Part of the ongoing governance by the directors of a non-profit organization (NPO) is having an understanding of changes in the business landscape in which the entity operates. This includes changes to the tax environment for Canadian NPOs. In the past year, the tax regulator has issued interpretations suggesting that a NPO that carries on a business activity with the intention of making a profit that is more than incidental or ancillary or at other than on a cost-recovery basis, would disqualify the NPO’s net profits from tax-exemption. This interpretation has cumulated in a new structured tax audit program for NPOs by the tax authorities. This article examines those recent tax developments and suggests a strategy for self- review in order to assess what impact if any these changes have on the tax-exempt status of a NPO entity in which you serve as a director.
In recent months, organizations referred to as non-profit organizations (NPOs) (which do not include Canadian registered charities1) and their advisors have been digesting new interpretations by the Canada Revenue Agency (CRA) regarding the tax-exempt status of these organizations. Typically, NPOs include trade associations, community and recreation clubs, social clubs, condominium corporations, homeowners' associations, and advocacy organizations etc.
NPOs are self-determining entities with respect to their tax-exempt status. Organizations that are legally structured as NPOs do not automatically qualify as tax-exempt organizations for tax purposes. Historically, the CRA has not actively reviewed these entities.
A NPO that asserts that it is a tax-exempt entity pursuant to paragraph 149(1)(l) of the Income Tax Act (Canada) (ITA) (and similar provisions in relevant provincial tax statutes), must meet the following conditions to be federally tax-exempt:
While the tax legislation that governs the qualifications of an organization as a tax-exempt NPO has not changed, the interpretation of what constitutes an organization that is “operated for any purpose except profit” has changed. For an organization that is not organized with a social welfare, civic improvement, pleasure or recreational purpose, but is organized and operated for other than commercial or financial reasons, the issue to address is whether an organization is considered to be organized and operated for any other purpose except profit. On this issue, the Courts and the CRA have consistent views on some matters and not in others as it relates to an organization’s qualification as a NPO for tax purposes. The Courts have interpreted that a NPO can carry on a commercial business even if it operates in the same sector as for-profit entities. The Courts have also asserted that nothing legislatively puts restrictions on the nature of a particular activity undertaken by a NPO, including a commercial undertaking. As well, the Courts have interpreted that there need not be a public benefit component for the entity to qualify as a NPO for tax purposes — an organization can exist to better the conditions within one or more areas for a member group be it a community group, an industry group, or a professional association as examples, provided no income of the organization is directly or indirectly distributed to, or made available for distribution to, any of its members. In contrast, the CRA now asserts that any profit from these business activities should generally be unanticipated and incidental and that its undertakings should be done more or less on a cost-recovery basis. The CRA also suggests that undertaking a business activity with the intention to profit or having an “unreasonably high” accumulated surplus are likely indicators of a “for-profit” purpose.
The CRA’s narrowing view of what organizations are considered to be “organized and operated for any other purpose except profit” signals a renewed interest by the tax regulator in NPOs. This, together with the rollout of a formal tax audit program for NPOs puts these organizations in the spotlight and points to a higher risk that a NPO’s tax-exempt status may be challenged. As a consequence, a NPO’s management team together with its board may now wish to undertake a pre-emptive review of the terms of its constitution and its current activities to confirm if the organization meets the conditions to be a tax-exempt entity. If necessary, the NPO may look to restructure some of its activities if it considers any of those activities to put its tax-exempt status at risk or may look to document the reasons for its carrying on these activities and/or accumulating reserves. NPOs may look to the assistance of others such as professional advisors with respect to the review of its activities and the strategies it can put in place to safeguard its tax-exempt status.
1 Registered charities are subject to tax and governance rules that differ than those that are applicable to NPOs, including those that govern their qualification as tax-exempt entities.