Economics of Non-Profit Accounting

Case Notes: North America

The International Journal
of Not-for-Profit Law

Volume 5, Issue 1, September 2002


Canadian Magen David Adom for Israel v. Minister of
National Revenue
2002 FCA 323.

by Robert Hayhoe*

Prior to 2002, there had only been a few relatively unimportant cases which considered the tax rules applicable to Canadian charities carrying on foreign activities.  Early in 2002, the Federal Court of Appeal decided the Canadian Committee for the Tel Aviv Foundation v. Canada  case[1] which, at least on one view of the decision, turned primarily on recordkeeping issues.[2]  However, the Canadian Magen David Adom for Israel  decision of the Federal Court of Appeal which has just been released addresses serious legal and policy issues.

Statutory Background

As a condition of registration, a Canadian charity which is registered with the Canada Customs and Revenue Agency (the “CCRA”) as a charitable organization is required by subsection 149.1(1) of the Income Tax Act ( Canada) to devote all of its resources “to charitable activities carried on by the organization itself.”  A deeming rule in subsection 149.1(6) deems within limits that grants to qualified donees have been spent on a charitable organization’s own activities.  As a result, a charitable organization may not make grants for a charitable purpose unless the grants are made to a qualified donee.

Qualified donees are defined by subsections 149.1(1) and 118.1(1) to include other registered charities, all levels of government in Canada, the United Nations, foreign universities customarily attended by Canadians, and foreign charities to which the federal government has made a gift in the past 12 months.[3] The list of foreign charities to which the federal government makes gifts is extremely short.

The Income Tax Act provides in subsection 168(1) that to the extent that a charitable organization “ceases to comply with the requirements of this Act (the Income Tax Act) for its registration as such… the Minister may… give notice to the registered charity… that the Minister proposes to revoke its registration.”  Thus, a charitable organization that does not devote all of its resources to charitable activities which it carries out itself is subject to de-registration at the discretion of the Canada Customs and Revenue Agency.

Factual Background

Canadian Magen David Adom for Israel (“CMDA”) was incorporated and registered as a registered charity in 1976 with the corporate object “To donate medical supplies and ambulances directly to the people of Israel.”  Until 1986, CMDA primarily carried out its purposes by sending money to American Red Magen David for Israel Inc. (apparently a U.S. charity) which used the funds to purchase ambulances and medical supplies which were given to Magen David Adom for Israel (“MDA”), an Israeli organization.  After a 1986 Revenue Canada audit of its 1983 and 1984 fiscal periods, CMDA began to purchase its own ambulances and medical supplies for shipment to MDA.

At the time of the 1986 audit, Revenue Canada applied an internal policy which is referred to as its “charitable goods policy” to permit CMDA to transfer ambulances and medical supplies to MDA.  This policy (which was never disclosed by Revenue Canada to the public or even to the tax professional community) provided that where a Canadian registered charity transferred goods which are meant by their nature to be used only for a charitable purpose (like medical equipment) to an organization that will use the goods for such purpose, the transfer will be considered to be an example of the registered charity carrying on its own charitable activity.

CMDA was audited again by Revenue Canada for its 1987 and 1988 fiscal periods.  Revenue Canada apparently did not raise any issues with respect to foreign disbursements.  However, in 1993, CMDA wrote to Revenue Canada to ask permission to purchase a new personnel identification system and a new ambulance telecommunications system for MDA.  Revenue Canada wrote back in 1994 confirming its view that the purchase of the telecommunications system was acceptable but that the identification system was an administrative item and therefore too indirect for its purchase to be charitable for CMDA.

Another Revenue Canada audit took place for the 1993 fiscal period.  The auditor criticized CMDA for purchasing the personnel identification system in contravention of Revenue Canada’s advice and also suggested (for the first time) that even the ambulances and medical supplies should be sent to MDA pursuant to an agency agreement.

Finally, Revenue Canada audited CMDA’s 1996 fiscal period.  The audit resulted in a threat of revocation of charitable registration for a number of reasons, including the absence of an agency agreement and the purchase of bullet proof vests by CMDA for use by MDA paramedics.  In the course of correspondence dealing with the audit findings, Revenue Canada took the position that the only way in which it was possible to transfer assets to a foreign charity is through an agency agreement or joint venture agreement.  As well, Revenue Canada raised a new issue (which had never been mentioned before to CMDA specifically or to the public generally) by suggesting that because MDA used its ambulances in the Golan Heights, the West Bank, East Jerusalem and the Gaza Strip (the “ Occupied Territories”), the transfer of ambulances to it was a violation of Canadian public policy.  In 1999, Revenue Canada also obtained a list of all sites where Canadian supplied ambulances were used at the time – the list included one ambulance which had been transferred by MDA to the Israeli Defense Force.

