Why charities should take compliance with tax rules seriously

May 03, 2019 17:09
The Inland Revenue Department has undertaken tighter and more frequent reviews on charitable entities with s88 tax exemption and their compliance efforts. Photo: ISD

The Audit Committee published a report in 2017 criticizing the Inland Revenue Department for its lack of supervision and scrutiny on compliance by charities in Hong Kong which have section 88 (“s88”) Inland Revenue Ordinance tax exemption. In response, the IRD has instigated tighter and more frequent reviews on s88 entities and their compliance efforts. In 2018 alone, 370 charities had their tax exemption status withdrawn by the IRD, highlighting a serious need for better compliance.

In some cases, s88 tax exemption status was withdrawn because the charity was untraceable, dissolved, wound up, liquidated or deregistered. However, charities may also risk having their status withdrawn if the IRD does not consider its activities as falling within its charitable purpose (or the s88 proviso). Therefore, it is crucial that charities take a diligent approach in disclosing their activities in the review questionnaire from the IRD (Form C.D.1A), which has recently been updated with a wider range of questions. Some charities were struck off by the IRD purely because they were not familiar with the new requirements and failed to provide complete and satisfactory answers within the deadline.

When answering the questionnaire, charities should be particularly careful with questions relating to donations and trading activities. Trading activities are generally allowed and are tax-exempted provided that they fall under the s88 proviso. Examples of tax-exempted items include admission fees received from an art exhibition, course fees received by schools, or the sale proceeds of crafts made by beneficiaries of a charity.

Therefore, it is extremely important for charities to explicitly explain how the trading activities are compatible with its stated charitable purpose in the review questionnaire. By the same token, if the charity conducts trading activities that do not fall within its charitable objects, the charity should notify the IRD of the consequent taxable profits and also make a corresponding disclosure in the questionnaire.

In terms of donations, charities should take conscious steps to ensure that donations are made to them voluntarily, free of any contractual obligations, and that the donors do not accrue any material benefit from the donations. On the other hand, the charities should also ensure that the donated funds are only spent on activities that are aligned with its charitable objects. As evidence, the IRD will look for a clear breakdown of spending in the questionnaire. Proper usage of donated funds is essential and the IRD will heavily scrutinize the charity for this.

Needless to say, failure to properly disclose donations and trading activities is non-compliance and may prompt the IRD to withdraw its s88 tax-exempt status. However, it is not a dead-end. To retrieve tax exemption status, the charity has to provide satisfactory answers to the questionnaire, which will then be reconsidered by the IRD as a fresh s.88 application. The IRD will also look at whether profit is derived from activities conducted after the withdrawal of s.88 status to assess the charity's tax payments.

In short, charities must diligently complete the questionnaire and return it to the IRD within one month of receipt. They should apply for an extension if the deadline cannot be met. Charities should notify the IRD immediately regarding a change in its correspondence address, to ensure receipt of the questionnaire. After all the hard work involved in acting for a good cause, it would certainly be a pity to have a charity's tax exemption status withdrawn, simply due to unfamiliarity with the new compliance requirements.

Jessica Chow, Trainee Solicitor at Withers, also contributed to this article

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Consultant at Withers