Tonight’s budget is expected to tighten a tax loophole for charities which run businesses unrelated to their charitable work. The government thinks it will increase revenue for Australia’s coffers. It won’t. It will simply line the pockets of lawyers and tax consultants.
The Hillsong church, which has links to the Gloria Jean’s coffee shop franchise, and the Seventh Day Adventist Church with its cereal company, Sanitarium, have been highlighted as possible organisations which would be caught by the new laws.
Ministers are acting after being lobbied by various sources, but in particular the Australian Tax Office. The idea is that the change will increase tax revenue, remove any uncompetitive advantage that charities with business links have, and changes will bring Australia in line with international practice.
But international experience suggests that taxing not-for-profit business income does not result in any increase in the tax take. Australia can’t expect to be any different.
The US experience
In the US in 1950 Congress enacted the Unrelated Business Income Tax (UBIT) which imposes a tax on the unrelated business activities carried on by not-for-profits. It denied exemption to “feeder organisations” operated for the primary purpose of carrying on a trade or business to pass profits to a not-for-profit.
Congress’ intention was to prevent exempt organisations from competing unfairly with for-profit firms and to protect the federal tax base.
So if any not-for-profit group makes money from an activity unrelated to the purpose for which it was granted the tax exemption, it is required to pay taxes on that income.
But near zero taxable income was reported by US not-for-profit organisations in the last ten financial years.
How can this be? There’s a widespread practice among not-for-profits to shift the expenses of mission-related activities to their commercial subsidiary’s books, not to mention a flurry of clever accounting practices, and much dancing on a pinhead about what constitutes a related purpose to the charity.
In particular, US universities have argued that for income to be taxable it must be earned in the process of a trade or business that is regularly carried on, a case that they argue does not apply to managing income from debt-financed investments.
The UBIT has, in effect, become a voluntary tax.
The UK experience
In Britain, there’s been an explosion in the number of charity shops in the last 20 years. They are profitable and a legal way to transfer money back to the parent charity.
Not-for-profits are using the Gift Aid scheme to significantly reduce their taxable income. It allows them to convert all the profits of their separate taxable subsidiaries to the not-for-profit parent.
So, as in Australia the tax system emphasises the destination of income rather than the source.
What it means for Australia
Not-for-profits have come to embrace the idea of participating in the market to maximise revenue. They have been involved in commercial businesses for a long time.
But if international experience is anything to go by, the proposed changes are unlikely to raise much revenue for the government.
Yet is likely to increase confusion among not-for-profits as they operate under a vague fear that commercial operations imperil their tax-exempt status.
The additional reporting to the ATO and not-for-profits’ need for advice from tax and legal consultants is likely to increase administrative and compliance costs.
This might well be a boon for the legal and tax consultancy industry but not the charity sector, or Australia’s bank balance.