A CRA technical interpretation released earlier this year addresses several issues related to the tax treatment of non-profit organizations (NPO). In the document, CRA reviews the treatment of the income of an NPO upon the loss of NPO status, the treatment of capital gains of an NPO, and the tax treatment of members who receive distributions from the NPO upon liquidation.
Loss of NPO status
CRA notes that the Income Tax Act (Canada) provides that the taxable income of an association is exempt from income tax for a period throughout which the association complies with all of the following conditions: (a) it is not a charity; (b) it is organized exclusively for social welfare, civic improvement, pleasure, recreation or any other purpose except profit; (c) it is in fact operated exclusively for the same purpose for which is was organized or for any of the other purposes mentioned in (b); and (d) it does not distribute or otherwise make available for the personal benefit of a member any of its income. Whether an NPO meets all of the above conditions and qualifies as a tax-exempt NPO is a question of fact that can only be determined after a review of the purposes and activities of the association for the year in question. This review should be conducted at the end of the year, not at the beginning of or during the year.
Where an NPO ceases to meet these criteria, it becomes subject to the rule in section 149(10) of the Act, which provides that where, at a particular time, a corporation ceases to qualify for a tax exemption as an NPO, a new taxation year is considered to start at the particular time. The corporation’s properties are deemed to have been disposed of at fair market value and reacquired at the particular time for the same amount, and the income earned after the particular time will become taxable.
Tax treatment of capital gains
The CRA document notes that when an NPO disposes of a capital asset, the taxable capital gain will be included in the NPO’s income but will be exempt from tax. However, if the main purpose of an association is to provide dining, recreational or sporting facilities for its members, special rules will apply. The Act will deem an inter vivos trust to have been created to hold the property of the association, and tax will be payable by the trust on any taxable capital gains from disposition of property. However, capital gains from the disposition of property used exclusively for and directly in the course of providing the dining, recreational or sporting facilities to the NPO’s members will be excluded from the income of the deemed trust.
Tax consequences on liquidation
Tax consequences related to the liquidation of an association will vary depending on the legal status of the association. If the association is a corporation with share capital, the Act may deem the corporation to have paid a dividend on the shares for the benefit of the shareholders where funds or property have been distributed or otherwise appropriated by the shareholders. If the association is without share capital, any funds or property distributed to a member may constitute the disposition of his or her interest in the association and be non-taxable. To the extent that the value of such interest exceeds its adjusted cost base (which is calculated according to the fees paid by the members for membership), the members may be subject to capital gains tax on the distribution.
Miller Thomson’s Charities and Not-for-Profit lawyers can advise on all aspects of NPO taxation.