Tax Law Notes
Tax Law Note:
What are the Options for Taxing Non-Governmental Organizations?
Last Updated: October 12, 2005
"NGO"1 is a term often used to refer to non-governmental, non-profit organizations (including charitable organizations) that have as their principal objective to act in public interest.2 The founding charter of such organisations typically (1) requires their funds to be used exclusively to finance their public benefit activities and (2) prohibits these funds from being distributed to their owners. The tax exemption of NGOs in most countries is based on compliance with these two conditions.3
NGOs may generally be categorized into two types: mutual benefit organizations (MBOs) that primarily serve the interests of their members and public benefit organizations (PBOs) that benefit the public or a certain segment of it.4 NGOs can take various legal forms. For example, in some countries they may be either associations or foundations. The legal form may or may not have tax significance.
1. Qualifying as a tax preferred NGO
Registration with the tax authority is commonly required to qualify for tax preferences. A key issue in this respect is the allocation of supervisory powers between the tax authorities and regulatory authorities that are responsible for non-tax aspects of NGOs. In some countries (e.g., the U.S.), the tax authorities play a dominant role in deciding which NGOs qualify for tax exemption. In many other countries, the tax authorities may largely rely on the supervisory function of another agency. Tax exemption may be conditioned on this agency's continuing approval of the NGO's operations.
There are also countries where exemptions are based on case-by-case agreements between the government and the NGO, particularly where non-resident NGOs are concerned, or are based on listing of specific organisations in laws or regulations.
Some countries provide that an NGO no longer qualifies for tax benefits if its business income exceeds a certain percentage of its total revenues for a determined period of time.5
2. Income taxes
Some countries simply exempt qualifying NGOs from income or profit tax. Others take the approach of distinguishing among different kinds of income.
a. Donations received
Donations received by the NGO are almost invariably exempted from income or profit tax.
b. Business profits
In countries that do not fully exempt NGOs from income or profit tax, business income may be:
c. Investment income
Investment income of NGOs is exempted by most countries. In countries where certain investment income of individuals (e.g., interest and dividends) is taxed under a flat final withholding tax, the same treatment is often extended to NGOs (in part for administrative reasons). In countries with a system of corporate/shareholder imputation, an issue arises whether tax-exempt NGOs should be given an imputation credit with respect to dividends received. This is rarely done.
d. Benefits for donors
An income tax deduction for individuals and companies making donations to NGOs is common but not universal.6 The deductible amount is sometimes limited by a "ceiling". There may also be a "floor" whereby a deduction is allowed only to the extent that the contributions exceed a specified amount. A floor might be justified: (1) to maximize the incentive to charitable contributions that can be obtained at a given revenue loss; (2) to avoid the (impossible) task of checking numerous small contributions by large numbers of taxpayers; and (3) because most individuals making small contributions (below the floor) would likely continue doing so even in the absence of a tax incentive.7
Specified supplies of services (e.g., educational or medical services) by NGOs may be treated as exempt supplies (less frequently, as zero-rated supplies).
Less commonly, goods or services supplied to, or imported by, NGOs are exempted. Sometime this is accomplished through a refund mechanism. In other words, the NGO must pay tax on goods or services purchased or imported and then claim a refund.
In some countries, no special treated is extended to NGOs under the VAT.8
4. Other taxes
With respect to other taxes (e.g., excise taxes, real estate transfer taxes, taxes on land and buildings, inheritance taxes) solutions range from total exemption to treating NGOs as regular taxpayers.
5. Administrative tax obligations
Generally NGOs are required to keep books based on general accounting rules, issue invoices, file an annual information tax return, provide tax and accounting information, and withhold and transfer income tax on wages and fringe benefits of employees.9
In some countries (e.g., U.S.) certain types of NGOs (e.g., churches) are relieved from some administrative obligations.10
6. Customs duties
Imports for public benefit purposes are often exempted from import duties. Sometimes the exemption is limited to certain types of goods, for example those to be used for humanitarian or disaster relief. The exemption may be revoked if the imported items are sold.
Fashioning a solution
1. Qualifying as a tax preferred NGO
One basic guideline for drafting is to try to the extent possible to have one definition for qualifying NGOs which is applicable for all taxes. This might include establishing different categories of NGOs, but categorization should not be different in different pieces of tax legislation.
