Scott Park, CPA, CA
Many people may consider not-for-profit organizations (NPO’s) and registered charities to be the same. However, while both types of organizations may operate on a non-profit basis, the two types are defined differently under the Income Tax Act.
For the purposes of this blog article the focus will be on NPO’s and maintaining their tax-exempt status. Guidelines for registered charities will be covered in a separate blog article.
Tax-Exempt Status for NPO’s
NPO’s are generally exempt from paying tax if they comply with all the following conditions:
Examples of NPO’s include: amateur athletic clubs, service clubs, sports associations, theatre, dance and music groups, activity clubs, religious fellowships, educations and literary societies and community service associations.
By virtue of being called a “not-for-profit” organization, many people may think that these organizations cannot make a profit. This is not true. In fact, many NPO’s engage in activities that result in revenues that exceed their expenses. However, these profits must be held in trust for the organization and can only be used in carrying out their goals and objectives.
Although the income earned by NPO’s is generally tax-exempt if it meets the conditions mentioned above, it is important to note that it could be subject to tax on its income earned from property. There is a provision in the Income Tax Act, which overrides the tax exemption when a NPO’s main purpose is to provide dining, recreational or sporting facilities for its members. These rules deem the income earned from property to be taxable. In addition, the disposition of property owned by the NPO could also trigger taxable capital gains.
Maintaining Tax-Exempt Status
If at any time, the NPO no longer meets the conditions previously mentioned, it’s tax-exempt status would be jeopardized. For NPO’s, the two conditions that seem to be put to the test most frequently would be operating exclusively for the purpose in which it was organized and earning profits that may significantly exceed their annual expenditure requirements.
Let’s use a hypothetical example of an existing tax-exempt NPO that was looking for additional revenue sources. Initially, it was organized with the primary purpose of being an organized athletic club and to promote amateur athletic programs in Canada. It initially earned revenues solely from membership fees. Then a few years after starting, it began to sell merchandise and athletic apparel to its members and the public, which soon provided a significant revenue stream that was on par or greater than the membership fees. In this scenario, this NPO would probably no longer qualify as a tax-exempt NPO due to this significant deviation from their primary objectives. This activity could be viewed as operating a normal commercial business operation.
It will be a question of fact to be determined with regard to the particular circumstances as to whether a NPO is carrying on a trade or business and if so, whether it will result in a finding that the NPO is not operated exclusively for non-profit purposes.
Some characteristics that might indicate that an activity is a trade or business are as follows:
As previously indicated, NPO’s have the potential to earn a profit from the activities for which they were organized. However, if a material part of the profits each year are accumulated and the balance of accumulated funds is greater than the NPO’s reasonable needs to carry on its non-profit activities, profit will be considered one of the purposes for which the NPO was operated. This would also be particularly evident if excess funds were used for purposes unrelated to its objectives such as:
The balance of accumulated profits that would be considered reasonable in relation to the needs of a NPO to carry out its non-profit activities is also a question of fact to be determined based on certain circumstances. It is conceivable for some NPO’s to have accumulated profits equal to approximately one year’s worth of anticipated expenses on its non-profit activities and not be considered excessive whereas in the case of other NPO’s it may be viewed as being excessive depending on the nature of their non-profit activities.
As discussed above, in cases where NPO’s have surplus funds that are accumulated in excess of their current needs, it may affect their tax-exempt status. However, in certain cases, when a NPO sets aside funds needed to acquire capital property that will be used to achieve its purpose, its tax-exempt status may not be affected. For example, this could be the case if a NPO annually sets aside funds to provide for a special project such as the construction of a new building to replace an existing building that no longer meets the NPO’s needs. Under these circumstances, a NPO would not likely lose its tax-exempt status, however, it would be prudent for the NPO to clearly document, identify and track all transactions concerning a special project in their accounting records.
NPO’s that qualify for tax-exempt status in a particular year may cease to qualify in a subsequent year by failing to operate in accordance with one of the purposes for which it was organized or by revising its objectives so that it is no longer organized in accordance with the conditions set out in the Income Tax Act.
It is prudent for NPO’s to review their non-profit activities at least on an annual basis to ensure they don’t lose their favorable tax status.
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