Public benefit organisations and tax: Where is the charity and justice?
04 April 2014
Posted by: Author: Lee-Anne Steenkamp
Author: Lee-Anne Steenkamp (University of the Western Cape)
An in-depth look at the tax relief offered to Public Benefit Organisations (PBOs) through the 2013 Taxation Laws Amendment Act
According to the definition of a ‘public benefit organisation’ in S30(1), the PBO can be formed in South Africa as a non-profit company (as defined in S1 of the Companies Act), or as a trust, an association of persons. Furthermore, foreign companies, associations or trusts can also qualify, provided that they are exempt from tax in that overseas country.
The following groups of activities are listed in the Ninth Schedule:
Not all tax-exempt PBOs can issue tax deduction certificates to donors. Section 18(2A) requires that the donation be utilised solely in carrying on activities contemplated in Part II of the Ninth Schedule.
- Welfare and humanitarian
- Health care
- Land and housing (for retired persons, clinics etc.)
- Education and development
- Religion, belief or philosophy
- Conservation, environment and animal welfare
- Research and consumer rights
- Sport (non-professional)
- Providing of funds, assets or other resources to other PBOs
- Support services to other PBOs
- Hosting certain international events
The 10% limit is based on taxable income excluding any retirement fund lump sum benefit, retirement fund lump sum withdrawal benefit and now also severance benefits (the latter was inserted by the TLAA).
"When economic times are tough and money is tight, welfare organisations are usually the first to suffer. A well-designed tax system which incentivises charitable donations is one way in which Government can provide much needed support to welfare organisations”.
A ‘public benefit organisation’ (PBO) is defined in section 30 of the Income Tax Act No. 58 of 1962, as amended (ITA). Generally, such an entity must have as its sole or principal object the carrying on (in a non-profit manner and with a philanthropic intent) of one or more public benefit activities. These activities, which are set out in the Ninth Schedule to the ITA, must be for the benefit of the general public at large.
If the PBO meets the requirements of S30 (which includes obtaining approval by the Commissioner of SARS), it can qualify for tax exempt status in terms of S10(1)(cN). Consequently, it could also qualify to issue S18A tax deduction certificates to its donors. The following tax relief applies in respect of transactions with an approved PBO:
- Income tax relief on non-trade income and on part of the trading income of the PBO
- No donations tax on donations to PBOs
- PBO need not register for provisional tax
- S18A deduction for donations made to certain PBOs
- No estate duty on bequests to PBOs
- No capital gains tax on assets disposed of to PBOs (as well as on certain assets disposed of by PBOs)
- Zero-rating VAT on supplies made by certain PBOs
- VAT exempt supplies of donated goods
- No transfer duty on purchase of fixed property in certain cases
- No securities transfer tax on certain transfers of shares
- Associations not for gain can elect to account for VAT on a payment basis
Recent developments and legislative amendments
(i) Rollover treatment for excess deductible donations
Section 18A allows for a deduction in respect of a bona fide donation (in cash or in kind) made by a taxpayer to certain approved PBOs. Currently, the deductible portion may not exceed 10 per cent of the
taxable income of the taxpayer before the deduction under this S18A and S18 (medical). The excess donation is permanently lost.
The 2013 Taxation Laws Amendment Act (TLAA), Act No. 31 of 2013, introduces a much welcomed relief by allowing the above excess donation to be rolled over as a deductible donation in the subsequent year of assessment (again subject to the 10 per cent rule). If any excess remains, the excess can be further rolled over again. The amendment applies to donations paid or transferred during years of assessment commencing on or after 1 March 2014. This respite is contained in an added proviso to S18A(1)(B) which reads as follows,
"Provided that any amount of a donation made as contemplated in this subsection and which has been disallowed solely by reason of the fact that it exceeds the amount of the deduction allowable in respect of the year of assessment shall be carried forward and shall, for the purposes of this section, be deemed to be a donation actually paid or transferred in the next succeeding year of assessment.”
The Explanatory Memorandum on the Taxation Laws Amendment Bill, 2013 (‘Explanatory Memorandum’) explains [at paragraph 1.3] that while Government remains committed to the 10 per cent limitation, there is concern that the ceiling has an "unduly harsh impact” on large donations. In attempt to address this concern, taxpayers can now arrange their affairs so as to spread large donations over multiple years.
