Introduction – Tax Exemption for Non-Profit Organizations Under Paragraph 149(1)(l) of the Income Tax Act
The Canadian income tax regime offers various tax benefits to organizations operating enterprises for philanthropic purposes, rather than for profit. For example, a registered charity in Canada that advances a qualifying charitable aim (i.e. relief of poverty, advancement of education or religion, and any other charitable purposes regarded as charitable under law) for public benefit is entitled to an exemption from income tax. To encourage taxpayer participation in charities, a taxpayer who contributes to a registered charity and receives a donation receipt can also claim a charitable tax credit to help reduce taxes payable.
The Canadian income tax regime provides similar tax benefits to "non-profit organizations", which do not operate for a legally-recognized charitable purpose, but which advance a broader range of social benefits. Paragraph 149(1)(l) defines a "non-profit organization" as an entity, either incorporated or unincorporated, that meets the following requirements:
- it is, in the opinion of the CRA, not a charity (so, an entity organized for charitable aims cannot also and separately qualify as a non-profit organization);
- it is organized and operated exclusively for social welfare, civic improvement, pleasure, recreation or "any other purpose except profit" (that is to say, some purpose other than commercial or financial reasons); and
- the entity's income has never been paid to, made payable to or otherwise made available for the personal benefit of any of its members.
This article will focus on one core element of the common law and CRA administrative policy as it concerns whether a non-profit organization is or is not organized for a purpose except profit. More specifically, this article will focus on when a non-profit organization can and cannot preserve its tax-exempt status, when it actually earns a profit. The line between acting exclusively for purposes other than profit and acting for-profit in such cases can often be very unclear and unpredictable. Any Canadian taxpayer operating or who is considering forming a non-profit organization should be acutely aware of the court jurisprudence and CRA's administrative positions, so as to avoid falling on the wrong side of the law and needs to consult with a Toronto income tax lawyer. This article will begin by briefly surveying the law concerning the "profit-purpose" test established by the Canadian courts, and the factors that judges have historically looked to when answering whether a non-profit organization earning a profit is on the right side of the law. This article will then consider the CRA's administrative positions on the matter, and how those positions align with the state of the law. This article will conclude with some pro tax tips from our top Canadian tax lawyers and some frequently asked questions concerning the profit-purpose test for non-profit organizations under Canadian tax law.
The Profit-Purpose Test: "Organized and Operated Exclusively"
As discussed above, to qualify as a non-profit organization, an entity must be organized exclusively for social welfare, civic improvement, pleasure, recreation, or "any other purpose except profit". The language of this provision is very broad and effectively permits a non-profit organization to pursue any non-profit purpose, which does not also fall under one of the major heads of charity (i.e. relief of poverty, advancement of education or religion, and any other charitable purposes regarded as charitable under law). However, determining whether an entity operates exclusively for, and in accordance with, a purpose other than profit is more nuanced. There is no single "bright-line" test to answer this question, and it remains a question of fact in each case.
For income tax purposes, "profit" is widely accepted to mean the difference between receipts in a period, and the expenditures laid out to earn those receipts. The courts have not interpreted paragraph 149(1)(l) of the Income Tax Act so restrictively, so as to mean an entity cannot earn any profit to qualify for tax-exempt status. It is well-recognized that a non-profit organization can undertaken commercial or business activity to support its non-profit goals, and not just to enrich its members or proprietors. If those commercial activities are successful, then that would obviously result in a profit. So, earning an incidental profit from those activities is not improper.
But earning an actual profit can be a problem where it is more than incidental, or where that profit is earned from an activity or business that is not directly attributable to the entity's non-profit activities or purpose. Further, maintaining a surplus of funds that is not redeployed immediately to fund the organization's non-profit aims has been treated as one factor to support finding a for-profit purpose existed. Canadian case law provides some helpful examples of this principle. In Tourbec (1979) Inc. v. Minister of National Revenue, the appellant was a corporation formed to promote tourism in Quebec by organizing discount trips to the province for students and youth under the age of 35. The appellant accomplished this by operating a travel-agency business, which also offered services to the general population at full price. The court held the appellant was acting for profit and reaffirmed the CRA's decision to deny the appellant tax-exempt status as a non-profit organization. The court acknowledged the appellant had a philanthropic element to its operations, but it was only able to offer its services to youth and students at less than cost because those services were subsidized by the fees charged to the general population for its services. The appellant generated a considerable profit from its sales to the general population which exceeded its operating costs. The appellant's non-profit objectives were only attainable by operating a profitable business, and so the court concluded the appellant was in fact operating a travel agency business for profit.
The court's adverse view of the taxpayer's circumstances in Tourbec (1979) can be distinguished from cases where profit was generated, but that profit could be characterized as "incidental" to a greater non-profit purposes. For example, in Canadian Bar Insurance Association v. The Queen, the appellant was a corporation selling insurance products to lawyers. These products included life insurance and disability insurance, and coverage for business expenses during disability. The court held the appellant qualified as a non-profit organization and was not engaged for profit, despite the fact it engaged in a high level of commercial activity. First, the appellant's operations were focused on offering insurance products on a cost-recovery basis. Quantitatively, the appellant's total profits over the course of a seven-year period only exceeded $600,000, while its total revenue and operating expenses over that same seven-year period were almost $20 million each. And while the appellant did accumulate a reserve of funds year-by-year from the profit it earned from insurance premiums which was not actively deployed for non-profit aims, the court found the reserve was a result of the inherent difficulty in measuring the cost of insuring a particular risk, and because it was necessary for the appellant to maintain some reserve funds to obtain the favourable premiums it offered members to achieve its non-profit goals. The appellant's actual profit was nominal and came about because of inherent difficulties in fixing annual premiums on a pure cost recovery basis. Second, while the appellant offered services in a sector populated with commercial insurance companies, the appellant's services were restricted to professionals in the legal community, and not to the public broadly.
As we can see from the above, the fact a non-profit organization has earned a profit is not determinative of whether that organization is acting for the purpose of profit. Rather, the actual profit earned is coloured by the surrounding circumstances. Like in the case of Tourbec (1979), the court took offense at the fact the profit was earned from activities wholly unrelated to the core non-profit activities of the organization. But in the case of Canadian Bar Insurance Association, the appellant earned a fair profit that was clearly derived from its core non-profit activities. And the surplus it generated was also clearly connected with its non-profit aims, because it needed to maintain a surplus to provide lower premiums for its members on insurance products.
CRA Administrative Policy on Permissible Profits
The CRA has also published its own views in Information Bulletin IT-496R on what degree of profit is permissible for a non-profit organization to maintain tax-exempt status. While the CRA's published views on Canadian tax law do not have force of law in Canada, they have been recognized by Canadian courts as fundamental tools for the interpretation and application of Canada's tax laws to other taxpayers.
The CRA has stated that a non-profit organization may earn a profit from its non-profit activities, or some other activity, without losing tax-exempt status. So long as the income-generating activity is directly attributable to, or connected with, pursuing the organization's non-profit goals, then the CRA has acknowledged that a profit purpose will not necessarily exist. However, the CRA's administrative view emphasizes that an accumulated surplus of profits at year-end without a reasonable explanation will be a major challenge to maintaining that tax-exempt status. More specifically, if a "material" part of an organization's profit is accumulated year-by-year and that amount exceeds the organization's reasonable needs to carry on its non-profit activities, then the CRA will assume the organization has a for-profit purpose. This will especially be the case where any accumulated surplus is deployed to fund: (1) long-term investments to earn property income; (2) expanding facilities for normal commercial operations; or (3) loans to members or shareholders of the organization.
The CRA agrees that the reasonableness of a surplus will depend on the specific needs and goals of the organization. The reasonableness of a surplus will require a consideration of future anticipated expenses, and proper budgeting and projections. A surplus that could reasonably be expected to cover future operating costs will be viewed as permissible. However, a repeated accumulation of surplus year-by-year that is greater than the organization's needs will likely be treated as evidence of a for-profit purpose. The CRA has also clarified in Technical Interpretation 2009-0337311E5 ("149(1)(l) Organizations") that a surplus of profits accumulated to fund a future capital project, such as the above-noted example of expanding facilities for normal commercial operations, would demonstrate an inappropriate profit purpose, because the cost of that capital project would not be an expense earned to incur current revenue for the organization. Rather, the CRA has taken the position that an organization should fund capital projects by accumulating members' contributions over a period of time, or with an increased level of caution, using those segregated members' contributions to earn interest income to deploy for a future capital project. Fortunately, this demonstrates the CRA's administrative views fall reasonably in-line with the common law. And while those administrative views are not law, they are helpful aids for anticipating how the CRA will view the activities of a non-profit organization when evaluating its entitlement to tax-exempt status, especially where an organization is considering financing a long-term capital project.
Pro Tax Tip: Losing Tax-Exempt Status and Remedying Non-Compliance Under the Voluntary Disclosures Program
Where the CRA rejects an organization's claim for tax exemption as a non-profit organization, intentionally or unintentionally, the tax bill for the organization can be extreme. If the CRA determines that a previously tax-exempt non-profit organization began acting for profit at any time, then that entity is deemed to have lost its tax-exempt status as of the date it began to act for profit. That organization would then be treated as a taxable entity from that point onward. If that organization is incorporated, it is deemed to undergo a year-end immediately prior to the time before losing its tax-exempt status. As a result of that deemed disposition, that corporation is viewed as having disposed of all of its property at fair-market-value and to have re-acquired that property. Thus, that corporation will recognize a taxable capital gain on the accrued value of its property.
Depending on the time the organization began acting for profit, the additional penalties and interest owing on that increased tax bill can also be extreme. The CRA's Voluntary Disclosures Program ("VDP") provides an invaluable means of avoiding the worst consequences from the loss of tax-exempt status for a non-profit organization's proprietors, but only if action is taken quickly. Under the VDP, a Canadian taxpayer can voluntarily bring forward any tax non-compliance issues to the CRA before the CRA launches its own investigation. If a taxpayer qualifies for relief under the crypto VDP, then that taxpayer may be entitled to relief from any penalties for non-compliance like gross negligence penalties and partial interest relief on taxes owing.
However, a successful voluntary disclosure application is time-sensitive. In order to qualify for relief under the VDP, a taxpayer's disclosure must be voluntary, which means it must precede any enforcement action taken by CRA to investigate the non-compliance in question. The threshold for what qualifies as an enforcement action can be quite low, ranging from a tax audit by the CRA to a simple demand-to-file an outstanding return. Further, any disclosure must be complete, which means it must not only include all submissions, calculations and information concerning the tax non-compliance in question, but it must address all non-compliance issues the taxpayer is responsible for. Thus, if an organization has been acting for-profit for a number of years, then all years must be disclosed and accounted for. It is therefore crucial that you engage a top Canadian tax lawyer to help carefully plan and prepare any voluntary disclosure application, so all compliance issues are identified and addressed. In addition to increasing the likelihood that the CRA would grant tax amnesty, a well written disclosure application also lays the framework for a judicial review application to the Federal Court should the Canada Revenue Agency unjustly reject your voluntary disclosure application. If your non-profit organization has identified any reason it may be disqualified from tax-exempt status, then you should consult an expert Canadian tax lawyer right away to complete a compliance review of your organization and determine if filing an application under the VDP is necessary to correct any non-compliance issues.
FAQs:
What are the conditions that must be satisfied to qualify as a tax-exempt "non-profit organization" under the Canadian Income Tax Act?
Paragraph 149(1)(l) defines a "non-profit organization" as an entity, either incorporated or unincorporated, that meets the following requirements:
- it is, in the opinion of the CRA, not a charity (so, an entity organized for charitable aims cannot also and separately qualify as a non-profit organization);
- it is organized and operated exclusively for social welfare, civic improvement, pleasure, recreation or "any other purpose except profit" (that is to say, some purpose other than commercial or financial reasons); and
- the entity's income has never been paid to, made payable to or otherwise made available for the personal benefit of any of its members.
What does it mean for an organization to operate exclusively for a purpose "except profit" under paragraph 149(1)(l) of the Canadian Income Tax Act?
For income tax purposes, "profit" is widely accepted to mean the difference between receipts in a period, and the expenditures laid out to earn those receipts. It is well-recognized that a non-profit organization can undertaken commercial or business activity to support its non-profit goals, and not just to enrich its members or proprietors.
But earning an actual profit can be a problem where it is more than incidental, or where that profit is earned from an activity or business that is not directly attributable to the entity's non-profit activities or purpose. Further, maintaining a surplus of funds that is not redeployed immediately to fund the organization's non-profit aims has been treated as one factor to support finding a for-profit purpose existed.
What are the CRA's views on when a non-profit organization might operate with a profit purpose?
In the views of the CRA, according to Information Bulletin IT-496R, a non-profit organization can earn an incidental profit so long as the income-generating activity is directly attributable to, or connected with, pursuing the organization's non-profit goals. However, if a substantial part of an organization's profit is accumulated year-by-year and that amount exceeds the organization's reasonable needs to carry on its non-profit activities, then the CRA will assume the organization has a for-profit purpose. The reasonableness of a surplus will require a consideration of future anticipated expenses, and proper budgeting and projections. And, the CRA has taken the view that a surplus in profits accumulated to fund a future capital project is evidence of a profit purpose, because the cost of that capital project would not be an expense earned to incur current revenue for the organization.
