5 November 2009 External T.I. 2009-0337311E5 - 149(1)(l) Organizations

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: (i) Can a 149(1)(l) organization earn a profit? (ii) If the profit is intentional but used to fund the activities of the organization will the organization qualify for the 149(1)(l) exemption from tax? (iii) Can a 149(1)(l) organization engage in commercial activities? (iv) Does the CRA maintain a list of organizations that qualify for the exemption provided by 149(1)(l)?

Position: (i) Yes, but only if incidental and generally unanticipated. (ii) No (iii) Yes (iv) No

Reasons: (i) To qualify for the exemption an organization cannot be organized or operated with a purpose of earning a profit. (ii) It does not matter what the profit is used for, a 149(1)(l) organization cannot have any profit earning purpose. (iii) Paragraph 149(1)(l) does not restrict an organization to any particular activities, other than requiring activities not to be undertaken for profit. (iv) The CRA does not maintain a list of 149(1)(l) organizations as these organizations are not required to register with CRA.

XXXXXXXXXX 							2009-033731
L. Zannese
(613) 957-2747
November 5, 2009

Dear XXXXXXXXXX :

Re: Tax Exemption-149(1)(l)

We are writing in response to your emails of August 18 and September 17, 2009, in which you asked for our views regarding the tax exemption provided by paragraph 149(1)(l) of the Income Tax Act (the "Act") . We also acknowledge our telephone conversations regarding this issue (Erskine/XXXXXXXXXX ).

Specifically, you have asked the following questions:

(i) Can an organization that qualifies for an exemption from tax under paragraph 149(1)(l) of the Act compete against taxable entities?

(ii) Can an organization earn a profit and continue to be exempt from tax under paragraph 149(1)(l) of the Act? Can an organization intentionally earn a profit, and still be exempt from tax under 149(1)(l), as long as that profit is used solely for the purpose of supporting its objectives?

(iii) Is it possible for an organization to incorporate under Part III of the Ontario Corporations Act, but not qualify for the exemption from tax provided under paragraph 149(1)(l) of the Act?

(iv) Does the Canada Revenue Agency ("CRA") maintain a list of organizations that qualify as non-profit organizations for purposes of provincial legislation, but do not qualify for the tax exemption provided under paragraph 149(1)(l) of the Act?

(v) The recent Tax Court of Canada decision, BBM Canada v. The Queen, 2008 DTC 4129 ("BBM") concluded that an entity described in paragraph 149(1)(l) of the Act may conduct commercial activity but must conduct this activity at cost. If the XXXXXXXXXX provided a commercial procurement contract to an organization, and the organization generated a profit from this activity, would the organization be able to qualify for the tax exemption provided under paragraph 149(1)(l) of the Act?

If the above questions relate to a specific taxpayer and either a completed transaction or an ongoing situation, you should submit all relevant facts and documentation to the appropriate Tax Services Office ("TSO") for their views. A list of TSOs is available on the "Contact Us" page of the CRA website, www.cra-arc.gc.ca. Although we cannot comment on any specific situation, we are prepared to provide the following general comments, which may be of assistance.

Our Comments

(i) Paragraph 149(1)(l) of the Act.

Paragraph 149(1)(l) of the Act provides an exemption from tax for the income of organizations that meet all of the conditions set out in that provision. Among other criteria, the organization is required to be organized and operated for "any other purpose except profit"; consequently, it is common to refer to organizations qualifying for this tax exemption as "non-profit organizations". However, the term "non-profit organization" does not have a specific meaning for income tax purposes-the Act does not define or use the term "non-profit organization". For purposes of this letter we will refer to an organization that qualifies for the tax exemption provided by paragraph 149(1)(l) as a "149(1)(l) entity".

Paragraph 149(1)(l) of the Act provides an exemption from income tax for the income of

"...a club, society or association that, in the opinion of the Minister, was not a charity within the meaning assigned by subsection 149.1(1) and that was organized and operated exclusively for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit, no part of the income of which was payable to, or was otherwise available for the personal benefit of, any proprietor, member or shareholder thereof unless the proprietor, member or shareholder was a club, society or association the primary purpose and function of which was the promotion of amateur athletics in Canada;"

Very generally, then, in order for an organization to be a 149(1)(l) entity, the organization must not be a charity, must be organized and operated for a purpose other than profit, and its income cannot be payable to or made available for the benefit of its members.

