The CRA provided its view on whether a non-profit organization (“NPO”) can add a secondary source of income, fund a secondary business from a reserve accumulated from excess member contributions, and provide services to non-members while maintaining their tax exempt status (CRA document 2019-0825751E5 dated February 26, 2021).
Paragraph 149(1)(l) of the ITA defines an NPO to be a club, society, or association that is not a charity, is organized and operated exclusively for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit, and does not make available its income for the personal benefit of a member or shareholder (unless the member or shareholder is an association which has as its primary purpose and function the promotion of amateur athletics in Canada).
The CRA was asked whether an NPO can add a secondary business and use the net income from the business to fund its non-profit objectives, where the funding of this secondary business will be from a reserve accumulated from excess member contributions and held for future capital expenditures. The CRA was of the view that an NPO cannot engage in this activity. In this regard, the CRA indicated that the courts have recognized that an NPO can earn a profit, as long as the profit is incidental and arises from activities directly connected to its non-profit objectives. However, an NPO cannot make earning profit as a purpose of the organization, even if the profits are destined to support the not-for-profit purposes of the organization or another organization. This “destination of funds” argument has been rejected by the CRA and the courts. Therefore, an NPO cannot intentionally earn profit from a secondary business and use that profit to fund its non-profit objectives.
As well, the CRA was of the view that having a reserve that is able to fund a secondary business suggests that the organization has retained earnings larger than is necessary to meet its non-profit objectives and therefore the organization may not be operating exclusively for a purpose other than profit. In this regard, the CRA made reference to paragraph 8 of Interpretation Bulletin IT-496R, which indicates that an NPO may earn income in excess of its expenditures, provided that the requirements of the ITA are met. However, if a material part of that excess is accumulated each year and the balance becomes more than the reasonable needs of the organization to carry on its non-profit activities, then the organization will be considered to have a for-profit purpose, particularly where the excess is used for purposes unrelated to an organization’s objects. However, a review of all of the circumstances will be necessary (including how and why the surplus was accumulated and the length of time the surplus has been accumulated). The CRA indicated that generally surpluses may not be viewed as reflecting a for-profit motive if the organization is taking reasonable business steps to reduce the surpluses, such as by adjusting the costing of its products or services.
Lastly, the CRA was asked whether an NPO can provide services to non-members that are located outside of the geographical area where the organization currently services its members, where the services provided are the same as those provided to its members. The CRA indicated that an NPO is not prevented from providing services to non-members, provided it otherwise meets all of the requirements of the ITA which is a question of fact. However, if an organization is actively earning income from non-members (by providing them with services) and using the earned income to fund its non-profit objectives, it will be considered to be operating with a profit purpose. As well, making reference to paragraph 7 of Interpretation Bulletin IT-496R, the CRA indicated that where an organization’s goods or services are not restricted to members and their guests, or where it is operated in competition with taxable entities carrying on the same trade or business, it is an indication that it is not operated exclusively for non-profit purposes.
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