MEMORANDUM OF COMMENTS
concerning
THE DRAFT TAXATION LAWS AMENDMENT BILL, 2002
[Draft: 24 May 2002]

Submitted on behalf of:

The Non-Profit Partnership with assistance from Richard Rosenthal Attorneys

1. INTRODUCTION

The Non-Profit Partnership ("NPP") acknowledges, with appreciation, the opportunity to address the Committee on the draft Taxation Laws Amendment Bill of 2002, as it impacts upon the non-profit sector, and civil society. It particularly acknowledges the substantial improvements that are envisaged by the draft Bill, which not only clarify the drafting but also resolve a number of problems and deficiencies that have been identified in earlier versions of this legislation.

The NPP also wishes to thank the Committee, and in particular its Chairperson, for their continued efforts to facilitate a constructive interaction between the non-profit sector and SARS, and more recently also with the National Treasury. Through this collaborative process, which has extended over a number of years, it is felt that a good foundation has been laid for a much improved taxation framework that moves away from outdated practice and archaic concepts, and reflects recent developments affecting NPOs within this country, and also the growing body of international precedent representing "best practice".

As a result of this collaboration, we have demonstrated the reciprocal benefits of constructive engagement between decision-makers in government, and stakeholders in the non-profit sector. Many of the provisions in the draft Bill reflect the result of this collaboration, between our representatives and professional advisers, and the relevant officials of SARS and the National Treasury, who have made themselves available on a number of occasions for extensive discussions regarding the underlying issues, thereby assisting in the process of formulating legislation which is more practicable, and better serves to promote an enabling environment for civil society.

The NPP notes with particular appreciation that many of the concerns previously raised in respect of activities omitted from the Minister's initial Lists of "public benefit activities", have now been addressed in the revised lists contained in the Ninth Schedule. Once again, the NPP wishes to acknowledge the spirit of co-operation that has characterised this revision process.

As a result, the NPP is now in a position to report back to those organisations that have previously participated by alerting it to particular activities not included in the original lists, but with which they are concerned. This process of consultation with an affected constituency is a good example of democracy in action - thus, we have informed; explained; consulted; debated; and given consideration to a wide range of views; and in the circumstances, the NPP is now in a position to report to the non-profit sector on the outcome of this consultative process, which has been afforded the opportunity to participate in the democratic process of reforming legislation in our country.

It would however, be naive to suggest that the draft Bill represents a final or perfect formulation of the law. We recognise that it is only through experience gained by applying the new provisions that the legislation's practicability, or impracticability, can be established. To a certain extent, the latest amendments in the draft Bill bear testimony to this reality, noting that these amendments are being proposed only one year after the original legislation introducing the new tax framework first came into effect.

In the circumstances, and despite the significant improvements made, we are obliged to draw to the Committee's attention a number of residual concerns which are dealt with in detail under the heading "Specific Comments" in Section 4 of this Memorandum.

2. GENERAL COMMENT
Despite the significant improvement; made; there do remain a number of residual concerns which have been dealt with in detail under the heading "Specific Comment" in the next section of this Memorandum.

One overall criticism of the legislation - which might be addressed on a future occasion - concerns its prolixity and complexity, particularly in the light of the fact that it has reference to many organisations that have very limited capacity and resources. Thus, for example, Section 30 sub-section 3(b) requires that the Constitution of all public benefit organisations that seek tax exemption must not merely refer to, but repeat verbatim a prodigious series of conditions that are to be incorporated into the constituting documents of each such organisation.

An example of the type of formulation that is necessary is contained in a Schedule annexed styled "prescribed Fiscal Conditions" (Annexure "A"). Apart from the length and complexity of these provisions, each affected organisation, faced with the necessity of incorporating these provisions, must embark upon a Byzantine process, the convening of general meetings (with proper notice, containing details of the envisaged amendments), in the case of Voluntary Associations; the passage and registration with 1:he Companies Office of Special Resolutions, in the case of Section 21 Companies - with due regard to the need to provide proof of the timeous despatch of 21 days' prior written notice; and the approval of not less than 75% of a quorate attendance of members; and in the case of trusts, the drafting and adoption of formal Deeds of Amendment, including lodgment and registration thereof with the Master of the High Court.

