Canada
is a federal jurisdiction with ten provinces and three
territories. There are no statutory requirements, under
either federal or provincial law, governing the legal
form under which a not-for-profit entity must be organized.
The most common legal forms are:
"Non-share" (membership) corporations, incorporated under either federal or
provincial law. Federal corporate legislation is most commonly used where the
organization is operating in more than one province or internationally. Provincial
legislation is used most often when the organization is operating within a
single province or territory.
Trusts, which are recognized in common law provinces. Quebec, which is a civil
law jurisdiction, also recognizes forms similar to trusts.
Unincorporated organizations or associations.
With the exception of federal incorporation, the creation of any organization
is a function of the applicable provincial law, which varies somewhat, but
seldom substantially, from province to province.
B. Tax Laws
1. General Classification
The federal tax legislation in Canada makes distinctions
among not-for-profit organizations that may be relevant
for U.S. donors. Canadian federal income tax law distinguishes
between "non-profit organizations" (hereinafter "NPOs")
and "registered charities" (hereinafter "charities").
Although most potential grantees in Canada will be
"charities," it is possible that NPOs may also seek
funds from U.S. donors (NPOs may be organized for social
welfare and civic improvement purposes).
To qualify as an NPO, an entity must meet three tests. First, it cannot be
a charity or an organization that could be registered as a charity.
Second, it must be organized and operated exclusively for a purpose other than
profit. Third, no part of its income may be paid or made available for
the personal benefit of any proprietor, member, or shareholder (with an exception
for amateur athletic organizations).
The category of "charities" is divided into charitable organizations and charitable
foundations (consisting of private foundations and public foundations).
A charitable organization, whether or not incorporated, must devote its
resources to charitable activities carried out directly by the organization.
A charitable foundation must provide funding to other charitable organizations,
although it can also directly engage in charitable activities. Charities, like
NPOs, are subject to the non-distribution constraint.
2. Income Tax Exemption and Tax Treatment of Donations
Canada recognizes a statutory list of organizations which are not technically
"charities" but which are treated as such for the purpose of giving
tax relief for donations. These organizations, together with charities, are
collectively known as "qualified donees." Neither NPOs nor qualified donees
are subject to income taxation of any sort. Individuals are entitled to a tax
credit (as opposed to a deduction) for contributions to qualified donees. Corporations,
however, receive a tax deduction for their donations to qualified donees.
3. Other Tax and Fiscal Provisions
Canada has a 5% federal tax known as the Goods and Services Tax ("GST"). The
GST does not apply to foreign grants. Moreover, while charities and
NPOs are subject to the regime, there are many potentially applicable exemptions.
There are no particular customs exemptions for charities or NPOs. Real
property taxes, which are part of provincial and/or municipal jurisdiction,
are applied on a haphazard basis depending upon the jurisdiction.
II. Applicable Laws
There are potentially
fourteen different jurisdictions with laws applicable
to NPOs and charities, but clearly the most important is the federal
government. Key federal legislation consists of:
The Income Tax Act;
The Canada Corporations Act;
and
The Charities Registration (Security Information)
Act. [1]
While
the provinces have jurisdiction over charities, there
is a paucity of legislation in this area; instead,
most provinces rely primarily on the common law powers
of the Attorney General to act when there has been
a breach of fiduciary duty. However, Ontario and Alberta
have enacted legislation which is of some consequence,
namely:
The Charities Accounting Act (Ontario);
The Charitable Gifts Act (Ontario);
The Religious
Organizations Land Act (Ontario); and
The Charitable
Fund-Raising Act (Alberta).
Also relevant are
the Trustee Acts of all provinces.
Other Legal Authorities Consulted in Preparing
this Note:
The best single source of information about the
federal regulation of charities and NPOs is found
at the website of the Charities Directorate of
the Canada Revenue Agency (CRA). This site
has interpretation bulletins, forms, newsletters
and a searchable database for registered charities.
The definitive work on the incorporation of NPOs and charities in Canada,
covering all jurisdictions is Non-Share Capital Corporations by Jane Burke-Robertson
and Arthur B. C. Drache. It is published by Carswell, the Canadian arm
of Thomson Professional Publishing.
The pre-eminent source of all law relating to charities and non-profits is the multi-volume work entitled
Charities Taxation, Policy and Practice
by Arthur Drache and Robert Hayhoe, also published by Carswell.
III. Relevant Legal Forms
Neither
federal nor provincial law sets forth requirements
for the organizational form of an NPO or charity.
The most common forms are "non-share" corporations,
trusts, and unincorporated organizations or associations.
