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.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Principal Issues: Summary of jurisprudence on NPOs
Position TAKEN: N/A
Reasons FOR POSITION TAKEN: N/A
August 19, 2002
Excise and GST/HST Income Tax Rulings
Rulings Directorate Directorate
Corporate Financing Section
Attn: Pierre Bertrand G. Moore
Director 957-2747
Public Service Bodies and Governments
2002-015388
Non-Profit Organizations (NPOs)
As requested during our meeting (Moore/Bertrand) of July 18, 2002, we have provided some comments as well as a summary of income tax jurisprudence relating to non-profit organizations. We note that you were interested particularly in cases involving commercial activity undertaken by NPOs and accumulated surpluses and we have organized the court decisions accordingly.
As you know, in general terms, paragraph 149(1)(l) of the Income Tax Act provides that the taxable income of an association is exempt from tax under Part I of the Act for a period throughout which the association complies with all of the following conditions: it is not a charity; it is organized exclusively for social welfare, civic improvement, pleasure, recreation or any other purpose except profit; it is in fact operated exclusively for the same purpose for which it was organized or for any of the other purposes mentioned above; and it does not distribute or otherwise make available for the personal benefit of a member any of its income unless the member is an association which has as its primary purpose and function the promotion of amateur athletics in Canada.
Whether a particular association meets all of the above conditions and qualifies under paragraph 149(1)(l) as a tax-exempt NPO is a question of fact that can only be determined after the purposes and activities of the association are reviewed. Also, even though an association qualifies under paragraph 149(1)(l), it may be subject to tax on certain income under subsection 149(5).
Summary of Jurisprudence Relating to NPOs
Commercial Activity Undertaken by an NPO
Paragraph 149(1)(l) contemplates that an organization may carry on income generating activities and earn income and still qualify for exempt status provided that there is a causal relationship between the profit making activity and the exempt purpose of the organization. That is, the income generating activity cannot be the principal activity of the corporation and must be carried on, and the resulting income must be used, by the corporation to achieve its declared exempt objectives. It is a question of fact whether such a relationship exists.
Our understanding of the jurisprudence is that corporations may derive income from a taxable subsidiary, if the deriving of that income is ancillary to its non-profit objectives and the income in expended wholly in accordance with those objectives. However, where a corporation's sole objective is to fund specified activities and not carry on such activities directly we believe the better view is that it is a for-profit entity. It is also our view that an organization may directly engage only in funding activities; however, it can carry out other activities that are in furtherance of its other objectives indirectly through a wholly-owned subsidiary.
Where an organization that otherwise qualifies as a non-profit organization proposes to engage in an unrelated profit making enterprise, it is our view that, if the organization were to carry out this unrelated activity in a taxable, wholly-owned corporation and this corporation were to pay dividends out of its after-tax profits to the organization to enable the organization to carry out its non-profit activities, the organization may qualify as a non-profit organization as set-out in paragraph 149(1)(l) of the Act.
We refer you to the case of Gull Bay Development Corporation v. Her Majesty the Queen (84 DTC 6040). In the Gull Bay case, an organization which ran a logging operation on an Indian reserve was a "charitable organization" and not a commercial enterprise because its objectives were to raise funds for charitable activities. The Court held that the corporation was organized and operated exclusively for social welfare purposes, although the corporation also carried on a logging operation. In that case, the corporation was incorporated, inter alia, to promote the economic and social welfare of persons of native origin; it was not set up to carry on commercial activities even though it was engaged in a commercial activity. The profits from the logging operations were used by the corporation in social welfare activities carried on by the corporation. In addition, the social welfare activities were not a cloak to avoid payment of taxation on a commercial enterprise but were the real objectives of the corporation.
In the Canadian Bar Insurance Association v. The Queen, (T.C.C.) 99 DTC 653, the primary issue was whether the taxpayer was organized and operated for purposes other than profit. The taxpayer argued that there is no restriction on the range of permitted purposes which would entitle it to rely on the exemption so long as earning a profit was not one of those purposes. The taxpayer also acknowledged that its particular activity is in an area populated by commercial enterprises (i.e. insurance companies) but that this fact does not disqualify it from the exemption if its purpose was not profit making. The taxpayer's Letters Patent, general by-laws and its profit and loss results supported its claim that it was a non-profit organization exempt from tax. The court found that the taxpayer's high level of commercial activity and large stabilization reserve did not prove that the taxpayer was being operated for profit.
