Thursday, July 9, 2015

Dr Michael Gousmett: Taxing Non-related Large-scale Trading by Charities - correcting an unintended consequence

Recent letters to the Press have asked the question, why do trading operations undertaken by Ngai Tahu have charitable status, therefore are exempt from income tax?  As a charity specialist I always reply to such letters but the Press in exercising its editorial discretion does not always see fit for whatever reason to publish my informed responses. 

The latest letter, on 25 June by John Burn, pointed out that no doubt property developers and agricultural commercial rivals would be aggrieved at the fact that Ngai Tahu pays no income tax on its trading activities, the basis of which are public assets gifted by the government which now allows Ngai Tahu to build a huge corpus.  Mr Burn is quite right about the growth of Ngai Tahu’s trading activities and my response to the Press explained how that growth is occurring.

To be fair, Ngai Tahu is only one of over 700 entities with limited status on the Charities Register but, as Ngai Tahu has registered as a group, its 33 limited companies in the group do not provide individual financial statements and their results are not included in an advanced search on “limited” entities.  Of the registered limited entities, it is The Base Limited which currently reports the largest net surplus, at $19 million.  The Base Limited is a Tainui-related entity and is a part of the Waikato Raupatu Lands Trust and Group.  An aggregation of the financial statements of those entities produced gross income of $89.5 million and a non-taxable net surplus of $44 million from total assets of $1.2 billion whereas the Annual Return for the Ngai Tahu Charitable Group reported gross income of $408 million and a non-taxable net surplus of $135 million, on total assets of $1.15 billion.  Excluding Ngai Tahu, the top 100 limited entities reported non-taxable net surpluses of $182.5 million and for all limited entities, $209.6 million, while other entities reported net deficits of $86.5 million for which there are no tax advantages.

Since WWII, various governments have undertaken reviews of New Zealand’s tax system. A number of those reviews have questioned the income tax exempt status of what can only be described as commercial trading by charities. In 1967 the Ross Committee recommend that profits derived from trading by charities should be taxed. Roger Douglas argued similarly in 1987, and so did the Committee of Experts on tax compliance in 1998. The 2001 Tax and Charities Report recommended that trading by charities should be taxed and that unlimited deductions for charitable donations by companies should be provided.  In 2007 Cullen and Dunne obliged when they removed the cap on donations which is now to the extent of taxable income for private donors (refundable tax credits), and companies and Maori Authorities (deductions), but trading activities by charities continue to be untaxed. I argue that the rule for deductions by companies should be applied to all large-scale trading activities by charities whose trading activities are not related to their charitable purposes.  This would then have the effect of such charities being required to pay income tax on any undistributed funds and would encourage them to distribute to the greatest extent possible while also retaining funds to develop their businesses, many of which are in competition with for-profit businesses. Tax equity would then be restored and they would then be paying their fair share. 

What then is the inequity that currently exists with respect to the income tax exemption granted to trading charities?  I suggest that it is not pricing, as at the end of the day the market will ensure that pricing between competitors is equitable.  There are two issues.  The first concerns the trading activities of the entity.  If those activities are unrelated to its charitable purposes, then the entity should pay income tax.  A classic example is that of private schools, which trade in the provision of education or, in terms of charity law, the advancement of education.  The relationship between charging fees and providing education is clear.  But what if that same school has a farming, or forestry, operation?  Trading in farming or forestry is not related to the advancement of education (unless it is a training school per se), therefore in my opinion is an income taxable activity, with income tax paid on retained funds but after donations to the school have been claimed as a legitimate tax deduction.  The argument that because the sole shareholder, such as Ngai Tahu, has charitable status therefore the trading activities are exempt from income tax is not logical.  Why should the retained funds of large-scale unrelated trading activities by entities whose shareholder has charitable status be exempt from income tax?  Where is the public benefit from the activities of those entities as required under charity law?

The second issue is the benefit of the income tax exemption to the entity itself, and this is where the competitive advantage for trading charities arises, because the exemption allows for the accumulation of income tax-free funds to grow the business at a faster rate than its competitors, a point noted in the 2001 discussion document, Tax and Charities.  It is for this reason that in order to provide a level playing field the income of non-related large-scale trading activities undertaken by charities should, as many experts have said in the past, be liable to income tax.  It is time for the government to heed their advice.

New Zealand derived its charity law from England.  We talk of the Pemsel case of 1891 which laid down the four principle divisions of charity: the relief of poverty, the advancement of education, the advancement of religion, and other purposes beneficial to the community.  We talk of the “spirit and intendment” of the preamble to Statute of Elizabeth laid down by Elizabeth 1 in1601.  The curiosity is that while we allow non-related trading by charities to go untaxed, that is not the case in the United Kingdom, where such activity is taxed.  It is not case of whether or not the activity is charitable, the fact is that if the activity is unrelated to its charitable purposes it is taxed.  Another issue is the scale of activity.  For example, small-scale trading by second-hand charity shops is exempt, whereas if the scale was at the level of large-scale commercial activity, and clearly competing with the for-profit sector, income tax liabilities arise.  The precedent exists.  All it needs is a New Zealand government to finally act to rectify a flaw in our tax policy.  Or, like the Press, is the government in awe of the power and wealth of charities such Ngai Tahu, and reluctant to respond to this increasingly inequitable issue and to debate the matter publicly as a precursor to correcting this absurdity in our tax policy?  I doubt that when the income tax exemption was introduced in New Zealand in 1892 the government of the day had any idea of the unintended consequence the tax policy relating to charitable activities carried on for any public charitable purpose and not for any gain or profit would herald whereby in the 21st century large-scale non-related trading by charities would also benefit from this policy.

Dr Michael Gousmett FCIS PhD BCom(Hons) BBS Dip CM Dip Tchg is an Independent Researcher and Public Historian, and Director of New Zealand Third Sector Enterprises Ltd: “Promoting Integrity in Non-profit Performance”.

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