Welcome to NFP News
Welcome to the inaugural edition of BDO’s NFP News. We are committed to providing professional services to the Not-for-profit sector and keeping you abreast of the key issues. For this reason, our new newsletter will be produced twice a year to provide useful information that will help not-for-profit entities manage risk, identify opportunities and plan for the future.
As always, we welcome your feedback and encourage you to contact us if we can be of any assistance.
In today’s fast paced business environment, it is increasingly important for not-for-profit organisations to keep ahead of the game when it comes to detecting fraud within their operations. According to The Association of Certified Fraud Examiners’ 2010 Report to the Nations on Occupational Fraud and Abuse 80 per cent of fraud was committed by employees.
With this in mind, it is crucial that all not-for-profit organisations know how to deal with fraud.
In some instances employees may display characteristics (or red flags) that can indicate fraud is occurring. The Association of Certified Fraud Examiners’ Report found that some of the most common red flags displayed by perpetrators prior to the discovery of fraud were:
- Living beyond their means
- Financial difficulties
- Control issues and/or unwillingness to share duties
- Defensiveness, suspiciousness and/or irritability
- Not taking annual leave/holidays.
While perpetrators in some instances displayed characteristics prior to the fraud being discovered, it should be noted that just because red flags are present, it does not necessarily mean fraud is being committed.
There are also financial red flags that can highlight fraud. These include, but are not limited to:
- Unexplained decreases in cash flows
- Unexplained increases in expenses
- Unusual adjustments at period end
- Round dollar payments being made to suppliers to ‘part pay’ invoices
- Unreconciled bank accounts or suspense accounts
- Lack of complete and timely reconciliations and financial reports.
As employee frauds can often last for months or years before being discovered, early detection is vital.
A focus on efficiently using resources and operating to a clear strategy – (improving performance) – can be a powerful differentiator for not-for-profit organisations. If not done properly, however, it can be a time consuming and cumbersome task.
To help make the path to performance improvement success clearer, below are some simple tips that can be easily applied to ensure your not-for-profit organisation gets the most out of its performance:
Start with a reliable baselineMake sure you are measuring performance within a stable environment. If random events are occurring the baseline will not be stable and actual performance will be hard to measure, making performance improvement difficult to quantify.
Think in cyclesPlan, Do, Study (Check), Act1. (PDSA) is a well known business improvement cycle that sets out a logical approach to achieving incremental progress towards large scale business change. Be prepared to undergo multiple cycles in order to identify issues and develop solutions.
Determine value add as a percentage of total workTo ensure performance improvement initiatives are focused, categorise the type of work done. As a rule of thumb, about 30 per cent of time will be spent on value adding work, 25 per cent not working, 30 per cent on rework, 10 per cent on unnecessary work, and just 5 per cent on necessary work (e.g. administration and compliance).
Look for the 'less obvious' costs of qualityPerformance improvement initiatives should focus on how to increase quality, decrease costs and increase speed. Obvious costs of quality are things such as mistakes, rework, overtime, inspection, and defects. Every business is unique, so it is important to dig deep and unravel the patterns within your business to identify the less obvious costs of quality (e.g. rush delivery costs, absenteeism, low morale and customer dissatisfaction). The PDSA approach can help achieve this.
1.Made popular by Dr. W. Edwards Deming
Getting the most from GST concessions
While a host of GST related concessions are available for not-for-profit charities, we have found that not all organisations take full advantage of them.
Where a charity supplies goods for less than 50 per cent of their market value, or sells them for less than 75 per cent of what they cost, the supply is classified as GST-free. GST is not payable on a GST-free supply and input tax credits can be claimed for things acquired or imported to make the supply.
Most charities are familiar with these provisions in the context of their routine operations, and accordingly find themselves in net GST refund positions.
However, it is our experience that many organisations are unaware the above rules extend beyond their day-to-day charitable activities and can often apply to asset disposals and trade-ins. Specifically, we have noted that some charities routinely classify the sale of capital items (e.g. motor vehicles and office equipment) as taxable, even though these supplies satisfy the GST-free ‘less than 75 per cent of cost’ test.
The risk of this occurring is higher when goods, especially motor vehicles, are traded in, because the GST related documentation is often completed by the dealer.
For this reason, we recommend charities assess the GST classification of asset disposals and trade-ins as a matter of course, particularly in the context of the ‘less than 75 per cent of cost’ test. You could achieve real and legitimate savings by correctly reporting supplies of this nature as GST-free.
While the above concessions apply to non-commercial and altruistic activities of not-for-profit organisations, we note that changes to this system were announced in the 2011 Federal Budget. Specifically, unrelated commercial activities undertaken by not-for-profit entities will no longer have access to these concessions.
In recent times, there have been a number of taxation cases that have considered the application of the tax rules relating to organisations established for "community purposes".
One example, saw the Full Federal Court posed with the question of whether a community bank was income tax exempt pursuant to section 50-10 ITAA 1997 (see FCT v Wentworth District Capital Limited  FCAFC 42). In particular, the question was whether the entity, which was established to facilitate face-to-face banking services in rural towns without such services, was established primarily for “community service purposes”.
Section 50-10 item 2.1 provides that a "society, association or club established for community service purposes (except political or lobbying purposes)" is income tax exempt. The term "community services" is not defined by the legislation and as such it has been left to the Courts to provide appropriate parameters. What can be stated is that the Courts acknowledge the term evolves and must reflect contemporary community requirements and, unlike many other interpretations concerning charitable activities, the term is fluid.
In the case of Wentworth District Capital Limited, the Full Court agreed certain principles applied to s 50-10. As a result, these principles would be relevant to other institutions seeking to establish an exempt status. Click to see the principles identified by the Full Court.
