May 31, 2013

CRA letter on 149(1)(l) non-profit interest expense

Here is a letter from CRA dealing with a non-profit that has an interest expense.  The main issue was “Whether the interest expense incurred to renovate a building of a 149(1)(l) entity may be deducted from interest income earned on various GIC investments that is to be taxed in the deemed trust under 149(5).”  CRA’s position was that it could not.  The summary was that “Interest expense incurred to renovate a building is not incurred to earn the revenue earned on GIC investments.”

Here is the text of the CRA letter:

LANGIND E
DOCNUM 2012-0437651I7
AUTHOR Merrigan, Lori
DESCKEY 26
RATEKEY 2
REFDATE 130131
SUBJECT NPO - Interest Expense
SECTION 149(1)(l); 149(5); 18(3.1); 20(1); 20(1)(c)
SECTION
SECTION
SECTION
$$$$

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu’exact au moment émis, peut ne pas représenter la position actuelle de l’ARC.

PRINCIPAL ISSUES: Whether the interest expense incurred to renovate a building of a 149(1)(l) entity may be deducted from interest income earned on various GIC investments that is to be taxed in the deemed trust under 149(5).
POSITION: No.
REASONS: Interest expense incurred to renovate a building is not incurred to earn the revenue earned on GIC investments.

January 31, 2013

XXXXXXXXXX Tax Services Centre HEADQUARTERS
Income Tax Rulings
  Directorate
Lori Merrigan
(613) 957-9229
Attention: XXXXXXXXXX
2012-043765

NPO – Interest Expense

This is in response to your correspondence of February 20, 2012, asking for our comments with respect to the treatment of interest income and interest expense in relation to an entity described in paragraph 149(1)(l) of the Income Tax Act (the “Act”).  In this letter, unless otherwise expressly stated, all statutory references are to the provisions of the Act.

FACTS

These are the facts as we understand them:

* XXXXXXXXXX (the “Club”) files an annual T2 return as a tax-exempt corporation under paragraph 149(1)(l) for each taxation year.

* During the XXXXXXXXXX taxation year, the Club commenced an extensive renovation to the XXXXXXXXXX.  In doing so, it transferred $XXXXXXXXXX from its operating fund to its building fund in order to assist in financing the renovation.  The construction period ended during the XXXXXXXXXX taxation year.

* The total interest earned by the Club’s guaranteed investment certificates (“GICs”) in XXXXXXXXXX was $XXXXXXXXXX, and, pursuant to subsection 149(5), this was taxed in a deemed trust.

* Interest expense charged to the renovation project during the construction period (XXXXXXXXXX to XXXXXXXXXX) was $XXXXXXXXXX.  This interest expense was not taken as a deduction in calculating taxable income for purposes of subsection 149(5).

The Club would like to amend its XXXXXXXXXX tax return to reduce the income reported pursuant to subsection 149(5).  It proposes to do this by reducing the $XXXXXXXXXX of interest earned on the GICs by the amount of the interest expense of $XXXXXXXXXX incurred during the construction period.  However, in the same submission, the Club has also alternatively stated that, “In accordance with paragraph 18(3.1)(a) the interest expense should not be deducted, but rather should be netted against the interest revenue and added to the cost of the building.”

GENERAL COMMENTS

This paragraph includes some very general comments which form the underlying basis of the analysis which follows: The Income Tax Act requires that the income of a taxpayer be calculated on a ‘source’ basis, including the taxpayer’s income from the year from each business and property.  The taxable income of an organization, either a for-profit or a not-for-profit entity, generally includes income from a business and income from property.  For a not-for-profit entity, their taxable income from a business would generally be considered to be that from their day-to-day activities, which is distinguishable from its income from property.  Further, for a 149(1)(l) entity, expenditures incurred in renovating a building used in its day-to-day activities would not be considered to relate to the entity’s income from property.

ANALYSIS

An organization described in paragraph 149(1)(l) is exempt from tax under Part I on its taxable income.  Such an organization could have taxable income from its ongoing day-to-day activities as well as from property upon which it is exempt from tax by virtue of paragraph 149(1)(l).  However, where the main purpose of an organization is to provide dining, recreational or sporting facilities for its members, subsection 149(5) applies and an inter vivos trust is deemed to have been created.  The property of the organization is deemed to be property of the trust and tax is payable by the trust on its taxable income, that is, its income from property, for each taxation year.

In computing the taxable income of the deemed trust, interest income is typically considered to be income from property and included in the calculation of that taxable income.  Then, pursuant to subparagraph 149(5)(f)(i), in computing the taxable income, there may be deducted, in addition to any other deductions permitted by Part I of the Act, $2000.

Deduction of the interest expense:

For interest expenses to be deductible with respect to the calculation of income from property pursuant to subsection 149(5), the conditions of paragraph 20(1)(c) must be fulfilled, by virtue of subparagraph 149(5)(f)(i) which states, “…there may be deducted, …other deductions permitted by this Part…”.

The preamble of subsection 20(1) provides that an amount may be deducted in computing a taxpayer’s income from a property where that amount is “…wholly applicable to that source…” while subparagraph 20(1)(c)(i) requires that the interest sought to be deducted be “…borrowed money used for the purpose of earning income from … property …”.  Basically then, interest expense can only be deducted in calculating the income from property in the deemed trust if that interest expense was incurred in order to generate that income.  Paragraph 13 of Interpretation Bulletin IT-533, “Interest deductibility and related issues”, further comments that:

“In Bronfman Trust, the court stated, “...the text of the Act requires tracing the use of borrowed funds to a specific eligible use…” and also stated, “The onus is on the taxpayer to trace the borrowed funds to an identifiable use which triggers the deduction.” In Shell, the Court described the test by saying, “If a direct link can be drawn between the borrowed money and an eligible use…”, then the money was used for the purpose of earning income from a business or property. In addition, “Interest is deductible only if there is a sufficiently direct link between the borrowed money and the current eligible use….” In Singleton, the court said, “It is now plain from the reasoning in Shell that the issue to be determined is the direct use to which the borrowed funds were put.” Further, in Singleton, the court held that “...it is an error to treat this [a sequence of transactions] as one simultaneous transaction. In order to give effect to the legal relationships, the transactions must be viewed independently.”

“Thus, the test to be applied is the direct use of the borrowed money…”

Based on the information provided, in our view, with respect to the calculation of taxable income from property, the conditions of subparagraph 20(1)(c)(i) would not be met since the interest expense was incurred on borrowed money used to renovate the building, which is used in the Club’s ongoing day-to-day business-type activities, and no part of the borrowed money was used to acquire the GICs which generated the interest income.  As such, the interest expense is not deductible against the interest income included in the calculation of income from property pursuant to subsection 149(5).

This position has also been supported in case law.  The judge denied a deduction of the interest expense in Elm Ridge Country Club Inc v. The Queen (TCC), 95 DTC 715, because, similar to this situation, the funds were not borrowed to make investments and derive income therefrom.

In addition, paragraph 3 of Interpretation Bulletin IT-83R3, “Non-profit organizations – Taxation of income from property”, states that:

“Expenses related directly to the earning of property income (such as income from dividends, interest, rentals, etc.) are deductible in determining the amount subject to tax pursuant to subsection 149(5).”… “However, the interest paid on money borrowed at other times of the year to finance ongoing club activities would not be deductible in determining the trust’s income.” As reflected in the above paragraph, what needs to be resolved generally for the deduction of expenses of a 149(1)(l) entity when calculating the income from property in the deemed trust is whether the expense was incurred to earn the income that is taxed in the deemed trust.

Moreover, with respect to interest expense in general, to suggest that interest expense arose on borrowed money used for the purpose of earning interest income, as required by subparagraph 20(1)(c)(i), suggests that funds were borrowed for the purpose of earning interest income, and, therefore, depending on the facts of a situation, it could be argued that the entity involved has a profit purpose, and as such, it could be considered that the organization did not meet the requirements of paragraph 149(1)(l).

Capitalization of amount pursuant to subsection 18(3.1):

The taxpayer has referred to our previous document, 59383, wherein they indicate that, in accordance with paragraph 18(3.1)(a), the CRA confirmed that there is a basis for netting interest revenue on a construction loan security deposit against the interest expense incurred during the period of construction.

It should be noted that the comments provided above regarding the deduction of interest and subparagraph 20(1)(c)(i) also apply to income from a business such that:  ‘The preamble of subsection 20(1) provides that an amount may be deducted in computing a taxpayer’s income from a business where that amount is “…wholly applicable to that source…”, while subparagraph 20(1)(c)(i) requires that the interest sought to be deducted be “…borrowed money used for the purpose of earning income from … a business…”.’

Also, it should be noted that document 59383 related to a for-profit taxable corporation that pays tax on its taxable income including income from property and income from business.  There was a comment made that interest retains its identity which, in our view, clearly suggests that it was income from property.  Further, it should be noted that when calculating taxable income, both a for-profit entity and a not-for-profit entity could have a current year deduction under subparagraph 20(1)(c)(i) for interest on borrowed money used for the purpose of earning income from a business, or from property.  However, where the 149(1)(l) entity is exempt from tax on its taxable income, but falls under the requirements of paragraph 149(5), it can only have a deduction under subparagraph 20(1)(c)(i) on borrowed money used for the purpose of earning income from property.

Further, the focus of that letter was on what amount might be considered to reasonably be regarded as a cost attributable to the period of construction such that the cost is not currently deductible but is added to the cost of a building.  There were no comments made that would suggest that the interest expense on the money borrowed for the construction of the building that was to be used in the entity’s business activities was considered to be interest expense on money borrowed for the purpose of earning income from property.  In our view, in that letter, the interest expense clearly related to business income.  Then, based on hypothetical facts, CRA provided comments on what might be considered to be currently deductible by the taxpayer in the calculation of its business income and what could reasonably be considered to relate to the period of construction.  In our view, in 59383, the taxpayer then had interest income from property and an interest expense in the calculation of its income from business.

To compare that letter to the Club’s situation, the Club’s interest income retains its identity and would be included as income from property under subsection 149(5).  Further, it would seem that the Club could similarly use subsection 18(3.1) to capitalize the interest expense that could reasonably be considered to relate to the period of renovation of the building.  However, also in our view, with respect to the interest expense that may not be capitalized, clearly that amount would not be deductible in calculating the Club’s income from property for purposes of subsection 149(5).

