Why Even Have an Unrelated Business Income Tax?

Nowadays we pretty much take for granted that an activity does not merit tax exemption just because the profits are fed to a charitable activity.  That's why we have IRC 502 and 511, taxing feeder organizations and unrelated business income.  But that's not always true for former British colonies whose common law traces back to the Statute of Charitable Uses.  I am not even sure it's true in Britain.  In the UK, "charity shops" are basically normal retail establishments, the profits from which are not taxed because they are devoted to charitable uses.  Brody, et. al. reported not too long ago that unrelated trade or business is taxed in the UK only if it is likely to harm the charitable purpose.  It's only a recent phenomenon -- certainly no earlier than 2011 -- that Australia began taxing unrelated business income.  And New Zealand is only just now thinking about doing the same. Here is an interesting extended excerpt from The [New Zealand] Press:

New Zealand’s $80b tax-exempt charities sector is in the Government’s sights, but those running multimillion-dollar businesses within it are fighting back. Most of the country’s 29,000 charities are small, but some such as private schools and corporate iwi enjoy vast wealth and tens of millions of dollars in revenue each year, much of it from commercial interests. All those The Press spoke to this week argued this did not make their charity a business.

“You’re either charitable or you’re not,” Christ’s College board chair Hugh Lindo said. The Government has made a point this term of singling out the charities sector when discussing tax policy. In April, Prime Minister Christopher Luxon said he was open to reviewing tax exemptions for churches. (Charitable status is granted to organisations if its purpose is to relieve poverty, advance education or religion, or perform any other activity “beneficial to the community”. This exempts them from income tax and grants other concessions like tax credits on donations.) Last month, Finance Minister Nicola Willis was more explicit, telling the Finance and Expenditure select committee she was concerned not all charities were behaving charitably: “We don’t want to see [tax concessions] being exploited for activities which are more commercial in nature.”

“More commercial in nature” is the sticking point. On the face of it, Christ’s College looks wholly commercial. Its most recent annual report put its equity at $131m. In the year to January it earned $33m in revenue and in March added another $6.5m to its coffers from the sale of 21.5ha at Worsley Spur to a developer, weathering a $959,000 penalty interest bill in the process (the $12m sale dates back to 2022).

But the quantum of money isn’t the point, Lindo said. It’s what a charity does with it. “You should be free to generate your revenue for [a charitable] purpose from multiple sources,” he said. “What business has Christ’s College got in being a commercial landlord? My response is we’ve got a range of investments…[and] we apply all of those investments and assets to a single purpose ‒ educating young men.”

Since the earthquakes, Christ’s has divested most of its property portfolio, retaining only its Kimihia site near Lincoln that houses PGG Wrightson’s seed research centre and earns $730,000 a year in rent. Lindo said the Christ’s College Foundation has about $60m in capital reserves ‒ a perpetual fund to pay for its scholarship programme ($1.6m in the year to January) and keep the school running.

If taxing nonprofit business is so fundamental to charitable tax exemption, why is it of only recent vintage in the United States, relative to tax exemption overall, and why is it so tenuously enforced in the UK and in her former colonies? Surely, the unrelated business income tax doesn't bring in much revenue wherever it's enforced.  Still, I wouldn't suggest repealing it in the United States or that New Zealand pass on the effort. 

I guess maybe having an unrelated business income tax is a negative way of defining charity, useful for that purpose even if it brings in very little compared to total tax revenues.  Maybe the tax just helps discourage charities from coloring outside the lines in their charitable pursuits.  

darryll k. jones