The Charities Act 2005 - Tax Implications
Tax implications of the Charities Act 2005, including changes to the Income Tax Act, Tax Administration Act and Estate and Gift Duties Act.
The new Charities Act enacted in April 2005 established a Charities Commission which came into being on 1 July 2005. The Commission is required to provide a registration and monitoring system for charitable organisations and support and education to the charitable sector.
Several changes have been made to the Income Tax Act 2004, Tax Administration Act 1994 and the Estate and Gift Duties Act 1968 as a result of the passing of the Act.
The registration of charities is planned to start in late 2006. The registration system will be called the "Charities Register". The Commission will communicate with the charitable sector as it moves closer to opening this Charities Register and will support organisations wanting to register.
This article discusses the Charities Commission and the associated tax changes.
The Charities Act arose out of concern that the charitable sector needed to be more accountable for, and transparent in, its actions to the donating public, funders and the government. The government decided to introduce a number of legal requirements intended to ensure a greater degree of transparency and accountability. The most significant development was the decision to establish a register of charitable organisations. Another initiative was the requirement that charitable organisations file an annual return.
The need for changes was first raised in the June 2001 discussion document Tax and Charities. The government subsequently set up a working party which recommended establishing a charities commission.
The definition of "charitable purpose"
The Charities Act does not change the well-established common law definition of "charitable purpose" and, in fact, uses that definition as the basis for determining to whom the Act applies. Under the common law definition, the four categories of charitable purpose are:
- the advancement of education;
- the advancement of religion;
- the relief of poverty; and
- benefit to the community.
A charitable entity's purposes must fall into at least one of these categories. Furthermore, in carrying out this purpose the charitable entity must, with the exception of the relief of poverty, benefit an appreciably significant section of the community (public benefit test).
The Charities Act indicates that a charitable entity will not be disqualified from registering if it also has a secondary or supplementary non-charitable function (such as advocacy) as part of its charitable purpose. Arguably this is merely a clarification of current law.
The role of the Charities Commission
In keeping with the dual objectives of establishing a registration and monitoring system for charitable organisations, and providing support and education to the charitable sector, the Commission has been given a varied range of functions, including:
- promotion of public trust and confidence in the charitable sector;
- encouragement of the effective use of charitable resources;
- education of charitable organisations about matters of good governance and management;
- deciding applications for registration as a charitable entity;
- monitoring entities to ensure they continue to qualify for registration;
- collecting and processing annual returns submitted by charitable entities;
- reporting and making recommendations about charitable sector matters; and
- stimulating and promoting research about the charitable sector.
Benefits associated with registration
Registration with the Commission will be voluntary and will not alter a charity's legal status. An unregistered charitable entity will still be able to call itself a charity and collect funds from the public. However, there will be benefits for charitable entities registered by the Commission:
- Tax-exempt status
Registration is voluntary. However, a charitable organisation is required to register to maintain the tax benefits currently available to charities. These benefits include:
- an exemption from income tax for non-business income derived by charities (section CW 34 of the Income Tax Act 2004);
- an exemption for business income derived by or in support of charities (section CW 35 of the Income Tax Act 2004);
- rebates for individuals and deductions for companies and Maori authorities for charitable donations; and
- exemption from gift duty.
- Being listed on the Charities Register
Only entities registered with the Commission can call themselves registered charitable entities. Certain information about each registered entity will be publicly available by searching the Register. The Register will be at www.charities.govt.nz once it is open.
- Getting a registration number
The Commission will give registered charitable entities a registration number. Charitable organisations can display this number on promotional material. This will tell the public and funding organisations that the charity has met the requirements for registration.
- Information on the charitable sector
By registering, charitable organisations will provide the Commission with information on the charitable sector in New Zealand. This, in turn, will help the Commission fulfil its education and support function to the sector and public.
- Attending the Commission's annual meetings
The Commission will hold annual meetings that can be attended by registered charitable organisations. The meetings will give charitable organisations an opportunity to have a say in the work of the Commission.
