Archive for February, 2013

Non-Profit Tax Status and Usage of Funds in Other Countries

Thursday, February 21st, 2013

A non-profit organisation collects funds in country A (let’s say: in Germany) and transfers it to an organisation in country B. Under which condition is this transfer compatible with the non-profit tax status of the donor organisation in country A? Under which circumstances is the non-profit status endangered? International literature on non-profit accountability provides a lot of information on values, but the tax perspective is often forgotten. The non-profit status is, after all, also a tax status.

In general terms, the non-profit tax status of an NPO has three possible financial implications, depending on the respective legislation:

a) Donors who give resources to the NPO receive an acknowledgement of receipt for the donation, which the donors may use in order to reduce their personal income tax.

b) The NPO is exempted from corporative profit tax. The excess amount of inflows over expenses will not be considered as profit.

c) In some legislations, NPOs are allowed to run enterprises. Even more, in some cases, the profit of these enterprises is tax free, as long it is used for the purpose of the entity, and/or VAT privileges are granted.

Evidently, these tax advantages are desirable for an entity. It is understandable that national tax authorities make these privileges subject to certain conditions. As a rule of thumb, many legislations link these privileges to a public benefit (with the exception of those legislations that are very restrictive towards the freedom of assembly). If the NPO creates a public benefit, so the common sense, the tax incentives are justified.

 In Germany, our interpretation of this overall principal is very broad. Our legislators decided that even building tiny aircraft models and testing them in public parks is – no kidding – a public benefit. And this results in associations of aircraft model makers being public benefit organisations in accordance with German law. As a result, our public parks are crowded with model planes, model hovercrafts, model racing cars. Model speedboats scare swimmers in the lakes. Model helicopters circle around people taking a walk. This example shows that the criteria of what is a public benefit are rather inclusive than exclusive in Germany.

Now, let’s move on to cross border accounting. If an NPO is testing small model aircrafts in other countries, is this also a public benefit activity in Germany? Does it matter whether the activity is a public benefit activity in accordance to the standards of the country in which the performance takes place? Would it endanger the public benefit status, if this activity was forbidden in this country? Okay, we must admit that our example is a bit absurd. (Only armies use small model aircrafts abroad, and armies do not need a public benefit status, as far as I know).

 Let’s take a look at another example: human rights. An NPO collects funds for defending human rights in country A and spends it in country B. Of course, defending the Human Rights Charter of the United Nations is an honourable thing, and accordingly, associations of this kind have undoubtedly a public benefit status in many countries of the world. If they support activities in countries where the state is less supportive, does this undermine the public benefit status of the donor? If you ask a question like this, most people will answer: “No, of course not. This was exactly the purpose why the funds were collected!”

However, if you asked a German tax inspector, whether it would be compatible with the public benefit status to support actions that are – in the framework of the state of performance – clearly and systematically illegal, he would be confused. The reason is that the tax inspector needs clear instructions, and not an ideological brain wash.

This is what our legislation says (Schauhof, “Handbuch der Gemeinnützigkeit”, 2005):

·       In case a German public benefit organisation simply exists in order to collect funds for another entity in another country, the statutes of the collecting public benefit organisation must contain a provision in its statutes that explicitly mentions the receiving entity. In any case, the receiving entity must have a similar status (i.e. a public benefit status in the country where the funds are received). The statutes of the receiving entity must be available and translated.

·       It is also possible to engage and to pay individuals in other countries, within the framework of the mission.

·       The financial administration requires that the usage of funds (which were collected in Germany) is not used “against national interests”, whatever this means. There is no special requirement, how the final usage of funds should be proven – the administration allows a “free style” reporting. (This regulation allows introducing a sense of cultural hegemony into administration. As long as the purpose of the NPO is somehow within the range of the public opinion, it seems to be okay!)

·       Compliance with laws is required. A systematic ignorance of existing laws would lead to a withdrawal of the public benefit status.

Compliance with laws is, of course, a condition precedent for the public benefit status. The question is: which laws? Typically, human rights organisations rather rely on superordinate regulations (the UN Charter, the national constitution), while their opponents, usually civil servants of the respective state, will use the full arsenal of detailed tax instructions. As a rule of thumb, we can say that human rights activists are not sacked because they are human rights activists, but because of allegations of tax evasion.

A single non-compliance with some law (either in the country of registration or in the country of performance) does, in our understanding, not justify the withdrawal of a public benefit status in the country of registration. The non-compliance must be systematic.

However, it could also be that the whole NGO sector in a country does not pay income tax on salaries – in tacit agreement. Is a donor organisation allowed to support such a practice, within its public benefit status? A strong defense could be that the non-compliance with laws resulted from the action of a person or another entity, not from the public benefit organisation’s activity itself. But did the supervisory bodies know about the practice? An audit report, indicating the non-compliance, is an argument that the controllers could have been aware of the non-compliance.

After this point, we lose track of the actual legal situation: It could be that local grassroots organisations exaggerate the dangers in the country of performance and would like to preserve their “Robin Hood” status (because of different reasons); or it could be that the dangers are real – people will actually go to prison for the sake of the mission. It could be that the supporting public benefit organisations are more or less “astroturf” NPOs , i.e. not real grassroots organisations of citizens, but extensions of the state apparatus of country A that would like to realize projects in country B. Or it could be that the supporting NPOs try to create mechanisms of self-regulation, as Alice Obrecht described in her briefing (“One World Trust”, July 2012). Who can tell under these conditions of what true grit is and what is not?

And here is the dilemma: The question of what public benefit means is a political one. Democracies have a tendency to extend the public benefit status so far that the original substance (“citizens organise themselves for a public benefit”) is no longer visible. The status is diluted, by including also non-citizens, or including  other than public benefits. The result would be that there is no longer is a clear notion of what can be regarded as public benefit.

 Like private drones in public parks.

 Frank Fabel, CPA, MA