Australia's Future Tax System

Final Report: Detailed Analysis

Chapter B: Investment and entity taxation

B3. Tax concessions for not-for-profit organisations

B3–2 Existing NFP tax concessions and regulatory arrangements are complex

Tax concessions

The tax concessions available to NFP organisations 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 (see Table B3–1). Not all NFP organisations receive all concessions — generally the concessions depend on the particular public benefit purposes of the organisation.

Table B3.1: Main tax concessions for major types of NFP organisations(a)

  Value ($m) (2008–09) Charities Public benevolent institutions(b) and
health promotion charities
Deductible gift recipients NFP and public hospitals, and
public ambulance services
Income tax exemption(c)(d) * Yes Yes Yes
GST concessions * Yes Yes Yes Charities only
FBT exemption ($17,000) 260 Yes
FBT exemption ($30,000) 715 Yes
FBT rebate(e) 20 Charitable institutions only
Deductible gifts 1,080 Yes Yes Yes
  1. Entities may have more than one status (for example, a charity could also be a deductible gift recipient).
  2. There are over 11,000 public benevolent institutions in Australia, including organisations such as: Anglicare Australia Inc; Australian Federation of Disability Organisations Ltd; Australian Red Cross Society; Parents, Families and Friends of Lesbians and Gays Inc; Refugee Council of Australia Inc; and Society of St Vincent de Paul Pty Ltd.
  3. Many NFP organisations are taxable, but are entitled to special rules for calculating taxable income and lodging income tax returns and are able to access special rates of tax.
  4. Income tax exempt entities that do not meet the broad definition of a NFP organisation, such as municipal corporations, local governing bodies, constitutionally protected funds, and public authorities constituted under Australian law, are not discussed in this section.
  5. Certain non-government NFP organisations are eligible for this concession.

* The value of the concession cannot be quantified.

Sources: ATO (2007) and Treasury (2009).

This system of tax concessions is unnecessarily complex. At a federal and state level, the concessions are set out in at least 40 separate pieces of legislation, administered by 19 separate agencies (National Roundtable of Nonprofit Organisations 2007). This imposes significant compliance costs on NFP organisations.

The complexity of the concessions is exacerbated by their outdated application. For example, the classes of NFP organisation eligible for public benevolent institution status are based on the preamble of the Charitable Uses Act 1601 ('Statute of Elizabeth'). The narrow interpretation of 'benevolence' derived from the Statute of Elizabeth excludes activities that have evolved to be valued by the community, such as animal welfare, international aid and development, and the promotion of human rights. The current hierarchy of concessions does not fully reflect current community views about the merit and social worth of different activities, or respond flexibly to special circumstances (such as natural disasters).

Regulation

NFP organisations also face significant complexity in relation to their regulatory arrangements, particularly where they operate in more than one jurisdiction. Submissions to the Review have expressed concern that inconsistencies between state and federal regulations may deter NFP organisations from undertaking legitimate fundraising activities, and may undermine public confidence in the sector.

Findings

The tax concessions available to NFP organisations are complex and do not fully reflect community preferences.

The regulatory framework for NFP organisations is inconsistent and opaque.

Competitive neutrality

In 2008, the High Court of Australia's decision in Commissioner of Taxation of the Commonwealth of Australia v Word Investments Limited [2008] HCA 55 found that a commercial business that directs its profits to charities is eligible for endorsement as a tax concession charity. The decision means that NFP organisations now have a significantly larger scope to undertake commercial activities on a concessionally taxed basis.

The Review has considered the three main tax concessions (income tax, GST and FBT) from a competitive neutrality perspective.

Income tax

Income tax exemptions enable many NFP organisations to retain untaxed profits for further investment, while for-profit organisations must invest from after-tax profits. This is the main advantage conferred on eligible NFP organisations by the income tax exemption.

Some submissions have expressed concern that income tax concessions may undermine the efficient allocation of economic resources. Economic theory provides a conceptual framework for assessing these concerns through Samuelson's invariant valuations theorem (see Box B3–1). The application of the theorem relies on a range of assumptions, including that NFP organisations seek to maximise profits. Although this may not be true of all NFP organisations, it is a reasonable assumption given their purposes.

In practice, the provision of tax concessions to NFP organisations is likely to result in an over-allocation of resources to the NFP sector. However, this bias is offset to some extent by the fact that the philanthropic activities undertaken by NFP organisations provide public benefits.

Box B3–1: Samuelson's invariant valuations theorem

Samuelson's invariant valuations theorem (1964) provides a conceptual framework for assessing the impact of the income tax exemption for NFP organisations on resource allocation. The application of the theorem to NFP organisations assumes that these organisations seek to maximise profits in the same way as other businesses; however, this may not be true of all NFP organisations.

