With billions in ‘profit’ exempt from tax, changes to NZ’s charity rules are long overdue

The profit made on every breakfast bowl of weet-bix is tax exempt^[1], giving Sanitarium Health Food Company, owned by the Seventh-day Adventist Church, an advantage over other breakfast food companies. But this could be about to change.

Under current rules^[2], New Zealand’s charities are allowed to run businesses as long as the profits are not for personal gain. This means the government gives up millions in tax revenue from charities across the government.

In December, Finance Minister Nicola Willis proposed revising the tax rules for charitable organisations^[3]. The changes are set to be announced with this year’s Budget. According to Willis, there was about NZ$2 billion of “profit” in the charitable sector that was not subject to tax.

My new research – to be published later this year – looks at the integrity and fairness of the taxation framework that gives exemptions to charitable organisations competing directly with the for-profit sector.

Striking the right balance between supporting legitimate charitable activities and preventing the abuse of tax concessions is crucial for ensuring a level playing field in the tax system.

My study shows the tax exemption system in New Zealand, as it stands now, is not really fair and equitable. And it is past time for this to change.

For the public benefit

Under New Zealand’s charity law, a charitable organisation must operate for the public benefit and relieve the government of its burden^[5] to provide welfare services and assist disadvantaged people.

A paper prepared by the Tax Working Group, an advisory group that looked at New Zealand’s tax system between 2017 and 2019, estimated 30% of registered charities were likely to have some sort of trading activities^[6], such as second-hand stores.

To be eligible for tax exemptions, any gains from businesses must be reinvested in the organisation’s charitable activities.

The traditional justification for granting charitable organisations tax concessions is that they are dedicated to the greater good of society. The concessions are also meant to offset the disadvantages charities face in accessing capital.

But by treating the producers of identical goods and services differently, there is a risk of compromising horizontal equity principles^[7] – basically the idea that taxpayers in similar positions should pay similar amounts of tax.

There are concerns for the tax system’s integrity when charitable organisations shift their focus from providing a public good to providing private or unrelated goods (commercial activities).

In these cases, it is clear that tax breaks should be limited.

When governments offer tax breaks, they forego tax revenue. Governments end up having to raise money from other sources to meet their total tax collection targets, such as increasing tax rates on non-exempt firms, items and individuals.

Taxing unrelated activities

Overseas tax systems take a different view of exemptions for charities, offering examples for New Zealand to follow.

In the United Kingdom, for example, charities cannot undertake commercial trading activities unrelated to their charitable purposes while claiming exemption from income tax. This ensures fair competition between commercial activities.

In the United States, “unrelated business income” is subject to tax^[8], restricting concessions to ensure the tax regime matches conventional tax policy or social welfare policy.

In Australia, commercial trading unrelated to the charity’s core purpose^[9] is not allowed.

Ensuring transparency

To ensure greater transparency over who gets an exemption, the financial statements of all charities in New Zealand should also be filed on the Charities Register. These statements should be publicly available.

Charities also need to become more responsible and equitable in their operations. There needs to be stricter regulation, and compliance measures should be implemented. These would prevent tax exemption misuse that benefits a specific group or individuals.

The time for reviewing charitable purposes is long overdue in New Zealand, particularly given the UK and Australia have set out their concepts of charitable purposes in recent years.

References

1. ^{^} tax exempt (www.stuff.co.nz)
2. ^{^} current rules (www.legislation.govt.nz)
3. ^{^} revising the tax rules for charitable organisations (www.rnz.co.nz)
4. ^{^} Hagen Hopkins/Getty Images (www.gettyimages.com.au)
5. ^{^} must operate for the public benefit and relieve the government of its burden (www.change.org)
6. ^{^} 30% of registered charities were likely to have some sort of trading activities (taxworkinggroup.govt.nz)
7. ^{^} horizontal equity principles (www.pc.gov.au)
8. ^{^} “unrelated business income” is subject to tax (www.irs.gov)
9. ^{^} commercial trading unrelated to the charity’s core purpose (www.austlii.edu.au)