Inland Revenue is currently consulting on aspects of the tax rules relating to income derived by charities and not-for-profits. This article examines some of the issues raised for charities that are carrying on business and donor-controlled charities.

Current rule

Broadly, business income derived by a registered charity is exempt from income tax to the extent the charity’s charitable purposes are carried out in New Zealand. The exemption does not apply if a person with some control over the business is able to direct or divert an amount of business income to the benefit or advantage of a person that is not the charitable entity or not for the charitable purpose.

The exemption allows a registered charity to accumulate its business income tax-free for many years before the funds are used to further its charitable purpose.

What is being looked at

The focus of the proposals in the officials’ issues paper is the tax treatment of income derived from business activities that are not related to the charitable purpose. Feedback is sought on whether this income should be taxed.

Policy design

Some matters of policy design are highlighted in the issues paper such as the definition of ‘unrelated business activity’; including a de minimis rule for small-scale trading activities; and allowing accumulation of business income.

Regarding the definition of ‘unrelated business activity’, the issues paper mentions three possible specific exclusions. These are:

• Certain fundraising activities promoted primarily to raise money for the benefit of the charity.
• Charitable businesses substantially run by unpaid volunteers.
• Businesses primarily engaged in selling donated goods or services (e.g. charity op-shop).

The issues paper acknowledges the likelihood of imposing compliance costs on the charitable sector if the tax exemption for unrelated business income is removed. To minimise these costs, it suggests adopting the charities financial reporting threshold of over $5M per annum in expenses to determine whether the tax exemption would apply. This could preserve the status quo for many small-to-medium sized charities.

Accumulation of business income is an important aspect of the rules. It is recognised an amendment to the current business income tax exemption should also consider how best to provide tax relief when accumulated surpluses are eventually distributed for charitable purposes. The issues paper suggests a deduction could be allowed for distributions paid to a parent charity of a charity business.

Donor-controlled charities

A donor-controlled charity refers to a charity registered under the Charities Act 2005 that is controlled by the donor, the donor’s family, or their associates. Provided the qualifying criteria are met, these organisations may qualify for the tax concessions available to other charities, including the tax exemption for business income.

The concern with donor-controlled charities is the increased risk of tax avoidance and non-compliance due to the control the donor or their associates can exercise over the use of the charity’s funds. This may provide opportunities to defer application of the funds to its charitable purpose or use the funds for other non-charitable purposes.

Key matters being considered in relation to tax rules for donor-controlled charities include: whether a distinction should be made between donor-controlled charities and other charitable organisations; definition of ‘donor-controlled charity’; what, if any, restrictions should be placed on the investments a donor-controlled charity may make; whether a minimum distribution rule should be introduced. The latter could present practical challenges and could impinge on the efficient operation of the business/organisation.

Where to from here?

The officials’ issues paper is available on the Inland Revenue website. Submissions close on 31 March 2025.

Officials will review and consider the feedback received and make recommendations to the government. It is uncertain whether changes will be made and if so, what those changes will look like. Given the shorter consultation period, we may see an announcement from government in this year’s budget on 22 May 2025.