IN RECENT YEARS, THE CANADA Revenue Agency (CRA) has been cracking down on Canadian charities, revoking the tax-exempt status of more than 60 organizations. More recently, that focus has begun to shift toward non-profit organizations (NPOs). As a result, the CRA has launched a risk-identification research project that is examining NPO activities and their sources of revenue.
“These reviews help maintain the integrity of the Canadian tax system, as well as Canadians’ confidence in the fairness of the system,” says Philippe Brideau, senior media relations advisor with the CRA. “The CRA started this project to help characterize and quantify compliance and to measure tax at risk in the NPO sector.”
The Income Tax Act (ITA) provides NPOs with an exemption from income taxes, provided they meet certain criteria. But not all NPOs are tax-exempt.
In order to qualify as an NPO, an organization cannot be a charity. It must be organized exclusively for a purpose such as social welfare, civic improvement, pleasure, recreation or any other purpose other than profit. It must operate exclusively for the purposes for which it was organized and must have no income that is paid to or available to any proprietor, member or shareholder. NPOs can include trade associations, community and recreation clubs, social clubs, condominium corporations, homeowners’ associations and advocacy organizations.
Unlike charities, NPOs are not required to register with the CRA to confirm their tax-exempt status and, over the years, the NPO sector has not received the same level of scrutiny from the CRA as have registered charities. NPOs have been able to operate without having to confirm their tax-exempt status.
That freedom from scrutiny is coming to an end.
Now in the third and final year of its NPO research project, the CRA has identified 39,000 entities claiming tax exemptions under paragraph 149 (1) (l) of the ITA, which sets the criteria for tax-exempt NPOs. Of those organizations, the CRA is reviewing 1,400 randomly selected NPOs. No reassessments are being conducted, the CRA says, except in the most egregious cases.
Up to now, there has been no specialized program that focuses on auditing NPOs. But some NPOs claim the CRA is alleging that these NPOs are in violation of the ITA. These NPOs are questioning whether those allegations are accurate, says Dennis Alexander, a tax partner with Deloitte & Touche LLP in Toronto.
“The CRA has started taking positions on a number of things that no one has had to battle before, and that is causing a lot of uncertainty and anxiety in the [NPO] sector,” Alexander says. “There are no previous cases to look upon and [no] history about NPOs or assessments in this sector. The NPOs are confused as to whether the CRA is actually right or wrong about the allegations.”
The review process had begun with the CRA sending out “education” letters to various NPOs, with the aim of raising awareness of the rules. But some of these letters indicate that the organizations have been in breach of the ITA and must make adjustments to their activities in order to comply.
@page_break@ Upon receiving such letters, representatives from a number of NPOs have expressed concern to the Canadian Chamber of Commerce, which, in turn, has contacted the federal minister of national revenue, asking the minister to direct the CRA to stop issuing these education letters. By April 23, 2012, the CRA had stopped issuing such letters.
“Even though the CRA has retracted the letters because they created a level of anxiety,” says Alexander says, “I still have anxiety because I am seeing what [the CRA’s] positions are and I don’t know whether I agree with them entirely. The CRA is interpreting the law one way – [which] is contradictory to how the NPOs are interpreting it.”
The CRA has indicated that NPOs can earn a profit, but whether an NPO remains tax-exempt depends on the circumstances under which it earns that profit, according to Alexander. If an NPO generates a profit that is incidental to and arises from activities that support the organization’s not-forprofit objectives, the NPO can remain taxexempt. But an NPO that uses profit-making activities to fund its not-for-profit activities cannot remain tax-exempt, he adds, because it would then have a profit purpose.
“Generally, the NPOs’ view is that they can’t generate a profit overall,” Alexander says. “So, they have an activity that is generating a loss and they have [another activity] that is generating a profit to fund that loss. [NPOs think they can] still be OK because they do not have a profit objective.”
The CRA, Alexander continues, would regard that profit/loss offset as invalid: “That [conflicting view] is generating a lot of confusion.”
The CRA’s research project continues until the autumn of 2013, when the agency will release its full findings publicly.
“I think there are some NPOs that are clearly offside and need to be cleaned up,” Alexander says. “But there are others that may want to hold off [on any changes in their activities] until we see where the CRA is going with this.”
© 2012 Investment Executive. All rights reserved.