Over the past few months, CRA has released several documents commenting on the rules under the Income Tax Act that apply to non-profit organizations (NPOs). We have reported in past issues of this Newsletter on CRA’s increasingly strict interpretation of the tax exemption for NPOs. These more recent technical interpretations provide a useful summary of CRA’s current position on the NPO exemption.
In a technical interpretation released on April 7, 2011, CRA responded to three questions from a taxpayer regarding the NPO exemption. The taxpayer inquired as to (i) whether an unregistered charity could qualify as an NPO, (ii) whether NPOs are restricted to particular activities in order to qualify for the exemption, and (iii) whether an NPO can fundraise while continuing to qualify.
With respect to the first question, CRA confirmed that an unregistered charity cannot qualify for tax exempt status as an NPO. Thus, if an organization’s formal objects are confined to exclusively charitable purposes, the organization cannot be an NPO and can only achieve tax exempt status by being registered as a charity (or by amending its objects to include non-profit purposes that are not charitable at law).
In response to the second question – regarding the activities that an NPO is permitted to carry on – CRA confirmed that an NPO must be organized and operated for exclusively non-profit purposes (“any other purpose except profit”, as it is phrased in the Income Tax Act). It then provided a useful summary of its current position on what this means for an NPO. CRA stated as follows:
- An organization can earn profits, but the profits should be incidental and arise from activities that are undertaken to meet the organization’s not-for-profit objectives (these profits are referred to below as “incidental profits”).
- Earning profits to fund not-for-profit objectives is not considered to be itself a not-for-profit objective.
- An organization should fund capital projects and establish (reasonable) operating reserves from capital contributed by members, from gifts and grants, or from accumulated, incidental profits.
- Capital contributions, gifts and grants, and incidental profits should generally be accumulated solely for use in the operations of the organization (including funding capital projects or setting up operating reserves) and should not be used to establish long-term reserves designed primarily to generate investment income.
- Maintaining reasonable operating reserves or bank accounts required for ordinary operations will generally be considered to be an activity undertaken to meet the not-for-profit objectives of an organization. Consequently, incidental income arising from these reserves or accounts will not affect the status of an organization.
- Limited fundraising activities involving games of chance (e.g., lotteries, draws), or sales of donated or inexpensive goods (e.g., bake sales or plant sales, chocolate bar sales), generally do not indicate that the organization as a whole is operating for a profit purpose.
- In determining whether an organization has any profit purpose, the activities of the organization must be reviewed both independently and in the context of the organization as a whole.
CRA commented that certain types of profitable activities may be acceptable for an NPO, including running a canteen at an amateur hockey rink or a cafeteria at a non-profit youth hostel, or charging admission above direct cost for a children’s concert (assuming the organization was organized for the purpose of promoting youth participation in music). In each case, CRA stated the profitable activities are directly in support of not-for-profit objectives – i.e., providing appropriate facilities, promoting participation in music – and will generally be incidental in amount. CRA confirmed that an activity undertaken for the purpose of earning profits will not be acceptable, even if all profits are destined to support the NPO’s non-profit purposes.
Another document released on April 7, 2011 – an advanced income tax ruling commenting on a particular fact situation – confirmed CRA’s rejection of the “destination of funds” test for NPO status. The organization in question was operating a profitable commercial retail establishment, with these profits being used towards the organization’s non-profit activities of promoting employment. CRA confirmed that even if the profits from a for-profit activity will be used exclusively in the organization’s non-profit purposes, the organization cannot qualify for the NPO exemption. Only where profits are incidental to the organization’s non-profit purposes, and where the organization is not using its NPO status as a “cloak” to avoid tax on a commercial enterprise, will the organization qualify as an NPO. It stated that the operation of an unrelated commercial establishment constitutes a profit purpose and that the organization could not therefore qualify as an NPO.
On March 30, 2011, CRA commented on another question from a taxpayer, this time inquiring about the tax treatment of payments made to members of an NPO. The situation that the taxpayer had in mind involved payments intended to assist members in financial difficulty with child care expenses. Such payments would be made on the basis of a means test for each prospective recipient. The taxpayer asked how such payments would be taxed in the hands of the recipient, and whether the payments would jeopardize the NPO’s tax exempt status.
CRA first considered how such payments might be taxed in the hands of the recipient. It noted that they might be considered windfalls or gifts, in which case they would not be taxable to the recipient. It then stated that the more likely interpretation of the payments in question is that they are social assistance payments, which would be included in the income of the recipient and then deducted when calculating taxable income.
Turning to the NPO’s tax exempt status, CRA noted that the criteria for maintaining status as an NPO include the requirement that no part of the income of the organization may be payable or made available for the benefit of its members. CRA stated that it is a question of fact whether any given organization qualifies as an NPO, but noted that if an organization is making its income available for the personal benefit of its members, it will not qualify. This appears to suggest that organizations making social assistance payments to members out of income might not qualify for NPO status.
Taken together, these technical interpretations largely confirm CRA’s recent position with regard to the requirements for maintaining NPO status under the Income Tax Act. CRA’s comments on the types of for-profit activities that may be acceptable for an NPO are helpful, and suggest that CRA may be taking a slightly less rigid approach than what was suggested in its earlier technical interpretations released over the past year and a half. NPOs will nonetheless need to continue to be vigilant in ensuring that they meet the requirements under the Act, and will be well-advised to obtain legal advice before engaging in any for-profit activities and before making any payments to members.