The following is a summary of the Tax Concession Working Group’s Discussion Paper on potential reforms to the Not-for-profit Sector. The Working Group attempts to determine whether there are fairer, simpler and more effective ways of delivering the current envelope of support provided through tax concessions to the NFP sector. Accordingly, the Paper sets out a number of arguments which identify areas of concern pertaining to the current tax concessions available for NFP organisations. It consequently proposes a number of alternative reform measures which may be implemented to overcome such issues.
Income Tax Exemption and Refundable Franking Credits
Through future reform the Australian Government hopes to better target NFP tax concessions, develop a statutory definition of charity, and restate and standardise the special conditions for tax concession entities.
Current income tax exemption – types of exempt entities
The current tax law provides an income tax exemption to entities that primarily undertake purposes that are broadly beneficial to the community, such as charitable, religious, scientific and public educational institutions.
Income tax exempt entities must generally meet the ‘in Australia’ special conditions by operating and pursuing their purposes principally in Australia.
Concerns about income tax exemption
The principles guiding the income tax concessions are fairness, simplicity and effectiveness. While the tax concessions have continued to have a simplistic application, the development of the guidelines over the years have led to questions regarding the fairness of the concession – particularly in their application to entities that fall just outside the boundaries of the exempt categories.
Option 1.1. Who should be eligible for exemption form income tax?
Involves extending the categories of exempt entities such that a net gain in social benefit can be achieved by limiting concession and redistributing the benefits elsewhere.
Accordingly, it is necessary to consider what types of entities should be entitled to the income tax exemption, whether any special conditions should be attached to eligibility and whether these should be uniform or differ between different types of entities.
Refunds of franking credits
Options 1.2. Who should be eligible for refunds of franking credits?
One option is to extend the concession to a greater ranger of NFPs, however this may have revenue implications (with Australia Government expenditure growth already exceeding revenue growth).
Additionally, this may allow large, well-resourced NFPs to become eligible for refunds of franking credits, and such tax expenditure could probably be used for the benefit of a broader range of entities.
Other issues and reform options
Option 1.3. Extending the ATO endorsement framework
As the law currently stands for charities, income tax exemptions and other tax concessions are only available if the Commissioner of Taxation endorses the entity as a charity. However, other types of income tax exempt entities do not require endorsement from the Commissioner. Accordingly, it has been suggested that all NFP entities should require endorsement from the Commissioner in order to obtain income tax exemptions and other tax concessions. This could be linked to the extension of the Australian Charities and Not-for-profits Commission (ACNC) regulatory framework.
Option 1.4. Rewrite and consolidate rules for State, Territory and local government bodies.
The exemptions for government-owned bodies which resulted from an extension of the exemptions contained in the ITAA 1936 could be simplified and consolidated into the ITAA 1997.
Option 1.5. Increasing the tax free threshold for taxable NFPs
Taxable NFP companies must lodge a tax return if their annual income exceeds $416. No tax is applied to the first $416 of income. A rate of 55 per cent applies to income ranging between $417-$915 and 30 per cent tax applies to income of more than $916.
While this may reduce the regulatory and compliance burden when applied to small NFP companies, it may incentivise larger companies to create multiple entities to benefit from multiple tax-free thresholds, creating a compliance issue.
Deductible Gift Recipients (DGRs)
General DGR categories and endorsement
Division 30 of the ITAA 1997 sets out around 50 general DGR categories, the most significant of which is the public benevolent institutions (PBIs) which fall within the ‘welfare and rights’ category. This term has been interpreted strictly by courts and requires direct provision of services by an institution for the relief of needs that require benevolence.
As a general rule, all entities wishing to be endorsed as DGRs must formally apply for endorsement, with endorsement generally being ‘entity based’, rather than ‘activities based’. TO be endorsed, an entity must fit into one of the categories under Div 30 and satisfy an special conditions associated with the category under which they are seeking endorsement.
Specific DGR listing
Entities can also become DGRs by requesting specific DGR listing in Div 30.
This process is quite lengthy as it requires a legislative change to Div 30. Entities must satisfy Government agencies that they meet the requirements. Then these agencies must investigate the accuracy of the information provided and recommend whether the entity should be specifically listed by the Parliament.
Obtaining a listing on one of the four DGR registers involves entities applying directly to Australian Government agencies that administer the DGR registers. This can be a lengthy process.
Concerns with the DGR Framework
Eligibility – overlapping categories of entity type
The requirement to fit into a general DGR category presents problems for entities that undertake activities that fit within, or are covered by, more than one general DGR category as they may have to restrict their purposes and activities to fit within one general DGR category. In the alternative, they may set up other funds, authorities or institutions to carry on activities which fall within in a single category. Regardless, this generates increase compliance and administration costs.
