The Unrelated Business Income Tax, will your not-for-profit be affected?

Regulating the sector

With 600,000 entities contributing $43 billion to Australia’s GDP each year and a work force of just on 1 million people, the NFP sector is immensely significant to the Australian economy and the Australian way of life. The sector attracts $25.5 billion in government support and $7 billion of donations.

The Assistant Treasurer also estimates that there are 178 pieces of legislation and multiple layers of government which result in ‘suffocating’ the sector. The Australian Charities and Not-for-profits Commission (ACNC), due to start work on 1 July 2012, is charged with independently regulating and reporting on the sector. The Unrelated Business Income Tax (UBIT) applies from 1 July 2011 in respect of new activities commencing 10 May 2011.

Compliance needs

At a time when the third sector has been encouraged to find private ways to support their activities, the introduction of the UBIT is more than unsettling. The UBIT brings into sharp focus the importance of vigilance in the governance and compliance activities of Not-for-profits (NFPs), and in attending to annual and financial reporting obligations.

NFPs are very familiar with the need to maintain compliance, not only with their tax endorsements, but also employment and industrial issues, fundraising, governance and director’s duties, health and safety, and security of information.

Now there is another level of concern about the question of compliance: whether or not income earned on commercial activities is related or unrelated to an organisation’s philanthropic mission, and whether tax is payable on all or part of that income.

UBIT explained

What is the intention of the UBIT?

At first glance, it is a measure which requires that NFPs pay income tax on profits from activities that are not directed toward its altruistic purpose, but rather on profits which are retained for the organisation’s commercial undertaking.

This tax is not intended to affect the use of tax concessions to directly further an NFP’s altruistic purpose. However, the Assistant Treasurer has admitted that the difference between ‘related’ or ‘unrelated’ business activities is not clear.

Defining a NFP’s ‘profit’

In order to understand the UBIT, Treasury has given examples of how the equivalent tax works in the United Kingdom, Canada, the United States, Ireland and South Africa. These regimes have had mixed results. It is notable that New Zealand does not have a UBIT.

At this stage, Treasury does not have a settled view on how to define the nature of activities which could be conceivably said to ‘further’ a NFP’s altruistic purpose. It has issued a discussion paper, in which the first question is defining the scope of ‘related business’, ‘unrelated business’, ‘primary purpose’ and ‘non-primary purpose’ tests.

Commercial activities

It is likely that disability organisations that conduct commercial activities, which employ people they support, will not be affected. Small-scale or low risk activities such as lamington drive fundraisers and school fates will be excluded.

However, it is uncertain as to how it will affect many of the larger NFPs which engage in commercial activities to subsidise their philanthropic activities.

Treasury’s discussion paper has given rise to the question of whether NFPs will have to restructure. This was an early concern of many in the hospital and health care sector.

The discussion paper indicates that Treasury prefers any NFP’s commercial activities be undertaken through a separate entity such as a subsidiary or a trust. These entities could then be treated equivalently to other commercial entities, and as such would incur a tax on those profits which are considered ‘commercial’, that is, on those which are not redirected into the NFP for altruistic purposes. Fringe Benefit Tax concessions would not apply to these commercial entities.

Profits might be applied by way of franked dividends (if the parent company is a charity or DGR), by way of tax-deductible donations (if no commercial benefits flow) or by way of trust distribution (provided that such income is applied to the altruistic purpose). Franking credits are generally not available to non-charities such as sports clubs or industry groups that might enjoy income tax exempt status.

Implementation phase

The key date for the imposition of the UBIT was 10 May 2011. Tax concessions will not apply to new unrelated activities from that time. Treasury advises that it will phase out those tax concessions which apply to unrelated commercial activities operating prior to 10 May. This transition period allows for affected NFPs to restructure.

It will be particularly difficult to judge whether the expansion or change of existing activities will cause them to be treated as ‘new activities’, which would not be income tax exempt.

Entities that currently have government service delivery contracts are confused as to Treasury’s intention regarding the status of those contracts beyond the transition period.

What is your status?

What is clear, is that NFPs must form a view as to their status, and the status of their commercial activities, and whether they are ‘related’. Some may have to restructure themselves in order to meet the new tests that the UBIT may bring.