Minding the VAT risks of Foreign Donor Funded Projects

By Elaina Silby, Junior Consultant and Kagiso Nonyane, Senior Manager

Countries and international organisations regularly donate funds to other countries for a variety of political, economic, humanitarian and strategic reasons. In South Africa, this often takes the form of a Foreign Donor Funded Project (FDFP). In this Article, we provide a high-level overview of FDFPs and their VAT requirements, including recent legislative amendments and current proposals.

Introduction

A FDFP is a project mandated through a bi-lateral agreement, wherein the South African government contracts with foreign governments or other international entities for the provision of goods or services, for the benefit of South Africans. These underlying agreements are known as Official Development Assistance Agreements (ODAAs) (as envisioned in the Constitution).

As with most international aid agreements, there will be a requirement that none of the funding may be used to pay taxes. In the case of VAT, a taxpayer generally claims back the input tax that it paid, and pays the output tax that it received, leaving it with a net result that is broadly representative of the percentage levied on its “value-add”. The purpose of the VAT treatment of an FDFP is to allow it to claim back the input tax that it paid, without having to charge or pay any output tax.

Although the legislative concept of an FDFP has been in use since 2006, the legislation directly linking FDFPs to ODAAs was only promulgated in 2020. The direct linking was facilitated by requiring the Minister of Finance to approve the project for it to qualify as an “FDFP” for VAT purposes. For clarity, as part of the requirements for the Minister to approve a project, each FDPF must have defined goals, measurable outcomes and specified timelines, and be directly linked to an ODAA.

Additionally, the concept of an “implementing agency” was introduced. An implementing agent is the entity that implements, operates, administers or manages a FDFP. An implementing agent can be the South African government, any institution or body appointed by a foreign government or any person contracting directly with the South African or foreign government.

Prior to 1 April 2020, the FDFP itself was required to register for VAT. The amendment changed the dispensation, and required the “implementing agency”, rather than the FDFP, to register for VAT. Thereafter, an FDFP’s implementing agent had to report to SARS regarding the receipt of funding, its distributions and VAT obligations.

VAT, FDFPs, and the implementing agent

VAT registration is centered around the concept and definition of an “enterprise”:

A person becomes liable to register for VAT if the person is carrying on an “enterprise” as defined.
The ordinary definition of “enterprise” refers to an enterprise in which goods or services are supplied continuously or regularly for consideration (in or partly in South Africa).
However, the definition of “enterprise” also includes the activities of an “implementing agency”, without those activities having to meet the criteria of the ordinary definition of “enterprise”.
Therefore, even though the implementing agency does not receive consideration for rendering services while carrying out the FDFP, the implementing agency must register for VAT.

An implementing agency may have various FDFPs that it manages, in addition to its own activities. Its own activities may already have required the implementing agent to be registered as a vendor due to it qualifying as an ordinary “enterprise”. In this case, the ordinary “enterprise” would constitute the main VAT registration and the activities of the FDFPs would be branches of the main VAT registration.

For example, if an implementing agent (already registered as the main VAT vendor) manages separate FDFP’s such as an HIV initiative FDFP, a vaccine distribution FDFP and a rural clinic FDFP, each of these should have been registered as separate FDFP VAT branches of the implementing agent. Prior to the legislative amendments below, the requirement was that these projects must be registered as separate VAT branches of the main vendor which resulted in an increased administrative burden for the implementing agents, being the recipients of foreign donor funding. The administrative burden was a cost of compliance to the taxpayer (implementing agent).

The Taxation Laws Amendment Act 42 of 2024 amended the legislation to address the administrative burden, in recognition of the fact that foreign donor funding plays a pivotal role in addressing South Africa’s socio-economic and other challenges.

The amended legislation allows for the consolidation of all the FDFPs that an implementing agency is currently managing, into one VAT branch. To the extent that an implementing agent has already registered all of the various FDFP VAT branches, it has two options:

retain all the existing branches in the already separately registered FDFP VAT branch registration(s) until the projects are finalised; or
make an application to SARS to register a new FDFP VAT branch that will encompass all the FDFPs under the implementing agency’s management. The implementing agent would then have to deregister all the “old”FDFP VAT branches that are effectively being moved to the new single FDFP VAT branch.

FDFP’s that are approved after 1 January 2025 will be registered under only one FDFP VAT branch which represents all the FDFPs under the implementing agency’s management. Therefore, all new FDFP’s will automatically fall under the implementing agency’s single FDFP branch.

On 12 September 2024, BDO attended a public workshop held by National Treasury discussing the above 2024 legislative amendments where concerns were raised regarding delays being experienced with FDFP approvals - the Minister of Finance’s approval is required for a FDFP to qualify for VAT purposes.

Unless the Minister of Finance has given its written approval of the project as an FDFP, SARS will not recognise or register it as an FDFP for VAT purposes. By registering an FDFP as a branch of an implementing agency, a FDFP is allowed to claim back the input tax that it paid and to apply VAT at the zero-rate on the foreign donation received. By not being able to access the benefits of being a FDFP, the project stands the risk of being subject to VAT in the same way as any other “ordinary” enterprise.

During the workshop, National Treasury acknowledged the concerns attendees raised and advised that it would address the delays. It is unfortunate that a year later in 2025, this is still an issue.

Past and future administrative requirements

In terms of the legislation prior to the above amendments, the implementing agent had to register the main enterprise and each of the FDFP VAT branches separately with its own VAT number and maintain independent accounting systems for its own enterprise and for each of the FDFP VAT branches. It was also required to submit a separate VAT return for its own enterprise and for each FDFP VAT branch.

The Draft Taxation Laws Amendment Bill (issued for public comment on 16 August 2025), proposes that the implementing agency also be required to maintain and retain the following, effective from 1 April 2026:

An independent system of accounting for each FDFP;
for each FDFP that is accounted for under the separately registered single VAT branch during the financial year, a list of all registered projects, together with each project’s FDFP reference numbers, commencement and end dates;
a reconciliation of the income and expenses (and the VAT relating thereto) for each FDFP to the values submitted/declared for each tax period of the separately registered branch, and
written confirmation from Minister that the FDFP is a project established in terms of an ODAA.

General VAT compliance

FDFPs may only claim VAT on expenses incurred if they are in possession of a valid tax invoice at the time that they submit a VAT return. Generally, VAT vendors are not entitled to claim input tax on all their expenses and are limited to only claim permissible deductions. In the case of FDFPs, a more generous dispensation applies and FDFP’s are entitled to claim all the VAT incurred as input tax for expenses incurred in carrying on the project.

As a reminder, as with most tax records, the Tax Administration Act requires that all relevant tax records must be retained for a period of five years from the date on which the relevant return was submitted.

Conclusion

The 2024 amendments which allow for the consolidation of all the FDFPs that an implementing agency is currently managing into one VAT branch, will hopefully address the cost of the current administrative burden, being the cost of compliance for the implementing agent.

Due to the strict requirements, implementing agents are advised to ensure that they are compliant from a VAT perspective. Since one of the main requirements of an ODAA is that the donations are not used to pay any tax, any payment of taxes will be in direct contradiction of the ODAA.

Lastly, any non-compliance by an implementing agent threatens the project with the sanction of penalties and interest. Although funding penalties and interest (and administrative costs) are not the same as paying taxes, no donor wants to receive news regarding the use of donor funds for such purposes, rather than the intended use for the people of South Africa.

We therefore recommend that implementing agencies approach their tax advisors to determine whether a project qualifies as an FDFP, for assistance with the approval by the Minister of Finance, registration of the FDFP VAT branch and general VAT compliance.