On 24 February 2025, the New Zealand Inland Revenue (IRD) published an officials’ issues paper: Taxation and the not-for-profit sector (Issues Paper), with a tight deadline of March 31 for submissions. Among others, the Issues Paper outlined proposals to tax business income of charities in so far as it is unrelated to their charitable purposes and to tighten rules for donor-controlled charities. 

We welcomed the opportunity to comment on the proposals set out in the Issues Paper, but ultimately urged IRD not to go ahead with them. We have set out below a summary of our submissions.

Proposal to tax charities’ business income that is unrelated to their charitable purposes

The Issues Paper contains a number of suggestions implying that charitable trading entities have some advantages over their for-profit counterparts, putting these forward as valid reasons to tax charity business income in order to ‘level the playing field’. We submitted that none of these perceived advantages withstand scrutiny when considered more fully. For instance:

• The main perceived advantage put forward in the Issues Paper is that charities have an unfair competitive advantage as they can grow a business faster through an ability to accumulate funds tax-free and that New Zealand is an international outlier in this respect. We submitted that this is not quite the case. Australia has looked closely at its business income tax exemption for charities on a number of occasions, and consistently found that it should remain in place, disproving any merit of the perceived advantage in relation to expansion. In Canada, the authorities are responding to calls to return to an approach along the lines adopted in Australia and New Zealand, due to the stress their charities sector is experiencing around the funding gap. If we were to tax charity business income of any kind, the funding gap would be even more acutely felt here than in Canada - a country with population and a tax base many times the size of New Zealand's.
• The Issues Paper also suggests that charitable trading entities may have an ‘advantage’ over non-charitable trading entities in that they do not face the compliance costs associated with a tax obligation. We submitted that registered charities are in fact required to incur significant compliance costs in preparing the comprehensive transparency and accountability information required under the financial reporting rules. Just like their for-profit counterparts, charities are also subject to the compliance costs of tax obligations such as PAYE and GST.
• Another assumption put forward in the Issues Paper is that the charities’ ability to accumulate funds tax-free may give them lower costs in raising capital. Although the Issues Paper acknowledges that charities generally cannot raise equity capital (as private investors cannot receive a return), it does not acknowledge that charities’ ability to access debt capital is also limited. We submitted that charities often fail conventional lending criteria. They don’t have guarantors to call on and debt capital from the government or private funders is scarcely available. Arguably, the advantage rests with the for-profit sector. The ability to accumulate pre-tax funds merely offsets significant disadvantages that charities face in their ability to access sufficient capital to expand to an optimal size.

The Issues Paper proposes that only business income which is unrelated to a charity’s purposes should be taxed, but acknowledges that distinguishing such a business income from that which is related to a charity’s purposes could be difficult to achieve unless the legislation and associated guidance is clear. Our submission raised scepticism about the ability to produce clear legislation and guidance. The experience of other jurisdictions indicates that any attempt to draft around the arbitrary distinction between the two kinds of business income is in fact fraught with difficulty and has led to an ever-increasing spiral of complexity.

Donor-controlled charities

The Issues Paper proposes making a distinction between donor-controlled charities and other charitable organisations in order to have adequate oversight over the donor-controlled charities’ accumulation, distribution and investment (or any other) activities. We submitted that it is not necessary to create a new arbitrary category of this sort. If an individual charity is genuinely abusing its privileges, existing rules already provide adequate controls that can achieve the desired outcomes on an exceptions basis without resorting to arbitrary, blanket rules. As noted below, such existing provisions simply need to be used and enforced.

In relation to charities’ business income, tax legislation provides adequate control. It nullifies the business income tax exemption if a person with some control over the business is able to direct or divert an amount derived from the business to their benefit or advantage.

In any event, persons who run charities, regarded as ‘charity officers’ under the Charities Act 2005 (Charities Act), have important fiduciary duties they are subject to, pursuant to laws governing the legal form they take. For instance, it is very unlikely that a charity could purchase assets from a related party at non-market prices without breaching a fiduciary duty. Acting in breach of fiduciary duty is unlawful, and therefore already constitutes ‘serious wrongdoing’ under the Charities Act, which in turn is grounds for Charities Services to take action, including deregistration.

