NPO “Education” Letters

The Canada Revenue Agency (the “CRA”) has confirmed that a large scale information gathering project is underway in respect of not-for-profits (NPOs) and their income-generating activities. Between 2010 and 2013, Specialty Audit is coordinating the audit of 1440 randomly selected small and medium sized NPOs. The CRA says the goal of the audit is to “characterize and quantify compliance, measure tax at risk associated with the NPO sector and recommend courses of action”. The audit is essentially an intelligence gathering with respect to the NPO sector.

In order to maintain tax exempt status, NPOs cannot operate with a profit purpose. The CRA has said thus far, most NPOs are generally meeting their requirements necessary to maintain their status as tax exempt. However, in cases where the CRA has considered the NPO to be non-compliant, NPOs have been given an opportunity to comply voluntarily. In cases of serious non-compliance, the organizations have been reassessed.

The CRA has cited the following situations as those that have raised a concern:

• Operating businesses in competition with for profit businesses.
• Using NPOs for personal wealth creation or tax planning purposes.
• Using a non-profit corporation to hold a family cottage in order to, among other things, avoid the deemed disposition rules upon the death of a taxpayer.
• Creating unreasonable reserves to invest in real estate holdings.
• Setting up lucrative rental arrangements by condo corporations, and leasing roof space for cell phone towers, for the purpose of earning profits and reducing condo fees.

The CRA has also offered the following guidance regarding the profits that can be earned by an NPO while retaining its tax exempt status:

• Any profits should be incidental and arise from activities that are undertaken to meet the organization’s not-for-profit objectives.
• Earning profits to fund not-for-profit objectives is not considered to be itself a not-for-profit objective.
• Limited fundraising activities involving games of chance (e.g. lotteries, draws), or sales of donated or inexpensive goods (e.g. bake sales, plant sales or chocolate bar sales), generally do not indicate that the organization as a whole is operating for a profit purpose.
• An organization should fund capital projects and establish reasonable operating reserves from capital contributed by members, from gifts and grants, or from accumulated, incidental profits.
• Capital contributions, gifts and grants, and incidental profits should generally be accumulated solely for use in the operations of the organization including funding capital projects or setting up operating reserves and should not be used to establish long-term reserves designed primarily to generate investment income.
• Maintaining 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 objective of an organization. Incidental income arising from these reserves or accounts will not affect the status of an organization.
• Finally, in determining whether an organization has any profit purpose, the activities of the organization must be reviewed both independently and in the context of the organization as a whole.

Not-for-profits have been receiving “education letters” from the CRA suggesting that they are in breach of the Income Tax Act (Canada) (the “Act”) and providing an opportunity for these organizations to self-correct any past errors in reporting in respect of such activities. However, no conclusions seem to have been reached in respect of the application of the Act to such activities that are addressed in the letters.

The courts have drawn a fine line in many cases as to what activities are offside. They have said that engaging in commercial activity in a business-like manner does not necessitate a finding that an organization is operating with a profit motive. While we generally agree with the CRA’s characterization of profit-generating activities that will not amount to a profit motive, in some circumstances we disagree with its application of those principles to particular fact scenarios. Thus, if you have received a reassessment or a letter asking you to comply, we may be able to assist you.