Survey of the Treatment of Economic Activities of Nonprofit Organizations in Europe

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Year: 2007
Country: Transnational
Language: English
Document Type: Publication
Topic: Economic Activities,Public Benefit and Charitable Status,Regional/Global Overviews

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Copyright © 2007 by the European Center for Not-for-Profit Law, International Center for Not-for-
Profit Law and the Macedonian Center for International Cooperation. All rights reserved.” 1
SURVEY OF THE TREATMENT OF ECONOMIC ACTIVITIES OF NON-
PROFIT ORGANIZATIONS IN EUROPE 
I. INTRODUCTION
Economic activities are considered as a key income source for the non-
governmental,
not-for-profit organizations (NPOs) 1 in countries around the globe.
According to the John Hopkins Comparative Research Project (John Hopkins Survey),
53% of NPOs’ income in the surveyed countries is generated through fees for services,
economic activities, investments and other income generating activities.
2 Engagement in
economic activities enables NPOs to expand the pool of unrestricted resources, but also
to develop their services and increase their quality, and to target more effectively the
needs of the beneficiaries. In addition, this is an important resource especially for
advocacy NPOs, who need to be able to create an independent resource base for
implementation of their activities and thus retain a certain degree of independence from
the Government.
Almost all European countries allow NPOs to conduct economic activities
(directly and/or through subsidiary/company) in order to generate income to support their
activities. However, there might be some limitations in terms of the types of activities,
or the tax treatment of the income from such activities.
This paper was developed by the International Center for Not-for-Profit Law (ICNL) and the European
Center for Not-for-Profit Law (ECNL) for the Macedonian Center for International Cooperation (MCIC).
It was based on a draft paper developed by Prof. Chris Jansen, during his internship with ICNL.
Unless referenced differently, the country specific information in this paper has been compiled mainly from
three resources: (1) “The Survey of Tax Laws Affecting NPOs in CEE” published by the International
Center for Not-for-Profit Law (second edition, 2003, www.icnl.org
), (2) “Tax Treatment of Non-Profit
Organizations and Tax Benefits for Donors”, paper developed for a project for the Bulgarian Centre for
Not-for-Profit Law (BCNL) under the project “An Optimistic Look at NPOs and Domestic Resources”,
funded by the Trust for Civil Society in Central and Eastern Europe through the Bulgarian Charities Aid
Foundation (2006), and (3) “Economic Activities of Not-For-Profit Organizations”, prepared by ICNL
(1996).
1 The term not-for-profit organizations is used in a broad sense to encompass non-governmental legal
entities that are variously referred to as association, foundations, non-profit companies, public benefit
organizations, charities, civic organizations etc.
2 The study included 16 advanced industrialized countries, 14 developing countries from Africa, Asia and
Latin America, and 5 countries from Central and Eastern Europe, including the Czech Republic, Hungary,
Poland, Romania and Slovakia. See “Global Civil Society: An Overview,” Lester M. Salamon, the John
Hopkins Comparative Nonprofit Sector Project, 2003 (www.jhu.edu/~ccss).

Copyright © 2007 by the European Center for Not-for-Profit Law, International Center for Not-for-
Profit Law and the Macedonian Center for International Cooperation. All rights reserved.” 2
This paper examines the issue NPOs engaging in economic activity for profit with
the aim to address the two questions of whether such activity is allowed at all and, if so,
what are the tax consequences? It addresses these questions within the context of Europe
with the focus on the Central and Eastern European (CEE) countries.
3 The paper
provides both a survey of current practices and an analysis of the rationales and strengths
and weaknesses of the various approaches.
Part II briefly outlines the legal characteristics of NPOs and what differentiates
them from for-profit entities. Part III discusses “economic” and “commercial” activities
in order to define which types of NPO activities lie within the scope of this paper. Part IV
deals with the question of whether NPOs are permitted to engage directly in economic
activities. It discusses the exceptions to the general rule of permitting economic activity
and the various restrictions that may apply when economic activities are allowed. Part V
deals with the tax consequences to NPOs when they engage in economic activities. It
explains the various approaches adopted by the surveyed countries and the rationales and
strengths and weaknesses of each approach.
II. LEGAL CHARACTERISTICS OF NPOs
It is helpful to initially spell out what distinguishes an NPO from a for-profit
entity from a legal perspective.
First,

an NPO must be organized and operated primarily (but not exclusively) for
some purpose other than private gain. Generating some profit is not prohibited as long as
the NPO’s primary purpose is not for profit.
Second, NPOs are prohibited from distributing net revenues to private parties who
may be in a position to control the organization for personal gain, such as founders,
members, officers, directors, agents, and employees. This principle of non-distribution
does not generally extend to distributions, even to private parties, which are designed to
further public benefit purposes, such as charitable donations to the poo
r.
A

third assumption is that the organization’s characteristics, not its organizational
form, are determinative of NPO status. That is, the activities and purposes of the
organization are more important than the characterization of its legal personality, be it an
3 The notion: Central and Eastern Europe in the Report pertains to the following countries: Bulgaria,
Hungary, Latvia, Lithuania, Estonia, Romania, Czech Republic, Slovakia, Slovenia, Poland, Croatia,
Serbia, Bosnia and Herzegovina, Macedonia, Montenegro and Kosovo.

