The International Journal
of Not-for-Profit Law

Volume 1, Issue 4, June 1999

A quarterly publication of the International Center for Not-for-Profit Law

Taxation of Non-Profit Organizations: International Fiscal Association Congress 1999

Professor Ole Gjems-Onstad
Norwegian School of Management

Part I: A Never Ending Tax Policy Debate

The appropriate income tax regime for the taxation of non-profit organizations (NPOs) has been widely debated in various countries for a long time. The issues of tax policy have not been settled. There is no clear consensus as to how NPOs should be taxed, what the appropriate criteria for exemptions should be, and to what extent contributions to NPOs should receive tax benefits. As NPOs in many countries are entering into new fields of activity, due in part to the withdrawal of direct governmental intervention, the discussion is as important, and in many countries as unsettled, as ever.

The International Fiscal Association is the world’s leading organization of tax experts. On October 11, 1999, in Eilat, Israel, approximately 1,000 of its members will discuss the taxation of non-profit organizations for an entire day. In June 1999, as part of the preparations for the congress, IFA in collaboration with Kluwer, published a book containing the 30 national reports submitted to the conference, and a general report written by professor David Gliksberg, Israel (Taxation of Non-profit Organizations. International Fiscal Association. Vol LXXXIVa. Kluwer 1999). This volume is of considerable interest also to non-tax professionals interested in the relationship between government and NPOs. The discussion leader on non-profit taxation will be Professor dr juris Ole Gjems-Onstad, who is also the author of this contribution.

What are the issues to be discussed at the Eilat meeting? The subject matter of the proceedings is limited to income taxation. Neither VAT-issues nor excise taxes will be considered. As IFA is an international forum for tax debates, the international aspects of NPO-taxation will be an important part of the discussions in Eilat. The international aspects of NPO taxation are dealt with first as these present the problems that most states have not been able or willing to address by writing explicit solutions into their statutes, regulations or tax treaties. This article will present the problems to be considered in Eilat, but will not suggest conclusions.

Part II: International Aspects of the Taxation of Non-Profit Organizations

A. Breaking new ground

Many countries have yet to develop a clear position on some or all of the international issues attending the taxation of NPOs. It also may appear difficult to identify clear trends in the various countries on these issues. The international issues regarding the the taxation of NPOs may be addressed either at a national level, bilaterally through tax treaties, or multilaterally by groups of countries entering into multilateral tax treaties or through international organizations like the OECD or the EU. The problems to be addressed may be regarded both as tax policy questions, and as discrimination problems under the tax treaties and other treaties containing non-discrimation clauses.

The international aspects of NPO-taxation may be divided between two key subjects: The classification or criteria for qualifying as an NPO, and the tax regime applying to donations. In both fields, and both in domestic law and in the treaties, one is left with the impression that there is a considerable dearth of solutions. One may ask whether any country appears to have a clear tax policy designed to deal with the international tax issues regarding either the classification of NPOs or donations to them.

B. Outbound and inbound NPOs

The problems attending the classification of a cross-border or international NPO, at first may be viewed from two perspectives. One may apply the expression ”outbound NPOs” when discussing how NPOs domiciled in one country (the resident country) and performing all or part of their activities in another country (the source country) should be treated in the resident country. Should the resident country in any way apply different criteria for tax exemption or defining the tax base for NPOs with activities in other countries (outbound NPOs)? Should income produced in the other country/ies (the source country/ies) be more lightly taxed in the resident country than domestic income? Should the activities conducted in countries other than the resident country more appropriately be seen as for-profit or not-for-profit for the purposes of its classification as an NPO in the resident country?

From the perspective of the other country (the source country), the NPO in question may be called an ”inbound NPO”. Should the source country for tax purposes treat organizations resident in other countries different from national organizations? Some countries do not recognize, for tax or other purposes, NPOs that are not registered as local organizations. What kind of registration and control requirements should the national governments address to inbound NPOs? To what extent may it be feasible that organizations accepted as NPOs in their resident countries be allowed to operate as NPOs in other countries?

