On 12 March 2014, the Treasury issued an exposure draft of the Tax and Superannuation Laws Amendment (2014 Measure No.3) Bill 2014: in Australia special conditions (TSLA Bill 2014) and associated explanatory materials. It proposes to amend the tax law to restate and centralise the special conditions for tax concession entities.
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Background and changes to law that currently apply generally from 1 July 2013
In 2012, the former Government released the revised exposure draft of Tax Laws Amendment (Special Conditions for Not-for-profit Concessions) Bill 2012 (TLAB 2012) which proposed to amend the tax law to restate and centralise the Special Conditions for tax concession entities. This did not become law.
Subsequent to the revised exposure draft of the TLAB 2012, some amendments were made to the law under the Tax Laws Amendment (2013 Measures No.2) Act 2013 (TLAA 2013).
The tax law was then amended under TLAA 2013 to standardise some requirements for various types of tax concession entities, including entities registered with the Australian Charities and Not-for-profits Commission (ACNC) as charities (registered charities).
The amended law requires that for a registered charity to be exempt from income tax, it must:
- comply with all the substantive requirements in the entity’s governing rules, and
- apply its income and assets solely for the purpose for which the entity is established (s50-50(2) of the Income Tax Assessment Act 1997 (Cth) (ITAA 97)).
Broadly, the above amendments to the law are very similar to what was proposed previously by the former Government.
These amendments apply to income years starting on or after TLAA 2013 received Royal Assent (ie 30 June 2013). That is, the amendments that are already law will generally apply from 1 July 2013 to many registered charities that are exempt from income tax. Accordingly, registered charities that are currently income tax exempt should review their objectives, constituent documents, governance arrangements, activities and application of their income and assets for compliance with the amended law.
Suggested action to deal with changes already in the law
In particular, we consider the following should be done:
- The entity should review its governing rules (eg constitutions and trust deeds). Are all the substantive requirements of its governing rules being complied with? Do the rules need to be varied?
- The entity should review its application of income and assets. Is the entity applying its income and assets solely for the purpose for which the entity is established? Do the activities of the entity need to change so that it is applying its income and assets solely for the purpose for which it is established?
Failure to comply with these requirements would risk the charity’s income tax exemption endorsements being revoked by the Commissioner. The Commissioner has the power to revoke these endorsements under s426-55 of Schedule 1 of the Taxation Administration Act 1953 (TAA 1953).
The Commissioner may require an endorsed entity to give the Commissioner information or documents that are relevant to the entity’s entitlement to endorsement. The entity must comply with this requirement. Failure to provide such information to the Commissioner within the time period required would also risk the charity’s income tax exemption endorsements being revoked by the Commissioner.
In addition, the revocation of endorsements by the Commissioner may be retrospective. Under s426-55 of Schedule 1 of TAA 1953, the Commissioner may specify the effective date for the revocation. This date may be before the date of decision of the Commissioner, but must not be before the date that the entity first ceased to be entitled to the endorsement.
Definition of ‘not-for-profit’ not proceeded with
On 14 December 2013, the Government announced that it would not proceed with defining and standardising the use of the term ‘not-for-profit’ throughout the tax laws.
A definition of ‘not-for-profit’ was proposed by the previous Government in TLAB 2012. It allowed a NFP to gift surpluses and assets to other NFPs, even if those entities were owners or members, if the purpose of those entities was similar. Accordingly, the significant concession under the previously proposed change for groups of income tax exempt entities will no longer be available. Any charities that contemplated using this concession would need to review their group structure to ensure that they are complying with the current law.
Proposed changes under the exposure draft TSLA Bill 2014
In this exposure draft, the Government proposes changes to address some of the concerns raised by the public on the former Government’s TLAB 2012.
Below are some important points from the exposure draft TSLA Bill 2014.
Income tax exempt entities – ‘in Australia’ special condition and Word Investments decision
The exposure draft TSLA Bill 2014 restates the ‘in Australia’ special condition that applies to income tax exempt entities, ie the condition that these entities generally must operate and pursue their objectives principally in Australia, and for the broad benefit of the Australian community.
The reason for restating this special condition is that the High Court of Australia in Federal Commissioner of Taxation v Word Investments Limited (2008) 236 CLR 204 (Word) decided that a charity is considered to pursue its objectives principally ‘in Australia’, if it merely operates to pass funds within Australia to another charity that conducts activities overseas.
This finding was inconsistent with the Government’s policy underlying this special condition.
Proposed change to ‘in Australia’ special condition
The current law essentially contains an ‘expenditure’ based test to determine whether an entity meets the ‘in Australia’ special condition. This will be replaced with an ‘operates’ and ‘pursues its purposes’ based test, so a wider range of circumstances will be relevant.
Under the new test, relevant factors will include where the entity incurs its expenditure, where it undertakes its activities, where its property is located, where it is managed from and who directly and indirectly benefit from its activities.
If an entity gives money or property to another entity that is not exempt, the use of the money and property by that other entity is taken into account in determining whether the first entity is operating principally in Australia and pursuing its purposes principally in Australia. This in particular is aimed at overcoming the effect of the Word decision.
