Chapter 6 - Suggested solution

6.1 This chapter explores a possible solution to address the current tax consequences for deregistered charities identified in the previous chapter.

6.2 Our suggested solution is for a specific set of rules to deal with the income tax treatment of deregistered charities where the entity continues in operation. The suggested new rules would:

• clarify how the general tax rules, including the company, trust and other specific entity regimes apply to deregistered charities;
• establish the opening values of any depreciable property or consideration for any financial arrangements held by a deregistered charity when it becomes a tax-paying entity;
• prescribe specific timing rules for the application of the taxing provisions; and
• apply from the 2014–15 income year.

6.3 A specific set of rules is preferred for reasons of clarity and coherency.

Clarifying the general tax rules

6.4 Section HC 31 of the Income Tax Act 2007 provides a useful model for formulating rules to clarify how the general tax rules, including the various entity regimes, could apply to deregistered charities. This provision specifically deals with circumstances when an existing trust enters the tax base.

Establishing the opening values for depreciable property and financial arrangements

6.5 Section HC 31 of the Income Tax Act 2007 also provides a useful model for formulating rules for establishing the opening values of any depreciable property or consideration for any financial arrangements held by a deregistered charity when it becomes a tax-paying entity.

Prescribing specific timing rules

6.6 In most cases, the taxing provisions will apply from the effective date of deregistration – that is, the date the entity is removed from the Charities Register. This date usually applies on a prospective basis. However, it may sometimes be necessary to apply the taxing provisions from an earlier date. This will arise from the following circumstances:

• when the underlying reason for deregistration is because the entity was found never to have had a “charitable purpose” by Charities Services or the Courts, or
• when the charity has voluntarily deregistered and Inland Revenue has concerns that it was never charitable in purpose or ceased to be charitable at some point in the past.

In these circumstances, the taxing provisions can be applied from the date on which the entity was found not to have a charitable purpose.

6.7 In deciding whether to apply the taxing provisions from the date on which the entity was found not to have a charitable purpose we should also take into account the specific circumstances surrounding the entity’s charitable status before the “tax charity” rules (which included the registration requirement) were introduced from 1 July 2008. This would include, for example, whether an entity had received confirmation from Inland Revenue that it was entitled to the charities-related income tax exemption before 1 July 2008.

6.8 We suggest prescribing specific timing rules for the application of the taxing provisions. These timing rules would cover five distinct circumstances.

6.9 These rules do not address the specific issue that arises when a charity is deregistered solely because Charities Services (or its predecessor) formed a view that the entity was charitable in purpose but later changed its mind and deregistered the entity. For reasons of equity and consistency, an entity should be able to rely on the prevailing view of Charities Services, if it has in good faith complied with all of the information requirements of registration and no other reason for deregistration exists. This would suggest limiting deregistration to the date on which Charities Services changed its view, with the consequential effect of minimising retrospective tax liabilities.

6.10 In addressing this issue, however, it is important to balance these equity considerations with protecting the revenue base and the integrity of the charities registration process. Charities Services (and Inland Revenue) should retain the ability to enquire into deregistration situations in order to determine if there had been any disqualifying behaviour on part of the charity. We are interested in submitters’ views on how this issue could be addressed while ensuring that there are adequate mechanisms in place to protect the revenue base.

Periods of non-registration

6.11 The suggested solution would apply to determine the tax treatment to apply to periods of non-registration.

Other possible solutions

6.12 The suggested solution focuses solely on improving the existing tax rules in the Income Tax Act to ensure they can effectively deal with the current problems with the tax treatment of deregistered charities. Even so, we acknowledge that a mix of both legislative and operational measures may be required, and that Inland Revenue and Charities Services may need to work closely together to ensure a robust process for deregistered charities. This might involve giving Charities Services a wider range of tools to apply during the deregistration process. This could include, for example, the ability to set a retrospective date of registration such as to deal with broken periods of registration in appropriate circumstances.