Any city or town of any size will have a hospice shop selling second-hand furniture, books and clothes. The shop will be a permanent establishment, carrying on business like other such shops and will have at least some paid employees. However, the owner of the shop will invariably be a registered charity with the purpose of providing aid and comfort to the dying.
Accordingly, under New Zealand law, the income generated by the hospice shop will not attract income tax. That’s because we tax profit in New Zealand and charities don’t make profits. At least in the sense that such organisations are not allowed to accumulate and distribute assets for private pecuniary gain.
There is a populist argument that businesses run by charities benefit from an unfair advantage due to their tax-exempt status. The reasoning goes that, since these entities do not pay income tax on the profits generated from their operations, they can decrease prices below the breakeven point for their rivals or reinvest a larger portion of their earnings back into the business.
We are hardly the first country to have experienced such complaining. All the way back in 1950, the United States attempted to address the issue with an “Unrelated Business Income Tax”, which was designed to level the playing field between charities and for-profit entities.
The UBIT captures income derived from commercial activities that are not substantially related to the purpose that justifies the organisation's tax-exempt status. So, for example, if a university owns a farm or a bakery then, since the activities of those businesses do not contribute directly contribute to its educational mission, the income generated by them is subject to tax. In theory, this ensures that the university does not have an unfair advantage over for-profit farms and bakeries.
That’s the theory. What’s the experience?
Well, it’s made a lot of money for lawyers and accountants. They have had a lot of fun arguing about what is what is not a related business activity. It’s increased the administrative and regulatory burden on charities. It’s raised very, very small amounts of revenue for the US government.
And it’s generally failed to live up to the aim of addressing the actual policy concern it was set up to address.
John D. Colombo, an American legal scholar of charitable tax exemptions, points to a wide consensus of experts that shows that concerns about charities engaging in predatory pricing or aggressive market expansion have always been overblown. The reason is pretty simple: charities and for-profit businesses are not motivated by the same things. Charities are primarily motivated not by profit-maximisation but by their charitable missions.1
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