Profit motives present risk for condominium corporations, industry and professional associations. Earlier this year, the 2014 federal budget announced a public consultation on the tax framework for non-profit organizations (NPOs), which follows the Canada Revenue Agency’s (CRA) recently completed three-year review of compliance with the Income Tax Act in the broadly defined sector.

After scrutinizing 1,330 filers — deemed a statistically representative sample of the approximately 30,000 organizations that submit tax returns claiming an exemption — the CRA concluded a “significant portion” were offside with the Act’s requirements. The 2014 federal budget similarly reiterates concerns the CRA has expressed that many NPOs actively seek to generate revenue, accumulate excessive capital reserves and/or use the organization’s income for the personal benefit of its members.

“The CRA may want to see a legislative amendment (to the Income Tax Act) that would address these areas,” suggests Camille Jordaan, a lawyer practicing with Borden Ladner Gervais LLP’s charity and non-profit group. “It believes that some of these organizations are generating a lot of revenue.”

The budget pledges “the Government will release a consultation paper for comment and will further consult with stakeholders as appropriate.” Registered charities and amateur athletic associations have been excluded from the review, which will otherwise capture the diverse range of organizations defined in section 149(1)(l) of the Income Tax Act as groups organized and operated solely for: social welfare; civic improvement; pleasure or recreation; or any other purpose except profit.

Designated NPOs have been exempt from income tax since the Act was adopted in 1917 and, as the budget notes, there has been little re-examination of the enabling legislation since then. However, tax experts affirm that the CRA has become notably more restrictive within the past five to six years in its interpretations and rulings related to money-making activities.

Even before that, reporting requirements — the T1044 non-profit organization information return — were introduced in the early 1990s for all incorporated NPOs with more than $200,000 in assets and/or earning more than $10,000 annually in interest, dividends, rentals or royalties.

“Why did they start gathering the information? Because they want to know the size of the pot of untaxed revenue,” hypothesizes Stephen Chesney, a chartered accountant and partner in the firm, Parker, Garber & Chesney LLP.

Many condominium corporations, which are Chesney’s practice specialty, have ancillary sources of income from guest suites, rental of rooftop space for telecommunications antennas or contracts to generate electricity from solar panels. This draws the CRA’s attention both as untaxed revenue and as an undue benefit for condo owners, since the revenue helps to cover operating costs, thus lowering condo fees.

“I would recommend to clients, if they want to maintain the non-profit status, they must minimize that type of income,” Chesney advises.

An across-the-board tax hit could result if the current rules change. Every Canadian province mandates reserve funds in which condo corporations save for future capital repairs and replacement. Earned interest from these funds is not subject to tax and is typically cycled back into the reserves.

This interest revenue reduces the reserve fund contribution that would otherwise be collected from condo fees. Such reserve funds are also a tax-free savings vehicle unique to condominium owners.

“If they tax it, it will affect every condo in the country, no question about it,” Chesney says. “The question from the government’s perspective is, does this (untaxed interest) income amount to some kind of benefit that is unfair?”

Other types of associations may be bestowing benefits through differing member/non-member rate structures for events and publications, but, generally, they’d be more likely to run afoul of the CRA over profit motives or capital reserves. Although tax administrators have not defined what constitutes a reasonable reserve, it’s commonly assumed to be in the range of six to 12 months of operating expenses. There is less consensus about allowable profit, as the CRA appears to be targeting money-making opportunities it previously permitted.

Arguments in the CRA’s report on NPOs, posted on the government of Canada’s website in mid-February, are consistent with many of the Agency’s recent rulings and interpretations. Significantly, the report disputes what’s been the common practice of raising revenue to support programs and organizational growth.

The CRA contends that profit should be an incidental outcome of activities that serve an organization’s non-profit objectives — for example, selling more tickets to an educational or social event than originally foreseen — not an intentional pursuit.

“The earning of profit cannot be or become a purpose of the organization, even if the profit is earned to fund non-profit objectives,” the report asserts.

Canadian case law supports the more flexible view that NPOs can seek and earn profit to reinvest in their operations or hold in reserves. However, knowledgeable observers predict the federal government’s engagement in the issue could be a harbinger of legislative change that will supersede existing legal precedents.

“Budget 2014 signals that the federal budget in 2015 may contain a significant revision of the section 149(1)(l) of the ITA (Income Tax Act) concerning non-profit organizations,” states a Charity Law Bulletin from Carters Professional Corporation, a specialist in the field.

Even in the interim, given that the CRA is the government’s appointed overseer of tax policy and collection, organizations unwilling to mount a court challenge will likely choose to abide by the Agency’s rulings.

“Our advice to our clients is to really strive for zero-based budgeting. Do not budget things to make a profit,” Camille Jordaan says.

“If a not-for-profit is running a significant enterprise like a tradeshow or other revenue-generating activities, it would be worthwhile to confer with a tax adviser on whether these types of activities risk putting them in non-compliance,” concurs Colin Smith, a partner with Thorsteinssons LLP, Tax Lawyers.

If it is reclassified as a taxable entity, an organization is deemed to have disposed of and then reacquired its assets at fair market value. A new tax year would begin at that time and all earned profits would be taxed at applicable rates.

“Keep in mind that even if it is a for-profit organization, if it doesn’t generate any profit or net income on an annual basis, it would have no tax. But it would end up in a different (tax) regime where the reporting would differ significantly,” Smith explains.

“It will be more complicated,” Chesney maintains — also noting that there is no current guidance on what tax rate should be applied on a condo corporation’s ancillary income or what expenses can be written off against it.

For its part, the CRA is counselling rather than penalizing organizations and has pledged to ramp up education and outreach.

“The sense I get from the CRA report is that it’s not looking to assess organizations it views as being non-compliant, at least not until a legislative amendment is made and people understand what it means,” Jordaan says.

That’s a continuation of the approach taken in the recent review of the non-profit sector.

“During the whole three-year process they reviewed 1,300 NPOs and not one of them had its status revoked, which is heartening,” observes Michael Anderson, president and CEO of the Canadian Society of Association Executives (CSAE). “What I was hearing in feedback from members that had been reviewed was that the Canada Revenue Agency was giving them direction, almost on a case-by-case basis, on what they would need to do to comply.”

CSAE — which counts approximately 2,200 staff from industry, professional and issue-specific non-profit organizations among its membership — is still waiting for details, but expects to be a key stakeholder in the government’s public consultation.

“The Act was created in 1917,” Anderson notes. “We are now 97 years down the road and non-profit organizations have evolved in tremendous leaps and bounds over that period.”

Barbara Carss is editor-in-chief of Canadian Property Management.