vat on fines and penalties
by gerhard badenhorst

When and association or organization imposes a fine or penalty, the question often arises whether it is required to charge VAT on the fine or penalty. A fine or penalty can either take the form of a monetary payment, or it could comprise the suspension of privileges, or both.

The South African Revenue Service ("SARS") issued a ruling (general written ruling 439) with regard to non-statutory fines or penalties in which it states that usually the fine or penalty is due to the action or lack of action by the person who must pay the fine or penalty, and as such, the fine or penalty relates to a supply made and is subject to VAT at the standard rate. SARS therefore simply assumes that such a fine or penalty is paid as consideration for a supply of some sort and is therefore subject to VAT. It also seems that by implication statutory fines or penalties are not subject to VAT.

The issue is unfortunately not as simple as stated in VAT ruling 439. For a payment to attract VAT, it must comprise consideration for the supply of goods or services supplied by a vendor in the course or furtherance of an enterprise carried on by the vendor. Therefore, even if the association or organization that imposes the fine is a vendor, it will only be subject to VAT if the fine relates to a supply of goods or services.

For example, if a video club hires out videos to members for a fee, and according to its rules charges members a fine if a video is returned late, such fine is directly attributable to the hire of the video. The fine comprises additional consideration for the hire of the video, and is subject to VAT.

Similarly, if a local authority imposes a penalty for the excessive use of water or electricity in the form of an additional charge for such usage, the penalty relates directly to the supply of the water or electricity, and as such attracts VAT.

However, if the fine or penalty is not paid in respect of goods or services supplied, it does not attract any VAT.

In a New Zealand case, Case S65 (1996) 17 NZTC 7408, the court considered whether two law societies which imposed penalties against a solicitor rendered any services to the solicitor. The case involved a solicitor who was a member of the New Zealand Law Society and the District Law Society, which both imposed certain penalties payable by the solicitor to them. The solicitor sought to claim input tax thereon on the basis that the penalties were subject to VAT and that he was entitled to a tax invoice to enable him to claim input tax. In his judgment Willy DJ stated that: "One would have thought that to prosecute somebody is the opposite of doing them a service. It is the doing of a disservice". He concluded that the penalties were not consideration for any service supplied by the societies, that the societies were not liable for VAT or to issue tax invoices, and that the solicitor was not entitled to any input tax deduction.

In an unreported United Kingdom VAT Tribunal Case, Northamptonshire Football Association ("NFA") (BVC Tribunal, 1996) 2128 the court considered whether the imposition of fines or penalties was part of the business of the NFA. In this case the Tribunal Chairman concluded that the enforcement of the rules to which the fines and penalties relate is provided in consideration for the payment of the membership subscriptions and not in consideration of the fines and penalties imposed. The fines and penalties are the sanctions accepted by the members for breach of the rules, and are not consideration for the enforcement activity in any contractual sense.

The Australian Tax Authority ("ATO") determined that the payment of a fine or penalty is not consideration for any supply if it is imposed because of a breach of membership rules of an association and is primarily intended as punishment or to act as a deterrent. It is therefore not an additional amount of consideration for the supply of membership by the association to the member; upon payment of the fine or penalty the member receives no additional rights, benefits or privileges to those which the member was not already entitled immediately prior to the imposition of the fine or penalty.

The ATO determined further that in accepting the payment of the fine or penalty, the association does not enter into an obligation with the member to tolerate the misconduct, but it is rather fulfilling its obligation to all members to enforce the rules. The association can therefore not be said to make a supply where it already has a pre-existing obligation to continue providing the benefits of membership to all members.

The VAT implications of fines and penalties imposed by associations or organizations should therefore be carefully considered in view of the services supplied by that association or organization. If no additional services or benefits are provided to members, the fine or penalty imposed does not attract VAT.

gerhard badenhorst – tax executive

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