You have asked whether an organization can compete against taxable entities and still qualify for the exemption provided by paragraph 149(1)(l) of the Act. The wording of paragraph 149(1)(l) does not restrict an organization from undertaking any particular type of activity, including commercial activity. This issue was most recently reviewed by the courts in BBM, 1 in which the Tax Court of Canada commented:

"While these are very strict and rigid requirements, and potentially permit a very broad review or inquiry into an organization's purposes, the analysis can be considerably abbreviated by the fact that the statutory language does not mandate a qualifying purpose but permits the organization to have any purpose or purposes other than the one disqualifying purpose of profit."

Consequently, an organization can compete against taxable entities and still be exempt from tax under paragraph 149(1)(l) of the Act.

(ii) 149(1)(l) Entity-Earning, Retaining and Using a Profit

You have asked whether a 149(1)(l) entity can earn a profit, and whether the answer to this question depends on how the entity uses this profit. Specifically, you would like to know if a 149(1)(l) entity can intentionally earn a profit as long as the profit is used to support the objectives of the 149(1)(l) entity.

Paragraph 149(1)(l) of the Act requires that an organization be organized and operated "exclusively" for "any other purpose except profit" in order to be exempt from tax under that provision. In our view, the use of the word "exclusively" indicates that while an organization may have many purposes, none of those purposes may be to earn a profit. Thus, where an organization intends, at any time, to earn a profit, it will not be exempt from tax under paragraph 149(1)(l) even if it expects to use or actually uses that profit to support its not-for-profit objectives.

The CRA accepts that a 149(1)(l) entity can earn a profit; otherwise, the tax exemption provided would be unnecessary. Earning a profit, in and of itself, does not prevent an organization from being a 149(1)(l) entity. However, the profit should generally be unanticipated and incidental to the purpose or purposes of the organization. For example, an organization might budget with the intention of not earning a profit, but ultimately find itself with a profit because of expenses that were less than anticipated or that were reasonably expected but not actually incurred. If the original budget was reasonable, the profit earned would not, in and of itself, cause the organization to cease to be a 149(1)(l) entity.

The Supreme Court of Canada commented on the issue of a purported 149(1)(l) entity earning a profit in Woodward's Pension Funds v. The Queen, 62 DTC 1002 ("Woodward's"):

"... it is true that ... the appellant was organized for the stated object and purpose of assisting in the provision of funds for pensions to be paid to employees and ex-employees of the stores. Nevertheless, this last-named purpose 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. ... The appellant has entirely failed to establish that it was organized and operated exclusively for a purpose other than profit and the findings of the learned President that it was both organized and operated for a profitable purpose are unassailable."

The Tax Court of Canada followed the Woodward's decision in Tourbec (1979) Inc. v. M.N.R, 88 DTC 1442 ("Tourbec"). Tourbec involved an organization that sponsored travel for young people through the operation of a travel agency. On the issue of whether the organization operated for a purpose other than profit the court found:

"What effectively happened was that Tourbec used the revenues that it received from its regular sales, that is the sales to the general public, to subsidize to a certain extent certain services that were reserved exclusively to its customers who were students and young people."

...

"Given the facts, I cannot accept the appellant's submissions to the effect that it was an organization whose sole purpose was among those referred to in section 149(1)(l) of the Act. The philanthropic aspect of its operations was only incidental to its primary purpose which was to carry on a travel agency business. That incidental aspect could not have been achieved unless it had been able to make profits from its primary business."

While the reference to a "primary purpose" in Tourbec suggests that a secondary, profit-making purpose might be acceptable for a 149(1)(l) entity, we are of the view that the decision in Tourbec means that, for paragraph 149(1)(l) of the Act to apply, an organization's "sole purpose" (or only purposes) must be something other than earning a profit. 2 In our opinion, the decisions in Woodward's and Tourbec support the position that where an organization would be unable to undertake its not-for-profit activities but for its profitable activities, the organization cannot be a 149(1)(l) entity because it has a profit purpose.

We acknowledge that a 149(1)(l) entity may earn a profit as long as that profit is generally unanticipated and incidental to carrying out the entity's exclusively not-for-profit purposes: The Gull Bay Development Corporation v. Her Majesty the Queen, 84 DTC 6040 (FCTD) ("Gull Bay"). In Gull Bay the court found that the corporate entity in question was

"operated "exclusively" for the purpose set out in section 149(1)(l) pursuant to its charter, even though it may raise funds for this purpose by its commercial lumbering enterprise."

We note that the situation reviewed by the court in Gull Bay was very unusual and that the decision of the court turned greatly on the particular facts of that case, especially with respect to the finding that the profits were strictly incidental to the not-for-profit objectives. Also, the decision in Gull Bay must be read in light of the court's view that the corporation might be a "charitable corporation" and in light of subsequent court decisions such as Tourbec and BBM.

