On 3 April 2020, the Supreme Court of Appeal delivered a judgement against Diageo South Africa (Pty) Ltd (“Diageo SA”) in a value-added tax (“VAT”) matter relating to the supply of advertising and promotion (“A&P”) services to various non-South African brand owners in the group.
Diageo SA entered into an agreement with the foreign brand owners for the A&P of their products in South Africa. The brand owners invested in A&P to build and maintain brand recognition and generate sales by way of enhanced brand equity. The brand owners relied on Diageo SA to build their brands locally through A&P services in return for a fee. The A&P activities consisted of a range of activities, such as advertising across various channels, brand building promotions, events, sponsorships, and market research. Services that were rendered by Diageo SA included advertising media, website design, website building, social networking, and sponsorship of, amongst others, sports events.
To render the A&P services, Diageo SA made use of promotional merchandise and packaging, sample products, and branded giveaway items. These were given away free of charge to third parties for use or consumption within South Africa for the purpose of promoting the products. Two categories of goods were used. Firstly, the products of the brand owners (stock that has been taken out of the trading stock and used for product sampling or tasting); secondly, point-of-sale items were given to third parties and employees, for no consideration.
The fee charged by Diageo SA to the brand owners represented the cost incurred by Diageo SA in rendering the A&P services, which comprised the supply of both goods and services, to the brand owners. However, the tax invoices rendered by Diageo SA to the brand owners reflected a single total fee for services rendered. It did not differentiate between goods and services.
Why is this an issue? While the services to the brand owners are an exported service that can be zero-rated, the goods were consumed locally in South Africa and should have been standard rated (the principle of VAT being a tax imposed where the product is consumed). Part of the single fee charged to the brand owners should, therefore, carry VAT at the standard rate of 15%, and only a part thereof can be zero-rated.
Diageo SA took the view that the fee was charged on the basis that it constituted a zero-rated supply of the A&P services, since “exported services” in South Africa constitute zero-rated supplies. According to Diageo SA, there was only a single supply of A&P, not a separate supply of services and a separate supply of goods.
The court found that the single supply provided by Diageo SA to the brand owners consisted of both goods and services that were distinct and clearly identifiable from each other. There is no artificial and insensible result or commercially unreal outcome if that view is followed. The fee should, therefore, have been split between a zero-rated service, and goods at the standard rate.
The purpose of Section 8(15) of the VAT Act (in terms of which the decision was made) is to ensure that, in a case like this, Diageo and “other similarly positioned VAT vendors fulfil their obligation to pay VAT at the standard rate on the goods that they have supplied.”
Diageo’s appeal was dismissed and the assessments issued were maintained.