The federal Income Tax Act [2] does,
however, distinguish between NPOs and charities –
a distinction
that may prove useful in making equivalency determinations.
1. NPOs
The primary definition of a non-profit organization is:
"a club, society or association that, in the opinion
of the Minister, was not a charity within the meaning
assigned by subsection 149.1(1) and that was organized
and operated exclusively for social welfare, civic
improvement, pleasure or recreation or for any other
purpose except profit, no part of the income of which
was payable to, or was otherwise available for the
personal benefit of, any proprietor, member or shareholder
thereof…."
[Article 149(1)(l), Income Tax Act]
The term "club, society or association" includes
corporations and trusts. The key test is that the pursuit of profit
cannot be a purpose. But this does not mean that activities
generating a profit are forbidden, so long as the motive
for the activity is not the generation of profit. Also,
because the Income Tax Act does not require registration of
NPOs; in essence, they self-assess their status.
2. Charities
The Canada Revenue Agency distinguishes between "charitable organizations," "public foundations,"
and "private foundations" based on the entity's structure, source of funding,
and mode of operation. As a practical matter, charitable organizations are
operational charities, while foundations are almost always grantmakers.
Charitable Organizations
A registered charity is designated as a "charitable organization" if:
a) it devotes its resources mainly to charitable activities conducted by itself; and
b) more than 50% of its directors/trustees deal with each other at arm’s length
(i.e., individuals not related by blood, marriage, common law relationships,
or close business ties).
Public Foundations
A registered charity is a "public foundation" if:
a) it is constituted and operated exclusively for charitable purposes; and
b) it is a corporation or a trust.
A public foundation must also meet condition b) for charitable
organizations.
[3]
Private Foundations
A registered charity is a "private foundation" if:
a) it is constituted and operated exclusively for charitable purposes;
b) it is a corporation or trust; and
c) it is not a “charitable organization” or “public foundation.”
A private foundation is one where more than 50% of the board is not-at arm's length with each other.
Grants to private foundations may raise "out of corpus" and other issues for
U.S. donors. For a detailed discussion of issues arising with grants to private
foundations (as defined under U.S. law), please see Beyond our Borders, page
35-36.
IV. Public Benefit Status
NPOs
do not need to serve the public benefit. Indeed, most
of the major NPOs in Canada are organized for
the benefit of their members. Such organizations include
professional bodies such as the Canadian Bar Association,
sporting and social clubs, labor unions, and political
parties. However, since NPOs may be organized for social
welfare purposes, it is possible that an NPO may seek
funds from a U.S. donor.
In contrast, charities must satisfy the common law test of "charity." There
is no federal or provincial statutory definition of this term, and the concept of what
constitutes charitable activities draws heavily on traditional English
common law dating back several centuries. Over the years, the courts have
generally based their interpretation of "charity" on four categories described
in English common law:
the relief of financial hardship;
the advancement
of education;
the advancement of religion; and
certain other purposes
for the benefit of the community.
For the most
part, the Canadian provinces and territories have
not defined "charity" or "charitable purposes"
in legislation but - similar to the federal approach
- have left it to the courts to apply common law.
However, in some jurisdictions there are statutory
definitions, which, to varying degrees, expand
or modify the common law definition.[4] Finally,
it should be noted that, in the case of other
organizations that comprise the grouping "qualified
donees" (apart from registered charities), public
benefit is not a requirement.
V. Specific Questions Regarding Local Law
A. Inurement
The Income Tax Act, in defining both NPOs and charities contains the
following provision:
"no part of the income of which is payable to, or is otherwise available
for, the personal benefit of any proprietor, member, shareholder, trustee,
or settlor thereof" [Paragraph 149 (1)(1), The Income Tax Act].
This is interpreted to mean that no dividend or similar payment or
a liquidating distribution can be made for the personal benefit of
individuals, etc. It does not preclude, however, members or others
being paid for services actually rendered.[5] These
requirements, specified in law and practice, are generally consistent
with U.S. prohibitions on private inurement.
B. Proprietary Interest
In the case of an NPO, members may have a proprietary
interest and may, for example, be entitled to a return
of contributed capital upon retirement as a member
or upon the dissolution of the organization.
In the case of a charity, no proprietary interest is possible,
and the legislative framework precludes a member from receiving
any assets, whether out of income or capital. Indeed, if such a
transfer took place, the Income Tax Act imposes a 100% tax on the
amount so paid [Subsection 188.1(4), Income Tax Act].
