- The Federal Government’s extensive reforms to not-for-profit (NFP) sector laws continue. Some of these reforms are already operative to a degree. Others are imminent. There is no doubt that the reforms have the potential to add significantly to the complexity and burden of regulation of the NFP sector. In many cases the laws will pose significant liability risks to NFP entities and those individuals who serve in them often including volunteers.
- This is only a summary of what we consider to be some of the most significant aspects of a complex package of reforms.
The changes are principally:
- The establishment of a national regulator – the Australian Charities and Not-for-profits Commission (ACNC). This body will take over some of the ATO’s role in deciding whether organisations qualify for tax concessions. The ACNC will also oversee new governance and reporting requirements for the sector. In most cases until there is Federal/State co-operative reform, these new requirements will result in additional (not substitute) compliance burdens.
- The introduction of measures which will tax NFPs on income ‘unrelated’ to their altruistic purposes if the income is not applied to the altruistic purposes. In the Government’s view, profit generated in truly commercial activity should not be exempt from income tax unless it is promptly applied for altruistic purposes of the NFP.
- Tighter governance and compliance rules for ‘public ancillary funds’ – trusts that are established to provide benefits to other DGR (deductible gift recipient) organisations. These changes are already enacted and operative, subject to some transitional relief
- Tightening of the ‘in Australia’ test which organisations must pass to enjoy tax exemptions and concessions including DGR status. This results from the Government’s view that the Word Investments decision of the High Court created a loophole allowing tax exempt Australian entities in effect to give their money away to other charities offshore without accountability
- A statutory definition of ‘charity’ which takes up a reform abandoned about a decade ago.
The current status of the reforms
Changes to the tax concession and governance rules affecting public ancillary funds are already law and began operating in January 2012.
- Bills have been introduced for the ACNC establishment. The Australian Charities and Not-for-profits Commission Bill 2012 which establishes the ACNC is the main Bill. This entity will regulate and monitor Australian charities. The accompanying transitional and consequential amending legislation amends numerous other laws including tax laws and the Corporations Act. Because of opposition from the Federal Coalition the Bills did not pass in time for the intended 1 October 2012 start date and a new date is yet to be announced.
- Another Bill deals specifically with the ‘in Australia’ special conditions test in the Income Tax Assessment Act 1997. This Bill also proposes a formal definition and condition of being a ‘not-for-profit entity’ in order to access tax concessions. If passed this legislation will operate from Royal Assent - possibly to occur late this year.
- We are still awaiting an exposure draft of legislation to be introduced to provide for the taxing of profits generated from NFP entities’ unrelated commercial activities that are not applied for the altruistic purposes of the NFP. This proposed change was announced in the May 2011 Budget but its commencement was deferred until July 2012. Despite that date coming and going no legislation has yet been released even in draft and it appears that taxation ‘by press release’ is being effected. The reform will however undoubtedly be a complex one.
- The new statutory definition of ‘charity’ will not be introduced until 2013 at the earliest.
The Australian Charities and Not-for-profits Commission
The ACNC legislation seeks to do the following:
- achieve a national regulatory framework for the NFP sector to minimise the compliance burden on NFPs which may have to report to several different government bodies or organisations depending on the type of entity they are;
- provide for the ACNC to assume responsibility for registering entities as a NFP according to their type and subtype and effectively be gatekeeper for the application of tax concessions under Federal law; and
- assist these registered entities by providing them with guidance and education.
- It is unclear whether the new legislation will be able to achieve the first objective above. The ACNC Bill has not introduced or been accompanied by a harmonisation of the current State and Federal laws that affect the NFP sector. Until this occurs it is likely that the obligations and requirements under the Bill will only further add to the compliance burden on NFPs.
The ACNC‘s role in assessing eligibility for tax concessions
- Currently, charities that want to obtain Federal tax concessions must go through a process of obtaining endorsement from the ATO with the minor exception of some organisations that automatically obtain their status from legislation.
- The ATO would only endorse a charity (for example) if it is satisfied that the entity is in fact a charity. This has meant that the ATO, which many regard as ‘revenue-driven’, decides the eligibility of entities for concessions as part of the endorsement process. It has also made the ATO a de facto regulator of governance of charities in many respects given the importance of these concessions to most charities.
- From the commencement date of the ACNC, registration under the new ACNC Act will be a new prerequisite to obtaining tax concessions. The role of the ATO in endorsing charities will therefore be reduced to a more mechanical one. The ATO will still administer the tax law applicable to charities but effectively the ACNC will be the gatekeeper for the concessions.