Copyright © 2007 by the European Center for Not-for-Profit Law, International Center for Not-for-
Profit Law and the Macedonian Center for International Cooperation. All rights reserved.” 3
association, foundation, trust, non-profit company, or even, under some legal systems, an
unregistered and unincorporated organization.
III. DEFINITION OF “ECONOMIC” AND “COMMERCIAL” ACTIVITIES
Generally speaking, “economic activities” mean the active sale of goods or
services,
referred to as “trade or business” activities; it entails sale of goods and services
that are pursued with the frequency or continuity.
There are, however, a number of activities excluded
from this definition – i.e., not
considered “economic activities” – and therefore outside the sc
ope of this paper. The first such exclusion is isolated, irregular, or occasional activities which
involve the sale of goods or services but which are not pursued with the frequency or
continuity of comparable practices in the commercial sector. This would include, for
example, raffles, occasional fundraising dinners, and charity auctions. The second group of NPO activities often recognized as non-economic in nature
are those activities primarily or exclusively carried out with volunteer labor and/or
donated materials. An example of this would be a thrift- or second-hand store operated by
an NPO to generate profits for its public benefit purposes. The third exclusion recognized by many legal systems derives from historical
practices or traditions. This category includes activities considered to be intrinsically
connected to the public benefit purposes of certain NPOs. Examples may include
admission fees for museums, tuition fees, or fees from patients at not-f
or-profit hospitals.
In sum, transactions generally deemed not to be “economic” include
:
isolated, irregular, or occasional activities involving the sale of goods or
services

but which are not pursued with the frequency or continuity of
comparable practices in the commercial sector;
 activities primarily or exclusively carried out with volunteer labor and/or
donated materials; and
 historical practices or traditions.
 the receipt of purely gratuitous gifts, grants, donations, and contribut
ions;
 the receipt of net revenues from passive investments;
 the use of any funds from the above two to advance the public benefit
purposes of the NPO;
Regarding

allowable NPO activities, some jurisdictions attempt to create a
distinction between “economic” activities and “commercial” activities, treating
“economic” activities more permissively. For example, the laws in Hungary distinguish
between economic activities related to the statutory purposes and
commercial/entrepreneurial activities which “aim at or result in obtaining income and

Copyright © 2007 by the European Center for Not-for-Profit Law, International Center for Not-for-
Profit Law and the Macedonian Center for International Cooperation. All rights reserved.” 4
property” and are unrelated to the statutory activities. All economic activities that are
included in the statute of the organization as supporting the mission are not subject to
taxation. NPOs need to pay tax only on the income from the commercial/entrepreneurial
activity and only if such income exceeds the prescribed threshold in the
law (see below).
Most commonly, the issue is whether an NPO’s activity has a direct co
unterpart in
the commercial sector, in which case it would be considered not merely “economic” but
also “commercial”. Other factors have also been suggested to indicate inappropriate
commerciality, such as profitable operation and the accumulation of profits, competition
with for-profit companies, extensive and successful expansion, and the use of paid
workers.
This conceptual distinction between an economic and commercial activity is
slippery and difficult to define and implement. Also, in most cases it is not an issue. This
paper does not concern itself with distinguishing between the two terms, simply
employing the term “economic activities” in all cases, and referring to the commercial
activities only when this distinction is clearly applied in the countries analyzed in this
paper.
IV. ARE
NPOs PERMITTED TO ENGAGE DIRECTLY IN ECONOMIC
ACTIVITIES?
A threshold issue is whether and to what extent NPOs are or should be allowed to
engage
directly in economic activities and retain their not-for-profit status. At this stage
of the analysis, the question is not whether such activities are or should be tax exempt,
but whether there is or should be a limit to economic activities underta
ken by an NPO.
A. Generally permitted
In almost all countries of Europe NPOs are generally permitted to engage directly
in economic activities. There are, however, exceptions to this general rule, and even
when economic activity is allowed, it is only allowed under certain cond
itions.
B. Exceptions: Direct economic activity not allowed
Some countries have limited the ability of some forms of NPOs to directly engage
in economic activities. For example, in the Czech Republic foundations and funds are
limited to renting property and organizing cultural, educational, social and sports
activities, and lotteries and collections. In Slovakia, direct economic activity is not
allowed for foundations or non-investment funds. In Macedonia associations and

Copyright © 2007 by the European Center for Not-for-Profit Law, International Center for Not-for-
Profit Law and the Macedonian Center for International Cooperation. All rights reserved.” 5
foundations must found a joint stock company or limited liability company in order to
engage in economic activities.
C. Limiting conditions for engagement in economic activities
Most countries have set requirements that determine the ability of NPOs to
engage in economic activities. For example, article 3 of the Bulgarian Law on Non-Profit
Legal Entities provides for the following conditions:
(1) Legal persons with non-profit purposes are free to determine the means for achieving their purposes.
(2)

Restrictions on the activities and on the means for achieving the purposes of the
legal persons with non-profit purposes can be imposed only by law.
(3) Legal persons with non-profit purposes can engage in additional economic activities only if they are related to their main statutory activity as registered,
and if they use the revenue to achieve their statutory purposes .
(4)

The type of economic activity is determined in the statute or the articles of
incorporation of the legal person with non-profit purposes.
(5) Legal persons with non-profit purposes may conduct economic activity according to the laws governing the respective type of economic activity.
(6) Legal persons with non-profit purposes do not distribute profit.
1. Statutory purpose
The most common requirement on NPO economic activity employs the notion of
statutory purpose.
a) Economic activity related to statutory purpose
The first and most common condition of these requires that the economic activity
be related to the organization’s statutory purpose. Although the specific language may
vary, the principle remains the same. For example, Bulgaria allows only economic
activity “related to [the organization’s] registered statutory objective .” Estonia allows
economic

activity which “corresponds to the purposes stated in the Articles of
Association.” The countries with this requirement include Albania, Bulgaria, Croatia,
Estonia, Lithuania, Romania, and Slovenia.
b) Income from economic activity used to support statutory goals
A second condition related to statutory purpose requires that income from
economic activities be used solely to support statutory goals. That is, instead of focusing

Copyright © 2007 by the European Center for Not-for-Profit Law, International Center for Not-for-
Profit Law and the Macedonian Center for International Cooperation. All rights reserved.” 6
on “whether” the economic activity is related to the organization’s statutory purpose, this
requirement focuses on “how” the income from such activity is used. Bosnia &
Herzegovina and Bulgaria use this requirement.
2. Incidental/auxiliary/not primary purpose
Another most common type of condition for economic activity requires that such
activity not be the primary purpose or main activity of the NPO but rath
er an incidental or
auxiliary activity. Countries with this restriction include Albania, Lat
via, Czech Republic,
and Romania.
3. Identified in founding documents
Some countries allow an NPO to engage only in economic activities identified in
its founding documents. It is used in Croatia and Slovenia. For example, Croatia allows
NPOs engagement in economic activities to the extent it is necessary and only in those
activities, which are enumerated in the statute so that the registration authority could
review their legitimacy in advance. However, the lack of clear criteria regarding what is
considered to be an economic activity is one of the problems in implementing this
provision.
4
4. Registered
In Poland, an NPO can only engage in economic activities if the organization has
been registered in the entrepreneurs’ court register. In Montenegro, on the other hand, an
NPO can only engage in economic activities if those activities have been registered in the
commercial court’s register.
D. Analysis
1. Arguments in favor of allowing NPO economic activity
There are two principle justifications for allowing NPOs to engage directly in
economic activity. The first is that it plays a critical role in the sustainability of the NPO
sector . Income from economic activities is a primary source of funds for NPOs
(particularly in countries in a transitional phase where there is a dearth of private capital
4Hadzi-Miceva, K., “A Supportive Financing Framework for Social Economy Organizations”, paper
developed for and presented at a conference on Social Economy in CEE: Emerging Trends of Social
Innovation and Local Development, organized by OECD and LEED Program (2005)

Copyright © 2007 by the European Center for Not-for-Profit Law, International Center for Not-for-
Profit Law and the Macedonian Center for International Cooperation. All rights reserved.” 7
and philanthropic tradition), thereby reducing their reliance on government, foreign,
and/or private sources of funding. Such reliance can threaten not only the viability of
NPOs but also the independence and autonomy of the NPO sector. Deprived of their own
independent means of financing, NPOs may have to stray from their core mission and
cater instead to those goals for which grants and funding are available. Furthermore,
government and foreign aid usually does not continue indefinitely. Indeed, foreign donors
have already begun to phase out of the CEE region, forcing local NPOs to find alternative
sources of funding.
The second justification is that certain economic activities can directl
y accomplish
an NPO’s public benefit purposes . For example, if an educational organization sells a
book on teaching techniques, this not only serves an economic benefit to the organization
but also serves the public benefit purpose of promoting education. Preventing NPOs from
using economic means to attain their goals may directly impair their ability to serve their
public benefit purposes. The third justification is that to prohibit is not to prevent
. It would seem better to
regulate economic activity than to encourage it to go ‘underground – and thus inflict
harm to fair competition, which will be more difficult and costly to rem
edy.
Allowing NPOs to generate income could lead to an increased level of
effectiveness in program implementation and to better quality and more diverse services.
For example, charging fees for services and products raises the expectation of
beneficiaries to receive a higher quality of service. This triggers the institutional mindset
of NPOs, who become more aware about the need they aim to address and the value of
services they provide to their beneficiaries. In addition, the ability to engage in income
generating activities encourages NPOs to consider services that they could not otherwise
provide for through other funding sources. Finally, the ability of beneficiaries to choose
the service provider raises competition among NPOs, which leads to better quality of
services and enhances the effectiveness of their work.
5
2. Arguments against allowing NPO economic activity
The main argument against allowing direct NPO involvement in economic
activity is that it could create unfair competition with for-profit entities
. While this is
essentially a tax issue (i.e., that NPOs often get preferential tax treatment and, thus, an
unfair advantage vis-à-vis the for-profit sector), proponents of this viewpoint also
contend that NPOs have a competitive advantage over the for-profit sector because they
are not required to expend as much capital to achieve the same result.
6 As NPOs operate
5Hadzi-Miceva, K., “A Supportive Financing Framework for Social Economy Organizations”, paper
developed for and presented at a conference on Social Economy in CEE: Emerging Trends of Social
Innovation and Local Development, organized by OECD and LEED Program (2005)
6 See infra section V for a discussion of how countries deal with the NPO taxation issue.

Copyright © 2007 by the European Center for Not-for-Profit Law, International Center for Not-for-
Profit Law and the Macedonian Center for International Cooperation. All rights reserved.” 8
to serve the public benefit, they have a built-in positive reputation with consumers and
need not engage in public relations and advertising to the same extent as for-profit
entities do. In addition, NPOs often have access to bigger pool of human resource in the
form of volunteers and consequently spend less on wages thus giving them another
advantage over their for-profit counterparts.
A second argument is that allowing NPOs to engage directly in economic
activities may result in mission drift
. The promise of earning revenue to invest in their
organization may divert the attention of NPO managers from their core non-profit public
benefit purposes. A third argument is that allowing NPOs to engage in direct economic activity may
enable some organizations with for-profit intentions to organize and operate under an
NPO guise in order to achieve NPO benefits , reducing their tax payments and obtaining a
competitive advantage over other for-profit entities. Not only can this result in unfair
competition but may also lead the public to view NPOs as an illegitimate means of
avoiding taxation. This image, once created by even a limited number of NPOs, damages
the reputation of the entire sector.
V. TAX TREATMENT OF INCOME FROM ECONOMIC ACTIVITIES
The tax treatment of the income from economic activities differs widely among
the

countries of Europe. Some countries, such as Albania, Macedonia, the Netherlands
and Slovenia, tax all income from economic activities. Others prescribe certain
conditions, which must be fulfilled for the organization to benefit from profit tax
exemption.
The first difference among the countries relates to the types of organizations
that
receive the exemption from profit tax. The following models are represented in the
region:
A broad range of NPOs are eligible to claim exemptions (e.g., Czech
Republic,

Croatia, the Federation of Bosnia and Herzegovina, Hungary,
Latvia, Lithuania, Romania, Serbia, Montenegro and Slovakia).
 Only those NPOs that engage in certain types of activities intended for public
benefit

or organizations that have attained public benefit (PBOs) 7 status or
7The public benefit status essentially distinguishes between organizations that are established for the
mutual interest of the members, such as sailing clubs, from those whose activities benefit a larger
community. Countries generally list the type of activities that are considered of public benefit and prescribe
the criteria to further define the status. For more see: “A Comparative Overview of Public Benefit Status in
Europe” developed by ICNL and ECNL for MCIC (2007); www.ecnl.org

Copyright © 2007 by the European Center for Not-for-Profit Law, International Center for Not-for-
Profit Law and the Macedonian Center for International Cooperation. All rights reserved.” 9
charitable status (e.g., Albania, England, Estonia, Ireland, 8 Kosovo, Poland)
are eligible to claim exemptions. The definition of public benefit activities
differs, but generally these countries consider the following activities to be of
public benefit: charitable, humanitarian, environmental, education, etc.

 Very limited categories of organizations are eligible for tax exemptions. For
example,

in the Republic of Srpska, only legal entities that engage in labor
and professional rehabilitation and employment of people with disabilities are
exempted from corporate income tax.
Further, different countries use diverse methods
to determine the extent to which
the income from economic activities will be tax exempt. Generally, countries employ
different methods in order to restrict the use of economic income, so as to ensure that the
economic activity remains a supplemental, rather than the primary activi
ty of an NPO.
A. Generally tax all profits
One approach is to tax all NPO profits derived from direct economic activity. The
following countries generally tax all profits, with some exceptions as indicated: Albania,
Bosnia (Republika Srpska)
9, Bulgaria 10, Slovenia.
 Rationale
The main argument for full taxation of NPO economic activities is that if they are
not taxed there is potential for NPOs to gain a competitive advantage over for-profit
organizations. Some argue that tax-exempt profits give NPOs higher post-tax rates of
return on their business activities than for-profit organizations. Tax-free profits may also
enable NPOs to maintain lower profit margins on their economic activities. This
advantage could be used to reduce prices on goods and services below levels which are
competitive, or even sustainable, on the part of for-profit organizations. Additionally, an
NPO may use tax savings to reinvest in economic activities in a way non-exempt for-
8 For example, in Ireland the Revenue Commissioners determine which is granted charitable tax exemption.
This body will be issued a charity reference number e.g. CHY 1111 and this CHY number needs to be
quoted in all future correspondence with Revenue. For more see www.revenue.ie
9 As noted above NPOs (other than those engaged in labor and professional rehabilitation or employment of
disabled persons) are subject to corporate income tax. As discussed infra in section V(B)(1), there is no
taxation of NPO profits in the Federation of Bosnia & Herzegovina.
10 NPO income from economic activities is taxed. However, social and health insurance funds established
by law, scientific budget institutions, universities, and state, municipal and private schools are entitled to a
50% remittance of the tax on income directly connected or auxiliary to their main activity. The Bulgarian
Red Cross is entitled to 100% remittance. The remittance is accounted for by the organization as a reserve
and must be invested in the main activities of the organization.

