PREPARED BY THE NON-PROFIT CONSORTIUM
SUBMISSION TO THE PORTFOLIO COMMITTEE ON FINANCE DRAFT REVENUE LAWS AMENDMENT BILL 2005
19 and 20 October 2005
INTRODUCTION
We appreciate the opportunity to address the Committee on the amendments to the Income Tax Act that will impact on the non-profit sector.
We would also once again like to acknowledge the progress made in this area of tax policy since 1999 when the Katz Commission’s Report on the taxation of non-profit organisations was released. Furthermore we would specifically like to thank SARS and Treasury for upholding their commitment to meet with the non-profit sector on a regular basis.
In his budget speech this year, Minister Manuel announced that the revenue laws will contain measures to assist PBOs that rely in part on income from business activities. This announcement was welcomed since the non-profit sector continues to battle with a funding crisis. 2005 has seen prominent organisations such as Interfund close down due to a shortage of funds. Others such as The South African Grantmakers Association and the national offices of SANGOCO have had to drastically reduce their service offerings and capacity because of a shortage of funding. International donors no longer perceive civil society in South Africa as a priority area. Local philanthropy cannot yet fill the gap. Many organisations are therefore compelled to undertake some income-generating activities in order to remain sustainable.
In general, the proposed amendments to Section 6, Section 10(1)(cN) and Section 30(3)(iv)(b) will bring much awaited relief to Public Benefit Organisations (PBOs.) We are strongly supportive of the proposed amendments to the extent that they correctly separate the requirements for tax exemption from the regulation of economic activities of PBOs. The amendments bring to an end the "all or nothing approach" with organisations losing their tax-exempt status if they exceeded the provisions of Section 30(3)(iv)(aa) to (dd). However, while doing away with the "all or nothing approach", the proposed amendments offer a narrower way of determining a minimum threshold, for the exemption from income tax, of income generated from regular unrelated trading activities.
We would like to raise the following concerns regarding the amendments as well as a number of more general matters that we hope will also be addressed:
COMMENT ON PROPOSED AMENDMENTS TO SECTION 10(1)(cN)
It is inappropriate because a public benefit organisation may have as its "sole objective" the carrying on of one or more public benefit activities and those public benefit activities may not be so closely related that it is accurate to describe them as one objective. For example, an organisation may have the objectives of promoting a particular religious faith as well as providing a home for orphans.
2. We welcome the fact that the amendment does away with the all or nothing approach to regulating income generating activities. However we believe that the scope to earn up to 15% of gross receipts from non-related business or trading activities, without paying tax, should be retained.
Subsection (3)(b)(iv) of Section 30 previously allowed a public benefit organisation to earn the greater of R25,000.00 or 15% of its gross receipts by way of non-related business or trading income without contravening the conditions for approval of its exemption.
The current amendment altogether removes the percentage threshhold.
The monetary threshhold is preserved, but has been converted to a rebate and is to be included in Section 6. The rebate is R10,800.00, the same as for individuals older than 65 years of age. If a tax rate of 29% were to be applied to all public benefit organisations, whether companies or trusts, the threshhold of taxable income would be R37,241.00.
Of course, this is not comparable with the previous threshhold of R25, 000.00 which referred to "gross income". A public benefit organisation may now have gross income of millions and provided its taxable income, that is its taxable profit, after the deduction of allowable expenditure, does not exceed R37, 241.00, it have no tax to pay.
Example
If an organisation owns commercial premises which it obtained in a bequest, and it rents out the spare office space to other NPOs with the aim of sustaining its own non-profit activities, in terms of Section 1 of the Income Tax Act this would be regarded, as trading as it amounts to "letting of any property". This activity is not related to the objectives of the organisation and is not of an occasional nature. It would therefore not fall under the categories Section30 (3)(b)(iv)(bb) or (cc) or (dd) in terms of the current provisions. If the organisation’s gross receipts for the 2005/2006 amounts to R6million, it would mean that the maximum exempted trading income under the de minimus rule for that year would be R900 000. In terms of the proposed amendments, the organisation would only be entitled to a maximum rebate of R10 800, which at the current tax rate of 29% for voluntary associations and Section 21 companies, would be the equivalent of a maximum exempt trading income of approximately R37241. The proposed amendments would in these circumstances provide for a significantly lower threshold on exempt trading income compared to the current provisions of the Act. The organisation would be much worse off in terms of amendments compared to the existing provisions.
