Australia's Future Tax System

Consultation Paper

Section 7: Not-for-profit organisations

Overview

Not-for-profit (NFP) organisations perform a valuable role in Australian society. They are eligible for a range of tax concessions and receive direct government funding in support of their philanthropic and community-based activities.

The tax concessions for the NFP sector are complex and applied unevenly.

Gifts are an important source of funding for NFP organisations. The current gift deductibility arrangements impose compliance costs on individuals and provide higher income donors with a greater taxation benefit than lower income donors.

Consultation questions

Q7.1 What is the appropriate tax treatment for NFP organisations, including compliance obligations?

Q7.2 Given the impact of the tax concessions for NFP organisations on competition, compliance costs and equity, would alternative arrangements (such as the provision of direct funding) be a more efficient way of assisting these organisations to further their philanthropic and community-based activities?

This section considers the main tax concessions available to NFP organisations. It does not canvass issues that are the subject of separate inquiries, including accountability and disclosure, the contribution of the NFP sector to the economy, and proposals to improve the integrity of prescribed private funds.

Overview of tax concessions

Australia applies a range of tax concessions to different types of NFP organisations (see Table 7.1). These concessions include: income tax exemptions; a higher GST registration threshold; the ability to make supplies GST-free in certain circumstances; GST input credits; capped exemptions from (or rebates of) fringe benefits tax (FBT); and the ability to receive tax deductible gifts. Box 7.3, at the end of this section, describes these concessions.

The concessions available to various NFP organisations are listed in the Australian Treasury's 2007 Tax Expenditures Statement (Australian Treasury 2007). Among these are tax deductions for gifts to approved donees, which are estimated to cost $950 million in 2008-09, and FBT concessions which are estimated to cost $880 million in 2008-09. There is insufficient data to quantify the cost of income tax exemptions because many NFP organisations are not required to lodge income tax returns. Similarly, it is not possible to estimate the value of GST concessions as a significant proportion of the NFP sector is not required to register for the GST.

The complexity of the current arrangements was highlighted in the 2001 Report of the Inquiry into the Definition of Charities and Related Organisations (Australian Government 2001), which noted that 'much of the confusion in the sector is related to what tax or other concessions attach to what type of entities'. This complexity can impose administrative and compliance costs for NFP organisations and donors.

In addition to complexity, the uneven application of tax concessions is a long-standing source of concern within the NFP sector. These concerns were articulated in RSPCA Australia's submission (RSPCA Australia 2008) to the Senate Economics Committee 2008 inquiry into the disclosure regimes for charities and NFP organisations. The submission indicated that the current arrangements 'infer that some charitable purposes are more worthy than others'.

Internationally, a range of models are used to provide government support for NFP organisations, including direct funding and simplified tax concessions. In the case of direct funding, some models provide government contributions independent of public contributions, while others match government contributions with public contributions.

Table 7.1: Summary of main tax concessions for major types of NFP organisations(a)

  Charities Public benevolent institutions and
health promotion charities
Deductible gift recipients NFP and public hospitals,
and public ambulance services
Income tax exemption(b) Yes Yes - Yes
GST concessions Yes Yes Yes Yes
FBT exemption ($17,000) - - - Yes
FBT exemption ($30,000) - Yes - -
FBT rebate(c) Charitable institutions only - - -
Deductible gifts - Yes Yes Yes
  1. Entities may have more than one status (for example, a charity could also be a deductible gift recipient).
  2. Many NFP organisations are taxable, but may be entitled to special rules for calculating taxable income and lodging income tax returns and may be able to access special rates of tax.
  3. Certain non-government NFP organisations are eligible for this concession.

Summary of key messages from submissions

Many submissions express concern over the number of NFP organisations establishing business ventures, suggesting that these tax concessions unfairly disadvantage competing taxable entities. Several submissions note that NFP organisations are servicing commercial markets unrelated to their philanthropic activities, including: turf supplies; insurance; music sales; pizza shops; and breakfast and health foods. However, others suggest that commercial pursuits simply provide these charities with more funds for their philanthropic and community-based activities.

Several submissions recommend the extension of the mutuality principle to provide a complete tax exemption for member-based organisations to provide clarity and certainty.

Submissions on the appropriateness of the FBT concessions for NFP organisations present mixed views. While some favour the abolition of these concessions, others suggest eligibility should be broadened. One submission notes that the value of FBT concessions has been eroded over time.

Submissions note that the gift deductibility arrangements impose compliance costs on individuals, and express concern that the rewards for charitable giving vary depending on the income of the contributor (the higher their applicable marginal tax rate, the greater the benefit).

Competitive neutrality

Income tax

If an entity's purpose is solely charitable, it can undertake other activities that are incidental to, and in advancement of, its charitable purpose. These may include commercial activities. While such activities are not in themselves charitable, they are generally used to raise funds to further charitable purposes (and thus often attract the same tax concessions). Moreover, some of the practices of businesses operated by charities may also provide a public benefit, such as training and employing homeless youths. Entities that do not have a sole charitable purpose are not considered charitable. These issues were recently considered by the High Court (see Box 7.1).

