16. Grant Thornton Australia and New Zealand Not for Profit sector survey 2013/2014

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Accounting firm Grant Thornton recently released the results of its bi-annual survey of not for profit (NFP) organisations in Australia and New Zealand: Doing good and doing it well? Grant Thornton Australia and New Zealand Not for Proft sector survey 2013/2014.  The report does not refer to the number of entities in the Australasian not for profit sector, but common estimates are 600,000 in Australia (of which 57,000 are registered charities) and 90,000 in New Zealand (of which 26,000 are registered charities).  The results are based on 72 Australian survey responses and 344 New Zealand survey responses.

SUMMARY

It’s always good to get an insight into the NFP sector, particularly when that insight compares New Zealand and Australia, so the Grant Thornton report is worthwhile reading.   Bear in mind that their findings are based on a small sample size of only 416 organisations out of about 690,000 organisations in the Australasian NFP sector.

I have to admit I’m still not convinced about the final conclusion that there are “few significant differences between New Zealand and Australia”.

From the points highlighted in this blog, it looks to me like Australia’s NFP sector is way ahead of New Zealand in the use of social media, concerns about compliance and government regulations, the level of board member awareness of their obligations, NFP support for a national regulator, and NFP reliance on government funding. 

So rather than the Australasian NFP sector being homogenous, there are still enough differences for us to take lessons from our neighbour across the ditch.

DETAILS

Here are eight observations in the survey that caught my eye.

1.  By and large, and once size and turnover are taken into account, there are few significant differences between New Zealand and Australia (p.4).

On the face of it, this observation isn’t unexpected because New Zealand and Australia have so many similarities.  However I wonder what a detailed analysis, rather than a small survey, of the two sectors would uncover.   For example, are there significant differences in the NFP structures and vehicles used?  Do significantly more NFPs qualify for donation tax credits / deductible gift recipient status in one country than another?  Which country has the most effective tax policy for NFPs?  Does the proportion and profile of NFP volunteers significantly differ between the two countries?  The survey left me questioning whether there actually are significant differences in the two NFP sectors but the areas of difference just aren’t canvassed in the survey.

2. The use of social media is one area in which Australian organisations seem to be generally more sophisticated than their New Zealand counterparts (p.5).  The survey reveals that 79% of New Zealand respondent’s organisations have a website, whereas the corresponding figure is 99% in Australia (p.23).

They could well be right.  Shame on New Zealand NFPs for being stuck in the twentieth century.

3.  Funding and fundraising were identified as the major issues by around three quarters (76%) of New Zealand respondents and around two thirds (68%) of Australian respondents (p.6).

No surprises here. I doubt this will ever change - funding is always going to be a dominant issue for the sector.

4.   Australian NFPs are particularly concerned about government and compliance with government regulations, including new governance standards by the Australian Charities and Not-for-profits Commission (ACNC) and the introduction of the National Disability Insurance Scheme.  By contrast, government and compliance were not such significant issues in New Zealand (p.6).

Australia’s multiple layers of government, particularly at the State/Territory and Commonwealth levels, make it no surprise NFPs would be more concerned with compliance that side of the Tasman.  That is why they are so focused on initiatives to reduce red tape and administrative burdens on the sector.  Perhaps the Australian concerns are heightened because their legislation tends to have more administrative and other penalties for non compliance, so the consequences of not complying with government regulations can be harsh on NFPs.  Australian law also tends to be more prescriptive – for example they have regulated governance standards for registered charities whereas New Zealand has not.  Arguably, however, that gives the sector more certainty about what is expected, so it raises the sector standards and consequently the level of public trust and confidence in NFPs.

5. Directors and Trustees of NFPs are expected to meet increasingly high standards of performance and accountability.  Less than half (43%) of New Zealand respondents said that all board members understand this, compared with 65% of Australians (p.10).

The paper notes that “there is still a need for board member education within the sector”.  If 57% of New Zealand boards have at least one member who does not understand their responsibilities, then you can’t argue with that conclusion.

6. New Zealand has recently introduced a number of changes to financial reporting.  77% of respondents said they were aware of the changes and the compliance requirements are largely seen as reasonable.  However one in five were unsure about their impact (p.14). 

This was a surprisingly positive result in respect of the upcoming New Zealand changes, especially given the very high level of special purpose, unaudited and poor quality financial accounts provided to the charities regulator at present.  Perhaps the NZ authorities should be congratulated for ensuring there is public awareness of the changes.  On the other hand, perhaps the level of positivity would significantly reduce if the sample was just taken for small charities. 

7. In Australia the ACNC commenced in December 2012, the charity governance standards came into force from 1 July 2013 and the Statutory Definition of Charity Act comes into force on 1 January 2014.  Australian respondents support the direction of the reforms with a clear majority (83%) believing the sector needs a national regulator (p.16).

This is great news for the ACNC.  Hopefully Grant Thornton’s findings have some sway with the new Liberal Government, which is on record as saying it will abolish the ACNC, replacing it with a centre for excellence focused on innovation, education and best practice.  The findings might also be useful ammunition for the ACNC supporters who don’t see any advantage in having an emasculated regulator.

 8. In 2013, government grants and contracts were the most significant funding source for 53% of New Zealand respondents, whereas they are the most prominent source of funding for 79% of Australian respondents (p.30).  Those organisations in the social services sector are most likely to rely on government grants and contracts and generally deliver services for which government agencies are the default funder.

