Ruling Compendium

(a)

The draft ruling does not assist organisations in drafting or amending their governing rules in order to comply with the governing rules condition and income and assets condition.

(b)

The draft ruling does not set out whether written rules should go into more detail, or whether unwritten rules should be reduced to writing.

The ruling sets out principles which are intended to apply to any governing rules.

The Ruling will not prescribe the level of detail in an entity's rules.

No change.

(a)

What is meant by 'coherent' is not clear. Remove reference to 'coherent'.

(b)

What is meant by 'enforceable' is not clear. This is problematic for unincorporated associations, as these organisations do not have enforceable rules. The draft ruling appears to be premised on the assumption that the constitutions of unincorporated associations are enforceable contracts, rather than unenforceable compacts. As a matter of law, that is, this is a doubtful premise. It is a well-established legal principle that the courts will only intervene in the internal governance of unincorporated associations where there are property rights, trust law infringements or other exceptional arrangements.^[1]

The draft ruling therefore needs some clarification so far as it applies to unincorporated associations. References to 'enforceable' should be removed.

For example, governing rules are the rules that authorise the policy, actions and affairs of the entity or those who govern it. That is, insert 'or those who govern it' in the definition of governing rules.

This change should be carried through to all of the relevant references in the draft ruling.

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the entity is required and permitted to do, and

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those who control the entity are required and permitted to do in respect of the entity.'

This change has been carried throughout the final ruling.

To ensure it is clear that the draft ruling does in fact address these circumstances, we recommend that a clear statement to this effect be included in the binding part of the ruling, perhaps after paragraph 11. It would also be useful to separately address this issue in Appendix 2.

It is difficult to envisage a situation where provisions contained in a government funding contract could constitute a governing rule. A breach of a contractual term should be addressed through contract law.

That is, delete the references to: 'contracts entered into with government' and 'which may be voluntary'.

No change.

Under this view, there would be a complete overlap between the governing rules condition and the income and assets condition, and such an interpretation is therefore not preferred, on the basis that Parliament would have intended that the income and assets condition and the governing rules condition each have separate 'work' to do.

No change.

For a word or words to have a technical legal meaning, you would have to be able to point to some legislation or a case(s) that set out what that technical legal meaning is. This is not the case here.

We request that the Commissioner provide further detail as to what he regards as 'substantive requirements' and what he regards as 'procedural requirements' in an entity's governing rules.

The draft ruling should also provide further assistance for trustees in determining which provisions in a trust deed are substantive requirements.

An additional 8 examples have been included at paragraphs 124 and 125 in Appendix 1 of the final ruling to provide further guidance and clarity.

(a)

Regarding paragraph 91 of the draft ruling, how would the ATO determine which religious laws were 'substantive', and which ones not? The draft ruling does not assist religious organisations in determining whether a breach of their many religious laws, regulations, by-laws, etcetera, would result in a breach of the new special conditions. In particular, which are 'substantive requirements' for the purposes of the governing rules condition?

(b)

Further, it is unclear from the draft ruling whether the potential application of a religious dispensation in relation to a religious law would affect whether or not it was a 'substantive' requirement.

An additional 8 examples have been included at paragraphs 124 and 125 in Appendix 1 of the final ruling to provide further guidance and clarity.

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Has the entity substantively complied with all of the substantive requirements in its governing rules?

This is because there are degrees of non-compliance and while the rule may be substantive, the non-compliance may be trivial.

No change.

(a)

It is entirely impractical for affected entities to continuously monitor compliance at all times throughout the income year. It in turn creates difficulties in the areas of governance of such entities (for example, office bearers, auditors, etcetera).

(b)

This issue also needs to be also viewed in the context of the sheer diversity of the not-for-profit sector. That is, one size does not fit all, and the approach taken in the draft ruling may place an excessive and unreasonable compliance burden on large scale entities.

(c)

The ATO should take a proportionate approach that takes into account the size and complexity of the entity. Taking a proportionate approach would allow the ATO to consider a variety of factors including whether the controllers of the entity personally acted in compliance and had adequate systems in place to ensure compliance and identify and take action against non-compliance (or failed to do so). Additional detailed practical guidance could be included in the draft ruling, to ensure entities are made aware of what the ATO will require as evidence of satisfying the governing rules condition at all times during the income year.

Entities covered by the endorsement provisions in the Taxation Administration Act 1953 (TAA 1953) already have an ongoing obligation to monitor their entitlement to income tax exemption (see section 426-45 in Schedule 1 to the TAA 1953). The new special conditions extend the requirement for ongoing monitoring to a broader range of entities; we do not accept that this requirement is 'entirely impractical'.

Concerns about proportionality and fairness have been addressed by the inclusion of Appendix 3 explaining the Commissioner's administrative practice.

No change.

The purpose for which a fund is established is ascertained by considering the constituent documents of the fund (primarily in the case of a fund established as a trust the instrument of trust or the will) and any relevant legislation.