C. Truly international NPOs

Some NPOs may be considered as truly international NPOs. The world is their arena. To a large extent their operations are international. Technically, these large international NPOs may be the resident of one country where their headquarters are located, but their activities affect a large number of countries. They do not ”belong” to any country, and therefore one might discuss whether any country should have any right to tax their income or wealth.

One may consider whether there should be some kind of exempt tax regime for these truly international NPOs, alternatively tax exemption could be considered for the mother or ”holding” organization if there are many separate national or regional organizations.

Switzerland has been the host country of many of the most prestigious NPOs (also called NGOs – non-governmental organizations) of the world. A way of dealing with the tax problems of these NGOs and how they may be handled, is to discuss whether the Swiss legislation has features that should be adopted by other countries.

D. Tax treaties – non-discrimination

Tax treaties that have been written according to the OECD Model Tax Convention contain non-discrimination clauses. It does not appear clear to what extent the tax authorities in different countries find that the non-discrimination clauses of the tax treaties determine what kind of tax treatment should be accorded to income related to inbound and outbound NPOs.

Some states have specific clauses in their tax treaties dealing with specific kinds of income. Among some of the Nordic countries there are ”sub-treaties” exempting from withholding tax dividends received by specifically enumerated NPOs.

Part III: The Definition and Qualifying Criteria for Tax Exemption for NPOs

A. Tax expenditure or outside the proper tax base?

As few, if any, countries have a stricter income tax regime for NPOs than for ordinary businesses, the practical question is to what extent NPOs should qualify for any kind of tax exemptions or tax favours?

One can approach this issue from two different perspectives, but whichever perspective is chosen, one hardly avoids considering the theories of market failures, public goods and externalities when analyzing how the NPOs should be treated under the tax law. One perspective is to regard any tax exemption as a tax expenditure, an indirect way for the government to subsidize NPOs. The choice of tax treatment is then quite pragmatic: What is the most cost-efficient way of subsidizing NPOs both from administrative considerations and without causing harm to the economy by disturbing competition between NPOs and ordinary businesses? Applying the term ”tax expenditure” touches upon a conceptual debate that covers much more than the taxation of NPOs. In spite of tax expenditure budgets becoming quite widespread, critics say that one may well accept the tax expenditure concept as a useful tool for governmental budgets without adhering to the tax expenditure theory as a basis for solving many disputed issues of tax policy.

Another approach is to state that receipts by NPOs are not properly part of any appropriate definition of income. Therefore, NPOs should not generally be part of the tax base in the first place. Their exclusion is not a tax expenditure, but a logical consequence of how the tax base should be defined.

B. Legal requirements for exemption

An important part of any tax policy debate on NPOs includes legal requirements regarding the framework of the NPO. Should the NPO be formally incorporated in order to qualify for tax exemptions? May certain structures be prohibited and should ordinary business organizations and persons be allowed as members? One may also ask whether the exemption requirements should differ according to whether the NPO is a membership society, a foundation, or a corporation. In some countries, foundations are treated more strictly than membership organizations as a result of fears that foundations may be more easily controlled by a small group of interested parties. There may also be requirements as to how the officers of the organization are elected (common vote).

C. A case approach – modern NPOs that cause tax policy debate

One way of comparing the tax treatment of NPOs and discussing what tax rules are appropriate is to consider types of NPOs that cause considerable debate in many countries across the world. Activities that one traditionally would call charitable, today often take a form where the amounts of money involved and the fees charged makes that term seem less appropriate.

1. Hospitals

The best example is perhaps the way many NPO hospitals today take part in a large, expanding, and often highly profitable health industry. The market for health services is increasing rapidly in many countries. NPOs may be engaged in such activities in direct competition with for-profit firms. The amounts of revenue involved may be huge, and complaints about unfair competition from the for-profit firms are substantial and sometimes quite justified.

2. Educational institutions

The extent to which private institutions fulfill a portion of the educational needs of a country varies. In some countries private universities are very important institutions and sometimes form part of what may be called a core tax exempt area of NPOs charging fees for their services. As the mass market for education and life-long learning is rapidly evolving, this traditional part of any third sector of society is becoming more commercialized and more competitive. The tax treatment of the various players is not self-evident, and neither are the criteria for tax exemptions.