For further information on the deduction of capital cost allowance please see Interpretation Bulletin 83-R3, in particular, paragraphs 4 and 5.

CONCLUSION

In our view, the interest expense was incurred on borrowed money used to renovate the building that was used to provide sporting and recreational facilities to the Club’s members, i.e., in the day-to-day operations of the Club, and was not incurred on borrowed money used for the purpose of earning income on the GICs owned by the Club.  Therefore, the interest expense cannot be deducted when calculating the income from property that is taxed in the deemed trust by virtue of paragraph 149(5)(f).

Yours truly,

R.A. Albert, CPA, CA
Manager
Non-Profit Organizations and Aboriginal Issues Section
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

May 24, 2013

Industry Canada starts sending out default notices under the CNCA

Corporations Canada, under Industry Canada, has started sending out default notices to organizations that are under the new CNCA but have not filed their Form 4022 - Annual Return.  The Annual Return is quite easy to complete. Here is a link to it:
http://www.ic.gc.ca/eic/site/cd-dgc.nsf/vwapj/FRM-4022-e.pdf/$file/FRM-4022-e.pdf  It can also be filed online at http://www.ic.gc.ca/eic/site/cd-dgc.nsf/eng/cs04956.html

Here is the notice from Industry Canada with names removed:

“Annual Filing In Default
Canada Not-for-profit Corporations Act (NFP Act)
The above-mentioned corporation is in default of filing its 2013 annual return which was due to be filed between 2013-01-24 and
2013-03-25.

CAUTION
Failure to file an Annual Return may result in the dissolution of the corporation. Dissolution terminates the existence of a corporation and can have serious legal repercussions, particularly if the corporation is a registered charity under the Income Tax
Act.

HOWTOFILE
File ONLINE (and pay less)- filing fee is $20.
Visit http://www.corporationscanada.ic.gc.ca and choose “File an Annual Return.”
File by EMAIL, FAX OR MAIL- filing fee is $40.
Download Form 4022 -Annual Return from our website in PDF format or contact us. Email the completed form with credit card information to .(JavaScript must be enabled to view this email address). Fax the completed form to 613-941-4803 with credit card information or mail it with credit card information or with a cheque payable to the Receiver General for Canada.

OTHER REPORTING OBLIGATIONS

The corporation must keep the information regarding its registered office address and its board of directors up-to-date.

Visit the “Search for a Federal Corporation” section of our website to verify the corporation’s information and consult “Your Reporting Obligations under the Canada Not-for-profit Corporations Act (NFP Act)” to find out how to file these changes.”

May 12, 2013

CRA letter responding to questions from 2011 CTF National Conference CRA Round Table

CRA has released a letter providing responses to the questions posed at the 2011 Canadian Tax Foundation National Conference. CRA provides comments on the NPO Risk Identification Project and various comments on previous Interpretation Bulletin’s regarding NPO’s that have been released.  It is interesting to note CRA identifies that there “39,000 entities that file T2, T3 and/or T1044 returns.”  There are a large number of non-profits that do not need to file such returns and presumably some NPOs that are supposed to file but don’t.  The bulletin also discusses profit that is “incidental” and what are reasonable operating reserves for a non-profit. 

CRA letter responding to questions from 2011 CTF National Conference CRA Round Table.pdf

LANGIND E
DOCNUM 2011-0426111C6
AUTHOR Burnley, Pamela
DESCKEY 20
RATEKEY 2
REFDATE 111127
SUBJECT 2011 CTF Question re NPOs
SECTION 149(1)(l)
SECTION
SECTION
SECTION
$$$$

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu’exact au moment émis, peut ne pas représenter la position actuelle de l’ARC.

PRINCIPAL ISSUES: General questions about 149(1)(l)
POSITION: General positions provided.

November 27-29, 2011 CTF (Canadian Tax Foundation) Question regarding paragraph 149(1)(l)

1. At the 2010 CTF National Conference CRA Round Table, the CRA commented that the findings of the NPO Risk Identification Project would “increase the CRA’s information about the NPO sector and […] assist in the determination of:  - the level of non-compliance in the sector; - any significant data gaps that may require mandatory filing of prescribed forms; and – whether recommendations to the Department of Finance for more robust legislation are necessary”.

a) Can the CRA provide an update on the status of the NPO Risk Identification Project?

CRA’s response

* The CRA, through the Non-Profit Organization Risk Identification Project (NPORIP), has identified about 39,000 entities that file T2, T3 and/or T1044 returns claiming exemption under this provision. The CRA will audit 1,440 randomly selected NPOs over three years, approximately 480 files each year.

* The Project is currently in its second year.

* The audits start as a review of the organizations’ tax-exempt status, followed by a full-scope audit of the corporate file.  The majority of organizations will not be re-assessed.

* Should an entity claim but not qualify for the exemption under 149(1)(l) of the Income Tax Act , the CRA will conduct a full compliance audit of the corporate file and associated amounts reported on the T1044, T2 and T3 returns.

* The results of the NPORIP will allow the CRA to determine the compliance risk in the sector and recommend courses of action if required.

* The results of the audit findings will be compiled in a report to assist with the development of a compliance strategy.

