Chapter 4: Charitable structure, core definition, not-for-profit entities, dominant purpose

Charities Bill 2003: Relevant sections: Section 3: Definitions (1) In this Act, unless the contrary intention appears: entity has the meaning given by section 960-100 of the Income Tax Assessment Act 1997. Section 4: Core definition (1) A reference in any Act to a charity, to a charitable institution or to any other kind of charitable body, is a reference to an entity that: (a) is a not-for-profit entity; and (b) has a dominant purpose that: (i) is charitable; and (ii) unless subsection (2) applies—is for the public benefit; and (c) does not engage in activities that do not further, or are not in aid of, its dominant purpose; and (f) is not an individual, a partnership, a political party, a superannuation fund or a government body. Section 5: Not-for-profit entities An entity is a not-for-profit entity if: (a) it does not, either while it is operating or upon winding up, carry on its activities for the purposes of profit or gain to particular persons, including its owners or members; and (b) it does not distribute its profits or assets to particular persons, including its owners or members, either while it is operating or upon winding up. Section 6: Dominant purpose (1) An entity has a dominant purpose that is charitable if and only if: (a) it has one or more purposes that are charitable; and (b) any other purposes that it has are purposes that further or are in aid of, and are ancillary or incidental to, its purposes that are charitable. (2) An entity has a dominant purpose that is for the public benefit if and only if: (a) it has one or more purposes that are for the public benefit; and (b) any other purposes that it has are purposes that further or are in aid of, and are ancillary or incidental to, its purposes that are for the public benefit.

Introduction

4.1 The workability of the draft Bill will be tested, in part, by whether it enables charitable bodies to operate in a contemporary context. Charitable bodies are increasingly collaborating with each other, with business and with government to achieve their charitable purposes. They are adopting new corporate structures and financing models to achieve more effective and efficient services. One of the Board’s Terms of Reference is to consider whether the draft definition is flexible enough to adapt to the changing needs of the sector, especially where the common law has not explicitly addressed certain issues.

4.2 The draft definition prescribes that a charitable body must be an entity, must be not-for-profit and must have a dominant charitable purpose (sections 3, 4, 5, 6). These sections, particularly when read with the EM, may lack the workability and flexibility the sector needs for the 21^st century. In particular:

• The provisions might not cater for the structure of many modern charitable organisations either because the common law is unclear or because there are no relevant cases.

• The draft Bill and EM appear to diverge from the common law in some respects and could exclude some bodies that currently have charitable status.

• The definition could impede the development of more innovative and efficient structural arrangements within the sector such as new corporate structures, financing models and joint ventures.

4.3 The uncertainty about whether a charitable body’s ‘activities’ will jeopardise its charitable status has been discussed in Chapter 3. The term ‘ancillary or incidental’ has caused uncertainty because it is not clearly defined, particularly since the EM suggests that ‘scale’ will be used to determine whether purpose or activities are ‘ancillary or incidental’. This has particular relevance to charitable bodies which cross-subsidise their charitable activities through commercial activities and sizeable fund-raising.

Overview of submissions

4.4 A number of submissions noted that the draft Bill and EM could exclude, or create uncertainty for, some entities that are now an integral part of the modern charitable sector.

Groups of related entities

4.5 There may be no useful common law position on many modern structures within the charitable sector because there has been little development in the common law over recent decades. For example, some large complex organisations, especially religious organisations, now comprise a number of entities, each with a specific function that contributes towards an overall mission or charitable purpose. Some submissions noted that charitable bodies have also established separate legal entities to comply with legislative requirements in the finance and insurance sectors. These separate entities might not come within the definition of a charity even though they have been established to provide services exclusively to a charitable body or bodies. (Catholic Church; Anglicare)

4.6 The absence of common law guidance has left structural developments in the sector to be addressed by ATO rulings. ‘If the substance of the [ATO] policies are not incorporated into the Bill, the status of these entities may be compromised.’ (Catholic Church)

4.7 Some respondents stated that sections of the draft Bill do not accurately reflect the common law as it applies to the distribution of surpluses within a group of related charities. They also argued that the definition of not-for-profit (section 5) is unworkable as it goes further than the common law by prohibiting the distribution of profits and gain to ‘particular persons, including…owners or members’.¹ ‘The common law only prohibits the distribution of profits and assets to “members”…. Any codification of the not-for-profit element should be no more onerous than the common law test.’ (Catholic Church in Australia)

4.8 Several suggestions were made to overcome these perceived problems for religious bodies. Some religious bodies have suggested: that the definition of entity could be amended to include a ‘religious institution’ so that all entities forming part of the institution could be regarded as charitable bodies (Catholic Church in Australia); or that the draft Bill could include special religious group provisions along the lines of the GST legislation.

