12 March 2012 Internal T.I. 2011-0404671I7 - Paragraph 149(1)(l)

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Did the Corporation qualify for the tax exemption provided by paragraph 149(1)(l) for the taxation years under review?

Position: Likely, no

Reasons: It appears that the Corporation was not operated exclusively for a purpose other than profit.

March 12, 2012

Compliance Programs Branch HEADQUARTERS
Specialty Audits Section Income Tax Rulings
Attention: Rubin Dressler Directorate
L. Zannese
(613) 957-2747

2011-040467

XXXXXXXXXX
(the “Corporation”)

We are writing in response to your request for our views as to whether the Corporation qualified for a tax exemption pursuant to paragraph 149(1)(l) of the Income Tax Act (the “Act”) for the XXXXXXXXXX and XXXXXXXXXX taxation years. In particular, you asked whether the large retained earnings held by the Corporation along with the amount of interest income earned from investments resulted in the Corporation failing to meet the requirements of this tax exemption. You also referred to concerns regarding a large bonus paid out to members of the Corporation in XXXXXXXXXX .

FACTS

Based on the information you provided to us, our understanding of the facts is as follows:

XXXXXXXXXX .

• Generally, the Corporation provides XXXXXXXXXX services to the XXXXXXXXXX businesses. The range of XXXXXXXXXX services provided by the Corporation has expanded significantly since it was established (for example, XXXXXXXXXX ).
• The Corporation has different ranks for its employees: XXXXXXXXXX .
• An individual is qualified to be employed as a XXXXXXXXXX by the Corporation if the individual:
  • XXXXXXXXXX
• The members of the Corporation are the XXXXXXXXXX employees.
• When providing XXXXXXXXXX services to the XXXXXXXXXX , XXXXXXXXXX % of the hours worked must be by employees who are either former members of XXXXXXXXXX or former XXXXXXXXXX employees. The charge for these services is based on the XXXXXXXXXX standing offer.
• The Corporation generally charges its business customers the same rate that it charges the XXXXXXXXXX for its services.
• The XXXXXXXXXX have the right of first refusal with the XXXXXXXXXX on any contract.
• According to its financial statements, the Corporation had unrestricted retained earnings of $XXXXXXXXXX and $XXXXXXXXXX .
• The Corporation has recorded the following amounts of net income:

Taxation Year Reported Net Income
XXXXXXXXXX $XXXXXXXXXX

• The XXXXXXXXXX net income earned in XXXXXXXXXX resulted from billing clients at a rate higher than that approved by the XXXXXXXXXX officer. The Corporation did not realize that a lower rate was in effect until after clients had been billed.
• The Corporation’s business plan for XXXXXXXXXX indicates that the Corporation intends to expand its services into “high margin” business lines.
• The Corporation appears to have established as a financial goal a net profit of $XXXXXXXXXX per year.
• The Corporation’s income is earned exclusively from third parties.
• The Corporation’s net income depends significantly on the amounts paid to member-employees as salaries and bonuses.
• The Corporation’s main objective continues to be to provide employment to its members. We understand that as part of meeting this objective, the Corporation seeks to expand its business in order to provide higher salaries and bonuses to its member-employees (XXXXXXXXXX ).

OUR COMMENTS

In general terms, paragraph 149(1)(l) of the Act provides that the taxable income of an organization is exempt from tax under Part I of the Act for a period throughout which the organization meets all of the following conditions:

• it is a club, society or association;
• it is not a charity;
• it is organized and operated exclusively for social welfare, civic improvement, pleasure, recreation or any other purpose except profit; and
• its income is not available for the personal benefit of a member or shareholder.

Based on the facts provided, there is little or nothing to distinguish the Corporation from a for-profit XXXXXXXXXX business, and we understand that it competes directly in this market. The regular and consistent increase in retained earnings supports the view that the Corporation has operated for a profit purpose. The net income, while not large in comparison to gross revenues, has been consistently accumulated and used to expand the business of the Corporation or to acquire investments. The fact that all of the income of the Corporation is derived from third parties is of particular concern in this regard. The objective of maximizing revenues in order to pay higher salaries and bonuses to member-employees indicates a profit purpose. Finally, we share your concern that at least some part of the reserves have been accumulated for the purpose of generating investment income.

In conclusion, we agree with you that the Corporation did not qualify for the tax exemption provided by paragraph 149(1)(l) of the Act for the taxation years under review.

Please contact us if we may be of any further assistance.

Yours truly,

Eliza Erskine
Manager
Non-Profit Organizations and
Aboriginal Issues
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch