1.4 Non-profit council-controlled organisations

Local government: Results of the 2005/06 audits.

The Local Government Act 2002 (the Act) extended the accountability regime for entities associated with local authorities to include non-profit entities such as charitable trusts and incorporated societies. Formerly, only local authority trading enterprises were covered. This change affected the accountability regime for about 100 trusts and incorporated societies associated with local authorities. These entities, and the former local authority trading enterprises, became council-controlled organisations (CCOs) under the Act.

Since 1 July 2003, the non-profit entities have had to comply with the accountability and reporting requirements for CCOs under the Act. These requirements are generally more complex than those that applied under their trust deeds or rules.

The Auditor-General is currently the auditor of 118 council-controlled trading organisations and 93 non-profit CCOs. The Auditor-General also audits another 80 organisations that are related to local authorities but are not CCOs. This group includes entities that have been exempted from being CCOs under section 7 of the Act, and local government-related entities that are controlled entities under section 5 of the Public Audit Act 2001. Exemptions are discussed in paragraphs 1.417 to 1.426. The control test in the Public Audit Act 2001 is discussed in Part 2.2 of this report.

This article comments on issues and developments in the non-profit CCO sector for the year ended 30 June 2006, including:

  • reporting on performance;
  • the number of CCOs that local authorities have exempted from the accountability regime in the Act;
  • audit of exempted organisations;
  • making the statement of intent (SOI) and annual report publicly available; and
  • the implications of the Charities Act 2005.

Reporting on performance of council-controlled organisations

An important part of the accountability framework for CCOs in the Act is the requirement to prepare an SOI at the start of the reporting period. The purpose of the SOI is to provide:

  • a public statement of the activities and intentions of the CCO for the year, and the objectives to which those activities will contribute;
  • an opportunity for the local authority to influence the direction of the entity; and
  • a basis for the entity’s governing body to be accountable to the local authority for the entity’s performance.

A CCO must include information in its annual report about its achievements against that SOI, including:

  • a comparison of the performance of the entity with the SOI; and
  • an explanation of any material variances between that performance and the SOI.

As well as auditing the financial statements of a CCO, we are required to report on the performance targets and other measures by which performance was judged against the entity’s objectives. In other words, the audit opinion must cover the entity’s report on its performance, measured against its SOI (performance information).

All CCOs had to have an SOI in place for the year beginning 1 July 2004. They were also required to include performance information in their annual reports for the year ended 30 June 2005, unless the local authority had exempted the CCO under section 7 of the Act (exemptions are discussed in paragraphs 1.417 to 1.426).

We monitored compliance with these requirements during 2004/05 and 2005/06. Although many CCOs met the new requirements, several did not include performance information in their annual reports because they did not have an SOI in place at the start of the period. In some cases, the CCOs were inactive (for example, they were name protection companies). While there may be little point in such entities producing an SOI, the requirement applies unless the local authority has exempted the CCO.

We were surprised that local authorities had not used the power in section 7 of the Act more actively to exempt small non-profit CCOs from the accountability regime. We have asked our appointed auditors to ensure that local authorities are aware of this option.

For the years ended 30 June 2005 and 30 June 2006, we issued qualified audit opinions for several active CCOs for failing to include performance information in their annual reports. This was because they did not have an SOI in place to report against. We were particularly concerned where active CCOs did not have an SOI in place for the following period either.

Part 1.5 of this report, which covers non-standard audit reports issued during the 2006 calendar year, includes qualified audit reports for CCOs for not reporting performance information against an SOI. It is disappointing to note that, in some instances, a CCO has been qualified for the same reason for two consecutive years. The Appendix lists the names of the entities that received a qualified audit report for not reporting performance information.

We did not qualify the audit report of inactive CCOs (such as name protection companies or dormant companies that were not engaged in any activity during the year),1 provided the entity had disclosed the breach of law in its financial statements.

A small number of CCOs were set up part way through the financial year, and did not prepare SOIs. They therefore did not include performance information in their annual reports.

We had previously suggested to the Department of Internal Affairs that the Act be amended to provide that:

  • a CCO set up or acquired in the first six months of a financial year should prepare an SOI; but
  • a CCO set up or acquired in the latter six months of a financial year should not have to prepare an SOI for that period.

We are pleased to note that the Act was amended in 2006 to incorporate our suggestion.2

Exempted organisations

Section 7 of the Act provides for entities to be exempted from the requirements for CCOs. There are two ways in which a CCO may be exempted:

  • The Governor-General, on a recommendation from the Minister of Local Government, can exempt a CCO that is already subject to appropriate accountability under an Act other than the Local Government Act 2002. The Minister must be satisfied that the entity’s accountability under the other Act is of a similar nature and effect to that required under the Local Government Act 2002.3
  • A local authority can exempt small non-profit CCOs under section 7(3). The Act does not define “small”, but a local authority cannot exempt a councilcontrolled trading organisation. When exempting a non-profit CCO, the local authority must consider the nature and scope of the activities provided by the CCO, and the costs and benefits of an exemption to the local authority, the CCO, and the community.

A local authority may revoke an exemption at any time, and must review any exemption within three years of granting it and then at least every three years.

The power for local authorities to exempt small CCOs from the requirements was included in the Act to address concerns raised about compliance costs for small non-profit entities. Once exempted, an entity is no longer a CCO (for the period of the exemption) and is not subject to any of the accountability requirements of the Act.

However, an exemption under the Act does not affect accountability requirements in other legislation, such as the Incorporated Societies Act 1908 or the Charities Act 2005, or provisions in an entity’s own trust deed or rules.

Several local authorities have inactive companies that meet the definition of a CCO. Examples of “inactive” companies are companies formed for name protection purposes or companies that formerly carried out trading activities but are retained for tax or other reasons.

Where a former trading company is inactive, it is unlikely to be a councilcontrolled trading organisation and may qualify for exemption by the local authority under section 7(3) of the Act.

We asked our appointed auditors to report to us, as part of the 2005/06 audits, on the extent to which local authorities have used the exemption power in section 7(3) since the enactment of the Act.

Our findings are:

  • As at 30 June 2006, local authorities had exempted 74 entities under section 7(3).
  • Most of the exemptions had been given recently, in 2005 or 2006.
  • Thirty-two of the 85 local authorities have used the exemption power.
  • Fifty-three local authorities have not used the exemption power. Several of those local authorities do not have CCOs.
  • The exempt entities are a mixture of small trusts and inactive companies.
  • Forty-four trusts, 25 companies, and five other entities have been exempted.
  • City councils tend to have the most CCOs and have therefore made the greatest use of the exemption power, with the Auckland City Council and the Manukau City Council exempting 10 and nine entities respectively.

Audit of exempted organisations

An exemption under the Act does not necessarily affect audit requirements. Once exempted under section 7 of the Act, an organisation is not subject to any of the requirements in the Act, including the requirement to prepare financial statements for audit by the Auditor-General. However, an entity such as a trust or incorporated society is likely to be required to prepare financial statements and have them audited under its trust deed or rules. Similarly, the directors of an inactive company that is exempted from the CCO accountability requirements still need to meet the requirements of the Financial Reporting Act 19934 and the Companies Act 1993 concerning financial statements and audit. An exemption given by a local authority from the accountability regime for CCOs under the Act does not negate such requirements, as the exemption is for the purposes of that Act only.

The Auditor-General usually remains the auditor of exempted organisations because, under the Public Audit Act 2001, the Auditor-General must audit the financial statements and other information that a public entity is required to have audited. Therefore, where an exempted organisation is a public entity by virtue of the control test in section 5 of the Public Audit Act 2001 (see article 2.2 of this report), the Auditor-General will continue to be the exempted organisation’s auditor.

Making the statement of intent and annual report publicly available

A CCO is required to:

  • make its completed SOI available to the public within one month after the date it is adopted or delivered to the shareholders; and
  • make its annual report available to the public within three months of the end of the financial year.

Where a CCO is required to make a document available to the public, it must take reasonable steps to:

  • ensure that the document or a copy of the document is accessible to the general public; and
  • publicise both the fact that the document is available and the manner in which copies of the document may be obtained.5

There are varying degrees of compliance with these requirements among CCOs. We have therefore asked our appointed auditors, as part of the audit for 2006/07, to check that CCOs are meeting these requirements.

Implications of the Charities Act 2005

Many non-profit CCOs are incorporated charitable trusts or incorporated societies with charitable purposes. They are subject to the Charities Act 2005, which was enacted in April 2005 with different sections coming into force on different dates. The broad intention of the Charities Act 2005 is to enhance the accountability of charities.

The Charities Act 2005 established a new Crown entity, the Charities Commission, which is responsible for running a registration, reporting, and monitoring system for charities. Those charities that wish to retain or gain income tax-exempt status are required to register with the Commission.

Existing organisations must register by 1 July 2008 to maintain any existing income tax and gift duty exemptions.

Once registered, charities must submit an annual return to the Commission within six months of balance date.

The content of the annual return is determined by the Charities (Fees, Forms, and Other Matters) Regulations 2006 (in force from 1 November 2006). The annual return must include the charity’s financial statements. On receiving the annual return, the Commission is required to examine the entity’s activities to determine that the entity continues to qualify for registration as a charitable entity.

These Charities Act requirements will add to the legislative compliance obligations for CCOs (and exempt CCOs) that wish to register as charitable entities.

1: See article 1.5 for an explanation of a qualified opinion.

2: Local Government Act 2002, section 64(6).

3: The Otago Museum Trust Board, the Canterbury Museum Trust Board, and the Museum of Transport and Technology Trust Board have been exempted by this procedure.

4: The Financial Reporting Act 1993 has been amended to provide that an inactive company need not prepare financial statements, but this amendment is not yet in force.

5: Local Government Act 2002, section 5(3).

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