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- NPOs MAKING MONEY...AND OTHER COMPLIANCE ISSUES
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- Basics of Maintaining NPO Status
- Making Money as an NPO
- NPO Risk Identification Project
- Practical Questions
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- The terms “non‑profit” and “not‑for‑profit” (“NPOs”)
are used interchangeably and generally refer to organizations whose
profits are not passed on to their members
- This section provides an update on recent CRA views on the tax exempt
status of NPOs, including
- Capacity of NPOs to earn profits
- Carrying on a trade or business through an NPO
- Recent CRA views create much uncertainty for NPOs and substantially
limit their revenue-generating capacity
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- To qualify as an NPO, organization must meet all 4 criteria under
paragraph 149(1)(l) of the Income Tax Act (“ITA”) throughout any
taxation year in order to maintain tax-exempt status
- Not be a charity
- Be organized exclusively for social welfare, civic improvement,
pleasure, recreation or any other purpose except profit
- Be operated exclusively for social welfare, civic improvement,
pleasure, recreation or any other purpose except profit
- Not distribute or otherwise make available for the personal benefit of
a member any of its income
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- It is a question of fact that can only be determined after a review of
the purposes and activities of the NPO
- NPO status must generally be reviewed on a year by year basis
- Document 2010-0380581I7 - It is possible for an organization to qualify
for exemption as an NPO for a period shorter than its fiscal year
- Being incorporated as a not-for-profit under corporate legislation does
not mean that the organization is an NPO for tax purposes
- See CRA IT-496R, Non-Profit Organizations http://www.cra-arc.gc.ca/E/pub/tp/it496r/README.html
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- Must not be a charity
- If CRA considers an organization to be a "charity“ as defined in
subsection 149.1(1), then it cannot qualify in that period as a
tax-exempt NPO
- No explicit opinion from CRA is required and no ruling would be issued
because it is always a question of fact (Document 2009-03299)
- If an NPO is denied charitable registration, this does not automatically
mean that it is not a charity
- Document 2010-0380581I7 - an organization with exclusively charitable
purposes does not qualify as an NPO, even if it is not a registered
charity
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- 2. Must be organized for
non-profit purposes
- NPOs must be organized exclusively for social welfare, civic
improvement, pleasure, recreation or any other purpose except profit
- Document 2010-0380581I7 - NPOs may be established to further any
purpose other than for a profit purpose, no requirement that an NPO
must have a “benevolent” or “social” purpose
- When determining the purpose for which an association was organized,
the instruments creating the association will normally be reviewed,
including letters patent, articles of incorporation, memoranda of
agreement, by-laws, etc.
- Rarely an issue, though recent audits have commented on dissolution
provisions in this context
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- 3. Must be operated for
non-profit purposes
- NPOs must in fact be operated exclusively for social welfare, civic
improvement, pleasure, recreation or any other purpose except profit
- This is the criteria that is the subject of the most uncertainty for
NPOs, particularly with respect to NPOs making money
- CRA is generally of the view that an NPO can engage in commercial
activities and earn an unintentional profit, but if it would be unable
to undertake its not-for-profit activities but for its profitable
activities, the organization cannot be an NPO because it has a profit
purpose (Document 2009-033731) - details later
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- 4. Must not distribute income to
members
- An NPO must not distribute or otherwise make available for the personal
benefit of a member any of its income unless the member is a RCAAA
- No part of the income of an NPO, whether current or accumulated, can be
paid to a member, nor may it declare and pay dividends out of income
- An NPO may fail to comply with this requirement on a winding-up,
dissolution, or amalgamation resulting in tax liability
- Certain types of payments will not, in and by themselves, disqualify an
NPO, such as reasonable salaries, wages, fees or honorariums for
services rendered to the NPO
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- Where the NPO is a corporation, a T2 Corporation Income Tax Return (or
a T2 Short Return for eligible corporations) must be filed within 6
months
- All NPOs must also file a Form T1044, Non-Profit Organization (NPO)
Information Return in the following circumstances:
- The total of all amounts received or receivable by the NPO in the
fiscal period for taxable dividends, interest, rentals or royalties is
more than $10,000;
- The total assets of the NPO at the end of its immediately preceding
fiscal period exceeded $200,000; or
- The NPO had to file an NPO information return for a preceding fiscal
period
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- Where subsection 149(5) of the ITA applies (generally to an NPO whose
main purpose is to provide dining, recreational or sporting facilities
for its members), an inter vivos trust is deemed to have been created
for the NPO’s property income
- T3 Trust Income Tax Information Return must be filed within 90 days from
the end of the deemed trust’s taxation year where the deemed trust has
tax payable with respect to property income, or has disposed of any
capital property that is not used directly in the course of providing
dining, recreational or sporting facilities to its members
