As previously reported (see BDO's tax factor 2012-02 and 2011-01), the Canada Revenue Agency (CRA) reviewed the operations of non-profit organizations (NPOS) to determine if they are consistent with the definition of NPOS in the income tax act (the act). This was done as part of the CRA's “non-profit organization risk identification project”, referred to here as “the project”.
The project started in 2009 and has now concluded. Prior to starting this project, few NPOs had been subject to scrutiny by the CRA. When carrying out this project, the CRA stated that it was a research project that would be used as both an educational tool and a means to gather information about the tax risks associated with the NPO sector.
The definition of an NPO in the Act requires that it be organized and operated exclusively for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit. In the interpretation of the phrase “any other purpose except profit”, the CRA has allowed an organization to carry out profit-making activities that are incidental to the main purpose of the organization, but has determined that any profit-making activities that are not incidental will disqualify the organization from enjoying the status of an NPO under the Act.
In February 2014, the CRA posted a report on the results from this project. The key findings are as follows:
- In a small number of cases, the CRA found that the organization's governing documents (such as articles of incorporation, letters patent, and by-laws) did not indicate that it was organized exclusively for a purpose other than profit (which is a specific condition).
- The CRA noted a variety of activities with apparent profit generating motives carried out by a wide range of organizations. Also, a significant number of organizations had disproportionately large capital or operating reserves that resulted from surpluses generated by non-incidental profits.
- The CRA identified a small number of cases where the organization had generated income which was made available for the personal benefit of a proprietor, member, or shareholder. This again is specifically not allowed if an organization is to qualify as an NPO.
Overall, the results from the review of the randomly selected organizations suggest that a significant portion of them would fail to meet at least one of the requirements that must be met to be an NPO. By far, the largest issue appears to be situations where the organization earns a profit that goes beyond being incidental.
The issue of non-incidental profits is a difficult one to deal with, as it appears that the CRA considers some activities to have a very low threshold before they are considered non- incidental. As an example, the CRA has said that simply selling advertising space at a recreational club can be non-incidental if the revenue from this activity is planned for when budgets are set.
In the CRA's report of the project, they disagreed with the common NPO industry view that as long as profits are used to further the organization's purpose, the source of the funding shouldn't matter. Instead, the CRA states that the earning of profit cannot be or become a purpose of the organization, even if the profit is earned to fund non-profit objectives.
As we have noted previously, it is our belief that the rules for NPOs should be reviewed by the federal government. As a recent development, the Department of Finance announced in the 2014 budget that they will hold consultations on the NPO rules.
With the release of the CRA report and the consultations that have been announced, we would suggest the following:
- Where an organization earns profits that go beyond being incidental, you may want to assess your risk in this area. If the risks are not high, you could wait for the results from the consultation process. We believe that one possible outcome from the consultations could be a framework where an NPO could pay tax on a relatively small source of profit without endangering the organization's NPO status generally. Such a framework could eliminate many of the issues identified by the CRA. If risks are felt to be high in this area, you may want to start planning a process to restructure the operations, possibly through the creation of another entity. BDO has assisted a number of organizations in assessing and responding to these identified risks.
- Major issues, such as correcting the organization's governing documents, carrying on major activities that involve earning a profit or making income available to members, should be reviewed in consultation with your organization's professional advisors to determine the appropriate course of action.
If you have any questions on the CRA report, the NPO consultations, or if you require advice as to how to assess your risk in this area, please contact your BDO advisor.
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