Relying heavily on government funding is no longer a stable basis for the long-term survival of a not-for-profit (NFP) organisation, particularly with unstable financial conditions and increasing competition from corporate social responsibility programs.

The need to diversify funding is leading many NFP organisations to seek revenue from commercial enterprises. Doing so requires lateral thinking and careful analysis of the plethora of complex tax-related laws involved, especially considering the reforms that are currently occurring for the NFP sector and the risks involved in not understanding them.

Risky business

When a NFP organisation starts generating additional income from profit-driven sources, the most obvious risk it faces is endangering its tax exempt status.

For example, a NFP employment service that provides support for people who face barriers to employment could reduce its exposure to the vagaries of government funding by moving to profit-driven placement in the private sector. However, the NFP must take great care when doing so as it may risk some of its tax concessions, particularly fringe benefit tax.

Seeking the advice of a lawyer will help guide the organisation through complex changes and could help avoid potentially fatal errors.

The Unrelated Commercial Activity Income Tax Act

The Word Investments case involved members of the Christian missionary organisation, Wycliffe Bible Translators. Word Investments Ltd (itself originally endorsed as a charity) was founded by members closely associated with Wycliffe. The profits of its business ventures were given to Wycliffe and other similar organisations, causing it to be refused ‘income tax exempt charity’ status by the Australian Taxation Office (ATO).

The case showed that commercial activities conducted by a charitable organisation, which raised funds for another charity or charitable purpose, did not prevent that organisation from being considered ‘charitable’ and retaining its tax exempt status. However, the new Unrelated Commercial Activity Income Tax Act, which has been implemented as part of the reforms announced in the Federal Government’s 2011 – 2012 Budget, is intended to limit tax benefits available to a range of permissible trading activities for charities. Consequential impacts include the potential loss of benefits to the charitable body, such as fringe benefit tax concessions.

Continuing review

While the Federal Government is on record as supporting NFPs diversifying their funding sources, including through unrelated commercial activities, it is also committed to providing statutory certainty by introducing the new Australian Charities and NFP Commission (ACNC) as it moves to ease the ATO out of its role as a default NFP regulator, where it has been struggling in a conflicted role of determining charitable status. The ACNC’s relationship with the ATO will continue so long as the ATO continues to determine eligibility for tax concessions.

There have been five major reviews of the NFP sector over the past decade and a number of delays to implementing aspects of the ACNC. Considerable uncertainty remains, including review of the statutory definition of a charity, with the new definition expected to apply across all commonwealth agencies from 1 July 2013. This could potentially overturn 400 years of common law decisions to arrive at a concept of what a charitable purpose is, even though history has shown that idea changes considerably as social and economic conditions change.

In-house conflicts of interest

The sector is stretched considerably. A recent study commissioned by the Australian Institute of Company Directors examined the contribution that NFP directors make to their organisations and to the community, finding that almost 90 per cent of non-executive directors of NFP organisations work – on a voluntary basis – the equivalent of seven weeks each year on director’s duties.

NFP directors are required to give undivided loyalty and must avoid situations where there is a real or substantial possibility of conflict between their personal interests and those of the organisation, and this is where it is best to use a lawyer.

The problem is that substantial difficulties can arise where a subtle conflict of interest is not identified either by the party involved or the other members of the board. Left unchecked, such conflict has the potential to destabilise the board and damage the organisation’s reputation. At times, inexperienced directors can wander into a position of conflict unawares and while such a conflict is not a strict liability but ‘a counsel of prudence’, the law requires an obligation on the part of directors not to take advantage of a situation if a conflict arises.

Taking care

Recently, the High Court found that seven former James Hardie non-executive directors had breached corporate law by making a misleading statement about the company’s asbestos compensation fund. As the Australian Securities and Investment Commission’s Chairman Greg Medcraft stated, this case serves as a warning to all company directors that they will be held responsible for making misleading statements about an organisation’s financial viability. Embarking on profit-generating enterprises raises the stakes in this regard.

The idea of revenue-generating activities within NFP organisations is not new. It is continually evolving and new operating models have developed, allowing principles related to business to meld with the values behind philanthropic approaches to relieving social problems and disadvantage. Getting a lawyer to help organisations determine the best strategy to seek such diversity could help them avoid potentially fatal errors.