TAX ISSUES FOR NOT-FOR-PROFIT ORGANIZATIONS by qxc16070

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									Tax Issues For Not-For-Profit Organizations




                                  Prepared and Presented by:


                                      Carole Chouinard
                          Gowling Lafleur Henderson LLP

                                        October 16, 2007
                TAX ISSUES FOR NOT-FOR-PROFIT ORGANIZATIONS



The Courts and governments have long recognized that not-for-profit organizations

provide substantial benefits to the community. If the government provided the services,

facilities and activities provided by not-for-profit organizations, significantly greater

governmental expenditures would result. In recognition of the importance and value of

not-for-profit organizations, tax-related statutes provide benefits to such organizations.

These benefits are generally exemptions from tax (such as income tax) or for certain

activities related to not-for-profit organizations (such as GST).


While it is true that not-for-profit organizations are generally not subject to income tax,

as discussed in this paper, there are certain circumstances under which not-for-profit

organizations, and also certain types of not-for-profit organizations, are indeed subject to

tax. For instance, where a not-for-profit organization carries on activities in a business-

like manner, it may lose its tax-exempt status and become subject to income tax. In

addition, organizations whose main purpose is to provide dining, recreation or sport

facilities to their members are subject to income tax in respect of their property income

and certain capital gains.


This paper addresses the following topics which are of relevance to not-for-profit

organizations and more specifically, the issue of tax as relates to not-for-profit

organizations: for-profit activities, organizations engaged in providing dining, recreation
                                                    2



and sporting facilities, reorganizations, the goods and services tax and compliance

matters.


A.      Requirements for Exemption from Income Tax

        i.       General Requirements

Paragraph 149(1)(l) of the Income Tax Act 1 provides an exemption from tax on the

taxable income of a club, society or association (collectively hereinafter called

“organization”). 2 An organization is generally exempt from tax under Part I of the Act

for a period throughout which the organization complies with all of the following

conditions:


        (a)      it is not a charity;


        (b)      it is organized exclusively for social welfare, civic improvement, pleasure,

                 recreation or any other purpose except profit;


        (c)      it is in fact operated exclusively for the same purpose for which it was

                 organized or for any of the other purposes mentioned in (b); and


        (d)      it does not distribute or otherwise make available for the personal benefit

                 of a member any of its income unless the member is an association that



1
  RSC 1985, c. (5th Supp.), as amended (herein referred to as the “Act”).
2
  The Ontario Corporations Tax Act provides an exemption similar to that provided under the Act and
indeed, largely incorporates the federal exemption by reference to the relevant provision in the Act.
                                                       3



                  has as its primary purpose and function the promotion of amateur athletics

                  in Canada.


The expression “club, society or association” used in paragraph 149(1)(l) is considered to

be broad enough to include a purpose trust 3 and an incorporated entity, including a

corporation incorporated under either the Canada Business Corporations Act or the

Ontario Business Corporations Act. 4 Although an inter vivos trust could presumably be

set up or be organized for social welfare, civic improvement, pleasure, or recreation or

for any other purpose except profit, by the very nature of trusts, most would have

difficulty meeting the requirement of paragraph 149(1)(l) of the Act that no part of its

income be made available for the personal benefit of any proprietor or member. This is

so because a trust is generally constituted to hold or manage property for the benefit of

one or more beneficiaries. 5


Since there is no requirement in paragraph 149(1)(l) of the Act that an entity be resident

in Canada in order to qualify as a not-for-profit organization under paragraph 149(1)(l) of

3
  Purpose trusts are generally set up, not to benefit specified persons, but to ensure that particular purposes
are carried out.
4
  See CRA document 1991-380, March 1991. However, since both the CBCA and the OBCA require that
at least one class of shares have dividend rights, a corporation incorporated under the CBCA or the OBCA
would be precluded from qualifying under paragraph 149(1)(l) of the Act.
5
  In the case of L.I.U.N.A. Local 527 Members’ Training Trust Fund v. R., [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. 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. CRA is prepared to treat employee training trust funds as purpose trusts for purposes of paragraph
149(1)(l) and, provided they spend their funds on furthering the non-profit purposes for which they are
formed, CRA will consider them to be eligible to qualify as not-for-profit organizations: see CRA
document 9408145, June 27, 1994. However, CRA has also indicated that if the trust agreement provides
that the funds can be returned to the employer upon windup of the trust, the training trust fund would be
disqualified as a not-for-profit organization: see CRA document 9218667, August 20, 1992.
                                                       4



the Act, non-resident entities that meet paragraph 149(1)(l) will be exempt from

Canadian income tax, including “branch tax” under paragraph 219(2)(c) of the Act.