(a)

Paragraph 127 of the draft ruling states that 'regard must be given to the current circumstances of the entity'. It would be helpful if an example was used to explain this.

(b)

While we accept that the law requires exempt income status is to be determined in each year, the term 'apply' should be considered in a broader context of possible accumulations, and the ATO's views on accumulations are not determined until the end of the year. Accordingly, the language of TR 97/22 ('a significant proportion of surplus funds') sets the context better.

The Commissioner's view on accumulation is consistent with the position in TR 2011/4. The accumulation of income is a broader concept than 'surplus funds'. However, the final ruling considers both 'net' income and 'gross' income to provide greater clarity.

The draft ruling necessarily has to make this distinction (which is consistent with the general law) to avoid the unworkable consequence that a strict application of the wording of the legislation would demand.

No change.

This ruling explains special conditions that apply far more broadly than just the type of entities covered by those other rulings.

No change.

Example 7 in the final ruling provides an example of where a payment on behalf of members, purportedly in pursuit of the entity's objects of promoting the study of madrigal, would not satisfy the new special condition.

The view of the draft ruling seems to be that if the entity's purposes that are stated in its constituent documents include purposes that are incidental or ancillary to its charitable purpose, the entity will not lose its income tax exemption if it applies its income and assets condition towards one of these incidental or ancillary purposes. If, on the other hand, the entity's constituent documents do not make reference to ancillary or incidental purposes, the income and assets condition will be breached if the entity carries out incidental or ancillary purposes. The entity would therefore arguably lose exempt status.

The inability of an entity to pursue ancillary or incidental purposes will have a negative impact on the entity and the community. Further clarification is requested.

In particular, paragraphs 132 to 136 of the draft ruling includes ancillary and incidental purposes to charitable organisations as coming under the 'purposes' head. However, the prior and legally binding section of the draft ruling contains no mention of incidental or ancillary purposes.

The Commissioner's position should be made clearer, particularly in the binding section of the draft ruling.

1.

the number of years that an entity can accumulate income;

2.

the % of income that can be accumulated; and

3.

the purposes for which income can be accumulated without attracting adverse ATO attention.

However, depending on their circumstances, entities should still be permitted to accumulate outside the safe harbours. This should be expressly acknowledged in the draft ruling.

No change.

(a)

To assist in creating certainty for entities concerned about accumulating funds and falling foul of the income and assets condition, it would be beneficial for the draft ruling to include an example of where accumulation would be considered inappropriate. Further clarity on levels of acceptable accumulation allowable under the income and assets condition would be welcome.

(b)

Entities would benefit from 'bright-line' tests regarding threshold limits surrounding the 'income and assets condition'. Currently the draft ruling notes an entity will fail the test where it accumulates 'most' of its profits over a number of years and where the accumulation is not consistent with its purposes.

(c)

There is currently no guidance surrounding the Commissioner's interpretation of the terms 'profit' or 'most'. More examples on this would be helpful, dealing with different reasons for accumulation, long-term accumulation plans, and entities that seek to accumulate all of their income over a period of time. Guidance on whether the Commissioner would seek to interpret the ability to accumulate income differently for charitable funds and other types of charitable entities would also be welcome.

An additional example has been included in the final ruling where an entity's accumulation does not satisfy the income and assets condition (see Example 11).

Example 8 has been amended to provide a further example of where accumulation would be appropriate.

When taken in context of the draft ruling only, the word 'incidental' appears to connote minor or insignificant activities. Further, the use of the word 'incidental' in such a context is not in keeping with ATO existing Tax Ruling TR 2005/21 and Tax Ruling TR 2011/4 on charitable entities. These Rulings state that an incidental activity for a 'charitable institution' need not be minor in quantum and what is critical is if those activities are 'in aid of' the charity's purpose. This is supported by the High Court in the Word Investments case, which accepted that a charitable institution could undertake substantial trading activities if charitable activities were the 'immediate natural and probable consequence' of its activities.

The draft ruling should take further steps to clarify its intended use of the term 'incidental' and especially, clarify that 'incidental', at least in relation to charitable institutions, need not mean 'minor'.

Paragraphs 26 to 28 have been added to the final ruling to clarify that incidental or ancillary purposes are merely aspects of an entity's purpose for which it is established. Incidental or ancillary does not mean minor in quantitative terms.

Further clarity is also needed as to whether the term 'one-off' is intended to apply across the life of an entity, or whether 'one-off' is assessed on an annual basis.

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the misapplication or misapplications are immaterial in amount, and

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there is a one-off misapplication or occasional, unrelated misapplications of part of the income or assets of an entity for a purpose other than the purpose for which the entity is established during an income year.

That is, insert 'or minor in extent and importance'.

Appendix 3 to the final ruling sets out the circumstances in which the Commissioner may consider whether or not to allocate resources to take compliance action in respect of an entity which has become taxable for a period of time due to a breach of the governing rules condition or the income and assets condition.

No change.

