Two recent CRA technical interpretations have signalled a change in the way that the CRA is interpreting the provisions of paragraph 149(1)(l).  This paragraph provides an exemption from tax that is available to organizations meeting certain requirements.  The CRA’s Interpretation Bulletin IT-496R “Non-profit Organizations” breaks down the requirements for maintaining “non-profit” status pursuant to this paragraph as follows:

  1. the organization is not a charity;
  2. it is organized exclusively for social welfare, civic improvement, pleasure, recreation or for any other purpose except profit;
  3. it is in fact operated exclusively for the same purpose for which it was organized or for any of the other purposes mentioned in (b); and
  4. it does not distribute or otherwise make available for the personal benefit of a member any of its income.

The Income Tax Act itself imposes few restrictions on the permitted purposes of a non-profit organization.  The key elements are that the purposes of the organization do not include the pursuit of profit and that the organization is in fact operated exclusively for a purpose other than profit.  In IT-496R, the CRA states that an organization may earn income in excess of its expenditures provided that the requirements of the Act are met and that the excess may result from the activity for which the organization was organized, or from another activity.  However, the CRA states that if a material part of the excess is accumulated each year and the balance of the excess at any time is greater than the association’s reasonable needs to carry on its non-profit activities, profit will be considered to be one of the purposes for which the organization is operated.  The CRA states that it will be particularly likely to infer a profit purpose when the assets representing the accumulated excess are used for purposes unrelated to the organization’s objects.  The CRA provides the following examples:

  • Long-term investments to produce property income;
  • Enlarging or expanding facilities used for normal commercial operations;
  • Loans to members, shareholders or non-exempt persons.

The CRA states that the question of whether the amount of accumulated excess income is reasonable in relation to the needs of the organization to carry on its non-profit activities is a question of fact to be determined with regard to the association’s particular circumstances, including such things as future anticipated expenditures and the amount and patterns of receipts from various sources.

Miller Thomson Analysis

In a technical interpretation released on November 5, 20091, the CRA was asked to consider a number of questions.  In this context, the relevant questions were as follows:

  1. Can an organization earn a profit and continue to be exempt from tax under paragraph 149(1)(l) of the Act?
  2. 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?

The CRA responded that it is not the profit itself that causes an organization to fail to qualify for the exemption, but whether it intended to earn a profit.  Although this technical interpretation does not expressly disagree with IT-496R, it appears to take a broader interpretation of when an organization will be found to be operating with a profit purpose.  Essentially, the technical interpretation takes the position that where an organization budgets for any surplus in a given year, it will be found to be operating with a profit purpose.  The technical interpretation accepts that an organization may budget with the intention of not earning a profit, but may nonetheless earn a profit due, for example, to lower than expected expenses.  The CRA states that provided the original budget was reasonable, the profits earned will not lead to a finding of a profit purpose.  However, the technical interpretation states that in order to qualify for the exemption, any profits earned must be “generally unanticipated and incidental.”

This technical interpretation also suggests stricter limits on the ability of a non-profit organization to budget for surpluses for the purpose of funding future capital projects.  The CRA states that a “profit” is considered to be the positive difference between an organization’s revenue and the expenses incurred to earn that revenue.  The CRA states that in determining the expenses that were incurred to earn revenue, an organization may take into account depreciation of capital assets and ongoing current expenses but not future capital projects.  The CRA acknowledges that an organization may accumulate members’ contributions over a period of years in order to finance a future capital project, and that the organization may earn reasonable investment income on such accumulated funds, even though this might be considered anticipated profit.  However, it states that if such excess funds are collected for the purpose of earning investment income rather than to fund a particular capital project, this would constitute a profit purpose and the organization would no longer qualify as tax-exempt under paragraph 149(1)(l).

The CRA’s position in this technical interpretation was furthered in a second technical interpretation dated December 15, 20092.  In this technical interpretation, the CRA was asked to respond to the following questions:

  1. Can a condominium corporation rent a suite for an amount in excess of its costs of operating and maintaining the suite and still qualify for the exemption from tax provided by paragraph 149(1)(l)?
  2. If the rental profits are used to reduce members’ fees, does this affect the exemption?

The CRA stated that in its view, in order to meet the requirement that it is operating exclusively for any other purpose except profit, a condominium corporation can charge fees for services that are approximately equal to the cost of providing those services.  A condominium corporation cannot intentionally charge fees in excess of cost and still be considered to be operating exclusively for any other purpose except profit.  With respect to the second question, the CRA stated that a reduction in members’ fees in this manner would result in the corporation making the income of the condominium corporation available for the personal benefit of its members, which would also disqualify the corporation from claiming the exemption.  This technical interpretation suggests that to qualify for the exemption, each of an organization’s activities must be operated on a cost recovery basis.

It would appear to be the CRA’s view that it is no longer permissible to use revenues from one activity to support another activity.  In other words, an organization that operates on an overall cost recovery basis does not necessarily qualify for the exemption.  The CRA’s interpretation of paragraph 149(1)(l) in both of these technical interpretations is quite restrictive and appears to be more restrictive than the interpretation that has developed in the courts.  Indeed, it is also more restrictive than its policy as set out in IT-496R.  As well, courts have accepted that, in certain circumstances, organizations may intentionally earn profits that are incidental to the carrying on of their non-profit purposes, and that this will not cause the organizations to cease to qualify for tax exempt status under paragraph 149(1)(l).

Given that many significant non-profit organizations operate in a manner inconsistent with the CRA’s new position, we would expect that this audit initiative will result in major reassessments denying long standing major non-profits their tax exemption.  We understand however that this review will not necessarily result in reassessments at first instance but will instead result in identifying areas of non-compliance and education letters to organizations found to be in non-compliance.  Existing non-profit organizations should ensure that their planning, budgeting and reporting processes are as consistent as possible with the CRA’s new position.  For example, budgeting should be conservative so as not to predict surplus and reserves should be accounted for explicitly.