In 2001 (two years after last hearing from Revenue Canada) the CCRA (the successor to Revenue Canada) sent a notice of revocation of charitable registration to CMDA listing three grounds, being improper receipts (subsequently abandoned as a ground), gifting of resources to MDA without the required agency agreement, and Canadian public policy.

Federal Court of Appeal Decision

CMDA appealed its revocation to the Federal Court of Appeal.  The Court made short work of the public policy argument while still acknowledging that earlier Canadian charity decisions had accepted that a purpose is not charitable if it violates Canadian public policy.  Here, the decision that a Jewish charity operating in the Occupied Territories was in violation of public policy appeared to be based on Canadian acceptance of certain United Nations resolutions on the subject of the Occupied Territories.  The Court found it difficult to accept that these resolutions could prevent the provision of emergency medical care in the Occupied Territories from being charitable.  The Court also noted that the Canada-Israel Free Trade Agreement permits preferential Canadian tariff treatment for goods imported from the Occupied Territories.  The Court decided that in order for the CCRA to rely on public policy in this context, the supposed policy would have to be communicated in specific “legislation or some equally compelling public pronouncement.”

The Court’s approach to the public policy issue must be correct.  The suggestion that the Canadian tax authority can develop a secret view of public policy which has never been communicated clearly by the tax authority or any other arm of the Canadian government, which appears to be contrary to a trade agreement and deals with a subject upon which there is no consensus in Canadian society is odd.  Furthermore, even if there was a clear Canadian public policy of opposing Israeli involvement in the Occupied Territories, it would likely not apply to emergency medical care.  To the extent that the claimed Canadian public policy existed, it might apply to prevent a Canadian registered charity from relieving poverty among Jews in the occupied territories or advancing the Jewish religion in the occupied territories on the theory that these activities increase Israeli control over the Occupied Territories.  However, unless it could be shown that the emergency medical care was limited to Jewish settlers, its provision should not violate claimed public policy.

The (three judge) Court split on the issue of whether the gifting of resources to MDA (the only remaining ground for revocation) was enough to support the CCRA’s revocation of registration.  The majority observed that even if the charitable goods policy was good law (and they were prepared to so assume), the transfer of medical equipment to MDA did not fall within the policy because CMDA could not reasonably have expected MDA to use the goods transferred to it only for charitable purposes.  The majority seems to have based this conclusion on the fact that MDA makes its radio network available to the Israeli Defense Forces in times of crisis.

The conclusion that MDA might use transferred property for non-charitable purposes is probably correct, although a more complete analysis would have been useful.  The involvement of MDA with the Israeli Defense Forces would not prevent the MDA from being charitable in Israel since the defense of the realm is charitable at common law under the fourth head.  However, as a matter of Canadian charity law, it is only the defense of Canada (or perhaps either other countries with which we share Queen Elizabeth II as head of state or even other countries to which we are bound by specific mutual defense obligations) which is charitable.

Furthermore, the Court’s decision to assume rather than decide that the charitable goods policy is good law is disappointing.  This issue is important to many registered charities and needs resolution.  The Federal Court of Appeal is a senior court (with an appeal to the Supreme Court of Canada only with leave) and as such has a responsibility to address legal issues which come before it.  While it may be that the Federal Court of Appeal is not the best institution to hear this type of case[4], it nevertheless has the responsibility.

A version of the charitable goods policy should be accepted as legally correct.[5] If a particular good is of such a nature that it cannot reasonably be expected to be used for a purpose other than a charitable one, then its delivery by a Canadian registered charity to a foreign charity or to some other organization which although not charitable at law agrees to use the good for a charitable purpose, is a charitable activity carried on by the Canadian charity.

An example (not linked to the facts of the Canadian Magen David Adom case) might help.  If a Canadian registered charity with the purpose of making available to the public complimentary copies of the Koran with the marking “for free distribution only – not for sale” distributed the books in bulk to a charitable organization in Saudi Arabia, this wholesale distribution would be in itself a charitable activity carried on by the Canadian charity (the retail level distribution of the same books by the Saudi charity would be a separate charitable activity).