Suffice it to say that thousands of organisations are faced with the prospect of having to amend their Constitutions , for which purpose they will need to engage (at their own expense) the services of legal practitioners and accountants with the necessary skills, in order to assist them to comply with these requirements.

The alternative procedure might have been to formulate legislation in such a manner as to require the signing of a Written Undertaking of Compliance with the relevant provisions, which would thereby become binding upon organisations seeking tax exempt status, notwithstanding any interim dissonance in their written Constitutions. In this manner, the issue would then become one of compliance rather than necessitate the amending of constituting documents.

The problem of a "knock-on effect" is exacerbated by the fact that the prescriptive provisions may be altered by the Legislature from time to time (as is, presently envisaged); and on occasion of each such amendment every tax exempt organisation has to repeat the process, and once again amend its Constitution in order to ensure continuing compliance.

3. IMPLEMENTATION
In response to our prior representations, provision is now made (vide clause 3(3B)) for the Commissioner to approve organisations with retrospective effect. This is an essential mechanism to deal with the hiatus that would otherwise exist, particularly with respect to newly established organisations, in circumstances where the Written Undertaking procedure is not applicable.

It will be recalled that in terms of section 21(2)(a) of the Taxation Laws Amendment Act 2000, existing organisations which previously enjoyed tax exempt status retain such status until the Commissioner notifies his decision, provided inter alia a Written Undertaking of Compliance with the provisions of section 30 is lodged with the Commissioner within a period of twelve months -now extended in terms of section 30(3B) to 31 December 2003.

These provisions have to a large extent overcome the problem previously referred to, but a difficulty still persists. We refer to the fact that until such time as existing organisations complete and file a Written Undertaking which makes reference to the new legislation (due not later than 31 December 2003), their prior tax exemption continues but it is unclear what conditions apply (the new or the old) during this "interregnum". Suffice it to say that the conditions and constraints imposed under the previous legislation are substantially different to those imposed under the new legislation, and it is essential that the issue be clarified as to which conditions - the old or the new - apply during the period prior to formal approval of the applicant organisation, and including any period to which the retrospective application of the exemption may apply.

4. SPECIFIC COMMENTS
PROPOSED AMENDMENTS TO THE INCOME TAX ACT NO.58 OF 1962
SECTION 1O(1)(CA)(ii):
This Subsection follows the provision of the Ad: in terms of which institutions, boards, or bodies (such as Universities or Technikons) which are established under any law, are exempted from income tax. The subsection extends the exemption to wholly owned subsidiary companies, provided they fall within the description of "South African companies, all the shares of which are held by any such institution, board or body, if the operations of such company are ancillary or complementary to the object of such institution, board or body"'.

The provision is important to Universities and Technikons inter alia, because it enables them to "house" particular income generating and related service operations in wholly-owned subsidiaries.

Unfortunately, the manner in which this provision is presently drafted gives rise to at least two technical problems, viz

1. Where the subsidiary company is owned not by one such institution, but jointly by several - as in the case of collaborative research and educational facilities; and

2. Where the subsidiary company is not a company limited by shares, but as in the case of Section 21 Companies, limited by members' guarantees.

There are several existing examples of major entities in the Higher Education sector which are not provided for, viz. the Cape Higher Education Consortium (Association Incorporated under Section 21) ("CHEC"); and the Tertiary Education Network (Association Incorporated under Section 21) ("TENET"). CHEC is engaged in a range of activities in order to improve and rationalise shared resources for the benefit of Universities and Technikons in the Western Cape. TENET is engaged in providing (at cost) broadband internet service to all South African Universities and Technikons. Both these entities are established as Section 21 Companies - that is, companies without share capital, but having a broad-based institutional membership.

