Tax reforms stir debate among NFP directors

New Zealand’s not-for-profit (NFP) sector stands on the brink of transformative tax reform, with Inland Revenue inviting stakeholders to re-examine long-held exemptions and tax settings that have underpinned the charitable landscape for decades. 

At the centre of the debate is the broad exemption currently allowing charities to enjoy tax-free income from business activities – regardless of whether these directly further their core charitable purposes.

With growing concerns over potential tax avoidance in donor-controlled organisations and the blurred lines between related and unrelated business activities, the proposed changes could prompt a significant reshaping of governance and operational structures. The IRD consultation document “Taxation and the not-for-profit sector” was announced in a press release from the Minister Finance and Minister of Revenue. The consultation document outlines an array of policy challenges – from defining “unrelated” business income to potentially imposing new compliance costs on entities that have long thrived under the existing framework. 

These measures, which extend to clarifying mutuality rules and rethinking breaks such as fringe benefit tax exemptions, are expected to demand that directors, trustees and governance professionals adopt a more rigorous approach to tax compliance and strategic planning.

As discussions intensify over issues such as the potential removal of tax exemptions for non-charitable income and the regulation of transactions within donor-controlled charities, industry experts caution that a reformed tax regime could introduce substantial operational challenges and reshape holding structures that many organisations have carefully cultivated over the years. 

With Inland Revenue set to enforce a more stringent focus on tax governance and compliance – Including enhanced documentation and testing – the sector must rapidly adapt to mitigate risks associated with increased scrutiny and potential fiscal liabilities. 

Directors and their organisations are encouraged to engage proactively with these consultations and assess their organisational strategies in light of the proposed reforms. 

Consultation closes on 31 March 2025.

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Some “taxing” questions for charities

By Darshana Elwela – Principal, KPMG New Zealand Tax Team

1. The scope of the charitable business income tax exemption 

Currently, a charity’s income, including income from any business activities carried out directly and indirectly, is tax exempt to the extent its charitable purpose is carried out in New Zealand. This is regardless of the type of business or trading activity undertaken and whether it directly relates to the charitable purpose. 

The issues paper asks whether this tax exemption is too broad and should apply where a charity undertakes a business or trading activity that is unrelated to its charitable purpose. It raises a number of design considerations if the exemption is removed for income from unrelated business or trading activities, such as:

• how an unrelated business should be defined
• whether there should be a “de minimis” exemption for small-scale business or trading activities
• whether there should be tax relief on distribution of business income to the parent charity.

Feedback is also sought on practical issues, such as current holding structures for charities’ investments in businesses and the transitional impacts if such a change proceeds. 

2. Whether “donor-controlled” charities should be treated differently  

The concern is the scope for transactions between donors’ (non-charitable) business activities and their “controlled” charity (defined as a registered charity that is controlled by the donor, their family or their associates) to be used to artificially reduce or avoid tax. The issues paper notes that other countries have more robust rules around transactions involving donor-controlled charitable organisations, such as private foundations. 

The issues paper asks whether such transactions should be prohibited altogether, subject to anti-avoidance rules (such as market value requirements) and/or whether donor-controlled charities should have a minimum distribution requirement each year, to prevent unrestricted accumulation of funds. 

3. Other tax policy issues  

The issues paper also considers the following: 

• The appropriate tax settings for NFPs that are mutual associations. The issues paper notes that most NFPs may not technically qualify for mutual tax treatment as their constitutions do not allow accumulated surpluses to be distributed to their members on wind-up. This has the potential to adversely impact many thousands of NFPs that currently do not pay tax on member transactions and levies, from professional bodies to sports clubs.
• The removal of specific exemptions for certain types of NFPs. These include regional promotion and scientific/industrial research bodies and non-resident charities with no charitable purpose in New Zealand.
• The need for the fringe benefit tax exemption for benefits provided to employees carrying out a charity’s charitable purpose. There is a concern that this may create labour market distortions.
• The effectiveness of the donation tax credit. The issues paper notes that only 20 per cent of donors claim all of the donation tax credits they are entitled to each year. 

Who is impacted?

The full spectrum of charitable and NFP organisations, from registered charities to Māori organisations, professional, trade and regulatory bodies to clubs and societies, are likely to be impacted by one or more of the issues under consideration. 

Key considerations for those in governance roles  

The issues paper poses a number of “taxing” questions for the charitable and NFP sectors: 

• What would the impact be if the tax exemption is removed for unrelated business activities? Not only from a new income tax liability, but the accompanying compliance costs. 
• What will the impact be on your holding structures for different businesses?
• Is your charity likely to qualify as “donor controlled” and, if so, what transactions could be impacted if one or more of the reforms under consideration proceed?
• The uncertainty around the current application of the mutuality rules is highlighted in the issues paper. Any reform in the area, to clarify the application of the mutual tax rules, could result in changes to how different NFPs need to operate and fund their activities – for example, if subscriptions and other levies become subject to tax. 

Consideration of the above should be part of charities’ and NFPs’ approach to good tax governance. Inland Revenue is placing more focus on tax governance, including documentation and testing of processes. The charitable and NFP sectors are not necessarily immune from this enhanced scrutiny. For example:

• Is tax part of your overall governance framework? This should include any non-income tax obligations, such as GST and employment taxes. 
• Is there monitoring of any conditions to access the charitable tax concessions, or for application of mutual tax treatment? Are the results reported to those in governance roles? 
• Are there robust processes to comply with non-income tax obligations, and regular testing of these for continuing accuracy and effectiveness? 

 

We will be hosting a webinar on the proposed changes in the third week of March, date tbc. This will be of particular value to directors who intend to make a submission.