Introduction – Exemptions
What have become known as the ‘in-Australia’ test special conditions in tax law for tax-exempt entities were introduced in more or less the current form in the Taxation Laws Amendment Act (No 4) 1997.
In introducing the Bill, which in substance amended various provisions in and around section 23 of the Income Tax Assessment Act 1936 dealing with tax exempt entities, the Parliamentary Secretary to the then Prime Minister indicated a number of objectives for the amendments, in so far as they directly impacted the tax exempt status of Australian organisations, as including:
- To address tax avoidance through tax exempt entities distributing funds off-shore (but without impacting the distribution of funds received from donations, gifts, offerings and “plate money”);
- The protection of the integrity of charitable activity;
- To comply with Australia’s international obligations to demonstrate an anti-terrorism position by being stricter about the way charities move money between countries.
The Amendments inserted into the ITAA 1936 applied in relation to income derived from on or after 1 July 1997.
These provisions are currently found in Division 50 of the ITAA 1997.
As the Explanatory Memorandum to the current Bill (Tax Laws Amendment (Special Conditions for not-for-profit concessions) Bill 2012) indicates, the expression ‘in Australia’, in various contexts has been inherent in the notion of the deductibility of gifts to public charitable institutions’ as far back as the Income Tax Assessment Act 1915.
In the early 1920s, after some judicial interpretation of the provisions, the concept of the ‘in Australia” test was further elaborated upon in the Income Tax Assessment Act 1922.
After attracting some consideration in the 1934 Royal Commission on Taxation and the 1935 Conference of Commonwealth and State Commissioners of Taxation, the gift deductibility provisions were moved to a separate provision in section 78 of the Income Tax Assessment Act 1936, which then allowed a deduction for gifts made to certain “funds, authorities or institutions in Australia”.
The successors to these provisions are currently located in Division 30 of the Income Tax Assessment Act 1997.
After the decision of the High Court of Australia handed down in December 2008 in Federal Commissioner of Taxation of the Commonwealth of Australia v Word Investments Ltd (2008) 236 CLR 204 (“Word”) the ATO responded in May 2009 indicating the finding in the Word case was inconsistent with the clear policy intent underlying the special conditions. The Government announced in the 09/10 Budget that it would amend the ‘in-Australia’ Special Conditions to ensure that Parliament retained the ability to fully scrutinise those organisations seeking to pass money to overseas charities and other entities.
On 23 August 2012 the Tax Laws Amendment (Special Conditions for Not-for-Profit Concessions) Bill 2012 was introduced into the House of Representatives with another 2 Bills reforming the Not-for-Profit sector. At the time this presentation was prepared the new Bill had not passed through Parliamentary processes.
The amendments before Parliament certainly better organise the provisions as they apply respectively to exempt entities and DGRs.
The current Bill follows 2 exposure drafts of the proposed legislation and the consideration of submissions following the release of each of these drafts.
Tax Exempt Entities
Under the current test in sec 50.50 an entity is not exempt from income tax unless the entity has a physical presence in Australia and, to that extent, incurs its expenditure and pursues its objectives principally in Australia.
The new or proposed new test has moved away from the “expenditure test” notion to a test that will involve the consideration of all surrounding circumstances such as :
- Where the entity incurs its expenditure;
- Where it undertakes its activities;
- Where its property is located;
- Where it is managed from
- Where it is resident or located;
- Who is directly or indirectly benefitting from its activities
The periodic self-review is an important plank in the whole scheme of exemption entitlements so entities will need to take into consideration a wider range of factors in their self assessment function. The wider scope of factors to take into account will need to be effectively communicated by the new Commission to less resourced entities especially given the possible implications of getting this wrong.
For an entity whose exemption from Income Tax is covered by the newly restated Special Conditions it is not exempt from income tax unless it:
- Is a not-for-profit entity. This expression is now defined in the proposed new sec 995-1(1) ITAA 97; and
- Operates principally in Australia and pursues its purposes principally in Australia; and
- Complies with all the substantive requirements in its governing rules and applies its income and assets solely for the purpose for which it is established.