Theoretically, it might be possible for such Section 21 Companies to seek tax exemption as "Public Benefit Organisations" in terms of section 10(1)(cN); but unfortunately this creates its own problems, including the prescriptive and restrictive provisions relating to permissible investment, "trading", and governance.

The problem could be quite simply resolved by means of a small amendment to sub-section 10(1)(CA), as follows:

"(ii) [Existing Clause]
Any South African company all the shares of which are held by one or more such institution, board or body, if the operations of such company are ancillary or complementary to the object of such institutions, boards or bodies.

(iii) [New Clause]
Any association not for gain incorporated in terms of section 21 of the Companies Act 1973 (Act 61 of 1973), provided that all the members of such association are institutions, board';, or bodies referred to in subsection (i), and/or their respective nominees."

[The need for a reference to nominees arises from the fact that Section 21 Companies are deemed to be "public" companies, and as such require a minimum of 7 members. The lacuna is resolved by including as members, both institutions and their respective nominees.]

SECTION 18A (page 20 et seq):
Preliminary:
1. It is noted with appreciation that the List of qualifying public benefit activities (Part II of the Ninth Schedule) has been expanded in terms of the undertaking of the Minister of Finance in his latest Budget Speech; and that provision is made for such List to be further expanded from time to time as may be deemed appropriate and affordable by the fiscus.

It is the view of the Non-Profit Partnership that all public benefit activities should be eligible for section 18A tax deductible status, both in the interests of sustainability of hard-pressed civil society organisations; and in order to obviate a distortion of donation patterns by taxpaying donors; and in order to simplify the legislation and the demands it imposes on SARS and the affected organisations. At this stage there are a number of anomalies, e.g.

1.1 The fact that all except three of the activities itemised under "Education and Development" are included, and it is unclear why the whole category cannot be covered.
1.2 For reasons that are likewise unclear, there is now included the establishment and management of trans-frontier areas, whereas other more basic and compelling needs in society are not similarly favoured.

2. One of the complicating implications of the present fiscal "dichotomy" is that particular activities may from time to time be extracted from Part I and added to Part II of the Ninth Schedule. This has complex implications for organisations who engage in both section 18A activities and non-section 18A activities - for example, in relation to the 75 % distribution rule. The problem is exacerbated by the fact that SARS has intimated an intention to impose a condition (not provided for under the legislation) that section 18A activities must be conducted in a dedicated entity that does not involve itself with non-section 18A activities. In the result, large organisations involved in supporting a broad cross-section of public benefit activities are now faced with the necessity to fragment their operations and constitute two separate entities, which in turn raises problems involving the transfer of endowment funds, and the appropriation of grants and donations.

The duplication of entities has cost implications and imposes further demands upon SARS' oversight. It is suggested that this self-imposed and artificial structural separation is unnecessary, and that the purposes of the Act could be satisfactorily achieved - with less cost and difficulty for both SARS and the organisation concerned - if the requirement be merely (as heretofore) that separate books of account and vouchers be maintained in respect of the two categories of activity, and that if necessary an Auditor's Certificate accompany the submission of financial statements, verifying the separation of income and expenditure as between the two categories.

Subsection 1(a)(ii) : The Minister is now enabled to determine other activities than those currently itemised in Part II of the Ninth Schedule. For practical reasons, we would urge that the Minister be enabled to make such determinations also with retrospective effect. As the present series amendments clearly illustrates, it is inevitable that new activities will be identified from time to time that were inadvertently omitted, and an anomalous situation would arise if such omissions were not capable of being rectified retrospectively, in appropriate circumstances.

Subsection 1A and B : It has been a consistent principle that Parliament should retain control over the substantive provisions of this legislation, in order to avoid a situation such as that which previously pertained, whereby the Commissioner could impose at will further conditions, without Parliamentary involvement or oversight. Hence, the requirement that all new activities are to be tabled and incorporated into the Act within twelve months after promulgation.

Our present concern relates to the power reserved to the Minister to 'prescribe additional requirements',' which in effect represents a reinstatement of the Commissioner's erstwhile powers to prescribe subordinate legislation. We would urge that any such additional requirement as the Commissioner may decide to impose, should likewise be included in the substantive legislation within a period of twelve months; and that prior to promulgation, there be a public participation process, consonant with the principles stated in the Promotion of Administrative Justice Act.

