A recent report issued by the CRA indicates that a significant number of incorporated non-profit organizations (NPO) in Canada do not comply with the rules in the Income Tax Act that provide for an exemption from tax on their activities. The government announced in the 2014 federal budget that it intends to review the income tax exemption rules for NPOs and release a consultation paper on the issue to address these concerns.
The CRA’s report is the result of its recent three-year review of NPOs, which suggested that a significant portion of incorporated organizations may not qualify for tax exemptions claimed. As a result, NPOs should follow developments closely in this area and may want to take action now to review their structure to ensure they qualify for the tax exemption or consider future action to prepare for an potential changes in the rules.
In the 2014 federal budget, Finance indicated that it is aware of concerns that some organizations claiming NPO status may be earning profits that are not incidental to the non-profit purposes, making income available for the personal benefit of members or maintaining large reserves. There is also a concern that, because of the reporting rules, it is difficult to assess whether an organization qualifies as an NPO.
A non-profit organization (NPO) that is a club, society or association organized and operated exclusively for social welfare, civic improvement, pleasure or for any other purpose except profit qualifies for an exemption from income tax if it meets certain conditions. A charity, however, is not considered to be an NPO for income tax purposes.
In 2009, the CRA launched a three-year non-profit organization risk identification project to provide insights on how NPOs were operating under the provisions of the Act. As a result of this project, the 2014 federal budget indicated that Finance will carry out a review to determine whether the income tax exemption for NPOs is properly targeted and whether there is sufficient transparency and accountability.
For more details see, TaxNewsFlash-Canada 2014-08 "2014 Federal Budget Highlights".
CRA releases NPO risk identification report
The CRA recently released its findings from the NPO project in a four-page report, in which it states that the existing legislation may benefit from further examination. During the project, the CRA noted that of 30,000 identified organizations claiming NPO status, it reviewed 1,337 randomly selected files over three years.
In the report, the CRA observed that many in the non-profit sector believe that NPOs must produce a profit for their programs to thrive and for their capital assets to be maintained. In particular, the CRA says there is a common view that, as long as profits are used to further the organization’s purpose, the source of the funding shouldn’t matter. However, the CRA’s position is that an NPO can earn profits, but the profits should be incidental to and arise from activities that are undertaken to meet the organization’s non-profit objectives. The CRA confirms that earning a profit cannot be or become a purpose of an NPO, even if the profit is earned to fund non-profit objectives.
According to the CRA report, a significant portion of incorporated organizations would not meet at least one of the exemption requirements set out in the rules concerning NPOs. Specifically, the CRA notes that a significant portion of NPOs would fall into a higher category of risk, which includes NPOs that:
- Earn profits that were not incidental or not related to their non-profit objectives
- Have disproportionately large reserves, surpluses, or retained earnings
- Have income that is payable or made available for the personal benefit of a proprietor, member, or shareholder.
The CRA advised that many of the organizations that fall within this higher-risk audit category would not actually qualify for the tax exemption and would need to be reassessed, which would in most cases result in an increased tax liability to the organization. However, it did not reassess NPOs during this three-year review, preferring instead to educate organizations of the issues.
In addition to sending the report to Finance for consideration, the CRA said that, in the meantime, it plans to use targeted outreach activities, client service, and revised educational materials to advise NPOs of their income tax obligations.
Finance announced that it intends to release a consultation paper on this issue to provide an opportunity for stakeholders to comment on any proposals, but has not yet provided a date when this paper is expected to be published.
As a result of these developments, NPOs should consider reviewing their structure to ensure they qualify for the tax exemption and to prepare for any potential changes that may be announced by Finance in the future. Presumably, the CRA’s target outreach and education programs will allow NPOs some time to address any current issues.
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We can help
Your KPMG adviser can help you assess the effect of any potential changes to the rules concerning NPOs, and point out ways to take advantage of their benefits or ease their impact. We can also keep you abreast of the progress of the consultation process and help you bring any concerns you may have to the attention of Finance.
Information is current to February 28, 2014. The information contained in this TaxNewsFlash-Canada is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG’s National Tax Centre at 416.777.8500.
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