What VAT is, the different types, and how it affects businesses and their customers
STEVEN JONES
VALUE-ADDED TAX (VAT) is a consumption tax levied on the value added to goods and services at each stage of production or distribution.
VAT is a significant source of revenue for the government, and plays a crucial role in funding public services and development projects. Introduced on 30 September 1991, it replaced the previous General Sales Tax (GST) that had been in force since 3 July 1978.
VAT classifications
The Value-Added Tax Act 89 of 1991 categorises certain goods and services into three main VAT classifications:
- Standard-rated,
- Zero-rated, and
- Exempt.
Each category has distinct implications for consumers, businesses, and the government.
Standard-rated VAT
This is the most common VAT classification, and applies to the majority of goods and services. The standard rate of VAT is currently 15%, and is applied to the final price of taxable goods and services. For example, if a retailer sells an item for R1 000, the customer will pay an additional 15% (R150) as VAT, making the total price R1 150.
Wholesale businesses often quote their prices as ‘ex-VAT’, or VAT-exclusive. However, retail businesses are required to quote VAT-inclusive prices, based on the ‘what-you-see-is-what-you-pay’ principle.
Businesses registered for VAT collect this tax from their customers, and then pay it over to SARS after deducting any input VAT that they have paid on their business purchases.
Zero-rated VAT
Zero-rated items are essential goods and services on which VAT is charged at a 0% rate. This means that the supplier does not add any VAT to the price of these items, but they are still considered taxable supplies for VAT purposes.
The objective of zero-rating is to provide relief for essential items and make them more affordable for consumers, especially those with lower income.
Some common zero-rated items include basic food items like maize meal, brown bread, rice, fresh fruit, and vegetables; petrol, diesel, and illuminating paraffin; farming inputs; and exported goods.
When a business supplies zero-rated items, they can still claim input tax de-ductions on the VAT they have paid on their business expenses. While they don’t collect VAT on these sales, they can recover the VAT paid on their inputs, which can be an incentive for businesses to deal with zero-rated goods.
Exempt VAT
Exempt items are goods and services that are not subject to VAT at all. Like with zero-rated supplies, no VAT is added to the selling price of exempt supplies.
However, the difference is that while the business can still claim input VAT deductions on related expenses against zero-rated supplies, it cannot claim any input VAT on such related expenses against exempt supplies.
Exempt items are typically considered essential, non-luxury items. The cate-gory includes non-fee related financial services, residential rental accommodation, public road and rail transport, and educational services provided by approved institutions.
If a business is making both exempt and taxable (i.e. standard and/or zero-rated) supplies, any input tax relating to expenses that cannot be directly allocated to either exempt or taxable supplies must be apportioned based on the relative percentages of taxable and exempt supplies.
Implications for consumers and businesses
The distinction between standard-rated, zero-rated, and exempt VAT has several implications for consumers and businesses.
Consumers
For consumers, the difference lies in the prices they pay for goods and services. Standard-rated goods and services are more expensive due to the inclusion of the VAT amount, while zero-rated items are cheaper.
In the case of exempt items, since the business is denied a deduction for any related input VAT, the cost of the input VAT foregone is likely to be recovered in the selling price. Therefore, while the amount paid by the consumer does not include VAT at the full standard rate, a portion of the price includes the disallowed input VAT claim.
Businesses
For businesses, the different VAT classifications impact their cash flow and administrative processes.
Businesses dealing with standard-rated items must collect VAT from customers and pay it to SARS after accounting for their input VAT deductions. Businesses dealing with zero-rated items do not charge VAT but can claim input tax deductions, while those dealing with exempt items do not charge VAT and cannot claim input tax deductions.
While exempt VAT partially relieves consumers from paying VAT on these specific items, it poses challenges for businesses operating in exempt sectors. These businesses are unable to recover VAT on their expenses, which can impact their profit margins.
As a result, they may face higher operating costs, which could be passed on to consumers through increased prices—thereby negating the benefit of the VAT exemption.
Furthermore, the distinction between zero-rated and exempt VAT can be complex, leading to interpretation challenges and potential disputes between businesses and tax authorities. Careful consideration and clarity are required to determine the appropriate VAT treatment for goods and services, especially in cases where the distinction may not be clear-cut.
If a business is selling goods or services on credit, or is granting payment terms (e.g. 30 days after invoice date), VAT may negatively impact its cash flow if it is registered for VAT on the ‘invoice basis’.
The bases on which business may register for VAT with SARS, and the implications thereof, will be covered in a future article.
Since VAT becomes payable to SARS on the 25th of the month following the end of each two-month period (known as the ‘tax period’), VAT on any invoices raised during the tax period needs to be paid over to SARS—even if their customer has not yet paid their account!
Businesses need to ensure proper record keeping and VAT compliance to avoid penalties, and to ensure accurate reporting to SARS. They may also need to determine which VAT category their supplies fall into, and adjust their pricing and operations accordingly.
Conclusion
In South Africa, VAT plays a significant role in generating government revenue and promoting economic objectives. Given that VAT collections make up just over 26% of total tax revenue (per the 2023/24 Budget), it is a tax that is not likely to go away.
Understanding the distinctions between standard-rated, zero-rated, and exempt VAT is therefore crucial for consumers and businesses alike. While the standard-rated VAT applies to most goods and services, zero-rated items have a 0% VAT rate but remain taxable, while exempt items are not subject to VAT at all.
These classifications have implications for pricing, cash flow, and administrative processes, requiring businesses to carefully consider their VAT treatment and compliance obligations.
Steven Jones is a registered SARS tax practitioner, a practicing member of the South African Institute of Professional Accountants, and the editor of Personal Finance and Tax Breaks.
