Treatment of accumulated assets
Issue: New sections CV 17 and HR 12 should not be introduced, pending a thorough review
Clauses 19 and 108
(New Zealand Law Society)
New sections CV 17 and HR 12 set out the requirements of the new tax on net assets. They provide that an entity has an amount of income equal to the greater of zero or the value of its net assets held at the time that is 12 months after the date of deregistration, subject to some adjustments.
These adjustments carve out certain assets, which reduce the net assets balance that will be subject to tax. The items carved out are:
- any assets distributed to charitable purposes in the 12 months after the entity is deregistered; and
- any assets (not including money gifted or left to the entity while it was deriving exempt income.
The New Zealand Law Society submits that these amendments should not be made, pending a thorough review of their potential consequences. It considers that the proposed tax treatment of net assets may have unintended and inappropriate consequences. Specific concerns include:
- The amendments do not attempt to “claw back” accurately or in a scientific way the benefits of tax-exempt status to the entity in relation to accumulating assets and income.
- Some deregistered charities may be prevented from distributing their accumulated assets for charitable purposes post-deregistration. This may arise if the entity’s purposes as set out in its constitution or rules are determined to be non-charitable in purpose.
- Although the apparent simplicity of the proposed amendments may seem attractive, the potential application of the amendments to a wide range of deregistered charities needs to be carefully considered.
Officials do not support the general thrust of the submission. We believe the policy underlying the new requirements of the tax on net assets is appropriate.
Current tax law (legislation and case law) supports the ability of charities to accumulate their income for future use, and no symmetry is required between the income tax exemption and the payments towards charitable purpose, either in amount or timing. Although there is a requirement for deregistered charities which cease to operate to distribute their assets and income to charitable purposes, there is no such requirement when deregistered charities continue to operate.
The stated policy is that the assets and income of a charitable entity with tax-exempt status should always be destined for a charitable destination, irrespective of whether the entity ceases to exist or not. However, if a deregistered charity continues in existence, the value of the deregistered charity’s net assets (assets minus liabilities) should be subject to income tax. The imposition of tax in this instance is consistent with the current policy intentions underlying the charities-related tax concessions. In other words, the tax concessions should only be available to bona fide charities and deregistered charities should be held to account for the assets and income they have built up while they enjoyed the benefit of the tax concessions.
The proposed adjustments to the net assets balance and the one-year transition period before the tax is imposed is intended to provide encouragement to deregistered charities to distribute their assets for charitable purposes.
We consider that the proposed tax on net assets with adjustments and the resulting calculations is a simple, low compliance-cost option but we acknowledge it may result in a tax impost for some deregistered charities that is higher than what they would have paid had they always been subject to tax.
We have some sympathy for the specific concern relating to deregistered charities that may not be able to distribute their assets for charitable purposes post-deregistration because they had been found not to have a charitable purpose. To remedy their specific issue we consider that the entity could be permitted to distribute its assets for the purposes set out in its constitution or rules.
That the submission be declined in general.
That new section HR 12 be amended to allow deregistered charities to distribute their assets in accordance with their constitution or rules.
Issue: The tax on net assets should be paid a year after the day of final decision, rather than a year after deregistration
Clauses 19 and 108
(Ernst & Young, New Zealand Institute of Chartered Accountants, Sue Barker)
The tax liability should be calculated on net assets held by the deregistered charity on the “day of final decision” rather than the day the entity is removed from the Charities Register. The starting date for the calculation of the tax liability of the deregistered charity should be consistent with the date its tax-exempt status ceases under section CW 41. The proposed date of the day the entity is removed from the register does not take into account either the possibility of interim reinstatement to the charities register or the appeals process, which can be lengthy and carry on over a number of years. (New Zealand Institute of Chartered Accountants, Sue Barker)
Other provisions base the income tax consequences of deregistration on the date an entity’s income ceases to be exempt under sections CW 41 or 42. Clause 27 proposes to amend section CW 41 so that organisations’ income and “tax charity” status for those purposes would not necessarily end on removal from the Charities Register, but could continue until a later “day of final decision” as to their charitable status. We suggest that section HR 12 should also be based on the date of cessation as described in proposed section HR 11(1) for consistency. (Ernst & Young)
Submissions are correct in noting that the time at which the entity should have to pay tax on the net assets it has not distributed for charitable purposes should be one year after the date of final decision, rather than one year after the date of deregistration. It is entirely possible that a disputes process could take more than one year and so the amendments, as currently drafted, could lead to a requirement to distribute the net assets before a final decision is made on whether an entity does in fact have charitable purposes.
The definition of “day of final decision” determines this is the later point of two dates, namely the day the entity is removed from the charities register, and the day all appeals are exhausted. Consequently, entities which dispute the deregistration decision will have a longer period before the tax on net assets is required to be paid.
That the submission be accepted.