In Montreal Milk Producers Co-operative Agricultural Ass'n v. M.N.R., (Ex. Ct.) 58 DTC 1010, affirming (T.A.B.) 55 DTC 22, the taxpayer aided in the marketing of its members' milk and processed their surplus milk into milk products in a plant they owned. The taxpayer indicated that its activities in helping its members market milk products had no profit motive. The court found that the profits of the association were taxable since any profits were those of the association and not the profits of its members.
In Tourbec (1979) Inc. v. M.N.R., 88 DTC 1442, the corporation carried on a travel agency business and 75% of its sales were to the general public. The corporation contended that it used its revenues generated by its regular travel business to subsidize the travel of youths and was not a non-profit organization. The court found that the taxpayer's sole purpose was not social welfare, civic improvement, pleasure or recreation or any other purpose except profit.
In Gulf Log Salvage Co-operative Association v. M.N.R., (T.A.B.) 60 DTC 239, the association was organized to carry on a station for salvaged logs and return them to their owners and to provide these services at cost. The association had no power to pay dividends to its shareholders. The court held that it was a non-profit organization since revenue was generated on a cost-recovery basis.
In M.N.R. v. Bégin, (Ex. Ct.) 62 DTC 1099, affirming (T.A.B.) 60 DTC 257, a partnership was formed to sell beer and the partnership agreement provided that all the profits from the sale of the beer would be distributed for purposes of social welfare, charity, education and civic improvement. The partnership agreement also provided that if the partnership agreement were dissolved, all of the remaining assets would be distributed for charitable purposes. The court held that the partnership was operated as a non-profit organization.
In Forest Lawn Cemetery Co. v. M.N.R., (T.A.B.) 52 DTC 84, the taxpayer was a company incorporated under the British Columbia Cemetery Companies Act to establish and maintain a public cemetery. Two other companies were responsible for the development of the cemetery in return for a share of the proceeds. Although a profit was shown, this was not and could not be distributed to shareholders by virtue of the provincial Act. It was held that the company was a non-profit organization operating solely for civic improvement.
In Cumba Co-operative Health Services v. M.N.R., (T.A.B.) 52 DTC 253, an incorporated company provided prepaid hospital and medical services to its members and their dependents. The member paid an annual fee and in return the company agreed to pay the member's medical bills. Only members were entitled to receive this benefit and an individual had to apply to become a member before being entitled to coverage for their medical or hospital bills. The contract between the member and the company provided that any monies regarding the member's medical or hospital bills were to be paid directly to the hospital and not to the member. Each year the company set aside money in a reserve for future claims. Any balance of money left over after the payment of operating expenses, medical bills and the reserve was returned to the members in proportion to their contributions to the company. Members had to pay a yearly fee in order to ensure their contract with the company was renewed. The company was not licensed to carry on the business of insurance and provincial authorities did not consider that the company was carrying on that business. The court found that no profit was received by the members and any monies they received from the company was a return of contributions and not income. The company was held to be a non-profit organization and exempt from tax.
In Gatineau Golf Assoc. Inc. v. M.N.R., (T.A.B.) 67 DTC 435, the objects of the golf Association showed that it was to acquire or rent a golf course for a golf club. The Association rented a golf course from a golf club. Members' fees and green fees collected were used by the Association to pay the rent to the golf club, leaving only a minimal balance each year. In exchange the club provided the golf course and equipment. It was held that the club and the association were independent of each other, the former was a commercial, the latter a self-operating non-profit enterprise.
Accumulated Surplus
In assessing whether a corporation is being operated on a for-profit basis, in addition to looking at the nature of the activities being carried on, we will consider whether the corporation is earning income in excess of its expenditures. The realization of a profit in any particular year is not necessarily indicative of a for-profit motive, however, if a material part of the excess is accumulated each year and the balance of accumulated excess at any time is greater than the corporation's reasonable needs to carry on its non-profit activities, profit will be considered to be one of the purposes for which the corporation is operated. This will be particularly so where assets representing the accumulated excess are used for purposes unrelated to its objects such as the enlarging or expanding of facilities used for normal commercial operations, making of loans to members, shareholders or non-exempt persons, or investing in long-term assets for the purposes of earning property income. Where the facts of a situation indicate that the purposes for which a corporation are operated are two-fold: to earn profits and to carry out its non-profit purposes, it is our view that the test that the organization be operated exclusively for a purpose other than profit will not be met.