Some explanation of the 'inappropriate conduct' which is being referred to is needed in the draft ruling, as it is not immediately apparent from the legislation or the EM what the offending conduct is. None of the examples in the draft ruling state that they are illustrations of 'inappropriate conduct'.

The examples given in the ruling explain how the law can apply to particular factual circumstances.

How this is so is not immediately apparent from the legislation or the EM. The draft ruling should make at least some reference to the case. This is particularly concerning because one of the more important points made by the High Court in that case was that in revenue matters the benign construction usually applied to charitable trusts did not apply. The draft ruling would be improved by an explanation of how the case law is 'confirmed' by the introduction of the new special conditions.

It would be useful to know what specific compliance action the Commissioner would take in the appropriate circumstances. Does this involve taking away an entity's endorsement for income tax exemption? If so, this should be made clear in the draft ruling and further guidance should be provided on both how and when the Commissioner is likely to revoke endorsement.

The Commissioner seems to be indicating that he has other powers beyond revocation of endorsement (for example, per paragraph 161, the Commissioner states he could 'require the entity to take additional steps to correct the breach or misapplication').

The Entity C recommend that a clear statement regarding how the Commissioner may administer the revocation power be included in the binding part of the draft ruling with additional guidance contained in Appendix 3 amended as suggested by the Entity C.

Paragraph 38 of the final ruling makes it clear that a breach of either or both special conditions will result in a loss of income tax exemption.

Concerns about fairness have been addressed by the inclusion of Appendix 3 explaining the Commissioner's administrative practice.

Paragraph 191 of the final ruling has been amended to change the word 'require' to 'advise'. This reflects the potential for a dialogue between the entity and the Commissioner about what 'corrective action' is appropriate in a particular case. It takes into account the Commissioner's compliance approach and the appropriate application of resources as set out in Appendix 3.

The revocation of endorsement only applies to registered charities. This ruling applies to all 'entities' as defined in paragraph 5 of the final ruling. The Commissioner's power to revoke endorsement is contained in section 426-55 of the Taxation Administration Act 1953.

Amendments to the draft ruling are required in order to further clarify when this will be the case, for example under the current regime, whether submitting an Annual Information Statement to the ACNC will be sufficient to satisfy the Commissioner of compliance without the need for an additional determination.

No change.

In Example 3, the Commissioner regards the requirement for approval of expenditure in QWE's governing rules as a procedural requirement; however, on another interpretation, it is possible this could also be characterised as a substantive requirement as there could be a real reason why a particular organisation sets this spending limit rather than it being an arbitrary limit (for example to ensure monies are not spent inappropriately).

The examples included in the draft ruling do not assist to clarify which requirements are 'substantive' and which are 'procedural'.

The substantive requirements in an entity's governing rules are those that define the rights and duties of the entity. The remainder of an entity's governing rules are procedural requirements, which are the rules prescribing the method or manner in which the rights and duties of the entity are carried into effect, and where applicable, enforced. Administrative processes are typically procedural requirements.

These clearer interpretations have been carried through the final ruling, including the Examples.

If it is not possible to include an additional example highlighting the use of sources beyond an organisation's constitution, removing the sentence 'there may also be other sources (such as relevant legislation) that comprise or supplements an entity's governing rules' from paragraph 10 would also be appropriate.

Examples in the draft ruling raise questions about how an entity produces its income. This is not relevant to special conditions dealt with in the draft ruling, and references should be removed.

No change.

Where chains of opportunity shops operate effectively under a charity's auspices, some paid employees typically work alongside volunteers to ensure roster management and safe handling, storage and transport of goods. There should be no suggestion, either explicitly or by omission, that some paid employment in the operation of an opportunity shop should in any way render a charity ineligible for tax concessions.

The test under the legislation that is considered in the draft ruling is how an entity applies its income - how an entity produces its income was dealt with in Word Investments and should be irrelevant in any ruling on the application of the special conditions. In our view, Example 8 should be removed from the draft ruling.

Further, the 'majority of profits' notion does not necessarily take into account expense items.

Similarly an example that covers Award nights the organisation may hold for its staff or the people it cares for would be a welcome clarification. Such events require an appropriate level of entertainment to make the occasion a suitable recognition event.

(a)

The draft ruling attempts to introduce a 'one size fits all' approach to charitable and non-charitable exempt entities.

(b)

It would be beneficial for the ATO to confirm within the ruling that the Commissioner's specific interpretation of such entities in TR 2011/4 and TR 97/22 respectively would continue to apply.

The ruling provides the Commissioner's interpretation of the new special conditions that apply to approximately 600,000 entities in the not-for-profit sector. Broad principles have been explained and examples provided across all types of exempt entities in the sector.

Comment 7.1(b):

The ruling does not concern the meaning of 'charity' (cf TR 2011/4) or 'being established for the encouragement of a game or sport' (cf TR 97/22). This ruling explains special conditions that apply far more broadly than just the two types of entities covered by those other rulings.

Where appropriate other rulings are cross referenced. For example, see paragraphs 169 and 170 of the final ruling regarding accumulation.