* As this is a research project, it would be premature at this time to comment on the results of the pilot and what further courses of action would be recommended.

b) Will the CRA be recommending changes to the relevant legislation?

CRA’s response

If the NPO Risk Identification Project identifies particular areas of concern within the NPO sector, this information will be shared with the Department of Finance.

2. In 2009, the CRA issued a number of technical interpretations that appeared to signal a more restrictive approach to paragraph 149(1)(l) than that set out in Interpretation Bulletin IT-496R, “Non-Profit Organizations”. 

Does IT-496R continue to reflect the views of the CRA?

CRA’s response

Interpretation Bulletin IT-496R, “Non-Profit Organizations”, generally continues to reflect the views of the CRA.  Interpretations issued since the bulletin was written in 2001 clarify and, in limited cases, modify our comments in the bulletin. 

3. The interpretation of the requirement in paragraph 149(1)(l) that an organization be “organized and operated exclusively for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit” has proved particularly contentious.

In one 2011 document (2010-0380581I7), the CRA stated that “[l]imited fundraising activities involving games of chance (e.g., lotteries, draws), or sales of donated or inexpensive goods (e.g., bake sales or plant sales, chocolate bar sales), generally do not indicate that the organization as a whole is operating for a profit purpose” (emphasis added).

However, the CRA has also stated that, in its view, the use of the word “exclusively” in paragraph 149(1)(l) indicates that while an organization may have many purposes, none of those purposes may be to earn a profit such that, where an organization intends, at any time, to earn a profit, it will not be exempt from tax under paragraph 149(1)(l) even if it expects to use or actually uses that profit to support its not-for-profit objectives.
 
How should these statements be reconciled?
 
CRA’s response

Profits from fundraising activities described in the 2011 document are usually incidental when viewed in terms of the amounts involved and in relation to the operations of an organization as a whole.  Consequently, the CRA does not view these activities as indicating a profit purpose.  Earning profits that are not incidental may indicate that an organization has a profit purpose even if the profits are destined to support the not-for-profit objectives of the organization or another organization.

4. When will the CRA consider profit to be “incidental” to an organization’s exclusively not for-profit purposes?  For example, assume an organization – that is not a charity – is organized exclusively for a purpose other than profit.

a) Could the organization put on an event connected to its not-for-profit activities that is intended to generate a profit?

b) Would the amount of the profit (in absolute dollars or relative to the organization’s other revenues or expenses) be relevant?

c) Would it make a difference if the profit generated by the event were used to (i) pay down long-term debt, (ii) establish a reserve for future years, or (iii) defray the organization’s general operating expenses such that, on the whole, the organization operates on a break-even basis for the year?

CRA’s Response
An organization can put on an event connected to its not-for-profit activities and earn a profit as long as the profit is incidental.  Whether profit is incidental depends on the amount involved and the scope and nature of the activities compared to the operations of the organization as a whole.

The amount of the profit, both in absolute dollars and especially relative to the organization’s other revenues and expenses, is relevant.

If the profit generated by the event is incidental, it does not matter how the profit is used to meet the organization’s not-for-profit objectives, as long as the income is not payable to, or otherwise available for the benefit of members.  Any reserve established for future years should be limited to identified, specific (operational or capital) needs; a reserve established for the purpose of generating investment income will likely indicate that the organization is not operating exclusively for a purpose other than profit.

5. The CRA has stated that “[m]aintaining reasonable operating reserves or bank accounts required for ordinary operations will generally be considered to be an activity undertaken to meet the not-for-profit objectives of an organization” (2010-0380581I7). 

Can the CRA provide a rule of thumb as to the quantum of accumulated income that the CRA would generally consider to be acceptable?

CRA’s Response

No.  As explained in Interpretation Bulletin IT-496R, “Non-Profit Organizations”, the amount of accumulated excess income considered reasonable in relation to the needs of an organization to carry on its not-for-profit activities and goals is a question of fact in each situation to be determined with regard to the organization’s particular circumstances. 

Pamela Burnley
2011-042611

April 24, 2013

CRA releases updated Guide on GST-HST information for Non-Profit Organizations

Last month CRA released an updated Guide which explains how the goods and services tax/harmonized sales tax (GST/HST) applies to non-profit organizations. This includes registration requirements, exemptions, rebates, and simplified methods of accounting that may apply to a non-profit organization.

Here is the CRA Guide on GST-HST Information for Non-Profit Organizations.pdf

March 28, 2013

ONCA delayed again - implementation no earlier than January 2014

The following text is from the Ontario government website: “ONCA is targeted to come into effect no earlier than January, 2014. Existing not-for-profit corporations will have a three-year transition period once ONCA is in effect.  Community Legal Education Ontario (CLEO) will provide support to not-for-profit corporations as they make the transition to ONCA.”  Therefore, the July 1, 2012 target date has been delayed by at least 6 months.  Also the Ontario government is noting that CLEO will be providing support but no details have been provided at this time.

Here is a link to the Ontario government page:
http://www.sse.gov.on.ca/mcs/en/Pages/not_for_profit.aspx

Here is a note I received from the Ontario government:

“Sent to you on behalf of David Brezer, Director of the Consumer Policy & Liaison Branch, Ministry of Consumer Services.

I am writing to provide you with an update on the implementation status of the new Not-for-Profit Corporations Act, 2010 (ONCA).

