Key Context: When tax exemption applies and when it doesn’t
If improvements are seen, SA is expected to exit the Financial Action Task Force (FATF) greylist in October 2025 or later. The country’s exit depends on the results of an on-site assessment by the FATF Africa joint group, which is scheduled to take place around May 2025. If the assessment is favourable, the FATF plenary will recommend removing SA from the greylist in June 2025.
A tax-exempt institution is an entity, either wholly or partially, exempt from income tax under section 10 of the Income Tax Act 58 of 1962 (the IT Act). Such entities include PBOs, recreational clubs, membership associations and homeowners associations.
The tax-exempt status stems from the activities and nature of these institutions, which warrant such preferential treatment. These exemptions generally allow charities, sports clubs, societies and even trade unions to conduct their activities without the burden of paying income tax.
Tax-exempt status can be obtained only if the Sars commissioner is satisfied that the institution complies with specified requirements. This involves an approval process that must be undertaken with Sars. An institution will not automatically obtain tax-exempt status by registering as a nonprofit company, being a non-government organisation (NGO), association, club or registering as a taxpayer.
The qualifying criteria differ for each type of institution. However, a commonality among these institutions is that their constitutions, written instruments or founding documents must meet certain specifications. The nature of activities and funding sources must also meet specific requirements.
These requirements must be contained in an institution’s founding documents. For example, the institution may not distribute funds or profits in the form of dividends or the like. Additionally, on dissolution, the institution’s assets must be disposed of to a similar institution or the government. There must not be a “for-profit” objective.
What is exempt?
Even if Sars approves an institution as tax-exempt, it does not mean that all its income will be exempt from income tax. For example, levies received by or accrued to homeowners’ associations are exempt from income tax, while other forms of income, such as commercial rental income, will be fully taxable.
The receipts and accruals of PBOs resulting from their public benefit activities will be fully exempt. In contrast, any other business activity (such as commercial rental income) will not enjoy total exemption. Specific associations might qualify for total exemption provided they have particular objectives and funding from specific sources.
Welfare organisations for purposes of VAT
An exemption from income tax does not necessarily extend to VAT. The VAT Act No 89 of 1991 does, however, contain provisions for the preferential VAT treatment of certain entities. The VAT Act contains a more restrictive concept for so-called “welfare organisations”, limited to a particular pool of PBOs. The VAT Act also includes the concept of an “association not for gain”, the relevance of which is that any donation received by such an association not for gain would fall outside the scope of VAT.
There is no overall VAT exemption for an entity type, but the VAT treatment of certain types of transactions is determined by the nature of the entity concluding them.
Strict compliance measures have been implemented to avoid the abuse of these institutions for tax purposes. Furthermore, a delicate balance must be maintained so that taxpaying “for-profit” taxpayers are not prejudiced if exempt entities conduct similar activities but are not taxed.
A further reason is that the FATF has specifically identified NPOs as vulnerable to terrorist financing abuse and money-laundering. Sars has, therefore, undertaken to carefully oversee tax-exempt institutions to prevent their use for illegal activities.
Important takeaways
In summary, the Income Tax Act provides for institutions with preferential tax treatment. Even where such a nonprofit company, association or recreational club meets the requirements of the act, an active application process must be undertaken to obtain tax-exempt status. A compliant written instrument, among other requirements, is essential to obtain this status.
Once the relevant approval is given, strict compliance requirements must be followed to prevent any issues with Sars.
Consulting a reputable tax adviser is necessary to ascertain whether the entity qualifies for full or partial exemption and then to identify the correct application process for the relevant exemption.
• Written by Estian Haupt, associate director at SA Direct Tax, Leonard Willemse, associate director at SA Indirect Tax, and Dawid Oosthuizen, an associate at specialist tax and transaction advisers AJM
Subscribe for free: iono.fm | Spotify | Apple Podcasts