Copyright © 2007 by the European Center for Not-for-Profit Law, International Center for Not-for-
Profit Law and the Macedonian Center for International Cooperation. All rights reserved.” 10
profit organizations could not. Also, tax exemptions may provide NPOs with a larger
capital base, which can be used to finance expansion and outbid for-profit organizations
for land and facilities. In summary, proponents of this approach argue that with the
possible exception of certain traditional public benefit activities, it is necessary to tax all
economic activities to place NPOs and for-profit organizations on an equal footing in the
marketplace. This argument often has strong appeal. For example, this fear prompted the
Croatian legislature to pass a law pertaining to this perceived competitive advantage.
11
Income from economic activities by NPOs may be subject to tax if the Tax
Administration finds that exempting that income would result in the NPO’s gaining an
“unjustified privileged position in the market,” in which case the economic activities are
taxed at a rate of 20%.
A second argument in favor of full taxation is that NPOs enjoy competitive
advantages over for-profit organizations separate from tax exemptions, thus eliminating
the need for further subsidization. As mentioned above,
12 NPOs may already have a
competitive advantage over the for-profit sector because they are not required to expend
as much capital to achieve the same result. As NPOs operate to serve the public benefit,
they have a built-in positive reputation with consumers and need not engage in public
relations and advertising to the same extent as for-profit entities. In addition, NPOs often
have access to free labor in the form of volunteers and consequently spend less on wages
and benefits for their employees, giving them another advantage over their for-profit
counterparts. Also, in addition to generating income from economic activities, NPOs may
also be receiving government funds and private donations. Proponents would argue that
these non-tax benefits eliminate the need to provide NPOs with tax benef
its.
Third, the full taxation approach is easier to administer since NPOs are treated
like any other organization for tax purposes. And fourth, full taxation eliminates the
possibility and therefore minimizes the potential for abuse by organizations attempting to
take advantage of NPO tax preferences.
There are, of course, strong arguments against the full taxation approach or, put
another way, in favor of some sort of preferential tax treatment for NPOs. These are
discussed in the following sections.
B. Full exemption/no taxation
Some countries fully exempt income from economic activities. For example, in
the Federation of Bosnia and Herzegovina NPOs are not subject to corporate income tax
and therefore all of their income from economic activities is exempted f
rom taxation.
11 See section V(G).
12 Section IV(D)(2).

Copyright © 2007 by the European Center for Not-for-Profit Law, International Center for Not-for-
Profit Law and the Macedonian Center for International Cooperation. All rights reserved.” 11
In Croatia associations and foundations are generally exempt from profit tax.
However, if an organization performs for-profit activity and if exemption from the tax
would give the organization an “unjustified privileged position in the market” then such
income will be taxed at the regular tax rate. The law does not define what will constitute
“an unjustified privileged market position” and it therefore leaves it up to the tax
administration to determine on case-by-case basis.
As noted earlier, in Hungary all NPOs are exempted from profit tax on income
from economic activities (however are taxed on the income from commercial activity as
explained below)
Rationale
The main reason to fully exempt NPO from taxation of income from economic
activities, is that such NPOs often lessen the government’s burden to provide similar
services and so NPOs need to rely on own income generation to implement them. The
government is compensated for the loss of tax revenue (which results from exempting the
income from taxation) by its relief from this financial burden, which would otherwise
have to be met by appropriations from public funds, and by the benefits resulting from
the promotion of the general welfare. Further, giving NPOs a competitive advantage (through exemption in taxation) in
certain fields may serve the public as NPOs are often able to identify needs and solve
problems more quickly and efficiently than government bureaucracies. Also, NPOs are
often able to provide needed services at a lower cost and higher quality than for-profit
organizations, which are bottom-line driven.
Taxing NPOs depresses the development of the NPO sector. This is a particularly
apt argument under a tax regime which requires NPOs to pay tax on economic activities
even when they are related to their public benefit purposes. In the latter case NPOs are
limited in their ability to financially sustain their operations. Such an approach also fails
to provide incentives for NPOs to engage in public benefit activities involving an
economic component (e.g., an association for the blind selling walking canes) since these
activities would be subject to full taxation.
Finally, as to the argument that giving NPOs preferential tax treatment results in
unfair competition with the for-profit sector, it has been argued that empirically such
concerns are largely unfounded and the negative impact on the for-profit sector
overestimated. First, small businesses are often able to avoid profit taxes by means
unavailable to NPOs. Large salaries and expensive offices may allow small businesses to
substantially reduce paying income tax. Indeed, several countries have abolished small

