Over the past several months, CRA has released two technical interpretations commenting on aspects of the tax exemption for non-profit organizations under paragraph 149(1)(l) of the Income Tax Act (Canada).
In order to maintain status as a tax exempt NPO, an organization must be organized and operated for exclusively non-profit purposes and cannot make any of its income available for the benefit of its members. The recently published technical interpretations address these requirements in the context of different situations.
Refund of Excess Membership Fees
In one technical interpretation, CRA addressed how it would treat an organization that overestimates its membership fees and refunds the excess to its members at the end of the year.
CRA confirmed that the refund of excess membership fees would not normally result in the denial of tax exempt status. However, it stated that the organization's financial records and the facts surrounding the distribution must support the characterization of the amounts as a refund of fees and not a payment of income to the members. In order to support this position, the refund payments should be available proportionately to all members or groups of members of the organization.
CRA also stated that if the refund resulted from a mixture of membership fees and outside fundraising, this may be indicative of a profit purpose on the basis that the NPO is fundraising beyond its needs to carry out its activities. CRA noted that NPOs may carry on limited fundraising activities so long as these activities do not become so significant as to constitute a purpose of the organization.Provided that the fundraising activities are acceptable and the refunded fees do not exceed the membership fees paid in the year, CRA stated that the refund of excess fees to the members on a proportionate basis will not generally jeopardize the tax exempt status of the organization.
Loans to taxable subsidiary
In another technical interpretation, CRA commented on the use of a taxable subsidiary by an NPO.The facts in the document are heavily redacted but indicate that CRA was commenting on an NPO that had accumulated excess revenue over several years and had acquired a taxable subsidiary corporation. It appears that the NPO was making periodic interest and non-interest bearing loans to the subsidiary, such that the subsidiary had accumulated interest-bearing debt to the NPO.The NPO was reporting interest revenue (which was added to the balance of the non-interest bearing loan) and the subsidiary was reporting interest expense.
The NPO requested CRA’s views on whether it qualified as tax exempt under paragraph 149(1)(l).
CRA stated that the fact that an organization incorporates and holds the shares of a taxable subsidiary will not, in itself, mean that an organization does not meet the requirements of paragraph 149(1)(l). It stated that, generally, an organization claiming the exemption can earn a profit as long as the profit is incidental and arises from activities directly connected to its not-for-profit objectives. It noted that the name of the taxable subsidiary suggested a connection to the not-for-profit objectives of the NPO, but could not confirm this as it did not have the objects of both organizations.
CRA confirmed that although holding shares to earn income from property may suggest a profit purpose, CRA has accepted that where an organization that otherwise qualifies as an NPO engages in an income generating activity that is carried out in a taxable, wholly-owned corporation, and this corporation pays dividends out of its after-tax profits to the organization to enable the organization to carry out its not-for-profit activities, the organization may still qualify for the exemption as set out in paragraph 149(1)(l).
CRA went on to state, however, that on the facts of the particular case, the ability of the NPO to provide ongoing loans to the taxable subsidiary suggested that the NPO had retained earnings in excess of its needs to carry out its not-for-profit activities, which suggested a profit purpose. It stated that using income to finance profitable activities in a taxable subsidiary suggests that the organization is not using its income to support its non-profit objectives. As such, CRA stated that an organization that provides loans to a taxable subsidiary would not likely qualify as a tax exempt NPO.
This technical interpretation is interesting for its discussion of the parameters within which an NPO may establish a taxable subsidiary to carry on profitable activities and transfer after-tax income to the NPO. It confirms on one hand that NPOs may legitimately establish taxable subsidiaries for the purpose of conducting profitable activities that could not be conducted directly by the NPO. However, it suggests that there are limits on the extent to which an NPO can finance the activities of such a subsidiary out of its own revenue. This leaves some uncertainty as to how much support an NPO can provide to a taxable subsidiary on an ongoing basis. It is also noteworthy that CRA commented that the alignment of the objects of the NPO and the subsidiary may be a factor in determining whether the use of the taxable subsidiary is consistent with the non-profit purposes of the NPO.
NPOs that are considering whether to establish a taxable subsidiary will therefore need to take care and obtain professional advice to ensure that the structure does not place the NPO offside the rules.