The minority judgment in this case took a similar approach to the public policy issue as did the majority (finding no violation of public policy).  However, the minority applied administrative law doctrine to conclude that (even assuming that the charitable goods policy is not correct) because the CCRA made the discretionary decision to revoke CMDA’s charitable registration on grounds which were partly irrelevant or wrong (the public policy ground) and arguably partly relevant (the transfer of goods to MDA without limitations preventing the goods from being used for non-charitable purposes by MDA), the Court has a duty to require the CCRA to decide again on relevant grounds only.  The minority Judge was strengthened in his conclusion by the fact that although the issue of whether CMDA could transfer goods to MDA had been raised in previous audits, it was only when the public policy issue was added to the mix that the CCRA decided to revoke registration.  Although I am no administrative law specialist, surely this must be the correct approach.

I understand that leave to appeal the decision of the Federal Court of Appeal is being sought from the Supreme Court of Canada.  It is to be hoped that leave will be granted so that clarity can be brought to this area of law which is so important to Canadian charities which carry on activities outside of Canada.

*Robert Hayhoe is Barrister & Solicitor at Miller Thomson LLP in Toronto. He also serves as Regional Co-ordinating Editor ( Canada) for IJNL.  He can be contacted at

[1] 2002 F.C.A. 72, 2002 D.T.C. 6843.

[2] See my case comment at 4:4 IJNL.

[3] For a more detailed description of the various qualified donees in the context of foreign grantmaking, see Robert Hayhoe, “A Critical Description of the Canadian Tax Treatment of Cross-Border Charitable Giving and Activities”, (2001) 49 Canadian Tax Journal 320 at 322-327.

[4] The Voluntary Sector Initiative Joint Regulatory Table considered this issue and concluded that “The single option now available, an appeal to the Federal Court of Appeal, has failed to create sufficient precedents or to provide organizations with an accessible and quick means of appeal.”   Voluntary Sector Initiative Joint Regulatory Table, Improving the Regulatory Environment for the Charitable sector – Interim Recommendations (2002) .

[5] While I realize that I have written previously on the topic of charities carrying on foreign activities without discussing the charitable goods policy (Hayhoe op cit., note 3), this is partly because of the secret nature of the CCRA’s policy and partly because of a specific client issue and should not be taken as a suggestion that the content of the charitable goods policy is incorrect.

Ontario Public Guardian and Trustee v National Society for Abused Women and Children, [2002] O.J. No. 607.

In 1999 three individuals established a charity for the relief of abused women and children, which then concluded fundraising contracts with businesses that the charity’s directors owned or were employed by.  The contracts provided for the businesses to receive commissions of 75% to 80% of the gross funds raised plus, in the case of one contract, monthly administration fees.  Consequently, the charity applied only CA$ 1,365 to charitable work out of nearly CA$ 1 million in funds raised on its behalf.  The court held that the amount of compensation payable under the fundraising contracts was unconscionable, such that the agreements were void.  The court found that the charity directors had a clear conflict of interest and breached their fiduciary duty as directors in concluding the contracts, and ordered the directors of the charity to repay to the charity all the monies that they had received via the fundraising companies, following which the directors could submit claims for reasonable compensation, subject to court approval.  The court also confirmed that charity directors in Ontario have a fiduciary duty to disclose unreasonable fundraising costs to donors [Editor’s note: this ruling follows the court’s decision on this point in the Aids Society case in 2001 (see IJNL Volume 4, Issue 4)].

Reported in Charity Law Bulletin No. 13, 29 April 2002) PB

Des Chenes (Commission Scolaire) v R ., [2001] GSTC 120, Federal Court of Appeal, on appeal from [2000] GSTC 36

A group of school boards claimed full Goods and Service Tax (GST) input tax credits for GST paid on the purchase of school bus transportation services supplied to them by independent carriers on the basis that their onward supply of the services to the Quebec provincial government were zero-rated supplies.  A provincial government subsidy was provided to each school board to pay for the transportation.  The Tax Court considered the guidance in Technical Information Bulletin B-067 and concluded that the link between the subsidy and the transportation service was not sufficiently direct to constitute consideration for a supply to the Quebec government.  The Federal Court of Appeal reversed this decision, finding that since the school boards were obliged to use the subsidy for transportation and the definition of consideration in section 123 (1) Goods and Services Tax Act referred to any amount payable “by operation of law”, the amount payable was consideration.

