Principal Issues: Whether a cooperative, which otherwise qualifies as a NPO for the purposes of paragraph 149(1)(l) of the Act, can pay interest on community bonds and preferred shares that it has issued to members and non-members, without losing its NPO status.
Position: A cooperative which otherwise qualifies as a tax-exempt NPO can pay interest on community bonds in favour of creditors that are members or non-members without losing its tax exemption as long as the financing is legitimate, is not a stratagem to distribute surplus funds to its members, favours the exempt purposes of the organization, and the interest rate is reasonable. A cooperative cannot qualify as a tax-exempt NPO if it has, at any time, the ability to pay interest on preferred shares.
Reasons: Prior positions, jurisprudence.
XXXXXXXXXX 2022-094529 Simon Morin
January 7, 2025
Dear XXXXXXXXXX,
Subject: Payment of interest by a co-operative on community bonds and preferred shares held by members and non-members
This is further to your request for a technical interpretation received on August 4, 2022 and amended on February 21, 2024 (the “Request”) in which you requested our advice with respect to the application of paragraph 149(1)(l) of the Income Tax Act, R.S.C. 1985, c. 1, (5th Supp.), as amended (the “Act”). We apologize for the delay in responding to your Request.
More specifically, you wish to obtain our opinion on the impact that the payment of interest by a cooperative on community bonds it has issued to its creditors, held either by a non-member or a member of the same cooperative, would have on the tax exemption provided for in paragraph 149(1)(l). Second, you asked whether our answer would be the same if the interest were paid on preferred shares issued by the cooperative and held by a non-member or a member of the cooperative.
In your request, you have assumed that the cooperative is a cooperative within the meaning of the Cooperatives Act, RLRQ c. C-67.2 (the “CA”), that it is operated on a non-profit basis and that it qualifies as an exempt non-profit organization (“NPO”) which is exempt from tax under Part I of the Act by virtue of paragraph 149(1)(l) if the question relating to the payment of interest were not taken into account (the “Co-operative”).
Unless otherwise indicated, all statutory references are to provision of the Act.
Our Comments
This technical interpretation provides general comments about the provisions of the Act and related legislation. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC70-6R12, Advance Income Tax Rulings and Technical Interpretations. However, we can offer the following general comments.
In general, paragraph 149(1)(l) provides that no tax is payable on the taxable income of a person for the period during which that person was, among other things, a club, society or association that, in the opinion of the Minister, was not a charity within the meaning assigned by subsection 149.1(1) and that was organized and operated exclusively for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit, no part of the income of which was payable to, or was otherwise available for the personal benefit of, any proprietor, member or shareholder thereof (a “tax-exempt NPO”).
Our comments are limited to the impact of the payment, and the right to pay, interest on community bonds and preferred shares issued by the Cooperative to its members or to non-members with respect to the condition “no part of the income of which was payable to, or was otherwise available for the personal benefit of, any proprietor, member or shareholder”. In this regard, paragraph 11 of Interpretation Bulletin IT-496R ARCHIVED, Non-Profit Organizations (“IT-496R”), states that for an organization to meet this condition, no part of the income of an association, whether current or accumulated, can be payable to, or otherwise made available for the personal benefit of, any member of the association unless the member is of an organization whose main purpose and function is the promotion of amateur athletics in Canada. For example, an organization would not be entitled to the exemption if it had distributed income during the year, directly or indirectly, to a member or had caused it to be used for the personal benefit of the member. An organization would also not be entitled to the exemption if it had, at any time, the power to declare and pay dividends out of its income. Nevertheless, paragraph 12 of IT-496R states that certain types of payments made directly to members, or indirectly for their benefit, in consideration for services rendered to that organization, will not, in and by themselves, disqualify an association from being tax-exempt under paragraph 149(1)(l), provided the amounts paid are reasonable and no more than those paid in arm's length situations for similar services. Such payments to members include salaries, wages, fees or honorariums for services rendered to the association.
Community obligations
You stated in your request that the community obligations in question are loans or debt obligations from the community in support of the Cooperative to enable it to carry out a project, contribute to its mission and serve its community. The characterization of a community bond as a debt, as well as the existence of a debtor-creditor relationship, are questions of fact that require an examination of the relevant documents.
As pointed out in documents 2012-0471531I7, 2011-0392841E5 and 2000-0047455, members of an NPO who, as creditors, would be entitled to receive interest at a reasonable rate on amounts they have advanced to the NPO would not affect the NPO's status as a tax-exempt NPO. Thus, we are of the view that the payment of interest on community bonds, which qualify as debts, by the Cooperative in favour of its holders, whether members or non-members, pursuant to a legal obligation, should not, in and of itself, prevent the Co-operative from qualifying as a tax-exempt NPO, provided that the financing is legitimate, is not a scheme to distribute surplus funds to its members, furthers the Co-operative's exempt purposes, and the interest rate is reasonable. However, we reiterate that it is a question of fact whether a member of an organization receives an amount in that person’s capacity as a creditor or as a member.
Preferred shares
Generally speaking, the CA provides that a cooperative may, in addition to granting patronage dividends, pay “interest” on preferred shares.
In Canada v. Shell Canada Ltd., 98 D.T.C. 6177, the Federal Court of Appeal indicated that “Something is not interest merely because the parties agree to call it interest”. Thus, the terms used are not necessarily determinative of their nature, and it is relevant to consider all of the facts and circumstances in order to determine the true legal characterization of an amount paid. In our view, the fact that a payment on preferred shares is characterized as interest by the CA or in a corporate document, such as a resolution, by-law or constating document, does not necessarily make it an interest for income tax purposes. In this case, section 49.4 of the CA provides that interest may include a participation in the operating surplus or surplus earnings of the cooperative.
Furthermore, as stated in documents 2003-0036531E5, 2005-0146061E5 and 2006-0194871I7, we are of the view that “interest” paid on preferred shares proportionately among the shareholders as a return on invested capital or based on the available profits or surpluses of the cooperative is in reality, as the case may be, an authorized distribution of surpluses or a dividend on share capital and constitutes a distribution of the organization's profits. It follows that the payment of such “interest” by an organization is incompatible with the condition that “no part of the income of which was payable to, or was otherwise available for the personal benefit of, any proprietor, member or shareholder”.
In addition, the CRA's position is that a corporation cannot qualify as a tax-exempt NPO if it has the specific power to distribute its income to its members, owners or shareholders. This position also applies to a cooperative's power to allocate and pay interest or patronage dividends on preferred shares. Thus, even if no interest on preferred shares is paid, we are of the view that the Cooperative cannot qualify as a tax-exempt NPO if it has the power to pay interest on preferred shares at any time. In this case, we point out that section 148 of the CA provides that the articles of a cooperative may include a clause prohibiting it from distributing a patronage dividend and from paying interest on any class of preferred shares that it determines.
We hope that you find our comments of assistance.
Best regards,
Sophie Larochelle, LL.B., M.Fisc., MBA
Manager
Specialized Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch