Recent activity in the not-for-profit sector has made it clear that many organisations are beginning to operate in a more commercial manner.
With such changes occurring, not-for-profit organisations may wish to consider how to best protect their assets. Commercial ventures can, in some instances, create environments in which it is possible that customers or other third parties will sue, increasing the importance of asset-protection. Equally, the commercial activities run by not-for-profits can generate significant income, which is important to protect.
Separation of Operation and Assets
One of the foremost ways in which an organisation can protect its assets is by separating its structure into essentially two arms – an operational arm, and an asset-holding arm. The simplest way to do this tends to be by setting up a subsidiary organisation, or even several subsidiaries. Following the restructure, one of the entities in the corporate group can hold particular valuable (or even all) assets, and the other entity can run all of the operations.
If an organisation is to be sued, it almost invariably arises from its operations. If the organisational entity is sued, and the valuable assets are held by another asset-holding entity, it is less likely that the assets will be exposed in a litigation context. This is not always guaranteed, however, due to various legislative provisions. It is recommended that organisations seeking to restructure in order to protect their assets seek legal advice on how to best do so.
Types of Restructure
The seemingly most straightforward way of facilitating such a restructure is to keep all of the current assets in the existing entity, and to create a new entity (as a subsidiary) to which the operations will be transferred.
The benefit of this approach is that fewer items and assets need to be transferred, which can be logistically simpler. In this approach, some assets will still need to be transferred (or licensed) to the new subsidiary, such as intellectual property and employees, but this is not as complicated as needing to transfer across all assets.
Transfer of certain types of assets can attract significant taxation implications, such as stamp duty, capital gains tax, and possibly GST. Keeping the assets in the already established entity can help to mitigate this, by lessening what needs to be transferred (thereby potentially minimising any taxation liability). Before effecting a restructure, the taxation implications should be considered with reference to the types of assets being transferred, in which jurisdiction, and which laws will apply.
If an organisation does not currently hold significant assets, but plans to hold more in the future (such as real property), then the organisation may alternatively prefer to set up a new subsidiary to purchase assets, with the existing entity continuing to run the operations. Under this model, the new subsidiary can make its assets available to the current entity, through documented agreements such as leases or licences. The benefit of this approach is that fewer administrative changes will be required for the current operational entity. It will not, however, be appropriate if significant assets are already held in the corporate group.
Not-for-profit Status
When an organisation separates its assets and operations between two entities, once the new structure is set up it is almost inevitable that the two organisations will need to freely move assets between each other.
For instance, if the asset-holding entity holds the organisation’s monies, it may need to distribute these funds to the operational entity to allow the organisation to be able to fund its activities. If one entity in the group is a charity, it will need other entities to also be charities in order to legally make distributions to them. Charitable status provides taxation benefits, in particular if one is a deductible gift recipient.
This raises the question of whether moving monies or assets between the entities in the group will affect either entity’s charity status. Particularly relevant is that in such a structure, the parent will be a member of the subsidiary; charities are generally forbidden from making distributions to their members.
However, under taxation law, there is an exception for charities that make distributions to charitable body corporate members which have similar objects. In such a parent/subsidiary relationship, it is foreseeable that both will have similar (or even the same) objects, as they are both part of the same larger charitable group. This will allow them to legally make distributions between each other.
The ‘Word Investments Case’
In a corporate group following an asset-protection restructure, the asset-holding entity will essentially only exist to make its assets available to the other entity in the group.
The High Court case of Commissioner of Taxation v Word Investments Ltd [2008] HCA 55 (known as the Word Investments Case), considered the issue of whether an organisation that only fundraises for other charities, rather than directly conducting charitable activities itself, still has charitable objects and is eligible to have charitable registration.
This case stands as authority that such an organisation can be registered as a charity. This extends to particular types of charities; for instance, an organisation can be a public benevolent institution if its purpose is to raise funds for other public benevolent institutions. The same is also true for health promotion charities.
The relevant consequence of this is that an asset-holding subsidiary can still be a charity if it has charitable objects and only applies its funds for those objects, even if it does not directly conduct charitable activities.
Potential Taxation Issues
As mentioned above, there can be significant taxes that apply in a restructure. However, there are exceptions that can apply, which require detailed consideration on the particular facts.
The exception to GST of a ‘sale of a going concern’ can apply to a transfer where the transferor gives (or makes available to) the transferee everything that is needed to run the business. This can be difficult to satisfy, as if anything required to run the business is not transferred, then it may not be a sale of a going concern.
There are also stamp duty concessions for certain charities. Charities should bear in mind that as stamp duty is a state tax, ‘charity’ is not defined the same as by the Australian Charities and Not-for-profits Commission. An organisation that is a registered charity may not be considered a charity (or sometimes even a not-for-profit) under the relevant state Duties Act. Only the transfer of certain types of assets gives rise to stamp duty, so this may not be an issue to begin with.
We recommend that an organisation which is seeking to restructure in order to protect its assets seeks legal advice on the various implications, such as protection in litigation, and also the taxation consequences.
This article was written by John Vaughan-Williams, Lawyer.