Charities must also undergo a rigorous process in order to register as a charity, including addressing the issue of conflicts of interest. This is strictly monitored by Charities Services.

Minimum annual distributions by donor-controlled charities

We opposed the proposal to require donor-controlled charities to make minimum annual distributions as such a requirement would be fraught with difficulty. We noted that this is evident from the strong opposition by submitters to the review of the Charities Act. In its October 2019 regulatory impact statement, the Department of Internal Affairs summarised that that the submitters thought that this option was “inflexible, did not recognise the careful planning and responses by charities, is an arbitrary intervention to an arbitrary problem, and would have significant adverse consequences on funding arrangements and behaviour”.

We submitted that a key difficulty with any minimum distribution requirement is the complexity around how it will be calculated and the elaborate definitions that will be necessary for a calculation that will be easy to understand, fair and equitable.

The rules imposing minimum distribution requirements in other jurisdictions provide a cautionary tale, not least because they were introduced in a different time and in a different context to address perceived problems that may not exist in New Zealand.

In particular, a key factor driving mandatory distribution requirements in other jurisdictions has been a desire to prevent abuses, on the basis that endowed (i.e. privately funded) charities were not subject to the same level of scrutiny as entities that receive donations from the public. However, all New Zealand charities, without exception, are already subject to comprehensive transparency and accountability requirements, providing tools of disclosure that enable scrutiny by government agencies and the public that was simply not available in countries such as Canada, Australia and the US when the minimum distribution requirements were imposed there.

General comment

Our submission’s aim was to persuade the IRD not to go ahead with the proposals set out in the Issues Paper. The proposals would necessitate putting in place a complex set of tax rules which will be difficult to enforce. They would require expenditure of scarce taxpayers’ and charities’ resources, and may not achieve the desired outcomes, such as generating meaningful additional tax revenue. Instead, we urged the Government and the charities regulator to refer to, and enforce, the current rules which provide adequate means for dealing with the issues identified in the Issues Paper.

Further, we noted that a piecemeal approach to the change of the settings for the not-for-profit sector which we have seen in the recent years is damaging to the sector. Important decisions that greatly affect the sector are being made on basis of assumptions that are not fully tested and thought through and where time for consultation with stakeholders is sorely lacking.

Charities law issues are complex and their impact on the sector and on the society as a whole is far-reaching. We submitted that before any more piecemeal changes are made, we need to ensure that the fundamentals of the charities law framework are sound. Any tax changes should be deferred until a full, independent, review of the Charities Act has taken place. This will ensure that any changes to tax law are consistent with, and do not cut across, fundamental charities law principles.

Government’s response

Speaking to media after her first pre-Budget speech, Nicola Willis, the Minister of Social Investment, Finance and Economic Growth, has confirmed that plans to push ahead with a charities tax at this year's Budget has been pushed out by a year. She said:

"We had a short consultation period - more than 900 submissions - and what officials have advised us is that there are some real complexities to work through. I'd hoped that we could make the changes by the Budget, but actually it's really important we get these changes right."

While some commentators had estimated a charities tax could collect billions in revenue, Willis said "people had overestimated what that would look like. IRD's estimate was at the most it would be worth around $50 million a year, and for that sum of money it wasn't worth taking the risk."

Having been in close touch with other submitters during the consultation period, we are not surprised that our sentiment on the proposals in the Issues Paper was widely shared among the submitters. We welcome that the Government has taken our and our fellow submitters’ views on board and await any further developments in relation to the proposals.

The proposals are ultimately a reaction to a disapproval of the behaviour of a handful of charities, but as noted in the Law Association’s recent article Critics line up against the government’s plan to tax charities (and echoed in our submission), it is not the job of the IRD and tax legislation to reign in these ‘outlier’ organisations. Ultimately, the proposals risk punishing legitimate charities with increased taxes and compliance costs. 

This alert was written by Silvia McPherson, a Consultant in our Private Wealth team.