Copyright © 2007 by the European Center for Not-for-Profit Law, International Center for Not-for-
Profit Law and the Macedonian Center for International Cooperation. All rights reserved.” 12
business profits tax due to their failure to collect. Second, small businesses are eligible to
receive loans from lending institutions, whereas NPOs are generally ineligible for loans.
Third, economic activities in which NPOs take part generally fall in the province and
jurisdiction of the not-for-profit sector and therefore do not compete with for-profit
entities. This is especially true when a country uses the “relatedness” approach to NPO
tax exemption.
13
C. Destination of income approach
This approach looks at the
destination of the NPO’s income – or what are the
purposes
for which the income is used. Under this approach, income used for charitable
or public benefit purposes is tax exempt; all other income is taxed. While some countries
use this approach in its pure form, others place a ceiling (threshold) on tax exempt
income, even if it is used for charitable purposes.
Countries that exempt all income which is used for charitable or public benefit
purposes include Kosovo (No tax for PBO-status NPOs if income is used for public
benefit purposes
14) and Poland (No tax if income is devoted to public benefit goals
specified in the tax law 15).
 Rationale
This is a desirable approach in many ways. First, it is based on the premise that
tax exemptions should only subsidize activities which benefit the public, so only income
actually spent in furthering public benefit purposes should be tax exempt. Proponents
argue that tax preferences are appropriate for activities which would or should otherwise
have to be undertaken by the government to improve the situation of the
citizenry. Second, although this approach does require a (sometimes difficult) determination
of whether income has been spent for public benefit purposes,
16 generally speaking it
13 See section V(D).
14 Non-PBO NPOs are taxed to the extent they exceed allowable expenses for the
reporting period
15 However, the tax exemption does not apply to certain economic activities, including the production of
alcoholic beverages, tobacco, fuel, electronic devices, or production or trade of precious metals.
16 For example, what connection is required between the expenditure and the NPO’s purpose? Money spent
on food for the poor is key to the goals of a foundation fighting hunger. But is job training (arguably
enabling the beneficiaries to find employment which would result in money for food) sufficiently related?
What about childcare services which would enable the beneficiaries to search for employment? It is
difficult to draft and implement legislation or regulations that adequately define the required connection
between the expenditure and the public benefit purpose. Therefore, determinations must often be made on a
case-by-case basis.

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avoids the complex analysis required in some other approaches, such as the relatedness
test, discussed below.
Third, when there is no limit to the exemption, this approach provides the greatest
level of financial support to NPOs since, as long as income is devoted to public benefit
purposes, NPOs do not incur any tax liability. Of course, this “advantage” is a matter of
perspective. From the government’s point of view this is a disadvantage as this approach
would probably generate the least amount of tax revenue. This revenue loss can,
however, be limited by imposing a ceiling on the amount of income exempt from taxes, a
“threshold” approach discussed in the next section.
The main criticism of this approach is that it creates unfair competition. For
example, under this approach, if an NPO established to aid the poor earned income from
the manufacture and sale of radios, such income would be tax exempt if used for public
benefit purposes. The NPO would probably be competing with other for-profit
manufacturers of radios who would be paying taxes on whatever profits they earn and
would therefore have to sell the radios at a higher price. Thus, this approach risks
potentially negative macroeconomic consequences for the business sector. Indeed, the
United States abandoned the destination of income approach in favor of a relatedness
approach due to unfair competition concerns. Another criticism of this approach is that it allows NPOs to engage in income-
generating activities completely unrelated to their goals, with various possible negative
consequences. First, it may divert an NPO’s attention and energies away from the
purposes and goals for which it was established. Second, this approach may lead the
public to view NPOs as nothing more than for-profit businesses in disguise. Third, more
than other approaches, it may attract unscrupulous individuals seeking to use an NPO for
tax evasion purposes.
D. Relatedness approach
This approach looks to the source of the income. Under this approach, NPO
income
is tax exempt if it derives from economic activities sufficiently related to the
public benefit purposes of the organization.
17 Generally the activities that are considered
as unrelated to the statutory goals will be taxed same as other entities. This is the case of
Latvia.
Rationale
17 This is the approach used in the U.S. This approach is also generally used for the exceptions (e.g., in
Bulgaria) to the otherwise full-taxation approach discussed in section V(A). That is, these exceptions
typically look to the source of the income.

