10 August 2006 Internal T.I. 2006-0194871I7 - NPO status

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: Given a particular bylaw of a specific entity, can it be said that the entity qualifies as an NPO?

Position: No. The entity is not organized in accordance with paragraph 149(1)(l).

Reasons: The bylaw in question authorizes the distribution of surplus earnings to the members. As such, it cannot be said that the entity is organized in accordance with paragraph 149(1)(l).

								August 10, 2006

HEADQUARTERS						HEADQUARTERS
Appeals Branch						Income Tax Rulings
Tax and Charities Appeals Directorate		  Directorate
								Renée Shields
	Attention:  Don Beamish				(613) 948-5273

								2006-019487

XXXXXXXXXX

This is in response to your memorandum of June 29, 2006 requesting our views as to whether XXXXXXXXXX qualifies as a non-profit organization ("NPO") for purposes of paragraph 149(1)(l) of the Income Tax Act (the "Act").

To qualify as an NPO, an entity must be both organized and operated in accordance with the requirements of paragraph 149(1)(l) of the Act. From our review of the materials provided, we understand that of particular concern with respect to XXXXXXXXXX is Bylaw 11, which provides as follows:

11(a) Surplus earnings, including surplus funds resulting from contributions to construction and extension pipeline costs, remaining in the hands of the Association at the end of any fiscal year shall be dealt with as follows:

1. By setting aside necessary reserves;

2. By paying if deemed advisable by the directors and at such rate as the directors may decide, interest to the members on their respective contribution to construction and extension line costs.

It is our view that Bylaw 11, and in particular subsection 2 thereof, authorizes a payment of income to the members, thereby violating paragraph 149(1)(l) of the Act.

XXXXXXXXXX representative asserts that to qualify as interest, an amount must be a sum calculated with reference to a sum of money advanced, paid according to a rate and the accrual of time. Since these factors do not exist, his position is that such payments would not qualify as "interest". He further asserts that because interest is an expense to be deducted from earnings in determining income, a payment of interest cannot be a payment from surplus earnings. In his view, Bylaw 11 sets up an impossibility and is therefore of no effect.

Generally speaking, we agree with the representative's comments regarding interest. However, we do not believe that these views support dismissing the significance of Bylaw 11 with respect to XXXXXXXXXX NPO status.

The Federal Court of Appeal commented in R. v. Shell Canada Limited, 98 D.T.C. 6177 that, "Something is not interest merely because the parties agree to call it interest." The Income Tax Rulings Directorate has supported this view in several interpretations. For example, and of relevance to this discussion, is the following comment in Document 2000-00153411:

The nomenclature used to describe an amount by the parties to an agreement is not necessarily determinative of its nature. Rather reference to the facts and surrounding circumstances may be made to determine whether an amount paid pursuant to the agreement between parties may more appropriately be classified as something else.

We believe this position has application with respect to Bylaw 11. The preamble to Bylaw 11 indicates that it will address what XXXXXXXXXX may do with surplus earnings at the end of a fiscal year. Calling a payment to members "interest" does not make it interest. It is a label attached to an authorized distribution of surplus earnings.

XXXXXXXXXX representative also asserts that because no payments under Bylaw 11 have been made to members, the issue is moot. He relies on the Tax Court of Canada's decision in L.I.U.N.A. Local 527 Members' Training Trust Fund v. R. We disagree with the representative on this point. L.I.U.N.A. is distinguishable from the situation at hand in that L.I.U.N.A.'s constating documents did not specifically authorize payments to members. In such a situation, the court's "wait and see approach" may be appropriate. However, where constating documents specifically authorize a distribution of income to an entity's members, it is our view that the entity cannot qualify as an NPO. Ruling 2003-0027251R3 is a recent expression of our position on this issue. In the Ruling, an NPO proposed to amend its bylaws to authorize the payment of patronage dividends to members. We ruled that upon passing such a bylaw (as opposed to at the time such a payment was made), the organization would lose its NPO status.

Nor are we persuaded by the representative's assertion that because the legislation is drafted in the past tense, the test is backward-looking and therefore only prohibits an actual distribution as opposed to the possibility of a future distribution. Given that the entire provision is drafted in the past tense, taking this approach would render the "organized" part of the NPO test redundant.

XXXXXXXXXX

We trust that these comments will be of assistance.

Mickey Sarazin, CA
Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch