The taxation of charities

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The relief of aged, impotent, and poor people; the maintenance of sick and maimed soldiers and mariners; schools of learning; free schools and scholars in universities; the repair of bridges, ports, havens, causeways, churches, sea banks, and highways; the education and preferment of orphans; the relief, stock, or maintenance of houses of correction; marriages of poor maids; support, aid, and help of young tradesmen, handicraftsmen and persons decayed; the relief or redemption or prisoners or captives; and the aid or ease of any poor inhabitants covering payments of fifteens, setting out of soldiers, and other taxes.

Today’s concept of charity is based on the above passage which is from the preamble to the Charitable Uses Act 1601.

Later, in 1805, while arguing in the UK case of Morice v Bishop of Durham, Sir Romilly boiled the Statute down into the ‘four heads’ of charity that we still use today; the relief of the poor, the advancement of learning, religion, and purposes beneficial to the community. Since then, many commonwealth countries have further refined ‘charity’ to include aspects such as health, amateur sports, culture, environmental protection and human rights.

Recognising the role that charities play in society, charities have long benefitted from various tax exemptions. Not only are a charity’s surpluses exempt from income tax, but profits derived from commercial activities are also exempt. Benefits exist within the Goods and Services Tax Act and the fringe benefit regime. Also, third party companies can claim a tax deduction for donations to charity and individuals can claim donation rebates.

As a society we support the work that charities do by accepting an increased tax burden, to allow the above tax concessions to exist. But are they fair?

The fact charities don’t pay tax on business profits is a topic that appears in the media with regular frequency. The perception exists that the broad tax exemption charities enjoy provides them with an unfair advantage and charities are reinvesting too much of their profits back into their businesses, rather than applying those profits to their charitable purposes.

There is no right or wrong answer. It is a matter for society to debate as a whole. But it is worth keeping a few things in mind.

Irrespective of whether a dollar exists today or in five years’ time, all income and assets of a charity must be applied to a charitable purpose. Profits reinvested back into a business are not gone, they exist in the form of its assets. As long as there is life in the charity, its income and assets will be applied to charity.

If charities were subject to income tax, the amount of resources available to apply to charitable activities would reduce accordingly. If a charitable need were such that it must be fulfilled, but charities were unable to do so, it would likely fall on the Government to pick up the slack. Hence, the tax revenue generated would be recycled into the same areas of need that were satisfied by charities in the first place. Whether the Government or the charitable sector is best placed to serve such needs is a question for another day.

Not only do charities benefit society as a whole, but they do pay taxes in other forms. GST is payable on their supplies of goods and services and PAYE is paid on salaries paid to staff. The more successful a charity is, the more GST and PAYE that is likely to be paid.

The notion that charities are funnelling profits to non-charitable activities should also be taken with a grain of salt. Charities Services, Inland Revenue (IRD) and the Department of Internal Affairs are responsible for regulating and policing the charitable sector.

To gain initial registration with Charities Services, a charity’s stated purpose and governing rules are carefully scrutinised. All charities must submit an annual return, including detailed financial information, and since 2015 any charities with annual expenses of more than $500,000 are required to have their financial information verified each year by an independent auditor.

In addition to oversight by Charities services, IRD are consistently undertaking investigations to ensure charitable entities comply with their stated purpose. IRD has recently been described by the Minister of Revenue as “religious” in their efforts to maximise tax revenue. Furthermore, the Department of Internal affairs has an investigative arm devoted to the adherence of charitable entities to the Charities Act.

Any deviation from the legislation would therefore quickly ensure a charitable trading business would lose the tax exemptions afforded to them, whereby they would become liable for income tax on current and past profits in the same way as a standard taxpayer.

Too often charities are vilified for not spending enough of their profits on charitable purposes. But we need to make sure we take a long term view. There will always be a need for charities to play what is an important role in society – that won’t change. Reinvesting some of their profits like other businesses means they are better equipped for tomorrow.

The comments in this article of a general nature and should not be relied on for specific cases. Taxpayers should seek specific advice.

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Hayden Farrow

Hayden Farrow is a PwC Executive Director based in the Waikato office. Email: hayden.d.farrow@nz.pwc.com

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