A condition to be met for an organization to qualify for exemption from tax under

paragraph 149(1)(l) is that the organization not be a charity as defined by section 149.1 of

the Act. In general, this means that if the organization is one that could be registered as a

charity, but has not registered as a charity, it will be denied the exemption from taxation

under paragraph 149(1)(l) of the Act. 6 Generally, where an organization has very broad

objects and carries on a number of activities, some of which would be considered

charitable and some of which would not be considered charitable in nature, the

organization would not qualify for registration under the Act.


When determining the purpose for which an organization was organized, the instruments

creating the organization will normally be reviewed. These instruments may include

Letters Patent, Articles of Incorporation, Memoranda of Agreement and By-Laws. If a

review of these documents reveals that the organization was created for other than one or

more of the accepted purposes (i.e., social welfare, civic improvement, pleasure or

recreation, and any other purpose except profit), the organization will not qualify for

exemption.



6
  Where a non-resident entity has a branch office in Canada, it is the non-resident entity’s objects and
activities and not those of the branch office that are relevant in determining whether or not the requirement
that the organization not be a charity is met. If a non-resident entity is a charity, but is not eligible to be
registered as a charity because it does not meet the residency requirements in the definition of “registered
charity”, it will not qualify as a not-for-profit organization for the purposes of paragraph 149(1)(l) of the
Act and will therefore be taxable in Canada in respect of its income earned in Canada.
                                                     5



To qualify for exemption, an organization must not only be organized exclusively for

non-profit purposes, but it must in fact be operated in accordance with these purposes in

each year for which it seeks exemption under paragraph 149(1)(l) of the Act.                             A

determination of whether an organization was operated exclusively for and in accordance

with its non-profit purposes in a particular taxation year can only be made by reviewing

all of the organization’s activities for that year. Such a determination cannot be made in

advance of or during a particular year, but only after the end of the year. An organization

that qualifies for exemption in a particular year may cease to qualify in a subsequent year

by failing to operate in accordance with one of the purposes for which it was organized or

by revising its objects so that it is no longer organized in accordance with a purpose

specified in paragraph 149(1)(l) of the Act.


         ii.      No Distribution of Income to Members

To qualify for exemption under paragraph 149(1)(l), no part of the income of an

organization, whether current or accumulated, can be payable to, or otherwise made

available for the personal benefit of, any member of the organization. 7 For example, an

organization would not qualify as tax-exempt if it distributed, or was entitled to

distribute, 8 income during the year, either directly or indirectly, to, or for the benefit of,




7
  Payments made by a condominium corporation that qualifies as a not-for-profit organization for capital
improvements or repair and maintenance projects in respect of common property will not generally affect
its status as a tax-exempt not-for-profit organization and will not constitute a benefit to the unit owners.
However, if the property is not considered to be common property, then for purposes of paragraph 149(1)(l)
of the Act, such payments will be considered to be paid for the personal benefit of the members.
8
  CRA document 2006-019487117, August 10, 2006.
                                                    6



any member. 9 However, if an organization were to use its surplus funds to subsidize

membership fees, it would not be jeopardizing its tax-exempt status under paragraph

149(1)(l) of the Act, if its surplus funds would normally be used to finance its non-profit

activities for which members would ordinarily be requested to pay by way of

membership fees. 10


A provision in an organization’s constituting documents allowing the organization to

distribute its assets on dissolution to its members will not, in and by itself, affect the

organization’s status as a tax-exempt entity under paragraph 149(1)(l) of the Act.11

However, as soon as the board of directors of such an organization passes a resolution

authorizing the dissolution of the organization and a member of the organization becomes

entitled to receive property from the organization, the organization will lose its not-for-

profit tax-exempt status and will become subject to tax. 12


Subsection 149(2) of the Act provides that, in making a determination as to whether an

organization has distributed its income to its members, such income is deemed to be the

amount of income determined on the assumption that the amount of any taxable capital

gain or allowable capital loss is nil. Accordingly, a not-for-profit organization is allowed

to distribute its net taxable capital gains to a member without prejudicing its tax-exempt


9
  While dividends would be a common manner to make income of an organization available to its
members, there are other situations where an organization may be considered to have personally benefited a
member without the distribution of income. An example of this would be the payment of an unreasonably
high amount to a member or shareholder for goods or services provided to the organization by the member.
10
   See CRA document 923594A, January 11, 1993.
11
   When it comes to distribution of assets, including income, on dissolution, CRA appears to favour the
“wait and see approach”.
12
   CRA document 2002-0180335, October 20, 2003.
                                                    7



status.    In addition, certain types of payments such as salaries, wages, fees or

honorariums for services rendered to the organization that are made directly to members,

or indirectly for their benefit, will not generally disqualify an organization from being

tax-exempt under paragraph 149(1)(l) where the amounts are reasonable and no more

than those paid in arm’s length situations for similar services. A return of capital to

members will also not disqualify an organization under paragraph 149(1)(l) of the Act. 13