How the definition is structured may depend on legislation outside of tax law - some countries have laws on noncommercial organisations to which reference may be made.
Several elements should be included. The first has to to do with the purposes for which the NGO is established and operates. Best practice in defining PBOs is to refer generally to activities carried out in the public interest, instead of attempting to list qualified purposes (education, charity, protection of the environment, etc.). The risk is that a specific listing will leave out meritorious organisations, particularly those that may raise issues unpopular with government (e.g., protection of human rights). Of course, specific activities can always be given as examples under a rule referring to public interest activities.
Qualifying NGOs should also be subject to some restrictions, as described in the first paragraph of this note.
In addition to the substance of the definition, process should be considered. To what extent should responsibility for determining whether an organisation qualifies be given to tax officials, and to what extent can another regulatory agency be relied on? The answer may depend on practicalities of administrative capacity and potential for corruption. To the extent that corruption is a concern, an attempt should be made to fashion any rules so as to limit the discretion of tax officials so as to avoid abusive situations.
2. Taxation of business activities
A key issue is how income from economic activities should be taxed. Often, a distinction is made between related and unrelated economic activities. A related economic activity is carried out in furtherance of the actual public interest purpose of the NGO (e.g. employing disabled employees in a workshop). An example of unrelated economic activity would be the operation of a restaurant (off premises) by a museum, simply for the purpose of earning money. A closer issue would be presented by the case when a museum opens a café within the building for visitors.11 In the latter case, the operation of the café arguably facilitates the visiting of the museum and therefore furthers the museum's public purposes, even if it happens to turn a tidy profit. Whether the café would be treated as an unrelated business depends on the specific laws and regulations involved. As can be seen from these examples, determining whether a particular activity is related or unrelated is often a difficult exercise.
One of the reasons advanced for taxing the profit of economic activities is to avoid creating a situation of unfair economic competition with regular taxpayer entities that engage in the same kind of activities (e.g. language courses within a religious NGO). Under this rationale, an economic activity of an NGO that does not compete with the private sector should not be considered an unrelated business.
On the other hand, such a rule may be difficult to administer, since it requires a distinction to be made between related and unrelated activities. While conceptually simpler, the approach of taxing all economic activities also suffers from problems in practice, particularly concerning the allocation of expenses between economic activities and the exempt activities of the NGO.
An alternative that is particularly attractive for small NGOs would be to adopt a de minimis test whereby a small amount of economic activity (regardless of whether it is considered related or unrelated) would be exempt from tax in any event. Small in this context can be defined in terms of a percentage of total expenses of the NGO as well as by using a specific monetary amount.12 The definition of small turnover could also be defined in coordination with VAT rules. For example, where a charity carries on an activity at a level below the VAT registration threshold, the income from this activity could also be exempted from profit tax.
Exempting NGOs from income or profit tax on all business activity, while simple, involves a revenue cost and raises the competitiveness concerns identified above, as well as possible abuse, particularly where tax administration is weak.
In some countries, the issue of taxing business activity in principle does not come up, because the framework law for NGOs prohibits them from carrying out any business activity. This type of rule tends not to work out well in practice, since many NGOs end up carrying out business activities even if the law prohibits this. Moreover, prohibition of business activity can hobble the development of the nonprofit sector.
Thus, no ideal answer exists. The solution should be fashioned in light of the administrative resources that can be dedicated to auditing NGOs, the pattern of activity of NGOs in the country, and the extent to which the tax system is to be used to favor NGO activity. In countries where corruption in the tax administration is a problem, it may be important to design rules that minimize contacts between NGOs and tax officials, and reduce cases where disputes between them may arise. The focus in such countries probably should be to minimize abusive situations that present a significant threat to the public revenues, rather than on seeking to collect small amounts of tax from numerous small NGOs.
3. Tax treatment of contributors
Decisions on whether to allow a deduction from income or profit tax for contributions to qualifying NGOs should turn on considerations of revenue needs, administrative constraints, and the desired level of public support through the tax system. The definition of NGOs qualifying for tax-deductible contributions may be narrower than the definition used for exempting the NGOs on their own income (for example, only PBOs may qualify for deductible contributions, while both PBOs and MBOs might be exempt from profit tax). This is because the level of public subsidy tends to be higher by reason of a rule allowing deductible contributions. In the case of a childrens' soccer league, for example, exempting it from profit tax on its sales of tickets and refreshments will lose little or no revenue, unlike allowing parents to take a deduction for contributions they make.
