10 June 2011 Internal T.I. 2011-0398661I7 - 149(1)(l)--Profit Purpose and Income to Members

By services, 17 December, 2016
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149(1)(l)--Profit Purpose and Income to Members
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English
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149(1)(l)
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2011-0398661I7
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Technical Interpretation - Internal
Author
Lisa Zannese
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392816
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Principal Issues: Did the corporation qualify for the tax exemption provided by paragraph 149(1)(l) of the Act for the taxation years under review?

Position: No.

Reasons: The corporation operated a for-profit business during those years. In addition, income of the corporation was made available to one of its members.

								June 10, 2011
	Compliance Programs Branch			HEADQUARTERS
	    Speciality Audits Section			Income Tax Rulings
	Attention:  Rubin Dressler			  Directorate
								L. Zannese
								(613) 957-2747
								2011-039866

XXXXXXXXXX (the "Corporation")

We are writing in response to your request for our views as to whether the Corporation qualified for the tax exemption provided by paragraph 149(1)(l) of the Income Tax Act (the "Act") for the XXXXXXXXXX to XXXXXXXXXX taxation years. We also acknowledge receipt of the materials provided for our reference, which included the auditors' notes, a summary of the Corporation's incorporating documentation and the Corporation's financial statements for the years under review.

FACTS:

Based on the material provided, our understanding of the facts is as follows:

  • The Corporation was registered on XXXXXXXXXX under XXXXXXXXXX .
  • The Corporation has no share capital.
  • The objects of the Corporation include:
    • establishing, maintaining, organizing, expanding and administering a school offering XXXXXXXXXX classes;
    • awarding diplomas, and certificates to students who have completed the requirements of the XXXXXXXXXX ;
    • printing, editing and distributing publications to students on the subjects of XXXXXXXXXX ;
    • organizing and hosting conferences to promote education;
    • acquiring by purchase, lease or otherwise real and personal property to meet the above objectives;
    • hiring professors and other necessary staff.
  • The by-laws state that there will be two classes of members (active and honourary).
  • For the years being reviewed there were XXXXXXXXXX active members:
  • XXXXXXXXXX
  • According to the by-laws, other persons may become active members of the Corporation upon request and through acceptance by the board of directors. The person applying for membership must meet any requirements set in resolutions of the board and must comply with the by-laws relating to the suspension, expulsion and resignation of a member.
  • Active members should be prepared to pay weekly or monthly contributions. The amounts payable and for which periods of time are to be determined in a resolution passed by the board of directors.
  • There is no specific clause that deals with the disposition of property held by the Corporation should it cease operations.
  • The Corporation offers XXXXXXXXXX courses in XXXXXXXXXX .
  • The Corporation expanded in XXXXXXXXXX when it purchased a XXXXXXXXXX school in XXXXXXXXXX . This school is a registered charity. The remainder of the facts pertain to the XXXXXXXXXX only.
  • The Corporation received subsidies from the Province of XXXXXXXXXX , which accounted for approximately XXXXXXXXXX its revenues for the years under review.
  • The remainder of the Corporation's revenues are mainly from fees charged to students.
  • The Corporation recorded a loss in XXXXXXXXXX . From XXXXXXXXXX to XXXXXXXXXX the Corporation has earned a profit every year:
  • XXXXXXXXXX
  • The Corporation rents its building from a sister corporation owned solely by the Corporation's president, XXXXXXXXXX .
  • The Corporation invested just under $XXXXXXXXXX in leasehold improvements to this building. Of this amount, it recorded $XXXXXXXXXX as a current expense.
  • The Corporation guaranteed loans of $XXXXXXXXXX on behalf of its sister corporation, using as collateral $XXXXXXXXXX . These loans related to other properties owned by the sister corporation.
  • The Corporation charged a fee to the sister corporation of XXXXXXXXXX % of the guaranteed amount and earned $XXXXXXXXXX in fees from this arrangement for the XXXXXXXXXX and XXXXXXXXXX taxation years.
  • The guarantees were cancelled in XXXXXXXXXX .
  • The Corporation provided advances to the sister corporation totalling $XXXXXXXXXX as of XXXXXXXXXX . The interest rate on these advances was XXXXXXXXXX % for XXXXXXXXXX and XXXXXXXXXX . The Corporation earned $XXXXXXXXXX in interest income for the XXXXXXXXXX and XXXXXXXXXX taxation years from these advances. No interest was charged on the amount outstanding for the XXXXXXXXXX taxation year.
  • The Corporation advanced money to the XXXXXXXXXX school in XXXXXXXXXX , so that the school could develop additional programs. Advances were also made to help the school finance its share of the renovations to its building. At the end of the taxation year, the advances were recorded as donations in the Corporation's financial documents, and a donation receipt was issued to the Corporation for the amount of the advances.
  • The Corporation pays a rent charge of approximately $XXXXXXXXXX . The real estate expert in the local Tax Services Office views this amount as excessive, and suggests that a market rate would be between XXXXXXXXXX. The Corporation pays rent on the entire building, even though the sister corporation is using some of the building for office space and to store its own records.
  • The Corporation recorded expenses of approximately $XXXXXXXXXX which related to personal expenditures of the president.
  • The Corporation also included as an expense the amount of $XXXXXXXXXX for XXXXXXXXXX that was leased by the sister corporation.
  • The sister corporation has increased the amount of assets it owns from XXXXXXXXXX properties in XXXXXXXXXX to XXXXXXXXXX properties in XXXXXXXXXX . Some of the properties relate to the Corporation (i.e. XXXXXXXXXX ). However, XXXXXXXXXX properties have no relation to the Corporation. XXXXXXXXXX .
  • The sister corporation has reported the following amounts of taxable income over the last several years:
  • 	Year		Amount of Taxable Income
	XXXXXXXXXX 	XXXXXXXXXX
  • The sister corporation has paid out the following amounts of dividends to its sole shareholder (XXXXXXXXXX, President of the Corporation):
  • 	Year		Amount of Dividends
	XXXXXXXXXX 	XXXXXXXXXX