If an organization amends its constituting documents to allow it to distribute excess

funds, whether from annual surplus or from reserve funds, to its members, the

organization ceases to qualify as a not-for-profit organization as of the date that it amends

its constituting documents and becomes subject to tax under Part I of the Act. 14

Alternatively, if a not-for-profit organization amends its constituting documents to

remove a provision entitling it to distribute its remaining assets on winding-up or

liquidation among its members and to replace it with a provision allowing the directors of

the organization upon liquidation or winding-up to distribute the remaining assets in their

sole discretion, CRA is unlikely to consider that the organization qualified as a tax-

exempt not-for-profit organization from its creation, since an organization cannot be

made to retroactively qualify for prior periods. 15




13
   See CRA document 922031A, October 26, 1992 and CRA document 9909875F, April 19, 1999.
14
   CRA document 2003-0027252R3, 1994.
15
   See, however, CRA document 2007-0221381E5, February 20, 2007, where CRA indicated that, given the
unique circumstances of the organization and the fact that the wording in question had been amended prior
to being acted upon, it would consider the organization to have qualified as a not-for-profit organization
under paragraph 149(1)(l) from the time of creation.
                                                      8



B.       For-Profit Activities

The fact that an organization must be operated exclusively for not-for-profit purposes

does not mean that the organization cannot generate a profit.                        Many not-for-profit

organizations must have a regular and reliable source of income in order to continue to

operate as a viable self-supporting organization. In addition, the realization of a profit in

any particular year is not necessarily indicative of a for-profit motive.


Paragraph 149(1)(l) of the Act contemplates that an organization may carry on income

generating activities and earn income and still qualify for exempt status, provided that

there is a causal relationship between the profit making activity and the exempt purpose

of the organization. That is, the income generating activity cannot be the principal

activity of the corporation and must be carried on, and the resulting income must be used,

by the corporation to achieve its declared exempt objectives.                        In this regard, the

jurisprudence has tended to distinguish between organizations that happen to realize

profits from their non-profit activities (for example, Gull Bay Development

Corporation 16 ), which may qualify as non-profit organizations, and those that have as a

purpose the raising of funds (for example, Woodward’s Pension Society 17 and

Tourbec 18 ), which generally would not.




16
   Gull Bay Development Corporation v. R., [1984] C.T.C. 159 (F.C.T.D.).
17
   [1962] C.T.C. 11 (S.C.C.).
18
   Tourbec (1979) Inc. v. M.N.R., [1988] 2 C.T.C. 2071. Tourbec carried on a travel agency business and
75% of its sales were to the general public. It contended that it was a not-for-profit organization, since it
used its revenues generated by its regular travel business to subsidize the travel of youth. The Court found
that Tourbec was not a not-for-profit organization under paragraph 149(1)(l) of the Act, since it was not
organized and operated exclusively for one of the purposes mentioned in paragraph 149(1)(l).
                                                      9



In the Gull Bay case, the organization, the Gull Bay Development Corporation, had been

incorporated, inter alia, to promote the economic and social welfare of persons of native

origin. The organization engaged in a commercial activity, namely, a logging operation

on an Indian reserve. The Court held that the organization was organized and operated

exclusively for social welfare purposes, although the organization also carried on a

logging operation, since the profits from the logging operation were used by the

corporation in social welfare activities carried on by the organization. The Court also

opined that the social welfare activities were not a cloak to avoid payment of taxation on

a commercial enterprise but were the real objectives of the corporation.


It is generally more difficult for organizations that carry on activities in areas populated

by commercial enterprises to successfully argue that they are organized and operated for

purposes other than profit.            In the Canadian Bar Insurance Association 19 case, the

organization’s purpose was to facilitate the availability of insurance products to the legal

community in Canada and it operated in direct competition with for-profit companies in

the insurance industry. Upon assessment by the Minister denying tax-exempt status to

the organization, the organization argued that its high level of commercial activity was

not indicative that its purpose was profit. The Court held that the organization’s Letters

Patent, general by-laws and its profit and loss results supported its claim that it was a not-

for-profit organization exempt from tax and that the organization’s high level of

commercial activity and large stabilization reserve did not prove that it was operated for

profit.

