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Charities and not-for-profit organizations (NPOs) are turning to social enterprises to supplement and diversify funding sources in response to a reduction in government funding and private donations. This non-profit and charity supplemental funding brings new concerns with respect to maintaining their status for tax purposes.
As mentioned in a previous article entitled Non Profit’s Tax Filing Requirements, charities and NPOs have defined purposes that are different from each other. The CRA guidelines for charities are also different from NPO guidelines with respect to their business-like activities.
The rules for charities in Canada are often referred to as the “related business” rules and are quite well defined. They do not, however, apply to private foundations that are prohibited from carrying on any business.
For an activity to be a related business and therefore allow a charity to maintain its charitable status:
The first test is objective and easy to determine, while the second test is subjective. The second test focuses on purpose and is based on the facts of each situation.
Some of the activities sanctioned by the Canada Revenue Agency (CRA) include hospital parking lots and gift shops, rental of university residences in the summer, and distributions of promotional material such as t-shirts and pens with logos.
There have been numerous court cases and interpretations issued by the CRA that cover very specific situations, however they are beyond the scope of this article.
Charities are not specifically prohibited from making investments, but must hold them only with a view to devoting their resources to charitable activities. Charities must report an amount annually in their T3010 Registered Charity Information Return, for investments that are not used directly in their charitable activities, which are then used to calculate a minimum amount that must be spent on charitable activities (disbursement quota).
It is a question of fact whether a more active role in investing would be considered an unrelated business.
The rules for NPOs are much narrower.
A commercial activity carried on in a business-like manner is not necessarily disqualified if the activity is in pursuit of its purpose; however, an activity unrelated to an NPO’s purpose is offside, even if the profits are dedicated towards the NPO’s purpose.
The courts have indicated that if a non-profit organization’s goals cannot be achieved without making a profit, then it is not an NPO. The CRA allows an NPO to earn incidental profits in carrying out its non-profit purpose, but not an intentional profit to finance a future capital project. The CRA also allows limited fundraising, so long as it does not become significant enough for fundraising to be considered the NPO’s purpose.
The CRA’s incidental profit exception also applies to investment income.
Investment income from bank account balances and reasonable operating reserves are acceptable, so long as the amounts are incidental, but donations used to earn investment income to fund its non-profit purposes are not.
The above discussion of offside activities and investments demonstrate various ways that charities and NPOs can lose their favourable tax status. For charities, this could mean losing the ability to issue income tax receipts to donors, penalties based on gross (rather than net) profits, and even revocation. NPOs will be subject to income taxes including interest and penalties where T2 Corporation Income Tax Returns have not been filed.
The above content is believed to be accurate as of the date of posting. Canadian Tax laws are complex and are subject to frequent changes. Professional tax advice should be sought before implementing any tax planning. Manning Elliott LLP cannot accept any liability for the tax consequences that may result from acting based on the information contained therein.