In the 2009-10 Budget, the former Government announced that it would amend the ‘in Australia’ special conditions for tax concession endorsements as found in the Income Tax Assessment Act 1997 (ITAA 97).
Since that announcement, the following steps have taken place:
- July/August 2011 – First exposure draft & public consultation period;
- April/May 2012 – Second exposure draft & public consultation period;
- 23 August 2012 – Tax Laws Amendment (Special Conditions for Not-for-profit Concessions) Bill 2012 (the 2012 Bill) introduced to Parliament;
- 29 June 2013 – Some of the provisions of the 2012 Bill were enacted in the Tax Laws Amendment (2013 Measures No. 2) Act 2013 with effect from 29 June 2013. From that time, for an entity to be exempt from income tax, it must (a) comply with all the substantive requirements in its governing rules; and (b) apply its income and assets solely for the purpose for which the entity is established;
- 5 August 2013 – the 2012 Bill lapsed at the dissolution of Parliament;
- 14 December 2013 – the present Government announced that it would proceed with reforming the “in Australia” requirements. (It also announced that it would not proceed with defining ‘not-for-profit’ throughout the tax laws, which had been a part of the 2013 Bill.)
The latest development
On 12 March 2014 new draft legislation, draft regulations and explanatory material was released – Restating and Centralising the Special Conditions for Tax Concession Entities. We enter a new consultation period. The Government is inviting submissions from all interested individuals and organisations, with submissions closing on 7 April 2014.
The Government has indicated that improvements have been made to the exposure drafts to address concerns raised by the not-for-profit sector in relation to the 2012 Bill.
Full details of the exposure drafts and explanatory materials may be found here.
Summary of the new special conditions for tax exempt entities
Under the latest draft, for an entity to be exempt from income tax it must satisfy the following special conditions:
1. be a non-profit entity; and
2.(a) operate principally in Australia; and
(b) pursue its purposes principally in Australia; and
3. (a) comply with all the substantive requirements in its governing rules; and
(b) apply its income and assets solely for the purpose for which the entity is established.
No substantive change from the new special conditions as expressed in the 2012 Bill.
The “in Australia” requirement
As has been noted previously, the re-stated “in Australia” special condition (refer 2 (a) & (b) above) moves away from the expenditure based test in the current “in Australia” requirement. This will allow the Commissioner to consider a wider range of circumstances in determining if the condition is satisfied. The explanatory material notes, at para 1.59:
… the Commissioner is expected to consider all surrounding circumstances: including factors such as where the entity incurs its expenditure; where it undertakes its activities; where the entity’s property is located; where the entity is managed from; where the entity is resident or located; where its employees or volunteers are located; and who is directly and indirectly benefitting from its activities.
“Principally” means mainly or chiefly. Less than 50% is not considered principally. (Explanatory Material Para 1.60)
As is currently the case, tax exempt entities have an obligation to self-assess their ongoing entitlement to exemption. The wider range of circumstances that must now be considered in relation to the “in Australia” requirement will potentially make this self assessment more difficult.
“Tracing” of money given to another entity
As was the case with the 2012 Bill, if a tax exempt entity provides money, property or benefits to another entity, and the other entity is not tax exempt, then the use of that money, property or benefit by the receiving entity (or any other entity that it is subsequently passed on to) must be taken into account when determining whether the original tax exempt entity has satisfied the “in Australia” requirement.
This requirement to trace gifted monies was a cause for concern with the 2012 Bill. The Government has responded to these concerns by inserting an additional clause into the latest draft that limits the tracing requirement as follows:
…take into account the use of the money, property or benefits by an entity outside Australia only to the extent that it would be reasonable to expect the first-mentioned entity to have knowledge of, or to obtain knowledge of, the use of the money, property or benefits outside Australia.
We welcome this addition although what “reasonable” means may cause some concern and will take some time to be clear. What is “reasonable” would no doubt be greater the greater the value of the benefit moving overseas.
While the explanatory materials make the point that the tracing requirement ‘should present no greater an obligation on entities than already exists under charity law and the existing ATO endorsement framework’ (para 1.81), it is a wake up call to entities to be vigilant about how their funds are used, and where they ultimately end up. Your obligations don’t end when the funds go out of your bank account.
Under the current “in Australia” requirement, money or property received by a tax exempt entity by way of gift or government grant, and which the entity distributes overseas, can be disregarded in determining whether the entity satisfies the current “in Australia” requirement. (Section 50-75 ITAA 97)
When the first exposure draft re-stating the “in Australia” special condition came out in July 2011, the ‘disregarded amounts’ provision was completely removed. It re-appeared in the next draft and was included in the 2012 Bill, but significantly changed from its current form. The latest draft is virtually identical to the 2012 Bill in this regard, but the Government has now released draft regulations, which were really essential to be able to give full meaning to the re-stated disregarded amounts provision.
Essentially, an entity will only be able to disregard money it has received by way of gift or government grant in determining if it satisfies the re-stated “in Australia” requirement, if it complies with the regulations as set out below.
Also, to be able to rely on the disregarded amounts provision, the provider of the gift to the tax exempt entity must not be entitled to a DGR receipt, and must not itself be a tax exempt entity.
The draft regulations setting out conditions to be complied with in order to make use of the disregarded amounts provision:
(2) The entity must take reasonable steps to obtain evidence showing that:
(a) the activities it conducts outside Australia are a genuine attempt to give effect to its purposes; and
(b) the use by the entity of money or property outside Australia is effective in achieving the entity’s purposes.
[Our note: Your “Purposes” need to be carefully examined to ensure that they extend to advancing your charitable purpose overseas or at least are not limited to Australia.]
(3) If the entity works with another person (however described) that:
(a) is located in a country in which the entity conducts an activity; and
(b) works with the entity on the activity;
the entity must take reasonable steps to obtain evidence showing that it effectively interacts and coordinates the conduct of the activity with that person.
(4) The entity must not have engaged in conduct, or failed to engage in conduct, in circumstances in which the conduct or failure may be dealt with under an Australian law:
(a) as an indictable offence (whether or not the law also permits it to be dealt with as a summary offence); or
(b) by way of a civil penalty of at least 60 penalty units.
Note 1: The entity is always expected to comply with all Australian laws. An infringement of an Australian law that is serious enough to attract a penalty mentioned in subregulation (4) means that the entity cannot obtain the benefit of subsection 50?50(5) of the Act.
Note 2: Section 4AA of the Crimes Act 1914 explains the current value of a penalty unit.
Note 3: The operation of some Australian laws has been extended to overseas jurisdictions. Subregulation (4) is not intended to extend the operation of any Australian law to an overseas jurisdiction.
(5) If the entity is a registered entity under the Australian Charities and Not?for?profits Commission Act 2012, it must be in compliance with the governance standards under that Act:
(a) to which it is subject; or
(b) to which it would be subject but for any provision of that Act limiting the application of those standards to it.
(6) If the entity is not a registered entity under the Australian Charities and Not?for?profits Commission Act 2012, it must have reasonable processes in place:
(a) to ensure that it is giving effect to its purposes as set out in its governing rules; and
(b) to manage the risk of a breach of its governing rules; and
(c) to manage the risk of fraud or misconduct by an entity responsible for the management or administration of the entity.
The draft regulations are not as onerous as what had been hinted at in earlier material; however it is clear that a considerable compliance burden will fall upon those entities wanting to rely upon the disregarded amounts provision, and this will be felt most by smaller, less resourced entities.
We also note that the effect of draft item (5)(b) above, is to require a Basic Religious Charity (as that term is used under the Australian Charities and Not?for?profits Commission Act 2012) that wishes to make use of the disregarded amounts provision, to comply with the ACNC governance standards, which it is otherwise exempt from.
The final and important point to note is that if you are confident that you can satisfy the re-stated “in Australia” condition without relying upon the disregarded amounts provision, this would clearly be the preferred course, as then you will not be burdened by the additional regulatory requirements.
For many entities whose operations are Australia focused, and whose overseas involvement is minimal, the re-stated “in Australia” special condition should not be problematic.
For those entities which have a strong overseas focus, and for people contemplating establishing a new entity with an overseas focus, the compliance burden, and the resourcing required to meet that burden, will need to be carefully considered.
We note that our above commentary is limited to addressing the draft changes for tax exempt entities, and does not address the draft changes for deductible gift recipients.
As noted at the beginning of our commentary, the latest released materials are only exposure drafts, and we have entered another consultation period. There is still a long way to go before we have new legislation in place. We will be continuing to monitor developments.