Table 1: Calculation of amended S18A deduction – adjusted rollover
(ii) Deductible donations of appreciated immovable property
Section 18A allows a 10 per cent deduction of property donations (refer above). Briefly, the amount of the donation is determined in S18(3) as follows:
The Explanatory Memorandum [at paragraph 2.5] provides two reasons for the "lower of cost or market value” rule. Firstly, taxpayers should not obtain a deduction for pre-tax amounts (this is a reference to untaxed gains) and secondly, government was concerned that taxpayers overvalued their property so as to artificially enhance the deduction.
- Trading stock donated: amount equals cost price
- Other property: lower of cost to the donor (less any allowances claimed) or the fair market value on the date of donation.
A concomitant incentive is the S37C deduction of the cost of environmental conservation and maintenance on land. If the land is declared to be a national park or nature reserve with an endorsement on the title deed for at least 99 years, the lower of the cost or the market value of the land is treated as a S18A deductible donation. However, unlike regular deductible donations, the value of the deduction is spread over ten years at 10 per cent per annum.
In order to enhance the incentive for deductible donations on 99-year endorsements for land conservation, the TLLA provides that donations of appreciated immovable property that qualify as capital assets will be allowed to exceed cost. The Explanatory Memorandum recognises [at paragraph 2.5] that in some instances (for example, if the land has been passed on through family generations) the fair market value of the land is considerably larger than the cost. Therefore, failure to account for this appreciation basically negates most of the potential tax benefit for making a donation or a 99-year private endorsement.
Consequently, in terms of the amended rule, the deductible amount above cost will equal the lower of market or municipal value. The value of the S18A donation is calculated by using a newly introduced formula, inserted in S18A(3A):
- A = B + (C x D), where A = the amount of the deductible donation
- B = the cost of the land and buildings
- C = the notional capital gain that would have arisen if the land had been sold at the lower of market
- value or municipal value on the day of the donation
- D = capital gains tax inclusion rate (66.6% for individuals or special trusts and 33.3% in any other case)
The amendments are applicable to donations paid or transferred during years of assessment commencing on or after 1 March 2014. The amount (A) is treated as a S18A donation spread over ten years. However, in terms of the revised rollover rule, the non-deductible portion will be carried forward to the next year of assessment.
Table 2 below illustrates the amendment from the perspective of a 99-year endorsement of farm land by an individual who owns the farm. The farmland has a base cost of R250 000.
The donation is made during the year of assessment ending 28 February 2015 (this adjusted example is derived from the Explanatory Memorandum):
Table 2: Calculation of amended S18A deduction – appreciated immovable property
(iii) Interpretation of the expression "substantially the whole"
Under the partial taxation system a PBO is allowed to conduct a business undertaking or trading activity within certain prescribed parameters. Receipts and accruals derived from those activities in excess of prescribed limits are taxable (although the PBO retains its overall tax exemption status).
This exemption is contained in S10(1)(cN)(ii)(aa) (B) which determines that the business undertaking or trading activity, "is carried out or conducted on a basis substantially the whole of which is directed towards the recovery of cost".
SARS issued Binding General Ruling No. 20 on 10 December 2013 to provide clarity on the interpretation of the expression "substantially the whole" as referred to in sections 10(1)(cN), 10(1)(cO), 30B, paragraph 63A of the Eighth Schedule to the ITA and S9(1)(c) of the Transfer Duty Act. In terms of the ruling, "substantially the whole" is regarded by SARS to mean 90 per cent or more. However, in order to overcome certain practical difficulties SARS will accept a percentage of not less than 85 per cent. The ruling acknowledges that the percentage must be determined using a method appropriate to the circumstances.
The following potential practical difficulties could be encountered:
- It is currently unclear what SARS regards as "practical difficulties".
- Although the practice generally prevailing had been to use a percentage of 85 per cent, organisations
- could have been exempt from tax on business activities if 83 per cent or 84 per cent of the income from these activities were directed towards the recovery of cost.
- However, the new percentage could take organisations unawares.
- Consequently, PBOs could lose their tax exemption on business undertakings or trade activities.
When economic times are tough and money is tight, welfare organisations are usually the first to suffer. A well-designed tax system which incentivises charitable donations is a way in which Government can provide much needed support to welfare organisations.
Charles Dickens wrote that "charity begins at home, and justice begins next door". It would seem that recent legislative developments are a step in the right direction towards advancing the concepts of charity and justice in South Africa.
This article first appeared on the March/April 2014 edition of Tax Talk.