Government treads on charities' toes

By BRIAN FALLOW

It is not, the Government insists, a tax grab.

Finance Minister Michael Cullen says the purpose of the review of how charities are taxed is not to reduce the level of support the Government gives through the tax system, but to ensure that it is well targeted, transparent and can be monitored.

But the discussion document on tax and charities has raised hackles.

Its critics see it as a slap in the face for a sector which is more important than ever because of the contraction of the state.

They say it embodies a simplistic understanding of charities' business activities and financial management. The critics believe it will impose compliance costs that charities can ill afford.

Dr Cullen says that because the definition of charity for tax purposes is so wide it is easy to become a tax-exempt charitable institution.

It has been difficult for the Government to monitor whether they have fulfilled the charitable purposes for which they were set up.

"Nor do we know which groups in society benefit most from the tax exemption, or how much. Since there is no central register of charities we cannot even know how many there are," Dr Cullen said.

The discussion document concedes that the suspicion that the definition of charitable purposes may be out of date and too widely available "may be problems of perception only".

Its real problem is that the Government has so little information about the scope and cost of the tax exemption. It cannot tell whether the problems are marginal or more general.

National's tax spokeswoman, Annabel Young, said the fact that the legal definition of charity went back 400 years did not mean that it no longer worked. "We believe all charities are at risk from uncertainty from any change in a well-understood definition."

If a "public benefit" test was adopted, it would hit small charities doing good work in narrowly defined areas, Ms Young said.

Auckland accountant John Steer cites the case of a small charitable trust he administers. A bequest provides $15,000 a year for a music scholarship to Auckland University. "If it is taxed, that would be cut back to $10,000 a year," Mr Steer said. "If it has to register and file annual tax returns it would be cut further still. Well, why?"

Nor was it true, Mr Steer said, that charities' income escaped tax altogether now. Charities invested in shares cannot use the imputation credits attached to their dividend and so pay their share of the company's tax.

Also, charities which are companies must pay foreign dividend withholding tax on incoming foreign dividends even though they are exempt tax on local dividends.

Ms Young has an undertaking from Dr Cullen that this anomaly "will be fixed retrospectively in the next tax bill".

Then there is what might be called the Sanitarium problem. Because it is owned by a church, breakfast cereals manufacturer Sanitarium enjoys a tax advantage over commercial competitors.

"We are canvassing the idea of putting businesses run by charities on the same tax footing as other businesses," Dr Cullen said.

"If a charity retained its business profits it would be taxed at the normal corporate rate. But the profits would not be taxed if the charity used them for the charitable purpose for which it was set up."

Lynn Humphrey, tax partner with KPMG in Auckland, said the idea that charities should pay tax on business income not distributed in the year it accrued missed the fact that they often had good reasons for building up reserves.

"The needs of a charity's beneficiaries are inversely proportional to the way society is going. So the time at which the greatest claims are made on their income is probably the time they have the least income, and vice versa."

Peter Harrison, chairman of Independent Schools of New Zealand, said independent schools had to retain earnings as a buffer against the risk that the state contribution to their budget might be reduced, and for maintenance of their properties.

Mr Humphrey said the line between charity and business was not as easy to draw as the discussion document implied.

"Take the IHC, a significantly funded organisation which carries out a lot of work for which it is paid by the Government, and which looks after the intellectually handicapped. Is that a trading operation or a charity?

"Church organisations like Presbyterian Support or the Sisters of Mercy are carrying out significant functions in a businesslike way, as they have to, sometimes receiving significant payments from the Government or even from users, but which are still within the broad concept of their charity, as opposed to Sanitarium, where the church isn't there to make Weetbix."

The discussion document notes that an income tax exemption would not necessarily mean that a charity-owned trading operation would undercut its competitors.

"Because the tax-exempt entity can generally [gain] tax-free returns from all forms of investment, the 'after-tax' return it expects from a trading activity is correspondingly higher than that of its taxed competitors. It cannot rationally afford to lower its profit margins on a trading activity, as alternative forms of investment would then become relatively more attractive.

"On this basis the tax-exempt entity will charge the same price as its competitors. The tax exemption merely translates into higher profits and hence higher potential distributions to the relevant charitable purpose."

The Government plans to improve the accountability if the income tax exemption is limited to entities which register as charities and file publicly available accounts.

Dr Cullen said: "They would be monitored to ensure they are fulfilling the charitable purpose for which they receive Government support.

"Many charities already produce annual accounts. For those which do not, increasing reporting requirements will obviously increase their compliance costs. For this reason we have suggested setting an income threshold below which charities would not have to report, or would have simplified reporting requirements, and we are seeking the public's views on what the cut-off point should be."

Mr Humphrey said the compliance cost burden would be magnified because it would often fall on people working voluntarily or paid below market rates. "You can only rely on people's benevolence so far. If the secretary of a kindergarten is expected to file returns to the IRD and a charities commission, it may just become too much."

Ms Young said requiring pre-approval would increase the barriers to setting up a charitable activity.

"No country has solved the problem of cheaply assessing whether something is a charity. Setting up an independent organisation to pre-approve charities, as in Britain, would create a new unwieldy bureaucracy," she said.

"Government departments are likely to be too biased towards their own particular goals. The IRD by its very nature is already too focused on a tax-gathering role and would have an impossible conflict of interest."

The Government plans to lift the limit for the tax rebate on personal donations from $500 to $600 a year, and to remove the limit on the deductibility of company donations.

"But most companies do not have a mandate to make huge donations as it would be seen as an abuse of their shareholders," Ms Young said.

"We don't expect to see massive growth in corporate donations as a result of such a change."

The Government also plans to amend the law to clarify that GST-registered charities and other non-profit bodies would be able to claim GST refunds on most of their activities.

Submissions close on August 31.