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Profit Law and the Macedonian Center for International Cooperation. All rights reserved.” 14
The related nature approach attempts to address concerns of unfair competition
and it makes theoretical sense. Often, the most effective way for an NPO to achieve its
purposes is to pursue them through economic means. For example, NPOs which assist
certain disadvantaged groups within society would find it natural to produce and/or
distribute products that serve that group (like medical devices for people with
disabilities). NPOs supporting cultural causes often publish informational materials or
charge admission to cultural events. Such activities are a logical extension of the goals of
the NPO. As long as the public benefic goals remain the principle purpose of the NPO
and the income is not improperly distributed, exempting profits from such related
activities is appropriate and justifiable. A second argument in favor of this approach is that it does not provide NPOs with
tax advantages over for-profit entities in “unrelated” fields as there is little incentive for
NPOs to become involved in activities which are not related to their public benefit
purposes. Tax preferences are only provided for publicly beneficial activities. For these
activities, deemed particularly worthy of support by society, claims of unfair competition
by for-profit organizations might deserve a less sympathetic ear. Also, “related” activities
are often naturally within the jurisdiction of the NPO and may be of little commercial
interest to the for-profit sector. In addition, it is possible to cap the amount of tax exempt
“related” income to reduce concerns that this preference might be
abused or exploited. Third, by exempting only “related” activities, this approach encourages NPOs to
engage only in economic activities which are related to their purposes and generally
worthy of support. It reduces the temptation to get involved in economic activities merely
because they are profitable. Fourth, in granting such exemptions, governments not only provide additional
revenues to NPOs, they also provide incentives and send signals for NPOs to engage in
certain forms of behavior. NPOs often perform essential services that would otherwise
have to be performed by the government and which might be under-supplied without a
tax exemption. Additionally, the not-for-profit sector is often able to identify such need
more quickly and meet them more efficiently than governmental bureaucracies. While
this argument can be used to justify any governmental support of NPOs, it is much more
persuasive when it concerns activities related to public benefit purpose
s. Probably the major disadvantage of this approach is that it can be complex to
administer since it is often difficult to decide which economic activities are closely
enough “related” to satisfy the test. For example, if a museum opens a shop on its
premises to sell books about or copies of works in its collection, this is clearly related to
the purposes of the museum and should not give rise to taxable income. But what if the
museum opens a retail store somewhere else which sells materials about art and culture in
general? Geographic location can be important, since a coffee shop on the museum
premises would be seen as a natural step to enable visitors to obtain refreshments, which
such an establishment on the other side of town should clearly be considered an unrelated
activity.

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Therefore, it is difficult to draft laws or regulations which adequately codify the
concept of “relatedness” and guiding principles must often be established on a case-by-
case basis. After a body of decisions or norms concerning application of the rule exists,
this is likely to be a less serious problem. But for countries in a state of transition, where
guidelines for the not-for-profit sector are still being established, the concept of
“relatedness” creates a degree of uncertainty concerning the tax treatment of income. Not
only does this create a problem of administration, exposing NPOs to potentially arbitrary
administrative responses, but it might deter NPOs from engaging in legitimate income-
generating activities.
18
The problematic nature of applying the concept of “relatedness” is demonstrated
by the fact that it tends not to result in the collection of much tax revenue. 19 Still,
compared to the destination of income approach, this approach creates fewer tax
exemptions for NPOs, a negative for NPOs, but more tax revenue, a positive for the
government.
E. Threshold approach
1. The Approach
As already mentioned, this approach places a ceiling on NPO tax exemptions in
monetary terms, percentage terms, or both. For the countries surveyed, this approach,
when present, is always combined with another approach (i.e., a hybrid approach). For
example, the Czech Republic, Serbia, and Montenegro combine this approach with the
destination of income approach. And Hungary and Slovakia combine this with the
relatedness approach.
Hungary combines the relatedness test with the threshold method by introducing a
certain

limit of exemption for income from unrelated commercial activities. As
mentioned above, all economic activities that are included in the statute of the
organization as supporting the mission are not subject to taxation. Income from
18 There are various approaches to dealing with the “relatedness” problem. In the U.S., the tax authorities
determine whether the activity is “substantially related” to the public benefit purposes. To meet this test,
the activity must be causally related to the NPO’s public benefit purposes and “contribute importantly” to
it. I.R.C. 513(a) (1996). Hungary provides a list of “related” activities plus a catch-all provision, as
discussed below in section 5(D)(2)(a). See also the Slovakian example from the same section.
One approach with particular merit is to pass a law covering the basic provisions of “relatedness”
but leaving the task of preparing and enforcing precise definitions and practices to regulations or decrees.
This guidance may take the form of a list of exempt activities, specific instructions, and/or explanations of
examples.
19 See Susan Rose-Ackerman, Unfair Competition and Corporate Income Taxation , 34 Stanford L. Rev.
1017
(1982).

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Profit Law and the Macedonian Center for International Cooperation. All rights reserved.” 16
commercial/entrepreneurial activities (those that are unrelated to the mission) is taxed
only if such income exceeds the envisioned threshold. For example, all NPOs, regardless
of whether they acquired public benefit status or not, may benefit from tax exemption on
the income from commercial activities which does not exceed 10% of total income or 10
million HUF (€38,892). Further, the Hungarian law also creates two categories of public
benefit organizations, which are entitled to higher percentage of the exemption. Thus,
organizations that have acquired public benefit status are exempt for commercial income
that does not exceed 10% of total income or 20 million HUF (€77,785), and those who
have obtained status of prominent public benefit organizations are exempt up to 15% of
total income.
In Czech Republic , income from economic activities related to the statutory
purposes

of an NPO is subject to a reduced tax. All related income is exempt from
income tax up to CZK 300,000 (€11,203). In addition, revenues (i.e., incomes minus
related expenditures) at the end of fiscal year over this amount are reduced before
taxation by 30% or CZK1 million (whichever is less) if the proceeds are used for public
benefit purposes.
In France , earnings from economic activities are exempt from tax, provided that
they