The government will delay proclamation of ONCA to provide additional time for not-for-profit corporations to prepare for transition.  The Act is now targeted to be proclaimed no earlier than January 2014.  An update on proclamation will be made available on the Ministry’s website at: http://www.sse.gov.on.ca/mcs/en/Pages/Not_For_Profit.aspx. 

I am pleased to advise that the Minister of Consumer Services has approved a grant to Community Legal Education Ontario (CLEO) to develop and deliver a program that will build awareness about ONCA and provide a variety of supports to not-for-profit corporations as they make the transition to the new Act.  This grant is being funded through contributions by the Ministry of Consumer Services, the Ministry of Citizenship and Immigration, and the Ministry of Tourism, Culture and Sport.

In addition to the grant to CLEO, MCS and the Ministry of Government Services are continuing to finalize tools to support implementation (e.g., plain language guide, draft default by-law, electronic toolkit).  Additional tools (e.g., transition checklist) and information can be found on MCS’ website.
 
The government is committed to reviewing the Act following proclamation based on experience in the sector, including the issues that the Ontario Nonprofit Network has raised on behalf of its members.  The government is exploring the possibility of holding back from proclamation the provisions of the Act giving voting rights to non-voting members in certain limited circumstances, which is a key sector concern.  Where the case for amendments to improve the Act is made, the Ministry will seek to bring reforms forward for consideration. 

We would appreciate your help in communicating these developments to the not-for-profit sector.  Thank you for your continued support.
”

March 12, 2013

CRA letter on whether organization qualifies as a non-profit when it has a reserve

CRA recently released a letter which discussed whether a Corporation qualified for tax exemption when it held a reserve. In this case, the Corporation was receiving funds as a result of a funding agreement and could only expend them for specific purposes such as community, educational and charitable works or purposes. In CRA’s view, the Corporation was not running on a for-profit basis because, “...the Corporation has no control over the amount of funding it receives, nor over the framework under which it operates to determine qualified projects to fund.  The Corporation receives minimal passive investment income, does not solicit other income, and is actively looking for appropriate projects to fund while honouring the objects of the Corporation.”

Here is a PDF of “CRA_View_-_Qualifying_as_a_Non-Profit.pdf

LANGIND E
DOCNUM 2011-0425081I7
AUTHOR Burnley, Pamela
DESCKEY 26
RATEKEY 2
REFDATE 121217
SUBJECT NPO
SECTION 149(1)(l)
SECTION
SECTION
SECTION
$$$$

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu’exact au moment émis, peut ne pas représenter la position actuelle de l’ARC.

PRINCIPAL ISSUES: Does the corporation qualify for the exemption in paragraph 149(1)(l) of the Act?
POSITION: It appears to.
REASONS: The organization is not a trust.  It appears to be operated for a purpose other than profit, no income is being made available to members.  It is not a charity.

December 17, 2012

Compliance Programs Branch Headquarters
Specialty Audits Section Directorate Income Tax Rulings
  Directorate

Attention:  Rubin Dressler P. Burnley
(613) 957-2100
2011-042508

    XXXXXXXXXX (the “Corporation”)

We are writing in response to your request for our views as to whether the Corporation qualified for the tax exemption provided by paragraph 149(1)(l) of the Income Tax Act (the “Act”) for the years under review.  You specifically asked whether the organization is a charity, if a reserve indicated that it was operating with a profit purpose and whether an apparent trust arrangement affected the Corporation’s ability to qualify for the exemption. 

Based on the information you gave us, we understand that the Corporation receives funds as a result of a funding agreement negotiated between a city and a third party.  The Corporation has the ability to enforce the payments required by the agreement but cannot change the terms of the agreement.  The funds received by the Corporation can be expended only for specific purposes that must meet certain criteria.  Essentially, the expenditures must be for community, educational and charitable works or purposes and are limited to projects and programs which provide benefits to residents in a localized area.  The Corporation has a reserve as a result of a current lack of qualifying projects.

Initially, it appeared that a trust was involved, but the auditor subsequently confirmed that the organization in question is a corporation.  At our request, the Charities Directorate reviewed the objects of the Corporation and based on a preliminary review felt that the Corporation would not, in the present constitution, be a charity within the meaning assigned by subsection 149.1(1) of the Act. 

We also reviewed the information you gave us and we agree with the auditor that the Corporation was organized and operated to qualify for the exemption provided by paragraph 149(1)(l) of the Act for the years under review.  The Corporation has no control over the amount of funding it receives, nor over the framework under which it operates to determine qualified projects to fund.  The Corporation receives minimal passive investment income, does not solicit other income, and is actively looking for appropriate projects to fund while honouring the objects of the Corporation.  In our view, the Corporation is clearly not running a business on a for-profit basis. 

For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be made by you to Mrs. Celine Charbonneau at (613) 952-1361. In such cases, a copy will be sent to you for delivery to the taxpayer.