19
     Canadian Bar Insurance Association v. R., [1999] 2 C.T.C. 2833 (T.C.C.).
                                                    10



The issue of whether an organization is pursuing for profit purposes tends to arise in

other fairly common situations, such as where the organization earns significant income

from investing of its surplus funds, where it derives income from a taxable subsidiary or

where it rents space in a building that is in excess of its needs.


CRA’s view is that an organization’s status as a not-for-profit organization will generally

not be jeopardized where it generates income from investing excess cash, provided it

expends such investment income in achieving its non-profit purposes. 20                        This is in

keeping with the decision of the Federal Court in the Gull Bay case.                           CRA also

recognizes that an organization that earns income in excess of its expenditures for a

particular year may want to maintain part of such excess as an operating reserve. 21

However, if a material part of the excess is accumulated each year and the balance of

accumulated excess at any time is greater than the organization’s reasonable needs to

carry on its non-profit activities, profit will be considered to be one of the purposes for

which the organization is operated. 22 For example, a year-end accumulation equal to the

following year’s expenditures would probably be considered reasonable where an

organization carries out its annual fundraising drive in the last month of its fiscal period

in anticipation of its activities planned for the following year. However, where another

organization raises its funds on a regular basis throughout the year, it may be difficult to

justify a year-end accumulation in excess of an amount equal to its expenditures for one


20
   CRA document 2005-0114051E5, April 18, 2005.
21
   See paragraphs 8 and 9 of Interpretation Bulletin IT-496R, “Non-Profit Organizations”.
22
   That will be the case where an excess of income over expenditures persists over a long cycle of
operations, regardless of how such amounts are characterized for accounting purposes.
                                                  11



or two months. Where the present balance of accumulated excess is excessive or an

annual excess is regularly accumulated, it may indicate that the organization’s aims are

two-fold (i.e. to earn profits and to carry on its non-profit activities). In such a case, the

organization will not meet the operated exclusively for non-profit purposes requirement

in paragraph 149(1)(l) of the Act.


Many organizations use their surplus funds to establish reserves or contingency funds that

they deem necessary in the management of their affairs. CRA’s position with respect to

such funds is that, in general, they will not disqualify an otherwise qualifying not-for-

profit organization, if the reserves or funds are reasonable and reflect the organization’s

operational and risk-management requirements in carrying on its non-profit activities. 23

In addition, in cases where a special project requires a time period in excess of the current

and prior year to accumulate the necessary funds, CRA’s view is that such accumulation

of excess funds will not adversely affect the organization’s tax-exempt status if the funds

are accounted for in a separate special project fund until sufficient funds are accumulated

to carry out the specific special project. If the main purpose of the organization is to

provide dining, recreational or sporting facilities for its members, CRA recommends that

the special project fund consist of at least two separate accounts and that the capital of the

fund be credited to one account and that all amounts earned on the capital be maintained

in a separate account. 24 Provided that the funds accumulated in the special project fund

are used for that project, or to further the objects and purposes of the organization, there


23
     CRA document 9720343, 1997.
24
     See CRA document 9306405, August 18, 1993.
                                               12



will not be any tax consequences, other than the application of subsection 149(5) of the

Act to interest earned on the capital.


Where an organization that otherwise qualifies as a not-for-profit organization engages in

an unrelated profit making enterprise via a taxable, wholly-owned corporation and this

corporation pays dividends out of its after-tax profits to the organization, the organization

will not be precluded from qualifying as a tax exempt not-for-profit organization pursuant

to paragraph 149(1)(l) of the Act, provided the organization expends the dividends to

carry out its non-profit activities.


Where an organization owns the building it occupies and rents excess space, a question

often arises as to whether the rental of the excess space could jeopardize the

organization’s exempt status. CRA is not generally concerned when an organization

rents space in its building which is in excess of its current needs to carry out its objects.

The Agency will be concerned, however, when an organization acquires property that is

considerably in excess of what it might reasonably be expected to need in the foreseeable

future, that the property may have been acquired for the purpose of earning income. 25

Relevant considerations in such a situation would be the circumstances and purposes for

which the property was acquired, the duration of the profitable rental situation and




25
     See CRA document 2004-0092851E5, November 25, 2004.
                                                    13



whether the income earned during the period is used for the organization’s not-for-profit

objectives. 26


What appears clear from the jurisprudence is that activities pursued by an organization

which generate income will not jeopardize an organization’s tax exempt status, provided

the for-profit activities are ancillary to the not-for-profit activities and the income

generated by such activities is used by the organization in furtherance of its not-for-profit

objects. If, however, an organization devotes an unreasonable amount of its resources or

energies to profit-making activities, it could cause the organization to lose its tax-exempt

status under paragraph 149(1)(l) of the Act.               This is because the profit generating

activities would no longer be a means of funding the non-profit activities of the

organization, but rather the earning of profit, in and of itself, would be considered to have

become one of the objectives of the organization.


C.      Organizations Engaged in Providing Dining, Recreational and Sporting
        Facilities

When the main purpose 27 of an organization is to provide dining, recreational or sporting

facilities to its members, subsection 149(5) of the Act overrides the exemption in




26
   CRA document 2007-0224581E5, March 2, 2007.
27
   According to CRA, since there is no definition of “main purpose” in the Act, its determination in any
particular case is a question to be decided on the basis of all relevant facts. Nevertheless, CRA will
generally consider that a primary purpose would be one for which more than 50% of assets, revenues, time,
attention and efforts are expended: CRA document 2004-0060451E5, April 1, 2004. This suggests that the
main purpose test for an organization will be met where more than 50% of the assets of the organization are
utilized to provide dining, recreational or sporting facilities for its members.
                                                     14



paragraph 149(1)(l) of the Act and applies to deem the existence of an inter vivos trust. 28

The property of the organization is deemed to be the property of the trust and tax is

payable by the organization on its property income and on taxable capital gains from

dispositions of property, other than property used exclusively and directly by the

organization in the course of providing the dining, recreational and sporting facilities

provided by it for its members 29 , if the income from property and taxable capital gains

exceed $2,000. 30 For example, if such an organization were to rent space that is in excess

of its normal requirements, the rental income would be property income of the

organization and therefore taxable to the organization.


In order for subsection 149(5) of the Act to apply, the organization must either own or

lease 31 the dining, recreational or sporting facilities. Merely organizing or promoting a

particular sport is not sufficient to bring the organization within the taxing provisions of

subsection 149(5) of the Act. 32 However, in a technical interpretation, CRA opined that

where an organization incorporates a taxable corporation to hold and operate the sporting


28
   Not-for-profit organizations of the type described in subsection 149(5) of the Act must file T3 returns in
respect of their property income. Their income is subject to the highest marginal tax rate, which is
currently 29%. In addition, not-for-profit organizations that are corporations must file T2 returns.
29
   A gain realized on the sale of vacant land acquired in connection with a planned expansion of facilities
that was subsequently abandoned, was considered by CRA to be taxable, regardless of the reason for the
change in plans or the fact that the land was not used for any purpose whatever during the period it was
held: see CRA document 9306405, August 18, 1993.
30
   See generally, Interpretation Bulletin IT-83R3, “Non-Profit Organizations – Taxation of Income from
Property”.
31
   CRA opined that the main purpose of a hockey association that organized ice time for its member leagues
was to provide sporting facilities for its members: see CRA document 1991-218, September 1991.
32
   In Manitoba Curling Assn. Inc. v. M.N.R., [1984] C.T.C. 2567 (T.C.C.), the organization’s main purpose
was to organize and promote the game of curling in Manitoba. The Minister argued that because the
organization facilitated curling games, it came within the ambit of subsection 149(5) of the Act. The
organization was successful in its appeal, since the Court interpreted the word “facilities” to be a noun, not
a verb.
                                                15



facility, subsection 149(5) of the Act will apply to the organization if the organization’s

financial and operational relationship, as well as its services, are integrated with those of

the subsidiary corporation that owns the facility.33


If the income earned by the organization is income from business, as opposed to income

from property, subsection 149(5) does not apply. In Point Grey Golf & Country Club, 34

the organization had earned interest income from investments made by the organization,

which were earmarked for the construction of a new clubhouse.             The organization

appealed the Minister’s assessment under subsection 149(5) with respect to the interest

generated by the investments, on the basis that the interest constituted income from a

business. The Court dismissed the organization’s appeal and held that the organization’s

investment activities did not constitute a separate business since little labour or attention

had to be devoted to produce the return on the investments.


D.        Reorganizations of Not-for-Profit Corporations

Where a corporation is initially exempt from taxation and then loses its exempt status,

paragraph 149(10) of the Act applies. In general terms, when subsection 149(10) applies,

the organization is deemed to have its taxation year end immediately before the time of

the event that caused it to cease to be exempt. The organization is also deemed to have

disposed of all its assets for amounts equal to their fair market values immediately prior

to the deemed year-end, and to have immediately reacquired the assets for a cost equal to


33
     CRA document 2002-0119895, May 13, 2002.
34
     [1997] 1 C.T.C. 2721 (T.C.C.).
                                                  16



their fair market value. The effect of the deemed year-end and disposition rule is that any

gains that accrued on the assets of the organization while it was exempt from tax will not

be subject to tax. Any gains accruing on the assets after that time will be subject to tax.