- Initially the ACNC will only register NFPs that are, in legal terms, charities including charitable institutions and funds, public benevolent institutions and health promotion charities. Some other kinds of NFPs may enjoy tax concessions but are not technically charities (e.g. sporting clubs). In due course these may be moved into the ambit of the ACNC.
- In determining whether organisations satisfy the threshold tests for registration, the ACNC will classify them into type and sub-type. Under the initial type ‘charity’ are subtypes comprising those kinds of entities that qualify under the common law concept of charity (e.g ‘entities with a purpose that is the relief of poverty, sickness and the relief of the aged’). Other sub-types include the kinds of entity specifically recognised under the tax law including health promotion charities and public benevolent institutions. The scheme of types and sub-types will therefore reflect the scheme of tax concessions in the tax law.
To be entitled to registration an entity needs to satisfy the following conditions:
- that it is a not-for profit entity. A definition of a ‘not-for-profit entity’ will be inserted into the Income Tax Assessment Act 1997. To be a NFP an entity must not be carried on for the profit or gains of its owners or members, neither while it is operating nor upon winding up;
The ATO has always applied the tax law in the past as carrying this requirement with it. For example the ATO has always required charities that are companies or trusts to have suitable distribution and winding-up provisions prohibiting private gain from the entity. The legislation will now define and formalise the test of what is a ‘not-forprofit’;
- it complies with the governance standards and external conduct standards. It is difficult to know the full extent of what the standards will require without seeing the Regulations which have not yet been promulgated but will contain the substance of the governance and conduct standards;
- the entity has an ABN; and
- it meets the definition of a ‘charity’ in accordance with its common law meaning. This will change when a statutory definition of ‘charity’ is finally introduced. It remains to be seen whether the new definition will differ from the common law meaning.
- Once an entity is registered with the ACNC as a charity, its registration information will be passed to the ATO if the charity indicated in their application that they wish for the ATO to endorse them for access to tax concessions.
- Existing concession status of existing charities will be transferred to the ACNC register and they will not need to re-apply.
The ACNC’s other main tasks will be:
- to monitor all new and existing charities to ensure compliance with governance standards as set out in the Act or regulations made pursuant to it.
- to serve as a resource for charities to obtain information and guidance.
- to facilitate access to information about registered charities, not only to the public but also to government agencies with whom they deal.
- The ACNC legislation is a substantial package and creates the ACNC with the powers of a true independent regulator, including powers of access and investigation, powers to make directions and so on.
- Unfortunately the ACNC is not yet part of a scheme of co-ordinated State and Federal reform. The current patchwork of State laws about charitable fundraising has caused much irritation and expense to charities. The new Federal law will not really alleviate this although the Government hopes to promote through COAG sweeping national reform towards uniformity in due course. In the meantime the new measures simply add to the regulatory pile. Charities will still need to deal with the requirements of State legislation such as State associations incorporation acts and applicable State charitable fundraising legislation.
- Currently the reporting requirements for NFPs are determined by what tax concessions the entity can access and the legal form of the entity. Some NFP entities that are unincorporated and receive no government funding have no reporting requirements.
- Registered entities will be required to provide an annual information statement. This ensures that a minimum level of information can be collected by the ACNC and the information will be used by the ACNC Commissioner to ensure that the entities remain entitled to be registered by the ACNC and therefore continue to access tax concessions.
- The annual information statement is due no later than 31 December following the relevant financial year. The annual information statement requirement will commence in the 2012/ 2013 financial year. There is provision for substituted accounting periods. What information will be required in the annual information statement is currently under consultation and is yet to be finally prescribed.
- The financial reporting requirements apply to the 2013/2014 and subsequent financial years. There is provision for substituted accounting periods.
- Depending on the size of the registered entity, the reporting requirements become more burdensome. Entities that have annual revenue of between $250,000 but less than $1 million will be required to produce financial reports that need to be lodged with the ACNC annually. These can be audited or reviewed. Larger entities, meaning those that have annual revenue of $1 million or more, will be required to produce and lodge financial reports which have been audited. This is a similar scheme to that which currently applies to companies limited by guarantee under the Corporations Act.
- Until the 2014 /2015 year there is provision for the ACNC to accept reports or other documents that a registered entity has prepared under another regulatory scheme for a Federal government authority. This may prevent duplication of the reporting requirement for some bodies.
