SOUTH AFRICA: A FAVORABLE ENVIRONMENT FOR INGO TAX RELIEF
South Africa: A Favorable Environment for INGO Tax Relief
By Stephan Spamer and Betsie Strydom
International non-governmental organizations (“INGOs”) have become increasingly influential in world affairs, and make a vital financial contribution to the survival of many residents in developing countries. There are hundreds of non-governmental organizations operating in South Africa (“SA”), and these INGOs have a significant impact on the social, economic and political activity of SA (and Africa as a whole) and are investing large amounts of foreign currency in SA in respect of their public benefit activities.
Several INGOs which are based offshore establish a branch in SA in order to conduct their public benefit activities in SA or to oversee the affairs of their activities on the African continent. In terms of the South African Companies Act, an entity incorporated outside SA (“the Foreign Entity”) which has established a place of business or a branch within SA must be registered in SA as an external company. The effect of registration as an external company is that the Foreign Entity is recognised as a body corporate in SA and is subject to the provisions of the Companies Act. The fact that the external company does not have separate legal personality from the Foreign Entity has the result that the Foreign Entity is excluded from SA tax relief which is available to similar entities which are incorporated in SA, as more fully discussed below.
Proposed income tax relief
The registration of the Foreign Entity as an external company in SA does not make the Foreign Entity a resident for SA tax purposes. Regardless of its place of registration, the Foreign Entity will only be regarded as a SA resident if it is, or becomes, effectively managed from SA.
If the Foreign Entity is not effectively managed from SA and only has a permanent establishment in SA the Foreign Entity, as a non-resident, will only be taxed on income from a SA source. However, the South African Income Tax Act (“the ITA”) has adopted the description of a “permanent establishment” contained in article 5 of the OECD Model Tax Convention on Income and on Capital, which means that if the Foreign Entity has a fixed place of business, an office or a branch in SA, it would have a permanent establishment in SA through which a business is carried on. Accordingly, as a non-resident, the office or branch in SA would be subject to income tax on income from a SA source, and also subject to Capital Gains Tax (“CGT”) on any capital assets in SA that it disposes of.
The ITA grants preferential tax treatment to non-profit organisations which are classified as Public Benefit Organisations (“PBOs”) in terms of section 30 of the ITA, with the effect that PBOs enjoy the benefit of being exempt from a number of SA taxes. A PBO can be a company incorporated under section 21 of the Companies Act, a trust or an association of persons (a voluntary association governed by a constitution). However, the definition of PBO does not allow for the inclusion of SA branches of offshore INGOs, and therefore these branches do not qualify for tax exemption.
Because of the significant impact which INGOs have on the development of SA it is necessary that the ITA be amended to allow SA branches of foreign INGOs to qualify for PBO status. This will ensure that these branches are exempt from tax (and will also allow the branches to issue section 18A certificates to SA donors, thus ensuring that the donors qualify for a tax deduction).
At present SA branches of INGOs will only qualify for PBO status if the INGO amends its foreign constitution to comply with section 30 and 18A of the ITA. Typically, such an amendment may affect the INGO’s tax exempt status in the foreign jurisdiction, and therefore INGOs are not prepared to meet this requirement.
It is understood that, without an amendment to the INGO’s foreign constitution, the SARS’ Tax Exemption Unit will have difficulty in monitoring the INGOs compliance with the ITA. A possible solution is that branches of INGOs, which have been approved as charitable organisations in terms of legislation similar than section 30 and section 18A of the ITA, be allowed to apply for PBO status in SA. The criteria that exist, for example, in the United States of America in respect to organisations that seek recognition of exemption from federal income tax under section 501(a) of the Internal Revenue Code, and in the United Kingdom in respect of organisations that seek recognition from income tax under the Charities Act, 1993, are similar to the criteria laid down in section 30 and 18A of the ITA. Accordingly, it is proposed that the definition of a PBO in section 30, read with section 18A of the ITA, be amended to include branches of INGOs which have been approved as charitable organisations under this legislation.
Proposed Value-Added Tax relief
As a result of their presence in SA INGOs incur considerable amounts of expenditure, most of which is subject to Value-Added Tax (“VAT”), which is levied at a rate of 14% (fourteen percent) by vendors on the supply of goods or services which are made in the course or furtherance of any enterprise carried on by the vendor.
A “supply” is defined as including performance in terms of a sale, rental agreement, instalment credit agreement and all other forms of supply, whether voluntary, compulsory or by operation of law, irrespective of where the supply is effected. A “vendor” is defined in the VAT Act as any person who is required to be registered in terms of section 23 of the Act. Section 23 requires any person who carries on any enterprise and whose total value of taxable supplies (taxable turnover) exceeds, or is likely to exceed, R300 000 in any 12-month period, to register as a VAT vendor. Although a person making taxable supplies below R300 000 per annum is not required to register as a VAT vendor, section 23(3) of the Act allows any person who carries on any enterprise and whose total value of taxable supplies (taxable turnover) exceeds R20 000 in any 12-month period to voluntarily register as a VAT vendor. Voluntary registration will only be considered if such person has already reached a taxable turnover of R20 000 within one year.
An “enterprise” is defined as any enterprise or activity which is carried on continuously or regularly by any person in SA or partly in SA and in the course or furtherance of which goods or services are supplied to any other person for a consideration, whether or not for profit.
It is not a requirement that the activities forming an “enterprise” be conducted with the object of making a profit. A consequence of this is that non-profit organizations (associations not for gain) although not making any profit, may be engaged in taxable activities if they supply and charge for goods and services for a consideration which exceed R20 000 in the past 12 month period. However, where an association not for gain makes supplies for no consideration it may not register for VAT. An “association not for gain” is defined in section 1 of the Value Added Tax Act, 89 of 1991 (“the Act”) as an association or organisation which is not carried on for profit and is required to use any property or income solely in the furtherance of its aims and objects.
Expressly included in the definition of an “enterprise” are the activities of any “welfare organization”. A “welfare organization” is defined as any association not for gain which is:
- registered under the Non-Profit Organisations Act; and
- exempt from income tax in terms of section 10(1)(cN) of the ITA (in other words, registered as a PBO); and
- carries on welfare activities categorised under the headings welfare and humanitarian, health care, land and housing, education and development or conservation, environment and animal welfare.
A welfare organisation therefore enjoys special treatment as it is not required to meet the R20 000 threshold of taxable supplies to qualify for voluntary registration under the Act. In addition, it does not have to account for output tax where it merely donates goods or services to the needy, but may claim input tax on the VAT incurred on the acquisition of such goods or services.
As explained above, due to the fact that the SA branch of an INGO does not fall within the definition if a PBO it will not qualify for registration as a “welfare organisation”. It is proposed that the definition of “welfare organisation” be amended to the effect that the SA branches of foreign INGOs will also qualify as a welfare organisation. This will ensure that these branches are allowed to claim input tax on the VAT incurred on the acquisition of such goods or services in SA.
In response to the announcement by the Minister of Finance in its 2006 Budget Speech that one of the proposed adjustments to the tax rules for PBOs is to provide tax exemptions to foreign PBOs operating in SA, the National Treasury has recently indicated that it is investigating tax relief to INGOs in SA by amendments to the relevant tax legislation.