27 February 2015 the Australian Taxation Office (ATO) issued tax ruling 2015/1. It interprets two of the special conditions that certain income tax exempt entities must satisfy to remain income tax exempt. The two special conditions are contained in Section 50.50(2) of the Income Tax Assessment Act 1997 (ITAA) and state:
- The entity must comply with all the substantive requirements of its governing rules (governing rules condition).
- The entity must apply its income and assets solely for the purpose for which the entity is established (income and assets condition).
Governing Rules Condition
The tax ruling identifies the distinction between "substantive requirements" and "procedural requirements". The former deal with rights and duties of the entity; procedural rules deal with how rights and duties are applied and enforced. Substantive requirements express the object or purpose of the entity, include its not-for-profit clauses and its winding up provision and the requirement that it keep financial records.
The substantive provisions are usually found in an entity's constitution but if there is legislation applying to the entity or by-laws or regulations with statutory force, those provisions may also be considered substantive. A peak body or central authority may also impose overriding governing rules on a group of entities that belong to that body. For example, the ruling notes that the religious law of a church may be its only source of governing rules.
Income and Assets Condition
The tax ruling identifies two questions:
- what are the purposes for which the entity is established; and
- has the entity applied its income and assets solely for that purpose.
Purposes are defined from the constituent documents but activities must also support those purposes. Under the Australian Charities and Not-for-profits Commission Act 2012 the ACNC will always measure charitable eligibility of an organisation not only from the express statement of objects in its constitution but also from extraneous material, for example, websites, publications, media statements, marketing activities, word of mouth, to ascertain whether the activities reflect the purposes.
When does "solely" mean solely?
Accumulation of profit is allowed by the ruling; a one-off misapplication of part of the income or assets would be allowed, or if the misapplied amount was immaterial.
What about "expenditure ancillary" to the main purposes?
The ruling allows the entity to engage in "incidental or ancillary purposes" if they "tend to assist or naturally go with the achievement of the main purpose". So application of income and assets to an ancillary or incidental purpose would be permitted.
When must the test be applied?
The test would apply for a full financial year. For any part of a financial year that an entity does not satisfy the test its income loses exemption.
The ruling applies to income commencing both before and after its date of issue.
Is a failure to obtain approval for a large item of expenditure breach of a substantive requirement?The ruling cites some examples:
Example 1 – An incorporated associations constitution requires expenditure over $25,000 be approved by the national committee. An employee approves a larger expenditure. The amount is applied towards the association's objects. This is a procedural requirement so would not be a breach of the special condition.
Does profit from a commercial activity breach the income tax and assets condition?
Example 2 - A religious group pursues religious objectives. It also runs an opportunity shop and leases commercial premises, employs a part-time manager and a driver. The op shop retains some profit to meet expenditures for the following year but all other profit is applied to the religious group's objects. This is not in breach of the income or assets test.
When does "solely" mean solely?
Accumulation of profit is allowed by the ruling; a one-off misapplication of part of the income or assets would be allowed, or if the misapplied amount was immaterial.
What about "expenditure ancillary" to the main purposes?
The ruling allows the entity to engage in "incidental or ancillary purposes" if they "tend to assist or naturally go with the achievement of the main purpose". So application of income and assets to an ancillary or incidental purpose would be permitted.
When must the test be applied?
The test would apply for a full financial year. For any part of a financial year that an entity does not satisfy the test its income loses exemption.
The ruling applies to income commencing both before and after its date of issue.
Is a failure to obtain approval for a large item of expenditure breach of a substantive requirement?
The ruling cites some examples:
Example 1 – An incorporated associations constitution requires expenditure over $25,000 be approved by the national committee. An employee approves a larger expenditure. The amount is applied towards the association's objects. This is a procedural requirement so would not be a breach of the special condition.
Does profit from a commercial activity breach the income tax and assets condition?
Example 2 - A religious group pursues religious objectives. It also runs an opportunity shop and leases commercial premises, employs a part-time manager and a driver. The op shop retains some profit to meet expenditures for the following year but all other profit is applied to the religious group's objects. This is not in breach of the income or assets test.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