- There is also specific provision for some reporting requirements in Federal law to be ‘switched off’ for registered entities. An example is the requirement to notify changes in officers or address of a registered entity that is also a Corporations Act company.
Governance and external conduct requirements
- Entities wanting to maintain their registration with the ACNC will need to comply with the governance framework set up by the Bill which attempts to ensure a minimum governance and external conduct standards. In this context ‘external conduct’ refers to activities overseas or connected to overseas activities.
- The stated object of these governance provisions is to achieve accountability and also minimise the risk of mismanagement and misappropriation of the entity’s funds. The detailed requirements of the governance and external conduct standards will be contained in the regulations which are yet to be released for consultation purposes. Some in the NFP sector have expressed uneasiness about leaving the governance matters to the regulations as opposed to having them in the Act itself.
- Another notable feature of the Bill that has attracted comment is the ability of the ACNC to remove directors and trustees of organisations.
- There is also specific provision for some governance requirements in Federal law to be ‘switched off’ for registered entities. An example is certain duties of directors and officers of a registered entity that is also a Corporations Act company.
Liability of officers etc
- The initial drafting of the scheme of personal liability was much criticised as heavyhanded and unclear. It was remarked that the Bill may have been more onerous than the law affecting ‘for profit’ companies. Significant revision to the provisions originally proposed was made.
- If an entity is subject to an obligation or commits an offence under the provisions of the Bill, certain entities that are responsible for the management of the entity may also be subject to the same liability, obligation or offence. Responsible entities in this respect can include directors (as broadly defined) as well as trustees and committee members of unincorporated associations.
- There is provision that an amount that is payable by, for example, a company is also payable by each individual director. However this only applies if the amount is payable because of a ‘deliberate act or omission of the director involving dishonesty, gross negligence or recklessness’.
Tighter regulation for public ancillary funds
- Public ancillary funds are DGR trusts that are maintained solely for the purpose of providing money or property to other DGRs. Often called ‘foundations,’ these funds were formerly called simply ‘ancillary funds’.
- The new terminology distinguishes them from ‘private ancillary funds’ maintained by family groups as vehicles for private giving. Unlike private ancillary funds, public ancillary funds can and must solicit donations from the public.
The new law aligns regulation of public ancillary funds with those requirements already affecting private ancillary funds. The Government has promulgated the Public Ancillary Fund Guidelines which include
- requirements as to matters such as minimum annual distributions;
- requirement to lodge annual tax returns or information statements;
- governance standards;
- an obligation that the trustee seek donations from the public.
- Compliance is a condition of continued DGR endorsement. There is also an administrative penalty regime for trustees and trustee company directors. The introduction of the Guidelines dramatically increases the compliance burden on public ancillary funds and individuals involved in them.
- Existing public ancillary funds are taken to be endorsed by the Commissioner as DGRs under the new regime from 1 January 2012. All existing public ancillary funds will also be taken to have agreed to comply with the new prescribed Public Ancillary Fund Guidelines as from 1 January 2012. By 2015 most funds will require amendments to their trust documents to ensure compliance with the Guidelines.
Much tighter ‘in Australia’ special conditions
- A Bill has been introduced to specifically deal with the ‘in Australia’ special condition in the Income Tax Assessment Act 1997. According to the Government, ‘support’ in the form of Australian tax concessions should only be available where the charitable work is done for the benefit of the Australian community.
- This measure is targeted specifically to reverse the effects of the High Court decision in Federal Commissioner of Taxation of the Commonwealth of Australia v Word Investments Limited (2008) 236 CLR 204. In that decision the court held that a charity in Australia did pursue its objectives principally ‘in Australia’ even though that entity merely operated to pass funds in Australia to another charitable entity that conducted its activities overseas.
- The Government is also concerned that money applied outside Australia may lack accountability or may be administered for improper or even illegal purposes and that there is a want of supervision where money is used outside Australia.
‘In Australia’ special conditions test in relation to income tax exemption
The legislation seeks to tighten the existing law in respect to the ‘in Australia’ test. The result is that for a charitable entity to pass the ‘in Australia’ special conditions to be able to access income tax exemption it must:
- operate principally in Australia;
- pursue its purposes principally in Australia; and
- uses its income and assets solely to pursue the purposes for which it was established.
- ‘Principally’ in this context means mainly or chiefly. The explanatory memorandum to this Bill goes to state that anything less than 50% is not considered principally.
