CharityPack (current to 19 June 2003)

Chapter 1 Income tax are you entitled to ITEC endorsement?

This document has been archived. It is current only to 19 June 2003.

In this chapter we explain:

• the need to be endorsed as an income tax exempt charity
• charitable institutions and charitable funds, and
• requirements to be endorsed.

To be endorsed as exempt from income tax a charity must:

• have an Australian Business Number (ABN)
• be entitled to be endorsed (explained in this chapter), and
• apply to the ATO for endorsement.

The requirements for entitlement are different for charitable institutions and charitable funds. This chapter explains:

• the distinction between charitable institutions and charitable funds
• the requirements for charitable institutions to be entitled, and
• the requirements for charitable funds to be entitled.

Charities are not automatically exempt from income tax. From 1 July 2000 there is a new system of endorsement which means charities must apply to the ATO for exemption. If the ATO gives you notice that you are endorsed as an income tax exempt charity (ITEC):

• you are exempt from income tax, and
• you do not need to lodge income tax returns, unless specifically requested.

This chapter helps you work out whether your charity is entitled to endorsement. For charities that are entitled, the way to apply for endorsement is explained. Organisations that have previously received written confirmation from the ATO that they are charities must still apply for ITEC endorsement.

The income tax consequences of being endorsed as an ITEC are explained. Charities that are not endorsed as ITECs are covered.

If you are not sure whether your organisation is a charity you should first go to appendix 1 - Are you a charity? .

Endorsement

To be endorsed as an ITEC you must have an Australian Business Number (ABN) (see page 22). This must be the ABN of the entity itself. An ABN held for GST purposes by a non-profit sub-entity is not sufficient.

You must also meet other requirements to be entitled to endorsement. There are different requirements for:

• charitable institutions, and
• charitable funds.

The next section helps you work out if you are a charitable institution or a charitable fund.

Charitable funds that cannot be endorsed are:

• charitable funds established by will from 1 July 1997 which are not established in Australia, and
• charitable funds established by instrument of trust which are not established in Australia.

These charitable funds will only be exempt from income tax if they fall in some other income tax exempt category and meet the special conditions for it. Most are likely to be taxable and so must lodge income tax returns.

All other charities must be endorsed to be exempt from income tax. They are:

• charitable institutions
• charitable funds established by will before 1 July 1997
• charitable funds established in Australia by will on or after 1 July 1997, and
• charitable funds established in Australia by instrument of trust.

The requirement for endorsement applies even if the institution or fund also falls in some other category of income tax exempt entity. Other categories include religious institutions, scientific institutions and public educational institutions.

Assume a charitable institution is also a religious institution. To be exempt it must be endorsed as an income tax exempt charity.

Are you a charitable institution or charitable fund?

Charitable institution

You will be a charitable institution if you are an establishment, organisation or association that is instituted to advance or promote charitable purposes. Charitable purposes are explained in appendix 1 - Are you a charity?

Types of organisations that may be charitable institutions include welfare agencies, churches, public libraries, parents and citizens associations, refuges and research institutes.

A charitable institution can include an organisation established by will or instrument of trust, or its legal structure might be an unincorporated association or a corporation.

Incorporation is not enough, on its own, to show an organisation is an institution: its activities are also relevant.

A charitable institution would not usually include an organisation that is established, controlled and operated by family members and friends.

The object of an association is to advance charitable education. Its members are two engineers and their families. Funding comes from the members, and investments include leases made to the two engineers. Profits are used to make charitable distributions. The association is not a charitable institution.

Charitable fund

To be a charitable fund you must be established under an instrument of trust or a will. Also, you must mainly:

• manage trust property, and/or
• hold trust property to make distributions to other entities or persons.

In contrast, if you mainly carry on charitable activities you will be treated as a charitable institution and not as a charitable fund.

A charity was established by a deed of trust and manages assets to pay scholarships from the trust's income. It is a charitable fund. A charity was established by a deed of trust and operates a hostel for the homeless. It is more than simply a fund that is being administered for a charitable purpose.

It is a charitable institution.