R. Albert, CPA, CA
Non-Profit Organizations and Aboriginal Issues
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

CRA letter on non-profit providing funds to members and whether it affects status

CRA recently released a letter that discussed the tax implications of an entity that distributes revenue to its members from the sale of auction items. CRA stated, “With respect to the sale of auction items, it is not clear to us whether the items to be sold continue to be owned by the contributing members or whether the items are donated to the 149(1)(l) entity and then some profits from the sale of such items are distributed to the contributing members.  If the contributing members retain ownership of the items then, in our view, the income of the 149(1)(l) entity is not available for the personal benefit of a member and the tax-exempt status of the organization is not jeopardized for this reason.  However, if the items are owned by the 149(1)(l) entity and the revenue of such items, and therefore the revenue of the 149(1)(l) entity, is distributed to its members then the organization could lose its status as a tax-exempt organization pursuant to paragraph 149(1)(l).” CRA did not provide a definitive answer for this organization however they did indicate that “...if the members retain ownership of the auction items, as long as the auction is related to its objectives, and the profits are not material, the income would likely be considered to be incidental income of the organization and would not jeopardize the tax-exempt status of the organization.”

Here is a copy of the CRA letter on non-profit providing funds to members and whether this affects their status

LANGIND E
DOCNUM 2012-0441801E5
AUTHOR Merrigan, Lori
DESCKEY 25
RATEKEY 2
REFDATE 130205
SUBJECT 149(1)(l) - Funds Payable to Members
SECTION 149(1)(l)
SECTION
SECTION
SECTION
$$$$
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu’exact au moment émis, peut ne pas représenter la position actuelle de l’ARC.

PRINCIPAL ISSUES: 1. Whether an organization would lose its 149(1)(l) status if profits from the sale of auction items are shared with the contributing members.
POSITION: Maybe
REASONS: Depends on whether items are owned by members or by NPO.

XXXXXXXXXX
2012-044180
Lori Merrigan
(613) 957-9229

February 5, 2013

Dear XXXXXXXXXX

Re:  Paragraph 149(1)(l) – Funds Payable to Members
We are writing in response to your correspondence of March 28, 2012, regarding the tax implications to an entity described in paragraph 149(1)(l) of the Income Tax Act (the “Act”) with respect to the distribution of revenue to its members from the sale of auction items.  In particular, you have described a situation in which a 149(1)(l) entity holds an auction and items are contributed by members.  Proceeds from the auction of an item are then split between the 149(1)(l) entity and the contributing member.
In this letter, unless otherwise expressly stated, all statutory references are to the provisions of the Act.
The situation outlined in your letter appears to relate to a factual one, involving a specific taxpayer.  Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70 6R5, “Advance Income Tax Rulings”.  This Information Circular and other Canada Revenue Agency (“CRA”) publications can be accessed on the internet at http://www.cra-arc.gc.ca.  Although we cannot comment on your specific situation, we are able to provide the following general comments, which may be of assistance.
The CRA’s general views regarding 149(1)(l) entities are contained in Interpretation Bulletins IT-496R, which may be viewed at http://www.cra-arc.gc.ca.  To qualify as a tax exempt entity described in paragraph 149(1)(l) of the Act, an organization must be both organized and operated exclusively for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit.
One of the requirements that must be met in order for an organization to be considered to be a 149(1)(l) entity is that its income is not available for the personal benefit of a member or shareholder.  With respect to the sale of auction items, it is not clear to us whether the items to be sold continue to be owned by the contributing members or whether the items are donated to the 149(1)(l) entity and then some profits from the sale of such items are distributed to the contributing members.  If the contributing members retain ownership of the items then, in our view, the income of the 149(1)(l) entity is not available for the personal benefit of a member and the tax-exempt status of the organization is not jeopardized for this reason.  However, if the items are owned by the 149(1)(l) entity and the revenue of such items, and therefore the revenue of the 149(1)(l) entity, is distributed to its members then the organization could lose its status as a tax-exempt organization pursuant to paragraph 149(1)(l).
Further, regardless of the ownership of the items, where a 149(1)(l) entity receives proceeds from the sale of these items, whether those proceeds will affect the 149(1)(l) entity’s tax status will depend on whether this is incidental income of the 149(1)(l) entity and whether it is connected to the not-for-profit objectives of the organization. 
An organization claiming a paragraph 149(1)(l) tax exemption can earn a profit, as long as the profit is incidental and arises from activities directly connected to its not-for-profit objectives.  Examples of profitable activities that might be undertaken through a 149(1)(l) organization include running a canteen at a rink used for amateur hockey or a cafeteria at a not-for-profit youth hostel, or charging admission above direct cost for a children’s concert (where the not-for-profit purpose of the organization was to organize and promote youth participation in music).
In our view, if the members retain ownership of the auction items, as long as the auction is related to its objectives, and the profits are not material, the income would likely be considered to be incidental income of the organization and would not jeopardize the tax-exempt status of the organization.  Whether or not income from a particular activity is incidental is a question of fact.
We trust that these comments will be of assistance.
Yours truly,

R. A. Albert, CPA, CA
Manager
Non-Profit Organizations and Aboriginal Issues Section
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

February 27, 2013

CRA View - Qualifying as a non-profit

CRA recently released a letter that discussed whether an entity that operates a private high school for the purposes of earning profit qualifies as a non-profit organization. CRA held that the Academy was not operating exclusively for a purpose other than profit. They stated, “Where an entity realizes significant profits and accumulates surplus funds in excess of its current needs or where it engages in a trade or business that is not directly attributable to, or connected with, pursuing the non-profit goals and activities of the entity, we may consider that the entity is not operated exclusively for non-profit purposes.” CRA also provided a brief summary of the characteristics that might indicate an activity is a ‘trade or business”.

