ATO reforms affecting NFPs who self-assess as income tax exempt

The Australian Taxation Office (ATO) has commenced targeted consultation in relation to the upcoming changes for not-for-profit (NFP) entities that self-assess as eligible for income tax exemption (ITE). From 1 July 2023, NFP entities with an active Australian Business Number that self-assess as eligible for ITE will be required to lodge an annual self-review form along with supporting documentation with the ATO. Failure to lodge may result in loss of ITE and penalties may apply.

These reforms were announced by the Australian Government on 11 May 2021 as part of the 2021-22 Federal Budget. The reforms are intended to ensure that only eligible NFP entities access ITE resulting in the increased trust, transparency and integrity of NFP entities within the sector. The additional administrative burden will likely diminish in subsequent years as the ATO is funded to develop an online portal providing NFP entities with the ability to either confirm or amend a pre-filled self-review form.

Affected NFP entities

The changes will affect NFP entities that are not registered charities with the Australian Charities and Not-for-profits Commission (ACNC) and self-assess as ITE. Approximately 125,000 NFP entities[1] will be affected, many of which will be reporting to the ATO for the first time.

These entities fall into eight categories (the ITE categories):

  • Community service organisations including playgroup associations, community service clubs and senior citizens associations.
  • Cultural organisations established for the encouragement of art, literature or music.
  • Public educational institutions that are open to the public or a section of the public and whose sole purpose is providing education. This includes universities, grammar schools, primary and secondary schools and NFP business colleges.
  • Health organisations, being public hospitals or hospitals operated by NFP societies or associations and NFP private health insurers.
  • Employment organisations, being employee associations, employer associations or trade unions. Employee associations and employer associations must be registered or recognised under the Fair Work (Registered Organisations) Act 2009 or an Australian law relating to the settlement of industrial disputes.
  • Resource development organisations established to promote the development of aviation, tourism or specific Australian resources (being agricultural, aquacultural, fishing, horticultural, industrial, manufacturing, pastoral, viticultural and ICT resources). This includes promoting development through research, provision of facilities, training, marketing and facilitating cooperation.
  • Scientific organisations including scientific institutions, NFP entities established for the encouragement of science and funds established to enable scientific research to be conducted by or with a public university or public hospital.
  • Sporting organisations, being NFP entities established for the encouragement of a game, sport or animal racing.

Relevant considerations for all NFP entities seeking to self-assess as ITE are set out below.

Is the entity entitled to self-assess as income tax exempt?

Does the entity fall within one of the ITE categories?

All entities should confirm which of the ITE categories listed above (if any) they fall within. Entities should then review specific requirements that apply to their particular ITE category (as set out in the links above).

Should the entity be a registered charity?

Generally, the ATO requirement is that an entity that can be registered as a charity with the ACNC must be registered as a charity. This means that an entity that could be a registered charity is not entitled to self-assess as ITE – it must register with the ACNC as a charity to access ITE.

There is a significant overlap between the ITE categories listed above and those organisations that may be entitled to be registered as charities, particularly (but not exclusively) in the cultural, educational and health ITE categories.

A registered charity must report to the ACNC and comply with the ACNC Governance Standards. Registered charities also benefit from charity tax concessions, which are broader than those available to ‘mere’ NFP entities that are not registered charities.

Is the entity complying with the substantive requirements of its governing rules?

An often-overlooked requirement for all entities seeking ITE is the requirement to comply with the substantive requirements of the entity’s governing rules. This includes[2] the rules that:

  • give effect to the object or purpose of the entity (this is considered further below);
  • relate to the non-profit status of the entity (this is considered further below);
  • set out the powers and duties of directors and officers of the entity – directors and officers must take care to ensure that their decisions do not exceed the powers conferred on them by the rules. They must also take care to comply with their duties;
  • require financial statements to be prepared and retained;
  • set out the criteria for admission as a member of an entity – the entity should ensure that it is not inappropriately excluding individuals entitled to seek admission (or conversely, admitting individuals that are not entitled to membership);
  • require an entity to maintain a register of members – the entity should ensure that its member register is up to date and that individuals are added to and removed from the register in accordance with the requirements of the rules; and
  • relate to the winding-up of the entity.

Is the entity acting consistently with its purpose?

The entity must ensure it is acting consistently with the purpose or objects statement set out in its governing rules (which must be aligned with any requisite purpose for its ITE category). Generally, any other purpose of the organisation must be incidental, ancillary or secondary to the required purpose.

The ATO will look at an entity’s governing rules, activities, use of funds and history when considering its ‘true’ purpose. Entities whose activities have changed significantly over time should consider whether those activities are still directed towards the achievement of their purpose. Entities should also consider whether their secondary materials (such as the entity’s annual report, strategic plan, website and key policies) appropriately communicate their purpose.

Is the entity not-for-profit?

While a NFP entity can make a profit, that profit must be used for its purposes. This means that the entity must ensure that it is not making payments to members in their capacity as members. The entity must also ensure that it is not making other payments that could be characterised as conferring an inappropriate private benefit (such as excessive payments to employees or directors or payments to directors that are prohibited by the governing rules).

Does the entity need to meet one of the ‘three tests’?

Most ITE categories (with the exception of NFP private health insurers, employment organisations, scientific research funds and resource development organisations) require entities to meet one of three tests:

  • the entity has a physical presence in Australia (and to the extent it has a physical presence in Australia, pursues its objectives and incurs its expenditure principally in Australia);
  • the entity is named in the income tax law as a deductible gift recipient or has been endorsed as a deductible gift recipient; or
  • the entity is named in the Income Tax Assessment (1997 Act) Regulations 2021 (regulation 50.50.1, 50.50.02 or 50.50.01).

Even if the entity is not required to meet one of the three tests:

  • employment organisations must be located in Australia or incur expenditure principally in Australia; and
  • scientific research funds must be deductible gift recipients or be located in Australia or incur expenditure principally in Australia.

An ITE entity that has a significant presence outside Australia should carefully reviews these requirements to ensure it is complaint.

Has the entity reviewed the ATO self-assessment tools?

The ATO has produced the following self-assessment tools. These tools will assist entities to prepare the supporting documentation that is likely to be required for submission to the ATO:

How we can help

Moores can advise on what these proposed changes mean for your entity and work with you to confirm that the entity is entitled to self-assess as ITE.

Contact us

Please contact us for more detailed and tailored help.

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[1] Not-for-profit Sector Tax Concession Working Group: Fairer, simpler and more effective tax concessions for the not-for-profit sector (May 2013)
[2] Taxation Ruling TR 2015/1