As discussed below, most reorganizations do not trigger the application of subsection

149(10) of the Act. In addition, there are no tax consequences when an entity changes

from being exempt from taxation under one provision of the Act to being exempt under

another provision. For example, where a corporation that is for a period of time exempt

under paragraph 149(1)(d) becomes 30% owned by a person other than Her Majesty in

right of Canada, a province or a Canadian municipality, such that it no longer qualifies

for exemption under any of paragraphs 149(1)(d) to (d.6), but does meet the conditions

for exemption under paragraph 149(1)(l), there will be no income tax implications.


        i.       Amalgamations:

Where the legislation pursuant to which not-for-profit corporations are incorporated

permits amalgamation of such corporations, the corporations can amalgamate to form one

corporation with a combined membership and combined assets and liabilities.35 The Act

does not specifically address the income tax implications of the amalgamations of not-

for-profit corporations, however, CRA in various rulings has ruled that the amalgamation

of not-for-profit corporations will not result in the disposition of any of the assets of the




35
  Subsection 113(1) of the Ontario Corporations Act provides that corporations may amalgamate if they
have the same or similar objects. Corporations incorporated pursuant to the Canada Corporations Act may
not amalgamate.
                                               17



amalgamating corporations and that the cost and cost amounts 36 of the assets of the

amalgamated corporation immediately after the amalgamation will be equal to costs and

cost amounts of the assets to the amalgamating corporations immediately before the

amalgamation. In addition, CRA ruled that none of the members of the amalgamating

corporations would be considered to have received a gain on the disposition of their

memberships in the amalgamating corporations or to have received a benefit pursuant to

subsections 15(1), 56(2) or 246(1) of the Act as a result of the amalgamation of the not-

for-profit corporations. 37


          ii.     Winding-Up:

Upon winding-up, a not-for-profit organization will cease to be exempt from tax

immediately after the disposition of all or almost all of its assets.        Accordingly,

subsection 149(10) of the Act will apply immediately after the disposition of assets. Any

property distributed to members upon winding-up will be considered to be a capital

distribution to the members in satisfaction of their membership and will give rise to a

taxable capital gain to the members.


          iii.    Conversion From Corporation With Share Capital to Corporation
                  Without Share Capital:

A conversion from a corporation with share capital to a corporation without share capital

pursuant to paragraph 131(1)(f) of the Ontario Corporations Act is accomplished by way

of an application for Supplementary Letters Patent.               The application must be

36
     Within the meaning of subsection 248(1) of the Act.
37
     CRA document 2004-0103121R3, 2005, CRA document 2005-0142471R3, 2006.
                                                     18



accompanied by a special resolution of the directors and confirmed by at least 2/3 of the

votes cast at a meeting of the shareholders called for this purpose or confirmed in writing

by 100% of the shareholders entitled to vote at such a meeting. It appears that such a

conversion alters the constitution of the corporation, but does not generally result in the

original corporation ceasing to exist and a new corporation being created. Accordingly, it

is unlikely that the conversion would result in a disposition of property by the

corporation.


As regards the shareholders whose shares are redeemed as a result of the conversion, it is

not clear whether the corporation would be in contravention of the condition that no part

of its income be distributed to any proprietor, member or shareholder if it were to redeem

the shares for consideration.           It is also not clear whether the value of continuing

membership in the organization would be considered to be consideration for the

redemption of the shares. 38


         iv.      Conversion from Corporation Without Share Capital to Corporation
                  With Share Capital:

Where a corporation without share capital can, pursuant to the legislation of the province

of its incorporation 39 , convert to being a corporation with share capital, if the conversion

does not generally result in the corporation without share capital ceasing to exist and the

creation of a new corporation, for income tax purposes, the conversion will not result in a


38
  CRA refused to comment on this question in CRA document 2003-0007335, April 29, 2003.
39
  A corporation without share capital may apply under subsection 131(1) of the Ontario Corporations Act
for supplementary letters patent for the purpose of converting the corporation into a corporation with share
capital. The Canada Corporations Act does not provide for conversion into a share capital corporation.
                                               19



disposition of property by the corporation without share capital or any adverse tax

consequences to members. Although members of the corporation without share capital

could be issued shares of the corporation without adversely affecting the status of the

corporation under paragraph 149(1)(l) as a not-for-profit tax-exempt organization, the

Articles of Incorporation would have to make clear that the shareholders will not

personally benefit from the income, if any, of the corporation.40


          v.      Incorporation of Unincorporated Organization:

Incorporation of an unincorporated association will not, in and by itself, adversely affect

the association’s tax status under paragraph 149(1)(l) of the Act. 41


E.        Goods and Services Tax

Most supplies of goods and services by not-for-profit organizations are taxable, unless

the supply is otherwise prescribed in the Excise Tax Act as exempt or zero-rated. When a

supply by a not-for-profit organization is exempt, the organization is, in effect, treated

like a consumer: it pays the GST on purchases and does not receive input tax credits.