[Editor’s note: The Department of Finance introduced retroactive legislation in December 2001 to counter the potential loss of tax revenue arising from this decision. However, the legislation is limited to the provision of school bus transportation services, so the decision remains valid for the supply of other goods and services to provincial governments by wholly or partially exempt organizations in the municipalities, universities, schools and hospital sector.]

Reported in International VAT Monitor, March/April 2002. PB

United States

Kasky v. Nike Inc. , 45 P.3d 243 (2002).

In 1998 the US multinational Nike was sued in California on the grounds that it had engaged in unfair business practices by falsely representing the conditions of workers in its Asian production plants.  Without adjudicating on the merits of the lawsuit, the initial issue that the court was required to decide was whether the statements by Nike constituted “commercial speech,” in which case they could be subject to compliance with state advertising laws, or whether they were non-commercial public statements, in which case they would qualify for the protection of freedom of expression under the First Amendment to the US Constitution.  Both the San Francisco County Superior Court and the California Court of Appeals held that, based on the limited guidance of the US Supreme Court to date on the distinction between commercial and non-commercial speech, the correct test to apply was whether the content of Nike’s statements proposed a commercial transaction.  On appeal, the California Supreme Court, on May 2, 2002, reversed this ruling by a 4-3 majority, in which the majority applied a limited purpose test to determine that Nike had engaged in commercial speech; although the majority agreed that Nike’s statements concerned matters of public interest, they held that its commercial speech was not inextricably intertwined with non-commercial speech, such that the commercial speech could be separated and subjected to state advertising laws.  The dissenting judges disagreed with the finding that the statements constituted commercial speech and argued that it was a matter for the US Supreme Court to provide guidance on the boundaries between commercial and non-commercial speech in the context of First Amendment rights.

[Editor’s note: The decision in this case is potentially applicable to the commercial activities of nonprofit organizations.  In addition, given the importance of the issue, and its implications for companies wishing to participate in debates on corporate social responsibility, the case may be the subject of an appeal to the US Supreme Court.] PB

In Re Milton Hershey School Trust, 807 A.2d 32 (2002).

The Milton Hershey School Trust was established to own and operate a school for the benefit of orphan children, and was endowed with a controlling shareholding in what is now the Hershey Foods Corporation, which manufactures, amongst other products, Hershey chocolate bars.  The trust deed provided that the school should be located in Derry Township, an area adjacent to the Hershey chocolate factory and the surrounding community, which has also benefited from other charitable initiatives of the founder.  In July 2002 the trustees invited offers for the sale of its controlling interest with a view to diversifying the trust’s investment portfolio. [Under Pennsylvania law, the provision of the state version of the Uniform Prudent Investor Act (20 Pa. C.S.) enacted in 1999 that requires trustees reasonably to diversify their investments does not apply to trusts existing prior to the 1999 law.]  The Pennsylvania Attorney General sought an injunction to restrain the trustees from negotiating to sell its shares without first seeking court approval, claiming that the trustees’ action raised issues of the effect on the public interest of the proposed sale and a possible abuse of discretion by the trustees in initiating the sale process.  The injunction was granted by the Orphan’s Court Division of the Court of Common Pleas on the grounds that, notwithstanding the express power of the trustees to sell its shares in Hershey Foods, the Attorney General had authority to inquire whether the exercise of the power is inimical to the public interest, and because the socio-economic benefits  General has an added responsibility of protecting the public interest beyond ensuring that the benefits of the trust are delivered in accordance with the founder’s intent.  On appeal, the Commonwealth Court, in a 4-1 majority decision, upheld the injunction, without deciding on the merits of the underlying public interest issue, on the basis that there were no reasonable grounds for interfering with the lower court’s decision.  The dissenting judge considered that the lower court had made an error of law in holding that the Attorney General had authority to intervene, on the basis that there is no legal authority for the proposition that the Attorney General can act to protect a public interest that is not a designated object of the trust, and that the powers of the courts to restrain a sale of a trust asset are limited by the state Probate, Estate and Fiduciaries Code (20 Pa. C.S.) to intervening after, but not before, a sale agreement has been concluded.  PB

Tax Analysts v. Internal Revenue Service, 215 F.Supp.2d 192 (D.D.C. 2002).