The paper concludes that NZ NFPs are trying to become less reliant on government funding.  Maybe so.  Although perhaps government funding in Australia is just more obvious, with its vast array of Commonwealth Grant Guidelines and acquittal forms, whereas in NZ NFPs are less likely to recognise funding from the likes of lotteries and councils as government funding.  In any case, the difference between 79% reliance on government funding and 53% does appear to be quite significant.

15. NZ’s proposed new accounting standards for registered charities

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Most registered charities in NZ are not currently required by law to meet any particular standard of financial reporting.   They simply have to complete the financial question in the annual regulator return and attach financial statements that do not need to follow any accounting standards.  From a charity’s perspective this is a good thing – it means the treasurer can be very inexperienced and still prepare simple financial reports which are accepted by the regulator.  From a user point of view, it means the quality of financial information varies considerably between charities, so financial performance is difficult to assess and charity financial information cannot easily be compared.

However, significant changes are on the horizon.   From 1 April 2015 it is proposed that all registered charities will have to prepare accounts which meet accounting standards set by the NZ accounting standard setting body.  Failure to do so could result in fines for the charitable entity and every officer of the charity not exceeding $50,000.

What are the proposed changes, what’s good and bad about them, and will small charities cope?

Summary

For accounting purposes, registered charities will be split into four tiers:

Tier	Entities	Standards
1	- Publicly accountable - Expenses > $30m	Full PBE (Public Benefit Entity) standards
2	Expenses < $30m	PBE standards (Reduced Disclosure Regime)
3	Expenses < $2m	Simple format reporting standard (accrual)
4	Operating payments < $40k	Simple format reporting standard (cash)

The changes summarised in this blog discuss the proposed changes for charities in tiers 3 and 4 – which apparently make up 96% of all registered charities in NZ (39% and 57% respectively).  The changes are outlined in Exposure Drafts issued in December 2012, with feedback due by 28 June 2013.  They include links to templates and guidance notes.  In total, the proposals are outlined in 286 pages – so as you can imagine the devil is in the detail.

Analysis

On the surface, the proposals seem like a good approach.  They will put NZ ahead of Australia, and light years ahead of the current NZ approach, with clearer and mandatory accounting rules for all registered charities.  Financial information reported to the regulator will be more detailed, more consistent and more reliable.

It is excellent to see that related party transactions, the nature of fundraising activities and restricted purpose funds, all appear to be required to be disclosed by Tier 3 and Tier 4 charities.  These are three areas which are important to understand when reviewing any charity’s financial information.

There are eight specific reporting proposals which I specifically would like to comment on:

1. Reporting burden for small charities in Tier 4 and the lower end of Tier 3 

The level of reporting appears to be potentially onerous in comparison to what is currently provided in question 25 of the annual regulator return, particularly by Tier 4 charities with operating expenditure below $40,000.  For example, many may not be familiar with providing a statement of service performance, a statement of resources and commitments, or even notes to financial statements.  Even the smaller Tier 3 charities may struggle with providing a statement of accounting policies and a statement of cash flows. Although, as a user of the information, I am supportive of having this level of information available, will it create a challenging reporting burden for small charities and can this be alleviated in some way?  If not, what will the consequences be?

2. Lack of detail for grouped and consolidated charities

The exposure draft notes that it is only applicable to single entities and does not address charity groups or consolidation issues.  That is quite a major omission, especially in light of the specific grouping provisions in the Charities Act 2005, which do not require controlled charities to consolidate but leave consolidation decisions entirely at the discretion of the charities (subject to approval from the regulator).  The Act also enables charities to group on a basis other than control which means charitable group membership and totals are likely to be inconsistent with the group membership and totals calculated under accounting standards using the control test.   The omission from the exposure draft is also problematic if, as the exposure draft suggests, the criteria of size shall be applied to consolidated totals.  So it will be important to see how the grouping and consolidation issues will be addressed as soon as possible.   

3. Income from government grants and public donations

I would like to see receipts separately identify government grants and public donations.  This information is valuable because it tells users how much public funds have been made available to the charity.  It is reasonable to assume that such charities will be subject to an increased level of accountability to the public. 

4. Grants and donations paid by a charity

I would also like to see “grants and donations paid” be mandatorily disclosed in all cases, and that they be distinguished between payments made in NZ and payments made overseas.  This is important for the regulator, the Inland Revenue and the general public who would all want to know the extent of financial resources NZ charities are sending within NZ and overseas.

5. Volunteer and paid staff details

I was disappointed that Tier 4 charities do not have to quantify their volunteers and paid staff, which is something they already do for the regulator and gives a valuable insight into their pool of human resources.  I notice that even the UK regulator is making this information mandatory from 2013.

6. Commercial activity disclosed as a method used to raise funds

I would like to see the description of the methods used to raise funds specifically include a description of any commercial activities undertaken.  The example could include a scenario such as the following: “The charity operates a paint manufacturing business in order to raise funds which will be used for charitable purposes”. 

I believe users should be able to clearly identify commercial activities being conducted by a charity, particularly commercial activities that are unrelated to the charitable activities. Commercial activities may be a concern for users for several reasons: the officers of the charity may not be skilled to run commercial operations and therefore governance should be strengthened if commercial activities exist; the commercial operations may expose the charity to business risks and accumulated reserves may need to be diverted from funding charitable activities to propping-up failing business activity; commercial activities could make the charity particularly susceptible to providing private benefits to officers and related parties through business transactions; or the charity may get so involved in unrelated commercial activities that its charitable activities become secondary or virtually non-existent.  