Obligations associated with registration
To register, charitable organisations must:
- submit a copy of their rules;
- provide information about their current and proposed charitable activities;
- register the officers of the organisation;
- file an annual return within six months of their nominated balance date; and
- notify the Commission if certain information about their organisation changes.
If a registered charitable entity does not comply with the Act, the Commission has the authority if necessary, to:
- impose administrative penalties;
- issue warning notices;
- publicise instances of non-compliance;
- undertake further investigations; and
- deregister charities if necessary.
The Commission will also have the authority to ensure registered charitable organisations are fulfilling their described purpose and complying with the Act.
Given the link between registration and tax-exemption, the charities that can register are primarily those that would also qualify for the exemption from income tax for non-business income derived by those organisations, as set out in section CW 34 of the Income Tax Act 2004. In addition, some entities will be automatically registered.
Correspondingly, sections CW 34 and CW 35 of the Income Tax Act 2004 have been amended to limit their application to entities registered as registered charitable entities. Likewise, the gift duty exemption on gifts made to charities has been amended to apply only to societies, institutions and trustees of trusts who are registered as charitable entities.
The secrecy provisions in the Tax Administration Act 1994 have been relaxed to enable Inland Revenue to share information with the Commission.
As the agency responsible for the registration of charities, the Charities Commission will determine whether the organisation's purposes are charitable at law. Inland Revenue will continue to be responsible for ensuring that charitable organisations are eligible for various tax exemptions. Inland Revenue is working with the Commission using a "one-stop shop" framework to develop a process so that, as a consequence of registration with the Commission, an organisation will be treated as being eligible for the tax exemptions. Inland Revenue will retain the ability to undertake tax audits to ensure an organisation is charitable and complying with tax legislation. The Department of Internal Affairs is the department responsible for the Commission.
This change in classification means the Commission is not required to give effect to government policy but is instead required to have regard to government policy when directed by the responsible minister. As it was not considered appropriate for the Commission to make decisions that impact on the revenue base, the proposed function of registering all donee organisations remains with Inland Revenue.
Therefore there have been no legislative changes to the provisions that enable individuals to claim rebates, and companies to claim deductions, in relation to their charitable donations. This means that, in accordance with section KC 5 of the Income Tax Act 2004, responsibility for assessing donee status remains with Inland Revenue for entities operating domestically, and with Parliament for entities with overseas charitable purposes.
The fact that various functions remain with Inland Revenue does not necessarily mean that an entity will have to apply separately to Inland Revenue for the exemptions when it makes a registration application to the Charities Commission. An integrated process is being developed so that as a consequence of registration with the Commission an organisation will be eligible for donee status. Organisations seeking donee status that are not charities will need to deal with Inland Revenue.
The establishment of the Charities Commission on 1 July 2005, the amendments to the Income Tax Act 2004, Tax Administration Act 1994 and the Gift Duties Act 1968 will come into force through an Order in Council. The Charities Act provides that one or more Orders may be made bringing different provisions into force on different dates. The registration process is planned to be up and running in 2006. The tax provisions are likely to apply following the registration process, in the 2007-08 income year.
Detailed analysis of tax implications
Register of charitable entities
Section 13 of the Charities Act details the essential requirements that must be met by a charity before it can be registered by the Commission. Given the intent to have the same test for registration as for the charities' general income tax exemption, the registration test in section 13(1) reflects the current wording in section CW34 (1)(a) and (b) of the Income Tax Act 2004, which provides an exemption for non-business income of charities, whether they are trusts, societies or institutions.
Under section 13(1) an entity qualifies for registration as a charitable entity if,
- in the case of the trustees of a trust, the trust is of a kind in relation to which an amount of income is derived by the trustees in trust for charitable purposes; and
- in the case of a society or an institution, the society or institution -
- is established and maintained exclusively for charitable purposes; and
- is not carried on for the private pecuniary profit of any individual.