Moreover, under the ITAA 1997, ‘entity’ is defined such that it includes a trust but does not include a fund. Hence, it is possible for some larger NFP entities to operate several DGR funds or institutions as described in the previous paragraph.
The Productivity Commission Report in 2010 noted that few than half of all charities endorsed as income tax exempt are endorsed as DGRs. Consequently, it recommended extending the DGR status to all tax endorsed charities in the interests of fairness and simplicity. This would overcome the issue of distortion of donations towards DGRs and away from other charities that operate for the public benefit and have a charitable purpose.
Mechanism for encouraging charitable giving
Currently, Australia’s DGR framework allows taxpayers to claim a tax deduction for gifts to DGRs. The benefit taxpayers receive from the deduction is equivalent to their marginal tax rate, meaning high income earner receive a greater benefit in terms of reduction in payable income tax than lower income earners.
A tax offset (or rebate) would remove the regressive nature of the current tax deduction system.
Option 2.1. Extending DGR status to all charities such that all charities would be eligible for endorsement as a DGR entity
This would improve the fairness of Australia’s DGR framework by making all charities operating for the public benefit eligible to be endorsed as DGRs (thus eliminating the need for entities to fit within one of the DGR general categories or be specifically listed in Div 30). It would also encourage charitable giving by expanding the scope of DGR entities.
However, there are a number of issues with this proposal. Firstly, the current framework ensures that public funds are not used in an inappropriate manner to provide a private gain or benefit. However, there are some charities (for example NFP non-government schools) which provide significant private benefits to certain individuals that access their services. Not only does this give rise to integrity issues but it may also result in a significant increase in the revenue costs associated with the DGR concession.
Secondly, extending DGR status to all charities would have a significant fiscal cost which has been estimated to be at least $1 billion per annum – which is particularly high given the current fiscal environment.
Option 2.2. Extending DGR status to most charities, such that all charities except for those who provide primary and secondary education, charitable child care and are established for the advancement of religion, would be eligible for endorsement as a DGR entity.
Arguably, while this option overcomes the issues addressed in Option 2.1, it still maintains some of the complexity and distortions of the existing DGR framework. Moreover, it would be inconsistent with the approach of the ACNC Bill 2012, which states that an entity can be registered as a charity and have multiple sub-type registrations.
Option 2.3. Establishing endorsement conditions relating to the scope of charitable activities
This would allow DGR endorsement to remain at entity level and for endorsement conditions to be established to limit the scope of activities for which an entity can use its DGR funds. This would allow all charities to remain eligible for endorsement as a DGR but could not use DGR funds for the advancement of religion, charitable child care services, and primary and secondary education.
According to Treasury estimates, this would provide 42,000 charities with access to DGR funds (an increase of approx. 14,000) and would have a revenue cost of approximately $120 million per annum.
Option 2.4. Implementing a tax offset mechanism for gifts
The Treasury is currently performing a preliminary analysis of implementing a two-tiered fixed tax offset (or rebate) in place of the current system, with a 34 per cent offset for donations of up to $1,000 per year and a 38 per cent offset for donations of more than $1,000. This mechanism would be much simpler than the current one, and produce minor administrative costs for the Government and taxpayers whilst continuing to encourage donations to DGRs.
The Productivity Commission estimates a small overall decline in the level of giving to DGRs if these tax offset levels are implemented. However, from the Government’s point of view, an offset rate of 38 per cent is revenue-neutral.
Option 2.5. Hybrid system for donations to private ancillary funds (PAFs)
Under such a system, donations to PAFs could attract a tax deduction under the current deduction mechanism, and donations made directly to DGRs could be offset under a single or multiple tax offset mechanism.
Option 2.6. Tax incentives to encourage testamentary giving
The Mitchell Review of Private Sector Support for the Arts (March 2012) recommended that the Government introduce the capacity for private donors to make testamentary gifts in their wills to DGR art organisations, and receive an immediate tax deduction equal to the present value of the gift. The option also proposes that the deduction be allowed at the time the gift is included in will and not at the time of death.
However, this option lacks simplicity and effectiveness in its application, as the ATO would be required to estimate the present value of a testamentary gift, which would include an assessment of the life expectancy of the donor.
Moreover, implementing the Mitchell Review recommendations would require the exemption from CGT which currently applies to testamentary gifts to be repealed to prevent testators from benefiting from multiple tax benefits in relation to the same testamentary dispositions. Consequently, this would reinstate one of the previous barriers to testamentary giving to DGRs.