Subsection 5(a)(i) : A typographical error - delete the word "the "prior to the word 'purposes" in the second last line.

Subsection 5(b): We propose that the "penalty" be not imposed unless the regulating or co-ordinating body of a group has "deliberately or negligently" failed to exercise control.

We are concerned that a default on the part of the regulating or co-ordinating body results in the punishment of an innocent victim" (i.e. the donor), who thereby loses the right to tax deductibility. Moreover, the "penalty" is a blunt weapon, in that it brings down an overall sanction upon the entire group and all its members, whereas the offending party may be only a single errant constituent organisation. Accordingly, we suggest that provision be made for a particular constituent organisation to be penalised for its default, rather than the entire group; and that a remedy be provided for a donor who has in good faith made what the donor believed to have been a tax deductible donation. Such remedy could take the form of a right to claim repayment by the donee of an amount equivalent to the tax attributable thereto.

Subsection 1(b)(ii) We have previously made reference to an anomaly in this provision, which continues to stipulate that a recipient organisation is obligated "to distribute at least 75% of the funds received" in the year following the year of receipt. We understand that this provision is intended to ensure that the benefits of tax deductible donations "flow through" as quickly as possible. However, the present rigid formulation precludes the appropriation of such funds (as may be intended by the donor) for the establishment of a long-term endowment, or for some other good purpose which militates against immediate distribution; e.g. the acquisition of a building or some major equipment or asset required for the public benefit purposes of the organisation. Anomalously, the previous legislation (section 1()(1)(f)(A)) contained a similar requirement, but allowed the Commissioner to waive this requirement on good cause shown. For unexplained reasons, such discretion was eliminated by the new legislation, and this creates an untoward consequence in that a major donation cannot be used for a long-term purpose, such as the establishment of an endowment to fund scholarships, or the acquisition of a major asset.

In the circumstances, it is suggested that a further provision be inserted in section 18A along the following lines

"The Commissioner may, upon good cause? shown, and subject to such conditions as he may determine, either generally or in a particular instance, waive, defer, or reduce, the obligation in terms of subsection (1) (b) (ii), to distribute or to undertake to distribute, at least 75 per cent of the relevant funds received by or accrued to such organisation in a year of assessment, having regard to the desirability of enabling such organisation to establish a long term endowment fund, or to enable it to acquire a core asset, or for some other good purpose, as the Commissioner may deem to be in the public interest."

SECTION 30:
Definition : "Public Benefit Organisation" : The phrase "in a non-profit manner" in subsection (b)(i) has been retained though it is really meaningless.

In subsection (b)(ii), the prohibition of activity that promotes "the economic self-interest of employees" is unrealistic, inasmuch as employees have a substantive interest in establishing a secure financial base from which their remuneration is derived. Accordingly, we suggest the addition at the end of this sub-clause of the phrase, 'save to the extent of ~ reasonable and legitimate remuneration as envisaged by subsection 3(d)".

Subsection (b)(iii) envisages a double "filter" which is quite impractical. Thus, there has to be a calculation of
1. 85 % of total costs; and
2. 85 % of total time expended.

BOTH such calculations to be made - by a process of predicting the future -that is, at the time of engaging in the relevant activity, rather than at the end of the financial year.

Our preference would have been to eliminate this constraint on cross-border philanthropy. As we have previously obsessed, "human need and the philanthropic response knows no boundaries". [It is notable that cross-frontier Parks (which by no stretch of the imagination can be seen as a compelling social need) have been accorded not only income tax exemption, but also the benefit of income tax deductibility under Section 18A!]

However, if the principle is retained, we would urge that a single test be applied, based upon direct cost or expenditure only, without reference to time.

