In a technical interpretation (CRA View 2025-1062851E5), the Canada Revenue Agency (“CRA”) expressed its view on how a non-profit organization (“NPO”) club may use proceeds of sale of land in the context of subsection 149(5) of the Income Tax Act (“ITA”).
As background, the taxable income of an NPO under paragraph 149(1)(l) of the ITA is exempt from tax under Part I if it meets these requirements – it is a club, society or association; it is not a charity; it is organized and operated “exclusively” for social welfare, civic improvement, pleasure, recreation or any other purpose except profit (“Non-Profit Purposes”); and it does not make its income available for the personal benefit of its members (subject to a limited exception for certain amateur athletic organizations) (“No Personal Benefit Test”).
Ability to earn incidental profit
The CRA explained that the second requirement that an NPO must be organized and operated “exclusively” for Non-Profit Purposes means that (i) while an organization may have many purposes, none of those purposes can be to earn a profit, and (ii) the organization cannot “intend” to earn a profit, even if it expects to use or actually uses that profit to support its Non-Profit Purposes.
However, this requirement does not preclude an NPO from earning a profit, provided that the profit is “incidental” – meaning the profit is not significant, it arises from activities with Non-Profit Purposes, and it is used to meet the Non-Profit Purposes of the organization. On the facts described to the CRA, the property in question was rented to non-members on a sporadic and minor basis, and not actively pursued as a source of income. As such, the CRA stated that such occasional rental income would likely be considered incidental.
Application of subsection 149(5) and subparagraph 149(5)(e)(ii)
The CRA considered the application of subsection 149(5) and subparagraph 149(5)(e)(ii) to the proceeds of sale of the property by the club in question. An NPO whose main purpose is to provide dining, recreational, or sporting facilities for its members is subject to the rules in subsection 149(5). This provision deems an inter vivos trust to exist and deems the property of the NPO club to be the trust’s property; and thereby income tax is payable by the trust on its taxable income which is generally limited to property income and taxable capital gains.
However, subparagraph 149(5)(e)(ii) provides an exception to this tax on taxable capital gains from the disposition of property “used exclusively for and directly in the course of providing the dining, recreational or sporting facilities provided by it for its members.”
The CRA indicated that the phrase “used exclusively for and directly in the course of” is not found elsewhere in the ITA, and neither are the terms “used”, “exclusively”, and “directly” defined in the ITA. As such, CRA expressed its reliance on jurisprudence and dictionary definitions for those terms when considering the application of subparagraph 149(5)(e)(ii). On the whole, to qualify for the exception under subparagraph 149(5)(e)(ii), (a) the property must be “actively employed”, and “used exclusively for and directly in the course of” providing the dining, recreational or sporting facilities for its members, and therefore casual, indirect, limited or historical uses are not sufficient; (b) the use of the property must be restricted to the specified purpose of the organization for its members; not “secondary, incidental, or unrelated” uses”, and not used for the general public; and (c) the property’s use must have a “straightforward connection” and “clear link or relationship” to the organization’s dining, recreational, or sporting facilities for its members.
In this case, the property in question is the main parking lot used by the club’s members and qualifies for the exception under subparagraph 149(5)(e)(ii). It is not negatively impacted by the fact that it was rented to non-members occasionally that was “sporadic, minor, and not actively pursued.”
Use of proceeds of sale of property
The CRA also expressed its views on the treatment of proceeds from the disposition of the parking lot. The club indicated that some of the sale proceeds may be held in a reserve fund for future use, including to cover future capital improvements, to repair or replace equipment, or to reduce membership fees.
First, the proceeds may be held in a reserve fund, provided that it is reasonable and used solely in the operations of the organization. There is no specific quantum that is considered “reasonable” and each reserve fund must be considered in light of all circumstances of the organization, including its future anticipated expenditures and the amount and pattern of receipts from various sources.
Second, the reserve fund can be invested to earn passive investment income, provided that if the investment income accumulates and creates a surplus well beyond what is reasonably required for the organization’s operations, it may indicate that the organization is operated for a profit purpose, thereby leading to the loss of its status as a tax-exempt NPO.
Third, the taxable and non-taxable portion of the capital gain from the sale proceeds can be distributed to members, including by reducing membership fees. As indicated above, one of the requirements for NPOs is that it must meet the No Personal Benefit Test. Income for this purpose is determined in accordance with section 3 of the ITA. Since subsection 149(2) excludes any taxable capital gains or allowable capital losses, NPOs are permitted to distribute these funds to their members and not off-side with the No Personal Benefit Test.
Fourth, incidental profits earned from investing the sale proceeds can be used to reduce membership fees. However, payments of incidental profits directly to members would not be permitted due to the No Personal Benefit Test.