If a public benefit organisation is able to raise funds for itself by business activities, and other-tax paying entities are not unfairly prejudiced thereby, it is surely against the policy of promoting public benefit activities, to hamper the public benefit organisation from funding itself, by subjecting its profits to tax.
3. The traditional approach by SARS to the business activities of exempt organisations has been one of discouragement. Under the previous dispensation, when the now deleted Section 10(1)(f) was the main provision, SARS would often respond to an application by stating that it was a condition of approval of exemption that the organisation may not carry on any business or trading activities. While the replacement of Section 10(1)(f) by Section 10(1)(cN) as read with Section 30 and the list of public benefit activities, has been a breakthrough for those non-profit organisations that did not fit into the categories of educational, charitable or religious, it has also been a real benefit to SARS. It enables SARS to exercise far more supervision and control over the activities of exempt organisations, including restricting their business activities.
It is not obvious why SARS should wish to restrict public benefit organisations from trading if their trading income is for the purpose of funding their public benefit activities.
An underlying reason may be that a "non-profit" organisation is not by its nature meant to carry on profit making activities. It is submitted that this is a misconception. The reason for the use of the description "non-profit" is primarily related to the Section 21 Company being described as an association not for gain. But the description refers to the prohibition on the distribution of profits of the association to any members or office bearers, not to a prohibition on the carrying on of profit making activities.
The point should be mentioned that the carrying on of a business activity by a public benefit organisation does not necessarily mean that if it did not operate there would be a tax paying entity occupying the same space, as it were.
A public benefit organisation may be provided with the capital to establish itself only as a result of donor funding, funding that would not be able to be raised on commercial terms by a tax paying entity. Furthermore, the multiplier effect of the activities of a public benefit organisation may well have beneficial economic effects. An organisation carrying on publishing would need to commission a commercial printer to prepare its publications. An organisation selling subsidised food to the poor would need to pay for its supplies to commercial suppliers. A sports club selling liquid refreshments to members and visitors would need to acquire them from the same suppliers as a commercial retail outlet.
It is submitted that the words
"carried out or conducted on a basis substantially the whole of which is directed towards the recovery of cost"
should be omitted from (ii)(aa)(B) of the proposed amendments.
For the reasons already mentioned there is nothing wrong with a public benefit organisation making profits.
Another reason for dropping this requirement is a striking contradiction between requiring business operations to be conducted on a substantially cost recovery basis on the one hand while on the other hand requiring that it does not cause unfair competition to taxable entities. To take an example, if a public benefit organisation’s object is to relieve malnourishment in a poor community by selling food to it at less than cost with the assistance of grant funding to cover its overheads, it is bound to undermine the sales of a commercial competitor in the same field of activity.
Logically, the higher the prices charged by the public benefit organisation the less likely it is to woo customers away from the tax paying entity. In an example such as this there would be no unfair competition flowing from tax exemption.
Examples where where a public benefit organisation is likely to charge prices that are higher than cost are:
If an organisation can achieve a profit in these situations, a profit that would contribute to its sustainability and to the furtherance of its public benefit activities, it does not make sense to require it to charge fees on a substantially cost recovery basis.
5. Experiences in countries like Croatia, have shown that a similar provision on "unfair competition" has proven very subjective, and difficult to interpret. Also, it is not "unfair competition" for an NPO to enter a trade ordinarily the province of commercial business. That is simply competition. Non-profit organisations frequently do not have some of the advantages that small businesses have in terms of being able to avoid tax by deducting various expenses
6. It is submitted that the words "integral and directly related to the sole object of the organisation" in (ii)(aa)(A) of the draft should be replaced by the words
"incidental to the objectives of that public benefit organisation."
It is submitted that the requirement that business activities be integral and directly related to the organisation’s objectives is too demanding if the words are to be strictly interpreted. The effect would be to discourage the use of an organisation’s income earning potential and disincentivise efforts to become financially sustainable. There is also potential for dispute in interpreting whether particular activities are "integral and directly related" and when they are incidental.
