30 June 1998 External T.I. 9727005 - NON-PROFIT 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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

The taxpayer has requested a technical interpretation regarding various scenarios in which a non-profit organization (NPO) organized as a trust wishes to invest in various types of investments in the future. The taxpayer is asking if the status of the NPO would be affected if it invests in various investments.

Position:

We are unable to give a technical interpretation as to whether the NPO would lose its status if it made different types of investments as we do not have all the material facts. The determination of whether an organization qualifies as an NPO pursuant to paragraph 149(1)(l) is retrospective. Accordingly, we can only provide general comments.

Reasons: See 961356, 9202765, 9704605

XXXXXXXXXX 972700

June 30, 1998

Dear XXXXXXXXXX:

Re: Non-Profit Organization

This is in reply to your letter of October 6, 1997, in which you requested a technical interpretation regarding a non-profit organization, organized as a trust, that is considering acquiring certain types of investments.

You have outlined the situation as follows:

A non-profit organization (NPO) has been organized as a trust. The NPO makes various investments. The NPO will not be involved in the day-to-day management of the business underlying the investment. The purpose of the NPO acquiring such investments is to provide an on-going source of funds to be used to pursue the non-profit purpose of the NPO. In particular, you are concerned about whether the NPO would lose its tax-exempt status as an NPO under paragraph 149(1)(l) of the Income Tax Act (the “Act”) if it were to hold certain investments. The income earned each year from the investments will be spent on its non-profit activities and will not be reinvested by the NPO and therefore the comments in paragraphs 8 and 9 of IT-496 concerning “accumulated excess” are not at issue. The NPO is considering a wide variety of investments ranging from the acquisition of shares in private and public corporations, acquisitions of interests in limited and general partnerships and the acquisition of interests in trusts. Also, you have asked if our views would be different if the NPO acquired a controlling interest in any of the aforementioned investment vehicles.

When we (Moore\XXXXXXXXXX) met with you in April of 1998, we clarified certain issues with respect to your October 6th letter. As we understand, you are contemplating a situation where funds will be contributed into a NPO on an annual basis as a contribution of capital. The funds will be invested, likely by an investment manager, and income earned each year from the investment portfolio will be spent to carry out the NPO objectives. The investment fund will grow through time as more and more funds are contributed to the NPO. It was not clear from our meeting if the contributors to the NPO (i.e. the members) will be entitled to a return of their capital contributions to the NPO. You were also silent on the issue of capital gains realized by the NPO.

Our Comments

NPO Organized as a Trust

You have indicated that the NPO has been organized as a trust. Although it could be argued that a trust qualifies as an NPO pursuant to the conditions set out in paragraphs 5 and 6 of IT-496, Non-Profit Organizations, (i.e. it could presumably be set up or organized for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit), it is our view that by the very nature of a trust, most would have difficulty meeting the NPO requirements of being operated as an NPO on an annual basis. Most trusts would have difficulty meeting the condition that no part of its income, whether current or accumulated, may be payable or otherwise made available for the personal benefit of any proprietor, member or shareholder. This is so because a trust is generally constituted to hold or manage property for the benefit of one or more beneficiaries. However, having stated that, it is our view that purpose trusts, provided, among other factors, that they spend their funds on furthering the non-profit purposes for which they were formed, could likely qualify as NPOs. In the case of L.I.U.N.A. Local 527 Members’ Training Trust Fund v. The Queen, 92 DTC 2365, (1992) 2 C.T.C. 2410, the court held that although the training trust fund in question failed as a conventional inter vivos trust, it nevertheless qualified as a purpose trust, since it had three certainties required of a trust; namely, certainty of intention, certainty of subject matter and certainty of object. With regard to certainty of object, the Court indicated that the object in this case was clear; the trust had been set up in favour of purposes, as opposed to persons. Although such purpose trusts are void in law, the Court nevertheless concluded that the trust was valid by reason of section 16 of the Perpetuities Act of Ontario. It is a question of fact whether a trust is a purpose trust. Accordingly, we cannot comment on whether the organization you are referring to in your letter would meet the definition of “Non-profit organizations” in paragraph 149(1)(l) of the Act.

General Comments

As you know, in order for an organization to be exempt under paragraph 149(1)(l) of the Act, it must be both organized and operated exclusively for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit and no part of its income may be payable to or otherwise available for the personal benefit of any proprietor, member, or shareholder 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.

A determination of whether an organization was organized exclusively for exempt purposes would require an examination of the organization’s enabling documents, which may include letters patent, by-laws, articles, and so on. A determination of whether an entity was operated exclusively for, and in accordance with, its non-profit purposes in a taxation year is based on the facts of each case. Accordingly, we cannot provide any definitive opinions regarding the general scenarios you have described in your letter unless it is in the context of a factual situation relating to a particular NPO. However, we do have some concerns with the type of arrangement you are considering and therefore we have provided some general comments.

Even though the legislation (i.e. paragraph 149(1)(l) of the Act) would appear to be quite clear in that an NPO cannot have, as one of its purposes, the making of profit, jurisprudence with respect to paragraph 149(1)(l) of the Act has taken a somewhat more liberal interpretation and, generally speaking, has considered income earning activities of an NPO acceptable as long as the activities do not indicate that such profit was other than subordinate to achieving their exempt objectives. The Department has adhered to the decisions of the courts. In other words, the Department does not deny exempt status to an organization that carries on income generating activities which have a clear distinct causal relationship between profit earning activities and the exempt purpose of the organization. It is this point that causes us the most concern with the scenario you have described in your enquiry.

In the past, the Department has indicated that a distinct causal relationship would appear to be lacking when profit earning activities are not used to achieve the organization’s declared exempt objectives (e.g., see the Department’s comments on “accumulated excess” in paragraphs 8 and 9 of the bulletin). We are of the opinion that, in the absence of specific facts to suggest otherwise, an NPO that has as its principal activity the investment of assets (i.e. a significant investment portfolio) would not likely meet the “distinct causal relationship” test. In addition, if an NPO does not have an established policy about how its income generating activities are directly related to achieving its declared exempt objectives, other than to maximize profits every year and use such profits to fulfil the exempt objectives, we would be inclined to opine that the NPO would fail to meet the requirements of paragraph 149(1)(l) of the Act. We would also suggest that where the exempt objectives of the NPO are, for all intents and purposes, carried out or accomplished with very little activity required by the NPO (e.g., the NPO simply forwards its profits to the exempt cause and has very little direct involvement in carrying out such activities), the principle activity of the NPO is “profit making” and no such “causal relationship” would exist.

In our opinion, the above comments are consistent with jurisprudence on this matter. For example, the courts have developed the test of determining whether the earning of profit is both an “operating motivation” and a “focus of its activities”. Generally if there is a preponderant non-profit purpose to which any profit earned is merely incidental, the earning of such profits will not affect the tax-exempt status of the entity. This would not appear to be the case in the situation at hand. Based on our understanding of the situation you described to us during our April meeting, the contemplated investment activities is an end in itself as opposed to a means by which the organization achieves its exempt objectives and, accordingly, would likely not meet the causal relationship test.

In the case of The Gull Bay Development Corporation v. The Queen, 84 DTC 6040, (1984) C.T.C. 159, the corporation carried on an active logging operation and realized a profit from such activities. The court determined that the real objective of the organization was to carry out its social and welfare activities and not its commercial lumber activities. On that basis, the court found that the corporation was operated “exclusively” for a purpose set out in paragraph 149(1)(l) of the Act even though it raised funds for its objectives through a commercial enterprise. However, Gull Bay can be distinguished from other organizations that carry on income generating activities on the basis that the commercial activities carried on by Gull Bay had a “social welfare” nature since they provided employment and training for otherwise unemployed Indians on the reserve. In addition, the logging operations, while commercial in nature, were not operated as a true commercial logging company was operated since the nature of the agreement Gull Bay had with Northern Wood Preservers, (Saskatchewan) Limited, who had the cutting rights for the area in question, was almost of a quasi-charitable nature. The court found that “there is no doubt from the evidence in this case that a great deal has been accomplished in improving living conditions on the Reserve by the work done by employees of the Corporation with funds derived from the lumbering operations, and in providing gainful employment for members of the Band who would otherwise be on welfare” and that “the social and welfare activities of (the) Plaintiff are not a cloak to avoid payment of taxation on a commercial activities but are the real objectives of the Corporation.”

An organization whose claim for exemption under paragraph 149(1)(l) of the Act was accepted by the Department for prior taxation years could lose its exempt status as an NPO if it is carrying on an income generating activity as its principal activity. However, an organization may possibly correct this by ceasing to carry out the non-qualifying income generating activities, altering the non-qualifying income generating activities to make them acceptable to the Department, or by transferring those non-qualifying income generating activities to taxable entities. With respect to the latter solution, and as discussed in our April meeting, we would not think the transfer of the income generating activity to a flow-through entity would avoid the paragraph 149(1)(l) issue. For example, in our view, an NPO could be jeopardizing its exempt status under paragraph 149(1)(l) of the Act in a situation where the NPO’s principal activity is an investment in a partnership, and there is a flow-through of the investment income or active business income from the partnership to the NPO, and there is no causal relationship between the income generating activity of the partnership and the declared exempt objectives of the NPO.

In summary, we can appreciate your need for some direction from the Department with respect to the various investment opportunities you are contemplating for various NPOs. However, there are simply too many factors that have to be taken into consideration by the Department when making a determination of NPO status. We can only make a final determination when we have all the relevant facts. In this regard, the process for an enquiry such as this should be in the form of an advance income tax ruling request where we would generally be provided with all the relevant facts and documentation. Even though we have concerns with the scenario that you have described, we would still be prepared to consider, on a case by case basis, a ruling request.

As you are no doubt aware, the Department has accepted that where the income generating activity has been transferred to a wholly-owned subsidiary of the NPO, and dividends are paid out of the subsidiary’s after-tax profits to the NPO to enable the NPO to carry out its non-profit activities, the NPO may still qualify as a NPO, as set out in paragraph 149(1)(l) of the Act.

We trust our comments will be of assistance to you. Please note that these comments represent our opinion of the law as it applies generally and, as stated in Information Circular 70-6R3, are not binding on the Department.

Yours truly,

J. Wilson
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch