After many years of inaction in the sector, 2011 appears to be the year in which the Government has NFPs fairly and squarely in its sights.
It seems that the Government has been spurred on by its losses in the Aid/Watch case (refer to Balancing Act Issue 18 for commentary at http://www.makdap.com.au/docs/charity/publication/Makinson%20&%20d'Apice%20Balancing%20Act%20-%20Issue%2018.pdf) and the Word Investments case (at http://www.makdap.com.au/docs/charity/publication/Bulletin%20-%204%20December%202008.pdf).
The Government has apparently been motivated to address what it considers to be significant loopholes in the law which may compromise tax revenue.
It has also sought to clarify its position in light of those decisions to create greater certainty within the NFP sector.
In March 2010 the Government launched the national compact which was stated to establish the framework for a partnership between the Not-For-Profit sector and Government. In particular, it promised a reduction in red tape for NFPs. It is hard to see how many of the 2011 Government initiatives will go anywhere towards the reduction in red tape – perhaps with the possible and significant exception of the proposed "report once use often" accounting regime.
Some of the important developments in 2011 are:
The Government issued a Consultation Paper in January 2011 and following consideration of the responses to the Consultation Paper, the Treasurer announced the establishment of a national regulator to be known as the Australian Charities and Not-For-Profits Commission (ACNC) to operate with effect from 1 January 2012. For further information in relation to this refer to our Bulletin at http://www.makdap.com.au/docs/Makinson%20&%20d'Apice%20Bulletin%20May%2020111.pdf .
Since that time, the Government has been going full speed ahead to implement the decision. The Government has appointed an advisory board to assist in establishment of the ACNC and has also appointed a NFP Reform Implementation Task Force.
The establishment of the ACNC is now a fait accompli and we are hopeful that the "report once use often" accounting regime which is promised will assist NFPs. We will have to wait to see whether the other consequences of the establishment of the ACNC operate for the benefit of NFPs or add to the red tape.
The Government has now issued its final report on the Scoping Study for National Not-For-Profit Regulator which can be accessed at http://www.treasury.gov.au/contentitem.asp?NavId=035&ContentID=2054.
Unrelated Business Income Tax (UBIT)
The budget announcement which is likely to have the largest impact on the activity of NFPs is the introduction from 1 July 2011 (in some cases) of income tax upon NFPs in respect of surpluses from their "unrelated commercial activities" which are not applied towards their altruistic purposes. For further information refer to our bulletin at: http://www.makdap.com.au/docs/Makinson%20&%20d'Apice%20Bulletin%20May%2020111.pdf .
This tax actually came into effect more than a month ago on 1 July 2011 for unrelated commercial activities that commenced after the budget speech. Even though it is now in place, we still don‟t know the rules.
The Assistant Treasurer issued a consultation paper seeking the sector‟s view and we are awaiting further advice from the Government as to how or whether this new tax (referred to as "UBIT") comes into effect.
If it does, we anticipate the following issues that NFPs will need to address:
- assess the need to set up separate structures (perhaps separate companies) to carry on unrelated business activities;
- determine which of the NFPs activities are related and which are unrelated;
- categorise activities as to whether they are active‟ or passive‟ (as passive activities are unlikely to be subject to UBIT);
- there will be significant accounting, legal and staff costs resulting from the imposition of UBIT for all NFPs that are engaged in unrelated business activities to any extent.
We are concerned that the proposed UBIT will result in significant additional administration and cost to NFPs which will detract from funds available for their altruistic purposes.
We lodged a submission with the Assistant Treasurer which summarises our concerns which can be viewed at: http://www.makdap.com.au/docs/charity/publication/Submission%20to%20Consultation%20Paper%20Better%20Targeting%20of%20Not-For-Profit%20Tax%20Concessions1.pdf.
Addendum to Taxation Ruling TR2005-22
On 28 June 2011 a draft addendum was issued to Taxation Ruling TR2005-22 – Income Tax and Fringe Benefits Tax Companies Controlled by Exempt Entities. The draft addendum was issued to take into account the decision of the High Court in Word Investments.
The High Court found that Word Investments was a charitable institution because, having regard to factors such as the proper construction of its objects as set out in its Constitution, the circumstances of its foundation and the way in which it put into effect the company's objects and its activities, it was clear that its own purposes were charitable. It is our view that the draft addendum is an appropriate response to the decision in Word Investments.
"In Australia" special conditions for Tax Concession Entities
The Assistant Treasurer has released for public consultation an exposure draft of legislation that will restate the "In Australia" special conditions for tax concession entities. It seeks to ensure that:
- income tax exempt entities must be operated principally in Australia and for the broad benefit of the Australian community; and
- deductible gift recipients (DGRs) generally must be operated solely in Australia and for the broad benefit of the Australian community.