CRA View - Qualifying as a non-profit

LANGIND E
DOCNUM 2012-0458491I7
AUTHOR Messore, Anna
DESCKEY 26
RATEKEY 2
REFDATE 121130
SUBJECT Private School – Non-profit organization
SECTION 149(1)(l)
SECTION
SECTION
SECTION
$$$$
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu’exact au moment émis, peut ne pas représenter la position actuelle de l’ARC.
PRINCIPAL ISSUES: Does the entity qualify as a non-profit organization pursuant to paragraph149(1)(l) of the Act
POSITION: No
REASONS: The entity operates a private high school for the purpose of earning profit.
November 30, 2012

Specialty Audit Section, Headquarters
Specialty Audit Division IT Rulings Directorate
Small & Medium Enterprises Directorate A. Messore
Compliance Programs (613) 957-2747
Attention : Gilles Rochette
2012-045849
XXXXXXXXXX (“Academy”)
This is in response to your email request dated August 10, 2012, in which you have asked us to review the audit file prepared by XXXXXXXXXX with a view to determining whether the Academy qualifies as a non-profit organization by virtue of paragraph 149(1)(l) of the Income Tax Act (“Act”).
BACKGROUND
Based on the documentation enclosed with your request and information received during telephone and email conversations with XXXXXXXXXX, we understand the facts to be as follows:
HIGH SCHOOL:
1. XXXXXXXXXX (“High School”) is a privately owned and operated independent high school located in the XXXXXXXXXX area.  Founded in XXXXXXXXXX, the school currently has about XXXXXXXXXX students, XXXXXXXXXX % of whom are international students and the remaining XXXXXXXXXX % Canadian.
2. High School is a normal commercial enterprise with taxable income and tax payable on its income.  In XXXXXXXXXX it had taxable income of $XXXXXXXXXX and Part I tax payable of $XXXXXXXXXX.
3. XXXXXXXXXX.
4. XXXXXXXXXX.
5. XXXXXXXXXX.
6. XXXXXXXXXX. 
ACADEMY:
7. On XXXXXXXXXX, the Academy was incorporated as a non-profit organization under the XXXXXXXXXX.
8. XXXXXXXXXX.
9. XXXXXXXXXX. 
10. XXXXXXXXXX. 
11. XXXXXXXXXX.
12. XXXXXXXXXX.
13. XXXXXXXXXX.
14. XXXXXXXXXX. 
15. XXXXXXXXXX.
16. In XXXXXXXXXX the Academy made a profit of approximately $XXXXXXXXXX.
17. All of the Academy’s earned profits are deposited and kept in an interest-bearing bank account.  To date, the cumulative earned profits residing in the Academy’s bank account amount to $XXXXXXXXXX.  There is no evidence of any specific plan for these reserve funds.
ANALYSIS
For an entity to qualify as a non-profit organization within the meaning of paragraph 149(1)(l) of the Act it must be operated exclusively for a purpose other than profit.
Where an entity realizes significant profits and accumulates surplus funds in excess of its current needs or where it engages in a trade or business that is not directly attributable to, or connected with, pursuing the non-profit goals and activities of the entity, we may consider that the entity is not operated exclusively for non-profit purposes.
Some of the characteristics that might indicate that an activity is a trade or business are as follows:
1) It is a trade or business in the ordinary meaning, that is, it is operated in a normal commercial manner;
2) Its goods or services are not restricted to its members and their guests;
3) It is operated on a profit basis rather than a cost-recovery basis;
4) It is operated in competition with taxable entities carrying on the same trade or business.
In general, an entity will be considered to be operating a business in a normal commercial manner if it habitually engages in an activity that is capable of producing a profit.  The Academy’s operation of a school for a fee is an example of a business operating in a normal commercial manner.
The Academy does not restrict the supply of education services to members and their guests.  Any student can be admitted to the Academy if he is accepted for admission to High School and meets the eligibility requirements for a XXXXXXXXXX. 
The Academy is operating on a for-profit rather than cost-recovery basis.  Its tuition fee structure is identical to High Schools, whose purpose in operating the school is clearly for-profit. 
High School is a for-profit business which operates in competition with other private high schools.  The same can be said of the Academy since it is likewise run by High School and in identical fashion.
The Academy is engaged solely in the for-profit business of providing education services for a fee.  Furthermore, the Academy has accumulated profits in its bank account without any specific plan for their use.  There is no indication either in the articles of incorporation or in the day-to-day activities of the Academy that its activities are attributable to, or connected with, any other non-profit or exempt purposes.  The rationale for creating the Academy and XXXXXXXXXX.
In our view, the Academy is not operated exclusively for a purpose other than profit.  As a result, the Academy would not be considered a non-profit organization as defined in paragraph 149(1)(l) of the Act. 
Further to the above comments, we refer you to Interpretation Bulletin IT-496R entitled “Non-profit organizations.”
Please do not hesitate to contact Anna Messore at (613) 957-2747 if you require further assistance.
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library.  A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases.  The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer.  Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity.  Requests for this latter version should be made by you to Mrs. Celine Charbonneau at (613) 952-1361.  In such cases, a copy will be sent to you for delivery to the taxpayer.
Yours truly,
Roberta Albert
Manager
Non-Profit Organizations and Aboriginal Issues
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

CRA View - NPO and Community Contribution Companies

CRA recently issued a letter on whether an NPO will jeopardize its exemption from tax where it incorporates a Community Contribution Company (C3) to carry on for-profit activities. The CRA took the position that, “where an NPO incorporates a C3 and holds the shares of a taxable C3 subsidiary, this will not, in itself, cause the organization to lose its exemption under paragraph 149(1)(l) or the Act”.

