In Armenia, most CSOs predominantly rely on grant funding. This has been true both before and after the ban on entrepreneurial activities for public organisations was removed in 2016. However, the ambiguity in the legislation, and particularly mentioning of grant funding in the context of economic activities in the Tax Code effective of 2018, has raised concerns among CSOs. During meetings that took place in 2023, the government authorities responsible for tax policies confirmed that grant projects shall be considered as service provision, which could be accounted as economic activities, once they imply pre-agreed project proposal and budget.
Inconsistency in using the concept of grants in the legislation
Armenian laws do not provide definition for grants. The definition of grants is provided only in the context of state grants by the government decision on the procedure for providing subsidies and grants to legal entities from the state budget. At the same type, the concept ‘grants’ is used in a number of laws, including those relevant to civil society organisations (CSOs).
- The abovementioned government decision defines grant as “a gratuitous and non-returnable monetary allocation from the budget to an organisation for the purpose of carrying out its statutory tasks in order to promote any branch of the economy or any type of activity.”
-
According to the Law on Public Organisations, the income sources for the organisation, among others, may include funds received from entrepreneurial activities, monetary inflows from the state budget, and donations, including grants. Thus, in the context of this law, grants are treated as type of donations.
-
Similar provision is set in the Law on Foundations, where the possible income sources of foundation include gifts and donations of individuals and legal entities (including gifts and donations of foreign citizens, legal entities, international organisations), monetary inflows from the state budget, and grants. Thus, in this case grants are treated as distinct from donations and entrepreneurial activities.
-
The definitions set in the Armenian Tax Code, however, state that the concept of provided work and delivered services (considered as economic activities which generate entrepreneurial income) also include the work and services that are covered by grants or subsidies.
Donor funding as the main source of income for Armenian CSOs
Financial sustainability of Armenian CSOs is the most vulnerable aspect of their activities: it continuously gets the lowest scores among all sustainability dimensions of USAID CSO Sustainability Index. Although Armenian legislation allows CSOs to access diverse sources of income, as mentioned in CSO Meter Report 2022, this possibility is not fully functional. This is due to the lack of incentives for CSOs to fundraise and undertake entrepreneurial activities, and therefore, most CSOs rely on donor funding.
At the same time, public organisations did not have a possibility of implementing entrepreneurial activities until the new law was adopted in December 2016. Thus, the practice of getting grant funding for CSO projects had been in place far before the ban on the entrepreneurial activities was removed. Grant projects have never been perceived by CSOs or donors as service provision that could be accounted as economic activities.
Tax Code sets threshold for CSOs to become VAT payers
The Tax Code, which includes activities funded by grants in the definition of work and services, has been effective since 2018. Since then, CSOs have become alarmed how their grant projects would be treated in this context, as this new definition could mean that grant projects are interpreted as a type of economic activities.
-
Even if grants are accounted as economic activities, there is no risk to be profit taxed as grant projects do not accrue any profit (as a rule, donor regulations require that unspent funds are returned to the donor).
-
However, value added tax (VAT) might be applicable. The Tax Code states that non-profit organisations become registered as VAT payers and have to charge twenty per cent VAT for provided goods, work and services in instances where the annual turnover of the organisation exceeds 115 million AMD (around 270,000 EUR), but only on the amount exceeding the threshold. Further , based on the Tax Code provisions, if the income for a certain year exceeds 115 million AMD, the organisation immediately falls into VAT payer category in the following year and thus has to charge VAT and pay it for any income subject to taxation.
At the same time, as practical evidence shows, CSOs continued to account grant projects as non-profit activities and reported to tax bodies accordingly, without facing any challenges related to their reports or payment of taxes.
The downside for CSOs for treating grant projects as economic activity
To address the ambiguity of legal formulations, the CSO Meter 2022 report recommended that the Ministry of Finance specifies the type of income included in the turnover serving as a basis for the VAT threshold, considering only the income from economic activities, as well as ensures that non-profit activities are not treated as economic activities. To promote this recommendation, meetings with the Ministry of Finance and State Revenue Committee were organised with support of the Office of Prime Minister, with the following conclusions:
-
The government representatives insisted that grant projects are indeed considered economic activities, as long as they are provided on the basis of pre-approved grant project and budget.
-
Possibility for tax exemption is provided to specific projects, for example in case there is a special government decision on the status of a specific project (e.g. if the project has gained the status of “charitable”). On the other hand, non-profit organisations are exempt from taxes in case they provide goods, work and services on a free of charge and non-repayable basis. In this regard, unconditional grants and donations (i.e. those that are not based on a specific proposal, budget, or reporting requirements) are exempt from taxes (as in this case the provided services and works will be considered as free of charge and non-returnable).
-
Grants from EU and USAID are also considered as income for economic activity. The government officials also confirmed that even though USAID and EU funded projects are exempt from VAT based on intergovernmental agreements, the grant funding from these organisations should be accounted in the calculation of threshold, although with no obligation for charging and paying VAT in case of passing the threshold.
CSO are concerned over the current government proposed solutions
CSOs are generally concerned that the interpretation of grant projects as economic activities might pose risks for organisations relying on grant funding. As a rule, CSOs do not often have any unrestricted financial resources (that they can use on their own discretion) to pay the VAT accrued. Also, the donors might not allow including VAT in the grant budget. The government officials taking this into account suggested three options for CSOs to resolve this issue:
-
First solution is that CSO can apply to relevant government commission and gain charitable status for their project, thus getting exemption from VAT. This solution means that CSOs would have to engage in bureaucratic procedures of getting charitable status, while this status might apply only to social projects of charitable nature, although the sector`s area of work is much broader.
-
Second solution is that CSOs can apply to the government for co-funding and thus cover VAT costs through co-funding. This option can bring an increasing risk to CSOs’ independence and critical stance towards the government. For example, organisations working on human rights protection or watchdog projects are usually reluctant to apply for government funding not to undermine their independence.
-
Third solution is that CSOs can minimise the VAT amount through making purchases and outsourcing services from entities that are registered as VAT payers, thus deducting the respective VAT amounts from the total VAT costs. CSOs do not consider this as a sound solution as grant budgets usually only partly include the purchase of goods and outsourcing services. An additional challenge is that many small companies and service providers work in special tax regimes and are not registered VAT payers.
As an alternative, CSOs would have to ensure that their funding does not exceed the threshold within the current year.
Treatment of grants as entrepreneurial income threatens CSOs’ access to funding
Overall, the interpretation of grants as economic activities threatens the access to funding, which is a fundamental right of non-profit organisations. Furthermore, it results in a number of additional potential challenges, such as including grant projects in accounting of economic activities, the necessity to provide invoice to donors, and overall confusion of what constitutes a non-profit versus entrepreneurial activities. This issue was reflected in the CSO Meter 2023 report as a deterioration in the area of Access to Funding with the respective decrease in the area score.