By Hiran Patel & Ben Smith
Is your charitable entity earning business income? If so, Inland Revenue has released guidance around the extent to which this business income should be treated as exempt.
Registered charities in New Zealand largely enjoy the benefits of both business and non-business income being exempt from income tax in New Zealand. While great in theory, further work is required by charities wanting to reap the benefits of a full tax exemption.
The latest Inland Revenue interpretation statement issued in September 2024 on the charities business income exemption provides guidance and some useful examples for what comprises “business income” for a charity, and how the exemption is intended to apply in different scenarios. If a charity’s charitable purposes are not limited to New Zealand, then apportionment between business income directed towards charitable purposes within NZ and overseas may be required, resulting in tax implications for the charity.
Benefits of charitable status
Income derived by a charity will generally fall into one of two buckets, being “business income” or “non-business income”. Both types of income can be exempt from income tax, although business income is subject to additional restrictions. The restrictions could result in all, some, or none of the charity’s business income being exempt.
A significant portion of New Zealand registered charities may only derive “non-business income” meaning no further consideration is required as to whether their income might be taxable. However, for charities that derive “business income”, further thought should be given to where the charity’s charitable purposes are undertaken before the charity can enjoy the full benefit of a tax exemption.
When does a charity have business income?
Registered charities can derive income from a variety of sources. Whether the amounts are business income depend on the nature of the charity’s activities and what type of business activities it might carry out. It is a question of fact as to what income arises from a charity’s business activities as opposed to non-business activities.
Without going into detail on when a charity might be conducting business activities, Inland Revenue’s statement notes that the object of a charity’s business may be directed towards charitable ends instead of pecuniary gains. However, this does not prevent the charity from being deemed to carry out business activities. The interpretation statement provides the relevant principles to consider for charities in determining whether they have a business activity.
How the business income exemption applies
Once a charity has established that it is deriving business income, to be able to rely on the business income exemption the following conditions need to be satisfied:
It is a question of fact as to whether a charity carries out its charitable purpose in New Zealand and to the extent it carries out any of its charitable purpose outside New Zealand, then a reasonable apportionment basis must be determined to split the business income between exempt and taxable. Similarly, a reasonable apportionment of expenditure incurred in deriving the business income must be made between expenditure to the extent it is incurred in deriving assessable income vs exempt income.
Territorial restriction
The statement confirms the Commissioner’s view that a charity carries out its charitable purpose in New Zealand if:
A charity’s rules and where its purpose is carried out is relevant to determining whether this is in New Zealand, however this is a question of fact.
Where charitable purposes are not limited to New Zealand, there needs to be a reasonable basis for splitting business income to charitable purposes in New Zealand, and those overseas. No apportionment is required if a charity’s charitable purposes are limited to New Zealand.
The statement provides some useful examples of acceptable apportionment methodologies and clarifies that whatever basis is chosen, while it does not need to be exact, it must be reasonable. Once a reasonable basis has been established (provided there are no material changes to the charity’s business from the prior year) the same approach can be used for each subsequent year.
The apportionment methodologies mentioned in the statement include:
Apportioning different types of income towards different purposes
For charities that have a partial overseas charitable purpose, the statement also covers situations where a charity allocates different types of income towards different activities both within and outside New Zealand. The Commissioner considers that where a charity’s trust deed or other rules restrict the business income towards a charitable purpose in New Zealand, this will be appropriate application of the territorial restriction.
Another situation the Commissioner considers appropriate would be where there is appropriate tracking of its business income to demonstrate it is restricted to charitable purposes in New Zealand.
A word of warning – the mere existence of both non-business and business income does not mean apportioning the non-business income towards overseas charitable purposes and the business income portion towards New Zealand purposes would be a reasonable approach. There must be sufficient ring fencing or tracking of the business income and how it is applied, which can be demonstrated to Inland Revenue if required to justify such a position.
Review of charities on the horizon
The interpretation statement is a welcome clarification of existing rules that apply to charities, which have been in place for a number of years. If your charity has business income requiring apportionment, it is likely you also have an obligation to file income tax returns. While this may sound daunting, your Deloitte tax advisor can assist with getting you registered for the right tax types and provide assistance with filing returns and correcting any prior year errors.
We also understand Inland Revenue has been directed to add a review of the tax rules for charities to their tax policy work programme (which is expected to be released in late 2024). So, while we have received clarification on the business income exemption, there might be a shake up to charitable exemptions in the future.