7. Transitional provisions

The first performance report does not require comparative information and pre-existing assets only need to be recorded if they are significant and have values that are readily obtainable.  I believe this should only apply to new charities who have not already reported their financial information to the charities regulator.

8. For the purposes of the NFP tier criteria, should the definition of expenses include or exclude grants made?

I believe the definition of expenses for the NFP tier criteria should exclude grants made.  It is common for constitutional documents to refer to the percentage of surplus that should be distributed by way of grants and donations.  To include grants and donations in as operating expenses is inconsistent with this approach.

In many instances charity officers will have significant discretion over the amount of grants to make.  It would not be helpful if a charity’s officers felt compelled to reduce the amount of their charity’s grant payments because of pressure to avoid moving the charity into a larger tier for accounting purposes (and/or a higher audit/review threshold).  This problem will be avoided if grants are excluded from the definition of expenses.

As an aside, I do not support NZ’s novel approach to categorise charities by operating expenditure as opposed to revenue.  An operating expenditure criterion is not consistent with any international charity regulator approach and it will reduce the ability to compare NZ charities with charities in other jurisdictions.  It will also impose additional costs on charities which are already familiar with using revenue as a threshold measure (for GST, for example) but will now also have to monitor and forecast operating expenditure for threshold purposes. 

Conclusion

My overall conclusion is that the proposals are a huge improvement from the status quo, if you look at them through the lense of a general user.  If changes can be made to accommodate the above issues they would be even better.  However if I was a non-accountant treasurer of a small charity, this new level of detail – and the penalties that come with them – may be alarming.    I suspect that finding a volunteer treasurer for a small charity is going to be a lot more difficult from 1 April 2015.

­­­­­­­­­­­­­­­

The detail: Future proposals

In July 2012 a new Financial Reporting Bill was introduced into Parliament by Commerce Minister Craig Foss.  The Bill, once enacted, will repeal the Financial Reporting Act 1993 and is expected to apply from 1 April 2015.

The Bill amends the Charities Act 2005 to require the annual return of a charitable entity to be accompanied by financial statements. For registered charities in Tiers 1 and 2, the financial statements must comply with GAAP. In the case of other registered charities in Tiers 3 and 4, compliance with a non-GAAP standard (which will set a lower tier of financial reporting) is sufficient.  The proposed change effectively gives the accounting standards as issued by the External Reporting Board (XRB) force of law.

The tiers have been defined as follows:

Tier	Entities	Standards
1	- Publicly accountable - Expenses > $30m	Full PBE (Public Benefit Entity) standards
2	Expenses < $30m	PBE standards (Reduced Disclosure Regime)
3	Expenses < $2m	Simple format reporting standard (accrual)
4	Operating payments < $40k	Simple format reporting standard (cash)

There is also a new section 42B in the Charities Act which provides for an offence of knowingly failing to comply with financial reporting standards. The charitable entity and every officer of the charity may be liable under this offence, which has a penalty of a fine not exceeding $50,000.

Exposure Draft Documents

The XRB says it recognises that NFPs “may have limited access to professional accounting expertise”, and have therefore “written the standards for Tiers 3 and 4 in relatively simple language where possible”.

Below are the links to the Exposure Drafts issued in December 2012 (with feedback due by 28 June 2013).  They include links to templates and guidance notes.  In total, the proposals are outlined in 286 pages.

In summary, for tier 4 registered charities with expenses < $40k (simple format reporting – cash) charities must prepare a performance report which has five sections (two less than Tier 3 entities): entity information, a statement of service performance, a statement of receipts and payments, a statement of resources and commitments (which is similar to a balance sheet) and notes to the financial statements.

For tier 3 registered charities with expenses < $2m (simple format reporting – accrual) charities must prepare a performance report which has seven sections (two more than Tier 4): entity information, a statement of service performance, an income statement, a balance sheet, a statement of cash flows (not required for Tier 4), a statement of accounting policies (not required for Tier 4) and notes to the financial statements.

ED XRB A1 (FP Entities + PS PBEs + NFPs Update) The proposed third revision to Standard XRB A1 issued by the XRB Board to give effect to the new Accounting Standards Framework (69 pages).

ED PBE SFR-A (NFP)	Tier 3 Accrual Accounting Standard (70 pages).
ED PBE SFR-C (NFP)	Tier 4 Cash Accounting Standard (39 pages).

Tier 3
ED Template PBE SFR-A (NFP)	Optional Template for ED PBE SFR-A (NFP) - PDF Version (23 pages)
Guidance Notes	Guidance Notes Accompanying the Optional Template for ED PBE SFR-A (NFP) (42 pages)
Tier 4
ED Template PBE SFR-C (NFP)	Optional Template for ED PBE SFR-C (NFP) - PDF Version (14 pages)
Guidance Notes	Guidance Notes Accompanying the Optional Template for ED PBE SFR-C (NFP) (29 pages)

There are 18 specific consultation questions:

Tier 3

1. Do you consider that the proposed structure will provide appropriate information for users of the Performance Report?

2. Do you consider that the proposals relating to the Statement of Service Performance are practicable?

3. Do you agree that grants, donations and fundraising revenue should be recorded as an asset and revenue when the cash is received (even when there are conditions attached to the donation or grant).

