Fair Tax Eliminates Political Activity Restrictions, Taxes Unrelated Business Consumption
In a consumption tax system, charities are typically exempt from paying taxes when buying, and collecting taxes when selling, as long as either transaction relates to the charitable mission. Charity as buyer or seller signals the absence of personal consumption, I guess, thereby making exemption appropriate. Here is how the House Republicans’ national sales tax proposal (“The Fair Tax Act”) would define and treat exempt organizations:
SEC. 706. NOT-FOR-PROFIT ORGANIZATIONS.
(a) Not-For-Profit Organizations.—Dues, contributions, and similar payments to qualified not-for-profit organizations shall not be considered gross payments for taxable property or services for purposes of this subtitle.
(b) Definition.—For purposes of this section, the term ‘qualified not-for-profit organization’ means a not-for-profit organization organized and operated exclusively—
(1) for religious, charitable, scientific, testing for public safety, literary, or educational purposes,
(2) as civic leagues or social welfare organizations,
(3) as labor, agricultural, or horticultural organizations,
(4) as chambers of commerce, business leagues, or trade associations, or
(5) as fraternal beneficiary societies, orders, or associations no part of the net earnings of which inures to the benefit of any private shareholder or individual.
(c) Qualification Certificates.—Upon application in a form prescribed by the Secretary, the sales tax administering authority shall provide qualification certificates to qualified not-for-profit organizations.
(d) Taxable Transactions.—If a qualified not-for-profit organization provides taxable property or services in connection with contributions, dues, or similar payments to the organization, then it shall be required to treat the provision of said taxable property or services as a purchase taxable pursuant to this subtitle at the fair market value of said taxable property or services.
(e) Exemptions.—Taxable property and services purchased by a qualified not-for-profit organization shall be eligible for the exemptions provided in section 102.
Interestingly, the definition omits any requirement that nonprofits restrict or entirely avoid political activities. This doesn’t surprise me since Republicans are generally opposed to restrictions on entity political speech, and certainly the prohibition against campaign intervention is of recent and murky vintage. The proposal also maintains “social welfare” organizations as a classification. I don’t see a purpose, though, in the absence of political restrictions in the proposal.
Right now donations to social welfare organizations are not deductible. The proposal would effectively make donations deductible because sales taxes would not be collected for donations to social welfare organizations, nor would social welfare organizations be required to collect sales tax on related sales, apparently. As it relates to politics, the proposal might be superior to what we have now since, as the Judicial Watch post yesterday suggests, it is nearly impossible to enforce political restrictions given the Gordian knot that comprises campaign speech law. Fair Tax proposals also claim to divorce taxation from any purpose other than revenue collection and therefore disdain anything not germane to that goal. Legitimate positions to take, I suppose.
Part (d) above captured my attention, too. I wonder if that provision means that any transfer of goods or services by a nonprofit, whether in connection with dues or donations (and “the like”) or not would be subject to sales tax. Is the proposal seeking to limit exemption to organizations that do not engage in sales or compensated services? Maybe some state tax/nonprofit experts can shed some light. Anyway, as relates to UBIT, a sales tax exemption can be a subsidy alone, or simultaneously a subsidy from and a threat to taxable business:
1. A subsidy because the nonprofit can sell a widget for the same price as a for-profit and retain the entire amount, while the for-profit would have to remit a portion of the price to the taxing agency. In that case, the purchaser is essentially making a charitable contribution equal to the tax the nonprofit keeps for its charitable mission. But assuming the goods are of equal value, the transaction does not undercut sales by the for profit except in an appropriately competitive way (i.e., without government subsidy). Does it? Maybe the stamp of “government approved tax exempt” is an unfairly competitive endorsement.
2. A subsidy and a threat because the nonprofit could sell the same product as its for-profit competitor at a discount equal to the amount of tax from which the nonprofit is exempt. In this instance, maybe we are extracting a charitable contribution not from the purchaser, but from the for-profit competitor in an amount equal to the expected for-profit volume loss caused by the nonprofit’s competitive advantage. The nonprofit retains the same amount per purchase as the for-profit, the purchase is not appropriately labeled a “donation” because purchaser gets quid pro quo while the for-profit competitor subsidizes the non-profit’s volume by (1) sacrificing some of its volume to the nonprofit’s lower price or (2) lowering its prices (while still paying taxes) to the same price as that offered by the nonprofit. In other words, the burden of tax deduction is felt most acutely by direct for profit competitors.
I don’t know a lot of about how the unrelated business concern would impact or be implicated by a national sales tax. But this January 4, 2023 Indiana Revenue Ruling applying the unrelated concept to what looks like an Indiana chapter of the Boy or Girl Scouts is worth reading if you want to get into the topic. It concludes that sale of uniforms, achievement badges etc. to scouts would be tax free because those items are related to the charitable mission. Its careful to note that the sale of unrelated goods would be subject to tax, meaning the Scouts must collect sales tax on those items. The difference in the Indiana statute and the federal proposal is that there is specific provisions regarding what sales are related to the charitable mission. The federal proposal appears silent on the issue. Write about this if you are looking for a paper topic. I didn’t look too hard but I didn’t find any deep scholarship on the question whether charities would fare better under an income or sales tax.
darryll jones