The exposure draft can be accessed at http://www.treasury.gov.au/contentitem.asp?NavId=037&ContentID=2053. The closing date for submissions is 12 August 2011.
In our view, this proposed legislative change is likely to present significant issues for a number of NFPs. Our concerns are:
- NFPs which are presently entitled to tax exemption as charity, education, science or religious funds or institutions, community service organisations, employee or employer associations (including trade unions), funds contributing to other funds, hospitals, sports and cultural organisations may lose their entitlement to tax exempt status if they do not strictly comply with the proposed new section 50-50;
- to maintain tax exempt status, an entity must operate principally in Australia and pursue its purposes principally in Australia. The exposure draft does not define principally except to say that it means "mainly or chiefly" and less than 50% is not considered "principally";
- if an NFP donates money to another entity which is not a tax exempt entity in Australia then it may lose its entitlement to tax exemption;
- the NFP must comply with all (our emphasis) the requirements in its governing rules. This may be particularly harsh in the event of a minor breach by an NFP of its governing rules. It would be important for NFPs to consider the content of their governing rules to ensure that they will not be impacted by this proposal. Many religious NFPs do not have "governing rules" and it is difficult to understand how this section can apply to those NFPs;
- to maintain exemptions, NFPs are required to use their assets and income solely (our emphasis) to pursue the purposes for which it was established. This is a harsh requirement as there is no apparent relief from this strict requirement;
- there is a definition of "not-for-profit entity" in the legislation which will apply not only to the Income Tax Assessment Act but also for FBT and GST legislation. The section does not allow an NFP entity to distribute its surplus or assets to its owners or members. In our view this definition will need to be amended to allow for such distributions where the owner or member is itself an NFP;
- a tax exempt entity which is entitled to the benefit of franking credits would need to be entitled for the whole of the year in question to obtain a refund of franking credits.
- The "In Australia" requirements will not apply to Overseas Aid Funds that are endorsed as DGRs. However, if an organisation is also engaged in other activities involving donations overseas, it may be subject to the limitations on donation outside Australia in respect of those other activities.
We urge NFPs to consider the impact of this proposed legislation on their activity and lodge a submission by the due date, ie 12 August 2011.
Public Ancillary Funds
On 14 July 2011 the Assistant Treasurer released for public consultation an exposure draft of legislation and draft guidelines providing a new regulatory framework for public ancillary funds.
The time frame for comment was extremely short and submissions in relation to the exposure draft were required by 1 August 2011 however, curiously, comments can be lodged concerning the draft guidelines up to 31 August 2011. Copies of the documents can be accessed at http://www.treasury.gov.au/contentitem.asp?NavId=037&ContentID=2048. It is apparent that the Government has resolved that it will establish binding guidelines on how public ancillary funds are operated which are similar to the guidelines established for private ancillary funds in 2009.
Some of the important aspects of the draft documents are:
- the Treasurer has power to make legislative guidelines about the establishment and maintenance of public ancillary funds (PAF);
- there will be a minimum level of annual distribution required from PAFs. The level proposed is 4% of the net assets of the PAF as at the end of its prior financial year or $11,000.00 per annum whichever is greater;
- there will be a requirement for all trustees of new PAFs to be corporate trustees. There is a grand-fathering provision to allow for PAFs that exist prior to the commencement date (1 January 2012) to continue without a corporate trustee;
- PAFs will be required to lodge income tax returns each year. This is yet another example of increased red tape for the NFP sector;
- the Commissioner of Taxation will have significant powers to remove trustees of PAFs and to appoint new trustees and direct trustees as to how they must act.
Definition of Charity
Finally (!), the Government is proposing a new definition of what constitutes a "charity". We refer you to our Bulletin of 11 May 2011 at http://www.makdap.com.au/docs/Makinson%20&%20d'Apice%20Bulletin%20May%2020111.pdf.
The Government has indicated that it will release a consultation paper on this proposed definition shortly. It has foreshadowed that the definition will be based upon the 2001 Report of the Inquiry into the Definition of Charities and Related Organisations taking into account the findings in the Aid/Watch case.
All these proposals will mean changes to the administration and structuring of almost all NFPs. Hopefully, the imposition of further red tape can be minimised in the process but we have concerns that the additional administration involved by NFPs will mean that some of their income and assets that would otherwise be applied for their altruistic purpose will now be caught up in additional administration expense.
Should you require further information or assistance in relation to the drafting of submissions or how these changes may impact on your NFP please contact Mr Bill d'Apice of our office.