The following are common types of charitable fund:

• Holding property for charitable use a charity that holds and maintains a church building and the surrounding land for use for religious worship and related purposes.
• Distributions to other charities a charity that manages an investment portfolio with returns being distributed to educational charities which apply for grants.
• Distributions to persons in need a charity that solicits donations and uses them to make grants to help disabled persons.
• Distributions for other charitable purposes a charity that holds income-producing property and solicits donations and uses them to pay for the construction and maintenance of buildings for cultural charities.

Requirements to be entitled - charitable institutions

Charitable institution tests

A charitable institution can be entitled to endorsement if it meets at least one of three tests:

• it has a physical presence in Australia and, to the extent it has a physical presence in Australia, it pursues its objectives and incurs its expenditure principally in Australia
• it is a deductible gift recipient , or
• it is prescribed by law in the income tax regulations, and
  • it is located outside Australia and is exempt from income tax in its country of residence, or
  • it has a physical presence in Australia but incurs its expenditure and pursues its objectives principally outside Australia.

Physical presence in Australia test

This test has two elements:

• does the charitable institution have a physical presence in Australia? and
• to the extent the charitable institution has a physical presence in Australia, does it pursue its objectives and incur its expenditure principally in Australia?

If the charitable institution does not meet these requirements, it may still satisfy the test see Disregarded amounts.

Physical presence

A charitable institution has a physical presence in Australia if it is wholly in Australia, or it has a division, branch or sub-division in Australia.

It does not have a physical presence in Australia if it is present in Australia only through an agent, or it merely owns investment property in Australia.

Objectives and expenditure principally in Australia

If a charitable institution has a physical presence in Australia only, it must pursue its objectives and incur its expenditure principally in Australia.

Principally means mainly or chiefly. Less than 50 per cent is not 'principally'.

The pursuit of objectives in Australia can include things done offshore if they are only a means of pursuing those objectives. For example, sending employees to an offshore conference to aid their efficiency for the Australian objectives will be pursuing objectives in Australia.

Minor offshore expenditure is acceptable.

An association is a religious charity. It is physically present only in Australia, but it also sends materials to missionaries overseas. As long as these activities and expenditure are not major, it will meet the physical presence test.

If the charitable institution has a physical presence in Australia as well as another country, it is necessary to work out the extent to which it is physically present in Australia. Then it is only to that extent that the purposes and expenditure must be principally in Australia. This means that a charitable institution which, when viewed as a whole, does not principally have its purposes and expenditure in Australia can still meet the physical presence test.

A society is a medical charity. It operates two clinics, one in Australia and one in Papua New Guinea. Each clinic operates separately, with general administration being done in PNG. If the Australian activities and expenditure are mainly for the Australian clinic it will meet the physical presence test. VBN Welfare runs support programs through four centres, one in Australia and three in Malaysia. All funding comes from Australia and a similar amount is spent on each centre. To the extent VBN Welfare has a physical presence in Australia, it is not principally pursuing its objectives and incurring its expenditure in Australia. It could only meet the physical presence test through the disregarded amounts.

Disregarded amounts

A charitable institution may still meet the physical presence test even if it does not, in fact, pursue its purposes and incur its expenditure principally in Australia, to the extent it has a physical presence in Australia. This will depend on its distributions of disregarded amounts.

Disregarded amounts are amounts that the charitable institution receives as:

• gifts, including testamentary gifts
• proceeds from raffles, dinners, charity auctions, jumble sales and similar fund-raising activities, or
• government grants.

It is assumed that any offshore distributions are made first from any disregarded amounts that are able to be distributed offshore. If a disregarded amount cannot be distributed offshore, the assumption does not apply to it. For example, government grants made only for use in Australia and gifts of land physically in Australia are not assumed to be distributed offshore.

The effect of making this assumption is that offshore distributions can be made up to the total of these amounts without jeopardising entitlement to endorsement.

A corporation provides religious instruction in Australia and New Zealand. The amounts it uses for the New Zealand teaching are never more than the disregarded amounts. Because the disregarded amounts are assumed to pay for the New Zealand activities, the corporation can still meet the physical presence test. Continuing the earlier example of VBN Welfare which runs support programs in Australia and Malaysia: if its disregarded amounts substantially cover the funding of the Malaysian programs, it could meet the physical presence test. This is because the disregarded amounts are assumed to be the first spent offshore.

Deductible gift recipient test

Deductible gift recipients (DGRs) are entities to which donors can make income tax deductible gifts. They are explained in detail in the ATO publication GiftPack which is available by phoning 13 24 78 .

From 1 July 2000 DGRs:

• are listed by name in the income tax legislation, or
• have received a notice from the ATO stating they have been endorsed as DGRs.

A charitable institution is entitled to ITEC endorsement if it is a DGR, but will still need to apply separately.

However, if the charitable institution is endorsed as a DGR only for a fund or institution that it operates, it does not meet the DGR test. For example, a charitable school could be endorsed as a DGR for a building fund that it operates. Deductible gifts could be made to its building fund. Because the charitable school would be a deductible gift recipient only for the building fund, the school would not meet the DGR test.

Endorsement of DGRs applies only from 1 July 2000. Accordingly, for a charitable institution to work out, in the period up to 30 June 2000, whether it will meet the DGR test, it can treat itself as a DGR if:

• it reasonably considers itself to be entitled to endorsement as a DGR
• its endorsement as a DGR is for the entity in its own right (and not only for a fund or institution that it operates), and
• it has lodged an application for that endorsement.

If its application for endorsement as a DGR is later rejected it will need to determine whether it meets the physical presence test or the prescribed by law test for endorsement as an ITEC. If it does not meet either test, it must notify the ATO that it is not entitled. The ATO will then revoke its endorsement as an ITEC.

Prescribed by law test

Charitable institutions can be prescribed by name in the income tax regulations. The Government decides which institutions will be prescribed. At the time of publication only five institutions and their members had been prescribed as charitable institutions. Applications for prescription can be sent to the ATO which will forward them to the Government for consideration.

The prescribed charitable institutions do not need to be endorsed to retain their exemption from income tax as long as they satisfy the requirements for exemption. They can apply for endorsement if they choose.

Conclusion

If you have worked out that you are entitled to be endorsed. It explains how to apply for endorsement. If you are not entitled to be endorsed, you should read, Income tax - if you are not an ITEC .

Requirements to be entitled charitable funds

Charitable fund tests

To be entitled to endorsement, all charitable funds must be applied for the purposes for which they were established. This is explained Applied for its purposes. Some funds will also need to meet further tests. This will depend on whether the charitable fund was:

• established by will before 1 July 1997, and if so what assets it has received since that date, or
• established in Australia.

The following flowchart summarises the conditions charitable funds must meet to be entitled.

Flowchart charitable funds requirements to be entitled

Applied for its purposes

To be entitled to endorsement, a charitable fund must be applied for the purposes for which it was established. If it is not being applied for those purposes, it is not entitled to endorsement.

If a charitable fund uses its property and income only and fully for its charitable purposes it will meet this requirement.

Examples where a charitable fund is not being applied for its purposes include:

• where distributions are made for non- charitable purposes, for example money is given to an associate of the trustee
• where trust property is being invested in ways to confer private benefits on particular persons, for example a trust asset is being leased to a business associate of a trustee at an uneconomic rent, or
• where income is being accumulated excessively, for example no income has been distributed and the accumulation is not under a particular plan designed to better serve the charitable purposes.

Charitable funds not established by will before 1 July 1997

To be endorsed, charitable funds that were not established by will before 1 July 1997 must be established in Australia.

To be endorsed, these charitable funds must meet at least one of four additional tests. These tests are explained The four tests.

Charitable funds established by will before 1 July 1997

If a charitable fund is established by will before 1 July 1997 its entitlement to endorsement will depend on the assets it has received from 1 July 1997.

If, on or after 1 July 1997, a charitable fund:

• has paid real and substantial value for all new assets it received, and
• has not received any assets under a will,

it will be entitled to endorsement. This is provided it has an ABN and is being applied for the purposes for which it was established.

Other charitable funds are deemed to consist of two separate trusts, called an 'old trust' and a 'new trust'.

The 'new trust' consists of the following property:

• assets given to the charitable fund after 30 June 1997 for which it did not pay valuable consideration
• assets becoming part of the charitable fund under a will after 30 June 1997
• assets received in substitution for those assets, and
• any income derived from these assets.