In recent years, several inquiries have considered the appropriateness of the income tax exemptions for charities operating commercial enterprises.

For example, the 2001 Report of the Inquiry into the Definition of Charities and Related Organisations (Australian Government 2001) recommended that commercial purposes should not be denied charitable status where they further, or are in aid of, a dominant charitable purpose, or where they are incidental or ancillary to a dominant charitable purpose. It acknowledged that charities operating commercial enterprises may become involved in activities that have no obvious connection with their charitable purpose and noted that the public may be concerned with such activities. The inquiry concluded that 'prohibiting charities from engaging in commercial enterprises would be an unnecessarily heavy-handed way to address these concerns'.

In 1995 the Industry Commission (forerunner to the Productivity Commission) released a report, Charitable Organisations in Australia (Industry Commission 1995) that, among other things, addressed the issue of competition between for-profit organisations and community social welfare organisations. The Commission concluded that:

… the income tax exemption does not compromise competitive neutrality between organisations. All organisations which, regardless of their taxation status, aim to maximise their surplus (profit) are unaffected in their business decisions by their tax or tax exempt status.

Box 7.1: Commissioner of Taxation v Word Investments Limited [2008] HCA 55

In May 2008, the High Court granted the Commissioner of Taxation special leave to appeal against the decision of the Full Federal Court in Commissioner of Taxation v Word Investments Limited, which was handed down on 14 November 2007. The Full Federal Court's decision was upheld by the High Court on 3 December 2008.

Under the High Court's decision, a commercial business may be a charity if its profits are required by its constitution to be given to a charity.

Another result of this decision is that a charitable institution which raises money to distribute to an organisation which, although located in Australia, pursues its objectives overseas may be endorsed as tax exempt.

The full implications of the decision are not yet clear.

Mutual receipts

The receipts that NFP member-based organisations (for example, licensed clubs) collect from dealing with their members are generally treated as non-assessable, non-exempt income (mutual receipts). These entities are subject to income tax on profits from transactions with non-members and on some transactions with their members.

Several submissions call for the extension of mutuality to provide a full tax exemption for NFP member-based organisations. Such an extension would enhance any competitive advantage these organisations hold relative to fully taxable businesses offering similar services.

Submissions also call for mutuality to be legislated (like other features of the concept of 'income', reliance is currently placed on the common law and ATO rulings). While legislating mutuality may provide increased certainty for NFP member-based organisations, it would add to the complexity of the tax law.

Fringe benefits tax

The FBT concessions provided to the NFP sector (see Box 7.3) can provide NFP organisations with a cost advantage for the recruitment and retention of staff. The concessions are capped to prevent over-use and limit the impact on competitive neutrality. This is a particularly significant concession for hospitals, given that the NFP health sector constitutes a large share of the health industry and competes directly with the private health sector for qualified staff. Some ineligible charitable and community organisations have criticised the concessions on the grounds that they have led to staff losses (through the inability to match market salaries for qualified staff) and resulted in a greater proportion of their funds being directed into salaries.

Similar issues in respect of competitive neutrality arise in relation to the treatment of 'rebateable' employers, which are eligible for a rebate of 48 per cent of the amount of FBT that would otherwise be payable. The rebate applies up to $30,000 per employee and reflects the fact that these employers do not benefit from the tax deductibility of FBT costs.

The FBT concessions provided to NFP organisations may result in a greater proportion of income being provided to employees as fringe benefits, rather than as cash. In turn, this could exacerbate the issues related to transfer payments discussed in Section 4.2.

As noted in Section 4.2, the Government has asked the Panel to examine the complexity of the existing FBT arrangements for the NFP sector and make recommendations to improve equity and simplicity for the long term.

Goods and services tax

Certain NFP organisations are able to treat some or all of their separately identifiable branches as separate GST entities. As a consequence, one or more sub-entities may fall below the $150,000 GST registration threshold for NFP organisations, when the complete entity would exceed the registration threshold. This is intended to reduce the compliance costs of NFP organisations and may result in a reduced GST liability for some NFP organisations.

The GST concessions for charitable organisations would not be expected to impact on competitive neutrality. Unlike income tax exemptions, the activities of charitable organisations are taxable under the GST legislation, unless an explicit concession applies. Since the commercial activities of charitable organisations would not be expected to qualify for these GST concessions, this is unlikely to lead to competitive neutrality concerns.

Gift deductibility

Gift deductibility allows donors to eligible charities to claim a tax deduction for donations over $2.

Deductions are provided as a mechanism for distributing government funds to charitable organisations, on the assumption that they will increase the size of charitable donations. However, the degree to which this is the case is unclear.

Broadly, deductible gift recipient (DGR) status is extended to those organisations whose activities provide a benefit to the public or a significant group within the public. The general DGR categories include public benevolent institutions, public universities, public hospitals, approved research institutes, arts and cultural organisations, environmental organisations, school building funds and overseas aid funds.