Bodies involved in commercial activities and fund-raising

4.9 A number of submissions queried whether some charitable bodies might lose their charitable status because of the scale of their involvement in commercial activities or fund-raising to support their charitable purpose. This uncertainty has particularly arisen because Example 1.1 in the EM, which deals with ascertaining when an activity will be considered ‘ancillary or incidental’, refers to fund-raising that is ‘small scale’. (Anglicare Australia; Salvation Army). There is a belief that this test of scale does not reflect the common law. It was suggested also that paragraph 4(1)(c) is unnecessary and overly restrictive in requiring that an entity not engage in any activities that do not further, or are not in aid of, its dominant purpose. It could also lead to interpretation difficulties. (Arnold Bloch Leibler; ACFOA; Oxfam Community Aid Abroad; ACROD Ltd)

Partnerships, joint ventures and shared service arrangements

4.10 The draft Bill excludes a ‘partnership’ from the definition of a charitable body (paragraph 4(1)(f)).² Some respondents were concerned that this could exclude joint ventures formed to harness a diversity of skills and resources.

4.11 Some respondents noted that the draft Bill appears to exclude entities established to provide several charitable bodies with ‘shared services’, as it might be difficult to establish that the separate entity had a ‘dominant charitable’ purpose. This could impede efforts by charitable bodies to use their resources more efficiently following the example of the public and private sectors.

Charitable trust instruments

4.12 In Australia, testamentary charitable trust provisions are normally in favour of charitable purposes generally. Consequently, such trusts are taken to include purposes to benefit individuals who are ‘poor relatives’ or ‘poor employees’ of the founder (because of the common law’s anomalous recognition of such purposes as charitable). However, the purpose of benefiting ‘poor relatives’ or ‘poor employees’ will be excluded from charitable status under the draft Bill (subsection 7(1)). This means that, for the purposes of subsection 6(1) of the draft Bill, standard testamentary charitable trusts will have purposes that are not charitable and that are not ancillary or incidental to charitable purposes.

4.13 It is rare for wills to have a power to amend. The only option available in such cases is to apply for a cy prhs order of the Supreme Court of the relevant State or Territory. This could be expensive and time consuming even if legally possible.

4.14 One suggestion was to include a provision that the legislation does not apply to charitable bodies established before the actual date of commencement of the legislation (foreshadowed to be 1 July 2004). This would be consistent with section 50-5 of the ITAA 1997 which grandfathers wills made before 1 July 1997 from certain provisions of Division 50. (Freehills)

4.15 Another suggestion is for the ATO to grant tax concessions on the condition the charitable body did not provide benefits to ‘poor employees’ or ‘poor relatives’. If this option were possible it could avoid the need to change the instrument and the costs involved.

Peak bodies

4.16 While a number of peak bodies in the charitable sector are currently Income Tax Exempt Charities (ITEC), some were uncertain if they would satisfy the requirements of having a dominant charitable purpose if the draft Bill is enacted. A number of submissions suggested that the draft Bill should state clearly that peak bodies representing charitable bodies are recognised as sharing the dominant charitable purpose of their members. (Church and Charitable Public Hospitals Association Ltd)

4.17 Suggestions for ensuring peak bodies do not lose their charitable status included:

• that the draft Bill adopts the approach to peak bodies reflected in Taxation Ruling TR 2003/5 in relation to PBIs; ³ (ACROD Limited) or

• that peak bodies be specifically referred to in the definition of entity. (Federation of Community Legal Centres (Victoria) Incorporated)

Bodies associated with government

4.18 The draft definition excludes a Commonwealth, State, Territory or foreign government body, and a body controlled by such a body, from being a charitable body under the draft Bill. The EM cites several PBI cases including the Mines Rescue Board of New South Wales v. Commissioner of Taxation to describe the common law approach to determining whether a body is subject to ‘government control’ (paragraphs 1.18-1.24). It notes that government control has been determined by whether, for example, a Minister has various powers over the composition and decisions of the Board. However, the common law has not been clear on this issue. ‘[T]he government control issue in practice is the most important and difficult issue we face in relation to the common law concept.’ (Freehills)

4.19 Many submissions, especially from volunteer emergency services, legal services and health organisations which have close links with government, claimed that it is already difficult to determine whether they are charitable under the common law, and that paragraph 4(1)(f) does not aid this situation.