A not-for-profit organization that publishes information concerning tax laws sued the IRS under the Freedom of Information Act (FOIA) seeking access to certain IRS letter rulings with regard to revocations and denials of tax exempt status to various organizations.  In a Memorandum Opinion granting the IRS’ motion for summary judgment, the United States District Court for the District of Columbia held that the exempt organization (EO) denial and revocation rulings were not “final opinions” within the meaning of FOIA.  Rather, they fall within FOIA’s specific exemption for “return information,” which is required to be confidential by IRC Section 6103.

Section 6104 states an exception to Section 6103 allowing the IRS to disclose information concerning organizations that are “exempt from taxation.”  However, in the regulations interpreting Section 6104, the Treasury specifically excluded revocations and denials of tax exempt status from the disclosure requirement of Section 6104.  The District Court held this to be a reasonable interpretation of the statute.  It noted, moreover, that the Joint Committee on Taxation of the US Congress has had pending before it since January 2000 a proposal to amend Section 6104 specifically to require public disclosure of tax exemption denials and revocations.  And it therefore refused to engage in “judicial activism” absent a failure of the Congress to act.

[Editor’s note:  this is an important issue with regard to the protection of the public in the case of not-for-profit organizations, particularly those that engage in public fund raising and claim to be tax exempt.  It remains to be seen whether an appeal will be taken and/or whether Congress will act]. KWS

The Barnes Foundation.

Barnes Foundation executives are seeking permission for to move the world famous Barnes Collection from a suburb of Philadelphia (Merion) to Center City.  The action, which is pending in Montgomery County Orphans Court (which oversees trust and estate matters) argues that the move is necessary to save the financially strapped Foundation.  An August financial report found that the Foundation had lost $1.36 million in 2000 and 2001, and it is projected to lose $800,000 this year.

Supporters of culture and the arts in Philadelphia have rallied behind a bold plan to move the collection from its suburban galleries to new space downtown.  Rich with works by Renoir, Matisse and Cezanne and valued as high as $25 billion, the Barnes collection would be a coup for the city, which is striving to remake itself as a tourist destination.

But before it can make the move, the Barnes Foundation must win court approval to violate the explicit wishes of its founder.  Albert C. Barnes, a doctor and pharmaceutical manufacturer, who amassed the collection in the early 20th century, stipulated that the collection must remain exactly as Barnes left it when he died in 1951 at 79.  A cantankerous millionaire, who had no children, Barnes detested Philadelphia’s society and the Philadelphia Museum of Art, which he viewed as elitist.

Barnes Foundation executives are seeking permission for the move, arguing it is necessary to save the financially strapped foundation.  “We have been walking along a financial precipice for some time.  Any rational person could see we weren’t going to make it,” said Bernard C. Watson, president of the Barnes’s board of trustees.  Major donors (such as the Pew Charitable Trusts) have made future support contingent on moving the collection to downtown Philadelphia, from a residential neighborhood in the Main Line suburb of Merion, where, by court order, visitors are limited to 1,200 over three days a week.  The plan to move the collection to a new building along the city’s Benjamin Franklin Parkway has widespread support among the city’s foundations and individual donors, who have already pledged $80 million of the $150 million needed for the new building to endow the foundation.

Mr. Barnes’ 51-year-old charter for the Foundation gives Lincoln University, a historically black college in nearby Chester County, the power to nominate four of the board’s five members.  The board’s new proposal would expand the number of trustees to 15.  The board believes the change is necessary to extend the board’s reach to more wealthy individuals and foundations that could help raise funds necessary to support it.  The expansion would also dilute the power of the Lincoln trustees.  Last week, the executive committee of the Lincoln board of trustees approved a resolution to condemn the proposed move as a violation of Barnes’s wishes.  A formal legal challenge could come soon.

The Pennsylvania State Attorney General’s office, which oversees public interest in trust and estate cases, is also examining the board’s petition, but it has not yet taken a position.  In 1958 the Attorney General filed suit against the Barnes Foundation, demanding that it open the collection to the public in return for its nonprofit status.  That was not the only time Barnes’s charter was modified by the court.  In recent years, homeowners in Merion have complained about excessive traffic at the galleries, and the maximum number of weekly visits was set at 1,200.  The foundation also won court approval to lend some of the paintings to other museums.

These are highly contentious issues, both politically and procedurally.  “This is not something that will be decided in the court of public opinion,” according to Kimberly Camp, the Barnes Foundation’s Executive Director. “This is going to be up to the courts, and it could be a very long process.”  [Editor’s note:  This story is based on reports in the Philadelphia Inquirer.]  KWS