IV. Issues of Principle

25.20. Charitable organisations are regarded in most developed countries as playing an important part in the social structure and many have existed for a long time. They perform community welfare services which State instrumentalities financed from revenue would otherwise be called on to provide. They are supported by a large amount of voluntary work by private citizens who are sufficiently public-spirited to devote a significant part of their time and resources to causes they espouse, incurring expenses for which no tax deduction is claimed.

25.21. It would not be denied, therefore, that there is a case for subsidising charitable organisations from public funds. Tax concessions, by way of allowable deductions from the tax base or exemption of the income of the charitable organisation, are forms of subsidy. It is important to consider, however, whether they are the most appropriate ways of encouraging and supporting private philanthropy.

Subsidy by Deduction

25.22. If gifts are deductible from income for tax purposes, the government in effect reimburses the donor for a larger share of the gift the higher the donor's income, and this may be thought vertically inequitable, even though the donor does not reap any personal material benefit from the making of the gift. A tax credit would overcome any suggested inequity between taxpayers, but there is no empirical evidence to show at what percentage rate the credit would have to be set if the present incentive effect of deductibility were not to be reduced for high-income donors. If the percentage were put at 67, the incentive to the top marginal rate taxpayer would be unchanged, lower marginal rate taxpayers would have greater tax incentive, and there would be an increase in the total subsidy. If the percentage were put at a figure lower than 67, some higher rate taxpayers would have less tax incentive to give, some lower rate taxpayers would have more, but the outcome for total contributions to charity, and the resulting total subsidy, would be difficult to estimate.

25.23. In the United States it has recently been proposed by some that, in place of the allowing of deductions to the donor, there should be a matching subsidy from

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public funds equal to the whole or part of the donor's gift, the subsidy going directly to the charity. This would be similar in principle to the United Kingdom system, but would have a wider operation. Under a deduction system, as already explained, a donor on a 60 per cent marginal rate who makes a gift of $100 in effect gives $40 to the charity himself and acts as agent in the giving of a further $60 from public funds. If the allowable deduction were withdrawn, the donor would presumably still be prepared to give $40; and in that he might give more than $40, say $50 or $60, the government grant to the charity could be reduced to $50 or $40 to produce the same yield to the charity. Surveys in the United States of the effect on donors of replacing deductibility by government grants have produced varying evidence, the point being to determine by how much of the tax subsidy the donor would reduce his gift in the absence of the subsidy. The donor might feel less secure about the direct grant than he does about the tax subsidy, and this factor, together with a fear of more government intervention, would affect the extent to which donors would reduce contributions in the changed circumstances envisaged. It should be borne in mind too that whenever a donor contributes, the charity receives the gift there and then. With pay-as-you-earn and deductibility, the donor waits until he is assessed before getting the subsidy, whereas under a direct grant system the charity must wait to receive the grant. The possibly greater administrative costs of a direct grant system over a deduction system must also be considered.

25.24. Similar considerations bear on the question of whether the exemptions of gifts from the gift and estate duties are appropriate ways of subsidising charities.

25.25. In summary, a change from the present deduction system to a rebate system would overcome the objection by some to the deduction system that it is vertically inequitable. A change to a direct grant system would not only overcome this objection but could give government much greater flexibility in settling the amounts of subsidies going to particular charities. However, any change is likely to involve a smaller subsidy than at present in the case of a gift by a high-income or large-fortune taxpayer, and he will thus have less encouragement to make gifts. And it is fair to assume that these taxpayers are the principal source of donations.

25.26. The objection in terms of vertical equity is, in the Committee's view, not a strong one, because a donor cannot be said to obtain a personal material benefit from the making of a gift. And the lesser flexibility in setting amounts of subsidies which a deduction system involves compared with a direct grant system may be seen as offset by the greater encouragement to make gifts which a deduction system may involve. Until empirical evidence is forthcoming showing how far a change would encourage or discourage the making of gifts, the Committee believes that the present deduction system should be retained.

Subsidy by Exemption of Income

25.27. Two objections might be made to exemption of income as a method of subsidising the activities of a charity. The first is that the amount of subsidy given by the exemption depends on the amount of income derived by the charity and not on a judgment as to the charity's worth and needs. The second relates to the case where commercial activities are undertaken by charities: other organisations engaging in similar commercial activities are placed at a competitive disadvantage.

25.28. The first objection is answered by saying that, except in the special cases with which the second objection is concerned, charities are non-profit organisations with

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little or no income apart from investment income. The exemption of investment income is a further encouragement to donors whose gifts when invested generated that income, and an addition to the subsidy from public funds which accompanied the gifts to the charities.

25.29. In the Committee's view the exemption of the investment income of a charity can be justified as flowing from the encouragement to donors to give to charities and the supporting of the subsidies which are the method of encouragement.

25.30. The objection in terms of competitive disadvantage of other organisations engaged in similar commercial activities has led, as mentioned in paragraphs 25.13–25.16, to measures being considered, and in some countries taken, to tax certain parts of the income of charities.

25.31. In considering the points for and against levying tax on income, the Committee is aware that some charities conduct activities such as schools, hospitals and laundries which are staffed wholly or partly by those whose everyday work reflects both their charitable calling and their professional training, supported in some cases by those who need rehabilitation or special supervision. Other charities conduct distinct activities such as food processing or book selling which are business undertakings though they may have some features distinguishing them from their competitors.

25.32. In many instances an element of unfair competition no doubt exists, but dealing with it poses problems. One method would be to bring to tax all income of all business activities. This would be inappropriate, however: it would cover, for example, the income of a public hospital conducted by a charity, when such a hospital is unlikely to be competing in any significant way with a private enterprise.

25.33. A second method would be to bring to tax income from business operations not carried on as part of the principal activities of the charity. On this basis, the public hospital income might escape but the income from a sheltered workshop manned by the physically handicapped, whose gainful employment is necessary for medical therapy, might not.

25.34. A third method would seek to tax income from activities competing with ordinary enterprises. Such a basis would be undesirable: the Commissioner would be required to rule on competition which might vary from one situation to another and over the course of time.

25.35. A fourth method would tax business income not applied for the main purposes of the institution. This method accords with the British law referred to in paragraph 25.15. It would tend to limit the business activities of charities generally.

25.36. Any method which brings to tax part of the income of a charity will involve difficulties, both for the charity and for the Commissioner, in segregating those items of expenditure to be allowed as deductions.

25.37. There is, however, a need for a close examination of the activities of charities to determine whether business income should continue to be exempt. If it appears that unfair competition with non-exempt persons results from exemption, specific measures should be introduced to qualify the exemption. These measures would limit the exemption to income from business activities directly related to the carrying out of the purpose for which the charity was established and which is the reason for its exemption from tax. There might be a proviso which would allow the exemption

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where the work in connection with the business is mainly carried out by the beneficiaries of the charity. If such measures are adopted, it will be necessary to qualify the exemption of investment income so that it does not extend to income received from another body in which the charity holds more than a specified interest; and it might also be necessary to deny a deduction to that body for gifts to the charity. Otherwise a company might be set up by the charity to conduct business activity and its profits escape tax because of interest payments to the charity or because of gifts made to the charity. There would not be any need to deny the exemption in relation to dividend income received from that company. The income from which that dividend will have been paid would have been taxed in the hands of the company. In any case to deny the exemption would bring about a discrimination between a trust for charitable purposes which would pay tax on its dividend income and a charity which is a company which would be entitled to a rebate of tax on dividends received.