C. Dissolution
The dissolution of a corporation is governed by the
applicable federal, provincial, or territorial law
under which it was set up. In the case of a trust,
the dissolution would be governed by the trust deed
or, if the deed were silent on the subject, might
require the intervention of a court.
In practical terms, aside from the legal procedures, the key
element remains the federal Income Tax Act. For NPOs, there are
statutory rules that deal with the conversion of such an organization
into a taxable entity, including the winding up and distribution
of assets to members. When this occurs, the law requires that
the organization's tax-free status be terminated, deeming a disposition
of all the assets for tax purposes, and taxing the recipients
of any money or assets.
On the other hand, to be registered as a charity, there must
be a clause in the incorporating documents or by-laws that states
that upon winding up (or a loss of registered status) all the
assets must go to another qualified donee. If this is not done,
there would be a 100% tax on recipients of any assets [Subsection 149(10) and Subsection 188(1), The Income Tax Act].
D. Activities
1.
General
As discussed above,
an NPO can be set up for any purpose other than profit.
In practice, this means that almost any sort of activity
can be a legitimate purpose. Indeed, the Income Tax
Act does not require registration of these organizations,
and they self-assess their own status.
The act also deems certain activities to be charitable,
including the transfer of funds to a qualified donee,
the carrying on of a related business and, within very
strict limits, "political activity." These issues are
discussed below.
2. Economic Activities
NPOs, by definition, cannot carry out any activity for
profit. However, it is quite clear that they can engage
in a range of activities that generate revenue and, indeed,
may generate a profit if it is clear that this is not
a purpose of the organization.
Registered charities (other than private foundations)
are allowed to carry out "related business activities" [Paragraph 149.1(6), Income Tax Act]. This term is undefined. As a practical matter, the first
time a case came before the courts, a two-to-one majority
held that any activity was a related business if the
profits were used in charitable activities of the organization.
This case was later distinguished by the same court and it seems fair to say that the "destination test" will no longer apply in determining what is a related business.
E. Political Activities
NPOs
have no limits on political activities and indeed,
political parties are a sub-category of the NPO category
of organizations (as they are in the US).
Charities pose a more complex case. The Income Tax
Act seeks to limit political activity, requiring that
those activities are "ancillary and incidental" to
the organization's charitable activities, and "do not
include the direct or indirect support of, or opposition
to, any political party or candidate for public office"
[Paragraph 149.1(6.2), Income Tax Act]. While this latter limitation would seem to meet the
U.S. ban on "electioneering" activities by qualified
donees, the lack of guidance with respect to what is
"political" under Canadian law may pose some issues
for U.S. donors.
In addition, the courts in Canada have consistently
expanded the notion of what is meant by the term "political
activities," and it now seems that one is hard pressed
to distinguish between education, advocacy, and political
statements.
The Canada Revenue Agency has issued a paper, CPS 022, which attempts to explain its view of these issues.
F. Racial Discrimination
There is a great deal of legislation to combat racial discrimination and the promotion of racial hatred in Canada, and the courts have not been hesitant to apply this legislation to NPOs. In case after case, the courts, bolstered by legislation, have tried to ensure that any form of discrimination in the field of charities and NPOs is barred. (See for example Canada Trust v. Ontario Human Rights Commission 74 OR (2d) 481; 69 DLR (4th) 321; Gould v. Yukon Order of Pioneers [1996] 1 SCR 571; re Ramsden Estate 139 DLR (4th)746.)
That said, the tax authorities also have the legislative power to recognize foreign universities as being the equivalent, for tax purposes, of a Canadian registered charity. Because the statutory test is simply that the institution “usually” has Canadian students and that it is accredited in its own jurisdiction, it is possible that some such universities might practice some forms of discrimination. A full list of such institutions will be found in Schedule VIII of the Income Tax Act.
G. Control of Organizations
No
restriction exists on the control of Canadian not-for-profit
organizations by other organizations or persons.
For public foundations, which are formed by a government
entity, control is exercised by such entity. With
respect to other organizations, it is possible that
a Canadian association or foundation may be controlled
by a for-profit entity that establishes it, even though
it does not own it (which will lead to additional IRS
scrutiny). The same would be true for a Canadian association
or foundation controlled but not owned by an American
grantor charity (which requires that the charity
specifically so provide in the affidavit).
VI.
Tax Laws
The following section discusses
relevant tax legislation, recognizing that taxes
may affect the amount of the grant actually flowing
to the donee.
A. Tax Exemptions
Neither
NPOs nor registered charities are subject to any
taxes on income.[6] Nor
are there taxes on any activities falling outside
of an organization’s statutory powers. That
is to say, if an NPO actually turns out to have a
profit motive, then it loses its NPO status and
is treated as an ordinary taxable entity.