Valuable consideration is a payment of real and substantial value.

The 'old trust' consists of the remainder of the charitable fund. Effectively this will be all of the fund as at 30 June 1997, and property acquired from that date which:

• is received in substitution for assets held before 1 July 1997
• was given in return for valuable consideration, or
• is income derived from that property.

The charitable fund will need to prepare accounts for each of the 'old trust' and 'new trust'. Costs will reduce the part of the fund to which they relate. Charitable distributions can be streamed from the 'old trust' or the 'new trust', unless the facts indicate otherwise.

A foundation was established by will on 1 January 1995. At 30 June 1997 it held cash at bank. After that date it received:

• land under a will
• rent on letting the land, and
• interest on cash at bank.

It made distributions of money to other charities each year. The foundation is deemed to be:

• the 'new trust' comprising the land, rents and any interest on the rents, reduced by the distributions but not more than the amount of rent and interest it has available for distribution, and
• the 'old trust' comprising the remainder of the trust property.

The 'old trust' is entitled to endorsement, provided its charitable fund has an ABN and is being applied for the purposes for which it was established.

The 'new trust' has to meet additional tests as set out at The four tests. The charitable fund, of which the 'new trust' is a part, must have an ABN. The 'new trust' does not need a separate ABN.

If the 'new trust' meets the additional tests, the whole charitable fund will effectively be entitled to endorsement.

The four tests

There are special requirements for charitable funds not established by will before 1 July 1997 and 'new trusts' which are applied for their purposes. They must meet at least one of four tests. The tests are:

Australian purposes

It incurs its expenditure principally in Australia, and pursues its purposes solely in Australia, and has done so at all times since 1 July 1997.

Deductible gift recipient

It is a deductible gift recipient.

Australian distribution

It distributes solely, and has at all times since 1 July 1997 distributed solely, to charities that, to the best of the trustee's knowledge, are:

• located in Australia
• incur their expenditure principally in Australia, and
• pursue their purposes solely in Australia.

Gift distribution

It distributes solely, and has at all times since 1 July 1997 distributed solely, to charities that, to the best of the trustee's knowledge, are DGRs.

Australian purposes test

This test has two elements. The charitable fund or 'new trust' must:

• pursue its purposes solely in Australia, and have done so at all times since 1 July 1997, and
• incur its expenditure principally in Australia, and have done so at all times since 1 July 1997.

If the charitable fund or 'new trust' does not meet these requirements, it might still satisfy the Australian purposes test see Disregarded amounts.

The charitable fund or 'new trust' must pursue its purposes exclusively in Australia. However, carrying out activities outside Australia can be acceptable if those activities are only for the sake of pursuing the purposes in Australia. For example, sending an employee to an overseas conference would be acceptable if it was to improve the efficiency of the Australian operations.

The incurring of expenditure must be principally in Australia. Less than 50 per cent is not 'principally'. Expenditure includes distributions made for charitable purposes.

WER Trust holds and maintains church property. It manages three sites in Australia and one in the Solomon Islands. It does not meet the Australian purposes test because it does not pursue its purposes solely in Australia.

For the requirement that the test be met at all times since 1 July 1997 see At all times since 1 July 1997.

Disregarded amounts

If a charitable fund or 'new trust' does not, in fact, pursue its purposes solely and incur its expenditure principally in Australia, it might still, in some situations, meet the Australian purposes test. This will depend on its distributions of disregarded amounts. For a description, see the box below.

Distributions of some amounts are disregarded when working out whether a charitable fund or 'new trust' meets the:

• Australian purposes test
• Australian distribution test, or
• gift distribution test.

Distributions are ignored when they are of amounts that the charitable fund or 'new trust' received as:

• gifts, including testamentary gifts
• proceeds from raffles, dinners, charity auctions, jumble sales and similar fundraising activities, or
• government grants.

These are the disregarded amounts. The disregarding of these distributions has different implications for the different tests.

It is assumed that any offshore distributions are made first from disregarded amounts that are able to be distributed offshore. If a disregarded amount cannot be distributed offshore, the assumption does not apply to it.

