NPOs' Response to CRA "Education Letters"

Since 2010, the CRA has sent almost 1,500 "education letters" to not-for-profit organizations (NPOs), typically advising the organization of its potential non-compliance with the Act and urging it to adjust its activities accordingly. No specific action or response is requested. Although these letters may be considered a form of audit by the CRA, they do not seem to lead directly to the imposition of any penalty. Nonetheless, NPOs should think carefully about whether any organizational or other changes should be made.

The stated purpose of these letters is to educate NPOs about their compliance obligations and to encourage them to comply. The letters are part of the NPO Risk Identification Project, which the CRA initiated to gather intelligence about the nature and extent of compliance by NPOs with the Act. The CRA views these letters as more cost-effective than traditional audits in promoting compliance. The "education letter" approach is also being used for individuals in connection with rental and business income, employment expenses, and capital gains or losses. The CRA's website says that 47,000 such T1 letters were to be sent out in January and February 2012, so the NPO letters are part of a much bigger CRA strategy.

Paragraph 149(1)(l) of the Act defines an NPO as a club, society, or association that is not a charity and requires it, among other things, to be organized and operated exclusively for social welfare, civic improvement, pleasure or recreation, or any other purposes except profit. Golf, curling, and ski clubs, condominium corporations, and professional associations are often organized and operated as NPOs.

The CRA's letters appear to focus primarily on whether NPOs carry on their activities for "any other purposes except profit." Court decisions that consider the scope of paragraph 149(1)(l) seem to suggest that an NPO may have a planned profit, provided that the organization uses it for an overall non-profit purpose. For example, in Gull Bay Development (84 DTC 6040 (FCTD)), a corporation earned more than $25,000 in profit from a logging operation in order to ameliorate the economic and social welfare of Gull Bay Indian Reserve members.

The chief concern is whether NPOs should ensure that all of their activities are not profitable. The Canadian Chamber of Commerce states that the current practice of almost all of its association members (which are probably among the largest NPOs) is to have at least some profit-oriented activities.

Responses to the "education letters" have included lobbying for changes, increasing directors' liability insurance, and resignations of concerned directors. In at least some cases, however, dealing directly with the CRA's concerns may not require significant changes. NPOs can review their constating and internal documents--such as incorporation certificates, letters patent, or articles of incorporation; financial and accounting records; meeting minutes; budgets; and internal policies--to determine whether they conform to the requirements of a tax-exempt entity. They can also document the reasons for and the sources of accumulating funds; avoid budgeting for profit; segregate funds held for capital projects; and consider financing capital projects, to the extent possible, with membership contributions. Condominium corporations can specify long-term plans to set aside monies for planned expenditures (for example, a new roof every 20 years), as many provinces already require them to do, rather than simply reporting an annual profit and budgeting for more profits for the future. If an NPO pays or receives intercompany fees, the fees should be examined to determine the financial impact and to avoid accumulating an unreasonably high surplus, which the CRA may interpret as an indicator of a for-profit purpose.

Lidiya Nychyk
Ernst & Young LLP, Toronto

Canadian Tax Focus
Volume 2, Number 3, August 2012
©2012, Canadian Tax Foundation