UNIFORM RATE OF TAXATION FOR ALL PUBLIC BENEFIT ORGANISATIONS
There doesn’t appear to be any rational justification for the fact PBOs that are charitable trusts are taxed at a rate of 40% while PBOs that are Section 21 companies and voluntary associations are taxed at a rate of 29%. The grounds for the difference in tax rates that apply to business trusts and for-profit companies, for example the allowance for the effects of STC, are not applicable or relevant to charitable trusts and Section 21 companies and voluntary associations.
Since the amendments to Section 6 make a provision for a uniform rebate for all PBOs, regardless of whether they are charitable trusts, Section 21 Companies or voluntary associations, there should be a uniform rate of taxation for all PBOs regardless of whether they are charitable trusts, Section 21 companies or voluntary associations.
SIMPLIFICATION FOR SMALLER ORGANISATIONS AND ALIGNMENT WITH REQUIREMENTS IN THE NPO ACT
It is with some concern that we note there are no amendments to Section 30 that make the distinction between smaller and larger PBOs, or provide for simpler registration procedures and reporting requirements for smaller PBOs, and no attempt to align the reporting requirements with the reporting requirements in terms of the Non-profit Organisations Act of 1997. We would be more than willing to present suggestions for simplification if and when required.
CONCLUSION
It is a considerable step forward that the public benefit organisations will not lose their status if the business income limits are exceeded. There is often much more than exemption from income tax that depends on public benefit organisation status, particularly, access to funding from other public benefit organisations, from institutions. Other benefits arise from exemption from estate duty and donations tax, from capital gains tax, from transfer duty, and in some cases from the Skills Development Levy.
In short we would like to appeal that more scope should be allowed to public benefit organisations to generate funds for themselves from business or trading activities in order to provide for their own sustainability without having to pay tax.
Thank you very much.
Acknowledgement of Contributors
The following individuals and organisations have contributed in resources, time and expertise in the preparation of this submission:
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Non-Profit Consortium 1st Floor Horizon House, 15 Pepper Street, Cape Town, 8001 Tel 021 4223413 Fax 021 4223329 |
Tracy Fortune Executive Director, AttorneyTessa Brewis NPO Law Programme Manager, Attorney Ricardo Wyngaard Attorney |
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The International Center for Not-for-Profit Law 1126 16th Street, NW |
Stephan Klingelhofer Senior Vice PresidentCathy Shea Program Director |
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Douglas and Velcich (CA) SA PO Box 32707 Braamfontein 2017 |
Jim Friedman |
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CMDS C. Masters Development Services cc |
Paul Tyler |
ANNEXURE A
We are of the opinion that Section 10(1)(cN) of the Income Tax Act should be altered as follows:
Section 10(1)(cN)
the receipts and accruals of any public benefit organisation that has been approved by the Commissioner in terms of Section 30(3), to the extent that the receipts and accruals are derived –
(i) otherwise than from carrying on any business undertaking or trading activity; and/or
(ii) from any business undertaking or trading activity of that public benefit organisation and
(aa) the gross income derived from all such business undertakings or trading activities other than the income arising from business or trading activities contemplated in (bb), (cc) and (dd)
(A) is derived with the sole purpose of funding the objectives of the organisation; and
(B) does not exceed 15% of the gross receipts of such public benefit organisation; and/or
(bb) the undertaking or activity is –
(A) incidental to the objectives of the public benefit organisation; and
(B) does not result in unfair competition in relation to taxable entities; and/or
(cc) is derived with the sole purpose of funding the objectives of the public benefit organisation and is of an occasional nature and undertaken substantially with assistance on a voluntary basis without compensation; and/or
(dd) is approved by the Minister by notice in the Gazette, having regard to –
(A) the benefit to society of the undertaking or activity;
(B) the relevance of the undertaking or activity to the objectives of the public benefit organisation;
(C) the potential for economic distortion, including unfair competition with taxable entities, that may be caused by the tax exempt status of the public benefit organisation carrying out the undertaking or activity,
and subject to such conditions as he may prescribe with regard to the factors listed in (A), (B) and (C) above.