Some “taxing” questions for charities

Inland Revenue is consulting on the tax settings for charitable and not-for-profit (NFP) organisations. Its issues paper, Taxation and the not-for-profit sector, asks whether key tax settings for these sectors, including exemptions, are still fit for purpose and identifies a number of policy issues for consideration.

These are wide ranging, as is the potential scope of reform. Directors, trustees and others in governance roles at charities and other NFPs need to be aware of the key issues, their potential impact, and engage as part of this consultation process.  

Policy issues and areas for reform

The main issues covered are:   

The scope of the charitable business income tax exemption

Currently, a charity’s income, including income from any business activities carried out directly and indirectly, is tax exempt to the extent its charitable purpose is carried out in New Zealand. This is regardless of the type of business or trading activity undertaken and whether it directly relates to the charitable purpose.

The issues paper asks whether this tax exemption is too broad and should apply where a charity undertakes a business or trading activity that is unrelated to its charitable purpose. It raises a number of design considerations if the exemption is removed for income from unrelated business or trading activities, such as:

• how an unrelated business should be defined;
• whether there should be a “de minimis” exemption for small-scale business or trading activities; and/or
• whether there should be tax relief on distribution of business income to the parent charity.

Feedback is also sought on practical issues, such as current holding structures for charities’ investments in businesses and the transitional impacts if such a change proceeds.

Whether “donor-controlled” charities should be treated differently  

The concern is the scope for transactions between donors’ (non-charitable) business activities and their “controlled” charity (defined as a registered charity that is controlled by the donor, their family or their associates) to be used to artificially reduce or avoid tax. The issues paper notes that other countries have more robust rules around transactions involving donor-controlled charitable organisations, such as private foundations.

The issues paper asks whether such transactions should be prohibited altogether, subject to anti-avoidance rules (such as market value requirements) and/or whether donor-controlled charities should have a minimum distribution requirement each year, to prevent unrestricted accumulation of funds.

Other tax policy issues  

The issues paper also considers the following:

• The appropriate tax settings for NFPs that are mutual associations. The issues paper notes that most NFPs may not technically qualify for mutual tax treatment as their constitutions do not allow accumulated surpluses to be distributed to their members on wind-up. This has the potential to adversely impact many thousands of NFPs that currently do not pay tax on member transactions and levies, from professional bodies to sports clubs.
• The removal of specific exemptions for certain types of NFPs. These include regional promotion and scientific / industrial research bodies and non-resident charities with no charitable purpose in New Zealand.
• The need for the FBT exemption for benefits provided to employees carrying out a charity’s charitable purpose.  There is a concern that this may create labour market distortions.
• The effectiveness of the donation tax credit. The issues paper notes that only 20% of donors claim all of the donation tax credits they are entitled to each year.

Who is impacted?

The full spectrum of charitable and NFP organisations, from registered charities to Māori organisations, professional, trade and regulatory bodies to clubs and societies, are likely to be impacted by one or more of the issues under consideration.

Key considerations for those in governance roles  

The issues paper poses a number of “taxing” questions for the charitable and NFP sectors:

• What would be the impact if the tax exemption is removed for unrelated business activities? Not only from a new income tax liability but the accompanying compliance costs.
• What will be the impact on your holding structures for different businesses?
• Is your charity likely to qualify as “donor-controlled” and, if so, what transactions could be impacted if one or more reforms under consideration proceed?

The uncertainty around the current application of the mutuality rules is highlighted in the issues paper. Any reform in the area, to clarify the application of the mutual tax rules, could result in changes to how different NFPs need to operate and fund their activities – for example, if subscriptions and other levies become subject to tax.

Consideration of the above should be part charities and NFPs’ approach to good tax governance. Inland Revenue is placing more focus on tax governance, including documentation and testing of processes. The charitable and NFP sectors are not necessarily immune from this enhanced scrutiny. For example:

• Is tax part of your overall governance framework? This should include any non-income tax obligations, such as GST and employment taxes.
• Is there monitoring of any conditions to access the charitable tax concessions, or for application of mutual tax treatment? Are the results reported to those in governance roles?
• Are there robust processes to comply with non-income tax obligations, and regular testing of these for continuing accuracy and effectiveness?