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.