The theorem states that where taxable income is the same as economic income, the discounted present value of a stream of cash flows is independent of the tax rate. In other words, the maximum amount that an individual is prepared to pay for an asset is independent of the tax rate.

Consequently, a tax on economic income will not create arbitrage opportunities between taxpayers on different rates and will not affect either relative or absolute asset values. Accordingly, it will not distort the composition or level of investment in the economy. Thus, providing that economic income is taxed, the existence of concessionally taxed NFP organisations should not distort asset allocation (or the level of investment) in the economy.

However, as the current income tax base differs considerably from economic income, and as the tax concessions for NFP organisations are linked to particular activities regarded as providing a public benefit, the concessions are likely to distort investment decisions. However, to the extent that the concessions address a market failure (that is, the under-provision of social services), they may still increase wellbeing.

In relation to pricing, NFP organisations, like for-profit organisations, will seek to maximise their profits in support of their philanthropic activities. Accordingly, it appears that the income tax exemption does not provide an incentive for NFP organisations to undercut the prices of their for-profit competitors; rather, NFP organisations follow the same pricing policies as their competitors to maximise their profits.

Finding

The NFP income tax concessions do not generally violate the principle of competitive neutrality where NFP organisations operate in commercial markets.

Mutuality

A range of NFP organisations are clubs that are not income tax exempt, because they do not qualify as operating for a tax exempt purpose. However, these clubs are subject to the mutuality principle, which is based on the notion that a person cannot make a profit from selling to themselves.

As a result, where a taxable NFP club provides services for a charge to its members, it is not considered to derive income from those members. The result is that mutual receipts are excluded from the club's calculation of its income tax liability. Unlike the gift deductibility provisions, which require deductible gift recipients to use their income in accordance with particular philanthropic objectives, NFP clubs that benefit from the mutuality principle are free to spend their mutual receipts as they wish (subject to their objects that typically do not involve philanthropic purposes).

In Australia, many small clubs benefit from the mutuality principle, including community organisations (such as vintage car clubs), professional associations, and strata title bodies corporate. In these cases, there is usually a clear and direct nexus between the mutual purpose of the club and the services received by members.

The principle also benefits a number of very large NFP clubs with many members and high levels of turnover, which engage in trading activities in direct competition with the hotel and restaurant industries. Any mutual receipts these clubs receive, including membership fees and restaurant, bar and gambling revenues (which account for most of the total income of hospitality clubs), are tax exempt. By contrast, hotels and restaurants are assessed on all of the income they receive.

In the case of clubs with large trading activities in the fields of gaming, catering, entertainment and hospitality, a practice has emerged to establish wide membership at a nominal charge for patrons whose only substantive activities at the club are as customers of the trading activity (whether personally or by bringing 'guests'). It is not clear that the wider community should entirely forgo tax on all of these profits, although some concession could be retained, particularly to support smaller clubs.

Finding

Where NFP clubs operate large trading activities in the fields of gaming, catering, entertainment and hospitality, the rationale for exempting receipts from these activities from income tax on the basis of a direct connection with members is weakened.

GST

The GST concessions provided to NFP organisations are unlikely to impact on competitive neutrality. Unlike income tax exemptions, the commercial activities of NFP organisations are taxable under the GST legislation, unless an explicit concession applies.

Finding

The NFP GST concessions do not violate the principle of competitive neutrality where NFP organisations operate in commercial markets.

Fringe benefits tax

In effect, labour is taxed at a reduced rate for NFP organisations that are eligible for FBT concessions. These organisations can offer benefits such as mortgage repayments, laptop computers, and motor vehicle leases tax free, or at a reduced rate — concessions that are unavailable to their for-profit competitors. Consequently, NFP organisations have an advantage in attracting staff in labour markets, as they can afford to pay the market wage at a lower cost.

This bias is particularly problematic in the hospitals sector, where nursing shortages are an ongoing concern. Modelling provided to the Review14 suggests that the current configuration of the FBT concessions is contributing to wage inflation across the sector. It is estimated that the concessions provide nurses in public and NFP hospitals with around $2,800 in additional after-tax remuneration (approximately 6 per cent) compared to their counterparts in commercial hospitals, despite the similar nature of their work. Further, the concessions are not helping to increase the overall pool of nursing staff.

The impact of the FBT concessions is less clear where no direct for-profit competition exists (for example, in the provision of health services in remote areas). The removal of FBT concessions in these cases may make it difficult for NFP organisations to attract appropriately qualified staff, which may result in the downsizing or closure of programs.

Finding

The NFP FBT concessions provide recipient organisations with a competitive advantage in labour markets, by enabling them to pay the market wage at a lower cost.


14 Modelling undertaken by Access Economics.