Subsection (c)(i) It is suggested that this clause would read more clearly if the phrase "or at least a significant sector thereof" be substituted for the phrase "including any sector thereof"

Subsection (c)(ii) : In view of the broad scope of the public benefit activities referred to in the Schedule, it is not realistic to envisage that each such activity will necessarily benefit, or be readily accessible, to the "poor and needy". It is therefore suggested that the phrase "insofar as this be may be reasonably practical" be added.

Subsection (c)(iii) : The practice has developed in recent years that many Nonprofit Organisations undertake public benefit activities on behalf of, and under contract to, State Departments, and other State entities. It is therefore suggested that the phrase "or other payments" be added after the word "grants" in the second line.

We draw attention to a certain inconsistency in the use of the term "organ of state" as reflected in this subclause, contrasted with the use of the term "national or provincial sphere of government" in several other clauses. Provision should also be made for international organisations such as USAID; the European Union; the United Nations Development Programme; the ILO, and other international development and funding organisations not covered by the phrase "foreign state".

Subsection (2): It is suggested that any prescribed conditions with respect to public benefit activities be also incorporated into the Act within twelve months, for reasons of public policy, as indicated above.

Subsection (3)(b)(i) : It would be anomalous to provide an indefinite ongoing exception applicable only to certain Will Trusts relating to persons who died prior to a fixed date (31 December 2003). The problem might be better addressed by according the Minister, or the Commissioner, power to waive this requirement on good cause shown in respect of any Trust established by Will (irrespective of the date of death).

Subsection (3)(b)(iii)(cc) : It is not clear why Local Government should be excluded; nor as to why other organs of State (a phrase previously used), or other State entities, should not similarly qualify.

Subsection (3)(g) : The Nonprofit Organisations Act, 1997, contains a number of prescriptive requirements which frequently occasion difficulty, including that the Constitution of registered organisations must contain provisions stating that:

1. "the organisation '5 financial transactions must be conducted by means of a banking account"; and
2. "the Constitution must determine the date of ending of the financial year".

These particular requirements of the NPO Act frequently result in the rejection of applications for registration, necessitating a convoluted and time-consuming process of constitutional amendments, notwithstanding the technical nature of the requirements. There are other respects in which the prescriptive requirements of the NPO Act differ from those contained in the Income Tax Act. For example, the definition of "nonprofit organisation "in the NPO Act refers to "a public purpose", as distinct from the very specifically defined ' public benefit activity" dealt with under the Income Tax Act.

It is suggested that in the light of these changes and experience gained, the NPO Act be also reviewed jointly by the NPO Directorate and SARS, in order to promote harmony between the provisions of both statutes.

Subsection (3)(h) : The word "advance" is equivalent to the word 'support'; and might be eliminated as tautologous.

Subsection (3)(A) : The notion that groups of organisations serve "under the direction of a regulating or co-ordinating body" is probably unrealistic, particularly in respect of groups, congregations and churches. The problem could be resolved by inserting after the word "direction", a phrase such as "or supervision (for purposes of this section)".

As indicated above, the provisions with reference to group registration, do not adequately cover the likely situation of one or a few errant constituent organisations. The so-called regulating or co-ordinating body may not be able to compel compliance. Its obligation should be satisfied in such circumstances by being required to report to SARS the existence of any such material failure of which it becomes aware.

Subsection (3)(B) : It is suggested that the power to back-date the approval of a particular organisation should cover not merely section 10, but also section 18A, where applicable.

It is also suggested that the clause end with the phrase "with retrospective effect'; more particularly as the date upon which the organisation "first qualified" may be unclear, as this presupposes a number of formalities, including changes to the Constitution; registration under the Nonprofit Organisations Act; the filing of a Written Undertaking, et al.

Subsection (5)(A) : It is suggested that this new provision be amplified as indicated by the underlined phrases, viz "Where ai7y regulating or co-ordinating body contemplated in subsection (3)(A) has deliberately or negligently failed to take any steps contemplated in that subsection to exercise control over any Public Benefit Organisation, or to notify the Commissioner in respect of a material failure to comply by one or more of its constituent organizations. the Commissioner shall after due notice withdraw the approval of the group of Public Benefit Organizations or in respect of the particular defaulting constituent organisations, with effect from the commencement of that year of assessment, where the regulating or co-ordinating body shall have failed to take corrective steps [are not taken by that organisation] within a period stated by the Commissioner in that notice".

