Many so-called nonprofits actually earn substantially more than they spend. The major difference between nonprofits and regular businesses is how these profits are used. While regular businesses pay their surpluses to their owners, such as by paying dividends, nonprofits can never benefit their members and must use their funds to further their cause. Find out what happens when a nonprofit has excess surpluses.
Rules Concerning Excess Surpluses
Contrary to registered charities, which must meet an annual disbursement quota, there is no hard and fast rule for regular nonprofit organizations regarding excess surpluses. Instead, your organization has to follow to the basic rule in the Income Tax Act to avoid getting classified as a commercial enterprise and having to pay taxes. The nonprofit must be organized and operated for the purpose of social welfare, civic improvement, pleasure, recreation or any other purpose except profit. The Canada Revenue Agency has often stated that the determination of whether an organization qualifies as a nonprofit is a question of fact and must be analyzed on a case-by-case basis. As a nonprofit, your organization can earn income in excess of its expenditures, as long as it does so in line with the organization’s official purpose.
Inappropriate Use of Surpluses
Problems arise when your nonprofit accumulates a large surplus each year and the balance of the surpluses far exceeds the organization’s reasonable needs to carry on its nonprofit activities. In such cases, the CRA may consider that one of the purposes for which the organization operates is profit. In particular, the CRA frowns on accumulation of surpluses for purposes that aren’t related to the organization’s objects. Examples of these are:
- Long-term investments to produce property income, such as interest.
- Enlarging or expanding facilities used for normal commercial operations.
- Loans to members, shareholders, or non-exempt persons.
Since there isn’t a precise mathematical test, the amount of surpluses considered to be reasonable in relation to the needs of a particular nonprofit has to be determined on a case-by-case basis. You need to consider things such as future anticipated expenditures and the amount and pattern of your income from various sources, such as fundraising, membership fees, or training course fees.
Getting the CRA’s Opinion
It’s possible to ask for and receive an opinion from the CRA on a specific case. For example, an association that had large accumulated surpluses asked the CRA if the creation of scholarships could be considered an acceptable use of funds. In the CRA’s opinion, if the organization had managed to accumulate enough surpluses to create scholarships, it was probably retaining too much of its profits and not operating as a nonprofit. If your nonprofit faces a problem with excess surpluses, you can solve it fairly easily by either spending more towards the achievement of your organization’s goals or making donations to a registered charity.