3. Sports organizations

The change in the criteria for being able to participate in the Olympic Games illustrates well how the top part of the sports sector is becoming more commercialized. In some countries, e.g. the US, sports clubs have been a highly profitable business. In many other countries, sports organizations have traditionally constituted a vital part of the non-profit third sector. It appears evident that sports clubs listed on a stock exchange should not be tax exempt. On the other side of the spectrum, clubs offering athletic training on a non-professional basis for children and ordinary people, are ordinarily considered to be tax exempt.

4. Political organizations and churches

Political organizations are a controversial part of the tax debate on NPOs. To what extent may and should a political organization qualify for tax exemptions?

Under constitutional law in some countries it is also debatable whether it is legal to subject to tax income earned from the core religious activities of a church or a congregation. Should churches and other religious organizations be subject to a special tax treatment that applies criteria for tax exemptions that are different than those that apply to ordinary NPOs?

Part IV: The Tax Base – Unrelated Business Income – Passive Investment Income

Inspired by the US terminology, the question of what NPO income should be taxed is often referred to as the taxation of unrelated business income. Capital gains and passive investment income also represent special areas of concern.

In discussing what business income should be taxed, the relatedness test is vital. What should the relationship be between the NPO and its business activities so that the profits will benefit from the NPO tax exemption? Should there be different tests of relatedness for different kinds of NPOs, and for different levels of income? There may also be a rule saying that the business income of an NPO is only to be taxed when it is earned on a more permanent basis, excluding from taxation the profits earned in more temporary or incidental involvement in business activities.

Income from passive investments will often be regarded as typically tax exempt income by an NPO. Many Francophone countries, however, tax income from real property even to NPOs. It is again hard to make broad statements in the area of NPO taxation. For countries exempting income from passive investments as a general rule, an issue is whether income such as rents and dividends should be tax exempt regardless of the amounts involved.

Certain kinds of income may be subject to special classification rules. Income from real estate may be subject to taxation regardless of whether it qualifies as business income under more general rules. One might also discuss whether royalty income, profits from advertisements, etc. should be treated in the same way as business income without further qualifications. An NPO may benefit from income by the way of capital gains. An important issue is how such income should be classified. Is it passive investment income or business income?

Part V: Tax Planning and Tax Abuse

A. The non-distribution constraint

Any special tax regime will necessarily invite tax planning, either to allow taxpayers to benefit from or to avoid the incentives or disincentives involved. Spending requirements, that certain parts of the income of an NPO be used to finance its core NPO activities within specific time limits, may be regarded as one way of preventing an NPO being set up as some kind of tax-free investment vehicle. The non-distribution constraint is the more traditional and general instrument to avoid the possibility that the parties behind the NPO are able to exploit tax exemption for their own personal benefit.

Should the non-distribution constraint be absolute? Is the non-distribution constraint adequate as some kind of ultimate or sole determinant of NPO status? Should there, as e.g. in Norway, be left open any possibility for regular ownership as long as the dividends distributed are very moderate and clearly less than what might be earned on a loan to the NPO?

A non-distribution constraint does not normally imply that any interested parties may not enter into transactions with the NPO. But it is then important to implement adequate and easily controllable arm’s length standards on pricing of loans, contracts, etc. between NPOs and related parties. What are the modern challenges to non-distribution constraints and how should they best be mastered by the tax authorities?

B. Family foundations

Foundations may be used for family tax planning purposes. If the foundation is also set up for non-profit purposes, what proportion of its income or activities may devoted to family beneficiaries or family purposes without losing any of its taxation benefits? Should there be any possibility at all of setting up foundations that partly promote family tax planning purposes and benefit from NPO taxation exemptions? Should any family tax planning benefit be regarded as some kind of infringement of the non-distribution constraint?

C. Asymmetric effects – debt and interest planning

Some countries have stopped the asymmetric effects that may easily be exploited for tax planning when interest income received by the NPO is exempt, but deductible for interested parties furnishing the loan. It may even be a business corporation that is owned by the NPO and, through tax deductions for interest, is able to circumvent or greatly reduce the taxation of unrelated business income. To what extent should such arrangements be viewed as unacceptable tax planning, and what problems do counter-measures meet?