Section 56 (Donations Tax):
Large numbers of Non-Profit Organisations do not require income tax exemption for the simple reason that their income derives from donations or grants (which are of a capital nature), and consequently they have no net taxable income. As presently formulated, the exemption from Donations Tax necessitates a primary exemption from Income Tax in terms of section 10(1)(cN). It is suggested that this is unnecessary, and that a donation should be exempted if the beneficiary is a registered public benefit organisation, on condition that the proceeds of the donation are applied solely for the purpose of a scheduled "public benefit activity".

NINTH SCHEDULE
PART I:
Item 1(I): It is suggested this item read, "the provision of legal services for poor and needy persons, or for the benefit of the General pubic".

The reason for this addition is that public interest and human rights organisations such as the Legal Resources Centre, provide services substantially to the poor and needy, but in some instances for the benefit of a much wider constituency - for example, in respect of environmental and public health issues.

Item 1(m): It is suggested that this item reach, "the provision of [day care] facilities for the Protection and care of children under school-going age of poor and needy parents".

The need for such facilities may extend beyond the limits of "day care".

Item 2(a): This item to read, "the provision of health care services to poor and needy persons; or in response to health needs of the General pubic".

Item 2(b) : It is suggested that the opening phrase read, "the care or counseling of terminally or chronically ill persons

Item 2(c): It is suggested that this item read, "The prevention of HIV( infection, the provision of preventative, therapeutic, and educational programmes relating to HIV/Aids".

Item 3(d): This item is very specific as to the particular structures and facilities, and we would therefore suggest that it be amended to read as follows "building and equipping of community centers, clinics, sports facilities (or) creches or other facilities and amenities for the benefit of the poor and needy".

Item 4(j) : The requirement that school buildings or equipment be located on land owned by the State, Public Benefit Organisations, or other institutions as referred to, does not cover the situation of farm schools, which play an important and deserving role in rural situations This omission could be covered by a further phrase, along the following lines

"Or upon land owned or held by other persons or entities, under conditions which secure, to the satisfaction of the Commissioner, the right to the use of such facilities for the benefit of the poor and needy, for a period of not less than 25 years."

Item 5(b) We have previously drawn attention to the anomalous wording of this item as referring to "the promotion and/or practice of a belief" - that is, without any qualification as to the sanity or lunacy of the "belief" referred to. Perhaps the provision could be rendered more coherent if (following a Canadian precedent) reference were to be made to a belief "directed to promoting the ethica4 spiritual, emotional or physical wellbeing of the community".

Item 6(b) : We suggest some minor changes to this item, as follows : "the promotion, establishment, protection, preservation, or maintenance of areas, collections or buildings of historical, aesthetic or cultural interest; including national monuments, national heritage sites, museums, (including) art galleries, archives and libraries".

Item 6(c) : This item to read, "the provision of youth leadership and development programmes".

Item 9 : The phrase "as a pastime" is curious, suggesting a casual and superficial relationship with the sport concerned. We would suggest that the phrase be deleted.

Item 10(a): There are many different types of donations "in specie',' apart from merely "funds or assets'; and we therefore suggest that the item read, "funds (or), assets, rights, services, or other resources by way of donation". The heading to clause 10 requires consequential editing.

Item 10(b): The phrase "direct cost" is problematic, not only because it may be difficult to calculate, but also because various organisations (the Independent Development Trust ('IDT") being an example) enter into contracts with the State involving a recoupment of both costs and a reasonable "overhead" to make provision for organisational support and the cross-subsidisation of other activities.

Item 10(iv) : Once again, there is an inconsistency in the reference to "any Department of State or Administration in the National or Provincial sphere of Government". What is omitted are Local Government and other entities or organs of the State.

PART II:
The same changes (where applicable) have reference to the equivalent items in this Part of the Ninth Schedule.