Deductions may be limited via floors or ceilings. From the point of view of providing an incentive for charitable contributions, a floor is preferred to a ceiling. Ceilings might respond to concerns about overall revenue loss and avoidance of abuse.
Whether deductions are allowed for contributions by individuals must be determined in light of the overall policy for individual income taxation: when this involves severely minimizing the number of returns, it is difficult to allow a deduction for charitable contributions (unless, perhaps, a very high floor is used).
4. Indirect taxes
Some of the most troublesome problems in practice are presented by exemption of NGOs from indirect taxes on inputs. Such exemptions should in principle be avoided, but there is often pressure from donors to grant them. If VAT or customs duty exemptions are granted, it would be important to establish rules for maintaining the assets that are granted VAT or customs duty preferences within the sphere of the public benefit activity (e.g. by establishing a period of time during which an imported car cannot be sold within the country).
As far as output by NGOs is concerned, it may be possible to identify types of supply which would be appropriately exempted.13 These might include various kinds of supply that are not made on a profit-making basis, for example supplies offered below cost or where the percentage of volunteer labor in the inputs to the supply is high. In such cases, exemption might even result in higher tax revenue than if the supplies were taxed, since under exemption no input credit is allowed. An example would be food supplied by a soup kitchen, in a situation where the soup kitchen charges a small amount, which might not even be sufficient to cover the direct input costs.
For Further Reference
Ole Gjem-Onstad: VAT and Non-Profit Organizations, VAT Monitor, March/April 1994 (International Bureau of Fiscal Documentation)
Milton Cerny: The Heart of Europe - Government Seeks a New Roe in the Emerging Civil Society, Tax Notes International, December 21, 1998
Debra Morris: Charity Taxation in the United Kingdom, Tax Notes International, September 27, 1999
Milton Cerny: Taxation and Transition: Nonprofit Organization in a Market Economy, Tax Notes International, September 27, 1999
1The series of Tax Law Notes has been prepared by the IMF staff as a resource for use by government officials and members of the public. The notes have not been considered by the IMF Executive Board and, hence, should not be reported or described as representing the views of the IMF or IMF policy.
The term probably originated in diplomatic usage when referring to non-governmental participants in international conferences. It has since been applied more broadly. However, it can be criticized as not being very precise.
2International Tax Glossary (3rd ed., IBFD: 1996).
3Gloria Teixeira: Non-Governmental Organizations: Some Tax Considerations, INTERTAX, volume 28, Issue 4, 2000 (Kluwer International).
4International Center for Not-for-Profit Law, The Tax Treatment of Nongovernmental Organizations, A Survey of Best Practices from Around the World (1998) [hereinafter "ICNL"].
5Milton Cerny: The Heart of Europe - Government Seeks a New Role in the Emerging Civil Society, Tax Notes International, December 21, 1998.
6The Tax Treatment of Nongovernmental Organizations, A Survey of Best Practices from Around the World, International Center for Not-for-Profit Law, 1998.
7See U.S. Treasury Department, Tax Reform for Fairness, Simplicity, and Economic Growth 69 (1984).
8Ole Gjem-Onstad: VAT and Non-Profit Organizations, VAT Monitor, March/April 1994 (International Bureau of Fiscal Documentation).
9For example the U.S. imposes the obligations on filing informative returns on qualifuing NGOs. US Internal Revenue Code sec. 501 and Regulation sec. 301.6104(d)-1.
10For example, section 7611 of the U.S. Internal Revenue Code allows an examination of a church to be conducted only if a high-level Treasury official has a reasonable basis for believing that there is a problem, and only if written notice is provided to the church. The examination must be concluded within 2 years. Repeat examinations are limited. Churches are also exempted from having to file the annual returns that are generally required of exempt organizations. See I.R.C. § 6033(a)(2)(A)(i).
12For example, an activity could be considered small if the expenses of the activity were:
(1) less than $250,000; and13In the parlance of the Australian GST, "input taxed", since exemption implies that the charity bears the burden of VAT on inputs.