However, unlike consumers, certain non-profit organizations are entitled to a partial

rebate of the GST they pay.


The fact that some supplies are exempt and some are taxable creates complexity for the

non-profit sector. Each organization must determine which, if any, of its supplies are

exempt and which are taxable, and under what conditions. As well, each organization
40
     CRA document 2001-0086615, June 19, 2001.
41
     See CRA document 960807A, November 15, 1996.
                                                      20



must determine which purchases qualify for input tax credits (because they are purchased

for use in commercial activities) and which do not (because they are attributable to

exempt supplies).


Not-for-profit organizations must register for GST if they provide taxable supplies in

Canada and they are not a small supplier 42 .                  A not-for-profit organization that is

registered for GST must collect GST on its taxable supplies of goods and services and

can claim input tax credits for the GST it pays on expenses to provide these taxable goods

and services.         In addition, a special GST rebate allows certain not-for-profit

organizations, namely, organizations that receive government funding which represents at

least 40% of their total revenue for a particular fiscal year, to recover 50% of the GST

paid on purchases and expenses for which they cannot claim input tax credits. 43


Although most goods and services supplied by not-for-profit organizations are subject to

GST, the following exemptions apply specifically to the not-for-profit sector:


(a)      Free supplies: supplies of goods and services are exempt when all or substantially

         all (i.e., 90% or more) are provided free of charge.


(b)      Fund-raising activities: sales of goods are exempt when all of the following

         conditions are met:


42
   A not-for-profit organization is a small supplier in a particular calendar quarter if its worldwide revenues
from taxable supplies are $50,000 or less in the previous four consecutive calendar quarters. A small
supplier that is engaged in a commercial activity in Canada can choose to register voluntarily.
43
   There is no requirement that a not-for-profit organization be registered for GST to claim this rebate.
                                           21



             •       the organization is not in the business of selling those goods;


             •       all the salespersons are volunteers;


             •       the sale price of each item is $5 or less; and


             •       the goods are not sold at an event where similar goods are sold by

                     persons in the business of selling such goods.


      For example, the sale of chocolate bars door-to-door for $2 by players of a minor

      hockey league organization is exempt from GST.


(c)   Gambling activities: admissions to gambling events are exempt if the following

      conditions are met:


         •   90% or more of the administrative functions and taking of bets are carried

             out by volunteers; and


         •   for a bingo or casino event, the games are not held in a commercial hall or

             any other place used primarily for gambling activities.


(d)   Goods and services sold for direct cost: the direct cost exemption applies to sales

      of goods and services that are bought for resale. If an organization wants to
                                                    22



        recover only its direct cost 44 , it can choose to make its sales either taxable or

        exempt.


        The sale of goods and services is exempt if the amount the organization charges is

        equal to or less than its direct cost and the organization does not charge GST to its

        customers.


(e)     Memberships: memberships sold by non-profit organizations can be exempt or

        taxable depending upon the type of benefits the members are entitled to. The

        following benefits are permitted when determining whether memberships sold by

        not-for-profit organizations are exempt:


             •   an indirect benefit that is intended to accrue to all members collectively;


             •   the right to receive services in the nature of investigating, conciliating, or

                 settling complaints or disputes involving members;


             •   the right to vote or participate in meetings;


             •   the right to receive or acquire goods and services for an additional fee

                 equal to the fair market value;




44
  Direct cost includes the amount paid when the goods or services were bought, the amount paid for an
article or material directly used to manufacture, produce, process or package the goods and GST/HST,
Quebec sales tax, and non-recoverable provincial taxes, duties and fees paid when the goods or services
were bought.
                                                     23



             •    the right to receive a discount for goods or services sold by the

                  organization when the total value of all the discounts is insignificant (less

                  than 30%) in relation to the membership fee; or


             •    the right to receive periodic newsletters, reports or other publications if:


                           the value of the newsletters, reports, and publications is

                           insignificant (less than 30%) in relation to the membership fees; or


                           the newsletters, reports, and publications provide information on

                           the organization’s activities or financial status except if their value

                           is significant in relation to the membership fee and a fee is

                           ordinarily charged to non-members.