These general categories restrict DGR status to a closely targeted set of organisations. While these categories have been created to reflect community demand and government priorities for the sector, some submissions indicate that they should be redefined as community activities and priorities change.

Compliance and equity

A number of submissions suggest that the compliance costs of the gift deductibility arrangements should be reduced, and express concern over the perceived vertical inequity of gift deductibility. Suggestions to address these issues range from abolishing deductions to enabling DGRs to collect and store tax file numbers, allowing donation information to be pre-filled on tax returns.

An alternative approach could involve the provision of a flat rebate for donors. While this approach would promote vertical equity, it would not reduce the compliance burden of the current arrangements as individuals would still be required to retain and report evidence of their donations to claim a rebate.

The United Kingdom's (UK's) Gift Aid scheme, which involves the payment of the tax benefit directly to the charity instead of the individual, may provide another potential model for consideration (see Box 7.2). While the scheme has been successful in the UK (HM Treasury 2008), its application in Australia may not address perceived vertical inequity (as donors who do not pay tax are not able to participate) and may increase compliance costs for charities.

Box 7.2: Gift Aid in the United Kingdom

Gift Aid was introduced in the UK in 1990, and is designed to enable the provision of tax-effective charitable donations to UK charities. The scheme originally applied to cash gifts of £600 or more. However, this limit was abolished in 2000.

Under the scheme, individuals subject to UK income tax can make a declaration to a charity (either orally or in writing) to enable their donation to be treated as a Gift Aid donation. The declaration must identify both the donor and the charity. The charity is then able to reclaim the basic rate of income tax paid on the gift from the government. Charities must maintain clear and auditable records of declarations to demonstrate that each donor has made an appropriate declaration.

The scheme enables higher-rate taxpayers to claim income tax relief above and beyond the amount claimed directly by the charities. Individuals who do not pay income tax are unable to use Gift Aid.

Consultation questions

Q7.1 What is the appropriate tax treatment for NFP organisations, including compliance obligations?

Q7.2 Given the impact of the tax concessions for NFP organisations on competition, compliance costs and equity, would alternative arrangements (such as the provision of direct funding) be a more efficient way of assisting these organisations to further their philanthropic and community-based activities?

Box 7.3: Further detail on the tax concessions provided to NFP organisations

Income tax

Income tax exemptions are provided to NFP organisations whose purposes are broadly beneficial to the wider Australian community, such as charitable, religious, scientific and public educational institutions.

Charities and income tax exempt funds within the NFP sector must be endorsed by the ATO to be exempt from income tax. Other categories of organisation can self-assess their exemption — such organisations include cultural, community service and sporting organisations.

NFP organisations, with income below $416 a year, that are not otherwise income tax exempt receive an income tax exemption. The concession is intended to ensure small organisations do not have to incur the compliance costs associated with managing their tax affairs, such as lodging annual income tax returns.

Mutual receipts

Receipts from members of clubs (including member subscriptions and trading income relating to members) are not included in the assessable income of NFP clubs, societies or associations. Other income received (for example, interest and profits from trading with non-members) is taxable.

Fringe benefits tax

Public benevolent institutions and health promotion charities are provided with a $30,000 capped exemption from FBT per employee, and public and NFP hospitals and public ambulance services are provided with a capped exemption of $17,000 per employee. These caps are not indexed.

The caps do not limit the amount of other FBT-exempt benefits (for example, superannuation contributions, work-related mobile phones and other miscellaneous benefits).

Goods and services tax

Not-for-profit organisations

NFP organisations, including charities, have a GST registration threshold of $150,000 a year compared with the general registration threshold of $75,000 a year.

Where an organisation is not registered for GST, it does not pay GST on its supplies and is not entitled to input tax credits for the GST paid on its inputs. NFP entities with a turnover below the threshold can choose to be registered. Registered entities pay GST on the taxable supplies they make and are entitled to input tax credits for the GST paid for their creditable acquisitions.

Donations to a NFP organisation (including charities) that are made voluntarily and for no material benefit are not subject to GST.

Concessions for charities, DGRs and government schools

Charities, DGRs and government schools receive a range of GST concessions including the ability to make supplies GST-free in certain circumstances, the ability to make supplies of second hand goods GST-free, and the ability to treat certain fundraising events as input-taxed.

Gift deductibility

Gift deductibility is provided to individuals who donate gifts of $2 or more in cash or gifts of property (subject to certain rules) to the organisations endorsed as DGRs. DGRs under the general categories must meet the relevant eligibility requirements and be endorsed by the ATO to receive their concessional status.

Prescribed private funds

Since 2001, individuals, families and businesses have been able to establish their own DGRs, known as prescribed private funds (PPFs). PPFs can receive donations for distribution to other DGRs (not PPFs).

Since their inception, PPFs have received donations of over $1.3 billion and made distributions of over $300 million.

Other tax concessions and grants

At the state level, many charitable institutions are exempt from municipal rates, stamp duty, land tax and payroll tax. At the federal level, exemptions from customs duty apply, as well as certain fuel tax concessions.

Many NFP organisations also receive grants from different levels of government, including block funding to cover some or part of their operational costs.