In the last issue of ART+law in March we looked at a recent High Court decision Commissioner of Taxation v Word Investments Limited  HCA 55 ('Word Investments') and what it meant for charities. Here, we drill down into the implications of that case for the arts.
In that decision the majority of the High Court found that Word Investments, a non-profit company operating a funeral business, was entitled to be endorsed as a 'charitable institution' for income tax purposes. In determining the charitable status of Word Investments the High Court confirmed that how an organisation raised funds was less important than the purposes to which those funds were applied.
For arts organisations, this means that if you are a charity you may be able to undertake commercial activities to raise funds. If you are a non-profit that already engages in commercial activity to raise funds you may want to re-assess your charity status.
Your organisation's status
Determining your organisation’s status can be a complex task. Tax law recognises two main categories of tax exemption.
The first category of income tax exemption applies where an organisation is:
- established for musical purposes or the encouragement of art, literature or music;
- not a charity; and
- meets one of three tests (most common being a physical presence in Australia).
Relevantly, an organisation can self-assess its eligibility for exemption provided it is not a charity. We recommend that you seek advice when self-assessing as the consequences of getting it wrong can be drastic.
Encouragement can include training, performing, displaying, providing information, studying, judging and critiquing. Associations established to advance the interests of their members such as artists or performers are unlikely to meet this requirement.
The second category is for charities. If your organisation is a charity it still may be tax exempt but must first be endorsed by the Australian Tax Office. Cultural organisations operating for the public benefit to advance the arts or educate the public in the arts are likely to be charities.
Lastly, if your organisation is not-for-profit but is not a charity or is established primarily for the benefit of members, it is likely to be taxed on the basis of the principle of mutuality. Under this principle, income received from members is not taxed but income from non-members is taxed.
While the decision in Word Investments strictly applies to charitable organisations, arguably its impact can be extended to the non-profit sector that self-assess their tax exemption. Your arts organisation preferably should qualify as a charity in order to rely on Word Investments.
The trouble for self-assessing bodies in relying on Word Investments is that the commercial operations may become a purpose in themselves rather than a means to a charitable end. This occurred in Cronulla Sutherland Leagues Club Ltd v FC of T (1989) 20 ATR 1404 where the court decided that the social activities had taken on a life of their own to the extent of being the main purpose of the club. The same caution in relying on Word Investments should be exercised by arts organisations that are charities before they increase their commercial fund-raising activities.
What is a charity?
The Tax Act does not define "charity" or what purposes are charitable, but essentially a charity is an entity that exists for the public benefit, including ones that promote the arts. It must also be not-for-profit, meaning that they are not carried on for the profit or gain of its owners, members, or other private persons.
However, not every purpose beneficial or valuable to the community is necessarily charitable.
Examples of arts organisations that are charities would be:
- an arts society whose purpose is to cultivate and encourage development of fine arts and its appreciation by the public;
- an Indigenous dance company whose purpose is to advance the welfare of Aboriginal people through traditional dance; or
- a youth orchestra whose purpose is to support and develop young people through music.
Recreational and entertainment arts organisations such as photography groups and science-fiction clubs would not be charities even if they are non-profit as they are primarily for the benefit of members. However, they may be tax exempt if they meet the "encouragement of art" purpose and the provision of social and recreational activities or facilities is not a main purpose.
Charities are not automatically exempt from income tax. To become a tax exempt charity you must apply to the ATO for an endorsement. Once you gain endorsement as a charity it is imperative that you maintain your charity status by pursuing the stated charitable objectives. Charitable tax concessions are not permanent, and charities are required to regularly conduct self-reviews as to whether they are entitled to charity endorsement. If an organisation no longer qualifies for charity endorsement they are legally obliged to notify the ATO. The ATO also selects a number of endorsed organisations each year to verify that they are still entitled to be endorsed.
What kind of activities can we do for fund-raising?
Even before Word Investments there was scope for charities to carry out commercial and business-like activities as long as they were only done to further the organisation's charitable purposes. Examples of this would be a charity orchestra that sells recordings of its public concerts, or an art gallery that sells artwork prints through its resident gift shop. The effect of Word Investments is that the scope of commercial activity charities can engage in has been widened. So, what kind of activities could you do?
Any commercial activity you do that ties in with the organisation's overall charitable objectives is not going to jeopardise its charitable status. An example of this would be a charity that works with Indigenous communities could set up a business selling Indigenous crafts and artworks. Word Investments has confirmed that the same organisation could derive passive investment income (eg. interest). Whether it could conduct the local supermarket is a different question where the decision in Cronulla Sutherland should be kept in mind.
The way income is spent is important. Any profits made from a charity's commercial activities must be used to support the charity; they cannot be used for private gain. This means that while paying employees of a charity's business would be permitted as part of the business's operation, distributing the profits amongst the charity's members would not. Profits may be distributed to other groups as long as the other groups are also charitable – non-charitable groups such as political organisations or lobby groups would not be allowed.
The best approach to keep in mind is that if the ATO comes to call, you need to be able to demonstrate to them that despite your commercial activities your dominant purpose remains charitable. This is demonstrated by how you spend your income – is the expenditure consistent with your objectives and that of a charitable purpose for the benefit of the public?
The ATO has issued a Decision Impact Statement saying that it will consider Word Investments in determining the status of any entity claiming an exemption as a charitable institution. However the outcome in each case will depend on an examination of the objects of each entity and whether the entity's activities give effect to those objects. Entities uncertain about their status can apply for a private ruling. The ATO further notes that it will be amending two of its tax rulings in light of the decision.
Finally, in December 2008 the Australian Senate released a report examining disclosure regimes for the non-profit sector. This report recommends sweeping changes to the way charities and non-profit organisations are regulated with the aim of increasing transparency and accountability. They include having greater consistency in legislation governing charities and non-profit organisations, and also that there be specific national legislation addressing fund-raising. If implemented these recommendations have the potential to significantly impact the operation of charities and non-profit organisations across Australia, however it is unlikely anything will be changing in the immediate future.
Jo Teng is a solicitor at Arts Law. This article was written with the assistance and tax commentary of Michael Dean at Walter Turnbull.