The Supreme Court of Appeal (SCA) has ordered Capitec to pay the SA Revenue Service (Sars) R71.5m as well as the cost of two legal counsel over a disputed VAT claim.
The claim relates to loan insurance payments that the bank received to protect it against default by dead or retrenched clients and how those payments influenced its VAT returns.
The R71.5m amounts to less than 0.5% of Capitec’s total interest income of R17.454bn reported in the year to end-February 2022, and less than 0.03% of its R242.16bn market capitalisation. Still, the bank’s shares closed 1.3% lower at R2,085.84 on the JSE on Wednesday.
“The amount is quite small compared to its market cap,” said Patrice Rassou, CIO at Ashburton Investments. “I don’t think it will be seen too negatively.”
The June 21 ruling by the SCA stems from a lengthy legal battle over the amount that Capitec claimed in its November 2017 tax returns as a notional input tax deduction related to the insurance payments, which it received for clients who defaulted on loan repayments due to death or retrenchment. Sars rejected the claim on the grounds it did not qualify for deduction and handed Capitec a 10% penalty for late payment and understating its VAT liability.
Capitec took the matter to the tax court, which ruled it was entitled to deduct from its VAT liability the tax fraction it was charged on insurance payouts received for portions of unsecured loans that could not be repaid by dead or retrenched clients. The tax court ordered Sars to refund Capitec the disputed R71.5m with interest, prompting the tax authority to appeal to the SCA.
At the heart of the issue was whether Capitec could legitimately claim a VAT deduction related to the insurance payouts it received for loan repayment cover that it provided to clients without charging them a specific fee for the service. The loan cover was provided to clients by Capitec, but it was underwritten by Channel Life Insurance and Guardrisk, which would pay the bank in the event that dead or retrenched clients couldn’t repay their loans.
Between 2014 and 2015 Capitec received insurance payouts and made corresponding premium payments for more than R582m in loan cover. However, it then claimed more than R71.5m in VAT deductions, an amount that constituted the tax fraction it paid on the insurance payouts which it ultimately used to settle outstanding loans by dead or retrenched clients.
At question was whether the loan repayment cover payouts to Capitec formed part of its fee or interest income; under the VAT Act the provision of fee-based financial services are subject to VAT, while interest charged is exempt. That has a direct bearing on what can be deducted from a company’s VAT liability and what cannot.
Sars argued that the loan insurance payments don’t qualify for VAT deduction because they essentially form part of the loan repayment income due to Capitec, which would constitute an “exempt supply” upon which no VAT is chargeable. The tax authority contended that because Capitec hadn’t charged clients a distinct fee for the loan cover, but instead built the charges into its loan repayment structure, they could not be viewed as fee-based financial services that would constitute a “taxable supply”.
Capitec argued that because borrowers were charged both interest and fees, it had indeed made separate consideration for the loan cover. It also contended that the loan cover was integral to its unsecured lending business and thus to generating both interest income and fees.
While that argument was accepted by the tax court, which found that the loan insurance fees were designed to recover the bank's costs in the event of a loan default and were not a separate and distinct service to the client, the SCA saw otherwise. In fact, the SCA ruled that Capitec’s argument was in part “ill conceived”.
Among the SCA’s key findings was that in situations where dead or retrenched clients were rendered unable to repay loans and fees via an unsuccessful debit order, Capitec automatically extended additional credit to them in the amount of the unpaid instalment. This had the effect of rolling the outstanding fees into the owed credit, which is an “exempt supply” under the VAT Act.
“Thus, the loan cover was supplied in the course of making exempt supplies, because the credit insurance policies ensured the recovery of the credit advanced to customers,” the SCA said in its ruling. “The payouts from the credit insurance policies settled the credit balance owing, and extinguished the credit risk arising in the event of retrenchment or death of the customer. This was the purpose and effect of the loan cover.”
However, the SCA ordered that the 10% penalty imposed by Sars on Capitec for late payment and understating its VAT liability be remitted. The SCA found that the lender had “reasonable grounds” for claiming the VAT deduction as it had obtained a legal opinion from a senior counsel favourable to it, which left its attempted but failed tax claim as the only way to “reasonably test the issue”.
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