Taxing non-profit organisations

Published October 8, 2018
— Photo/File
— Photo/File

Pakistan’s ranking on the Human Development Index (HDI), as measured by life expectancy at birth, expected years of schooling and gross national income per capita, is dismally low.

Pakistan ranked 147th among 188 countries in 2016, with 83 million people facing multidimensional poverty, over 70m having to deal with food insecurity and nearly 6m children not attending school.

In this context, the role of non-profit organisations (NPOs) is crucial for elevating the socio-economic status of people. Various NPOs are working across the country to alleviate poverty and improve social welfare. Around 240 registered NPOs are working for education, 180 for health, 81 for community development, 78 for civil and human rights, 35 for disaster risk management, 38 for promoting microfinance, 16 for protecting the environment, 30 for animal rights and welfare, 20 for research and public policy, four for promoting arts, culture and humanities and 20 for water and sanitation.

Tax authorities must ensure that only legitimate NPOs enjoy tax incentives. All NPOs are not inherently high-risk organisations

To help NPOs perform their charitable role without facing a scarcity of funds, tax laws in almost all countries provide them with relief like exemption from income tax. Likewise, benefits in the form of tax credits and exemptions are available to NPOs established in Pakistan for religious, education, charitable, welfare or development purposes.

Pursuant to Section 100C (1) of Income Tax Ordinance 2001 (ITO), NPOs that are approved under Section 2(36) of the ITO are entitled to a tax credit equal to 100 per cent of the tax payable. The tax payable is the sum of the tax payable under the normal tax regime (NTR), minimum tax regime (MTR) and final tax regime (FTR). However, in order to qualify for the 100pc tax credit, NPOs must comply with the conditions that a tax return has been filed, withholding taxes have been deducted/collected/paid, withholding tax statements for the immediately preceding tax year have been filed, and the administrative and management expenditure of the NPO in question does not exceed 15pc of total receipts.

However, this condition does not apply where total receipts in the tax year were less than Rs100m and charitable and welfare activities started within the previous three years.

NPOs are required to set off tax credit against their income from donations, voluntary contributions, subscriptions, income derived from house property, investment in securities of the federal government, and the business income expended in Pakistan in carrying out welfare activities.

Under Section 159 of the ITO, the commissioner may exempt an NPO from acting as a withholding agent under the withholding tax regime (WTR) if he or she is satisfied that all of the income of an NPO is entitled to the 100pc tax credit.

Nonetheless, from tax year 2018 onwards, surplus funds of NPOs are taxable at the rate of 10pc.

Although NPOs have to comply with the requirements under income tax rules before being awarded the status of Section 2(36) of the ITO, NPOs may deviate from the stated objectives and not always adhere to the rules at a later stage. The income tax rules stipulate that NPOs cannot be used for the personal gain of a particular person or a group of persons. Nonetheless, not all NPOs always adhere to this rule. Similarly, the rules also require that the constitution, trust deed, memorandum and articles of association, rules and regulations or the bylaws governing an NPO must provide for the prohibition of any part of its money, property or income being paid or transferred directly by way of dividends, bonuses or profits to any of its members or to the relatives of the members.

To help NPOs perform their charitable role without facing a scarcity of funds, tax laws in almost all countries provide them with relief like exemption from income tax. Likewise, benefits in the form of tax credits and exemptions are available to NPOs established in Pakistan for religious, education, charitable, welfare or development purposes

However, NPOs may be abused in different ways, including the exploitation of charitable funds, abuse of assets, misuse of name and status and engagement in an illegal or improper work. More importantly, the income tax rules require that all money, property and income from donations and charities of NPOs must be used to promote its stated aims and objectives. However, there are NPOs whose ultimate purpose is to raise funds, use their facilities or names to promote or coordinate inappropriate and unlawful work, such as terrorist activities.

The rules require NPOs to restrict the surplus money properly set aside, excluding restricted funds, up to 25pc of the total annual income. However, it has been observed that this requirement is not being observed by NPOs.

For example, the Securities and Exchange Commission of Pakistan (SECP) observed while issuing Anti-Money Laundering/Countering the Financing of Terrorism (AML/CFT) guidelines for NPOs that there are NPOs that are vulnerable to terrorism and other criminal abuse due to their global presence, in particular, NPOs operating in conflict zones or in areas with inadequate infrastructure. They engage in frequent movement of money, goods and people and often have complex financial operations with multiple donors. They are involved in investments and exchange of currencies and often receive and use cash in high volumes of small-scale transactions.

In this regard, the SECP also observed that NPOs vulnerable to terrorism and other criminal abuse are powerful vehicles for bringing people together for a common purpose and collective action, and may inadvertently provide a readymade social network and platform of legitimacy for terrorists or terrorist sentiments.

Tax authorities, therefore, are required to exercise due diligence to ensure that only legitimate NPOs enjoy tax incentives because not all NPOs are inherently high-risk organisations. Tax authorities also have to identify the high-risk NPOs which, by virtue of their activities or characteristics, are likely to be at risk for terrorist financing abuse.

Published in Dawn, The Business and Finance Weekly, October 8th, 2018

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