14 February 2012 External T.I. 2011-0392841E5 - Status of 149(1)(l) Entity

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: Whether the organization can maintain its 149(1)(l) status while trying to recover its losses and continue to meet its objectives.

Position: Maybe

Reasons: See discussion in letter.

XXXXXXXXXX 				2011-039284
					Lori Merrigan
					(613) 957-8979
February 14, 2011

Dear XXXXXXXXXX :

Re: Paragraph 149(1)(l) of the Income Tax Act (the "Act")

This is in response to your correspondence of January 7, 2011, inquiring about the application of paragraph 149(1)(l) of the Act to a particular fact situation. In this letter, unless otherwise expressly stated, all statutory references are to the provisions of the Act.

The situation outlined in your letter is related to a factual one, involving a specific taxpayer. It is not this Directorate's practice to comment on existing fact situations on completed transactions involving specific taxpayers. Please see our Information Circular 70-6R5, "Advance Income Tax Rulings", dated May 17, 2002. This Information Circular and other CRA publications can be accessed on the internet at http://www.cra-arc.gc.ca. However, we are prepared to provide the following general comments, which may be of assistance.

FACTS

The facts that you have given us, which we have assumed to be correct for purposes of our response, are as follows:

• The organization (the "NPO") has always filed its tax returns as a 149(1)(l) entity. The NPO was created XXXXXXXXXX years ago by three members: X and Y (related persons) and Z (an unrelated individual).
• The mandate of the NPO is to XXXXXXXXXX in the Province of XXXXXXXXXX .
• The NPO does not own any real property; it currently leases property that is owned personally by X and Y (the "Property").
• The Property currently houses XXXXXXXXXX .
• The NPO is currently in a loss position; losses have accumulated over the past XXXXXXXXXX fiscal years.

QUESTIONS

You have asked us to consider the following questions:

1. Can a member make a contribution to the NPO before the fiscal year-end to enable the NPO to pay its outstanding liabilities without the NPO being regarded as having a profit purpose?

2. If a member provides a loan (with or without interest at commercial rates) to the NPO sufficient to cover its outstanding liabilities, will the repayment of the loan or the payment of interest by the NPO mean that income of the NPO is available for the personal benefit of that member? Would generating income to cover the repayment of the loan (plus potential interest) in subsequent years mean that the NPO has a profit purpose?

3. Considering that the NPO's overall mandate is to XXXXXXXXXX , can the NPO assume the responsibilities of owning and leasing the Property and use any net rental income to offset losses from other activities without losing its tax-exempt status?

4. If the NPO embarks on fundraising activities to raise money toward the current year's operating expenses, or to cover the deficit, or for the purchase of equipment, would the NPO be viewed as having a profit purpose?

DISCUSSION

Overview

The CRA's general views regarding 149(1)(l) entities are contained in Interpretation Bulletins IT-496R, "Non-profit Organizations" and IT-83R3, "Non-Profit Organizations - Taxation of Income From Property", which may be viewed at http://www.cra-arc.gc.ca. Our comments below are based on the existence of a properly constituted and operated 149(1)(l) entity. However, we are not confirming that your organization currently qualifies for the exemption provided in paragraph 149(1)(l), nor are we able to provide such a determination. Whether or not your organization currently qualifies for the exemption provided in paragraph 149(1)(l) can only be determined once the corporation's income tax return for a particular fiscal period is filed and the activities of the corporation are reviewed by a Tax Services Office.

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

• 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
• no part of its income is available for the personal benefit of a member or shareholder.

1. Deficit - Member Contributions

In our view, requiring higher member contributions in a particular year to reduce prior years' losses would not indicate a profit purpose. Improving a loss position is not the same as accumulating amounts in excess of an organization's needs for the purpose of generating investment income. Outstanding liabilities could also be paid out of incidental profits from not-for-profit activities or income from limited fundraising activities (see discussion below).

2. Deficit - Member Loans and Generating Profits

In our view, a member may provide a loan to a 149(1)(l) entity without the repayment of the loan to that member being considered to be income of the 149(1)(l) entity that is payable to the member. However, it is always a question of fact whether a member receives a payment in his or her capacity as a lender or in his or her capacity as a member of the 149(1)(l) entity.

Generating income to cover the interest expense on a loan will not, in and of itself, indicate that an organization has a profit purpose. Interest on a debt that was incurred to meet a not-for-profit objective is an expense to be taken into account in determining whether a 149(1)(l) entity has profits (either generally or from a particular activity).

However, the principal portion of a loan should be repaid out of member contributions and incidental profits (or gifts and grants to the entity from other sources). Generating material profits - especially from third parties - to repay the principal portion of a loan may indicate that the 149(1)(l) entity is operated in part for a profit purpose (as well as its stated not-for-profit purposes).

Whether or not generating material profits in a particular year to offset prior years' losses indicates that an organization is operating in part for a profit purpose is a question of fact. Generating profits from a particular activity in order to offset prior years' losses related to that activity generally would not indicate a profit purpose.

If an organization is operating at close to cost over the course of a reasonable timeframe (which does not have to be a taxation year), and there is no evidence that material profits from one activity are being used either to cover expenses related to a different activity or to accumulate a reserve, then it is likely that the organization is operating exclusively for a purpose other than profit. The concern with material profits from one activity being used to pay for the expenses of a different activity is that a 149(1)(l) entity cannot be used as a cover (or "cloak") for a for-profit business (i.e., the activity with material profits). The fact that its profits are earmarked for a worthwhile cause (the "destination of funds" test) does not make an organization exempt from tax. This "destination of funds" test has been rejected on several occasions by the courts for both charities and not-for-profit organizations.

3. Leasing Activities

The courts have recognized that an organization claiming a paragraph 149(1)(l) exemption can earn a profit, as long as the profit is incidental and arises from activities directly connected to its not-for-profit objectives. For example, maintaining reasonable operating reserves or bank accounts required for ordinary operations will generally be considered to be an activity undertaken to meet the not-for-profit objectives of an organization. Consequently, incidental profits arising from these reserves or accounts will not affect the tax-exempt status of an organization. Other examples of profitable activities that might be undertaken through a 149(1)(l) entity include running a canteen at a rink used for amateur hockey or a cafeteria at a not-for-profit youth hostel, or charging admission above direct cost for a children's concert (where the not-for-profit purpose of the organization was to organize and promote youth participation in music).

Whether leasing activities are connected to the objectives of a particular 149(1)(l) entity is a question of fact. In your case, leasing space to XXXXXXXXXX at a reduced rent, or to the exclusion of other types of tenants, may be an activity directly connected to your not-for-profit objectives (although we cannot confirm this). In this case, incidental profits from the leasing activities could be used to offset losses or expenses from other activities or to repay outstanding loans. Whether or not profits are incidental is a question of fact; material profits may indicate that the organization is not operating exclusively for any purpose except profit even if the profits are used within the organization.

4. Fundraising Activities

The CRA accepts that certain fundraising activities can be carried on directly by a 149(1)(l) entity without jeopardizing its tax-exempt status. In particular, where a 149(1)(l) entity (usually a 149(1)(l) entity organized for social welfare, civic improvement, or pleasure or recreation) raises funds through activities carried out by volunteers, especially activities involving the sale of donated goods or services, or involving games of chance (including lotteries and bingos), carrying out these activities will not generally indicate a profit purpose within the meaning of paragraph 149(1)(l). However, the scope of the fundraising activities, especially by comparison with other activities, should not be so significant that fundraising can be considered a purpose of the organization.

We trust that these comments will be of assistance.

Yours truly,

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