A case on the taxation and administration of charitable trusts Overview of income tax exemption and charitable entities What is income tax? The answer may be simple. Further, basic understanding on definition of income is capable of answering why a charitable entity has optional privileges in its income tax obligation. The main reason for this special treatment is because its ‘nature of charitable purposes’ arguably reflects its non-profit orientation, which meaner that, in its simplest term, charity entities are deliberately established not to generate income.
Since one of the generally accepted definitions of income was the monetary payment received for goods or services, or from other sources, as rents or investments, it should follows that all monetary activities excluded from this definition are ‘substantially’ not income. Now it is easy to connect the dots. Since income tax is type of tax imposed on income, it implies that a charitable entity, for not having ‘income’, should be exempted from income tax. However, it does not necessary mean that non-profit organizations are automatically granted as income tax exempt entities.
For instance, in Australia, there are only around 7% of over 00,000 non-profit oriented organizations are income tax exempt charities. 4 Further, in connection with the definition of income, it is essential to note that in Australia there is no single part of relevant tax law, either in the Income Tax Assessment Act (IOTA) 1936 or IOTA 1997, which explicitly defines the term “income”. Accordingly, what constitutes income has long been argued in Australian courts. 5 The lack of a formal definition in Australian tax law is totally different from Indonesian tax law which explicitly defines the word ‘income’ as “… NY increase in economics capacity achieved by or accrued by a taxpayer from Indonesia as well as from offshore, which may be utilized for consumption or increasing the taxpayer’s wealth, in whatever name and form,…. “. 6 Exemption of income tax was largely given to the income of a fund established by will or instrument of trust for such public charitable purposes (given that the term “the fund was being applied for the purpose for which it was established” was 1 High Court Australia, retrieved 8 August 2013 2 It should be noted that the criteria for ‘charity’ was absence in Australian tax law.
It was set in case law. See “charity” derived 16 August 2013 3 Retrieved 10 August 2013 However, please note that various definitions may exist. 4 Tremolo, J. 2010. Tax exempt – It’s not about tax but charity. Revenue Law Journal, 20, 1-20. 5 Clark, B. 2004. The meaning of income: The implications of Stone v FACT. Revenue Law Journal, 14, 178-189. 6 Article 4 paragraph (1) Consolidation of Law of the Republic of Indonesia Number 7 of 1983 concerning Income Tax as lastly amended by Law number 36 of 2008. Satisfied) and the income of charitable entities before mid 1997.
Subsequently, income tax exemption regarding charitable institution and charitable fund become issues particularly since mid to 1997. 7 Based on Division 50 to IOTA 1997, there are nine type of entities whose their income (both ordinary and statutory) is exempted from income tax, with some special condition applied. In this section, the terms “charitable institution” and “charitable purposes” are used. The first term appears in section 50-5 Item 1. 1 with requires special conditions in sections 50-50 and 50-52. The latter term appears in Item 1. 5 and 1. B with requires special conditions in sections 50-52 and 50-57 for “fund established for public charitable purposes by will fore 1 July 1997” and required special conditions in sections 50-52 and 50-60 for “fund established in Australia for public charitable purposes by will or instrument of trust (and not covered by item 1. 5 or 1 . AAA)”. 8 Therefore, there are two main different concepts of charity that exist in these sections, a ‘physical approach’ which refers to “charitable institution” and ‘a non-physical approach’ which refers to “fund established… Or charitable purposes”. 9 Further, in section 50-52 (1) , it was stated that “An entity covered by item 1. 1, 1. 5, 1. AAA, 1. 58 or 4. 1 is not exempt from income ax unless the entity is endorsed as exempt from income tax under Subdivision 50- B. “II Further, it is essential to accurately specify the differences between a ‘charitable institution’ and a ‘charitable fund’ since the requirement to be endorsed as an income tax exempt status for a charitable fund is more demanding. 1 In search of legal interpretations of “the Fund was applied for the purposes for which it was established” The case of ‘FACT v Bargain  HCI 1 1’ is an example of a complete process, both administrative and legal process, on how interpretation issues of tax law are finally resolved. In term of duration, it took almost 7. 5 years to finalist the litigation process. In fact, the Australian Taxation Office (OAT) also considered this case is not only interesting but also significant. 2 Detail of each stage of the process is summarized in table 1 below. Based on section 50-5 Item 1. 5 B Dive 50 IOTA 1997, it is stated that exempt entity, amongst other definitions, was “fund established in Australia for public 7 See “Charitable institutions and trusts – income tax issues” retrieved 16 August 2013 8 IOTA 1997, Division 50 – Exempt entities. 9 However, it should be note that both the function of “charity” or “charitable” are not exist in this legislation.
See also no 2 10 See note no 8 11 See note no 4 2 charitable purposes by will or instrument of trust (and not covered by item 1. 5 or 1 . AAA)”. Therefore, in term of the two ‘types’ of charity entity, the foregoing case can be classified as a case which involved ‘charitable fund’ instead of ‘charitable institution’. Its category can be derived from the clause 3 of the relevant deed dated 14 October 1997 which stated that the trustees kept “the Trust Fund”, as stated in point 1 of High Court’s decision. The dispute between Mr..
Mrs.. Bargain (called as ‘taxpayer’ hereafter) and Federal Commissioner of Taxation was initially caused by an application submitted on 22 November 2 On Bengal to their position as the trustees of the “Kilos Metro Charitable Trust”, in order to fulfill required special conditions, they submitted an application to be qualified as an income tax exempt status to the Commissioner of OAT. Based on tax legislation, charity entities must be endorsed by the Commissioner to receive income tax exempt status since 1 July 2000. 3 In this case, the Commissioner found that the applicant did not satisfy a facial condition stated in section 50-60 of the IOTA 1997, that A fund covered by item 1. AAA or 1. 58 is not exempt from income tax unless the fund is applied for the purposes for which it was established… “. The Commissioner found that there were substantial violation of the purposes of the trust for which the fund is held by the trustee, such as untraceable mixed trust funds and its interest.
Also, the Commissioner revealed that there was financial misconduct by the trustees which gave them personal benefit regarding the use of trust fund to minimize a home loan liability. Table 1: The detail of litigation processes No 1 Who Bargain & Nor (as trustees of The Kilos metro Charitable Trust) / (called as ‘taxpayer’ hereafter) Federal Commissioner of Taxation (FCC of T) / The Commissioner Event Submit application for income tax exempt status When 22 November 2004 Important note The relevant deed was signed on 14 October 1997.
The requirement of exempt with effect from 1 July 2000 Refused to endorse taxpayer application 13 January 2005 3 Taxpayer Submitted application for reviewing the decision to 16 May 2005 The Commissioner stated that the use of particular transactions involving assets of he Trust (called “the Fund”) cannot be Justified as in line with the goal for which the Fund was established. 12 See “A snapshot of interesting and significant cases” retrieved 18 August 2013 13 See “Charities need to be endorsed as income tax exempt charities” retrieved 16 August 2013 14 Summarized from note no 17, 22 and 27 4 Administrative Appeals Tribunal (AT) Administrative Appeals Tribunal (AT) Revoked the Commissioner’s decision to refuse taxpayer’s endorsement 9 September 2005 5 The Commissioner Requested an appeal to Federal Court 6 Federal Court (Single Judge, Edmonds J)
Allowed the Commissioner’s appeal and cancelled the Tribunal’s decision Gave the taxpayer special leave and allowed the taxpayer to submit a cross- appeal to High Court Submitted an appeal to the High Court and requested to reinstate the decision of Edmonds J Concluded that there was an act of incompetent administration of the Fund during 2002 and 2007. The refusal of application to have endorsement of tax exempt by the Commissioner was correct and The Tat’s decision that revoked the Commissioner’s rejection of endorsement was an error. 2 June 2009 Full Federal Court (Dowdiest J, Kenny J, Middleton J) October 2010 As 9 September 2005, entitlement of endorsement as income tax exempt was given to assets of the trust (called “The Fund”) with effect from 1 July 2000 On 7 April 2008 the AT gave specific reason for declining the refusal decision of the Commissioner. The Commissioner conveyed that the case raised four legal question and eight causes of appeal.
The Judge posited that the Tribunal had erred in examining whether the Fund was applied for the goals for which it was founded. The taxpayer used this special leave to submit a cross-appeal to the High Court on 17 February appeal succeeds, taxpayer’s application should be declined. 8 Commissioner 9 Full High Court (French q, Summon J, Haynes J, Hoyden J, Cesarean J) 29 March 2012 The Judges ordered that the Commissioner’s appeal should be accepted and the taxpayer’s request for special leave to submit cross-appeal should be dismissed.
Since the Australian tax system adopts both administrative and legal processes to settle a tax disputes 5, taxpayer used his right by submitting request to review of 1 5 Woollier, R. , Barracks, S. , Murphy. S. & Evans, C. 2006. Australian Taxation Low (Sydney: ACH, 16th deed, 2005). 55-56 that rejection to the Administrative Appeal Tribunal (AT) as the initial stage of his objection. The Tribunal was established to give an administrative decision an independent review. 16 At this stage, the Tribunal have concluded , among other findings, that “… 4) Given the general evidence about the nature, purpose and extent of the Fund’s investment and administration, including the accountant’s acknowledgement of his obligation to compensate the Fund for his irregular administration, the proper conclusion is that the Fund was applied for the purposes of its establishment. 17 Therefore, on 7 April 2008, the Tribunal revoked the refusal of endorsement by the Commissioner and determined that as 9 September 2005 entitlement of endorsement as income tax exempt was given to assets of the trust (The Fund) with effect from 1 July 2000, in favor of taxpayer.
As a response, the Commissioner submitted an appeal by referring a written outline of prior tax cases and found that there were three interpretation problems on Tat’s decision. They were whether: “(1) the Fund was “established” for public charitable purposes within the meaning of section 50-5; (2) the Fund was applied for the purposes for which it as established within the meaning of section 50-60; and (3) the trustees of the Fund pursued its charitable purposes solely in Australia within the meaning of section 50-60(a). 18 On 12 June 2009, a single Judge in Federal Court stipulated a favorable decision for the Commissioner by concluding that the term “the Fund was applied for the purposes tort which it was established” was misinterpreted by the Tribunal in its examination to determine whether the required conditions were satisfied. Consequently, the Judge ordered that the Commissioner’s appeal must be accepted and the Tribunal decision’s must be annulled.
Whether the test to be applied pursuant to sis-60 of the Income Tax Assessment Act 1997 is quantitative or qualitative in nature. 4. Whether the intentions of the trustees of a fund are relevant in determining whether the fund has been “applied for the purposes for which it was established. “… “23, it was clear that the main issues the sprayer raised were interpretation problems. Eventually, nearly a year later, the Full High Court allowed the Commissioner’s appeal and declined taxpayer’s application of cross appeal.
The Judges concluded that the term “applied” of exemption provision of section 50-60 of the Act is not to be interpreted ‘generously’ since this kind of interpretation could lead to open opportunities for trustee to obtain a valuable personal benefit from its exemption status. Also, the Judges were convinced that there were misapplication and acts of maladministration of the fund which violated the purpose of the Trust.