ATO ID 2003/1088: Exempt entities: non-profit status - surplus funds paid to parent body
Date of decision: 26 August 2003
Year of income: Year ended 30 June 2002
Business line: Private Groups and High Wealth Individuals

Issue
Can the taxpayer, a wholly owned subsidiary of a body which is an exempt entity by virtue of Division 50 of the Income Tax Assessment Act 1997 (ITAA 1997), be considered an exempt entity in its own right if it pays surplus profits to its parent?

Decision
No. The distribution of profits to a member, even when that member is an exempt entity, will prevent an organisation from being considered to be a non-profit entity. Division 50 of the ITAA 1997 requires, among other things, that exempt entities must be non-profit.

Facts
The taxpayer company primarily engages in providing public clinical and other health services. The company is a wholly-owned subsidiary of an exempt entity but operates with total autonomy and is self-funded. The company's Memorandum of Association contains clauses preventing distributions of profit during operation and on winding up. The constitution of the company makes allowance for surplus funds to be retained by them as reserves for future expenditure, or to be 'donated' to the parent, with a request that they be used by the parent institution for research in areas relevant to the operations of the subsidiary. The company has not made donations to research bodies other than the parent. However, there is a history of significant surplus funds being regularly passed to the parent. An entity will be considered to be an exempt entity under Division 50 of the ITAA 1997 if it fulfils the requirements of one of the entity types listed within Division 50, together with any special conditions which may attach to that entity type. An entity cannot be an exempt entity unless it operates on a non-profit basis (Else-Mitchell J in McGarvie-Smith Institute v. Campbelltown Municipal Council [1965] NSWR 1641 and Federal Commissioner of Taxation v. Cappid Pty Ltd , 71 ATC 4121; (1971) 2 ATR 319. A 'non profit company' is defined in subsection 3(1) of the Income Tax Rates Act 1986 and means, among other things, a company that: In the present case, the constitution of the company allows it to make donations to its parent body - its only member. In limited cases, it may be accepted that a subsidiary may make gifts to its parent or ultimate beneficiary, in that entity's capacity as, for example, a Deductible Gift Recipient or a charity or other type of exempt organisation. However, in the case where a payment is made to a parent body, whether the payment is truly a gift is a matter which must be determined objectively, at the time the gift is made. A payment to a parent body is more likely to be a profit distribution and less likely to be a gift if there is evidence that the subsidiary has the ability to consistently make profits without the support of external funding or donors, and there is evidence of a purpose to distribute a significant portion of these profits to the parent body. The ability of the subsidiary entity to consistently generate profits could be evidenced by the fact that the entity is operating in a commercial environment with profit making competitors. A purpose of passing profits to the parent could be evidenced by: In the present case, the company operates in a commercial environment and has consistently generated significant profits. In addition, the form of the company's Memorandum of Association indicates that it has a purpose of generating funds to distribute to the parent body. The funds distributed to the parent are a significant portion of the company's annual profits. The company has no history of donating funds to bodies other than the parent. Therefore, it is considered that the funds transferred to the parent body in this case are not donations, but distributions of profit. As the entity has paid profits to a member, it is not operating as a non-profit organisation and cannot be an exempt entity under Division 50 of the ITAA 1997. Note: A body which makes profit distributions to members cannot be a Deductible Gift Recipient under Division 30 of the ITAA 1997, a public benevolent institution for the purposes of subsection 57A(1) of the Fringe Benefits Tax Assessment Act (1986) (FBTAA) or a rebatable employer for the purposes of subsection 65J(1) of the FBTAA.

Reasons for decision

Legislative references: Income Tax Assessment Act 1997 Division 50 Division 30
Case references: McGarvie-Smith Institute v. Campbelltown Municipal Council [1965] NSWR 1641
Subject references: Exempt benefits Fringe benefits tax Public Benevolent Institution Rebatable employer Charitable institution Gifts Non profit bodies Non profit entities Non profit companies