CRA -View NPO and Community Contribution Companies

LANGIND E
DOCNUM 2012-0456071E5
AUTHOR Townsend, Ann
DESCKEY 25
RATEKEY 2
REFDATE 130118
SUBJECT NPO and Community Contribution Companies
SECTION 149(1)(l)
SECTION
SECTION
SECTION
$$$$
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu’exact au moment émis, peut ne pas représenter la position actuelle de l’ARC.
PRINCIPAL ISSUES: Will an NPO jeopardize its exemption from tax under 149(1)(l) where it incorporates a Community Contribution Company (C3) to carry on for-profit activities.
POSITION: The ownership of shares will not, in itself, cause the NPO to lose its exempt status.
REASONS: Whether an organization is organized and operated for non-profit purposes is a question of fact in each situation. 
XXXXXXXXXX
2012-045607
A. Townsend

January 18, 2013

Dear XXXXXXXXXX

Re:  Non-Profit Organization and a Community Contribution Company

This is in response to your email requesting our views as to whether a non-profit organization (“NPO”) claiming the exemption from income tax provided by paragraph 149(1)(l) of the Income Tax Act (the “Act”) will jeopardize its exemption from tax if it incorporates a Community Contribution Company subsidiary to carry on for-profit activities.

Our Comments

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, “Advance Income Tax Rulings”. This Information Circular and other Canada Revenue Agency publications can be accessed on our website at http://www.cra-arc.gc.ca.  However, we are prepared to provide the following general comments. 

The Province of British Columbia amended its provincial Business Corporations Act, effective May 14, 2012, to allow for Community Contribution Companies (C3).  A C3 is described in provincial Information Bulletin 2012FIN0011-00024, as a new hybrid type company that is an alternative business model.  A C3 primarily benefits the community and provides limited investor returns.  The legislation provides that the dividends paid to investors of a C3 are capped to ensure profits are either retained by the C3 or directed for community benefit. 
In general terms, paragraph 149(1)(l) provides that an NPO is exempt from tax under Part I of the Act for a period throughout which it complies with all of the following:

a) it is not a charity;
b) it is organized exclusively for social welfare, civic improvement, pleasure, recreation or any other purpose except profit with no income available for the personal benefit of its members or shareholders;
c) it is in fact operated exclusively for the same purpose for which it was organized or for any of the purposes mentioned in (b); and
d) it does not distribute or otherwise make available for the personal benefit of a member or shareholder any of its income, unless the organization is an association which has as its primary purpose and function the promotion of amateur athletics in Canada.

In our view, as a C3 is organized to provide profit to investors as well as social benefits, it will not qualify as an NPO, and it will be subject to tax as a regular corporation under the Act.

Where an NPO incorporates a C3 and holds the shares of a taxable C3 subsidiary, this will not, in itself, cause the organization to lose its exemption under paragraph 149(1)(l) of the Act.  Generally, an organization claiming the exemption can earn a profit, as long as the profit is incidental and arises from activities directly connected to its not-for-profit objectives.  If an organization holds shares to earn income from property, it may be considered to have a profit purpose, even if the income from those shares is used in furtherance of the organization’s not-for-profit objectives.  However, the CRA has accepted that where an organization that otherwise qualifies for the exemption under paragraph 149(1)(l) of the Act, engages in an income-generating activity that is carried out in a taxable, wholly-owned corporation, and this corporation pays dividends out of its after-tax profits to the organization to enable the organization to carry out its not-for-profit activities, the organization may still qualify for the exemption as set out in paragraph 149(1)(l) of the Act. The facts of a situation would need to be examined to determine whether a particular holding of shares of a C3 would affect the status of its NPO parent. 

We trust that our comments will be of assistance.

Yours truly,

R.A. Albert, CA
Manager
Non-Profit Organizations and
Aboriginal Issues Section
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs

January 21, 2013

CRA letter on qualifying as an NPO when providing excess income to members

The CRA provided its view on whether a non-profit organization meets the requirements of paragraph 149(1)(l) of the Income Tax Act. CRA found that the organization was not operating for a purpose other than profit and income was being made available to its members, so it did not meet the requirements under the ITA. In this case, the corporation had a large amount of excess income and was using that income for purposes unrelated to the organization’s non-profit purposes (such as providing loans to members or shareholders and long-term investments). A not-for-profit organization under paragraph 149(1)(l) can earn a profit but it must be incidental and arise from activities connected to its non-profit objectives. Also, an organization that retains excess funds in order to invest them and earn income is not considered to be operating exclusively for a purpose other than profit.

Here is a copy of the letter:

CRA letter on qualifying as an NPO when providing excess income to members