Why charities tax got kicked into touch and what it means for NZ

Finance Minister Nicola Willis announced a review of charity business tax emptions then, following widespread sector opposition, send the proposals back to IRD for "more work". Photo / Mark Mitchell

In December Finance Minister Nicola Willis was worried about charity structures rorting the tax system.

“Wherever you have omissions from the tax regime, there will be some who structure their affairs in order to limit their liability, who may be, for example, building up funds that aren’t going to charitable purposes,” she told the press gallery when flagging an Inland Revenue Department (IRD) review of the sector.

While the review looked at a grab-bag of issues long bedevilling the sector – including its fringe benefit tax exemption, regulation of donor-controlled charities, whether subscriptions collected by clubs should be taxed – the headline issue was whether charities should continue to enjoy the ability to operate businesses free of tax.

The issue has in particular vexed competitors, who see their charitable rivals’ tax-free status as an unfair competitive advantage.

But fast-forward to April, following a release of formal proposal documents and a two-month consultation period, and the fervour for reform seems to have dimmed and become, at best, a medium-term objective.

“There is a lot of complexity involved with designing new rules so as to ensure they have integrity and are simple to understand. Therefore, the Government has asked Inland Revenue to do more work on the options,” Willis’ office said this week in response to questions about the proposal’s progress.

The sector welcomed the delay: “Great news,” Wayne Schache, finance director of the Baptist National Support Centre, said on Willis’ announcement.

His organisation had submitted against the proposal, criticising the short two-month consultation period and arguing it would crimp good works that picked up slack from government social service and health agencies.

“This outcome would be a disastrous outcome for the New Zealand communities we serve ... as the additional costs to Government will far outweigh the current tax concessions in business income earned by charities,” the Baptists concluded.

Documents obtained under the Official Information Act show Schache was firmly in the majority of those who provided Willis feedback. Of 901 submissions on the proposals, 86% were opposed to removing the tax exemption for charity business income.

In addition to written submissions, IRD said it also met with 40 large charities and sector groups as part of its consultation.

IRD said the meetings were held in confidence, without formal agendas, and cited “free and frank expressions of opinion” OIA exemptions in declining to identify who it had met with or provide notes or minutes of such meetings.

Willis’ office said she had only met with Philanthropy New Zealand to discuss the proposals in February. It had earlier expressed alarm at the possible scale of reforms and pressed for wide consultation.

An IRD summary of submissions on the proposals, with full feedback due to be made public this month, cited complaints about the short period of consultation, the load charities carry that would need to be taken over by government were their income crimped, and a preference for regulator Charities Services or IRD to better focus on bad actors than trying to bring the entire sector into the tax system.

And it became increasingly apparent that the possible tax prize from any reform was much smaller than some were claiming.

While the charitable sector is large in aggregate – an analysis of the charities register by the Herald this week shows nearly 8000 entities with $36b in gross income and $1.56b in annual surpluses that might suggest up to $400m of tax revenues were in play – it is extremely fragmented, with a huge pool of tiny operators, and a tiny pool of huge charities.

The IRD charity business income proposals had a broad de minimis exemption and only mulled targeting larger organisations, leaving 85% of organisations untouched.

And charities reporting a surplus also involve quite different calculations – almost certainly larger numbers – than a company working out a taxable profit.

Further carving out of business activity related to an organisation’s charitable purpose – such as universities supplying education, or health charities delivering medical care – saw the potential prize for Willis shrink further.

There was also much work flagged for tax and charity lawyers in determining what was and what was not unrelated business activity, with separate accounts needed to be generated for each.

This narrowed scope saw the eye-popping $400m estimate of fresh tax revenue almost vanish entirely.

“The sums involved are not huge,” Willis’ office said. “The most the proposed changes might have generated was about $50 million a year.”

And of that possible $50m most would appear to come from a handful of large charities with large business subsidiaries, such as the Wright Family Charity Group’s BestStart childcare empire, the Seventh Day Adventists’ cereal-making Sanitarium and the Open Brethren’s kiwifruit and dairy conglomerate Trinity Lands.

KPMG tax principal Darshana Elwela.

KPMG tax principal Darshana Elwela said the proposals lacked coherence. “It seemed a bit scattershot,” he said.

“In our view there was a bit of incoherence about what the potential problem was and how it was being proposed to be fixed. Sitting in the background of this was ‘Is tax policy the right lever?’ or should you be going back to the Charities Act, and the role of Charities Services, and how this applies.”

The feedback IRD summarised did suggest, however, that there are perhaps paths of lesser resistance. Reforming donor-controlled charities – that is, donors who effectively gift to charities they control and enjoy tax benefits for doing so while also determining what and how much to give to their favoured causes – had significantly less opposition.

Only 46% of respondents opposed setting a mandatory minimum of distributions for donor-controlled charities, and even less – 43% – opposed placing restrictions (largely arms-length) on what such charities can invest in.

Elwela said this issue also needed some more work, but seemed to be a live issue.

“Transactions between the donor and the charity could result in a more favourable tax profile for the tax-paying side. There were some genuine concerns some of that might be happening,” he said.

“The question we had does raise a wider question of whether these entities should be charities to begin with.”

Willis’ office denied the suggestions the reforms had been walked back or put on hold.

“The Government is focused on fairness and integrity of the tax system. It is important that any changes are the right ones, so it is going to take the time needed to get it right,” her office said.

Matt Nippert is an Auckland-based investigations reporter covering white-collar and transnational crimes and the intersection of politics and business. He has won more than a dozen awards for his journalism – including twice being named Reporter of the Year – and joined the Herald in 2014 after having spent the decade prior reporting from business newspapers and national magazines.