Most higher education providers are registered as charitable bodies at the Australian Charities and Not-for-profits Commission (ACNC). This entitles those providers to access the income tax exemption and other tax concessions. Many higher education providers also have deductible gift recipient (DGR) status for themselves or related bodies in their group.

Between 2012 and 2014, law changes were proposed that had the potential to adversely impact the tax status of higher education providers, where those providers donate funds to other organisations which operate outside of Australia, or where the higher education provider itself operates offshore (as many higher education providers do). The proposed changes affected the income tax exemption and DGR status. The government has previously indicated that it intends to enact these changes.

This article explains what the changes are, the confusing position as to the status of these proposed changes, and what higher education providers need to do in terms of governance to ensure that they meet the changes if and when enacted, so as to ensure that their tax status is unaffected.

Background to the proposed changes

To be entitled to tax concessions such as the income tax exemption and DGR status, entities must generally meet an 'in Australia' condition.

The current 'in Australia' condition for the income tax exemption is that the relevant entity must:  (a) have a physical presence in Australia and;  (b) to the extent that it has a physical presence in Australia, incur its expenditure and pursue its objectives principally in Australia.

This test, as it currently operates, considers the expenditure incurred and objectives pursued by the entity, but only to the extent of the entity's physical presence in Australia.

The current 'in Australia' condition for DGR status is that the DGR must be 'in Australia', ie that it must be established, controlled, maintained and operated in Australia and its benevolent purposes must be carried out in Australia (other than for certain overseas aid funds, or entities otherwise approved by a specific DGR listing).

There was some concern following the High Court of Australia's decision in FCT v Word Investments Limited (2008) 236 CLR 204 that the 'in Australia' conditions were not working appropriately. In that case, Word Investments Limited raised funds in Australia from commercial operations it carried out (eg a funeral business), and provided those funds to charities which operated outside of Australia. The High Court held that Word Investments did meet the 'in Australia' condition because it incurred its expenditure and carried out its activities 'in Australia' as was required by the test. The concern from the Commissioner was a policy concern - ensuring that the benefit of the income tax exemption was provided to an Australian entity that in turn benefitted Australians. The Commissioner was also concerned that Word Investments might not actually know that the recipient of the funds would utilise them for charitable purposes.

The proposed changes: 2012-2014

Legislation to amend the 'in Australia' conditions for both the income tax exemption and DGR status was introduced by the former Labor Government in August 2012, and lapsed at the federal election in September 2013. The Abbott Government announced in December 2013 that it would proceed with this proposal, and on 12 March 2014 exposure draft legislation was released which included the changes described below.

In the 2014 exposure draft legislation, it was proposed that the 'in Australia' condition for income tax exemption be amended to require that the income tax exempt entity operates principally in Australia and pursues its purposes principally in Australia. This requirement would broaden the test beyond considering the expenditure incurred to a test of where the entity operates and pursues its purposes. A wider range of circumstances could be considered in determining whether an entity meets this requirement, including factors such as where the entity undertakes its activities, where it is managed from, where it is resident or located, where its employees or volunteers are located and who is benefitting from its activities. Further, the consideration of an entity's activities would no longer be limited to the extent of its Australian operations.

The 2014 exposure draft legislation also proposed that the 'in Australia' condition for DGR purposes (not considered in the Word Investments case) would be amended to clarify that to obtain and maintain DGR status the entity must be established in Australia, and operate and pursue their purposes solely in Australia (with some exceptions). The exceptions to this test were proposed to include an exemption relating to scholarship funds, entities undertaking research into the causes, prevention or cure of diseases in human beings and 'touring arts organisations'. Those exceptions may have been helpful for higher education providers in relation to some of their activities offshore.

However, the 2014 exposure draft legislation also specified that the 'in Australia' condition for DGR purposes would not be breached if the activities outside of Australia were merely incidental to the Australian operations or if the activities outside of Australia were minor in extent and importance when considered with reference to the Australian activities. How those concepts were to be tested was not absolutely clear. However those provisions seemed to provide higher education providers which have their principal activities at Australian based campuses the ability to continue to maintain DGR status, if they have that status. However, these tests need to be supported by evidence.

In addition, the 2014 exposure draft legislation proposed that when a DGR or income tax exempt entity such as a higher education provider gave money, property or benefits to another entity that is not a DGR or income tax exempt entity, the use of those funds or property by the recipient would be taken into account when applying the 'in Australia' condition to the higher education provider. This was only proposed to apply to the extent that it would be reasonable to know how the recipient planning to use the funds or property. There was some guidance around when it was reasonable in the Explanatory Memorandum. This was specifically to tackle the concern arising from Word Investments.

What has happened to the 2014 exposure draft legislation?

The 2014 exposure draft legislation was not enacted in the final legislation and seems to have never been introduced into Parliament. This begs the question — does this indicate that the proposal to tighten the 'in Australia' conditions has been abandoned? The government has made no announcements to suggest that the proposal is off the agenda.

We think that a tightening of the 'in Australia' conditions is likely to be legislated in some form and it is important that higher education providers prepare themselves for this likely change.

What does this mean higher education providers should do?

Higher education providers with overseas activities need to consider whether their activities and circumstances will meet the new potential 'in Australia' tests.

As a governance matter, it would be sensible for higher education providers to anticipate that change will occur and take proactive steps to ensure that sufficient documentary evidence is retained to meet those new tests. This would entail:  1) maintaining detailed records to evidence the extent to which operations are carried out offshore (including as to the level of expenditure, number of personnel involved, the scope and extent of activity, and a comparison to records maintained showing the level of Australian activity), so as to demonstrate that the principal activity is in Australia;  2) considering the group structure, and particularly whether it would be sensible to restructure and utilise an entity which ring fences offshore activities from the Australian entity which has the income tax exemption or DGR status;  3) if funds are donated to other entities, obtaining from the recipient some form of assurance (eg a letter) that the funds will be utilised for charitable purposes, and ensuring that some evidence is obtained as to the activities of the recipient.