“Taxation and the not-for-profit sector” an officials’ issues paper released by Inland Revenue includes policy proposals that could fundamentally change the New Zealand charities and not-for-profit sector. At the very least if implemented the changes would represent the biggest shake-up in the taxation of charities and not-for-profits in New Zealand since 1940. The full paper is available here. 

The paper splits the policy proposals and discussion questions across three chapters:

• Chapter 2 (Charity business income tax exemption) explores the issues and rationale behind the charity business income tax exemption and discusses the policy design considerations if the exemption was to be removed (i.e., to tax companies owned by charities).

• Chapter 3 (Donor-controlled charities) examines integrity issues due to the lack of specific rules for donor-controlled charities in New Zealand and discusses policy design considerations, including international approaches.

• Chapter 4 (Integrity and simplification) addresses integrity and simplification issues to prevent tax avoidance and evasion, aiming for stable, predictable, and simple tax rules for the NFP sector.

In this article our experts explain and provide their views on the key proposals in each chapter.

Charity business income tax exemption

Since 1940, income derived from charity business activities has been tax-exempt, to the extent the charity’s charitable purposes are carried out in New Zealand. The headline proposal in the paper is to change this treatment by limiting the charity business income tax exemption to business activities that are themselves related to a charity’s charitable purpose. 

The consequences of this for charities will depend on the exact policy design (if the proposal is implemented). For example, officials have suggested that a de minimis threshold may apply that could be based on charities financial reporting tiers – this could mean that only tier 1 and 2 charities are affected which would be roughly 1,300 charities of the 11,700 charities registered in New Zealand. 

In any case we would expect that any regime for taxing unrelated business income derived by charities would provide relief when current year income is donated or accumulated surpluses are eventually distributed for charitable purposes. In other words, any tax would likely only be temporary until accumulations are applied to a charitable purpose. 

Officials have raised a number of options for what this ‘relief’ could look like, including allowing a deduction paid to a parent charity by a business or a special memorandum account for registered charities that carry out unrelated business activity and allowing refundable credits for tax paid that could be attached to dividends paid to parent charities in later years. Structuring this relief in a way that achieves the intended policy effect may, therefore, be possible without forcing charities to restructure or creating unintended incentives for charities.

Interestingly, while some media and political commentators have made the argument that the charity business income exemption gives charities an unfair competitive advantage this notion is refuted by officials in the paper who state that “although the exemption does provide a tax advantage it does not provide a competitive advantage”. This conclusion is supported by previous reviews of the taxation of charities and not-for-profits in New Zealand (notably in the Tax Working Group’s report and the 2001 review of Tax and Charities in New Zealand). 

This conclusion is also reflected in stated reasons for the review of the exemption, in which officials commented that:

whether charity business income unrelated to charitable purposes should be subject to tax therefore depends on the level of support that the Government wants to provide to charities

This comment highlights that the question of whether businesses run by charities that are unrelated to their charitable purpose should be taxed is fundamentally a political one. 

Officials have noted in the paper that New Zealand’s current income tax exemption framework for registered charities takes a destination of income approach, in that it treats all income earned by a registered charity as tax exempt because it will ultimately be destined for a charitable purpose. As noted above the proposal to limit the business income tax exemption to business activities related to a charities charitable purpose would likely provide relief when accumulations are applied to a charitable purpose. Consequently, it could be argued that the proposal is for the government to effectively borrow (at no cost to itself) from the charities sector. On the other hand, the changes would align the timing of donation tax benefits for businesses owned by charities with businesses not owned by charities.

Donor-controlled charities

Another key proposal in the paper is to introduce specific rules to combat tax avoidance and compliance issues that arise in respect of charities that are controlled by a key donor, the donor’s family, or their associates. 

The primary concern Inland Revenue officials have with donor-controlled charities is that individuals can establish donor-controlled charities and access the same tax concessions as other charities. This includes claiming donation tax credits and gift deductions on the same basis as they would have had they donated to an unrelated donee organisation at arm’s length. 

One example of how this treatment creates avoidance and compliance risks is in circular arrangements whereby the donor gifts money to a charity they control, claim a donation tax credit or gift deduction, and the charity immediately invests the money back into businesses controlled by the donor or their associates. 

Officials have proposed two options to deal with this integrity issue:

• introducing restrictions on investments made by donor-controlled charities and ensuring that transactions between donor-controlled charities and their associates would be at arm’s length terms or prohibited; and / or

• introducing a minimum distribution rule whereby donor-controlled charities are required to make a minimum distribution each year for charitable purposes. 

Integrity and simplification 

One of the policy proposals included in the paper that could have widespread implications is the proposal to remove the current tax concessions for mutual associations, as this change would impact a large number of not-for profit entities. 

The rationale for this proposal is that Inland Revenue has developed draft guidance (which will not be released until after submissions on the issues paper) that departs from its previous views on the taxation of mutual associations. The paper notes one of the key conclusions of this draft guidance is that trading, and other normally non-taxable transactions with members, including some subscriptions, should be taxable income regardless of whether the common law principle of mutuality would apply. 

The paper also considers some of the other income tax exemptions available to certain kinds of entities and proposes removing them, namely: 

• the exemption for local and regional promotion bodies; 

• the exemption for herd improvement bodies; 

• the exemption for bodies promoting industrial and scientific research; 

• the exemption for veterinary service bodies; and 

• the exemption for non-resident charities with no charitable purpose in New Zealand. 

The policy rationale for removing these exemptions as well as fringe benefit tax exemptions for charities is that they are historical and no longer fit for purpose and that they are inconsistent with New Zealand’s broad-base, low-rate tax policy framework. 

It is interesting that only these exemptions have been targeted for removal while others such as the exemption for the promotion of amateur sport (which Inland Revenue has since confirmed is not subject to review – see here) and the exemption for tertiary education institutions have not been. Arguably all such income tax exemptions are inconsistent with New Zealand’s broad-base, low-rate tax policy framework. As result, entities relying on any income tax exemption should consider making a submission on these rules to clearly state their support for the retention.

Next steps 

The policy issues and proposals outlined in the paper are extensive and have the potential to be very complex and wide ranging. The deadline to make a submission on the issues paper is 31 March 2025. There have been indications that decisions on what changes will be processed will be made shortly after this date for inclusion in the Government Budget which is due to be announced on 22 May 2025. 

We expect that any changes to the taxation of charities and the not-for-profit sector announced in the Government Budget would be included in the Annual Rates Bill, which is normally introduced to Parliament in August, however, given the breadth and potential implication of the reforms we would be surprised to see any announced policy implemented prior to 1 April 2027.

This article was co-authored by Liam Sutherland, a Solicitor in our Tax team.