For example, government grants made only for use in Australia and gifts of land physically in Australia are not assumed to be distributed offshore.

The effect of making this assumption is that offshore distributions can be made up to the total of these amounts without jeopardising entitlement to endorsement.

A fund provides educational scholarships. The students are in Australia and New Zealand. The amounts it uses for the New Zealand scholarships are never more than the disregarded amounts that are available for offshore distribution. Because the disregarded amounts are assumed to pay for the New Zealand scholarships, the fund is taken to be only providing scholarships for students in Australia. Given that this is solely pursuing purposes in Australia, the fund can still meet the Australian purposes test. Continuing the example of the WER Trust that manages church property: the fact that distributions might be less than the disregarded amounts will not help it meet the Australian purposes test. Its holding and managing of property in the Solomon Islands indicates its purpose is not solely in Australia, irrespective of the disregarded amounts.

Deductible gift recipient test

If a charitable fund is a deductible gift recipient (DGR) it meets this test. DGRs are entities to which donors can make income tax deductible gifts. They are explained in detail in the ATO publication GiftPack . Following is a brief explanation. DGRs:

• are listed by name in the income tax legislation, or
• have received a notice from the ATO stating they have been endorsed as DGRs.

The new system of endorsement of DGRs takes effect from 1 July 2000. Until then, if a charitable fund considers it will meet the deductible gift recipient test, it can treat itself as a deductible gift recipient if it has lodged an application for DGR endorsement.

If its application for endorsement as a DGR is subsequently rejected, the charity will need to determine whether it meets the Australian purposes test, the Australian distribution test, or the gift distribution test. If it does not meet any of these tests, it must notify the ATO that it is not entitled. The ATO will then revoke its endorsement as income tax exempt.

Australian distribution test

To meet this test the charitable fund or 'new trust' must distribute solely , and at all times since 1 July 1997 have distributed solely, to charities that, to the best of the trustee's knowledge:

• are located in Australia, and
• pursue their purposes solely in Australia, and
• incur their expenditure principally in Australia.

If the charitable fund or 'new trust' does not meet these requirements it might still satisfy the test see Disregarded amounts.

All distributions must be made to charities. Distributions do not include reasonable payments for goods and services received, for example, insurance or administration and accounting costs.

The charitable recipients must be located in Australia. They do not need to be located exclusively in Australia, but must have an enduring and substantial presence. If they pursue their purposes offshore they will not be acceptable recipients. For example, a charity spreading the gospel in Australia and Papua New Guinea would not be acceptable. The recipient must also incur its expenditure principally in Australia.

These requirements are 'to the best of the trustee's knowledge'. It will be sufficient if the trustee receives written confirmation from the recipient, and the trustee does not have reasonable grounds for doubt.

A charitable fund or 'new trust' could also satisfy this requirement through suitably worded questions in the forms through which applicants apply for funding.

However, if the answers to these questions are unsatisfactory, and the trustee still distributes to the applicant, its entitlement to endorsement may be jeopardised.

A fund is set up to give money to scientific charities. Its application procedures exclude all non-acceptable applicants. The fund can meet the Australian distribution test. The RTY Foundation does not get information from recipients about their location, purposes and expenditure. One of the recipients in fact funds projects in Australia and the Philippines. The Foundation's trustee has asked to not receive the recipient's newsletters and has asked to be removed from the recipient's mailing list. A claimed lack of knowledge by the trustee would not be accepted in these circumstances. If the Foundation is to meet the Australian distribution test it will only be through the disregarded amounts.

For the requirement that the test be met at all times since 1 July 1997 see At all times since 1 July 1997.

Disregarded amounts

If a charitable fund or 'new trust' does not, in fact, distribute solely in the required ways, it might still meet the test. This will depend on its distributions of disregarded amounts.

It is assumed that distributions to charities that are not located in Australia or not solely pursuing their purposes in Australia are made first from any disregarded amounts that can be distributed from them. If a disregarded amount cannot be distributed to them, the assumption does not apply to it. For example, government grants that must be used for a specified purpose may not be assumed to be distributed to them.

The effect of making this assumption is that distributions can be made to other charities up to the total of these amounts without jeopardising entitlement to endorsement.