D. Joint ventures

NPOs and ordinary businesses may set up joint ventures. From the NPO point of view it is important that such a joint venture does not imply any extra tax burden in excess of the tax incurred if it had performed the activities by itself. The NPO should also avoid having its assets tainted in such a way that any future capital gains will be subject to tax. The business party on should try to benefit from the tax exemptions granted the NPO, and avoid any kind of deemed realization rules due to its assets now being partly utilised in collaboration with an NPO. The tax authorities must decide whether this kind of cross-sectoral cooperation should be encouraged, or if it is more desirable to draw clearer lines between the two sectors.

A joint venture between an NPO and an ordinary business corporation may sometimes be hard to distinguish from a sponsorship arrangement. An important issue of great practical concern in many countries is how to set up a workable sponsoring scheme enjoying maximum tax benefits and avoiding unnecessary tax pitfalls.

E. Potential fraudulent use of NPOs

In some countries the tax exemptions, and perhaps the less controlled regimes, of NPOs have been exploited by organized crime for money laundering and other criminal purposes. One should be aware that such activities take place. What countermeasures have worked in jurisdictions trying to combat fraudulent tax planning schemes involving NPOs, and what kinds of NPO tax regimes are most easily exploited for criminal purposes?

Part VI: Contributions

A. Domestic tax issues

The central issue of interest regarding contributions concerns the tax benefits available to the donor. That the contributions should not be taxable to the recipient NPO does not appear as a controversial tax policy question. In many countries, the class of NPOs that qualify for tax benefited contributions is more limited than the class of NPOs eligible for tax exemptions. Trade unions and chambers of commerce are typical examples. How the line should be drawn between the NPOs that are exempt from tax and those that may receive tax benefited contributions is not clear. Neither is it settled whether the most efficient incentives are by way of deducting the contribution against the donor’s income, or through tax credits to him, or by way of rebates of the donor’s tax directly to the NPOs.

Another issue arises with respect to gifts of property. Non-monetary contributions may raise the question of taxing unrealized gains on part of the donor, or at least not allowing the untaxed part of the asset’s value be included in the deduction made against other income.

One of the most valuable contributions received by NPOs may be by way of voluntary work. If the work is performed by a professional, one question concerns whether the professional should be taxed under some kind of deemed realization or sale requirements. This problem is, however, often more relevant in a VAT perspective. Another question concerns voluntary contributions relating to activities that may result in taxable profits for the NPO. If the tax base of the NPO does not allow any kind of adjustment or reduction for the value of the voluntary contribution, they will be taxable in some indirect way. As a general rule, such an adjustment is not allowed.

B. Cross border contributions and activities

The globalization of the activities of NPOs also affects the question of the tax benefits regarding contributions given outside the taxpayer’s home country or for activities that take place outside the country. Few tax treaties address the taxation of cross-border donations. Yet, it is important to encourage international donations. Appropriate tax solutions will necessarily be part of the solution.

There are two main aspects of this question relating to cross-border donations and cross border activities by the recipient organization. Should the tax treatment of the donor be different if the recipient organization spends the contribution on activities in other countries (contributions to outbound NPOs)? To what extent should donations to non-resident NPOs qualify for deductions? One may here distinguish between foreign NPOs conducting activities in the country of the donor and the state granting the deduction on the one hand (inbound NPOs), and on the other hand foreign NPOs conducting activities in third countries and not in the country of the donor.

C. Charitable zones?

Within the European Union the commission has put forward proposals for a European Association, a European Mutual and a European Cooperative (the revised proposals are published as COM(93) 252 final – SYN 386-391). These proposals, that so far have not been adopted, have tax implications that should be considered as relevant to the international tax treatment of NPOs.

The European proposals concern the classification of the organizations as such, and not primarily contributions given to them. They may, however, be viewed as some kind of common charitable or common NPO zone. Such zones may represent a stepping stone towards finding a solution to the problems faced by companies involved in NPO-activities and charitable giving across borders. 

 

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