Trading PBOs - Advantages of Tax Exempt Status

donors tax status tax PBOs
Wednesday, 10 June, 2009 - 13:17

In many countries throughout the world, the definition of a non-profit organisation has long been that profits are not distributed - not that profits are not made. It has taken South African tax laws a while to catch onto this distinction. Tax-exempt Public Benefit Organisations (PBOs) are now permitted to trade without limitations. If their trading income does not fit under one of the headings which exempt it they are required to ‘ring-fence’ their trading income, and to pay tax on it, but are granted a generous ‘rebate’ on trading income. It is this ‘rebate’ which makes tax exemption attractive to trading NGOs

Is the international credit crunch affecting the funding of South African NGOs? If it is, this is only the latest in a series of developments - beginning with the diversion of funding away from NGOs after 1994 - that has led to NGOs focusing on business development and sustainability, in an attempt to lessen their reliance on donor funding.

Of course, the NGOs that wish to generate revenue, do not intend to distribute any profits made, but to plough them back into the achieving of their objectives.

In many countries throughout the world, the definition of a non-profit organisation has long been that profits are not distributed - not that profits are not made. It has taken South African tax laws a while to catch onto this distinction.

Under the old section 10(1)(f), tax exempt organisations were prohibited from carrying out trading activities. Under the new tax exemption laws, which were promulgated in 2000, they could trade, but only within the parameters of one of the subsections of section 30(3)(b)(iv) - one option was that trading could not exceed 15 percent of gross revenues.

This restriction was abolished with effect from 1 April 2006, and tax-exempt Public Benefit Organisations (PBOs) are now permitted to trade without limitations. If their trading income does not fit under one of the other headings which exempt it (now relocated from section 30(3)(b)(iv) to section 10(cN)(ii)), they are required to ‘ring-fence’ their trading income, and to pay tax on it, but are granted a generous ‘rebate’ on trading income. It is this ‘rebate’ which makes tax exemption attractive to trading NGOs.

When a PBO is taxed, it is allowed a ‘basic exclusion’ (which acts like a sort of a 'primary rebate') of R100 000 or 5 percent of gross receipts (whichever is larger), when taxable income is calculated. ‘Gross receipts’ includes all kinds of income-capital (eg donor funding), trading, passive, investment income etc. It follows therefore, that the greater the ‘gross receipts’, the larger the ‘basic exclusion’, and the less tax will be paid. Effectively, an NGO may make a profit on trade up to the value of R100 000 or 5 percent of its gross revenue, tax free.

It is important to note that, while the NGO may be a profit-generating organisation, its main objects must still be public benefit activities as defined, and its supporting documents must be framed so that they comply with the tax exemption legislation, so that the NGO may register as a PBO and take advantage of the benefits of tax exempt status, one of which is the ‘basic exclusion’.

Care should also be taken that the founding documents of the NGO do not still contain any of the prohibitive clauses required under the old legislation, or the organisation will be acting outside of its powers when it trades.

Nicole Copley is an NGO lawyer who has worked in the NGO sector for 16 years, drafting and amending founding documents, obtaining tax exemptions and NPO registrations, and providing advice and assistance to NGO's countrywide. Her background is in business law, and she also drafts and vets commercial agreements for her clients.

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