4. Do you agree that significant donated assets should be recorded at a current value?

5. Do you agree with the other simplifications proposed?

6. Do you agree that entities should be permitted to opt up to a Tier 2 PBE standard for a specific type of transaction?

7. Are there any transactions that are not addressed in the ED that are relatively common for Tier 3 and should be addressed?

8. Do you consider that the requirements for the proposed Statement of Cash Flows has been adequately simplified?

9. Do you consider that the proposed transitional provisions are practical?

10. Do you have any comments on the draft template and guidance notes?

11. Are there any other comments you wish to make?

Tier 4

1. Do you consider that the proposed structure will provide appropriate information for users of the Performance Report?

2. Do you consider that the proposals relating to the Statement of Service Performance are practicable?

3. Do you agree with the proposals for the presentation of receipts, payments, resources and commitments?

4. Are there any relatively common transactions for Tier 4 not-for-profit entities that are not addressed which should be?

5. Is there any further information that should be required so as to enable users to better understand the financial statements?

6. Do you consider the proposed transitional provisions are practical?

7. Do you consider that the draft Template and associated Guidance Notes would be useful?

14. NZ’s registered charities that have trading operations

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Some charities will have trading operations for the purpose of raising funds.  Sanitarium, for example, is a well known trading operation within the Seventh Day Adventist Church.  Others will have trading operations which actually carry out the charity's objects, such as private hospitals which support public health and retirement villages which support the elderly. 

This blog casts an eye over those charities that conduct trading operations unrelated to their charitable purposes.  The wide range of examples on the charities register suggests that it is common practice for registered charities that are corporations and, to a lesser extent, for registered charities that are trusts. 

In the majority of cases, having a trading income stream to sustain a charity is a good thing.  But is there a line which, if crossed, results in these businesses causing a lack of public confidence in the charitable sector?

Summary

Out of the 25,024 charities currently registered in New Zealand, about 3,800 (15%) recorded on their initial registration application that they expected to have “income from trading operations” as a source of future income.  However, based on the most recent returns filed with the regulator, 6,755 (27%) recorded an actual value for “cost of trading operations”.  If nothing else, this shows us that a lot of charities which did not expect to have income from trading operations when they registered, did eventually benefit from trading income.

The 6,755 most recent returns show a total gross income of $4.9b, total “cost of trading operations (excluding salaries and wages)” of $1.4b, total salary expense of $1.7b and net surpluses of $298m (that is, surpluses of $507m less losses of $209m).  These charities have assets of $17b and accumulated funds totaling $12b.  In other words, they make up a significant segment of the charitable sector.  However, it is worth noting that these totals are dominated by some or our biggest charities which have a wide range of income sources in addition to trading, such as the Salvation Army, the Seventh Day Adventist Church and Regional Facilities Auckland.  The recovery from the Christchurch earthquake also boosted totals on a one-off basis for the likes of the New Zealand Local Authority Protection Programme Disaster Fund and The Arts Centre of Christchurch Trust Board.

Unfortunately, when using the information on the charity register, it is not possible to easily distinguish trading operations that are related to the charity’s objects and trading operations that are not.  Nor is it easy to see what the trading activities actually are.  So anyone who would like to find out information about the charitable sector’s unrelated trading operations needs to trawl through a lot of individual financial statements.  At least, that is what I did in preparing to write this blog.

One immediate observation was that charitable corporations and, to a lesser extent, charitable trusts carry out the most trading operations that are unrelated to their charitable purpose.  I could find no examples of incorporated associations which carried out significant trading operations that were unrelated to their charitable purpose.

The range of trading activity conducted by registered charities is incredibly wide.  The examples of charitable corporations with trading activity unrelated to charitable purposes include agriculture and horticultural businesses, wineries, hotels, gyms, lawnmowing businesses, commercial renters, licence holders, furniture manufacturers, walking tour operators, fashionware retailers and commercial copying centres.  There are many more charities that are trading trusts and these include significant businesses, many of which operate in the farming sector.

In previous charitywatchnz blogs I have also come across examples of fishing businesses, transport businesses, providers of life insurance, property investment, orchard businesses, sellers of recycled building materials, joinery businesses, paint suppliers, seat belt manufacturers, nature retailers, car park providers, importing businesses, and even traders in bee balme.   The list goes on. 

Suffice to say, the well-known trading charity examples of Sanitarium, Mission Estate Winery, Iwi trading operations such as Tainui and Ngai Tahu, and Tait Communications, are just the tip of the iceberg.  Even Tana Umaga has set up a foundation which sells water bottles to fund youth scholarships.  And don’t forget that New Zealand’s biggest tax avoidance case, the Trinity scheme with its Douglas fir forests in the South Island, included trading charities which are still on the register today (they have the object of funding the Anglican Church and other charitable organisations).

Conclusions

As noted earlier, there is nothing wrong per se with charities that have trading activities unrelated to their charitable operations.  Having sustainable income streams is to be encouraged. 