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- An NPO that is also a Registered Canadian Amateur Athletic Association
(“RCAAA”) does not have to file a Form T1044. An RCAAA must file Form
T2052, Registered Canadian Amateur Athletic Association Return of
Information within 6 months of the RCAAA’s fiscal year end
- Certain NPOs may not be required to file any forms for a particular
taxation year if none of the conditions outlined above are met
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- Automatically becomes a taxable entity
- A deemed year end for the corporation is created and corporation deemed
to have disposed of and reacquired all of the corporation’s assets for
fair market value [paragraph 149(10) of the ITA]
- It also affects the corporation’s ability to carry forward losses and
other balances or reserves
- Members of an unincorporated NPO would become responsible for any
taxable income in the organization (CRA Document 2010-036970)
- Document 2010-035583 provides a recent discussion
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- Question: Is the NPO operating
for a non-profit purpose if it is:
- Carrying on a trade or business
- Accumulating excess income
- Earning investment income
- Carrying on a trade or business through a wholly owned subsidiary
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- a) Carrying on a trade or business through an NPO
- The ITA does not specifically prohibit an NPO from earning a profit or
engaging in commercial activities
- Paragraph 7 of IT-496R recognizes that “the carrying on a trade or
business directly attributable to, or connected with, pursuing the
non-profit goals and activities of an association will not cause it to
be considered to be operated for profit purposes” if those activities
are carried on within the NPO
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- IT-496R lists some characteristics that CRA considers in determining
whether an activity is a trade or business
- a) Is it a trade or business in the ordinary meaning, e.g. operated in
a normal commercial manner;
- b) Are its goods or services restricted to members and their guests;
- c) Is it operated on a profit basis rather than a cost recovery basis;
or
- d) Is it operated in competition with taxable entities carrying on
same trade or business
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- If the activity generates a profit, CRA has indicated as follows:
- The income generating activity cannot be the principal activity of the
corporation and the resulting income must be used by the corporation in
carrying out its exempt objectives (Document 1998-97046)
- There must be a causal relationship between the profit making activity
and the exempt purpose of the organization (Document 2002-01538)
- The profit must be it is unanticipated and incidental to carrying out
the NPO’s exempt purposes (Document 2009-033731)
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- Document 2010-0380581I7 - recent summary of CRA’s view
- NPOs must operate “exclusively” for purposes other than profit
- Incidental profits do not amount to a profit purpose
- May receive incidental profits through basic fundraising (lotteries,
bake sales, chocolate bar sales, etc.) and soliciting gifts and grants
- Can earn profits, but the profits should be incidental and arise from
activities that are undertaken to meet the organization's
not-for-profit objectives
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- Earning profits to fund not-for-profit objectives is not considered to
be itself a not-for-profit objective (i.e., no destination test)
- Should fund capital projects and establish (reasonable) operating
reserves from capital contributed by members, from gifts and grants, or
from accumulated, incidental profits
- Capital contributions, gifts and grants, and incidental profits should
generally be accumulated solely for use in the operations of the
organization (including funding capital projects or setting up
operating reserves) and should not be used to establish long-term
reserves designed primarily to generate investment income
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- Maintaining reasonable operating reserves or bank accounts required for
ordinary operations will generally be considered to be an activity
undertaken to meet the not-for-profit objectives of an organization -
incidental income arising from these reserves or accounts will not
affect the status of an organization
- May engage in limited fundraising activities involving games of chance
(e.g., lotteries, draws), or sales of donated or inexpensive goods
(e.g., bake sales or plant sales, chocolate bar sales)
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- In determining whether an organization has any profit purpose, the
activities of the organization must be reviewed both independently and
in the context of the organization as a whole
- CRA gave the following examples of acceptable activities that result in
incidental profit
- Operation of a canteen at a hockey arena
- Charging admission above direct cost for a children's concert (where
the not-for-profit purpose of the organization was to organize and
promote youth participation in music)
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- In CRA View 2011-0427611I7, after evaluating the information presented
to it, CRA determined that the NPOs profits were consistently increasing
every year, that its profits were not incidental, and that its profit
margins were such that the Organization had a for profit purpose
- Of particular concern was that the NPOs members equity had also
increased over the years such that CRA believed that the organization
could be accumulating funds in order to earn tax-exempt investment
income
- CRA concluded that the NPO had not been operating for a purpose other
than profit and did not meet the requirements of paragraph 149(1)(l)
