High Court Delivers Decision in
Commissioner of Taxation v Word Investments Ltd
On Wednesday 03 December 2008 the High Court handed down its decision in Commissioner of Taxation v Word Investments Ltd. The High Court ruled, by a four to one majority of justices, that the Commissioner's appeal against Word Investments Ltd’s application for Income Tax Exempt Charity ("ITEC") endorsement was denied. The decision has significant and sweeping implications for the not-for-profit sector, as outlined in this Charity Law Update.
The Facts before the High Court
Word Investments Ltd ("Word") was founded as a company limited by guarantee by members closely associated with Wycliffe Bible Translators (Australia) ("Wycliffe"). Wycliffe was engaged in the training or dispatching of missionaries overseas, the publishing of the Bible and the preaching of the gospel. Wycliffe enjoyed recognition from the ATO as an Income Tax Exempt Charity. Word did not conduct such activities itself directly, but instead conducted both an investment business and a funeral business. The profits of such businesses, after operating expenses, were given to Wycliffe, and other similar Christian organisations.
The Issues to be Decided by the High Court
The majority judgement considered that the facts of the case posed the following four issues for determination:
1) whether Word is prevented from being a "charitable institution" by reason of the fact that its objects are not confined to charitable purposes;
2) whether an entity which conducts a commercial activity for profit is a charitable institution because it distributes, its profits to charitable institutions;
3) whether Word is prevented from being a "charitable institution" because the institutions to which it gave its profits "were not confined as to the use to which they may put the funds distributed to them"; and
4) whether Word is prevented from being endorsed as an ITEC on the ground that it does not have a physical presence in Australia and that, to that extent, it does not incur its expenditure and pursues its objectives principally in Australia.
The High Court held in favour of Word by a majority of four to one justices, with Justice Kirby being the sole dissenter. The majority judgment's consideration of each of the four issues is set out below.
The Court held that the inclusion of clauses within Word’s memorandum of association empowering Word to 'carry on any business activity' and to invest funds did not state an object in itself, but merely created a 'power' to be utilised 'in aid of its charitable purposes'. Accordingly, the dominant objects of Word remained charitable. The Court noted that "to point to the goal of profit and isolate it as the relevant purpose is to create a false dichotomy ... The activities of Word in raising funds by commercial means are not intrinsically charitable, but they are charitable in character because they were carried out in furtherance of a charitable purpose."
It is important for our Clients to note that the majority also upheld the requirement that an ITEC endorsed entity self-assess its continuing ability to meet the requirements of endorsement in each given taxation year. We note that an entity may lose its ITEC endorsement where its purposes can no longer be regarded as charitable.
The Court ruled that an entity which does not conduct any significant charitable activities itself but, rather, conducts a commercial activity for profit can be a charitable institution where it distributes, its profits to charitable institutions. In so doing, the majority provided the following helpful analogy:
"One case would arise where a company limited by guarantee which had religious charitable objects organised itself into two divisions, one of which employed the company's assets to make profits, the other of which spent the profits on those objects. A second case would exist where a company limited by guarantee had the same objects and made the same profits, but gave them to other organisations which spent them on those objects."
The majority held that both of the above companies would meet the requirements of endorsement for ITEC.
The majority ruled that the distribution of profit by Word to Wycliffe and similar institutions was made with sufficient control to ensure its expenditure on charitable purposes, based upon the following reasoning:
1) Word's memorandum of association did not authorise payments to entities which were free to the use of the funds as they saw fit; and
2) a transfer of money intended for charitable purposes to another corporation established exclusively for charitable purposes will be sufficient to ensure such charitable purposes are met.
The Court noted that this would not be the case where "the transferor knows or ought to know that the money will be misapplied by the transferee."
The majority held that whilst section 50-50 of the Income Tax Assessment Act 1997 (Cth), requires that Word “has a physical presence in Australia and, to that extent, incurs its expenditure and pursues its objectives principally in Australia" the section does not require the profits paid by Word, to be expended by their recipient in Australia. Word satisfied the requirement of the Act, by incurring its expenditure and pursuing its objectives principally in Australia and in making the payment of profit to Wycliffe in Australia. It was not a requirement of Word's endorsement that Wycliffe and the other institutions to who Word made payments also incur their expenditure and pursue their objectives principally in Australia.
The Consequences of the Judgement
Organisations who are currently operating related structures and who have received an unfavourable determination on an application for ITEC status for a profit-generating entity may wish to give consideration to the submission of a fresh application for ITEC endorsement. It will be important for such organisations to give specific consideration to the objects of the profit-generating entity in making such application. It is recommended that legal advice be sought in this regard.
Organisations which are currently considering structuring through a series of related corporate or unincorporated structures with the intent of distinguishing profit making entities to gain ITEC status may wish to give further consideration to the rationale for separate entities. In making such determinations consideration should also be given to your specific asset protection requirements, and it is recommended that legal advice be taken where structuring is being considered.
It is finally noted that the ATO has issued a statement undertaking to 'move promptly to analyse the decision and implications for implementation.' The High Court judgement effectively exhausts the Commissioner’s avenues of appeal. Legislative reform to curtail the effect of the decision may be yet be considered by the ATO.
DISCLAIMER: This update contains general information only. It is not all inclusive and should not be considered legal advice. You should always obtain legal advice for your specific circumstances before relying on general information.