Option 2.7. Creating a clearing house for donations to DGRs which is linked to the ACN register could promote and encourage charitable giving.
A clearing house could provide the following benefits:
- Enable individual taxpayers to use one website to access information on all registered charities, enabling them to make an inform choice regarding their donations
- Simplify the making of cash gifts to DGRs, and provide a secure mechanism for individual taxpayers to make credit card donations to one or more DGRs in a single transaction
- Taxpayers could access the clearing house website for details of the deductible cash gifts during the financial year, thus reducing the compliance and administrative costs of DGRs
- Smaller charities with limited or no online fundraising facilities would greatly benefit from this mechanism
- It may assist increased workplace giving (Australia’s rate of workplace giving of 0.6 per cent, is considerably lower than that in the UK (1.3 per cent) and Canada (5.6 per cent)).
- Increased accountability and transparency
Option 2.8. Simplify property donation rules and anti-avoidance rules to reduce transaction costs associated with gifts
Current property donation rules are complex and may be confusing. Moreover, the valuation methods for obtaining a tax deductible amount for specific property types may be costly. Reforms could simplify these valuation rules.
The gift rules are complemented by integrity provisions. Reforms could simplify and strengthen the integrity rules for gifts so that donors have more certainty and safeguards continue to protect the integrity of the Australian tax system.
Option 2.9. Eliminate public fund requirements for charities registered by the ACNC
The current public fund requirements under Taxation Ruling TR 95/27 intend to ensure that moneys and property donated to the fund, which attract a tax concession, are used for the purpose for which the fund has been granted DGR status.
However, if an entity is registered by the ACNC and operating under its governance standards, it is more likely that the donated funds will be used for the purpose for which the entity has been granted DGR status.
Option 2.10. Increase the threshold for a deductible gift from $2 to $25
The main purpose of any change (whether it be different to that stated above or higher) would be to simplify administration for DGRs and donors. It would also reduce the compliance burden associated with providing receipts for donations of $2 or more.
It is likely that many donors of small sums do not claim a tax deduction so any change to the threshold may have minimal impact on donor behaviour. It may also encourage larger individual donations. Any concerns about a reduction in workplace giving through an increased threshold could be overcome by an
exception to donations made in such circumstances.
Fringe Benefits Tax Concessions
Concerns with the current fringe benefits tax concessions
There are a number of concerns with the current FBT concessions:
- Inconsistency of treatment – The only entities entitled to the exemption are PBIs, public and NFP hospitals, health promotion charities, ambulance services and religious entities. Some, but not all, income tax exempt entities are entitled to the rebate. Some of those not eligible for the rebate include entities that can access the exemption or those that are funds, rather than institutions.
- Issues of competitive neutrality where eligible entities compete directly with businesses that do not benefit from the FBT concessions – Entities entitled to the exemption have a competitive advantage over for-profit organisations in hiring and retaining staff, and also over other NFP entities that are not eligible for the exemption. Arguably, the concession might also be seen as a form of assistance to compensate for other disadvantages (e.g. impediments to the NFPs raising external finance).
- Use of concessions outside of initial policy intent
- Administrative burdens – There are considerable compliance burdens associated with FBT concession, including the requirement to organise and offer salary packaging and the recording and reporting requirements.
Revise the list of entities eligible for the exemption or rebate
Short term reforms
Currently, caps of $17,000 and $30,000 (gross) apply to fringe benefits provided by some NFP entities. However, meal entertainment and entertainment facility leasing benefits are unlimited as they are currently exempt from these caps. Consequently, an option could be, to require these types of benefits to be counted towards the respective caps.
Under the current framework, FBT caps are applied to employers rather than employees. Accordingly, an employer with several employees can access the full value of an additional cap for each employee. Consequently an option is to require employment declarations to include information about FBT concession to avoid employees from benefiting from multiple caps.
To align the FBT rate and the FBT rebate rate to avoid overcompensating eligible NFP entities for the effect of the FBT. As it currently stands, the FBT rate is 46.5 per cent and the FBT rebate rate is 48 per cent.
Align the minor benefit exemption with the commercial sector, which would allow NFP sector employers (subject to certain conditions) to be able to provide tax free benefits of up to $300 to employees.
Phase out capped FBT concessions and replace with alternative government support, for example by redirecting savings by direct funding for specific projects or funding to assist with recruitment of specialist staff.
Phase out FBT concession and replace with alternative tax-based support mechanisms for eligible NFP entities
- Alternative #1: Refundable tax offsets payable to eligible entities, which would provide a more transparent incentive to be employed in the NFP sector.