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- b) Accumulating Excess Income
- IT-296R indicates that an NPO may earn income in excess of its
expenditures and that the excess may result from the activity for which
it was organized or from some other activity
- A one-time capital gain from disposing of property does not jeopardize
NPO’s status (Document 2010-035802)
- But, if a material part of an excess is accumulated each year and the
balance of accumulated excess at any time is greater than the NPO’s
reasonable needs to carry on its non-profit activities the NPO will be
considered to be operating for a profit
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- The amount will be considered reasonable based on the needs of the NPO,
including such things as future anticipated expenditures and the amount
and pattern of receipts from various sources (e.g., fund raising,
membership fees, training course fees)
- In some circumstances, an accumulation equal to one year's reasonably
anticipated expenditures on its non-profit activities may not be
considered excessive, while a reserve equal to expenditures over a much
shorter period would be considered more than adequate in other
situations
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- If an NPO requires a time period in excess of the current and prior
year to accumulate the funds needed to acquire capital property that
will be used to achieve its declared exempt activities, its tax-exempt
status may not be affected
- Examples include the construction of a new building to replace an
existing building when it deteriorates or no longer meets the
association's needs or the condo roof referred to earlier
- Potential problem arises regarding how the funds are held while being
accumulated
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- c) Earning Investment Income
- In L.I.U.N.A. Local 527 Members’ Training Trust Fund v. The Queen, the
court held that an NPO would have to do more than merely earning
passive investment income to lose its status. The earning of such
income would need to be both an operating motivation of the fund and a
focus of its activity
- However, IT-496R indicates an NPO will be considered to be operating
for profit if it has excess assets held in long-term investments to
produce property income or in a term deposit or GIC that is regularly
renewed from year to year
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- An example (Document 2010-036605)
- CRA considered a situation where a proposed NPO intended to invest a
substantial amount of cash donated to it to provide income which would
be used by the NPO exclusively to pay for its cultural activities and
various related operations
- CRA confirmed that the activity of investing cash is considered to be
undertaken to earn a profit, which is contrary to the conditions of
the ITA. The only exception is where the income-generating assets will
themselves be used directly to meet an NPO’s not-for-profit objectives
within a reasonable time-frame
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- In CRA View 2011-0408851I7, members of the organization in question were
charged a commission on services provided to them, with the net profits
being distributed to the members at specified times throughout the year.
Because there was a difference in time between the inflow and outflow of
money, the money was invested the collected money until distribution to
the members occurred.
- Income from the investments was then used to defray the expenses of the
organization and to keep com-missions charged to its members as low as
possible.
- Did the expectation of this income affect its ability to claim NPO
status, especially with the organization’s desire to minimize the
commissions charged to its Members?
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- CRA stated that since the organization’s reasons for distributing the
amounts collected from users to Members was due to non-profit reasons,
it was reasonable to expect that the funds would be invested
- The profit from these funds could only be used to help meet operating
expenses and not to generate investment income
- If the investment income was the income of the members and not of the
organization (i.e. the organization was an agent of the members with
respect to the income), then the investment income would be taxed in the
hands of the members and would not affect the tax status of the
organization as an NPO
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- d) Carrying on a trade or business through a wholly owned subsidiary
- CRA has indicated that not only can an NPO carry on income-generating
activity (provided that there is a causal relationship between the
profit making activity and the exempt purpose of the organization), an
NPO may also derive income from a taxable subsidiary (Document
2002-0153887)
- Also, if an NPO holds all of the shares of the capital stock of a
taxable corporation, its NPO status is not necessarily endangered
(Document 2001-0093245)
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- Some commentators are of the view that CRA’s interpretations on this
question are overly restrictive:
- “[T]he requirement should not be read as a prohibition against the
profitable pursuit of not-for-profit purposes. If that were the intended
meaning of the rule, the statutory requirement would be phrased as a
prohibition against profit-making, not as a purpose test...
“[i]ncidental” profits, meaning profits that are a byproduct or incident
of an activity but not the activity’s point, anticipated or
unanticipated, generated in the pursuit of a not-for-profit purpose
should be permissible under a purpose test. Consistently profitable activity is
merely evidence of a profit purpose, not proof of it.”
- See David P. Stevens & Faye Kravetz, Current Developments in the
Application Of Paragraph 149(1)(1) Of The Income Tax Act, The
Philanthropist, 25:3 at p. 165.
