Are charities a vehicle for tax avoidance?

A recent decision of the Federal Court has highlighted that although using charities in Australia for tax avoidance purposes is not common, it can happen.

In February 2015, the Federal Court awarded the highest monetary penalty ever handed down against a taxpayer. The amount was $1.5 million. The court awarded civil penalties to the Australian Taxation Office (ATO) against Stephen Arnold, Leaf Capital and Donors Without Borders because they attempted to exploit the tax system by generating deductions for gifts to overseas charities to which their clients were not entitled.

In essence the arrangements, which dated back to 2009 and 2010, were that donors would enter into an agreement under which they paid 7.5% of the cost of certain drugs to be used in the treatment of HIV/AIDS in Africa.

These drugs were held in a warehouse in the UK. The balance of the purchase price of 92.5% was not payable until 50 years later. This meant that an initial outlay of $150 would technically enable a donor to claim a tax deduction of $2000.

A further issue at play was that these pharmaceuticals were never actually delivered to the African charities noted in the agreements with the donors.

In delivering his judgment, Justice Edmonds noted at least five grounds why the scheme was not available under the law, including that there was no actual delivery of the pharmaceuticals to the charities concerned at the relevant time and that the purchasers only paid 7.5% of the grossly inflated price of the drugs, yet claimed tax deductions of 100%.

Not only was there significant tax avoidance occurring in this series of arrangements but the judge also felt there was real immorality and a lack of any sense of contrition in the scheme promoters.

In coming to his conclusion Edmonds said: “Specific deterrence is a significant factor where, as here, the contraventions involved deliberate wrongdoing, sustained denials of contraventions and lack of remorse.”

He went on to state that “the penalties need to be substantial enough to persuade potential promoters that it is not worth the risk of whether a tax exploitation scheme will escape the detection by the Commissioner”.

But have these tax avoiders learnt their lessons? Interestingly, they had tried the same scheme in Canada in 2009. At that time, Canada’s equivalent of the ATO, the Canada Revenue Agency, had revoked the registration of the entity involved in the scheme on the grounds that the amounts claimed for the costs of the drugs were grossly inflated.

Yet, the Donors Without Borders website is calling for public support, claiming that almost $7 million worth of medicine was donated and delivered to sub-Saharan Africa in 2010, and that the ATO is trying to stop life-saving goods from reaching those suffering in Africa, being “more concerned about tax deductions than saving lives”.

This case is an incredibly blatant example of the use of charities and charitable giving for tax avoidance purposes. The perpetrators were probably caught because they were so flagrant.

But until 2012, it is quite possible that there were many more of these types of schemes going on. The ATO was the only government entity with the power to withdraw the privileges of tax deductibility of donations to organisations. Yet overseeing charities is not its main role nor is it its main area of expertise.

But the good news is, that since late 2012, Australia has had the Australian Charities and Not-for-profits Commission (ACNC). This federal government entity is charged with educating and regulating the charities and not-for-profit sector. Like any such organisation is it not infallible.

However, unlike the ATO, it does have staff that is experienced and knowledgeable about charities and not-for-profits. It has the power to investigate and deregister entities such as Leaf Capital.

And the ACNC’s additional powers of registration of charities, and the public scrutiny that this allows, may also mean that these types of entities may be caught and weeded out much earlier that has happened with the Leaf Capital case.

The future of the ACNC has been in doubt since the 2013 federal election saw a change in government to a Liberal/National Party Coalition. Under the stewardship of Kevin Andrews as minister for social services, the Coalition initially mandated the abolition of the ACNC.

In late 2014, the Social Services portfolio was given to Scott Morrison and he indicated that he was not interested in pursuing the abolition of the ACNC. The latest development is the May 2015 federal Budget which has allocated funding for the commission until 2019.

This is particularly welcome as the not-for-profit sector has come out strongly in favour of the work the ACNC is doing.

Fiona Martin is an associate professor in the school of taxation and business law at UNSW Business School.