- Alternative #2: A direct tax offset for employees of eligible entities, which would result in a direct reduction in income tax on an employee’s salary. It would replace the value currently derived from FBT concession in remuneration packaging for employees of eligible entities.
- Alternative #3: Tax free allowances for employees of eligible entities. This would provide a higher tax benefit to higher income earners, whilst the tax-offset option discussed above would provide the same tax benefit to all employees. The compliance burden for this option would be minimal, as the employee’s payment summary will disclose the identity of their employer.
While capped FBT concessions would be retained, the benefits that are allowable under the caps would be limited to benefits that are incidental to employment i.e. ‘non-remuneration benefits’
Goods and services tax concessions
The GST concessions that are available to NFP entities vary depending on the type of body.
A number of administrative concessions are available for NFP entities that help to simplify their reporting and accounting obligations.
Firstly, NFP bodies have a higher GST registration threshold ($150,000) compared to other entities which have a threshold of $75,000. Hence, NFP’s with smaller turnovers can choose to stay out of the GST system and avoid having to report and account for GST on the supplies they make. If NFP’s which do not reach the threshold do register for GST, they are able to claim input tax credits. However, this also means that they are required to include GST on any taxable supplies they make.
Input tax credits for volunteer reimbursements
Under the normal GST rules, input tax credits are generally only available for acquisitions that relate to the activities of a GST registered entity. Additionally, some NFP entities may claim input tax credits for reimbursements made to volunteers for expenses incurred that directly relate to their activities as a volunteer of that NFP body.
Concerns with the current GST concessions
The only concerns that have been raised are minor issues with compliance burdens around fundraising and non-commercial supplies.
As all GST revenue is paid to the States and Territories, it must be noted that any savings made from reforms in this area will not be reinvested in the NFP sector without agreement from the States and Territories. Any additional revenue will need to be paid to the States and Territories unless they agree otherwise. Any change to the rate or base of the GST requires the unanimous agreement of the State and Territory governments.
The first reform option (Option 4.1.) is to adopt a principles-based approach to the fundraising concession which would replace the current concession for fetes, balls, gala shows, dinners, performances and events where all goods are sold for $20 or less outside the ordinary course of the NFP body’s business. The second option (Option 4.2.) is to provide an opt-in arrangement for GST treatment of non-commercial supplies, which would otherwise increase compliance costs in cases where only a small number of supplies are non-commercial.
Mutuality, clubs and societies
A consequence of the principal of mutuality is that expenses related to members’ income are non-deductible.
However, some mutuals are not eligible for tax exemptions based on the mutuality principle, these include life insurance companies, friendly societies, mutual insurance
Mutual associations and clubs are also assessable on statutory income, such as capital gains, under specific provisions of the ITAA 1997.
Concerns about the principle of mutuality
The main concerns which have been expressed about operation of the mutuality principle are:
- uncertainty and complexity in operation in some cases, for example, tracking mutual and non-mutual receipts;
- competitive neutrality concerns where clubs carry out trading activities with members in competition with non-exempt businesses;
- social policy concerns especially given revenue foregone, for example, because much revenue of wealthier clubs is derived from gambling and hospitality (alcohol) services to members; and
- a concern about clubs issuing temporary memberships to the wider public. Particularly when determining whether the income from those individuals mutual income, and if so, whether it should be mutual income.
While other NFPs must spend their income/surplus on their specified charitable or other purposes, clubs which have a tax-free surplus resulting from the mutuality principle are free to spend their mutual receipts as they wish (subject to their objects).
Furthermore, larger clubs which are not income tax exempt but still benefit from the mutuality principle and have significant untaxed surpluses may be prone to engaging in substantial building or capital works activities for the benefit of members. This raises concerns as to whether the accumulated untaxed surplus is for what may be perceived as a private benefit. This is particularly an issue where the link between members and clubs is weakened, or where temporary or instant memberships are prevalent.
Trading activities arising from gaming, catering, entertainment and hospitality activities of mutuals should be subject to a concessional rate of tax on net income earned above a relatively high threshold.
Extend the mutuality principle such that the types of entities that are not subject to income tax are expanded. This would be encompassed through the legislation pertaining to tax concessions for mutual entities.
Repeal the common law principle of mutuality and replace it with legislation. Under the new tax concessions legislated, the types of entities that are not subject to income tax would be narrowed.
Specific anti-avoidance rules could be enacted which deal with circumstances whereby mutual entities avoid tax by reliance on the mutuality principle. This would address the issue of fairness.