The Australia Taxation Office has released a Draft Ruling (TR2014/D5 Special Conditions for Various Entities whose Ordinary and Statutory Income is Exempt) for public comment.
This Draft Tax Ruling applies to entities which include registered charities, a classification under which many Australian Indigenous corporations have registered for tax exemption. These entities have been registered as tax exempt under Division 50 of the Income Tax Assessment Act 1997 and in doing so, had to comply with a number of conditions.
The Draft Tax Ruling deals with two of of those conditions, being:-
1. the entity must comply with all of the substantive requirements in its governing rules; and
2. the entity must apply all of its income and assets solely for the purpose for wehich the entity is established.
While the Draft Tax Ruling in part merely confirms our understanding of the legislation, it does clarify a number of matters, including how the Tax Office will view compliance should you be subject to a tax audit.
The first item that is illuminating is that the Draft Tax Ruling views the constitution or Rule Book as the main, but not the only source of "governing rules". It goes on to say that other sources of governing rules may be legislation. Hence the "governing rules" in this tax context for a Native Title Prescribed Body Corporate is possibly wider than its Rulebook as registered with ORIC. Its governing rules may include any parts of the Native Title legislation that effect its incorporation, perhaps even parts of the Native Title Determination if the cause of its incorporation is mentioned, and even possibly any ILUA's which provide rules for the PBC.
The reason this is significant is that the condition that the entity must comply with ALL of the substantive requirements in its governing rules means that what the actual governing rules are, first need to be identified, and then to ensure that the PBC is compliant with all of them continuously throughout the year.
Secondly, the Draft Tax Ruling also makes clear that the entity must continuously throughout the year comply with the condition that it must apply all of its income AND assets solely for the purpose for which the entity is established. The Draft Ruling goes on to say that if at any time in the year the entity changes its purpose (perhaps by changing its Rulebook or changing the terms of an ILUA that may be seen as part of its "governing rules"?) then it must from that time on comsider whether it is applying all of its income and assets solely for its new purpose.
The Draft Tax Ruling provides a number of examples, two of which may be helpful for Aboriginal charitable entities including PBC's. These two matters have been of some concern to Aboriginal organisations in the last couple of years with contradictory commentary being aired. These matters are whether a charity can maintain a commercial operation, and whether a charity can accumulate funds.
Example 8 shows that profits from a commercial activity used to further entity's purpose is not a breach of the sole purpose condition. In this example of a religious charity, the opening, managing and funding of an "Op Shop" is not a breach of the condition that all of the income and assets of the entity be applied solely for its purpose. The example does however show that it does not breach that condition because all profits from the shop are applied solely for the purpose of that charity. We can infer from this that if an Aboriginal organisation's purpose was "the relief of poverty of the Native Title holders" and part of the profits of a commercial activity was to say, fund the construction of a Health Clinic, this may breach the income and assets test unless "caring for the health of the Native Title Holders" was also one of its purposes.
Another example in the Draft Ruling, example 10, shows that accumulation of funds is not necessarily a breach of the income and assets condition either. In this example of a scientific research entity, the entity is said to have received $310,000 in income, applying $210,000 towards meeting the entity's objects. It accumulates $100,000. However it does have a 5-year plan to accumulate enough money to upgrade research facilities and employ another research scientist, and because of this, it is not in breach of the income and assets test. Again one might infer that if the 5-year plan did not exist, or if there was no clear idea for the use of accumulated funds other than for a rainy day, this entity may have breached the condition to apply ALL of its income and assets for its purpose.
This last example does raise an interesting hypothetical. What if part of an entity's assets were used to construct or buy its office premises. The investment decision is clear - it is cheaper to own premises than to continuously pay rents, and it is an asset that can be financially and physically leveraged. However unless there is a clearly documented reason in some sort of plan about why this investment would actually assist the entity achieve its purpose, for example plans to house community activities and such like, or to reduce expenditure that can otherwise be spent on its purpose, it may not be compliant!
This last point shows how complex tax legislation is. Most Aboriginal organisations have been tax exempt "for years" and probably not reviewed their tax exemptions and whether they are technically compliant. With the changes to registering as a charity, the establishment of the ACNC, and various court cases including Commissioner of Taxation v Word Investments Ltd, charities are higher profile and there is a strong possibility that more and more Aboriginal organisations will be visited by "the Tax Man".
Please note that this is general commentary and does not form tax advice. If you believe the contents of this article may apply to your organisation, you will need to seek your own advice from your tax advisor.
To view the Draft Tax Ruling in full go to http://law.ato.gov.au/atolaw/view.htm?docid=DTR/TR2014D5/NAT/ATO/00001
To read about Word Investments go to http://sydney.edu.au/law/slr/slr31/slr31_2/Murray.pdf