We recognize that many organizations will undertake activities, including the purchase of investments (term deposits, for example), which are undertaken specifically to generate a profit, and that this will not necessarily cause the entity to cease to be exempt under paragraph 149(1)(l). It is situations where the organization devotes an unreasonable amount of its resources or energies to the investment activities, that would cause the organization to lose its tax exempt status under paragraph 149(1)(l). This is because the income generating activity would no longer be simply a means of funding the non-profit activities of the organization (i.e. a means to an end), but rather that the earning of income, in an of itself, has become one of the objectives of the organization.
In L.I.U.N.A Local 527 Members' Training Trust Fund - T.C.C. - 92 DTC 2365, its sole purpose, as stated in the trust agreement, was in the training of the members of the union. The Minister's position was that substantial cash reserves had been built up in the years under appeal and the income generated from those reserves is evidence that the fund had ceased to carry out its original non-profit object. The court found that the evidence in the case does not support the view that the fund had abandoned its original purpose of training members of the union. The funds were put in short term investments such as treasury bills and term deposits and no particular attempt was made to maximize profits. The court conceded that the fund had grown substantially and significant amounts of income were earned yet the fund was operated in the same manner as it had always been operated. The court also commented that the fund was a victim of its own success and that the fund did not have any control over the factors which led to its success. The fund could not stop the flow of funds from employers nor could it have responsibly failed to invest the excess cash in short term investments. In short, there was no evidence that the purpose for which the fund was operated was to earn a profit as opposed to carrying out the objects for which the fund was set up. The court made the following statement:
"For an organization to be operated for the purpose of earning a profit so as to disqualify it for the exemption under paragraph 149(1)(l) it would be necessary that it do more than merely earn passive investment income. The earning of such income would need to be both an operating motivation of the fund and a focus of its activity. The evidence does not support this conclusion. On the evidence, the earning of the interest income was not the purpose - primary or secondary - for which the fund was operated. The earning of interest was simply an incident of the only purpose for which the fund was operated, the training of the members of the union; it was a means to an end and not an end in itself."
In the case of Les Services de Santé du Québec v. M.N.R., (T.A.B.) 53 DTC 278, the taxpayer was a cooperative society which provided medical, surgical and hospital services to its members. The interest on bonds and on deposits was held to be taxable.
Organization and Operation of an NPO
As to whether an association may be considered to be organized and operated for non-profit purposes, paragraph 6 of Interpretation Bulletin IT-496R provides the following guidance:
An association may be considered to be organized and operated for any other purpose except profit if its aims and activities are directed toward the general improvement of conditions within one or more areas of business. An example of this would be where an association was organized to advance the educational standards within a particular industry or profession, to publicize, improve and promote the association's objectives in a general way and to encourage the exchange of relevant technical information. If the activities of such an organization were consistent with these aims, then it would qualify for exemption provided all other conditions of paragraph 149(1)(l) were complied with in the year."
The carrying on of for-profit activities does not necessarily preclude a corporation from being an NPO. What is critical is whether or not a corporation is organized or operated with the objective of earning a profit. Three cases in particular illustrate this principle: Gull Bay Development Corporation, 84 DTC 6040; Woodward Pension Society, 62 DTC 1002 (S.C.C.); and, Tourbec (1979) Inc., 88 DTC 1442. Taken together, these decisions establish that for-profit activities may be carried out by an NPO only if they are strictly ancillary to a not-for-profit purpose. If the earning of profit is itself an objective of the corporation, it is not an NPO. If the corporation in fact earns profits, they must be wholly expended in accordance with the organization's non-profit purposes.
In Woodward's, the company at issue was incorporated by a group of affiliates operating stores in various cities. No part of the company's property was payable to or otherwise available for the personal benefit of any proprietor, member or shareholder under its organizing documents. The company's object was to assist in providing pension funds to the employees of those affiliates. To raise these funds, the company acquired shares from the affiliates and sold them to the employees on an installment basis, the interest from which raised a surplus which was, in turn made available to the pension trustees. In assessing the company's status, the Supreme Court noted that the stated object and purpose of the organization, of assisting in the provision of funds for pension to be paid to employees and ex-employees, "could not be achieved without the share sale plan which was designed to make a profit to enable the payments to be made to the pension trustees", and concluded that the company was organized and operated for the purpose of profit.