However, here are five issues that struck me as having a negative impact on public confidence when I looked through some of the financial statements for the trading charities:

1. Poor / absent financial reporting.  Trading charities can have their financial information withheld from public view if they can convince the regulator that disclosure “may unreasonably prejudice the commercial position of the charity…”  In addition, in the current New Zealand environment where charity financial accounts submitted to the regulator do not have to comply with accounting standards, the quality of disclosure in financial accounts range from very good to very poor.  Both of these scenarios allow charities to avoid being publicly transparent.  They do not even have to disclose the nature of the trading activities they are carrying out.  In my view that is a problem for the reputation of the charitable sector at large, especially when business activity is being conducted.

2. Minimal grants/donations and wealth accumulation. The most egregious examples of poor behaviour, in my view, involve charities which do not conduct charitable activities themselves but instead make grants to other charities.  Their behaviour becomes egregious when they conduct significant business activity ostensibly as a fundraising exercise but make minimal, if any, grants to other charities from one year to the next.  As a result, wealth accumulates within these charities.  It is difficult to see why they should benefit from income tax exemptions or, for that matter, retain their status as a registered charity.

3. Business risks and insolvency disclosures.  Where trading activity involves significant risk to a charity’s assets, there is a real possibility that their donation income, government grants and accumulated reserves may be diverted from funding charitable activities to propping-up the failing business activity.  Alternatively, some trading charities may appear to be insolvent based on information currently disclosed on the register, but in fact they are supported by related party guarantees which are not disclosed.  In both cases, the public may be misled about the financial stability of some trading charities unless disclosure is improved.   

4. Excessive salaries and other apparent private benefits.  Any charity, not just a charity with a trading operation, will erode public trust and confidence if it appears to be providing private benefits to related parties.  Charities conducting trading operations unrelated to any charitable activity may be particularly susceptible to this accusation.  Based on information currently supplied to the regulator, it is relatively easy for a member of the public to calculate the approximate average annual salary paid to charity staff.  When those average salaries start to look excessive, for example where a closely-held charity pays its one or two employees well above industry norms, it would be useful for the charity to be asked to explain why the salaries are so high compared to the expected norm and/or confirm that the employees are not related to the officers of the charities.

5. Excessive complexity and related party transactions.  Several of the charities with trading operations identified for this blog, and in previous blogs, are part of complex structures involving other charities as well as for-profit entities.  One, the Trinity Foundation, has been confirmed in court as being part of a tax avoidance structure.  Some of these structures may be a clue that the controllers of the charities do not have exclusively altruistic motives.  If tax avoidance is a possible motive for any of them then, as was the case in the UK with the recent Cup Trust scheme, the public may legitimately assume that as a tax avoiding charity they are not operating for the public benefit.  In my view the job of the regulator begins with making sure that all charities within such structures fully disclose their related party relationships and transactions.  This transparency will increase public confidence in financial informaton provided by registered charities.

___________________________________________

The details

What follows is a discussion of:

1.       Trading definitions and whether trading operations are the same as having a social enterprise

2.       Implications of trading for the charity regulator

3.       Implications of trading for the tax man

4.       Implications of trading for competitors and the public at large

5.       Australia’s “unrelated business income tax” (UBIT) proposals

6.       Statistics for 6,755 charities with “cost of trading operations” in their most recent return

7.       Examples of the charitable trusts with income from trading operations. 

8.       Examples of the charitable corporations with income from trading operations

9.       Examples (or lack thereof) of the incorporated associations with income from trading operations

1. Definitions and social enterprises

The New Zealand regulator does not provide a comprehensive definition of a “trading operation”. Its financial information help sheet refers to trading operation examples such as “a shop or mail order business”.  However it does require all registered charities to state at the time of initial registration whether one future source of funds will be “income from trading operations”, and it requires all registered charities to annually quantify their “cost of trading operations (excluding salaries and wages)” and their “income from service provision / trading operations”.

According to the charity regulator’s recent discussion about social enterprises, just because a charity has trading operations does not mean it is a social enterprise.  In August 2012 the charities regulator sent out a survey to 11,000 charities who indicated they received income from “provision of services and trade”.  The purpose of the survey was to help understand where and how social enterprises are working in NZ and the barriers to their development.  The regulator said it would let the charities decide for themselves if they were “social enterprises”.  However it provided this definition:

“A social enterprise is an organisation that:

-          has a social, cultural or environmental mission, and

-          derives a substantial portion of its income from trade, and

-          reinvests the majority of its profits/surplus in the fulfillment of its mission.”

The regulator did not define what a ‘substantial portion’ means, however it stated that “in Australia the definition of a social enterprise specifies that income from commercial activity is 50% or more (but can be less for newer ventures…).”  Revenue from government contracts was classed as a form of trading income.

The final report, Mapping social enterprises in New Zealand - Results of a 2012 survey (.pdf) was released in January 2013.  There were 421 responses. 

2. Implications of trading for the charity regulator

The charity regulator’s “registration FAQs” explain trading implications as follows:

“How does the Commission view a charity which operates a successful trading company as part of its activities?

A charity which operates a successful trading company is likely to remain charitable, as long as the charity continues to have exclusively charitable purposes and activities, and no profits from the trading company can be distributed to non-charitable shareholders or individuals”

In other words, it doesn’t seem to matter whether a charity operates a trading company or not for the purposes of determining charitable status, as long as the charity remains exclusively charitable.

However, from a charity regulator compliance point of view, presumably trading does matter.  Trading charities:

-          have more opportunity to distribute profits for private benefit, through non-arms length related party transactions

-          are more likely to be involved with complex structures and/or transactions with for-profit entities that could indicate their purposes are not exclusively charitable

-          face more business risks which can put charitable funds in jeopardy.

