On 25 February 2015 the Commissioner of Taxation (Commissioner) released Taxation Ruling TR 2015/1 (TR 2015/1) which provides guidance on some of the special conditions which entities must satisfy in order for their ordinary and statutory income to be exempt from income tax.
TR 2015/1 considers two of the special conditions which are contained section 50-50(2) of the Income Tax Assessment Act 1997 (Cth) (ITAA97):
The Governing Rules Condition; and
The Income and Assets Condition.
A brief overview of each condition is provided below along with guidance on what you need to do to ensure you satisfy the condition.
Please note, TR 2015/1 only applies to income tax exempt entities and does not consider conditions for deductible gift recipients.
The Governing Rules Condition
The Governing Rules Condition requires an entity to comply with all of the substantive requirements in its governing rules. This involves identifying what the governing rules of the entity are as well as the substantive requirements in those rules.
The governing rules of an entity are those rules that authorise the policy, actions and affairs of an entity. Typically, governing rules would include trust deeds, constitutions or rules of association and an entity may have more than one source of governing rules.
Broad regulatory regimes which are not targeted to an entity specifically are not a source of governing rules. Neither are contracts, leases, licences and other similar agreements.
The substantive requirements in an entity’s governing rules are those rules that define the rights and duties of an entity and specifically include rules that:
- Give effect to the object/purpose of the entity
- Relate to the not-for-profit status of the entity
- Set out powers and duties of directors and officers
- Require financial statements to be prepared and retained
- Set out criteria for admission of members
- Require an entity to maintain a register of members
- Relate to winding up
Procedural and administrative requirements are not considered to be substantive requirements. Procedural requirements include how meetings are to be conducted, voting rules etc.
The Income and Assets Condition
The Income and Assets Condition requires an entity to apply its income and assets solely for the purpose for which it is established.
The purpose for which the entity was established is determined by considering all of the features of the entity and in particular any objects as set out in its constituent documents and the activities the entity undertakes. An entity can have more than one purpose.
An entity will have applied its income and assets “solely” towards its purpose or purposes if it has “exclusively or only” applied its income and assets for those purposes. It is a strict test however, the Commissioner acknowledges that misapplications of income or assets will not cause an entity to breach the condition so long as the misapplication is of an immaterial amount and is a one-off mistake or occasional unrelated mistakes.
An entity which accumulates income can still satisfy the condition, so long as accumulation is consistent with the purposes for which the entity was established . TR 2015/1 also confirms that entities who use profits derived from commercial activities to further their purposes will not breach the Income and Assets Condition.
The Income and Assets Condition must be satisfied at all times through an income year. Accordingly, if the purpose or objects of the entity change throughout the year, the entity must still ensure that its income and assets have been consistently applied solely towards the relevant objects at each point in time.
Breach of conditions
Where an entity has breached one of the special conditions, the Commissioner may take compliance action (including revoking endorsements). The Commissioner will generally not take compliance action if:
- corrective action has been taken within a reasonable time; and
- the corrective action has, or will, place the entity in the position or substantially the same position it would have been in but for the breach; and
- the entity notifies the Commissioner.
Corrective action is action that puts the entity back in the position it was before the breach occurred. Corrective action is different from a situation where the effects of the breach are subsequently remedied.
What should you do?
Organisation’s have an obligation to self-assess each year to determine whether they are still entitled to be exempt from income tax. If you are currently endorsed or self-assess as an income tax exempt entity, you must consider whether you continue to satisfy these and any other conditions each year. If you do not satisfy one or both of the conditions, your ordinary and statutory income will not be exempt from income tax.
If your organisation becomes aware that it is in breach of one of the special conditions, you should take steps to correct the breach and notify the Commissioner as soon as possible.