The ATO has released the Draft Special Conditions Ruling TR 2014/D5 – Income Tax: special conditions for various entities whose ordinary and statutory income is exempt
In August the ATO released draft ruling TR 2014/D5 regarding the proposed application of special conditions inserted by the Tax Laws Amendment (2013 Measures No. 2) Act 2013.
The special conditions require that:
- An entity must comply with all the substantive requirements in its governing rules (Governing Rules Condition); and
- An entity must apply its income and assets solely for the purpose for which the entity is established (Income and Assets Condition).
What organisations or entities does the ruling apply to?
The ruling applies to a number of income tax exempt entities (but not all) which are listed at Section 50 of the Income Tax Assessment Act 1997 (ITAA).
These entities include:
- registered charities;
- scientific institutions;
- public educational institutions;
- funds established to enable scientific research;
- societies, associations or clubs established for the encouragement of science;
- societies associations or clubs established for community service purposes;
- employee associations or employer associations;
- trade unions;
- public hospitals;
- hospitals carried on by a society or association;
- societies, associations or clubs established for the encouragement of animal racing, art, a game or sport, literature or music; and
- societies, associations or clubs established for musical purposes.
What is the Governing Rules Condition?
This condition can be broken into three questions:
- What are the governing rules of the entity?
- ‘The process for determining what constitutes the governing rules of an entity requires consideration of all of the various sources in which governing rules may be found. The written documents under which an entity was formed will usually be the main source of the entity’s governing rules. There may also be other sources (such as relevant legislation) that comprise or supplement an entity’s governing rules.’ [paragraph 10 of the ruling]
- What are the substantive requirements in the entity’s governing rules?
- ‘The substantive requirements in an entity’s governing rules include the rights and duties of the entity such as those:
- that give effect to the object or purpose of the entity;
- relating to the non-profit status of the entity;
- relating to the winding-up of the entity; and
- that require financial records to be kept.’ [para 107]
- Has the entity complied with all of the substantive requirements in its governing rules?
- ‘The governing rules condition is applied on a continuous basis throughout an income year. Therefore, in order for an entity to be exempt from income tax for all of an income year, it must (among other things), satisfy the governing rules condition at all times during that income year.’ [para 111]
What is the Income and Assets Condition?
This condition can be broken into two questions:
- What is the purpose for which the entity is established?
- ‘The purpose for which a fund is established is ascertained by considering the constituent documents of the fund (primarily the instrument of trust or the will) and any relevant legislation. For entities other than funds, the relevant purpose is determined primarily by reference to the entity’s constituent documents, but also by consideration of the activities of the entity…’ [paras 20 & 21]
- If the entity changes its purpose during the year, its governing documents must set out its amended purpose, and its income and assets must be applied solely for its new purpose.
- Has the entity applied its income and assets solely for the purpose for which the entity is established?
- An entity may accumulate income ‘provided that any accumulation is consistent with the purpose for which the entity is established.’ [para 24]
- ‘The income and assets condition is applied continuously throughout the income year. Therefore, in order for an entity to be exempt from income tax for all of an income year, it must (among other things) satisfy the income and assets condition at all times during that year.’ [para 27]
Why is the ruling important?
The ruling is important for a number of reasons:
- it clarifies the special conditions and how they will be applied (and can be adhered to) with more certainty;
- as the ruling is retrospective, any disentitlement to an income tax exemption may be retrospective. While an entity is in breach of either or both of the special conditions, its ordinary and statutory income will not be exempt from income tax;
- it clarifies what will happen in the event of breach of the special conditions and simultaneous failure to comply with the ACNC governance standards, and which authority will act depending on the circumstances; and
- it summarises criteria whereby the Commissioner of Taxation considers that it is not appropriate to allocate resources to take compliance action.
What should you do?
All registered charities, and other entities listed above should:
- review their governing rules;
- identify the substantive requirements of their governing rules;
- assess whether the substantive requirements are being complied with at all times; and
- assess whether income and assets are being applied solely for the purpose for which the entity is established.
If a breach or misapplication is identified the entity should immediately take steps to rectify the situation and a notification to the Commissioner of Taxation may be required.
Should you wish to make a comment in relation to the ruling, your submission should be forwarded to Jeremy Khaw of the Australian Taxation Office at Jeremy.Khaw@ato.gov.au by 26 September 2014.