are not distributed and that other features are present to distinguish the organization
from a commercial entity. Specifically, NPOs with annual revenue exceeding € 60,000
are eligible for tax-exempt status if: (1) management does not have a financial interest in
the NPO; and (2) the NPOs do not compete with the commercial sector.
20 NPOs with
annual revenue below € 60,000 can receive tax-exempt status only if (1) not-for-profit
activities are their predominant activities and (2) they do not distribute any income or
assets to any private interests.
In Germany , public benefit organizations (PBO) may carry out business activities.
Profits

are free from corporate and commercial tax, as long as the business activities are
necessary to pursue the PBO’s statutory public benefit purposes (education, health care
etc.). The same is true for charitable and church related purposes. Tax privileged
purposes are listed in the law. In order to benefit from tax privileges, PBOs have to
pursue these purposes and have to follow the principle of disinterestedness as defined in
the law: they may not have as a prime aim the acquisition of income, they may use their
resources only for statutory objectives, they may not distribute profits and may not pay
disproportionately high salaries. They must use their resources within the year following
the acquisition of the resources, but may build reserves within the margins mentioned in
the law. Additionally, the organization must be set up exclusively for purposes that will
make it eligible for tax exempted status and may compete with for-profit organizations

20 If it is found that the NPO does compete with the commercial sector, an additional inquiry is conducted
to see if the NPO conducts its activities along lines similar to those of the commercial sector.

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Profit Law and the Macedonian Center for International Cooperation. All rights reserved.” 17
only to the extent that such activities are “unavoidable” 21. Unrelated commercial
activities are ordinarily taxed if the income amounts to more than about
€ 30.678.
In Montenegro , the profit from an organization’s economic activities is exempt up
to 4,000 € and if used to further organizations statutory goals.
In Romania , non-profit legal persons are exempt from profit tax on income
obtained through economic activities
during a fiscal year, provided that the amount is less
than the equivalent in Romanian currency of €15,000 for a fiscal year and not more than
10% of the total non-taxable revenue of the organization.
In Slovakia , NPOs are generally exempt from taxation on income from statutory
activities.

The non-statutory economic activities of NPOs are taxed at the general income
tax rate, except that income from selling NPO property is tax exempt below SKK
300,000 (€ 8,935).
In Serbia , the income is exempted as long as it does not exceed 300,000 dinars (€
3,782).

This threshold is combined with the following conditions: (a) the income is not
distributed to the founders, employees, members of the management board or persons
affiliated with them; (b) the salaries do not exceed double the amount of the average
salary paid in the field of economic activity in which an organization is engaged; (c) all
earned profit was used to further the objectives for which the organization was created;
and (d) the NPO’s economic activities do not hamper competition with the private
business sector as defined by the anti-trust law.
2. Rationale
One rationale for this approach is that the government can use it to limit the losses
of tax revenue posed by the destination of income and relatedness method
s of taxation. A second rationale is that it is usually relatively easy to administer (although, as
this approach is usually combined with another approach, administrative difficulties may
remain). Third, this approach discourages for-profit organizations from masquerading as
NPOs to gain tax benefits and allays fears of unfair competition with the for-profit sector
by restricting the amount of tax free profits an NPO may generate.
21 Based on discussion with the German expert on taxation, Dr. Michael Ernst-Pörksen (C.O.X.
Steuerberatungsgesellschaft und Treuhandgesellschaft mbH)

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Fourth, limiting tax benefits on income from economic activities can help
preserve the integrity of the NPO sector by ensuring that the economic activity remains a
supplemental, rather than main, activity of the NPO. Finally, this approach still allows and encourages NPOs to engage in economic
activity, at least up to a point and provides guarantees against the possible misuse of the
income.
VI. CONCLUSION
Most countries in Europe permit most forms of NPOs to engage directly in
economic
activities. The legal framework that permits NPOs to engage in economic
activities plays a critical role in encouraging the sustainability of the NPO sector. The
income from economic activities is an important source of funding that allows NPOs to
operate independently, to pursue their statutory goals, and to engage in services and
activities in the public interest. Through generating own income from economic
activities NPOs may be able to provide more, better, and less expensive services, at a
savings to both the government and the individual beneficiaries of the s
ervices.
When regulating economic activities the following issues are generally addressed:
a definition of what constitutes economic activities; criteria of what is permissible, and to
what extent it is permissible; and the tax treatment of any revenue generated. The rules
permitting or restricting economic activities are distinct from rules relating to the taxation
of income from such activities – but they are closely related and work together to balance
the benefits of allowing economic activities with the need for some limitations on those
activities. Most countries broadly permit NPOs to engage in economic activities, but then
use tax laws to insure that NPOs do not engage in economic activities to the extent that
they become commercial companies.
There are various methods that can be used to determine the appropriate approach
to regulation and taxation of economic activities. In deciding which approach to
implement in the country it is important to consider the aims of the legislative reform, the
local economy situation, the level of development of the NPO sector and its capacity, the
level of engagement in economic activities, types of activities NPOs pursue and other
factors. Thorough consideration of all factors will help ensure that the most appropriate
strategies are adopted to support the aims of the regulation and ensure its effective
implementation.