DFA Charitable Determinations Pose a Challenging Test for Nonprofits

Charitable nonprofits in Arkansas need to be aware of the "otherwise performed by the government" test applied by Department of Finance and Administration (DFA) for sales tax exemption, as illustrated by recent DFA opinion letters.  This test is more stringent than that applied by the IRS for 501(c)(3) status, and nonprofits may face sales tax exposure, especially on their fundraising sales including fundraising dinners or events.  With property tax exemption rules and guidelines to be forthcoming soon, these rulings may also preview the direction DFA could take in the property tax charitable exemption context.

On the purchasing side, Arkansas does not have a generalized sales tax exemption like some states.  See, e.g., DFA Opinion 20180507 (Dec. 6, 2019).  Instead, a handful of organizations or specific types of organizations are listed by statute.  Many are listed in Ark Code Ann. § 26-52-401.

On the sales side, the critical exemption is for "[t]he gross receipts or gross proceeds derived from the sale of tangible personal property or service by charitable organizations, except when the organizations may be engaged in business for profit."  Ark. Code Ann. § 26-52-401(2).  This can apply to mission-driven sales or to fundraising sales, including tickets to fundraising events.  There is an additional requirement that the exempt sales not compete with sales by for-profit businesses.  See Ark. Code Ann. § 26-52-430; see also Rule GR-39 (but note that it has not been updated to account for the 2017 elimination of the "dominant motive" requirement).

What is meant by a "charitable organization" that can qualify for the exemption on its sales is defined by regulation.  See Rule GR-39(D)(1), incorporating by reference the "charitable" definition in GR-37(E)(6).  This definition provides that "charitable" "means an organization whose purpose is benevolent, philanthropic, patriotic or eleemosynary and whose function if performed, and not performed by a private party, would have to be performed at public expense."  (Emphasis added.)  So, a charitable determination requires consideration of what services government is required to provide if they were not performed by a private party.

In accord with this definition, DFA legal opinions show the agency applying a narrow interpretation compared with what is commonly considered charitable.  This can lead to surprisingly restrictive results, as organizations that benefit the public but do not overlap with functions provided by government are unable to quality.  Here are examples from the past year.  

Recognized charitable organizations include:

Organizations denied charitable status include:

(To DFA's credit, the Office of Revenue Legal Counsel regularly provides up-or-down rulings on which organizations can rely.  And, as the public opinions are redacted, there may be critical details that are not apparent in the published opinions.)

Leaders of nonprofits that are engaged in fundraising sales or events or other sales should consider whether their organizations qualify as charitable.  In particular, fundraising events may often be potentially taxable admissions to entertainment or amusement.  With total sales tax rates often approaching 10% or more, an event raising $100,000 could mean a tax bill of $10,000. 

Potentially affected organizations should consider their own activities and should compare their programs to what is provided by government.  While what is required to be provided by the government implicates deep political theory questions that go well beyond the tax world, as a practical matter DFA is likely to look to what is provided by statute and to established custom and history. 

In ambiguous situations, seeking an opinion from DFA may be advisable.  If a nonprofit organization determines that its sales are subject to tax, it could register and begin collecting sales tax, or it could seek a voluntary disclosure to address any prior-year exposure.

These charitable determination legal opinions may also be providing a preview of DFA's rules and guidelines on charitable property tax exemptions.  Under Act 819 of 2019, the Assessment Coordination Department (ACD), which has now become a part of DFA, is required to issue rules or guidance on property tax charitable exemption determinations.  See Ark. Code Ann. § 26-26-1125.  It would not be surprising for DFA to attempt to harmonize the definitions used in both contexts.

Update Feb. 18, 2020: One might also consider whether the isolated sale exemption applies to fundraising activities.  See Rule GR-49.  In Legal Opinion 20100917, DFA advised that a once-a-year golf tournament could not qualify for the isolated sale exemption.

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