2022-0953121E5 Taxable subsidiary of a 149(1)(l)

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Would an organization that otherwise qualified for the tax exemption under paragraph 149(1)(l) of the Income Tax Act continue to qualify if it transferred some of its assets to a taxable subsidiary that it incorporated in Canada ?

Position: Not likely.

Reasons: Based on the information provided, the organization would not be operated exclusively for any purpose other than profit.

Author: Mahendran, Ananthy
Section: 149(1)(l)

XXXXXXXXXX                                                                 2022-095312

                                                                                         Ananthy Mahendran

August 30, 2023


Re: Taxable subsidiary of a 149(1)(l) organization

This is in response to your correspondence of October 17, 2022, in which you asked whether an organization (“AbcCo”) would continue to qualify for the tax exemption under paragraph 149(1)(l) of the Income Tax Act (the “Act”) if it transferred assets (primarily intellectual property) (the “Assets”) to a taxable corporation that it incorporated in Canada (“SubCo”).

In this letter, unless otherwise expressly stated, all statutory references are to the provisions of the Act.

Specifically, you asked whether AbcCo would continue to qualify for the tax exemption under paragraph 149(1)(l) in the following three scenarios:

* AbcCo has voting control of SubCo (that is, SubCo is a subsidiary of AbcCo).

* AbcCo does not have voting control of SubCo.

* AbcCo takes back fixed-value preferred shares of SubCo in exchange for the transfer of Assets.

Our Comments

This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R12, Advance Income Tax Rulings and Technical Interpretations.

In general terms, paragraph 149(1)(l) provides that the taxable income of an organization is exempt from income tax for a period throughout which the organization meets all of the following conditions:

* it is a club, society or association;

* it is not a charity;

* it is organized and operated exclusively for social welfare, civic improvement, pleasure, recreation or any other purpose except profit; and

* its income is not available for the personal benefit of a member or shareholder.

Hereafter, referred to as a tax-exempt NPO.

As noted above, to be a tax-exempt NPO, an organization must be organized and operated exclusively for any other purpose except profit. According to the decision rendered by the Tax Court of Canada in Tourbec (footnote 1) , the word exclusively must be given its full effect and it is not sufficient that an organization should be organized mainly or primarily or chiefly for any purpose other than profit, it must be organized exclusively for that purpose. The use of the word exclusively therefore indicates that while an organization may have many purposes, none of those purposes can be to earn a profit. Thus, where an organization intends, at any time, to earn a profit, it will not be a tax-exempt NPO even if it expects to use or actually uses that profit to support its not-for-profit objectives.

The fact that an organization incorporates and holds the shares of a taxable subsidiary will not, in itself, cause the organization not to be exempt from tax under paragraph 149(1)(l). An organization claiming an exemption under paragraph 149(1)(l) must operate exclusively for any purpose other than profit. Generally, we consider that an organization earning incidental profit that arises from activities directly connected to its not-for-profit objectives does not have a profit purpose.

However, if an organization holds shares to earn income from property, it will be considered to have a profit purpose where the income is not incidental or not arising from activities directly connected to its not-for-profit objectives. This is so even if the income from those shares is used in furtherance of the organization’s or another organization’s not-for-profit objectives. The destination of funds argument has been rejected by the CRA and the courts on numerous occasions for both charities and tax-exempt NPOs.

Generally, an organization that holds long-term investments such as shares in a corporation does so to earn income from property, and therefore could not be considered to be operated exclusively for a purpose other than profit, even if the income from those investments are used in furtherance of the organization’s not-for-profit objectives. Furthermore, as indicated in your correspondence, SubCo’s activities would have the potential to generate income in excess of AbcCo’s current operational needs and are expected to generate a surplus in terms of revenues exceeding expenses. This is an indicator that the income is not incidental and AbcCo has a profit purpose for its investment in SubCo.

As you noted, the CRA has not expressed a view on whether a tax-exempt NPO can co-invest with others in a taxable corporation without jeopardizing its tax-exempt status under the Act. In our view, an organization’s investment in a taxable corporation will indicate a profit purpose where:

* the taxable corporation’s activities are not connected to the organization’s objectives,

* the organization does not control the corporation,

* the organization holds fixed-value preferred shares of the taxable corporation, or

* other shareholders have invested in the taxable corporation to earn a profit.

Whether AbcCo is a tax-exempt NPO for any specific time period is a question of fact that can generally only be determined after the end of the organization’s fiscal year, and considering all of the facts. Based on the information you provided to us, it is our view that, even if AbcCo was determined to be a tax-exempt NPO before its investment in SubCo, it would not continue to be a tax-exempt NPO as the investment appears to have been made to earn income from property (i.e., a profit purpose).

We trust the above comments will be of assistance.

Yours truly,

Ms. Nerill Thomas-Wilkinson, CPA, CA
Non-Profit Organizations and Indigenous Issues
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch


Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 Tourbec (1979) Inc. v. M.N.R., [1988] 2 C.T.C. 2071, 88 D.T.C. 1439

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