4.20 Volunteer emergency service organisations carrying out similar functions, each largely staffed by volunteers and supported by public fund-raising, could be treated differently for taxation concessions because some of them have founding statutes established under State Government Acts while others have been established by local government. (Fire and Emergency Services Authority of Western Australia (FESA)). FESA noted advice from the WA Crown Solicitor that confirmed its concerns. It was also suggested that, if charitable status were withdrawn from volunteer emergency service organisations, volunteers might choose not to be involved.

4.21 Many submissions noted that the common law is now less clear following the recent case of Central Bayside Division of General Practice Ltd v Commissioner of State Revenue.⁴

In this case, it was held that the body was not a charitable body even though the Minister had no control over the Board or budget.⁵ This appears to be a significant development, as the cases cited in the EM indicate that funding alone will not be regarded as establishing government control.

4.22 There were several suggestions for a definition of ‘government control’, including:

• ‘… the power to direct completely the entity’s acts and omissions, where such acts and omissions are not reasonably required under any funding agreement’; (Federation of Community Legal Centres (Victoria) Incorporated) and

• ‘… a definition of control based on that used in section 50AA of the Corporations Act.’⁶ (Freehills)

4.23 The EM does not refer specifically to local government as being a ‘government body’. It was unclear to respondents whether local governments have been excluded deliberately or whether they are to be included as bodies ‘controlled by the Commonwealth, a State or a Territory.’

4.24 If local governments are to be included in the definition, respondents suggested that this should be stated clearly. If local governments are included as ‘a body controlled by the Commonwealth, a State or a Territory’, it should also be made clear whether a body within the control of a local government is to be regarded as a ‘government body’. The City of Salisbury indicated that a number of charitable bodies that it currently auspices might not be regarded as charitable bodies if the proposed provisions are enacted.

Board assessment

4.25 The Board notes that the draft definition may not be sufficiently workable and flexible to charitable bodies as they operate today. In some cases this is because the draft Bill seeks to reflect the common law which remains either uncertain or no longer relevant to many emerging entities. Over the last 60 years, where no High Court cases have emerged, large charitable bodies have grown into complex groups of related entities. Other charitable bodies have begun collaborating in social enterprises where a business enterprise employs commercial practices to achieve its charitable objectives.

4.26 The Board is not convinced that the application of section 5 to distributions to ‘owners’ as well as to ‘members’ changes the common law in any significant way.

4.27 The question of whether peak bodies would meet the tests in the draft definition deserves some consideration. The ATO’s Taxation Ruling TR 2003/5 recognises PBI peak bodies as PBIs, based on a 1982 case involving the Australian Council for Overseas Aid.⁷ Peak bodies that exist to undertake functions such as education and research for charitable bodies would appear to be eligible if a similar approach were applied. The Board’s view is that it would improve the workability of the draft definition if some clarity could be provided in the Bill as to whether or not peak bodies would generally qualify as charities. This could perhaps be achieved by providing an example of a peak body that satisfied the definition of a charitable body.

4.28 The exclusion of ‘partnerships’ from being charitable bodies under the draft Bill has created confusion. This confusion has arisen largely because the term ‘partnership’ is a loosely but commonly used term to describe a range of collaborations, strategic alliances and joint ventures in the sector. If the legal meaning of a ‘partnership’ as used in section 960-100 of the ITAA 1997 is strictly applied, this concept is only relevant to a for-profit entity. If this is the intended meaning of the reference in the draft Bill then the EM should clarify this meaning. A drafting note in the draft Bill may also be necessary. Such a note could be added after the definition of ‘entity’ in clause 3, and be along the following lines:

‘Note: Under paragraph 4(1)(f) of this Act, some entities covered by the Income Tax Assessment Act 1997 are not able to be recognised as charities, charitable institutions or any other kind of charitable bodies.’

4.29 The Board believes that clear statutory definitions of ‘government body’ and ‘government control’ are required. The EM uses several PBI cases to convey the common law position. However, the common law is still unclear, especially following the recent decision in Central Bayside General Practice Division v. Commissioner of State Revenue. This draft Bill provides the opportunity to provide clarity and certainty to the sector, especially to the many respondents who are unsure if they are ‘government bodies’ under the common law. The draft definition should also clarify whether local government and bodies controlled by local government are intended to be regarded as government bodies.

4.30 The Board notes that testamentary trusts may not have a mechanism to amend their founding documents to meet the technical requirements of the draft definition. Grandfathering all charitable institutions established before enactment would be too wide an exemption that could defeat the purpose of the draft Bill. Another approach could be to permit such organisations to be prescribed as charitable by regulation.

4.31 The Board believes that the EM detracts from the clarity and workability of the draft Bill by indicating that an ‘activity’, such as fund-raising or revenue raising, which is not ‘small scale’ could put a body’s charitable status at risk.