In addition, section 13(2)(a) and (3) of the Act allows a binding ruling issued under the Tax Administration Act 1994 to be determinative of whether the income of the entity has been derived for charitable purposes in accordance with the Income Tax Act 2004. This saves a charity that has a binding ruling the compliance costs of having to apply for registration. But once the ruling ceases to apply the Commission can assess the organisation's status in the same way as that of other applicants. Under section 13(4) automatic registration ceases if the period for which the ruling applies expires, or if the ruling no longer applies to the entity, or if the repeal or amendment of a taxation law changes the way the taxation law applies in the ruling.
Similarly, section 13(2)(b) of the Charities Act provides that if the income derived by the trustees is deemed to be income derived by trustees in trust for charitable purposes, under section 24B of the Maori Trust Boards Act 1955, this is sufficient for automatic registration.
Section 14 of the Charities Act enables the Commission to make reasonable assumptions about the future derivation of income by an entity when an entity is newly established and has not yet derived income for charitable purposes. Also, section 20 of the Act allows for the backdating of registration to enable registration to apply from when a gift is made to establish a trust.
An entity cannot register, however, if under the Terrorism Suppression Act 2002 it is designated as a terrorist entity or an associated entity, or is convicted of an offence under section 7 of that Act.
Businesses carried on for charitable purposes
The Charities Act does not provide for the separate registration of businesses carried on by, or for, the benefit of charities. This means that a business that is carried on by a separate legal entity from the charity to which its profits are applied generally cannot register as a charitable entity unless it meets the general charitable purpose tests in the Act in its own right. Not being registered, however, does not negate the need for the business to observe the requirements in section CW 35 of the Income Tax Act 2004 if its income is to be exempt from income tax. Likewise, a registered charitable entity that derives business income in its own right must also meet the requirements of section CW 35.
Income tax exemption limited to registered charitable entities
Both sections CW 34 and 35 of the Income Tax Act 2004 have been amended to limit their application to entities registered as charitable entities (see sections 65 and 66 of the Charities Act. This means, for example, in the case of a business carried on separately from a charity, that the income of the business must be derived for the benefit of a registered charitable entity. Charitable income tax exemptions do not apply to council-controlled organisations or local authorities for income derived from council-controlled organisations.
Section 68 of the Charities Act adds a definition of "registered as a charitable entity" to section OB 1 of the Income Tax Act 2004, and section 70 of the Charities Act adds a definition of "Charities Commission" to section 3(1) of the Tax Administration Act 1994.
Section CW 36 of the Income Tax Act 2004 provides an income tax exemption for income earned by charitable bequests. Section 66 of the Charities Act amends section CW 36 of the Income Tax Act 2004 to provide a grace period for entities receiving charitable bequests before they need to register with the Commission. This provision deals with the situation where, for example, a bequest creates a charitable trust and it takes over a year for the estate to be settled. In such cases, registration as a charitable entity is not required until the end of the income year following the income year in which the person making the bequest died. After that time, income will be taxable unless the entity is registered.
Section 81(4) of the Tax Administration Act 1994 outlines the circumstances when the Commissioner of Inland Revenue may disclose information that would otherwise be subject to the tax secrecy provisions. Section 71 of the Charities Act extends section 81(4) to allow for information to be shared with the Charities Commission provided the person is authorised by the Commission to receive the information and the Commissioner of Inland Revenue considers that:
- it is not undesirable to disclose the information; and
- the information is reasonably necessary to enable the person to carry out their duties as lawfully conferred by the Charities Commission.
This relaxation of the secrecy provisions will, for example, enable Inland Revenue to pass on to the Commission its list of entities that have sought confirmation of their charitable status over the years, thereby streamlining part of the registration process.
Conversely, section 30 of the Charities Act enables the Commission to share registry information or documents with Inland Revenue when doing so is for the purpose of assisting the exercise of powers or functions under the Inland Revenue Acts. This will help to achieve a more integrated approach between registration and qualification for a range of tax exemptions.
Estate and Gift Duties Act
Section 73(1) of the Estate and Gift Duties Act 1968 has been amended by section 72 of the Charities Act so that the gift duty exemption applies only to gifts made to societies, institutions and trustees of trusts who are registered as charitable entities.