In Gull Bay Development Corporation, a corporation created to further the social and economic development of the Gull Bay Indian reserve carried on a for-profit logging operation in competition with private-sector entities and dedicated 100% of the profits realized to the not-for-profit objectives of the corporation. The court found that the corporation was an NPO within the meaning of paragraph 149(1)(l) notwithstanding its for-profit business activities. This case appears to have interpreted as standing for the proposition that the carrying on of a trade or business does not mean that an association is being operated for any purpose other than profit where the income from the trade or business is used in furtherance of the non-profit purposes. Yet, if one examines the court's reasons in that case, it can be seen that it is consistent with the decisions in Woodward's and Tourbec in that it confirms that an organization must have a not-for-profit purpose if it is to be a NPO under paragraph 149(1)(l).
In Gull Bay Development Corporation, the court noted that "non-profit purposes" does not necessarily mean that no profits would result from carrying the purposes out, but simply that the purposes are to be carried out without the intention of making profits. On the facts, the court found that the Gull Bay Development Corporation was not organized for the purpose of earning a profit.
In Tourbec, the company was a travel agency business that used its general profits to subsidize the travel of "young people". The Tax Court seemed primarily persuaded by the fact that the company's "philanthropic purpose or object could not have been achieved unless it had carried on its business which was a commercial operation for profit". It also noted that "the philanthropic aspect of its operations was only incidental to its primary purpose which was to carry on a travel agency. That incidental aspect could not have been achieved unless it had been able to make profits from its primary business".
The mere fact that a corporation has a governing statute respecting charitable or non-profit entities is not sufficient to find that a corporation is a NPO. For example, in Tourbec, the court stated:
"The fact that the appellant was incorporated under Part III of the Companies Act, that is, under the provisions governing the incorporation of non-profit companies, is not the criterion that establishes whether it is in fact a non-profit organization within the meaning of paragraph 149(1)(l)."
In Sutton Lumber and Trading Co. Ltd. v. MNR, 53 DTC 1158, the Supreme Court of Canada stated, at page 1161, the following:
"The question to be decided is not as to what business or trade the company might have carried on under its memorandum, but rather what was in truth the business it did engage in. To determine this, it is necessary to examine the facts with care."
In the court case of the Edmonton Badminton Club Ltd. v. M.N.R., (T.A.B.) 55 DTC 252, a recreation club that had been accepted by the taxing authorities for more than twenty years as a non-profit organization was reassessed for the prior five years on the grounds that it was not a non-profit organization. Since it was not shown that the club's activities had changed in any of the years under the reassessment or that any portion of the club's income or any other benefits from it ever went to the members, the reassessment was vacated.
In the case of Edmonton District Milk and Cream Producers Ass'n Ltd. v. M.N.R., (T.A.B.) 53 DTC 282, the taxpayer, an NPO, had wide powers but acted as a service organization. Its profits, less 10%, were added each year to members' shares, pro rata. The 10% withheld from profits was to go to a reserve fund distributable to existing members upon dissolution. In light of the judgment of Stanley Mutual Fire Insurance Company c. M.N.R., 53 DTC 1119, the fact that the taxpayer had wide powers did not necessarily mean it was not an NPO. It was not so much what it would do but what it actually did that counts. In other words, the court found that it is not the business that a taxpayer professes to carry on, but that which he actually carries on which determines whether or not the taxpayer is a non-profit organization.
Subsection 149(5)
Generally, a non-profit organization is exempt from Part I tax by virtue of paragraph 149(1)(l) of the Act. Subsection 149(5) of the Act overrides this exemption and results in the taxation of the income from property and the taxable capital gains of a non-profit organization that has as its main purpose the provision of dining, recreational or sporting facilities for its members. However, any business income that such a non-profit organization may realize from carrying on its various activities is not included in computing its income for purposes of subsection 149(5). Furthermore, subparagraph 149(5)(e)(ii) of the Act provides an exception from the inclusion in income of the taxable capital gain of a non-profit organization for a property that was used exclusively for, and directly in the course of, providing the dining, recreational or sporting facilities for its members.
