TR2015/1 has been issued by the Australian Taxation Office (ATO). The ATO has addressed two of the special conditions which must be satisfied by certain entities claiming Tax Exempt Status under Division 50 of the Income Tax Assessment Act 1997 (ITAA 1997).
What follows is an overview of the new Special Conditions which must be satisfied by not-for-profit entities (NFPs) to protect their income tax exempt status.
In particular it is important to understand the ATO interpretation of purpose and the extent of ancillary or secondary purposes for charitable NFPs in respect to their particular purpose.
The release of the ruling is a timely reminder to entities that claim income tax exempt status under Division 50 of the ITAA 1997 that compliance procedures should be put into place to ensure that:
- There is strict compliance with the governing rules of the entity, and
- The income and assets of the entity are applied solely for the purpose for which it was established.
All activities that are currently undertaken by the entity need to be considered. The entity must demonstrate how each activity is a core activity within the purpose of the activity or the activity is undertaken to assist the entity in delivering its purpose.
Consider the category of fundraising – This will usually be outside the core purpose but will allow the entity to generate income to pursue its sole purpose.
If new activities or a change of existing activities is proposed consideration should be given to:
- A review of the constituent documents of the entity should be considered,
- Change that would involve the application of the income or assets of the entity otherwise than solely for the purpose for which the entity was established.
Two Special Conditions
The two special conditions include:
- The entity must comply with all the substantive requirements in its governing rules (governing rules condition), and
- The entity must apply its income and assets solely for the purpose for which the entity is established (income and assets condition).
A breach of either of the conditions may cause an entity’s ordinary and statutory income to not be exempt from income tax.
To determine whether an entity satisfies the governing rules condition, consideration will need to be given to the following:
- ‘governing rules’ of the entity, and
- The ‘substantive’ requirements in the entity’s governing rules, and
The ‘governing rules’ of an entity are those rules that authorise the policy, actions and affairs of the entity, and thus direct what:
- The entity is required and permitted to do, and
- Those, who control the entity, are required and permitted to do in respect of the entity.
- It is recognising an entity may have governing rules from more than one source,
- The written documents under which the entity was formed will usually be the main source of its governing rules,
- A centralised source may provide some or all of the governing rules for a group of entities or a particular type of entity,
- Not all rules that apply to an entity will form part of the entity’s governing rules, and
- An entity must identify all of its governing rules in order to then consider what the ‘substantive’ requirements are in those rules.
‘Substantive’ requirements in the entity’s governing rules
Substantive (as opposed to the procedural) rules are those that outline the rights and duties of the entity and include rules such as those that:
- Give effect to the object or purpose of the entity,
- Relate to the non-profit status of the entity,
- Set out the powers and duties of directors and officers of the entity,
- Require financial statements to be prepared and retained,
- Set out criteria for admission as a member of an entity,
- Require an entity to maintain a register of members,
- Relate to the winding-up of the entity.
The ruling outlines the governing rules condition is applied on a continuous basis throughout the whole of an income year.
Income and Assets
In determining whether an entity has applied its income and assets solely for the purpose for which the entity is established, there are two considerations:
- The purpose for which the entity is established, and
- The income and assets applications solely for the purpose for which it is established.
Purpose for the establishment of the entity
The ruling outlines:
- The purpose for which the entity is established is determined by a consideration of all of the features of the entity including the objects in the entity’s constituent documents and the activities of the entity after its formation.
- In particular an entity can have more than one purpose including:
- An incidental or ancillary purpose, and
- An entity can change its purpose during an income year.
Application to income and assets solely for the purpose for which it was established?
- Income and assets must be applied solely for the purpose, not substantially or on the whole,
- Nevertheless some accumulation of the income of the entity is permissible, provided such accumulation is consistent with the purpose for which the entity is established,
- White a strict standard of compliance is required under the sole criteria test, misapplications of an entity’s income or assets of an insignificant nature will not breach the condition,
- The income and assets condition is applied continuously throughout an income year.
Review Action Required
For charities the ACNC Governance Standards particularly Governance Standard 1 dealing with not-for-profit and working charitable purpose requires compliance and that directors should now have risk management processes in place to consider the new tests and have checked the checklists and guides from the ACNC website.
In addition we outline the following action items:
- Consider the requirements to satisfy both the:
- Governing Rules Condition; and
- Income and Assets Condition.
- Consider the entity’s compliance with its Governing Rules (including relevant legislation).
- Review the entity’s Governing Rules (particularly its constitution).
- Consider if there has been a failure to comply, is it a substantive failure or a procedural failure?
- Consider any remedial action required? If so, what?
- Document the Governing Rules Condition review and minute at board level.
- Consider the entity’s purpose, for which it was established.
- If the purpose changed? If so, how?
- Consider if the income and assets of the entity have been applied to its purpose?
- If not, why not? If it is an accumulation, is the reason for the accumulation consistent with the entity’s purposes?
- Has there been a failure of the Income and Assets Condition?
- If so, is there any remedial action required? If so, what?
- Document the Income and Assets Condition review and minute at board level.
- Review all the other tests relevant to the entity for income tax exemption.
- Consider any remedial action required. Document and minute at board level.
- Consider whether an application to the ATO for a Private Binding Ruling is required?
Corporate Lawyers Sydney at Pavuk Legal can assist you with claiming tax exempt status for not-for-profit entities and on many other legal aspects.
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