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Tax Working Group signals agenda for review of charity taxation

October 04, 2018

Contacts

Partners Barney Cumberland
Special Advisors Stuart Hutchinson
Senior Associates Nick Bland

Charities

The Tax Working Group (TWG) has now issued its interim report on the NZ tax system. As signalled in our recent FYI Charity tax concessions in the spotlight, charity taxation is one of the areas that the TWG has focused on.

The TWG identifies key charity matters that it considers should be on the policy agenda - first as part of the DIA-led Charities Act review, and then as part of the IRD-led Tax Policy Work Programme.

This means that the Charities Act review now has greater significance for the charitable sector - especially its consideration of issues raised by the TWG regarding charities accumulating tax-exempt funds rather than using them for charitable purposes, and regarding specific regulation of privately-controlled charities.

This FYI outlines the key charity matters highlighted by the TWG, which are relevant to charitable and not-for-profit organisations right across the sector.

Key charity matters highlighted by the TWG

The TWG does not contemplate any tax measures to support the charitable sector, such as imputation credit refundability or taxation measures to facilitate social enterprise. Instead, the TWG focuses on regulating and restricting existing tax concessions for charities and other not-for-profits.

The principal charity matters highlighted for review are:

  1. Charity income tax exemptions (including but not limited to the exemption for charities’ business income), with a particular focus on the issue of funds being accumulated rather than distributed or applied for charitable purposes.

  2. More rigorous regulation of privately-controlled foundations and other such charities, for example in relation to governance arrangements, accumulation and distribution of funds, and investments.

  3. Further tightening of the tax rules applicable to entities that are deregistered under the Charities Act, to keep assets/funds within the charitable sector and discourage misuse of charity income tax exemptions.

  4. The continuation and scope of the current GST concession for GST-registered non-profit bodies in relation to claiming back the GST content of their expenditure.

The TWG’s position on each of these matters is outlined briefly below.

1.  Charity income tax exemptions - business vs. non-business income & accumulation of funds vs. charitable use of funds

The TWG recommends that the charitable sector’s effective use of the subsidy that it receives by way of income tax exemption to deliver intended social outcomes should be reviewed by the Government from time to time, and suggests that certain aspects of the current regime should be reviewed.

Various submitters had asserted that the charity business income tax exemption, and especially its application to businesses “unrelated” to the direct advancement of any charitable purpose, inappropriately confers an unfair competitive advantage over other businesses. The TWG largely rejects this.

Instead, the TWG suggests that the key issue in relation to the current charity income tax exemptions is the accumulation of tax-exempt funds (including both business and non-business income) which are not distributed or applied for charitable purposes (or are not used for such purposes for some time). The TWG says this may raise a competitive neutrality issue, as well as wider concerns regarding whether or not charitable purposes are ultimately being advanced by entities supported by the current exemptions.

The TWG’s view is that charities’ accumulated assets and income should be used for charitable purposes in order to qualify for tax exemption. It suggests that options such as minimum requirements in relation to annual charitable use of funds, or the taxation of retained income (offset by tax relief for charitable use of funds) should be looked at.

The TWG cautions, however, that any changes to current exemptions must allow for the legitimate accumulation of tax-exempt funds for charitable use.

2.  Regulation of ‘private’ charities

The TWG notes the lack of any specific regulation of ‘private’ charities that can benefit from both charity income tax exemptions and donation tax incentives, including receipt of tax-incentivised donations from the individuals and families involved in such charities (and from associated entities).

NZ differs from various other jurisdictions in this respect, and the TWG has recommended that specific regulation of private charities should be considered, especially in light of the increasing number and scale of such charities. The TWG apparently does not consider Charities Act registration and DIA Charities Services and IRD oversight of such charities to be sufficient.

Particular issues identified by the TWG include:

  • the lack of any requirement to have ‘arm’s length’ governance arrangements;

  • inappropriate accumulation of funds, rather than using funds for charitable purposes; and

  • inappropriate or imprudent investment of funds, including investment in enterprises connected with the individuals or families involved in such charities.

In reality, such issues are by no means unique to ‘private’ charities.

3.  Tighter deregistration tax rules

Punitive tax rules apply to entities that no longer qualify for charity income tax exemptions, in particular because they have deregistered (voluntarily or otherwise) under the Charities Act.

The broad intent of the rules is to incentivise the disposal or transfer of a deregistered entity’s assets/funds (or their full value) to another person for charitable purposes, within 12 months of deregistration. Failure to do so results in the deregistered entity being taxed on the value of its net assets (excluding certain assets, and assuming the entity does not qualify for any other exemption), as a proxy for “clawing back” the charity income tax exemption benefits previously claimed.

These rules have proved to be problematic. The original 2014 rules were replaced in 2018 (with effect from 2016), and further changes to the rules are proposed under a current tax bill.

But the TWG, citing overseas jurisdictions, thinks that the rules can be tightened further, with a view to more effectively keeping assets/funds within the charitable sector and discouraging misuse of charity income tax exemptions.

4.  Non-profit body GST input tax concession

As noted in our recent FYI Charity tax concessions in the spotlight, NZ resident GST-registered non-profit bodies, not just charities, benefit from a concession in relation to recovering the GST content of their expenditure, even if it does not relate to outputs that are taxable for GST purposes.

Some important changes are already proposed under a current tax bill. The intent of the proposed changes is to ensure that an organisation must account for GST when they dispose of an asset if the concession enables the organisation to recover GST in respect its' expenditure relating to the asset.

The TWG recommends that the continuation and scope of the concession should be reviewed and notes the possible option of further limiting the availability of the concession, for example to Charities Act registered charities.

What happens next?

There is a short timeframe to provide feedback on the interim report, by 1 November, before the TWG prepares its final report, due February 2019. However, charity matters are not expected to be a focus of the final report.

Instead, the charity matters highlighted in the interim report are expected to be considered, first, as part of the DIA-led Charities Act review, and then as part of the IRD-led Tax Policy Work Programme. The Government’s response to the report also affirms that the TWG’s charity-related work and recommendations should be directed to DIA and IRD.

The anticipated inclusion of matters raised by the TWG in the Charities Act review means that this review now takes on much greater significance for the charitable sector. The discussion document that will kick-start the consultation process for the review is due to be released in the final quarter of this year.

The anticipated inclusion of matters raised by the TWG in the Charities Act review means that this review now takes on much greater significance for the charitable sector. Public consultation on the review was originally scheduled for late 2018, but will now take place in 2019. The discussion document that will kick-start the consultation process is to be issued in early 2019 and the consultation and submission period is scheduled for March/April 2019. 

If you would like additional information and advice on these developments and their implications for you and your charity or not-for-profit organisation, the Simpson Grierson Tax Team would be happy to help.

Contact our tax and charities specialist Nick Bland, Senior Associate:
DDI +64 9 977 5313 | Mobile +64 21 241 4504
nicholas.bland@simpsongrierson.com