Tough Ruling in Non-Profit Distribution to Members
By Arthur Drache C.M., Q.C.
A recent ruling letter[1] from the CRA takes a fairly hard line on the distribution to members, a position which in our view can certainly be disputed.
The following is the fact situation. A non-profit organization provides, among other services, internet services to its members. A system was created through a buy-in fee paid by each member and then monthly user fees thereafter. The Organization has surplus funds from these member fees, which were accumulated for maintenance, repairs and upgrades. The surplus is no longer required for the internet service since that service will no longer be provided, however, the Organization itself is not being wound-up and other services will continue to be provided.
Now it seems to us that one can assume the service was being provided as a service and on a cost recovery basis. If this is accurate, the fact that a surplus ensued should not threaten the status of the corporation. It also seems to us that a refund of part of the fees which were not in fact used in providing the surplus is a reasonable approach.
But the CRA thought otherwise.
“To qualify as a tax exempt entity described in paragraph 149(1)(l), an organization must be both organized and operated exclusively for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit. In addition, no part of the income of the club, society or association can be payable or be available to any of its members. (our emphasis)”
This is a slight misstatement of the provisions of paragraph 149(1)(l) which says that “no part of the income of which was payable to or otherwise available for the personal benefit.” This provision is essentially what is known generically as a non-distribution clause to prevent the payment of profits to a member of the organization. We don’t think that refunding money which was overpaid is a personal benefit.
“In our view, in a scenario such as that described above, the distribution of surplus funds to members would likely result in prohibited personal benefits being provided to members, as the surplus was accumulated from income of the 149(1)(l) entity. We note that income, such as user or internet fees, that has been earned and accumulated by a 149(1)(l) is still considered income and cannot be distributed to members without the 149(1)(l) entity losing its tax-exempt status.”
That is one way to look at it.
But in our view, the payments can be simply viewed as a refund of fees which were set too high. In this interpretation, there would be a de facto trust situation where the excess (which in retrospect should not have been charged) did not become income to the organization as it was beneficially owned by the subscribers who were charged too much.
Let’s say that the organization was a golf club. There are fees for individual and fees for couples. A husband and wife pay the “couples” fee but before the golf season starts, one of the spouses dies. If the difference between the couples’ fee and the single fee were refunded, does the club stand to lose its non-profit status?
It is not a major issue for most we suspect that it does show that facts are subject to interpretation and it would have been just as easy and intellectually valid for the CRA to view that the return of overpayment did not threaten the status of the organization.
[1] 2012-0433131E5