OUR COMMENTS:

In general terms, paragraph 149(1)(l) of the Act provides that the taxable income of an organization is exempt from tax under Part I of the Act for a period throughout which the organization meets all of the following conditions:

  • 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 member or shareholder, unless the member or shareholder is an association which has as its primary purpose and function the promotion of amateur athletics in Canada.

Based on the information provided, the Corporation may be an unregistered charity. The Corporation is operating an educational institution, and education is generally a charitable object. Further, the Corporation's sister school is a registered charity. An organization that is a charity, whether or not it is registered with the Canada Revenue Agency, cannot qualify for the tax exemption provided by paragraph 149(1)(l) of the Act. You may wish to consider whether the Corporation is a charity. If it is, then in order for the Corporation to qualify for a tax exemption, it must register as a charity; the wording of paragraph 149(1)(l) prevents it from relying on that provision.

Assuming that the Corporation is not a charity, our review of the summary provided to us by the auditor of the Corporation's objects and by-laws suggests that the Corporation is organized in a manner that meets the requirements of paragraph 149(1)(l) of the Act. However, we agree with the auditor's view that the operations of the Corporation evidence a profit purpose. Moreover, it appears that income of the Corporation has been available for the personal benefit of its members, in particular to XXXXXXXXXX .

The Corporation can only claim the exemption from tax provided by paragraph 149(1)(l) of the Act if it is operated exclusively for a purpose other than profit. This does not mean that a 149(1)(l) organization cannot earn a profit; it can, but the profit must be incidental and must result from activities undertaken to support the organization's not-for-profit objectives. The earning of profit cannot be or become a purpose of the organization. The decision of the Federal Court in Gull Bay Development Corporation v. HMQ, 84 DTC 6040 ("Gull Bay") turns on this point.

In the current situation, the Corporation has earned a profit every year since XXXXXXXXXX , and these profits have been increasing in amount. The balance sheet of the Corporation records investments of approximately $XXXXXXXXXX , and unallocated reserves of approximately $XXXXXXXXXX for the fiscal year ending in XXXXXXXXXX . These amounts appear to be more than incidental and suggest that the Corporation has a profit purpose. In fact, there is little evidence that the Corporation is something other than a for-profit business undertaken for the benefit of its members, especially in light of the personal wealth element discussed below.

In addition to operating without a profit purpose, an organization claiming the tax exemption provided by paragraph 149(1)(l) of the Act cannot make its income available for the personal benefit of its members. Income of the Corporation has benefitted a member, XXXXXXXXXX , both directly and through his wholly-owned corporation, the sister corporation described above. The indirect benefit is evidenced by various transactions described below.

The Corporation provided guarantees using its investments as collateral for loans taken out by its sister corporation, which relieved XXXXXXXXXX of this encumbrance on his own funds. This financing directly supported the sister corporation's operations and acquisitions, which increased its value, and the value of XXXXXXXXXX 's shares. The Corporation provided the sister corporation with additional funding by paying advances totalling $XXXXXXXXXX as of XXXXXXXXXX . Although the Corporation charged interest on this amount for the XXXXXXXXXX and XXXXXXXXXX taxation years, for XXXXXXXXXX it lent this amount interest-free. The Corporation paid for approximately XXXXXXXXXX % of the costs of renovations to a building that was used by the Corporation but owned by the sister corporation. These renovations increased the value of the building, which increased the value of the sister corporation, again benefitting XXXXXXXXXX . Since XXXXXXXXXX , the sister corporation has been charging rent of $XXXXXXXXXX per square foot to the Corporation for the use of the entire building. The sister corporation has an office and records in this building but the Corporation pays rent for the whole space. The rent paid by the Corporation increased under a new lease signed in XXXXXXXXXX from $XXXXXXXXXX (including occupancy costs) to $XXXXXXXXXX . In addition, the rent is indexed to increase a minimum of XXXXXXXXXX % annually. The sister corporation has used this income to acquire additional real property assets; it went from owning XXXXXXXXXX buildings in XXXXXXXXXX to owning XXXXXXXXXX buildings in XXXXXXXXXX . Moreover, the real estate expert at the TSO suggests that the rent is excessive and a more accurate fair market value rent for a building like this would be between XXXXXXXXXX . Essentially, XXXXXXXXXX has arranged the affairs of the Corporation so that it has financed the sister corporation, increasing the value of the sister corporation and its ability to pay dividends to XXXXXXXXXX .

CONCLUSION

In light of all of the above, we agree with the auditor's conclusion that the Corporation did not qualify for the exemption from tax provided by paragraph 149(1)(l) of the Act for the taxation years under review. In particular, it appears that the Corporation operated for a profit purpose and made income available for the personal benefit of at least one of its members.

Please contact us, if we may be of any further assistance.

Yours truly,

Eliza Erskine
Manager
Non-Profit Organizations and Aboriginal Issues
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

Cc: XXXXXXXXXX