The Canada Revenue Agency (“CRA”) reminds certain non-profit organizations (“NPOs”) that distributing funds received by them as taxable dividends will jeopardize their tax-exempt status.
In CRA View 2018-0776681E5 (dated March 30, 2023) (“CRA View”), the CRA clarified the tax implications for when NPOs (such as condominium corporations) distribute capital or taxable dividends they receive to their members.
In that case, the wholly-owned subsidiary (“SubCo”) of the condominium corporation (“CondoCo”) planned on selling the real estate that SubCo owned, then distributing the capital gain to CondoCo by paying capital dividends and taxable dividends. CondoCo asked the CRA if it could distribute the dividends to members while retaining its NPO status.
Qualifying for tax-exempt status as an NPO: A refresher
By way of background, paragraph 149(1)(l) of the Income Tax Act (Canada) (ITA) grants tax exemption to a “non-profit organization,” provided it meets all of the following four requirements:
- it is a club, society, or association;
- it is not a charity;
- it is organized and operated exclusively for social welfare, civic improvement, pleasure, recreation or any other purpose except profit; and
- its income is not available for the personal benefit of a proprietor, member, or shareholder, unless the proprietor, member, or shareholder was a club, society, or association whose primary purpose and function is the promotion of amateur athletics in Canada.
Organizations do not register as NPOs to become tax-exempt under paragraph 149(1)(l). Rather, the NPO test is an annual, fact-based test that looks at the organization and its operations as a whole and whether they meet the requirements in paragraph 149(1)(l). An organization that qualifies as an NPO in one year might not qualify as an NPO in another year.
Profit purpose is a question of fact
Because residential condominium corporations are structured in accordance with provincial legislation (for example, under the Strata Property Act in British Columbia), condominium corporations do not function as strictly commercial entities; rather, they are examples of organizations that will typically be deemed to operate for reasons other than pursuing profit. As a result, condominium corporations generally meet the third requirement of paragraph 149(1)(l).
However, in the CRA View, Canada’s tax authority warned that, if an organization holds shares to earn income from property, the organization may be considered to have a profit purpose even if this income is used toward furthering their non-profit objective. Whether an organization that owns shares in and receives dividends from a wholly-owned subsidiary is considered to have a profit purpose is a question of fact.
Taxable dividends vs. capital dividends
For an organization to qualify as an NPO, the fourth requirement under paragraph 149(1)(l) requires that the organization’s income cannot be available for the personal benefit of proprietors, members, or shareholders.[1]
The CRA confirmed that income does not include any taxable capital gains amounts[2] or any capital dividends.[3] As such, distributing capital dividends to shareholders or members will not breach the fourth requirement of paragraph 149(1)(l) of the ITA and will not affect an NPO’s tax-exempt status.
On the other hand, unlike capital dividends, taxable dividends are considered income.[4] The CRA warned that organizations (such as CondoCo) that distribute taxable dividends to their members will breach the fourth requirement and subsequently lose their tax-exempt status under paragraph 149(1)(l).
Losing NPO status
If an organization no longer meets the requirements in paragraph 149(1)(l), it becomes a taxable entity and is subject to additional rules. Under paragraph 149(10), the organization’s current taxation year is considered to have ended immediately before the organization ceased to be exempt, and a new taxation year begins. At that time, the organization is also deemed to have disposed of all of its assets before reacquiring them at fair market value.
Organizations that lose NPO status in one year can qualify in a later year as an NPO. Whether a tax exemption is available in a later year is a question of fact determined after evaluating all the organization’s activities during that year in light of the requirements under paragraph 149(1)(l).
Takeaways
Though the CRA View focuses on condominium corporations, the document provides useful insights for all organizations claiming tax-exempt status as NPOs under paragraph 149(1)(l), such as amateur sports organizations, social or recreational groups, certain festival organizations, and professional associations.[5]
The CRA reminds NPOs that they may lose their tax-exempt status if they are seen as having a profit purpose. NPOs that hold shares to earn income from property may be at risk.
Additionally, any NPO that distributes any taxable dividends it receives to its members will lose its NPO status by violating the fourth requirement under paragraph 149(1)(l). However, NPOs that distribute capital dividends to their members will not be affected because paying capital dividends is not considered distributing “income.”
The CRA View underscores the importance of organizations maintaining accurate records that verify that the source of any distribution to members was the capital dividend that the organization received.
If you have any questions about the CRA View or are unsure of whether your organization’s activities might be putting its NPO status at risk, please speak with a member of Miller Thomson’s Social Impact Group.
[1] Unless their primary purpose and function is the promotion of amateur athletics in Canada.
[2] ITA, s. 149(2).
[3] ITA, s. 82(2)(b).
[4] ITA, s. 82(1).
[5] NPOs are distinct from registered charities, and the two rely on different provisions of the ITA for tax exemptions.