         Memberships in an organization are taxable if the main purpose of the

         organization is to provide dining, recreational, or sporting facilities to its

         members, such as a membership in a golf club.


         An organization can elect to have its membership fees be taxable, even it they

         would otherwise be exempt. This choice allows an organization to claim input tax

         credits for any expenses related to the memberships. 45




45
  As a result of this election, a not-for-profit organization would, for purposes of the Excise Tax Act, be
considered to be carrying on commercial activities. “Commercial activity” is defined in section 123 of the
Excise Tax Act, to include any business carried on, but does not include any activity without a reasonable
expectation of profit. In response to concerns that this election might preclude a not-for-profit organization
from qualifying as a tax-exempt organization under paragraph 149(1)(l) of the Act, CRA commented that
                                                     24



(f)      Recreational programs: membership fees and services for recreational programs

         established and operated by not-for-profit organizations are exempt if they consist

         of supervised instructional classes or activities involving athletics, outdoor

         recreation, music, dance, crafts, arts, hobbies, or other recreational pursuits in the

         following circumstances:


             •    the program is primarily provided to children 14 years old or younger, and

                  a large part of it does not involve overnight supervision.


             •    the program is provided primarily to underprivileged individuals or

                  individuals with a disability.


(g)      Relief of poverty, suffering or distress: food, beverages, or short-term

         accommodation provided to relieve the poverty, suffering or distress of

         individuals are exempt.           For example, GST does not apply to meals or

         accommodation at a shelter for needy individuals. Prepared meals provided in an

         individual’s home through programs designed for seniors, underprivileged

         individuals, or individuals with a disability, such as meals-on-wheels programs,

         are exempt.


(h)      Sponsorships: not-for-profit organizations often receive sponsorships from

         businesses to fund their activities.             In return, the organization may provide

         promotional services to the sponsor or may allow the sponsor the right to use its

the election would not adversely affect the status of such an organization under paragraph 149(1)(l): see
document 154, November 1990.
                                                    25



         logo or trade name. GST does not apply to these sponsorships, except when the

         payment made by the sponsor is primarily (i.e., more than 50%) for advertising on

         television, radio, in a newspaper, magazine, or other publication issued

         periodically. For example, GST would not apply where a corporation agrees to

         sponsor a not-for-profit soccer team in return for having its name on the team’s

         uniform. 46


F.       Compliance Matters

A corporation that qualifies as a non-profit organization under paragraph 149(1)(l) of the

Act is exempt from Part I tax, but is required to file an information return, Form T1044,

with its T2 income tax return 47 . However, pursuant to subsection 149(12) of the Act, if

the corporation has not earned more than $10,000 in interest, rentals or dividends, does

not own more than $200,000 in assets or was not required to file an information return for

any preceding fiscal period, then the corporation is not required to file a Not-for-Profit

Information Return for the period. 48 Accordingly, once an organization has been required

to file an information return, it will from that point on be required to file an information

return on an annual basis.




46
   For a comprehensive review of the GST rules as they apply to not-for-profit organizations, see Wood,
Peter H., “The GST: Charities and Other Non-Profit Organizations”, Report of Proceedings of the Forty-
Third Tax Conference, 1991 Conference Report (Toronto: Canadian Tax Foundation, 1992), 30: 1-53.
47
   Subsection 150(1) of Act.
48
   Prior to 1993, there was no uniform requirement for not-for-profit organizations to file anything,
although organizations that were a corporation were required to file a T2 return and trusts were required to
file a T3 return. As a result of the Auditor General’s report commenting on the lack of a general filing
requirement for not-for-profit organizations, subsection 149(12) was introduced in 1992 to require uniform
filing of an information return for years after 1992.
                                                     26



As regards the directors of a not-for-profit corporation, they may be liable for any taxes

that are owed by the organization on income that is not exempt from the payment of

taxes, such as property income where the organization is subject to subsection 149(5) of

the Act, as well as any goods and services tax that the organization was required to

collect and remit to CRA.


In addition, CRA has opined that section 159 of the Act could apply to the directors of an

organization if the organization has failed to comply with paragraph 149(1)(l) of the Act

and has then become a taxable entity. 49




49
  Supra, note 15. Subsection 159(1) of the Act provides, in part, that a legal representative acting for
another person is jointly and severally liable for each amount payable by the other person under the Act, to
the extent that the representative has possession and control of the other person's assets. If the
representative distributes assets of the other person before obtaining a certificate from the Minister of
National Revenue that the other person's tax debts have been paid, the Minister may, under subsection
159(3) of the Act, assess the representative for the amount of the debt.

								
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