To deal with the latter point about business risks, the charities regulator for England and Wales has, for example, introduced specific rules where trading (other than trading in pursuit of its charitable objects) involves significant risk to a charity's assets.  In those cases the trading must be undertaken by a trading subsidiary.

3. Implications of trading for the tax man

Inland Revenue’s operational statement 06/02 (December 2006) explains that charities with “business income” are subject to specific tax rules.  For tax purposes, a business is defined as any profession, trade or undertaking carried on for a profit.

If a charity has business income there are two instances where the business income will be taxable. 

Firstly, if there is a person with some control over the business who is able to direct or divert income derived from the business to their benefit or advantage.  In that case, all of the business income is taxable. 

Secondly, there may be a tax liability where the charity’s charitable purpose is not limited to New Zealand.  In that case the business income must be apportioned between those purposes within New Zealand and those outside New Zealand and the latter portion is subject to income tax.

4. Implications of trading for competitors and the public: Not a level playing field

The media and the public at large also have an interest in charities with trading operations.

“Super-rich tribes pay no tax” and “Tainui taxes set for review” were the headlines in the Waikato Times in June 2011.  Journalists asserted that some charitable organisations have amassed huge untaxed reserves, in part due to a tax exempt status, with Tainui's commercial arm compiling a $235m war chest.

Opposition politicians made statements that the law should be changed to avoid charities using their tax advantages to amass untaxed reserves from their trading profits and using them to dominate their competitors.  There were accusations that there was not a level playing field with other businesses which paid income tax.  In response, the Revenue Minister said an upcoming review of charities law would be a chance to see whether taxing the charities' retained profits would see more of the funds put to charitable use. He said such a move would bring New Zealand in line with Australia's tightening of rules around how much tax charities pay.

As recently as last week there was an article published by Dr Michael Gousmett in the New Zealand Centre for Political Research in which he commented on some of the apparent commercial organisations which have charitable and therefore income tax exempt status.  Dr Gousmett argued for the tax authority to have the legislative power to impose an excess surpluses retention tax on those charities that fail to distribute.  He also argued for grant-making charitable trusts to be required to “provide details to the public of the recipients of their largesse”.

5. Australia’s “unrelated business income tax” (UBIT) proposals

The Australian government has proposed that charities pay income tax on profits from activities that are not directed toward their altruistic purpose, but rather on profits which are retained for the organisations’ commercial undertaking. However the application of the draft legislation continually gets delayed. The most recent statement by the government in February was that the rules will be deferred until 1 July 2014.

6. Statistics for 6,755 charities with “cost of trading operations” in their most recent return

The following two tables show the totals for all of the charities who recorded a “cost of trading operations” in their most recent annual return filed with the regulator.  They also show the name and amount reported by the largest charity in each category.  

			$m		Largest
Financial Performance					$m
Service & trading income			$        1,864		$   182	Seventh Day Adventist Church
Government grants/contracts			$        1,450		$     70	National Maori PHO Coalition Incorporated
Other income			$           463		$     41	The Arts Centre of Christchurch Trust Board
Donations			$           422		$     27	Red Cross
Other grants and sponsorships			$           343		$     47	Regional Facilities Auckland
Other investment income			$           187		$     13	Salvation Army
Membership			$           108		$       9	Medical Council Of New Zealand
Bequests			$            57		$       8	Salvation Army
NZ dividends			$            27		$       2	Te Runanga A Iwi O Ngapuhi
Total gross income			$        4,921		$   187	Seventh Day Adventist Church
Salary and wages			$        1,680		$     63	Salvation Army NZ Group
Cost of trading operations			$        1,374		$   144	Seventh Day Adventist Church
Cost of service provision			$           580		$     41	Salvation Army NZ Group
Other expenditure			$           421		$     21	Auckland Grammar School Combined Trusts
Grants paid inside NZ			$           242		$     22	The Methodist Church
Depreciation			$           218		$     15	Regional Facilities Auckland
Interest paid			$            73		$     12	Tainui Group Holdings Ltd
Grants paid outside NZ			$            41		$       9	The Evangelical Alliance Relief Fund
Total expenditure			$        4,629		$   187	Seventh Day Adventist Church
Net surplus			$           298		$     37	The Arts Centre of Christchurch Trust Board
			$m		Largest
Financial Position					$m
Buildings			$        5,349		$   597	Regional Facilities Auckland
Investments			$        3,229		$   234	Saint John's College Trust Board
Land			$        3,011		$   379	Roman Catholic Diocese of Auckland Group
Other short term assets			$        1,856		$   433	NZ Loc Authority Protection Prog. Disaster Fund
Cash at bank			$        1,493		$     58	New Zealand Red Cross Incorporated
Other fixed assets			$        1,427		$   351	Regional Facilities Auckland
Computers/office equipment			$           432		$   288	Auckland Museum Trust Board
Inventory			$           165		$     15	Seventh Day Adventists
Total assets			$      16,963		$ 1,150	Regional Facilities Auckland
Non current liabilities			$        1,652		$   173	Regional Facilities Auckland
Current liabilities			$        2,254
Total liabilities			$        3,906		$   434	NZ Loc Authority Protection Prog. Disaster Fund
General purpose funds			$      10,246		$   935	Regional Facilities Auckland
Restricted funds			$           997		$   148	Salvation Army
Endowment			$        1,083		$   266	Salvation Army
Total equity			$      12,326		$   937	Regional Facilities Auckland
Total liabilities and equity			$      16,232