Issue: Gifts of money should be excluded from the net assets calculations
(Ernst & Young, New Zealand Institute of Chartered Accountants, New Zealand Law Society, Sue Barker)
As noted above, new section HR 12 requires deregistered charities to pay tax on the value of their net assets, with adjustments for assets distributed for charitable purposes in a one-year period, and for any assets (other than money) gifted or left to the person while that person was deriving exempt income under sections CW 41 or 42.
Submissions considered that:
- It is not clear why money is excluded from the net assets calculation. The words “other than money” should be deleted from section HR 12(2)(b). (Sue Barker)
- Gifts of money, or at least certain gifts of money, should be excluded from the calculation, as tax incentives will not necessarily have been claimed by donors in relation to such gifts, and there are other items that should also be excluded from the calculation – for example, possibly capital gain amounts or assets acquired before becoming tax-exempt. (New Zealand Law Society)
- Instinctively, amounts gifted to an organisation in any form should be excluded on the basis they represent some form of capital contribution rather than any trading or business income. Given the fungibility of money, the proposed exclusion for gifts of money is likely to be impossible to measure in practice since organisations may have cash on hand from various sources, such as gifts, trading or other income and sale of capital assets (which themselves may have been acquired using funding from a mix of sources). (Ernst & Young)
- The exclusion of gifted money from the proposed adjustment introduces an arbitrary distinction between donations made in kind and monetary donations. Such a distinction would drive behaviour that is not beneficial to either the charitable sector or the public. The proposal to include as “income” money gifted or left to the deregistered charity when the deregistered charity was deriving exempt income is contradicted by the Commentary to the bill. The Commentary states that for reasons of fairness an adjustment should be permitted for any donated assets as these assets were not funded by non-taxed income or through a tax-preferred source. Money that is gifted to a deregistered charity also meets these criteria: monetary donations are not “income” of the deregistered charity; and in most cases a donor’s monetary donation is from post-tax income. (New Zealand Institute of Chartered Accountants)
Officials note that new section HR 12 is intended to encourage deregistered charities to distribute their accumulated assets and income to charitable purposes within a reasonable time after they are deregistered.
One submission states that for a charity there is no fundamental difference from a tax perspective between a gift of a non-cash asset or of money. As noted in the Commentary on the bill, the distinction between cash and non-cash assets relates to the tax preference generally afforded to donors in relation to cash gifts.
Officials acknowledge that this tax could be viewed as severe. However, we believe it supports the Government’s policy position that money a deregistered charity acquired when it had an exemption from income tax should always be destined for a charitable purpose. This policy position is intended to maintain the integrity of charitable giving tax incentives, as donors can have some confidence that that charitable donations are more likely to remain in the charitable sector.
The policy position is also consistent with the requirement on charitable organisations to distribute all their assets to charitable purposes on winding up.
That the submissions be declined.
Issue: The tax on net assets should not apply to entities which have retrospective income tax liabilities
(New Zealand Law Society)
The new tax on net assets should not apply to a deregistered entity that is exposed to tax on a retrospective basis, at least when the benefits of tax-exempt status are clawed back in that way.
The tax on net assets is intended to protect the integrity of the revenue base by ensuring the tax concessions that apply to charities are well-targeted and policy intentions are met. This includes, for example, ensuring that if an entity has claimed tax exemptions as a charity and has accumulated assets and income, these assets and income should always be destined for a charitable purpose.
The submission is opposed to applying the tax on net assets in situations when the deregistered charity had been non-compliant with its constitution or rules and has had to reconstruct its tax position retrospectively. In this situation, applying new section HR 12 could be viewed as penal, but it is intended to encourage the entity to distribute the assets for charitable purposes.
Excluding deregistered charities that have been non-compliant from the tax on net assets would mean that the tax would only apply to entities which have complied with their constitutions or rules. This policy outcome would be unfair.
We also note that the benefits of the tax exemption are not fully clawed back, as the entity has had use of the money over the period of the tax exemption, and has enjoyed the compounding benefits of this.
That the submission be declined.
Issue: Split application date should be reconsidered
(New Zealand Law Society)
The rationale for the proposed split application date for section HR 12 should be reviewed, as it would be preferable for there to be a single application date. In light of the potential significance of the proposed amendments, the deferred April 2015 application would seem preferable, and this would not necessarily result in a rush of voluntary deregistrations bearing in mind the other tax consequences of deregistration and the fact that voluntary deregistrations would presumably be tracked during the period.
Officials do not support an application date of 1 April 2015 for new section HR 12 for entities which choose to voluntarily deregister. The split application date is intended to prevent entities choosing to “opt out” of the new tax on net assets by simply voluntarily deregistering from the charities register.
This new tax on net assets is a response to the current ability of charitable entities to accumulate assets and income while tax-exempt, and the lack of any requirement to distribute these assets for charitable purposes once the entity deregisters if it continues to operate.