- The new test replaces the existing ‘expenditure’ based test with the words ‘operate’ and ‘pursues its purposes’ which means a wider set of circumstances need to be considered which can include considering the management and control as well as employees in Australia, where the entity undertakes its activities and who is directly and indirectly benefiting from its activities.
- DGRs are exempt from this ‘in Australia’ special conditions for income tax exempt entities because they are subject to a separate ‘in Australia’ test as discussed below.
‘In Australia’ special conditions test in relation to DGR status
For an entity to obtain and maintain its DGR status, it must:
- be established in Australia; and
- operate solely in Australia; and
- pursue its purposes solely in Australia.
- This is a much stricter ‘in Australia’ test than is the one that applies to obtaining income tax exemption. It is not clear why the Government felt a test of pursuing purposes solely in Australia was needed for DGRs and there is concern about this measure also. Whilst activities that are ‘incidental’ to an entity’s activities in Australia will not cause the test to be breached, the boundaries of what is ‘incidental’ may be unclear and may inhibit organisations that engage in a significant degree of overseas activity or collaboration with overseas parties.
- This measure has significant implications for NFP entities such as universities or medical research institutes that have subsidiaries or operations in countries other than Australia. It has been criticised as being a parochial reform.
- The new measure will generally not affect the operations of ‘developing country relief funds’ approved by Ausaid, or similar concessions for overseas causes for which there is a specially designed regime in the tax law.
Unrelated Business Income Tax (UBIT)
- This reform was announced in the May 2011 Federal Budget. However the exposure draft of legislation that will put in place a new tax on ‘unrelated’ business income of an NFP is yet to be released. This measure will seek to tax the earnings from the ‘unrelated’ commercial activities of a NFP, if those earnings are not applied for the entity’s altruistic purposes. These unrelated commercial activities will also not be entitled to FBT exemption or rebate or be able to obtain GST concessions.
What is ‘unrelated’ business income?
- Of course the key question is what activities are ‘unrelated’ and potentially subject to the new tax measures. The Government is likely to look to overseas jurisdictions for a model to deal with this question.
- Currently in the USA the test applied for what is ‘unrelated commercial activity’ of a charity is any ‘trade or business which is not substantially related (aside from the need for funds) to the exercise of its charitable function’. One can imagine that a profitable funeral business such as that conducted by the charity in the Word Investments case would probably fall within the concept of ‘unrelated’ income.
The UBIT will have significant implications on entities that do conduct unrelated commercial activities. These implications which will include:
- requiring NFPs to keep a separate set of accounts for their unrelated commercial activities so as to allocate expenses and determine what are properly profits arising from ‘unrelated’ activities. Alternatively these organisations may have to house the commercial activities in separate business structures (e.g subsidiaries).
- it is likely that the proposed legislation will allow for some retention of profits at year end but the levels of acceptable retention and how relevant amounts are calculated are currently unknown.
- exposing charities and other NFPs which have profitable commercial businesses to the income tax law - something from which they have been shielded until now. Even if organisations are able to demonstrate compliance with the UBIT ‘application to purposes’ requirement, the cost of doing so may be significant in terms of advice and accounting fees.
- A number of major questions about the reform remain unanswered. We believe the UBIT will be an extremely complex measure and we suspect that complexity accounts for the delay in the emergence of even the draft legislation.
What should NFPs do?
It is now necessary for NFPs to review the new measures and assess their likely impact. In particular:
- NFPs and particularly charities which are first into the ACNC scheme, should monitor and review the ACNC legislation and ascertain what they need to do to ensure compliance, particularly in respect of governance and reporting.
- NFPs that have operations overseas will need to scrutinise their activities to consider whether they can still maintain their income tax exemption and DGR status in light of the restated ‘in Australia’ test. Restructuring may be needed in some cases.
- trustees of public ancillary funds need to review the new statutory guidelines for public ancillary funds and ensure they comply. This may mean changes to distribution and investment policy. In most cases changes to the fund trust deeds will be needed as existing periods of transitional relief expire.
- the effects of the UBIT – already in legal force ‘by press release' from 1 July 2012 should be considered by those NFPs that conduct commercial activities that could be seen as ‘unrelated’ to their charitable or altruistic purpose. More detailed review will be needed once the UBIT exposure draft is released and then when and if it becomes law. The UBIT may make significant restructuring desirable in many cases.
The changes affecting Australia’s not-for-profit sector are complex and this update only provides a summary of the most significant aspects of a complex package of reforms.