In the 2011-12 Federal Budget, the Government announced that it will change the tax concessions provided to not-for-profit (NFP) entities. The changes will affect certain charities and other NFP entities that conduct commercial activities.
The Government has proposed that the new arrangements will commence on 1 July 2011. Broadly, they will initially affect new 'unrelated' commercial activities that commence after 7.30pm (AEST) on 10 May 2011.
The purposes of this alert are to:
- outline the key features of the Government's proposal that will affect charities that conduct commercial activities; and
- analyse the key issues raised in the Government's proposal.
In Commissioner of Taxation v Word Investments Limited  HCA 55, the High Court of Australia, by a majority of 4:1, held that a company undertaking commercial activities can be a charitable institution and exempt from tax. This is as long as all of the following conditions are met:
- the company's main purposes and objectives are charitable;
- the company's profits are raised for charitable purposes and directed to charitable institutions;
- the charitable institutions (that the funds are directed to) are obligated to use the funds for charitable purposes; and
- the company itself has a physical presence in Australia and it incurs its expenditure and pursues its objectives principally in Australia.
The decision left open the possibility that a support entity of a charitable group conducting commercial activities, if it provides financial support to that charitable entity, could be tax exempt.
In Australia's Future Tax System – Report to the Treasurer (Henry Tax Review), it was recognised that the Word Investments decision means that charities have a significantly larger scope to undertake commercial activities on a concessionally taxed basis than before that case was decided 1.
The Henry Tax Review recommended that2 NFP entities that currently receive income tax or GST concessions should retain these concessions. In addition, NFP entities should be permitted to apply their income tax concessions to their commercial activities. This would reflect the principles of the Word Investments decision.
Despite the Henry Tax Review recommendation, the Government proposed in the 2011-12 Federal Budget to restrict the use of tax concessions by businesses run by charities, such as the type of commercial activities in Word Investments. The Government's proposal would also affect charities which only have relatively minor commercial activities.
The Government proposed to change this area of law because3:
- the Government believes it is important that charities use their tax concessions only to assist disadvantaged-people and not for 'unrelated' commercial activities; and
- the Government considers that the change will encourage charities to direct profits generated by 'unrelated' commercial activities back to the charities' altruistic purposes.
Key features of the Government's proposal
The key features of the Government's proposal are outlined below.4
Which entities will be affected
The proposed changes will affect the tax concessions provided to NFP entities (including charities).
What tax concessions will be affected
The tax concessions affected under the proposal are:
- income tax and capital gains tax (CGT) exemptions;
- fringe benefit tax (FBT) exemptions and rebate;
- goods and services tax (GST) concessions; and
- deductible gift recipient (DGR) support.
Activities that will attract tax concessions
Income tax and CGT exemptions for charities will continue to apply to profits or gains generated by any of the following activities:
- non-commercial activities;
- related commercial activities (ie commercial activities that further the charities' altruistic purpose. These include not-for-profit hospitals, op-shops that sell second-hand household items and clothing at discounted prices to those in need, NFP child care centres, and businesses whose purpose is to provide meaningful employment to disabled persons);
- unrelated commercial activities in which profits or gains are directed back to the charity to carry out its altruistic work;
- small scale and low-risk unrelated commercial activities (eg lamington drive fundraisers, school fetes and leasing out of church halls);
- unrelated commercial activities that exist as at 7.30pm (AEST) on 10 May 2011; or
- activities under a government service delivery contract entered into by charities as at 7.30pm on 10 May 2011.
As with income tax and CGT exemptions, charities will continue to have access to the FBT exemptions or rebate, GST concessions, or DGR support in relation to the above activities.
In respect of the unrelated commercial activities that exist as at 7.30pm on 10 May 2011, charities will initially be able to continue to use their tax concessions to support these activities. However, the Government will consult on the transitional arrangements for these activities. The Government intends to phase out the tax concessions in relation to these activities over time.
Activities that will not attract tax concessions
From 1 July 2011, even though a charity has its tax concession charity endorsement, the charity will still be required to pay income tax on profits and CGT on capital gains from the charity's activities that meet all of the following conditions:
- the activities are new unrelated commercial activities that commence after 7.30pm (AEST) on 10 May 2011;
- the profits or gains from the activities are not directed back to the charity's altruistic purpose (eg earnings that the charities retain in their commercial undertaking); and
- they are not small scale and low-risk unrelated commercial activities.
In respect of the activities that meet the above conditions, in addition to not having access to income tax and CGT exemptions, the charities will also not have access to the FBT exemptions or rebate, GST concessions, or DGR support.
The charities' tax concession charity endorsement and DGR endorsement (if they are also DGRs) will not be affected even if the charities carry out activities that meet the above conditions. Although these charities can still keep their tax concession charity endorsement, they will still have to pay tax in respect of the activities that meet the above conditions.
Key issues raised in the Government's proposal
Some of the key issues raised in the Government's proposal are discussed in Part 2.
1 Treasury (2010), Australia's Future Tax System – Report to the Treasurer, at 208
2 Treasury (2010), Australia's Future Tax System – Report to the Treasurer, at 211 (Recommendation 42)
3 Assistant Treasurer's Press Release No.077 (10 May 2011) – Making it easier for charities to help those who need it
4 Assistant Treasurer's Press Release No.077 (10 May 2011) – Making it easier for charities to help those who need it; Federal Budget 2011-12 Paper No.2
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.