It is always a question of fact whether an organization is operating for the purpose of earning a profit. A "profit" is generally considered to be the (positive) difference between an organization's revenue and the expenses incurred to earn that revenue: see the review of the meaning of "profit" in BBM. We are of the view that in determining the expenses incurred by an organization to earn revenue, it is appropriate to take into account depreciation of capital assets as well as ongoing current expenses. However, it is not appropriate to take into account the anticipated cost of future capital projects, because that cost cannot, by its nature, be an expense incurred to earn the current revenue. Thus, in considering whether an entity has a profit purpose, regard must be had to whether the entity is intentionally generating profit in order to finance future capital projects.

In our view, if a 149(1)(l) entity could intentionally earn a profit to finance future capital projects on the basis that this constituted operating at cost and therefore did not indicate a profit purpose, then any business where the members did not require income distributions could be organized and operated as a 149(1)(l) entity and accumulate wealth on a tax-free basis. In this situation, while members could not access the business' income immediately, the value of the organization, and consequently the value of the membership interests, would clearly increase. It would not be difficult to maintain that there was no profit purpose, as the courts have pointed out that where a business provides services to its members at cost, "[i]t would be difficult to impute a profit purpose" (BBM). Consequently, it is our view that in determining whether there is a profit purpose, "profit" should be given its ordinary commercial meaning, which does not include deductions for amounts related to future capital projects.

There are instances when a 149(1)(l) entity may have funds on hand in excess of its immediate operating requirements. While retaining excess funds may be evidence that an organization is operating with a profit purpose, generally, this will not in and of itself result in the organization failing to qualify as a 149(1)(l) entity. For example, in our view, a 149(1)(l) entity may accumulate members' contributions over a period of years in order to finance a planned, future capital project. Also, we acknowledge that the entity may earn reasonable investment income with respect to such accumulated funds, even though such income might otherwise be considered anticipated profit. However, if the excess funds were collected for the purpose of earning investment income rather than for the purpose of funding a specific capital project, then this would be a profit purpose and the organization would no longer be a 149(1)(l) entity.

(iii) Provincial Legislation and the Income Tax Act

Several of the provinces have enacted legislation that sets out how an organization must be organized and operated if it wants to be considered either charitable or not-for-profit for provincial purposes. For example, the Province of Saskatchewan has enacted the Non-Profit Corporations Act, 1995, and the Province of Ontario has similar legislation contained in the Corporations Act. Canada recently enacted the Canada Not-for-Profit Corporations Act.

While we cannot comment in detail on this legislation, we note that it appears that the criteria contained in the provincial "not-for-profit" legislation and in the federal Canada Not-for Profit Corporations Act are not the same as the criteria required to qualify for the tax exemption provided by paragraph 149(1)(l) of the Act. In particular, both the Saskatchewan and Ontario statutes only require that any profits or other accretions to the corporation be used in promoting the corporation's objects and activities. This suggests that organizations incorporated under these statutes can operate with a profit purpose, as long as that profit is used by the organization to support its objectives. Similarly, the Canada Not-for Profit Corporations Act provides that "no part of a corporation's profits or of its property or accretions to the value of the property may be distributed, directly or indirectly, to a member....except in furtherance of its activities..."

As discussed above, in our view, any profit purpose prevents an organization from being a 149(1)(l) entity. Consequently, it is possible for an organization to meet the requirements of federal or provincial "not-for-profit" incorporation legislation, but not qualify for the tax exemption provided under paragraph 149(1)(l) of the Act.

(iv) 149(1)(l) Entities-Registration

The CRA does not maintain a list of organizations that qualify for the exemption provided by paragraph 149(1)(l) of the Act. Unlike charities, these organizations are not required by the Act to register with the CRA.

(v) XXXXXXXXXX Procurement Contract

Whether an organization that has earned a profit qualifies for the tax exemption provided under paragraph 149(1)(l) of the Act is a question of fact. If the profit was incidental and unanticipated, the organization may still qualify as a 149(1)(l) entity. However, if the organization planned to earn a profit when it entered into the contract-for example, if the contract specifically contemplated a "mark-up"? the organization would not qualify for the tax exemption.

We trust that these comments will be of assistance.

Yours truly,

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

ENDNOTES

1 See also Canadian Bar Insurance Association v. Her Majesty the Queen, 99 DTC 653 (TCC).

2 See also the comments of Bowman J. from L.I.U.N.A. Local 527 Members' Training Trust Fund v. HMQ, 92 DTC 2365 at page 2380, where he refers to the taxpayer having neither a primary nor secondary profit purpose.