I am inspired to share this idea and bring to discussion, after hearing Christian leaders took the rare step on Sunday (25/3/2018) of closing Jerusalem’s church of the holy sepulcher in protest at Israeli tax measures and a proposed property law. Accordingly, for further discussion and research insight I raise issues related with why churches are tax exempted? What are the rationales and what about in Ethiopia?
Taxation is a governmental assessment upon property value transaction, estates of the deceased, licenses granting a right and/or income and duties on imports from foreign countries. It includes all contributions imported by the government upon individuals for the service of the state.
Generally taxes are divided into two broad categories as direct and indirect. Direct taxes are those assessed against income, land or real property, and personal property, which are paid directly to the government. Indirect taxes are assessed against articles of consumptions, such as products or services, but collected by an intermediary such as a retailer.
Tax and religious institutions
Most scholars and policy makers have now almost reached a consent that charities warrant tax exemption and charitable deduction. Though, there are still debates on the issue of church taxation, as charitable and nonprofit organizations, most scholars argue that church activities needs to be tax exempted. Saving the counter arguments, in this paper I am focusing on the justifications and rationales for church tax exemptions.
One of the major justifications is the basic principle and doctrine of separation of state and religion. This basic principle has three elements: - state and religious institutions are separated, there is no state religion and state cannot interfere on religious matter and religious institutions cannot interfere on state matter. The concept of Church tax exemption stated to protect the third element of state cannot interfere on religious matter and religious institution cannot interfere on state matter. Consequently, the supporter of this argument stated that state and religious institution needs to function independently. If the state once exempted the church reciprocally the church are expected not to interfere on political matter of the state.
In 1970 on the case of Walz Vs Tax Commission of the city of New York the high court has stated that a tax exemption for churches “creates only a minimal and remote involvement between church and state and far less than taxation of churches. An exception restricts the fiscal relationship between churches and state, and tends to complement and reinforce the desired separation insulting each from the other.” Additionally, the Supreme Court also said that” the power to taxation involves the power to destroy.” Taxing churches breaks down the healthy separation of church and state and leads to the destruction of the free exercise of religion.
The other rational related with the issue of charitable and nonprofit organizations are tax exempted. Charitable organizations are established to serve the society; they have no any goal of profit making. Thus, different state tax law specified that charitable and nonprofit organizations are tax free. The activity of churches considered to be charitable and nonprofit as a result they are beneficiary of state tax exemptions.
There is also a justification that though the government wants to tax the activity of the churches there is no formal transaction and it is difficult for the government to audit and regulate churches activities. There is also an argument related with empowering government to tax church would result the issue of double taxation.
Having the above justifications sometimes all churches may not be beneficiary of these tax exemptions. Depending on the law of the state they are expected to fulfill some criteria. The following are some of the prerequisite that are taken from the USA tax guide for churches and religious organizations. The guide has stated churches to be tax free: -
- Their net earnings may not inure to any private shareholder or individual;
- They must not provide a substantial benefit to private interests;
- They must not devote a substantial part of their activities to attempting to influence legislation;
- They must not participate in, or intervene in, any political campaign on behalf of (or in opposition to) any candidate for public office; and
- The organization’s purposes and activities may not be illegal or violate fundamental public policy.
Exception to church taxation
Even if there is a general principle that churches and religious organizations are tax exempted, there is an exception to the general principle. Though, churches are established as charitable and nonprofit organization sometimes they can engage in income-producing activities unrelated to their tax-exempt purposes. This income generating activity of the church is not a substantial part of the organization’s activities. Still, if the church engages in different income generating activity all income generating business of the church cannot be taxed. According to the USA tax guide for churches and religious organizations the following three conditions needs to be fulfill: -
- The activity needs to be constitutes a trade or business,
- These activity of trade or business is regularly carried on, and
- The trade or business is not substantially related to the organization’s exempt purpose. However, the fact that the organization uses the income to further its charitable or religious purposes does not make the activity substantially related to its exempt purposes.
Though, any religious activity fulfills the above criteria, the income may not be subject to tax if it meets one of the following exceptions: (a) substantially all the work in operating the trade or business is performed by volunteers, (b) the activity is conducted by the organization primarily for the convenience of its members or (c) the trade or business involves the selling of merchandise substantially all of which was donated.
Therefore, even if the general principle is churches are tax free, there is also a room that when they engage in income generating activities depending on the type of business they can be taxable.
In Ethiopia the power of taxation was administered by different organ with in different state structure. According to the FDRE constitution the power of taxation in Ethiopia is given to the federal government, state governments or concurrently for both central (federal) and state governments.
In order to address charitable deduction and tax exemption including church and religious organization it is better to see the VAT and Income Tax laws, which are the major tax legislation in the country. The VAT proclamation has clearly stated that one of tax exempted activities is the rendering by religious organizations of religious or church related services. On the other hand the income tax proclamation has stated when the churches or religious organizations engage in different income generating business, this transaction can be taxed. According to the income tax proclamation these organizations will be expected to pay income tax for the income they secure from such activities just like private individuals or business.
However, a non-profit sector will not be expected to pay income tax for the revenue it secure from the donation of its benefactors or members because such revenue does not constitute an income in the sense of the proclamation. And currently different religious institutions are highly engaging themselves in different business activity, sometimes which is difficult to identify are they tax exempted or not.
Therefore, within this introductory paper, I have tried to raise the issue of why churches are tax free/exempted and left the rest for further discussion and research.