4.32 The Board notes that it is unclear whether paragraph 4(1)(c) restricts the activities of a charitable body to activities that further or are in aid of its charitable purposes, or permits activities that further or are in aid of any of its acceptable purposes as described in section 6.

Recommendations

4.33 The Board recommends that, to improve the workability of the Bill, some clarity be provided in the Bill as to whether or not peak bodies would generally qualify as charities.

4.34 The Board recommends that the draft Bill should be amended to provide a clear definition of ‘government body’, including whether local government (currently omitted) is included, and a clear definition of ‘controlled by government’.

4.35 The Board recommends that consideration be given to addressing the problems that may be caused for testamentary trusts by subsection 7(1).

4.36 The Board recommends that the meaning of ‘partnership’ in paragraph 4(1)(f) be clarified in the EM or by the insertion of a note in the draft Bill along the following lines:

‘Note: Under paragraph 4(1)(f) of this Act, some entities covered by the Income Tax Assessment Act 1997 are not able to be recognised as charities, charitable institutions or any other kind of charitable bodies.’

4.37 The Board recommends that the words ‘small scale’ be removed from the EM’s example of ‘ancillary or incidental’ activities as it does not appear to be supported by the draft Bill, and further that the intent of paragraph 4 (1)(c) be clarified in the EM or the draft Bill.

4.38 The Board recommends that the relationship between paragraph 4(1)(c) and section 6 be clarified, possibly by the inclusion of a new subsection 6(3) along the following lines:

‘(3) If an entity has a dominant purpose as described in subsection (1) or (2), then an activity engaged in by the entity furthers or is in aid of its dominant purpose if it furthers or is in aid of any of the purposes covered by that subsection.’

---

¹ ACROD Limited suggested that an unintended consequence of section 5 could be the loss of charitable status for bodies whose beneficiaries were also members.

² Section 3 defines ‘entity’ as having the meaning given by section 960-100 of the ITAA 1997. That section includes a ‘partnership’ within the definition of an entity. Partnership is further defined in section 995-1 of the ITAA 1997 as ‘an association of persons carrying on business as partners or in receipt of ordinary income or statutory income jointly, but does not include a company’.

³ Taxation Ruling TR 2003/5: Income tax and fringe benefits tax: public benevolent institutions, paragraph 65:

‘Coordination of services and support

65. However we accept that a non-profit organisation may be a public benevolent institution in the circumstances of the Australian Council for Overseas Aid case where:

• its members are predominantly public benevolent institutions;
• it has a common benevolent purpose with its members;
• it provides services only to its members (apart from any provided directly to persons in need of benevolent relief);
• for those members which are not public benevolent institutions, it serves them only in relation to their public benevolent activities;
• it does not carry on activities separately from its members;
• its activities can be properly considered as a step in the benevolent process of the group of organisations;
• it and its members can be appropriately regarded as one whole enterprise of which the organisation is an integral part; and
• its activities are such that if they had been performed by the members themselves they would have been regarded as being carried on in the course of performing their benevolent activities.’

⁴ Central Bayside Division of General Practice Ltd. v Commissioner of State Revenue No. 8719 of 2002 (Victorian Supreme Court) on appeal from Central Bayside Division of General Practice Ltd. v Commissioner of State Revenue No. 2002/137 (Victorian Civil and Administrative Tribunal).

⁵ As held in Metropolitan Fire Brigades Board v Federal Commissioner of Taxation (1990) 27 FCR 279 and the Mines Rescue Board of New South Wales v Commissioner of Taxation (2000) 101 FCR 91.

⁶ Section 50AA of the Corporations Act 2001

‘Control

(1) For the purposes of this Act, an entity controls a second entity if the first entity has the capacity to determine the outcome of decisions about the second entity’s financial and operating policies.

(2) In determining whether the first entity has this capacity:

(a) the practical influence the first entity can exert (rather than the rights it can enforce) is the issue to be considered; and

(b) any practice or pattern of behaviour affecting the second entity’s financial or operating policies is to be taken into account (even if it involves a breach of an agreement or a breach of trust).

(3) The first entity does not control the second entity merely because the first entity and a third entity jointly have the capacity to determine the outcome of decisions about the second entity’s financial and operating policies.

(4) If the first entity:

(a) has the capacity to influence decisions about the second entity's financial and operating policies; and

(b) is under a legal obligation to exercise that capacity for the benefit of someone other than the first entity’s members;

the first entity is taken not to control the second entity.’

⁷ Taxation Ruling TR 2003/5 op cit.

 

Next: Chapter 5 - Serious Offience