2. NFP Reform Paul Ingram, 6 June 2012

3. What is happening? Proposed MeasureProgress to dateProposed start date Unrelated commercial activitiesConsultation Paper1 July 2012 In Australia (and other) requirements Second Exposure Draft First income year starting after date of Royal Assent Establishment of the ACNC: - General - Governance rules - New reporting framework - Fundraising reform Exposure Draft Consultation Paper Exposure Draft and Discussion Paper Consultation Paper 1 October 2012 1 July 2013 ? Statutory definition of charityConsultation Paper1 July 2013

4. Unrelated Commercial Activities

5. Background TR 2005/21 A purpose of carrying on a business or commercial enterprise as such is not charitable. This is the case even if the entity carrying on the enterprise is controlled by a charitable institution or its profits are ultimately applied for charitable purposes. However, a business or commercial enterprise that is merely incidental to the carrying out of a purpose that is otherwise charitable does not by itself prevent that purpose being charitable.’ (emphasis added)

6. Background Many tax advisers felt the ATO view was too narrow View that commercial activities should be acceptable as long as the profits are used for charitable purposes Crucial issue is not how moneys are raised, but how they are spent

7. Background Word Investments [2008] Company limited by guarantee established by Wycliffe Carried on purely commercial activities Funeral business General investment All profits gifted to Wycliffe

8. Background High Court: Word is a charitable institution Word endeavoured to make a profit, but only in aid of its charitable purposes. To point to the goal of profit and isolate it as the relevant purpose is to create a false dichotomy between characterisation of an institution as commercial and characterisation of it as charitable. Activities were not intrinsically charitable, but charitable in character because they were carried out in furtherance of a charitable purpose.

9. Government Takes Action ‘Better Targeting of Not-for-profit Tax Concessions’ Government will reform the use of tax concessions by businesses run by NFP entities Rules deal with ‘Unrelated Commercial Activities’ (UCAs) Start 1 July 2012

10. Key Aspects Income Tax NFPs will pay income tax on profits from UCAs, but only where those profits are not directed back to their altruistic purpose (ie. accumulated) DGR, FBT and GST concessions cannot be used to support UCAs Structuring/accounting rules Three different options being considered

11. Definition of UCAs Consultation Paper is quite vague Reforms will not affect commercial activities which ‘directly further an NFP entity’s altruistic purpose, even where the activity is done in a commercial way’ Such activities will be ‘related’ or ‘primary’ But no clear definition

12. Definition of UCAs Perhaps three ‘easy’ categories Activities that are intrinsically charitable, but carried out in a commercial way NFP hospitals Op shops NFP child care centres Businesses providing meaningful employment to the disadvantaged Passive investment

13. Definition of UCAs Beyond that? May need to demonstrate that the commercial activity is ‘incidental’ or ‘ancillary’ to the altruistic purpose Best guide: examples in Appendix 3 But distinction between ‘related’ and ‘unrelated’ remains unclear.

14. Definition of UCAs Eg. Schools Some activities related Tuck-shop, including sale of uniforms and text books Using hall and volunteers to run Bingo two afternoons a week to raise money for the school But what about more extensive public use of school facilities?

15. Definition of UCAs Small scale exception Consultation Paper refers to ‘small scale and low-risk activities, such as lamington drive fundraisers, school fetes and leasing out of church halls’ But how set the threshold?

16. Structuring Rules Option 1 UCAs would have to be undertaken through a separate entity, which would be taxed equivalently to commercial entities Will generally be able to negate income tax at the separate entity level gift to parent (if a DGR) dividends to parent (if DGR/charity) trust distributions (other NFPs)

17. Structuring Rules Option 1 (cont.) But there are other issues Income tax at NFP level (if it accumulates) No input tax concessions in separate entity (eg. FBT) Costs of restructure Legal/commercial difficulties with restructuring

18. Structuring Rules Option 2 Essentially the same as option 1, except the separate entity would only pay tax on retained profit at year end No PAYG instalments (cash flow advantage) But unlikely to be adopted Would require whole new corporate tax system

19. Structuring Rules Option 3 NFP entities could continue to undertake their UCAs, but separate accounting would be required Might save some restructure costs, but still some complexity Accounting for profit from UCAs FBT apportionments

20. Transitional Relief New rules start 1 July 2012, but will only initially apply to UCAs commenced after 7:30pm AEST on 10 May 2011 Additional relief for UCAs intended/contracted? But pre-10 May 2011 UCAs will be ‘phased in’ Timing yet to be determined ‘Same business test’ type rules in meantime

21. What to do now? Very difficult to provide practical advice, given uncertainty as to: definition of ‘unrelated’ which of the three structuring options will be adopted scope (and duration) of transitional relief We need to know before 1 July 2012!!!

22. What to do now? UCAs which are likely to qualify for transitional relief Likely recommendation: do nothing! Hang on to transitional relief as long as you can State tax concessions (PRT, Land Tax) difficult in separate entity? Defer/save restructuring costs

23. What to do now? Existing UCAs which are unlikely to qualify for transitional relief Start making preparations for having to move them But delay move until fate of three structuring options is clear Little gained by moving early But costs could be needlessly incurred

24. What to do now? Brand new UCAs May be some benefit in establishing these in a separate entity from the outset Save costs associated with moving them later But consider federal/state tax costs

25. What to do now? Choice of entity (if you do move) If NFP is a DGR Company or Discretionary Trust both acceptable If NFP is not a DGR Company only viable if NFP qualifies for imputation refunds Discretionary Trust may be better for cash flow anyway?

26. In Australia (and other) Requirements

27. Proposed Rules Three separate aims Standardise the special conditions for income tax exemption Standardise the ‘in Australia’ requirement for DGRs Insert a new definition of ‘not-for-profit entity’

28. Income Tax Exemption Most entities won’t be exempt unless: Not-for-profit entity Satisfy ‘in Australia’ requirements Comply with all substantive requirements in governing rules Use income and assets solely for the purpose for which established and operated

29. Income Tax Exemption Not-for-profit entity No profit or gain to members, either while operating or on winding up Governing rules/law prohibit distributions

30. Income Tax Exemption In Australia requirement Div 50 already has rules which restrict overseas activities But Word Investments suggests those rules are flawed Word satisfied test, even though it merely passed money to Wycliffe Australia, which used all the money overseas

31. Income Tax Exemption In Australia requirement (cont.) Under proposed rules, an entity must Operate principally in Australia Pursue its purposes principally in Australia Wider focus than old expenditure test Tracing rules

32. DGR Status In Australia Requirement Slightly tougher Operates solely in Australia Pursues its purposes solely in Australia Tracing rules Some exceptions

33. The ACNC

34. New national regulator for the NFP sector Proposed section 2-5(1): ‘The object of this Act is to promote public trust and confidence in NFP entities that provide a public benefit.’ Will take over part of ATO role from 1 October 2012 To eventually become ‘One-stop Shop’

35. The ACNC Key regulatory issues Registration Reporting Governance Fundraising

36. Registration Registration will be voluntary But must register if want to access federal tax concessions and other federal government support Transition If endorsed as charity by ATO now, will be deemed to be registered with ACNC on 1 October 2012 Reviewed upon adoption of new statutory definition on 1 July 2013

37. Reporting ‘Report-once, use-often’ reporting framework Charity passport Starts 1 July 2013 But with first reports only beginning to fall due after 1 July 2014 ‘Fixed form’ for annual information statement (financial and non-financial) Aligned with SBR and SCOA ‘accounting taxonomies’

38. Reporting (cont.) Reporting requirements will be proportional SmallNot a DGR Revenue less than $250,000 MediumNot small Revenue less than $1,000,000 LargeNot small Not medium

39. Reporting (cont.) Proposed Reporting Requirements Lodge Annual Information Statement Lodge Annual Financial Report Financials Reviewed Financials Audited SmallYesNo MediumYes No, unless choose to do so, or directed to do so LargeYes NoYes

40. Governance One of the conditions for registration will be that the entity meets the governance requirements of the Act But will only apply from 1 July 2013 Should eventually replace existing legislative requirements (State and Federal)

41. Governance (cont.) Only a Consultation Paper at this stage General approach 'To make it easier for the NFP sector, core governance principles-based rules that apply to all registered entities could be applied across the sector, with the level of regulation proportional to the size of the entity, its turnover, the risks it presents by virtue of its activities and the level of government support that an entity receives.'

42. Governance (cont.) Governance principles will be grouped into 5 areas: duties and minimum standards of responsible individuals, including rules for proper organisational management and running of the entity disclosure requirements and managing conflicts of interest risk management procedures the coverage of the minimum requirements of governing rules relationships with members

43. Governance (cont.) Definition of ‘Responsible Individuals’ will be broad Directors and officers, including persons who participate in making decisions, persons who have capacity to affect financial standing, and persons with whose wishes the responsible individuals are accustomed to act Individual trustees Directors and officers of corporate trustees

44. Governance (cont.) Responsible Individuals – Existing duties DUTIES Associations Incorporation Act (SA) Corporations Act (Cth) Not to act fraudulently Improper use of information Improper use of position Due diligence / reasonable care Liability for insolvent trading Avoid conflicts / disclosure Good faith / honesty 

45. Governance (cont.) New rules expected to at least pick up existing law Query ‘Business Judgement Rule’? Fiduciary type duty? Suggestion in EM that Responsible Individuals will need to exercise the same degree of care, diligence and skill that a prudent individual would exercise in managing the affairs of others

46. Governance (cont.) ACNC’s enforcement powers will include the power to suspend or remove trustees and/or Responsible Individuals Where ACNC satisfied that conducting affairs in a way that may cause harm to public trust and confidence

