BY Robert Gad , Megan Stuart-Steer AND Jo-Paula Roman
South Africa: tax considerations arising from the impact of COVID-19 on contractual obligations
Our firm has published several articles in relation to the impact of COVID-19 on the contractual obligations of parties, mainly due to the promulgation of emergency legislation impacting performance. This legislation under common law would be regarded as vis maior / force majeure (act of god), and may give rise (to some extent) to a supervening impossibility of performance of contractual obligations
Commonly cited examples of affected agreements are leases in respect of commercial property, where a landlord’s obligation to provide undisturbed use and enjoyment of the premises for the purpose for which it was let may be affected by such legislation. In this article we touch on a number of different types of contracts.
The manner in which such circumstances affect the parties’ rights and obligations under the affected agreement will depend on the terms of that agreement, as well as the particular facts at hand.
While we provide some comments on hypothetical scenarios below, it would be critical for parties to obtain both legal and tax advice in respect of their specific circumstances and the consequential tax effects.
Scenario 1 – suspended performance
Generally, when a contracting party cannot perform through no fault of their own, due to vis maior, they are not in breach of contract, but their counterpart is not required to perform due to the concept of reciprocity in contract. (Contractual reciprocity will not necessarily render each counter performance suspensively conditional).
In certain cases, this may affect only the timing of performance - for example, delayed delivery of non-essential goods purchased online. While in these circumstances performance is not possible during the lockdown, performance will be possible after the lockdown. Typically, the contract would effectively be “suspended” in this scenario.
In our view, the ordinary tax consequences of the transaction, in this scenario, are unlikely to be affected.
This is on the basis that the supplier of goods or services remains entitled to the consideration payable by the recipient, albeit that the delivery will be delayed. Thus a tax accrual will be triggered.
Similarly the recipient remains contractually indebted to the supplier, albeit that payment may be delayed, thus a tax incurral will be triggered.
In the case of the unconditional agreement, where performance is merely delayed, formally valid tax invoices issued and received for value-added tax (“VAT”) purposes should give rise to output tax liabilities and input tax claims respectively in accordance with ordinary principles, despite the suspension of delivery and payment. (However, the timing of those liabilities and claims for vendors operating on a payments basis may be affected.)
However, the timing of such tax consequences may be affected, for example, if the agreement is such that performance and counter performance are reciprocally conditional for tax purposes. Where such conditionality is contained in the agreement or arises by virtue of the nature of the performance, expenditure might not yet be incurred, and income might not yet be accrued (if not yet received) until the conditionality is resolved by performance. Thus the tax effects (and possibly the VAT effects) might be suspended too whilst one or both parties are unable to perform due to the vis maior and thus the obligations remain conditional
Scenario 2 – partial performance
In certain scenarios, only part of a party’s contractual obligations may become impossible due to vis maior / force majeure.
In these scenarios:
- to the extent that timeous performance is possible, the ordinary tax implications should apply;
- to the extent that performance may be “suspended”, see scenario 1 above; and
- to the extent that performance is not possible or the agreement may be cancelled, see scenario 3 below.
Scenario 3 – no performance / cancellation
In certain circumstances, the fact that performance is not currently possible, is fatal to the performance itself. For example, if one had ordered catering or entertainment for a function that is cancelled, not merely postponed.
In our view, unperformed obligations which will never be performed, should have no tax effects, or the effects should be unwound. (The manner of unwinding partially performed obligations will be dealt with in a separate note).
In cases where performance is not merely “suspended” or delayed and there is consequently a complete legal defence to any claim for payment, a party cannot be said to have “unconditionally incurred” expenditure for income tax purposes. The counterparty in turn cannot be said to have an accrued right to payment for income tax purposes.
For VAT purposes, the analysis is different but leads to a similar conclusion. VAT is fundamentally predicated on the supply of a good or a service. In the case of supervening impossibility of performance, by definition, the vendor is unable to provide the good or service.
Even if a valid VAT invoice were to be issued and/or even if the recipient were to pay for the supply which has become impossible due to vis maior / force majeure, we have some doubt that this will give rise to output tax liability or an input claim. The vendor has not “supplied” any good or service to the recipient due to vis maior / force majeure, i.e. no “supply” has taken place for VAT purposes.
In this event, there might be a common-law liability to return the affected contractual payment.
Scenario 4 – agreed alternative performance
Where circumstances necessitate a renegotiation of or amendment to existing terms of an affected agreement, careful consideration should be given to the tax effects of both:
- the amendment itself (specifically any alteration of parties’ existing legal rights and/or obligations); as well as
- the agreed alternative performance (which may affect or have different tax implications to those envisaged in any tax advice provided in respect of the original transaction).
Commercial leases – an interesting example
It seems unlikely that scenario 1 would apply to the commercial lease agreement example cited in our introductory paragraphs. In our view, such cases would more likely fall within the ambit of scenario 2 or 3.
Specifically, a landlord’s obligation to provide undisturbed use and enjoyment of the premises for the purpose for which it was let may be limited by the Regulations requiring retailers to close (in the case of retailers selling “non-essential” goods) or limit their operations (in the case of retailers stocking both “essential” and “non-essential” goods) for the duration of the lockdown. Thus for the lockdown period all or part of the use will be unavailable. This impossibility of performance would apply for so long as the vis maior continues and would erode that part of the lease period. Thus it seems unlikely that it could merely cause a delay in performance. There is no principle which would for example merely extend the period of the lease to compensate for the lost period of use. During the suspension period the prohibited use or portion of use is lost.
For tax purposes, the ordinary consequences would seem to continue to apply only to that part of the contract which is able to be performed, for instance a partial use of leased premises.
However insofar as part or all of the obligations under the lease cannot be performed, it would seem that the tax effect for the period is the same as if there was no contract at all, despite the fact that the lease continues to bind the parties. Accordingly:
- for income tax purposes:
- the lessee should not be said to have “unconditionally incurred” expenditure; and
- the lessor, in turn, should not be said to have an accrued right to payment; and
- for VAT purposes, arguably there is no “supply”, meaning:
- no VAT output liability can arise for the lessor;
- nor may an input credit be claimed by the lessee.
It is critical that parties to affected contracts accurately assess the legal implications of COVID-19 on their obligations, as this will inform the tax implications.
Even where legal advice in this regard is obtained, uncertainty regarding inter alia the duration of the lockdown may have an impact on parties’ ability to assess their legal position, which as noted above informs the tax considerations relevant to them. This is particularly true where, due to factual uncertainties, parties can only in due course discover which of the above scenarios are relevant to their circumstances. Consequent complexities may be aggravated where the lockdown crosses a taxpayer’s year end.
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COVID-19, also known as the Coronavirus, is an infectious disease caused by severe acute respiratory syndrome coronavirus 2 (SARS-CoV-2) that was declared a pandemic by the World Health Organization on 11 March 2020. The disease has since been reported in over 190 countries.
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