"1. The kind of community service referred to in s 50-10 is a practical or tangible help, benefit or advantage conferred on the community or an identifiable section thereof: Navy Health Ltd v Federal Commissioner of Taxation (2007) 163 FCR 1 at  and ; Victorian Women Lawyers’ Association Inc v Federal Commissioner of Taxation (2008) 170 FCR 318 at  and .
3. Community service purposes include the purpose of providing a community service, although the purposes contemplated are not limited solely to the act of provision. The expression is broad and may extend to encompass any activity whose purpose has a reasonable connection to the delivery of a community service. Facilitation and promotion, therefore, are purposes that are squarely within s 50-10: see the Explanatory Memorandum to the Taxation Laws Amendment Act (No 2) 1990 (Cth), cl 6.
4. The entity claiming the exemption must be established for those purposes. That requires an analysis of what the entity is doing in the relevant year of income, both as a matter of its constitutive documents, and also by reference to its actual activities.
5. The purpose must be the entity’s main or dominant purpose. The existence of other purposes will not lead to a different conclusion so long as a matter of true characterisation, the main or dominant purpose is still reasonably connected to the delivery of a community service. "
The factual analysis of what is an organisation's primary purpose is an essential element in determining whether that organisation satisfies the threshold test. In Wentworth District Capital the charactisation of the purpose was one of the contestable elements. The Australian Taxation Office (ATO) argued that the primary purpose was to conduct banking activities, whereas the entity maintained that its purpose concerned the provision of face–to-face banking services.
While the supply of commercial services such as banking would not represent a community service, the Judge did conclude that:
"…eschewed the proposition that the facilitation of the commercial supply of services in a town that would otherwise not be provided would always be a community service".
Institutions that are seeking exempt status pursuant to section 50-10 need to be contrasted with the “charitable” institution provision in section 50-5. An institution will be a charity where the institution satisfies the relevant requirements including the entity’s characterisation as a charity.
Charitable purposes are commonly grouped as:
- Trusts for the relief of poverty
- Trusts for the advancement of education
- Trusts for the advancement of religion
- Trusts for other purposes beneficial to the community and not falling under any of the preceding headings (Commrs for Special Purposes of Income Tax v Pemsel (1891) 3 TC 53).
In relation to grouping 4, Draft Taxation Ruling TR 2011/D2, the Commissioner states that for an institution or a fund to be considered charitable, it must be:
- Beneficial to the community, or deemed to be for the public benefit by legislation applying for that purpose, and
- Within the spirit and intendment of the preamble to the Statute of Elizabeth, or deemed to be charitable by legislation applying for that purpose.
Recent examples where the Courts have considered and endorsed the application of the charitable purpose rule are:
- An association incorporated for the advancement of women in the legal profession, being an organisation whose purposes were beneficial to the community (Victorian Women Lawyers' Association Inc v FC of T  FCA 983
- An institution that monitored, researched and campaigned for the delivery of overseas aid (albeit did not actually provide any aid itself), on the basis that the generation by lawful means of public debate concerning the efficacy of foreign aid directed to the relief of poverty was itself a purpose beneficial to the community (Aid/Watch Incorporated v FC of T  HCA 42).
There are many organisations and institutions established to undertake some activity that is purpose driven to assist some element of our community. Recent cases demonstrate that the parameters that apply to determine the tax exempt status of “community” based organisations is evolving to take on the changes in our community needs and expectations. The rigor the ATO would like to impose has been tested by the Courts and, to date, the Courts have successfully expanded the scope for community based organisations to obtain tax exempt status. The Federal Government’s current commitment to reforming Not For Profit sector regulation is also likely to create further changes in this area.
Financial reporting update
While there are no significant new requirements for financial reporting by not-for-profit entities for the 30 June year end, there are various issues that still require attention to ensure they are properly dealt with in the financial reports.
By way of recap, a number of changes were introduced last year that some not-for-profits may still be unaware of. For companies limited by guarantee, Corporations Law amendments were passed in the middle of 2010. The key amendments are:
- A series of size thresholds to determine if the preparation and audit of financial statements (and lodgement with the Australian Securities and Investments Commission) is required
- New requirements for the Directors’ Report to be included with the financial statements
- New streamlined reporting provisions designed to make reporting to members more efficient
- Reduced Disclosure Regime (RDR).
Experience from the June 2010 reporting season suggests not-for-profit entities may encounter some challenges when implementing the changes.
At face value the size thresholds provide relief to smaller entities, however proper consideration must be given to the requirements of a company’s constitution before any change is made, to ensure the relevant reporting provisions are not breached.
The new Directors’ Report requirements also need careful consideration, as comments made will be publicly available when financial statements are lodged with ASIC. Companies must now comment on matters such as objectives, how principal activities contribute to the achievement of objectives and what performance measures are in place. Precedents are available from entities that lodged financials from the June 2010 reporting season and are worth examining.
The RDR applies from 1 July 2013 but can be adopted early by not-for-profit entities who already prepare general purpose financial reports. There are savings in disclosures relating to financial instruments, related parties, business combinations, and impairment.
Very long term leases of land can be classified as a finance lease where risks and rewards are effectively transferred, despite there being no transfer of title. The key question is what is a very long lease? 50 years? 99 years?
AASB 101 states that a liability to, for example a bank, must be classified as a current liability if the entity does not have an unconditional right to defer repayment for more than 12 months after the reporting date. If an explicit statement is contained in a loan agreement that states the bank can recall the loan at any time, or at annual review, the borrowing will likely be considered to be current. The wording of many annual review clauses in borrowing agreements may be vague, so legal advice should be obtained if there is any uncertainty.
In addition to these new issues, not-for-profit organisations must be mindful of recurring requirements such as the impairment of assets and going concern considerations.