- If it provides money, property or benefits to a non-exempt entity the ultimate use of those resources by the non-exempt recipient must be taken into account in determining if the donor exempt entity is operating principally in Australia and pursuing its purposes principally in Australia (tracing provision);
- The exempt entity must comply with further conditions prescribed in regulations yet to be promulgated if it is to disregard government grants and non-tax deductible gifts in determining whether it operates principally in Australia and pursues it purposes principally in Australia.
Under the not-for-profit definition it must not be carried on for the profit or gain of its owners or members either while it is operating or upon winding-up and must comply with prohibitions from distributing its profits or assets to its owners or members as set out in the definition.
If reliance is placed upon disregarded amounts the entity will need to comply with further conditions prescribed in regulations which haven’t yet surfaced to my knowledge.
The Explanatory Memorandum indicates that the regulatory requirements concerning disregarded amounts are expected to include such things as:
- The entity must demonstrate that any activities undertaken outside Australia and the use of money or property outside Australia is effective in achieving the entity’s purpose;
- The entity must comply with all Australian and foreign laws, Australia’s International Treaty obligations and uphold the high reputation of Australia and its not-for-profit sector when sending money overseas; and
- The entity must show it has in place current and appropriate governance arrangements for the proper monitoring of any overseas activities undertaken by both it and any in-Country partners to ensure that any money and property is being used in a proper and effective manner.
In practical terms, if the regulations are of this nature, it will be extremely difficult for these entities relying upon disregarded amounts to assess their compliance with International Treaties and foreign laws in particular.
Deductible Gift Recipients
A DGR must be established in Australia, operate solely (as opposed to principally as is the case for merely exempt entities) in Australia and pursue its purposes solely in Australia.
There is relief for International Affairs DGRs, DGRs providing scholarships etc, and environmental organisations subject to other conditions. There are also commonsense provisions to accommodate activities that necessarily cross borders such as prescribed medical research which requires collaboration with overseas researchers.
The situation with DGRs has not radically changed, the ‘in-Australia’ requirements have simply been more clearly stated. As far back as the recommendations of the Ferguson Royal Commission in the early 1930’s the notion that organisations receiving tax deductable gifts must carry on their functions within the jurisdiction of the taxing authority has been to the fore.
If the activities of a DGR outside Australia are merely incidental to its operations and pursuit of purposes in Australia or are minor in extent and importance there will be no impact upon its status. A number of good practical examples have been provided in the Explanatory Memorandum.
As with the test for exempt entities tracing provisions have been inserted to cover circumstances where the DGR gives money to another entity. The ultimate use of these donated funds is taken into consideration as far as compliance with the tests is concerned.
As far as the re-stated and expanded ‘in Australia’ conditions are concerned there shouldn’t be an impact upon charities with a mainly domestic focus. There is still room for minor activities overseas but it certainly gets harder for those entities relying upon disregarded amounts to bring themselves within the conditions.
Australian charities with any aspect of overseas focus will have to think long and hard about their goals and the way they pursue them.
Whatever the proper application of the tracing provisions is ultimately determined to be, the justification of any cross-border payments will present a resource consuming exercise. The guidance material recommended by the Parliamentary Joint Committee in this regard will be essential reading.
In cases where they know they rely upon the current expenditure test with disregarded amounts there will be a clear need to devote proper resources to determine their position under the new tests. Without the benefit of knowing what will be in the regulations concerning the way disregarded amounts will be administered it will be extremely difficult to know what this position will be
For larger charities these shouldn’t be much of a noticeable impact on their activities abroad. For smaller organisations, with any kind of overseas focus, practical resourcing of compliance measures may well mean that their charity now ends at home. The gap between the usual meaning of “charity” and the taxation meaning of the same word especially in relation to any activities outside Australia has widened significantly.
A paper presented by Graham Corney, Consultant in Sydney 18 October 2012
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