7. Specific examples of business activity:  Trading Trusts

Out of the 3,570 charities which stated that “income from trading operations” was one source of funds in their registration applications, 1,596 (45%) were trading trusts.  The three largest trading trusts with trading operations (by gross income) are The Order of St John Regional Trust Boards, World Vision of New Zealand Trust Board and Dilworth Trust Board.  The following table shows the detail for 10 trusts with business activity unrelated to their charitable purpose (sorted in descending size of assets).  This gives 10 examples of the types of business activities they conduct compared to their charitable purposes, the average salaries they pay, the amount of donations they make, and other basic financial information. 

	Charity name	Business  activity	Charitable purpose	Gross income	Salary	Av FTE Salary	Donations made	Net surplus	Total assets	Total equity
				$000	$000	$000	$000	$000	$000	$000
1	The C Alma Baker Trust Group	Farming and investment	Further the science of agriculture/horticulture or  education	$3,441	$420	$38	$206	$606	$13,641	$13,344
2	S R & B J Williams Charitable Trust Board	Sheep and cattle farm	Waipawa Municipal Theatre and Kairaku Development Society	$737	$206	$0	$15	-$147	$9,503	$6,365
3	Matua Charitable Trust	Farming	Donate to a wide range of charities (religion, education, health, poverty)	$557	$200	$160	$91	$164	$9,262	$3,012
4	Gallagher Charitable Trust	Commercial rental	Donate to a wide range of charities	$510	$0	$0	$386	-$55	$9,139	$9,130
5	Pam Torbett Charitable Trust	Sheep, cattle and deer farm	Donate to a wide range of charities	$633	$33	Uknown	$366	$226	$9,098	$9,196
6	Shiloh Charitable Trust	Leasing beehives	Religion, education, relief of poverty	$300	$0	$0	$112	$121	$4,846	$1,818
7	Stellar Charitable Trust	Software licencing (StorMan software)	To assist the Seventh Day Adventist Church	$602	$0	$0	$118	$353	$4,708	$2,635
8	The Juffermans Charitable Trust	Forestry / dairy farming	NZCCS, IHC, Royal NZ Blind Foundation	$468	$0	Uknown	$15	$200	$2,697	$808
9	Te Whanau Trust	Piko Wholefoods - vegeterian wholefood store	Create employment by growing and selling organic food / promote understanding of organic principles	$530	$348	$50	$29	-$12	$1,519	$1,341
10	The Tana Umaga Foundation Trust	Water bottle sales	Assist youth education (scholarships)	$13	$0	$0	$2	$7	$73	$73

Here are several issues that these examples raise:

(i) Minimal donations made / wealth accumulation: All of the trusts in this sample are paying grants and donations to charities.  But are the amounts of grant distributions appropriate in the context of the size of some of the businesses? For example, is it sufficient for a charity like the Juffermans Charitable Trust with assets of $2.7m, to be making charitable distributions of just $15,000 and accumulating its surplus of $200,000?

(ii) Excessive salaries: When do salaries start to look excessive?  For example, when they average $160,000 per annum as in the case of the Matua charitable trust?  In these cases should the charity be given the chance to explain why the salaries are so high, or at least be asked to double check whether the paid staff hours they listed on the register are accurate?.

(iii) Undisclosed salary expense: Why do some charities say they have paid staff, but show no salary expense? For example the Juffermans Charitable Trust indicated it had one full time and one part time staff member, but did not disclose any salary expense.

(iv) Poor standard of financial information:  When should the regulator demand better financial accounts from registered charities?  For example the Stellar Charitable Trust financial accounts are at a very low standard for a $5m charity.  There are no notes to the accounts, no narrative explanations and no indication of any audit activity.  They did disclose licencing fee income but only a google search linked this to their software licencing business.

(v) Description of trading activities:  Should the regulator ask charities to describe their trading activities in order to increase transparency about what they do, rather than just allow them to tick the "income from trading operations" box with no further explanation and leaving it to readers to dig further into the financial accounts and other information sources.

8. Specific examples of business activity:  Limited liability companies

Out of the 3,570 charities which stated that “income from trading operations” was one source of funds, 308 (9%) were limited liability companies.  The three largest limited liability companies with trading operations (by gross income) are Idea Services Ltd (part of the IHC group), Auckland UniServices Ltd and Trust House Ltd.  The following table shows the detail for 10 companies with business activity unrelated to their charitable purpose, again sorted in descending size of assets. 