We accept the submitter’s point that there would not necessarily be a rush of voluntary deregistrations but believe a delayed application date could lead to some entities with substantial asset bases deregistering to avoid the new tax.
That the submission be declined.
Issue: Section HR 12 should be limited to tax which would have been payable had the entity never been charitable
(Ernst & Young, New Zealand Law Society, Te Ohu Kai Moana Trust)
We appreciate that it may be difficult to provide an appropriate basis for bringing any income accumulated during a tax-exempt period into account without some element of arbitrariness. It is not clear, however, that amounts received by an organisation would necessarily have been taxable income even if the body had never been registered as a charity. Amounts received from members might have been excluded under the mutuality concept or the organisation might have been eligible for some other income tax exemption. Any income tax arising under new section HR 12 should be limited to the tax which would otherwise have been payable had the entity never been charitable (assuming the organisation has sufficient records to support such calculation). (Ernst & Young)
Taxpayers should have an option to refine the calculation of “net assets” under section HR 12(2) to remove items that would not have been taxable to them (or resulted in tax to pay) if they were not applying the charitable income tax exemptions. As currently drafted, this provision will operate to tax a deregistered charity on assets they continue to hold 12 months after deregistration even when the assets would not have been taxable to them if they had not been applying the charitable exemption in sections CW 41 or 42.
Of particular relevance to organisations that Te Ohu Kai Moana represents are assets distributed to iwi organisations pursuant to a Treaty of Waitangi fisheries settlement. Receipt of these assets does not give rise to taxable income based on the application of general principles (that is, it is a capital receipt) irrespective of whether the recipient has charitable status. There are other settlements of a similar nature – for example, the forestry settlement (dealt with under the Central North Island Forests Iwi Collective Settlement Act 2008).
This issue is not limited to assets received pursuant to Treaty of Waitangi settlements. It is equally applicable to any other categories of income derived by the deregistered charity that would not otherwise have given rise to taxable income had it been derived by a taxpaying entity. For example, capital gains and unrealised revaluation gains on assets.
Taxpayers should be provided with an option to refine the calculation of “net assets” by removing certain items if they have sufficient information to do so. By making the refinement of the calculation optional, the proposed amendment will not impose a compliance cost on deregistered charities that choose to apply the simple definition of “net assets” (as currently defined). However, it also allows a more neutral (and equitable) outcome to be reached for taxpayers who choose to undertake a more detailed calculation of “net assets”. (Te Ohu Kai Moana Trust)
The provisions relating to the calculation of the amount of income to be recognised in section HR 12(2) and (3) need to be carefully reviewed and should be more closely aligned with the concept of clawing back the benefits of tax-exempt status. (New Zealand Law Society)
We acknowledge submitters’ points that if a deregistered charity chooses to retain its accumulated assets after deregistration, the tax imposed on those assets under new section HR 12 will not result in the same outcome as if the entity had never received the charitable exemption. This result is intentional.
Submitters are correct in noting that the formula could result in tax being applied to amounts that would not have been taxable if the entity had been subject to income tax when it received or derived those amounts.
We note that the calculation in proposed section HR 12 is intended to encourage the entity to choose to distribute those assets for charitable purposes, rather than to retain them. As noted in the Commentary to this bill, the Government believes that the assets of an entity with tax-exempt status should always be destined for a charitable purpose, irrespective of whether the entity ceases to exist or not.
We therefore do not support giving taxpayers an option to apply a refined version of the net assets formula.
We are recommending, however, that assets received pursuant to Treaty of Waitangi settlements should be excluded from the requirements of new section HR 12. This change recognises previous government policy decisions to enable the transfer of settlement assets as part of a Treaty of Waitangi settlement to be effected without tax impost.
That the submissions generally be declined.
That the submission on assets received pursuant to a Treaty of Waitangi settlement be accepted.
Issue: Clarifying the meaning of “liabilities”
(Matter raised by officials)
New section HR 12 should be clarified to explain what is meant by “liabilities”.
This clarification can be set out in the Tax Information Bulletin. An example of a liability would be the amount of tax which an entity would be liable to pay in relation to past years if it ceased to comply with its constitution or rules at some point before deregistration. Similarly, an entity might have incurred legal costs in disputing the decision to deregister it but not yet paid those amounts.
That the submission be accepted.
Issue: New section HR 12 should not apply to entities which are re-registered before the 12-month period ends
(Matter raised by officials)
New section HR 12 should be clarified to explain that when an entity is reregistered before the end date after which new section HR 12 takes effect, the entity should not be required to distribute its net assets or pay tax on those assets.
New section HR 12 should not apply to entities which are still eligible for an income tax exemption, whether by virtue of another exemption or because they have been reregistered as a charity.
As discussed in item “Issue: The application of other income tax exemptions to deregistered charities”, we have recommended that new section HR 12 be amended to clarify that if an exemption applies to an entity, the requirements in section HR 12 will not also apply.
That the submission be accepted.