Most operating companies that receive dividends assume that their value-added tax (VAT) position is straightforward. The business makes taxable supplies, VAT on expenses is fully deductible, and the dividend arrives exempt. Binding General Ruling (VAT) 16 (Issue 3), effective for all financial years commencing on or after 1 January 2024, changes that assumption. Importantly, BGR 16 is mandatory, unless SARS has agreed a different apportionment method.
The formula and the "C" problem
Section 17(1) of the Value-Added Tax Act 89 of 1991 requires apportionment where a vendor acquires goods or services partly for the purpose of making taxable supplies and partly for another purpose. BGR 16 prescribes the standard turnover-based method as the default formula: y = A / (A + B + C) × 100, where A is taxable supplies, B is exempt supplies, and C is any other income received or accrued during the period, whether or not it arises from a supply.
The "C" bucket is where the issue arises. Dividends, including dividends in specie, must be included in the formula to reflect underlying investment activity, even though they are not consideration for any supply. An operating company that would otherwise qualify for full input tax deductibility may, upon receiving a single dividend, find itself with an unanticipated apportionment obligation. SARS notes that "C" will typically include dividends. There is nothing inadvertent about this.
How dividends enter the formula
BGR 16 does not bring dividends into the formula in full. Under adjustment A3, the amount to be included is the three-year moving average of dividends received, multiplied by the spread between the prime rate and JIBAR. That proxy substantially reduces the impact, but
it does not eliminate it.
The adjustment introduces layered complexity. Where no dividends were received in the current year, a three-year moving average of the preceding years may be used. Where dividends were absent for at least two of those three years, a five-year average applies. A holding company that charges management fees and received no dividends for two out of five years must substitute those fees as the proxy, without any averaging. Vendors that do not qualify for any proxy must approach the Commissioner for an alternative method.
The position on trust distributions is more contested. SARS does not accept that distributions retain their income tax character for apportionment purposes. A distribution comprising interest, dividends, and capital gains is treated as analogous to a profit share from a joint venture, subject to the same adjustment and averaging. That position is arguable, but SARS has not moved from it.
When are dividends extraordinary income?
BGR 16 excludes extraordinary income from the formula under adjustment E4, defining it as non-recurring income received due to exceptional circumstances unlikely to be repeated. The rationale is that such income would significantly distort the apportionment ratio without affecting normal recurring expenses. Critically, the only express example given is dividends received as a result of a reorganisation or liquidation under sections 44, 46 or 47 of the Income Tax Act. SARS' use of dividends as the illustrative example confirms that certain dividends can qualify for exclusion entirely.
Where an operating company receives a very large, non-recurring dividend outside a restructuring transaction, it may be arguable that the dividend constitutes extraordinary income. However, BGR 16 contains a specific provision for dividends in A3, creating a tension with the general exclusion in E4.
The counter-argument rests on the principle of generalia specialibus non derogant, which holds that the specific overrides the general. BGR 16 contains a specific mechanism for dividends in A3. SARS could argue that the general extraordinary income exclusion in E4 should not override A3. Where a dividend does not arise from sections 44, 46, or 47, it is arguable that the dividend-specific rule in A3 governs, regardless of the dividend's size or one-off character.
The taxpayer has a compelling rebuttal. Had SARS intended A3 to be the exclusive treatment for all dividends, it would not have used dividends as the E4 example. E4 is not truly a general rule in relation to dividends. It targets a qualitatively different category of income, being income that is non-recurring, exceptional, and unlikely to be repeated, as distinct from the recurring investment dividends that A3 is designed to address. The two provisions operate in different spheres: A3 governs ordinary, recurring dividend income, while E4 provides an exclusion for truly extraordinary dividends.
Further, the sections 44, 46 and 47 dividends example is illustrative, not exhaustive. An extraordinarily large, one-off dividend arising from exceptional circumstances outside those sections is capable of meeting the E4 definition on its own terms.
The argument is viable where the dividend is genuinely non-recurring and arose from exceptional circumstances. E4 and A3 are best interpreted as complementary. A3 addresses ordinary, recurring dividends; E4 addresses the extraordinary. The fact that BGR 16 itself uses dividends as the example of extraordinary income is the most persuasive point in the taxpayer's favour. The point has not, however, been authoritatively resolved.
Practical implications
Operating companies that receive dividends, whether regularly or as a one-off event, should not assume that their input tax position is unaffected. BGR 16 requires active engagement with the formula, its adjustments, and its exclusions. The cost of overlooking the issue is a retrospective apportionment obligation, potential penalties, and interest. Early identification of the risk, proper classification of dividend income, and, where appropriate, an application to the Commissioner for an alternative method remain the most effective safeguards.