	Charity name	Business activity	Charitable purpose	Gross income	Salary	Av FTE Salary	Donations made	Net surplus	Total assets	Total equity
				$000	$000	$000	$000	$000	$000	$000
1	Trinity Lands Limited	Agriculture and horticulture: milk 10000 cows on 18 farms; supply gold kiwifruit to Zespri Group	Return all profits to promote the spread of the christian gospel	$26,092	$1,248	$68	$0	$1,824	$161,034	$100,130
2	Marist Holdings (Greenmeadows) Limited	Mission Estate winery: production, marketing and distribution of wines	Roman Catholic Church	$12,455	$2,096	$55	$0	$2,116	$33,693	$23,793
3	Quality Hotel Parnell Limited	Tourist accommodation, restaurant and conference facilities	To support the charitable purposes as set out in the last will and testament of Norman Barry	$4,090	$1,821	$38	$4	-$135	$15,232	$13,206
4	Horticentre Limited	Distribution of horticulture products (the second largest horticultural merchant in NZ)	Pay dividends to the NZ Horticentre Trust (which promotes research and education in respect of horticulture)	$20,637	$2,798	$76	$1	-$213	$13,055	$11,421
5	Trok Building Limited	Commercial rent and leasing, fitness business (gym), lawnmowing business	Raise money for charitable shareholder (Te Runanga O Kirikiriroa Charitable Trust)	$1,112	$156	$18	$0	-$177	$4,392	$1,833
6	Trinity Foundation (Services No.1) Limited	Licencing of land or granting Forestry Rights for the purposes of establishing forest estates.	To distribute income to its charitable parent, The Trinity Foundation Ltd (whose charitable purpose is to distribute to charitable organisations)	$36	$0	$0	$0	$36	$1,628	$1,628
7	Pathway Engineering Limited	Furniture manufacturing and distribution (accounts withheld, but 2010 published)	Governing documents withheld: Main beneficiary is other charities.  Part of Pathway Charitable Group which provides social services.	$2,721	$0	$0	$0	-$9	$856	$481
8	Awhina Experience Limited	Guided walking tours	Raise money for charitable shareholder (Te Putahitanga O Nga Ara Trust) which benefits the Pouakani People.	$11	$34	$34	$0	-$75	$117	-$1,410
9	Custom Copy Limited	Commercial copy centre	Relief of poverty	$330	$144	$48	$15	-$6	$109	$42
10	Babs Limited	Fashionware retailing	Distribute profits to Presbyterian foundation	$65	$0	$0	$0	$6	$19	$12

Here are several issues that these examples raise:

(i) Minimal donations made / wealth accumulation: Unlike the trading trust examples, only three of the companies actually distributed funds for charitable purposes by way of donations and even then the amounts were very small.  The majority either reinvested their surpluses in the business or they made deficits which drained their accumulated funds.  Is this appropriate for a registered charity?

(ii) Poor standard of financial information.  Again, the quality of financial reports varied enormously.  Some – including the largest in the sample, Trinity Lands Ltd – were allowed by the regulator to provide summarised financial statements prepared under FRS 43.  This type of statement gave very little insight into the financial affairs of the charity.

(iii) Insolvency disclosure:  One of the businesses – Awhina Experience Ltd - had negative equity.  It would have been insolvent had their parent companies not provided guarantees. Should an explanation be provided on the register when registered charities appear to be insolvent?

(iv) Disclosure of charities involved with tax avoidance schemes:  Although the financial details of Trinity Foundation Services (No.1 Ltd) look fairly innocuous, it is actually one of several Trinity Foundation charities that were part of NZ’s largest tax avoidance scheme involving Douglas fir forests, 300 investors and up to $3.7 billion in tax revenue.  As recently as November 2012 the Supreme Court upheld Inland Revenue’s appeal in the case.  Should the regulator require charities to disclose their past involvement in such schemes (especially if a court has found that tax avoidance occurred)? 

As an aside, the Trinity tax avoidance scheme was deemed to be tax avoidance because its investors claimed immediate tax deductions on a harvesting fee that was not due until 50 years in the future. In 2004 the High Court was told that the architect of the scheme, tax lawyer Garry Muir, consulted Anglican clergy before creating the Trinity Foundation in 1997 to make donations to causes such as the Anglican City Mission and the Anglican Church Pension Board. The Anglican Church denied it was involved in the scheme.  However today the companies still exist on the charity register because the profits are intended to go to the church and other charitable organisations.

9. Specific examples of business activity:  Incorporated Associations

Out of the 3,570 charities which stated that “income from trading operations” was one source of funds, 1,055 (30%) were incorporated associations.  The three largest incorporated associations with trading operations (by gross income) are Bernados New Zealand Incorporated, IHC New Zealand Incorporated and New Zealand Red Cross Incorporated. 

There are a range of incorporated associations with charitable activities including sports bodies (25 golf courses, 17 bowling clubs, 11 tennis clubs, etc), toy libraries, museum societies/associations, arts, heritage and similar associations. 

Incorporated associations are membership-based organisations and in general their financial statements are at a high standard with independent audited reports.  After a reasonably thorough review I was unable to find any incorporated association which was conducting significant commercial activities unrelated to its charitable purpose. 

Other blog posts with information about charities with business activities:

Several of my previous blogs also discuss charities with trading operations, including:

Corporate charities

Religious charities

Charitable groups

Reducing transparency – Tait Communications vs Sanitarium Health Food Company

Disclaimer

This analysis was based on information on the charities register, which is not verified by the charities regulator.  The analysis also relied on information provided in financial accounts filed with the regulator – much of which was not audited or independently verified.

One significant error on the register was corrected for the purpose of this analysis.  All financial information for the Dunedin Hospital Early Childhood Centre Association Incorporated for the year ended 31 March 2012 was overstated by a factor of 1,000.  In other words, its gross income of $1,412,282 was recorded as $1,412,282,000.  This has overstated aggregate income by $1.4 billion and overstated aggregate assets by $1.3 billion on the register.