This article looks at how charities pay tax, what rules apply and the penalties involved in any breaches of tax obligations by charities. It will provide an overview what it means to be a ‘charity’ in Australia under the Australian Charities and Not-For-Profit Organisations Commission Act 2012 (Cth) and discuss how charities can comply with their taxation obligations.
What is a Charity?
A ‘charity’ is an organisation that exists for the benefit of groups that are usually disadvantaged in some way and who need help and assistance. In Australia, a ‘charity’ also has a special legal meaning set out in the Charities Act 2013 (Cth) with three main elements.
A charity is a (1) not for profit organisation which has a (2) charitable purpose that is for the (3) benefit of the public. Each of these three elements are explained below.
1. Not for profit: A not for profit organisation is an organisation which does not operate for the profit, personal gain or any other benefit of particular people.
2. Charitable purpose: For a charity to have a purpose that is ‘charitable’, it must be a purpose listed in section 12 of the Charities Act 2013. A charitable purpose means, for example, the purpose of advancing health, education or advancing social or public welfare. There are 12 purposes recognised as charitable for the purposes of the Charities Act 2013.
3. Benefit of the public: A charity must provide a benefit to the public for it to be a charity. A benefit will be public if it is a benefit available to the general public or a sufficient member of the general public (section 6 of the Charities Act 2013). A benefit will not be a public benefit if it is only available to a small section of the community; it must be available to the general public.
Tax Rules
Once a charity has met the conditions required to become registered as a charity, they must keep abreast of the tax obligations that affect them.
The ATO’s Taxation Ruling TR 2015/1 (25 February 2015) ‘Income Tax: special conditions for various entities whose ordinary and statutory income is exempt’ applies to not for profit and charities, for their income to be exempt from income tax.
For a charity’s income to exempt from tax, it must meet two special conditions:
- The charity must comply with the substantive requirements of its governing rules (the governing rules condition); and
- The charity must use its assets and income only for the purpose for which the entity was established in the first place (the income and assets condition).
Substantive Requirements
The substantive requirements of an entity’s governing rules set out what a charity can and cannot do. This could be, for example, to engage in charitable fundraising to fund cancer research. Substantive requirements can be contrasted with procedural requirements such as the rules for holding meetings.
Income and Assets Condition
The income and asset condition relates to the purpose for which a charity was established. As we mentioned above, a purpose must be a ‘charitable purpose’ defined in section 12 of the Charities Act. A charity must only use its assets and income to further its charitable purpose. However, a charity is permitted to have a purpose which is incidental or ancillary to its original charitable purpose, which will not breach the Taxation Ruling.
Breaching Governing Rules of Income and Assets Conditions
The penalties for breaching these conditions are mainly tax and finance related. If an entity does not comply with its governing rules or does not use its income/assets only for the purpose for which it was established, then the entity may lose its tax exemption for the income year in which the breaches occurred. For most charities, funding and finances are a major concern, so the penalties involved with the breach of these two conditions is serious.
What does the ATO say about the Tax Ruling?
The ATO has stated that Tax Ruling will be applied strictly, however, there is some leniency for charities who get it wrong. A charity will still meet the income and assets condition if the funds that were not applied properly were an insignificant amount, and the misapplication was a one-off.
When looking to penalise a breach, the ATO will also consider whether the charity took any corrective action within a reasonable time to fix their mistake. If the corrective action put the charity in the same place it would have been in, had the misapplication not occurred; the breach may be waived.
Key Takeaways
Charities are exempt from income tax for policy reasons, including that charitable work improves the lives and living standards of those who are most vulnerable. So that charities do not abuse this beneficial tax status, charities are strictly defined and regulated entities. The ATO comprehensively audits charities and if a charity is found to have breached the rules, it can face significant tax and financial penalties.
We have included a brief discussion of one of the penalties levied by the ATO, but running a charity involves familiarity with a suite of rules and regulations governed by a matrix of regulatory bodies in including the ATO, ASIC and the ACNC. If you are looking to start a charity, receiving tailored legal advice should be your priority.