In the case of Elm Ridge Country Club Inc. v. The Queen, (F.C.A.) 98 DTC 6672, affirming (T.C.C.) 95 DTC 715, the corporate taxpayer was a NPO and a private club whose main activities included the provision of golf to its members. The taxpayer argued that interest earned on its short term deposits and on a small bond were tax exempt as they were part of its operating income and that its investment activities were not part of a separate business. The Minister treated the taxpayer's short term deposit interest as income from property and therefore taxable.
In the case of Point Grey Golf & Country Club v. The Queen, (F.C.A.) 2000 DTC 6217, affirming (T.C.C.) 97 DTC 854, the corporate taxpayer was an NPO operating a golf club. Funds were raised for a new clubhouse and these funds were invested in money market securities. The court held that the interest had not been earned in a separate investment business by the taxpayer and was therefore income from property (and subject to tax).
In the court case of Manitoba Curling Assoc. Inc. v. M.N.R., (T.C.C.) 84 DTC 1462, the taxpayer, an association of curling clubs, was held not to have a main purpose of providing sporting facilities since it was an umbrella organization which promoted curling and organized special events without owning any buildings.
Distribution of Income to Members (Including Distribution on Wind-up)
In L.I.U.N.A. Local 527 Members' Training Fund v. M.N.R., the court examined the issue of availability of the funds' income to the members. In an agreement, the trustees were authorized upon termination of the trust to distribute any remaining surplus in such manner as they saw fit. Such a distribution would be a distribution of capital except to the extent of the income earned in the year of distribution. The court held that this power held by the trustees did not entitle the members to be paid any portion of the income in the year in which it was earned unless and until such a determination is made to wind the fund up and pay any remaining surplus, including the income earned in the year, to the members:
"Where the trust document does not specifically permit the trustees to pay income to the members it is not until a determination is made on winding up to pay a portion of the income to the members that any part thereof becomes payable to or available for the personal benefit of a member. It is the year in which that is done that the exemption is lost."
In St. Catharines Flying Training School Ltd. v. M.N.R., (S.C.C.) 55 DTC 1145, reversing (Ex. Ct.) 53 DTC 1232, the taxpayer was a private incorporated company whose object was to give elementary training in flying in conjunction with the British Commonwealth Air Training Plan. Its charter contained a provision which did not allow the declaration of dividends. The court found that having a non-profitable purpose did not mean that no profit would ever result but that the purposes of the corporation were to be carried out without the intention of making a profit. The court also held that the taxpayer could not distribute profits and was not in the business of conducting a flying school for profit even if it did make profits.
In the case of Moose Jaw Flying Club Ltd. v. M.N.R., (Ex. Ct.) 49 DTC 655, the taxpayer operated a flying club and had amended its articles to prohibit the payment of dividends. In its returns for 1940 and 1941 it claimed and was granted an exemption as a non-profit organization. Subsequently, the club went into voluntary liquidation, its assets being distributed to its shareholders at the rate of $31 per $10 share. The Minister's assessment for tax for years prior to liquidation was upheld on the ground that the club's objects were not for civic improvement, recreation, or any other exempt purposes and that tax liability did not attach to the shareholders alone.
In Moose Jaw Industrialization Fund Committee v. M.N.R., (T.A.B.) 51 DTC 325, the City of Moose Jaw sold its electricity plant and gave the proceeds on the sale to the taxpayer which was incorporated for the purpose of encouraging the establishment of new industries in the City of Moose Jaw. The court held that the taxpayer, a company working for the advancement of a city by encouraging the establishment of new industries, was operating solely for civic improvement where no profits accrued to members. The problem of what would happen to surplus on winding up was not to be contemplated in determining whether a company was a non-profit organization.
In M.N.R. v. Lakeview Club Ltd., (Ex. Ct.) 52 DTC 1164, reversing (T.A.B.) 51 DTC 415, after the incorporation of the taxpayer, it immediately acquired the assets of The Lakeview Golf Club from 5 individuals all of whom who became directors of the company. Membership in the golf club was acquired by the payment of membership fees but members were not required to own or purchase shares of the company. The golf club had the power to declare dividends but never did so, and it used its earned surpluses to make repairs or improvements or supply necessary equipment required by the club in its operation. The court held that the company was a profit-making organization since its by-laws permitted the payments of dividends to shareholders.
We trust these comments will be of assistance. If you have any questions, please contact Gwen Moore at 957-2747.
Steve Tevlin
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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