A recently released technical interpretation (document # 2009-0337311E5) has given rise to concerns that the Canada Revenue Agency (“CRA”) may be altering its administrative policies with respect to how organizations that are established with the intention of qualifying as a 149(1)(l) tax exempt non-profit organization can operate.
By way of background technical interpretations are responses written by CRA rulings to authors who send a letter asking a list of hypothetical questions. The author generally will set out certain facts and questions and CRA responds. CRA makes it clear that it does not respond in a binding way to a specific fact situation and these technical interpretations are designed to assist Canadians in a general way to understand how CRA administers the Income Tax Act (the “Act”).
Paragraph 149(1)(l) of the Act provides an exemption from income tax for the income of
...a club, society or association that, in the opinion of the Minister, was not a charity within the meaning assigned by subsection 149.1(1) and that was organized and operated exclusively for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit, no part of the income of which was payable to, or was otherwise available for the personal benefit of, any proprietor, member or shareholder thereof unless the proprietor, member or shareholder was a club, society or association the primary purpose and function of which was the promotion of amateur athletics in Canada; (emphasis added)
A summary of the questions asked and the answers given by CRA in this technical interpretation follows below:
Question (i) - Can an organization that qualifies for an exemption from tax under paragraph 149(1)(l) of the Act compete against taxable entities?
CRA’s answer - Yes. Technically, a non-profit entity could compete against a taxable entity. The only requirement to be met (relying on the BBM Canada case quoted below) is that the non-profit entity cannot have a for profit purpose.
Question (ii) - Can an organization earn a profit and continue to be exempt from tax under paragraph 149(1)(l) of the Act? Can an organization intentionally earn a profit, and still be exempt from tax under 149(1)(l), as long as that profit is used solely for the purpose of supporting its objectives?
CRA’s answer - It is not the fact that an organization earns a profit that causes it to go offside – it is the intentionality of earning a profit. In other words if the organization accidentally earns a profit it is fine but if the profit is intentional (i.e. to save for a rainy day), that will cause the entity to be considered taxable. The letter references the words “operated exclusively….for any other purpose except profit” and suggests it means that a non-profit entity can never intend to make a profit and qualify as tax exempt under the section. This is the case even it plans to use the profit for its non-profit purposes (i.e. the rulings officer rejected the destination of funds test yet again).
The response goes further in that it suggests that earning a surplus to put money aside for capital projects of an organization is an indicator of a profit purpose and an organization that does this will not qualify for the tax exemption. CRA recognizes that it may be appropriate to have a rainy day fund for operating expenses, but clearly suggests that the only reserves for future capital projects should be those that are derived from member revenues not other income-generating activity of the organization.
Question (iii) - Is it possible for an organization to incorporate under Part III of the Ontario Corporations Act, but not qualify for the exemption from tax provided under paragraph 149(1)(l) of the Act?
CRA’s answer – Yes. CRA is clearly of the view it is possible for an organization to meet the requirements of federal or provincial "not-for-profit" incorporation legislation, but not qualify for the tax exemption provided under paragraph 149(1)(l) of the Act. This is because most corporate legislation does not contain language that suggests the entity must be operated exclusively for a purpose other than profit.
Question (iv) - Does the Canada Revenue Agency ("CRA") maintain a list of organizations that qualify as non-profit organizations for purposes of provincial legislation, but do not qualify for the tax exemption provided under paragraph 149(1)(l) of the Act?
CRA’s answer – No. The CRA does not maintain a list of organizations that qualify for the exemption provided by paragraph 149(1)(l) of the Act. Unlike charities, these organizations are not required by the Act to register with the CRA.
Question (v) - The recent Tax Court of Canada decision, BBM Canada v. The Queen, 2008 DTC 4129 ("BBM Canada") concluded that an entity described in paragraph 149(1)(l) of the Act may conduct commercial activity but must conduct this activity at cost. If [an entity] provided a commercial procurement contract to an organization, and the organization generated a profit from this activity, would the organization be able to qualify for the tax exemption provided under paragraph 149(1)(l) of the Act?
CRA’s answer - CRA indicated that the answer to this question would be based on the particular facts of the situation, but commented further that if the fee provided for in the contract included a markup – that it would be indicative of a profit purpose and thus the organization could be offside.
A review of the answers provided by CRA explains why the letter raises concerns among those entities that are currently operating as non-profit organizations and those who practise in this area. A number of long standing non-profit entities have worked to incorporate sound practices to ensure financial viability over the long-term. This has included embarking on capital projects to support their operations and operating to ensure deficits are avoided. Financial stability of any entity, whether operating as a for-profit or non-profit entity, should be applauded. In fact, one would have thought these standards are a requirement in today’s world of increasing transparency and accountability to shareholders, members and the community at large.
The unfortunate reality is that this exemption from tax on income applies to a broad array of operating organizations, many of which function consistently with these statements and many of which do not. Historically, CRA has left organizations operating as non-profits pretty much to themselves. If CRA intends to change its approach and renew interest in the operations of paragraph 149(1)(l) entities it should in our view update Interpretation Bulletin IT-496R to reflect the current operating reality of non-profits and work to educate that sector prior to embarking on a formal audit initiative or review.
In short, this author hopes that the responses in this technical interpretation are not indicative of a new quite restrictive administrative approach by CRA.