Similarly, a registered charity is not subject to
income tax. Any breach of the statutory rules might
lead to a revocation of its registration.
However recently enacted legislation does create a series of potential fines for breach of the rules and such breaches may also lead to a temporary suspension of the privilege of issuing receipts. As this is written, only two charities have been subject to these rules, but it is likely that more will be penalized. A list of charities which have had their privileges suspended will be found on the CRA web site.
B. Tax Treatment of Donations
The
main and vital distinction for practical purposes between
NPOs and charities (and other qualified donees) is
that gifts to the former cannot qualify for tax relief
for donations, while gifts to the latter may.[7] The
Canadian system relies on a tax credit
(as opposed to deduction) system to give tax relief
to individuals, while corporate donors receive
tax benefits through the conventional deduction
system. The rules are fairly complicated, and
details - which are particularly relevant to
grantmakers with entities established in Canada - can be found in Revenue Canada’s guide entitled,
"Tax Advantages of Donating to Charity."
In addition, it should be noted that Canada does
not have gift taxes. Moreover, there are no death
duties per se, though there may be a deemed disposition
of capital property on death.
C. Sales Taxes
Charities
and NPOs are generally part of the federal and provincial
sales tax regimes and though they may have some special
rules based on specific activities, there is no general
exemption available. That said, the federal
Goods and Services Tax does have a special feature.
Once an organization has calculated its net tax liability
if any (GST collected net of input tax credits), if
it is either a registered charity or a NPO which receives
40% of its funding from one or more levels of government,
it is entitled to receive a rebate of one-half the net
tax paid.[8] Moreover,
there is no GST due on foreign grants.
D. Tax Conventions
The
United States and Canada have entered into a tax
treaty that addresses cross-border donations. Specifically,
the tax treaty permits charitable deductions for
contributions made to Canadian charities if certain
requirements are met. The most important part of the
tax treaty rules is that the deduction may not
exceed the amount of the donor's Canadian
source income, which significantly diminishes
the utility of this provision to many U.S.
grantmakers. Moreover, under IRS Notice 99-47,
I.R.B., 1996-36, page 344, all Canadian registered
charities are deemed to be the equivalent
of a tax-exempt organization under the Internal
Revenue Code. Unfortunately, the Notice does
not address whether private foundations may rely
on this equivalency, so prudence suggests that
U.S. grantmakers still undertake equivalency determinations.
For a detailed discussion of this tax treaty, please
see Appendix II of Beyond our Borders.
[1] This
is new, post-September 11 legislation, which
deals with direct and indirect financing of terrorism
by charities. Interestingly, however, this legislation
does not cover NPOs.
[2] Each
province and territory has its own income tax act,
but in the area of NPOs and charities, almost all precisely
mirror federal legislation. Only Quebec has a separate
registration regime for charities, but that registration
is functionally automatic when evidence of federal
registration is presented.
[3] A legislative change which eliminates a contribution test has not as yet been passed but the CRA is administering the law as though it has been enacted. The test would require that “not more than 50% of the funds that the charity has received have come from one person or organization, or from a group of people or organization’s that do not deal with each other at arm’s length.”
[4] In
Alberta, the Charitable Fund-Raising Act extends the
common law by defining "charitable purpose" as including
"a philanthropic, benevolent, educational, health,
humane, religious, cultural, artistic or recreational
purpose, so long as the purpose is not part of a business."
Similarly, in Manitoba the Charities Endorsement Act
defines "charitable purpose" as including "any charitable,
benevolent, philanthropic, patriotic, athletic, artistic,
or civic purpose that has as its object the promotion
of a civic improvement or the provision of a public
service."
[5] Ontario,
following its interpretation of common law, takes the
position that no payment can be made to a director
or trustee of a charity, even if actual work is performed
for the organization.
[6] There
is in fact one small exception. Where a non-profit
organization is set up to provide "dining, recreational
or sporting facilities" to its members, it is subject
to tax on any passive investment income it might earn
in excess of $2,000.
[7] Of
course, payments made to an NPO may qualify for tax
relief as business deductions in appropriate cases.
Thus, lawyers would normally be able to deduct the
fees they pay to the Canadian Bar Association (a non-profit)
if the lawyer is practicing.
[8] While
for most organizations this may be a relatively small
concession for being in the system, it is hugely valuable
when major purchases are made or when a building is
being constructed. Indeed, many organizations which
might not otherwise wish to be registered as a charity
do so in order to qualify for GST rebates.
