Sweeping changes to the way charities and not-for-profit organisations are taxed in New Zealand, proposed by the government’s tax agency, Inland Revenue (IRD), have drawn sharp criticism from sector leaders and tax experts who warn the reforms are ill-defined, lack supporting data, and could significantly harm the country’s vital third sector.
An officials’ issues paper, “Taxation and the not-for-profit sector,” released by Inland Revenue outlines proposals that represent the most significant potential shake-up in the taxation of these organisations since 1940. The paper explores taxing business income deemed unrelated to a charity’s core purpose, introducing stricter rules for charities controlled by their donors, and removing several long-standing tax exemptions for specific types of not-for-profits.
The deadline for submissions on the complex proposals was 31 March 2025, with indications that policy decisions could follow swiftly for inclusion in the government’s Budget announcement on 22 May 2025.
Taxing charities’ ‘unrelated’ business income
The headline proposal seeks to limit the current broad tax exemption for income derived from charity-owned businesses. Since 1940, such income has been tax-exempt provided the charity’s purposes are carried out in New Zealand – a “destination of income” approach. The proposal would restrict this exemption only to business activities directly related to the charity’s charitable purpose.
Income from ‘unrelated’ business activities would become taxable, although IRD suggests mechanisms for relief could apply. These might include allowing deductions when funds are distributed to the parent charity or creating special memorandum accounts allowing tax credits when accumulated profits are later used for charitable purposes. Officials suggest a de minimis threshold, potentially based on financial reporting tiers, could limit the impact to larger charities – perhaps affecting around 1,300 of the country’s 29,000 registered charities.
However, this proposal faces strong headwinds. John Cuthbertson, tax leader at Chartered Accountants New Zealand (CA ANZ), described the potential requirement for charities to pay tax and then claim it back as imposing a “significant administrative burden.”
“The issue had been around for about two decades,” Mr Cuthbertson noted, adding there was a perception some charities gained an unfair advantage. “We are not sure whether that perception holds true. The reality here is the data that is being looked at is not all that great.”
Crucially, Inland Revenue’s own issues paper refutes the idea that the current exemption provides a competitive advantage. “Although the exemption does provide a tax advantage it does not provide a competitive advantage,” the paper states, a conclusion supported by previous reviews and highlighted by legal experts at MinterEllisonRuddWatts (MERW).
The IRD’s officials’ issues paper frame the decision as political: “whether charity business income unrelated to charitable purposes should be subject to tax therefore depends on the level of support that the Government wants to provide to charities.” Liam Sutherland, a solicitor at MERW, noted this could be viewed as the government effectively “borrowing (at no cost to itself) from the charities sector,” while acknowledging it aligns the timing of tax benefits with non-charity-owned businesses.
Philanthropy New Zealand (PNZ), the peak body for grantmakers, stated in its submission that it agrees with IRD’s analysis that there is no competitive advantage and therefore “no justification for change.” PNZ warned the change could stifle economic growth, discourage charities from diversifying income streams, and potentially create an investment bias towards lower-return passive investments if those remain tax-free, further exacerbating issues like the non-refundability of imputation tax credits for charities.
Defining what constitutes “unrelated” business activity is another major hurdle. “Around the world, it’s proven very hard to define this,” Mr Cuthbertson said. PNZ added that introducing new definitions adds complexity and costs, likely leading to legal challenges.
Crackdown on ‘donor-controlled’ charities
Another key proposal targets “donor-controlled charities” – those controlled by the donor, their family, or associates. IRD’s concern centres on individuals accessing the same tax concessions (like donation tax credits) as if donating to an arm’s-length organisation, creating risks like “circular arrangements.” An example cited involves a donor gifting money, claiming a tax credit, and the charity immediately investing the funds back into the donor’s businesses.
To counter this, officials propose either restricting the types of investments these charities can make and mandating arm’s-length transactions with associates, or introducing a minimum annual distribution rule, forcing these charities to disburse a set percentage of assets or income each year.
PNZ expressed concern that these changes could negatively impact philanthropic giving and questioned the need for new rules, pointing to existing tax avoidance provisions (like section BG 1 of the Income Tax Act) and enforcement powers under the Charities Act. “PNZ believes that instead of adding complexity and increased compliance costs… the existing enforcement options should be used,” their submission stated. They also warned that defining ‘donor-controlled’ could inadvertently capture legitimate organisations, such as some Māori entities established via Treaty settlements, and that minimum distribution rules could force charities to “waste funds on unworthy projects because of an arbitrary statutory timeline,” especially those undertaking long-term projects or holding endowments. CA ANZ echoed concerns about accumulation, noting charities often have valid reasons, like saving for new facilities.
Simplification and integrity measures questioned
Chapter 4 of the IRD paper addresses other integrity and simplification issues. A potentially far-reaching proposal involves removing tax concessions for mutual associations (like clubs, societies, and industry bodies), stemming from draft IRD guidance suggesting member transactions and some subscriptions should be taxable. This could impact approximately 9,000 NFPs, according to IRD.
The paper also proposes removing specific, often long-standing, income tax exemptions for:
Local and regional promotional bodies
Herd improvement bodies
Bodies promoting scientific or industrial research
Veterinary service bodies
Non-resident charities with no NZ charitable purpose
The rationale cited is that these historical exemptions may no longer be fit for purpose and are inconsistent with New Zealand’s broad-base, low-rate tax framework. MERW questioned the selective targeting, noting other exemptions like those for amateur sport promotion or tertiary institutions remain untouched. PNZ warned removing some exemptions could negatively impact government agendas like economic growth and tourism.
The FBT (fringe benefit tax) exemption for benefits provided to charity employees carrying out charitable purposes is also under review, potentially removing a valuable tool for charities competing for skilled staff.
Sector calls for pause and better process
A common thread in the responses from PNZ and CA ANZ is deep concern about the process and lack of robust evidence underpinning the proposals. PNZ highlighted the “fast-track” process, short consultation timeframe on complex issues, and “weak problem definition,” arguing it undermines the credibility of the proposals.
“We recommend growing understanding and strengthening any problem definition, options and proposals,” PNZ urged, calling for joint research, development of a social enterprise framework, and strengthening philanthropic incentives like donation tax credits and addressing imputation credit refundability.
Mr Cuthbertson stressed the need for better data before making potentially damaging decisions. “Our preference is that we get much better data on the charities sector, before decisions are made that could compromise the huge benefit that charities deliver to many of New Zealand’s most vulnerable communities.”
Both organisations suggested that misconduct issues are better addressed through existing mechanisms within the Charities Act rather than broad tax changes.
With potential policy decisions looming ahead of the May Budget, New Zealand’s charities and not-for-profits face a period of significant uncertainty. The sector’s plea is for a more measured, evidence-based approach to ensure that any reforms genuinely improve the system rather than inadvertently crippling organisations vital to the country’s social fabric and economic wellbeing.