The entity only needs to take reasonable steps to confirm or trace the use of the money, property or benefits outside Australia.
Making distributions overseas and ignoring distributions to the income tax exempt entity
The exposure draft TSLA Bill 2014 tightens the exception for distributions that an income tax exempt entity may make overseas which are disregarded when considering whether the entity meets the ‘in Australia’ special condition. These distributions must be distributions received by the entity by way of government grant or gift or contributions (money or other property) in circumstances where the provider is not an income tax exempt entity, and is not entitled to an income tax deduction in respect of the gift or contribution. The entity must also ensure that requirements in the regulations are met.
According to the explanatory materials, it is expected that the regulations will include the following requirements:
- The entity must take reasonable steps to obtain evidence that shows that any activities undertaken outside Australia are a genuine attempt to give effect to its purposes, and the use of any money or property outside Australia is effective in achieving the entity’s purpose.
- If the entity works with another person on activities outside Australia, the entity must take reasonable steps to obtain evidence showing that it effectively interacts and coordinates activities with the other person.
- The entity must not commit a serious infringement of Australian laws.
- If the entity is registered with the ACNC, it must be in compliance with the ACNC governance standards.
- If the entity is not registered with the ACNC, it must have reasonable processes in place to ensure it is giving effect to its purposes, to manage the risk of a breach of its governing rules, and manage the risk of fraud or misconduct by those managing or administering it.
A slightly narrower test will apply to deductible gift recipients (DGRs).
Under the current law, distributions received by the entity by way of government grant or gift (money or property), whether tax deductible or not, and whether the provider is an income tax exempt entity or not, may be distributed overseas, without additional requirements in the regulations. Accordingly, the proposed change will be significant for those income tax exempt entities that currently make distributions overseas.
Deductible gift recipients – ‘in Australia’ special condition
The exposure draft TSLA Bill 2014 codifies the ‘in Australia’ special condition that applies to deductible gift recipients (DGRs), including the requirement that these entities must generally be established in Australia, operate solely in Australia, and pursue their purposes solely in Australia and for the broad benefit of the Australian community. This is stricter than for income tax exempt entities generally where pursuing objectives principally in Australia is required.
If an entity provides money or property to other members of a group of entities that this entity is a member of, it may have to take account of the eventual use of the money or property. Therefore, if a DGR conducts substantial activities outside Australia, it may consider establishing a separate subsidiary to undertake these activities.
Also, if an overseas entity owns the majority of an Australian subsidiary, this would not of itself contravene the ‘in Australia’ requirement.
For international affairs DGRs (eg overseas aid funds), they are not required to meet the condition of operating solely in Australia and pursuing purposes solely in Australia.
A DGR will not breach the ‘solely in Australia’ test if its activities outside Australia are merely incidental to its operations and pursuit of purposes in Australia or its activities outside Australia are minor in extent and importance when considered with reference to its operations and pursuit of purposes in Australia.
If an entity provides money, property or other benefits to another entity that is not a DGR, the entity need only take reasonable steps to have knowledge of the use of the money, property or benefits by the other entity outside Australia.
The proposed law also creates a new DGR category for medical research institutions that operate outside Australia. Medical research institutions listed in this new DGR category will still be required to be established in Australia, but will be exempt from the requirements of operating solely in Australia and pursuing purposes solely in Australia.
There is also an exemption for certain touring arts organisations and entities on the Register of Environmental Organisations, if the conditions in the proposed law and regulations are satisfied.
The proposed new law will apply to determine whether an entity is entitled to be or remain income tax exempt/ DGR for income tax years starting the day after Royal Assent. For those entities that are endorsed as DGRs before introduction of the proposed Bill, and are not meeting the ‘in Australia’ special conditions, they have a transitional period of 12 months in which to comply with the new rules.
Suggested action to deal with proposed changes
While this is an exposure draft, and there is still the consultation process, because this is an exposure draft prepared after the previous consultation process, it is reasonably likely that the final legislation will be substantially the same as this exposure draft.
If it becomes law and receives Royal Assent by 30 June 2014, then it will generally apply from 1 July 2014.
Entities that are currently income tax exempt entities and DGRs should review their operations, objectives, constituent documents, activities and governance arrangements for compliance with the proposed new law.
In particular, we consider the following should be done:
- If the entity is a DGR, is it operated solely in Australia and pursuing its purposes solely in Australia? Consider all relevant activities. For example, a hospital may consider it obviously satisfies this test. But what does it do outside Australia? Does it have medical staff on secondment to overseas hospitals? Does it conduct overseas conferences? Does it support overseas healthcare activities? Does it bring in patients from overseas? Are the overseas activities merely incidental to its Australian activities or minor in extent and importance when considering its Australian activities?
- For medical research institutions that operate outside Australia, they should consider whether they will be able to be endorsed as a DGR under the new DGR category.
- If the entity is relying on the current concession that effectively excludes overseas distributions received as gifts in applying the ‘in Australia’ test, what will be the effect of the new, much tougher, law?
- Charities that are set up by overseas charities should consider how the new ‘in Australia’ condition will apply to them, and what changes should be made. If the Australian activities are not separately incorporated, would this be necessary in their particular circumstances?