By Adam Aptowitzer

Obviously, one of the defining features of a not-for-profit organization is that it indeed operates without the intent to pursue profit. Unfortunately, this often results in confusion for the directors, as they seek to understand the exact application of this idea in the context of pricing their services. There is a clear tension between the ability to charge more for goods or services provided by the organization, if for no other reason to put some money in the bank for a rainy day, and this most fundamental qualification of a not- for-profit. The question then arises as to whether or not such a corporation can amass assets and if so, how much?

The question is somewhat complicated by a number of factors. While it is difficult to rank the importance of these, the most practically difficult is the requirement that the directors act in a reasonable manner to safeguard the finances of the organization. Clearly then, the bias would be to amass as large as a fund as possible to protect against unanticipated downturns. Even a thorough reading of the Income Tax Act does not contradict this idea however that is not the end of the story.

The CRA’s opinion is that an organization that operates so as not to earn a profit could not, in theory, amass a large reserve due to income from its operations (absent a windfall or some other reason for a large base of liquid assets). Clearly, if an organization is given a large mass of money from its members or a donor, the CRA would not have the same level of concern. However, if an organization has priced its goods or services to earn a profit, and it is a successful business, then one would expect that there would be, over time, a large reserve developing. So, the CRA views a large reserve as a sign of a for-profit business, but this is a rebuttable presumption.

In the past the CRA’s rule was that it considered one year of operating reserve to be a baseline test for determining whether or not an organization was amassing too much money. That rule has been changed and the current rule takes into account that one year of operating reserve may not be the appropriate test in all cases. Now the CRA does not look at the simple mathematics, but rather at the purpose of the funds. For example, the CRA will look at the overall amount and question whether the corporation is a saving for a large capital purchase or if the amount is necessary to protect operations in circumstances that are logical to the situation. In some cases, that may mean one year of operating reserve and in some cases it may mean six months or three years.

The directives still aren’t clear
How then are the directors to decide what would be the appropriate amount in the circumstances that would be acceptable by the CRA? Unfortunately, there is still neither Court guidance nor further CRA opinion on this point. Clearly, if the corporation is seeking to make a large capital purchase the amount of the reserve would necessarily be the amount to make the purchase and whatever fit ups or moving expenses are required for the organization to take possession and dedicate the facility to its cause.

This is likely easier for corporations to calculate than the reserves necessary for a rainy day fund. On this, it can be taken for granted that reasonable people will disagree on the appropriate level, unfortunately if it is the CRA that disagrees the corporation could be deemed to be a for-profit, and therefore taxable organization, retroactive to the change in nature of the corporation. For this reason, directors must not only make the decision to have an operating reserve but seek professional accounting advice to determine the appropriate size of the fund. And this amount should be revisited every few years as the size of the corporation’s ‘business’ grows or shrinks, and the overall financial climate changes. While the CRA may disagree as to the final number that an accountant suggests, a corporation that has pro-actively sought this opinion will have a good basis upon which to argue that no CRA punishment should be levied.

Moreover, seeking professional advice regarding the amount of the operating reserve is in alignment with the director’s function to safeguard the organization. An operating reserve is not a luxury in a down time. It may be that when the organization hits that down time the directors will not have saved enough in order to keep the organization a float but this is virtually guaranteed if there is no reserve at all.

Adam Aptowitzer is a tax lawyer with special expertise in the law as it pertains to charities, not-for-profit organizations, and other non-taxable entities anywhere in Canada. His practice involves tax litigation for private taxpayers and charities and he has represented clients at the Tax Court of Canada, the Federal Court of Appeal and the Supreme Court
of Canada.

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