In a speech to the National Press Club on 27 May 2011, Assistant Treasurer Bill Shorten released a consultation paper entitled 'Better targeting of not-for-profit tax concessions'. The consultation paper marks the first stage of the reforms announced in the 2011 Federal Budget. Social enterprises, charities and not-for profit (NFP) organisations with significant income-generating activities will need to consider how these reforms may impact their ability to continue such activities in a sustainable and tax-effective manner.
The intended purpose of the reforms is specifically aimed 'to ensure a level playing field between for-profit and NFP commercial activities'. This is a significant policy shift in the role and functions of not-for-profits as opposed to for profits delivering public benefit activities.
The consultation paper covers three main issues in its consideration of a limitation to tax concessions for not-for-profits:
- What activities/scale of activities should be permissible without jeopardising tax concessions?
- How should unrelated commercial activities be structured?
- What transitional arrangements should be implemented as the reforms are introduced?
A copy of the consultation paper can be accessed here.
A summary of the questions for consultation is set out below.
This issue considers the appropriate nexus between the primary and non-primary purpose of an NFP. These reforms will have the effect of limiting the tax effective methods or activities which an NFP may undertake and may mean that they are required to scale down some more effective income generating activities.
- What should be the scope of a related business, unrelated business, primary purpose or non-primary purpose test?
- Should there be a small scale threshold and if so, what would be the appropriate threshold?
- Is there an alternative principle that could be used to provide a small scale or low risk activity exception?
Entity and activity structure options
The consultation provided three options to implement its reform of targeted tax concessions:
Option 1: Unrelated commercial activities could be undertaken through a separate entity which would be taxed equivalently to other commercial entities in Australia.
Option 2: Unrelated commercial activities could be undertaken in a separate entity and profits retained in the entity at the end of the year would be taxed.
Option 3: NFP entities could undertake unrelated activities within the NFP entity.
- Would there be an unintended consequence resulting from any of these options?
- Which option do you prefer and why?
- Would we need to proceed with more than one option?
To illustrate the options, take the example of a NFP entity and a for-profit entity that both operate book stores. The stated charitable purpose of the NFP entity is to 'alleviate poverty in the community' and it does this by seeking public donations and supplying meals to the homeless.
The issue will be whether the operation of the book store is 'an unrelated commercial activity'. If it is then:
- Option 1 requires the operation of the book store by the NFP to be carried out under a separate entity, and the separate entity will be taxed in the same way as the for-profit entity regardless of any distribution to the NFP
- Option 2 requires the operation of the book store by the NFP to be carried out under a separate entity and any surplus generated by the separate entity that is not distributed back to the NFP is taxed in the same way as the for-profit entity
- Option 3 allows the activity to remain in the one entity but places the charitable purposes of the NFP at risk, since the tax concessions are granted by the ATO on the basis that its operation of the book store is 'incidental or ancillary' to its primary charitable activities. This will depend on the scale between its primary charitable activities and its book store operation activities.
The transition to compliance with the proposed reforms will result in significant financial and administrative restructuring costs for NFPs. This is likely to have a significant effect on many NFPs who may need to consider whether they could or should continue to operate. NFPs who rely on unrelated business activities may well begin to consider restructuring their income generating activities to avoid an unintended consequence.
- Would assistance be required to transition to the new arrangements?
- What costs will need to be borne by the entity?
- What are the implications of longer vs shorter transitional periods?
- Would identification of the existing activity be by reference to the overall business or to particular activities?
- Should activities intended to be carried on or contracted to enter into before the delivery of the budget be included? How would these be evidenced?
- Where an entity already operates with existing income tax exempt commercial activities, what should be the test for identifying new activities during the transition?
- What is an acceptable time limit for allowing tax concessions for existing government service delivery? Why?
- In relation to entities moving from tax exempt to taxable activities, will the continuation of the 'rule of books' model in division 57 in schedule 2F of the ITAA 1936 achieve an appropriate transition from exemption to taxable status?
- Are there any other factors to consider in transferring a taxable function or activity of an exempt entity to a separate entity?
Gadens Lawyers is able to assist charity and not-for-profit organisations to structure their organisations and activities in order to minimise risks to their tax concession status that may be caused by their social enterprise or income-generation activities, or to restructure their activities in preparation of the reforms.
Gadens Lawyers is also able to advise organisations that would like to make a submission to the Treasury.
The closing date for submissions is Friday, 8 July 2011.
For more information, please contact:
t (02) 9931 4873
t (02) 9931 4738
t (02) 9931 4951