A trust provides funding for educational charities. It uses its investment income to fund Australian charities and it funds Canadian charities up to the amount of the gifts it receives. As long as the distributions to Canadian charities do not exceed the amount of gifts that it could distribute offshore, the trust can still meet the Australian distribution test.

Continuing the earlier example of RTY Foundation which made a distribution to a charity that funds projects in the Philippines: if the distribution to this charity is less than the disregarded amounts it has available for offshore distribution, it can still meet the Australian distribution test.

If a charitable fund or 'new trust' fails to meet the:

• Australian purposes test
• Australian distribution test, or
• gift distribution test

at any time from 1 July 1997, it cannot meet that test at any time in the future. Changes of activity cannot overcome an earlier failure to meet the tests. A charitable fund established after 1 July 1997 would have to meet the test at all times that it has existed. It could not, of course, have met the test before it existed. If a charitable fund or 'new trust' ceases to meet a test and does not meet any other test, it ceases to be entitled to endorsement. It must notify the ATO so that its endorsement can be revoked. The ATO does not have any discretion to ignore a cessation of entitlement.

Gift distribution test

To meet this test the charitable fund or 'new trust' must distribute solely , and at all times since 1 July 1997 have distributed solely, to charities that are, to the best of the trustee's knowledge, deductible gift recipients (DGRs).

If the charitable fund or 'new trust' does not meet these requirements it might still satisfy the test see Disregarded amounts .

For distributions before 1 July 2000, gift deductible bodies approved by the ATO were listed on the ATO web site at www.ato.gov.au .

From 1 July 2000 DGRs must be endorsed by the ATO. The only exceptions are those funds listed by name in the income tax legislation.

All endorsed DGRs and others that have an ABN will have their gift status entered on the Australian Business Register (ABR). If an endorsed DGR is endorsed only for a fund, authority or institution that it operates, the distribution must be made for that fund, authority or institution. A full description of DGRs is included in the ATO publication GiftPack which is available by phoning 13 24 78 .

If the charitable recipients of the distributions are not, in fact, DGRs, provided the trustee has exercised reasonable care and was of the genuine belief that the recipient was a DGR, the requirement will be satisfied. A charitable fund or 'new trust' can satisfy itself of the recipient's status :

• by checking the ABR to see if the recipient is a DGR
• through suitably worded questions in its application forms for funding, or
• by checking the status of recipients with the ATO by phoning 13 24 78.

Otherwise, if distributions are in fact made to non-acceptable recipients, the charitable fund or 'new trust' will only meet the gift distribution test through the Disregarded amounts.

A fund has procedures in place to always check that applicants for funding are charitable DGRs. Even if the trustee is misled by the information received and some of the applicants turn out not to be deductible gift recipients, the fund will still meet the gift distribution test because the trustee has acted to the best of its knowledge.

For the requirement that the test be met at all times since 1 July 1997, see At all times since 1 July 1997.

Disregarded amounts

If a charitable fund or 'new trust' does not, in fact, distribute solely in the required ways, it may still meet the test. This will depend on its distributions of 'disregarded amounts' (see an explanation What are disregarded amounts? ).

It is assumed that distributions to charities that are not DGRs are made first from any disregarded amounts that can be distributed to them. If a disregarded amount cannot be distributed to them the assumption does not apply. For example, government grants that must be used for a specified purpose may not be assumed to be distributed to them.

The effect of making this assumption is that distributions can be made to other charities up to the total of these amounts without jeopardising entitlement to endorsement.

A foundation provides funding for various charities. It uses its investment income to make distributions to deductible gift recipients. It also funds some educational charities which are not endorsed as deductible gift recipients. If the distributions to the educational charities are less than the disregarded amounts it receives, it can still meet the gift distribution test.

Conclusion

If you have worked out that you are entitled to be endorsed, see Applying for ITEC endorsement . It explains how to apply for endorsement. If you are not entitled to be endorsed, you should read Income tax if you are not an ITEC .

Need more information?

If you have any queries after reading this guide, or if you need more information, please contact the information sources listed on the back cover of this guide.

ATO references:
NO NAT 3131