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- The language simply does not deal with the anticipated use of the funds
so basing a determination on whether a NPO qualifies on whether it would
be unable to undertake its not-for-profit activities but for its
profitable activities is without basis in the legislation and, arguably,
irrelevant
- According to Stevens and Kravetz, the judicial decisions are much closer
to the view that incidental profit-making and profit-making to support
non-profit activities are permitted
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- The NPO Risk Identification Project was a 3-year research project on tax
compliance in the non-profit sector completed in the summer of 2013
- NPOs have been under the microscope of CRA, particularly with respect to
the revenue they earn in addition to membership fees
- CRA randomly selected NPOs to review from the 39,000 NPOs that file T2,
T3 and/or T1044 returns
- Over the three years of the project, 1440 NPOs were to have been
reviewed
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- Education letters issued as part of the project had caused great concern
among NPO sector and prompted many discussions with CRA
- Perrin Beatty, President and CEO of the Canadian Chamber of Commerce
wrote a letter on March 13, 2012 to the Minister of National Revenue
expressing the concerns of the NPO sector
- Stated CRA appeared to be unaware of impact of letters on members of
NPOs
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- Mr. Beatty stated:
- “Our concern is not with the examination, but with the lack of
communications about its purpose and with the Agency’s practice of
issuing “education letters” to organizations which have been audited
under this process. Although
the Agency has often stated that “no conclusions have been reached”,
these letters inform the organizations that they are in breach of the
Act, and urge them to make adjustments in their activities to comply”
- As of April 23, 2012 CRA was directed by the Minister to stop issuing
the education letters and is only providing written views upon request
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- CRA now has an informative question and answer section for NPOs to
consult http://www.cra-arc.gc.ca/tx/nnprft/qa-eng.html
- CRA states that education letters were meant to “raise awareness of the
rules governing the benefits available” to NPOs under the ITA and that
reassessments are only occurring in the most “egregious cases”
- CRA maintains its position that it is possible for an NPO to generate a
profit but
- the profit must be incidental; and
- arise from activities that support the organization’s not-for-profit
objectives
- Report due early in 2014
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- OTHER EXEMPTIONS
- Because of concerns with respect to reserves and profit-making
activities many organizations are considering whether they want to
maintain NPO status and/or whether they can claim exemption from tax
under other paragraphs of subsection 149(1)
- For example:
- (c) a municipality in Canada, or a municipal or public body performing
a function of government in Canada
- Mostly Indian bands but may also include quasi-municipal/regulatory
organizations
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- (e) an agricultural organization, a board of trade or a chamber of
commerce, no part of the income of which was payable to, or was
otherwise available for the personal benefit of, any proprietor, member
or shareholder thereof
- Does this include industry associations or professional associations?
- (i) a corporation that was constituted exclusively for the purpose of
providing low-cost housing accommodation for the aged
- (j) a corporation that was constituted exclusively for the purpose of
carrying on or promoting scientific research and experimental
development
- (k) a labour organization or society or a benevolent or fraternal
benefit society or order
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- Does the organization continue to meet the definition of a non-profit
organization under the ITA?
- Are the organization’s objects/purposes sufficient to ensure that it is
not a charity, e.g., by including in its objects or purposes a
disqualifying clause such as lobbying for legislative change?
- Does the organization earn a profit from a particular activity? If so,
is the earning of the profit incidental or intentional, how much profit
is earned from each activity and what is the profit used for?
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- What does it mean to not intend to earn a profit from a particular
activity?
- Can an NPO organize an activity with a margin? 2%, 5%, or 0%
- CRA seems to be mandating zero-based budgeting on each activity
- Many commentators take the view that this approach is wrong
- CRA seems to be confusing the purpose of an activity with the purpose
of the organization
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- Does the organization maintain reserves in excess of a reasonable level
acceptable to CRA?
- Be careful about how capital projects are funded, CRA suggests this
may only occur through increased member fees
- Does the organization carry out revenue activity within a taxable
entity? If so, governance issues will need to be carefully considered
- Is the organization filing all required income tax forms?
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- Recent CRA views create much uncertainty for NPOs and substantially
limit their capacity to make money
- While these views are open to challenge on the basis that they
contradict existing jurisprudence, NPOs seeking to comply will have to
look closely at their revenue-generating activities and take proactive
measures to ensure that they are not caught offside the CRA’s recent
administrative positions
- Still remains to be seen though what the outcome of the Risk
Identification Project will be and whether money making activities will
be offside of CRA requirements
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- THANK YOU
- Karen J. Cooper
- kcooper@carters.ca
- (613)235-4774
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