Public benefit organisations – the tax treatment of income derived from trading activities

Public benefit organisations (PBOs) play an important role in society as they relieve the financial burden on the state to undertake public benefit activities. Tax exemptions and deductions are available to assist PBOs achieve their objectives.

The sole or main object of a PBO must be to conduct a public benefit activity. The PBO's public benefit activity must, in accordance with s30 of the Income Tax Act, No 58 of 1962 (Act), be carried out in a non-profit manner and with an altruistic or philanthropic intent. Consequently, a PBO which carries on a public benefit activity with the sole purpose of making a profit will act contrary to the fundamental objective of a PBO. However, in a situation where a PBO, as part of undertaking a public benefit activity carries on a business undertaking or trading activity and earns income, is the PBO contravening the provisions of s30 of the Act? Put differently, what will the tax consequences be where a PBO carries on undertakings and activities for a profit, while the sole or main object remains the conducting of a public benefit activity?

As a point of departure, s10(1)(cN) of the Act permits a PBO to carry on business undertakings or trading activities, provided that the sole or main object of the PBO remains the carrying on of a public benefit activity as listed in Part I of the Ninth Schedule to the Act. Prior to April 2006, the law regulating the extent to which a PBO may conduct business undertakings or trading activities was contained in s30(3)(b)(iv) of the Act. In terms of this old rule, a so-called 'all or nothing' approach was followed as PBOs were prohibited from carrying on business undertakings or trading activities outside certain restricted limits. A PBO which failed to comply with these provisions forfeited its status as a tax exempt entity.

Currently, s10(1)(cN) of the Act provides that the receipts and accruals of a PBO that arise i) otherwise than from any business undertaking or trading activity or ii) from a business undertaking or trading activity which falls within one of the four exemption categories listed in the section, will be exempt from normal tax. The exemption categories under which the business undertaking or trading activity must fall in order to render any receipts or accruals exempt from tax, are the following:

• activities or undertakings which are integral and directly related to the PBO's sole or principal objective;

• activities which are occasional in nature and are undertaken substantially with assistance on a voluntary basis without compensation;

• activities approved by the Minister of Finance (Minister) by way of notice in the Government Gazette (GG) having regard to certain criteria; or

• any activities that are not integral and directly related to the sole object of the PBO, not of an occasional nature or not approved by the Minister, to the extent that the receipts and accruals do not exceed the greater of 5% of the total receipts and accruals of the PBO for the tax year or R200 000.

Each category has its own set of requirements, all of which must be met before the particular exemption will apply. Each category will be discussed in more detail below.

Integral and directly related trade

Section 10(1)(cN)(ii)(aa) of the Act provides that in order to qualify for this exemption:

• the undertaking or activity must be integral and directly related to the sole or principal object which is the approved public benefit activity carried on by the PBO;

• substantially the whole of the undertaking or activity must be conducted on a cost-recovery basis; and

• the undertaking or activity should not result in unfair competition with other taxable entities.

Interpretation Note No. 24 (issue 3) published by the South African Revenue Service (SARS) on 4 February 2014 (IN 24), dealing with the partial taxation of trading receipts of a PBO, provides that a business undertaking or trading activity will be regarded as having been carried out on a basis substantially the whole, if at least 85% or more of the undertaking or activity is directed towards the recovery of costs (such as the costs of hiring venues, transport, equipment etc) and not the maximising of profits.

In addition, a PBO should not be in a more favourable position than a taxable entity conducting the same business undertaking or trading activity. In this regard, it is important for a PBO to determine whether there are other taxable entities carrying on the same or similar business undertakings or trading activities so as to not fall foul of this requirement. SARS will consider each case on its own merits in order to determine whether a PBO has such an unfair advantage.

Occasional trade

In order to qualify for exemption as an occasional trade, s10(1)(cN)(ii)(bb) of the Act provides that the business undertaking or trading activity must:

• take place on an occasional or an infrequent basis; and

• be undertaken substantially with assistance on a voluntary basis without compensation.

IN 24 provides that an undertaking or activity of an occasional nature is "one conducted on an irregular, infrequent basis or as a special event." Annual sales at which donated second-hand clothing are sold, charity golf days involving donated or sponsored prizes or a gala dinner to raise funds are examples of an activity of an occasional nature.

Further, any assistance in the business undertaking or trading activity must be predominantly undertaken on a voluntary basis without compensation. However, the costs incurred in the bona fide reimbursement of reasonable and necessary out-of-pocket expenditure will be allowed.

Ministerial approval

According to s10(1)(cN)(ii)(cc) of the Act, a business undertaking or trading activity may be approved by the Minister by notice in the GG by taking into account the following factors:

• the scope and benevolent nature of the undertaking or activity;

• the direct connection and interrelationship of the undertaking or activity with the sole or principal object of the PBO;

• profitability of the undertaking or activity; and

• level of economic distortion that will be caused by the tax exempt status of the PBO carrying on the undertaking or activity.

IN 24 provides that any submission to the Minister must "demonstrate and motivate the benefits of the business undertaking or trading activity for the general public, together with reasons why it will not result in unfair competition with other taxable entities, or erode the tax base." To date, no such undertakings or activities have been approved by the Minister.

Basic exemption

To the extent that the business undertaking or trading activity of the PBO does not fall within the first three categories listed above, the receipts and accruals of such undertaking or activity will, subject to a basic exemption, be subject to normal tax (s10(1)(cN)(ii)(dd) of the Act).

The basic exemption is the greater of 5% or R200 000 of the total receipts and accruals of the PBO. In other words, the total receipts and accruals of any business undertaking or trading activity which do not fall under the exemption categories in s10(1)(cN) of the Act, will be subject to tax. However, the PBO will be entitled to a deduction which is equal to an amount of 5% or R200 000 of the total receipts and accruals (whichever is greater). It is important to note that the total receipt and accruals from all undertakings and activities must be added together before the deduction of the basic exemption.

In light of the above, to the extent that a business undertaking or trading activity of a PBO falls under one of the categories listed above, the receipts and accruals from such undertaking or activity will be exempt from normal tax. However, in the event that the undertaking or activity does not fall under any exemption category, the PBO will be entitled to the basic exemption, while the remaining receipts and accruals from undertakings or activities will be taxed at 28%.