Not-For-Profit Organisations - Taxable or Not
(commentary courtesy of Chartered Accountants Australia New Zealand)
Are you or a family member involved in a community club? Do you pay a subscription fee or levy to participate in the club’s activities? In Inland Revenue (IR) officials’ issues paper, Taxation and the not-for-profit sector, it suggests these and other receipts from transactions with members are taxable to the club. This would be contrary to current practice by many, especially small not-for-profits (NFPs).
Mutuality
The key principle relied on for the tax-free treatment of receipts from members of NFPs is mutuality. Simply put, this states that one cannot profit from oneself; hence member contributions and transactions are not subject to tax.
The principle is modified in the Income Tax Act 2007. Broadly, the effect of the modification restricts the application of the position stated above so that in some cases, member subscription and trading income received by a NFP may be taxable.
The Problem
The heart of the problem is inconsistency in the tax treatment of amounts received by NFPs. This has been caused by different advice given on how the mutuality principle, the income tax legislation and IR’s operational practice and guidance apply to an NFP entity. Adding to the confusion is:
The waters are now muddied further by the issues paper highlighting that:
The current situation is unfair and causing uncertainty and confusion.
What To Do
Given the far-reaching effects of changes in the law for NFPs and untenable state of the current situation, CA ANZ has recommended:
No matter what is decided, it is critical that IR remain cognisant of the compliance costs that would be imposed on a significant number of community organisations largely run by volunteers.
Mutuality
The key principle relied on for the tax-free treatment of receipts from members of NFPs is mutuality. Simply put, this states that one cannot profit from oneself; hence member contributions and transactions are not subject to tax.
The principle is modified in the Income Tax Act 2007. Broadly, the effect of the modification restricts the application of the position stated above so that in some cases, member subscription and trading income received by a NFP may be taxable.
The Problem
The heart of the problem is inconsistency in the tax treatment of amounts received by NFPs. This has been caused by different advice given on how the mutuality principle, the income tax legislation and IR’s operational practice and guidance apply to an NFP entity. Adding to the confusion is:
- The existence of specific legislative tax exemptions for certain NFPs such as friendly societies and credit unions and bodies promoting amateur games and sports.
- Uncertainty about IR’s view on whether income from transactions with members of an NFP is taxable.
The waters are now muddied further by the issues paper highlighting that:
- Guidance stating receipts from members of an NFP were non-taxable was withdrawn in the early 2000s and not replaced; however, the position currently published on IR’s website is that membership subscriptions and levies are not taxable.
- Profits from member transactions or subscriptions may currently be taxable as business income or income under ordinary concepts (neither of these terms are explained).
- IR has come to an updated view that under the modified mutuality rule, “normally taxable transactions with members, including some subscriptions, are taxable income”; and the mutuality principle would not generally apply to most NFPs as their constitutions would prohibit distribution of surpluses to members (i.e. the qualifying criteria for mutuality has not been met). This revised view is set out in a draft operational statement yet to be published or released for public consultation. The view could therefore change.
The current situation is unfair and causing uncertainty and confusion.
What To Do
Given the far-reaching effects of changes in the law for NFPs and untenable state of the current situation, CA ANZ has recommended:
- IR determine the appropriate policy position for taxing NFPs by aligning the tax rules to the nature of the NFP – that being the entity does not exist to make a profit. Under this approach, the starting position is all transactions of an NFP should be non-taxable, tax avoidance excepted.
- At a minimum, the law should be amended to clarify that membership subscriptions and levies are non-taxable.
- If IR pursues its revised view that the mutuality principle would not apply to most NFPs and transactions with members, including some subscriptions, are taxable, an appropriate de-minimis rule is required to remove small NFPs from the tax system.
No matter what is decided, it is critical that IR remain cognisant of the compliance costs that would be imposed on a significant number of community organisations largely run by volunteers.
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