47. Governance (cont.) There will also be a range of offences False or misleading statements Late lodgement Non-compliance with ACNC directions Both administrative and criminal penalties Responsible Individuals likely to be exposed

48. Fundraising Proposed fundraising rules will eventually replace most (but not all) existing State and Federal regulation Consumer protection Permitted calling hours Unsolicited selling

49. Fundraising (cont.) Minimum information requirements At time donations are solicited Subsequent reporting Regulation of third parties that raise funds on behalf of charities in return for a direct financial or other benefit

50. Fundraising (cont.) Possible exemptions Government grants Corporate donations Donations from Ancillary Funds Workplace appeals Donations to religious organisations from own members Lotteries and raffles (State law) Fundraising below $50,000 annual threshold

51. Statutory Definition of Charity

52. Common Law Definition For a purpose to come within the technical legal meaning of ‘charitable’, it must be: Within the spirit and intendment of the Statute of Elizabeth 1601 (or deemed to be by legislation) (‘Charitable Purpose Requirement’) For the public benefit (or deemed to be by legislation) (‘Public Benefit Requirement’)

53. Common Law Definition (cont.) Charitable Purpose Requirement Four traditional heads of charity Relief of poverty Advancement of education Advancement of religion Other purposes beneficial to the community

54. Common Law Definition (cont.) Public Benefit Requirement Purpose offers a benefit to the community that is real and of value, either tangible or intangible Benefit is available to the public or a sufficient section of it

55. Proposed Statutory Definition Will apply from 1 July 2013 Will be based on draft Charities Bill 2003 That Bill was intended to merely ‘replicate’ the Common Law, but probably went a bit further Will Gillard Government want to go further again?

56. Charities Bill 2003 Core definition of charity NFP entity Dominant purpose is charitable and for the public benefit No activities that do not further, or are not in aid of, its dominant purpose Not have a disqualifying purpose No conduct that constitutes a serious offence Cannot be an individual, partnership, political party, super fund or government body

57. Proposed Statutory Definition (cont.) Four traditional heads may be expanded to eleven Health Culture Natural environment Suffering of animals Civil and human rights Protection and safety of general public Reconciliation, mutual respect and tolerance

58. Proposed Statutory Definition (cont.) Potentially controversial issues ‘Exclusively charitable purpose’ vs ‘dominant’ Focus on purpose or activities? No presumption of public benefit

59. Proposed Statutory Definition (cont.) Removal of presumption of public benefit Presumption actually of limited scope at Common Law anyway? But true that schools have never really been required to demonstrate public benefit in Australia

60. Proposed Statutory Definition (cont.) Independent Schools Case (UK) UK Charities Commission started querying the extent to which the independent schools in the UK were providing access to the poor Unpopular requirements re levels of scholarships, bursaries etc Schools took this to Court and won

61. Proposed Statutory Definition (cont.) Independent Schools Case (UK) Key question was whether class of persons who can afford fees is sufficient to constitute a section of the public Total exclusion of the poor is certainly not acceptable – there must be some access beyond fee-paying students But Charities Commission guidelines held to be too restrictive

62. Proposed Statutory Definition (cont.) Independent Schools Case (UK) 'Although it is necessary that there must be more than a de minimis or token benefit for the poor, once that low threshold is reached, what the trustees decide to do in the running of the school is a matter for them, subject to acting within the range within which trustees can properly act. That is something entirely different from imposing on the trustees the view of anyone else about what is "reasonable".'

63. Proposed Statutory Definition (cont.) Will Australian independent schools face the same issues? Consultation Paper on statutory definition does refer to the UK debate (at 86): ‘While some issues may not arise in Australia because of differing school systems, it is nonetheless expected that guidance similar to that issued by the Charities Commission…will be provided in Australia but modified where necessary to suit Australian conditions and laws.’

64. Other Developments

65. NFP Sector Tax Concession Working Group Formed in response to some of the discussion at the Tax Forum Possible issues Scope of existing DGR concessions Whether input tax concessions – GST, FBT, PRT, Stamp Duty, Land Tax etc - should be scaled back to address competitive neutrality concerns Clubs and mutuality

66. COAG NFP Reform Working Group Representatives of Commonwealth, State and Territories Aim is to reduce regulatory burden on NFP sector where possible

67. Building Funds ATO has issued a draft ruling – TR 2011/D5 which is more restrictive than old TR 96/8 Old TR 96/8 Multi-purpose buildings acceptable as long as primary and principal use was as a school or college Rule of thumb that ok as long as school use more than 50% of the time

68. Building Funds (cont.) TR 2011/D5 withdraws that rule of thumb Non-school use must be either: Integral to use as a school Minor or occasional Examples quite narrow But new position will only apply from date of the final ruling

69. Some Concluding Remarks Lots happening! Keep an eye on further developments Educate your boards and relevant staff Seek expert advice where necessary