its scope to Crowd Funding, Peer-to-Peer lending and Cryptocurrency. The recent introduction of these offerings to the financial service industry has forced the discussion of these instruments in this report to be largely academic. In order to determine the true VAT consequence of these instruments one requires a peculiar knowledge of technical operations of each of them. For the purposes of this report a simplified, general approach has been applied to each of these instruments as well as submissions with regard to the VAT effects these instruments will attract within these simplified examples.
Limitations and areas for future research
This report is limited to an analysis of the financial services most commonly encountered. The report makes important submissions regarding the treatment VAT on the various financial services within its discussion scope. The report does not examine the operations of the various instruments with regard to income tax or other fiscal legislation nor does the report provide an in-depth analysis and/or description of each of the services discussed.
Future research into the interaction between the income tax and VAT effects of the various instruments will prove a valuable addition to this research. Analysis of the VAT effects on extremely complex financial arrangements such as Credit Default Swaps, synthetic currency loans, high-frequency trading and many others is of great importance to the Fiscus and the financial sector.
110 | P a g e After consideration of the submissions put forward by this report and the evidence provided in support of these submissions it is clear that there is no ‘one size fits all’ application of the financial services provision of the VAT Act to financial transactions. The judgement of Binns- Ward J in VAT Case 1390 is a welcomed interpretation method when dealing with VAT on financial instruments It is respectfully submitted that even when applying this method, the look-through to the economic substance of an arrangement is not always as clear as it seems as. In some extreme cases, even the contracting parties may not fully understand the economic implications of the transactions they are party to (and such a lack of understanding is what fueled the financial crises). Considering the intricacies of the services discussed in this report and the pace at which new structures are developed, the following extract is a parting thought:
‘The line between investing and gambling is artificial and thin. The soundest investment has the defining trait of a bet (you losing all of your money in the hopes of making a bit more), and the wildest speculation has the salient characteristic of an investment (you might get your money back with interest).’244
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