22 February 2005 External T.I. 2004-0095001E5 - Charity - unrelated business

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: A charitable organization is planning to develop and lease real property. Whether the charitable organization would be considered to be carrying on an unrelated business and therefore be subject to the proposed penalty in draft subsection 188.1(1).

Position: Factual determination. Provided general comments.

Reasons: A determination can be made only after a review of the relevant facts, including the terms and conditions of the particular lease and the extent of property development activities.

XXXXXXXXXX 								2004-009500

February 22, 2005

Dear XXXXXXXXXX:

Re: Charitable Organization - Unrelated Business

This is in reply to your letters of September 16 and December 23, 2004 concerning the income tax measures proposed in the 2004 federal budget. In particular, you expressed concern with the proposed penalty applicable to a charitable organization carrying on an unrelated business.

You advise that the practice of the XXXXXXXXXX has been to dispose of surplus land, invest the proceeds and use the income generated to further the mission of the church. The XXXXXXXXXX is contemplating an alternate plan to generate an income stream. Rather than sell the properties, the proposal being considered is to develop leasing properties. XXXXXXXXXX If, as expected, the rental income from leasing the building exceeds the investment income that would otherwise be earned from investing the proceeds, the XXXXXXXXXX will likely develop other suitable properties rather than sell them. You have asked for our views on whether the development and lease of a building would result in the XXXXXXXXXX being considered to be carrying on an unrelated business and therefore be subject to the proposed penalty.

Written confirmation of the tax implications arising out of a particular fact situation is given by this Directorate only where the transactions are proposed and are the subject of an advance income tax ruling request. For information on obtaining an advance income tax ruling, please refer to Information Circular 70-6R5 which can be found on the Canada Revenue Agency website at www.cra-arc.gc.ca. However, we are prepared to provide you with the following general comments.

Paragraph 149.1(2)(a) of the Income Tax Act (the "Act") provides that the charitable registration of a charitable organization may be revoked if the organization is carrying on an unrelated business. The 2004 federal budget proposed new sanctions and in this regard, the Minister of Finance released draft legislation on December 6, 2004 to implement measures proposed in the 2004 federal budget. The draft legislation includes new subsection 188.1(1) of the Act which imposes a penalty equal to 5% of the gross revenue for a taxation year of a charitable organization or a public foundation from a business not related to the charitable activities of the charity, or 5% of the gross revenue for a taxation year from any business carried on by a private foundation. Proposed subsection 188.1(2) of the Act increases the penalty for a repeat infraction to 100% if the Minister of National Revenue has, for a previous taxation year and less than five years before the time of the repeat infraction, assessed the 5% or this 100% penalty. These proposed penalties apply to taxation years that begin after March 22, 2004.

It is a question of fact whether a particular charitable organization is carrying on an unrelated business. The first determination, however, is whether or not the particular activity of the charity constitutes the carrying on of a business. A taxpayer engaged in property development activities would generally be regarded as carrying on a business. However, this determination can only be made after reviewing all of the surrounding facts and circumstances such as the extent of the property development activities. In the case of leasing activity, we note that Interpretation Bulletin IT-434R sets out the criteria for determining whether a rental operation carried on by an individual is a source of business income or of property income. Paragraph 5 of IT-434R states:

Where a building is rented en bloc (e.g., an office building), with the landlord providing (in addition, of course, to the accommodation) only maintenance of the building as such and perhaps heat and air conditioning, the rental clearly is one of property and does not constitute the carrying on of a business. The same situation is considered to exist where a building is rented piecemeal (e.g., an apartment block) and the tenants are provided with only those basic services which, by custom, have come to be regarded as an inherent part of that kind of property rental, e.g.: heat, water, elevator service, telephone in lobby, indoor or outdoor parking spaces, laundry room with equipment for tenants, maintenance of the building itself (including janitor and window washing service, repainting of apartments), maintenance of adjacent areas (including snow and garbage removal service) and maintenance of any appliances and furnishings provided in the rented accommodation.

Essentially, the nature and extent of services provided for, or made available to, tenants must be considered in determining whether a particular operation is a leasing business. Services which would tend to indicate that the earning of rental income constitutes the carrying on of a business would include services such as cleaning of the rented premises, provision of parking attendants, security guards, the provision of meals and drinks to tenants, and a mail distribution service.

The criteria in IT-434R are some of the factors that are considered in determining whether a particular charity is carrying on a business. Reference should also be made to Policy Statement CPS-019, "What is a Related Business?", which can also be found on our website. While it does not specifically address leasing or property development activities, it lists factors to be considered on whether a particular activity of a charity constitutes a business. Each situation will, as noted earlier, have to be assessed with reference to all relevant facts.

If the facts indicate that a charitable organization is carrying on a business, the next question is whether the business is a related or unrelated business. In this regard, CPS-019 outlines the Charities Directorate's policy for determining whether a registered charity is carrying on a related business or an unrelated one. CPS-019 notes that there are two kinds of related business. The first is one that falls within the definition of "related business" in subsection 149.1(1) of the Act. The second is a business that is linked to a charity's purpose and subordinate to that purpose. We note that the fact that the rental income earned will be used to fund the XXXXXXXXXX charitable activities is not a factor in determining whether the business is a related business. Based on the information provided, it is not likely that developing and leasing activities would constitute a related business of the XXXXXXXXXX.

Finally, we note that a charitable organization, by definition, is required to devote all of its resources to charitable activities. Accordingly, even if the developing and leasing activities do not constitute the carrying on of a business, if such activities occupy a significant portion of the XXXXXXXXXX time and resources, it may call into question whether the XXXXXXXXXX is devoting all of its resources to charitable activities and whether such activities have become a non-charitable purpose in its own right.

If you have any questions on the information contained in CPS-019 or wish to discuss further when a particular activity takes on a risk of being considered a non-charitable purpose, please contact Blaine Langdon of the Charities Directorate at (613) 957-6152. As noted above you can request an advance income tax ruling which would necessarily require you to disclose all of the relevant details with regard to the proposed development and leasing activity.

We hope that our comments are of assistance.

Yours truly,

F. Lee Workman
Manager
Financial Institutions Section
Financial Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch

cc.: Terry de March, Charities Directorate