A.
INTRODUCTION
On November 28, 2008, Canada Revenue
Agency (“CRA”) published a reminder indicating that the
3.5% disbursement quota will apply to charitable organizations
registered before March 23, 2004, for their fiscal period
beginning on or after January 1, 2009.
Since these charitable organizations may not be familiar
with how the 3.5% disbursement quota is calculated, this
Charity Law Bulletin explains how to calculate the
3.5% disbursement quota.
All registered charities are required
to expend a portion of its assets annually in accordance
with a disbursement quota, which is a prescribed amount
that registered charities must disburse each year in order
to maintain their charitable registration. The purpose of
the disbursement quota is “to ensure that most of a charity’s
funds are used to further its charitable purposes and activities;
to discourage charities from accumulating excessive funds;
and to keep other expenses at a reasonable level.”
Having a good understanding of the disbursement quota rules
is important not only for charities, but also for donors
and their advisors. The source of the gift, the nature of
the proposed recipient charity, the nature of the property
gifted, and restrictions that may be imposed on the gift
by the donor will all have a bearing on the disbursement
quota consequences of the gift.
B.
BACKGROUND OF THE 3.5% DISBURSEMENT QUOTA
By way of background, new disbursement
quota rules were enacted by Parliament on May 13, 2005,
upon the passage of Bill C-33,
as a result of proposals contained in the 2004 Federal Budget
released on March 23, 2004. All registered charities are
required to comply with an 80% disbursement quota, which
is generally equal to 80% of receipted gifts and gifts received
from other registered charities in the immediately preceding
year (except gifts of capital received by way of bequest
or inheritance, 10-year gifts and specified gifts received
from other registered charities). However, prior to the
enactment of Bill C-33 in 2005, only public and private
foundations (but not charitable organizations) were subject
to the 4.5% disbursement quota on assets not used directly
in charitable activities or administration.
In addition to reducing the 4.5% disbursement
quota to 3.5%, Bill C-33 amended the Income Tax Act
(Canada)
(the “Act”) by expanding the application of the reduced
3.5% disbursement quota to charitable organizations. The
reason for this, as stated in the 2004 Federal Budget, is
that while historically charitable foundations were the
primary beneficiaries of endowments, both charitable organizations
and foundations today can and do hold endowments from which
investment income is generated. The Department of Finance
was concerned that if charitable organizations were not
subject to the 3.5% disbursement quota, this investment
income would not be subject to any disbursement quota obligation.
For charitable organizations registered after March 22,
2004, the 3.5% disbursement quota applies to their taxation
years that begin after March 22, 2004. For charitable organizations
registered before March 23, 2004, the 3.5% disbursement
quota will apply to their taxation years that begin on or
after January 1, 2009.
As a result of the application of the
3.5% disbursement quota to charitable organizations, concerns
were raised in the charitable sector regarding the ramifications
of the application of this requirement on small charitable
organizations. In response to this concern, the reduced
3.5% disbursement quota applies to all registered charities
(including charitable organizations, public foundations,
and private foundations) only if the amount of their investment
assets is greater than $25,000. Since foundations have always
been required to satisfy the 4.5% disbursement quota (now
3.5%), it is not clear why the de minimis threshold
of $25,000 would also apply to them. However, despite the
Department’s attempt to relieve hardship that may be faced
by small charitable organizations, there is still concern
that the threshold of $25,000 is too low and therefore would
not be of assistance to them.
Failure by a charity to comply with the
disbursement quota may result in its charitable registration
being revoked.
In practice, however, de-registration is not likely to occur
unless there have been continuous failures to meet the disbursement
quota. Apart from de-registration, the Act provides two
ways of dealing with disbursement shortfalls. First, disbursement
excesses from the preceding five taxation years and/or from
the immediately subsequent taxation year may be applied
against disbursement shortfalls. Second, a charity may apply
to have its disbursement quota reduced for the particular
taxation year.
Other than de-registration, Bill C-33 also provides that
transfers among charities to avoid disbursement quotas may
result in a penalty of 110% of the fair market value of
property transferred, with the transferor and transferee
charities being jointly and severally liable for the penalty.
C.
CALCULATION OF THE 3.5% DISBURSEMENT QUOTA
The detailed method for the calculation
of the 3.5% disbursement quota is set out in Regulations
3700, 3701, and 3702 of the Income Tax Regulations.
The calculation of the 3.5% disbursement
quota is based on the average value of property
owned by the charity, which was not used directly in charitable
activities or administration, in the 24 months before the
beginning of the fiscal period in question.
For charitable organizations registered
before March 23, 2004, they must know that
value for 2007 and 2008 when calculating the 3.5% disbursement
quota for the fiscal year 2009. The average value is recorded
on a charity’s annual information return, Form T3010B,
on line 5900. However, if the average value
of the charity’s property not used for charitable activities
or administration is $25,000 or less, the charity does not
have to calculate the 3.5% disbursement quota.
1.
Number of periods
In order to calculate the 3.5% disbursement
quota, it is necessary to divide the 24 months immediately
preceding the fiscal period in question into 2 to 8 equal
and consecutive periods. The value of the
assets is an average value based on the number of periods
so chosen. The number of periods to be chosen will depend
on the accounting method and the type of property the charity
holds. Usually, the number of periods is chosen the first
time when the charity files its first annual information
return. In the case of charitable organizations to which
the 3.5% disbursement quota begins to apply for the
fiscal year beginning in 2009, they will need to choose
the appropriate number of periods when they file their T3010B
for their 2009 fiscal period. Once the number of periods
is chosen, CRA’s approval will be required in order to change
it in the future.
Once the number of periods has been
chosen, the charity will need to determine the value of
its assets not used directly in charitable
activities or administration at the end of each period,
aggregate them and divide it by the number of periods chosen.
The 3.5% disbursement quota will be 3.5% of the result thus
calculated.
The charity should be careful in choosing
the number of periods the first time, because it may affect
the amount of the 3.5% disbursement quota to be expended
for various reasons.
First, the number of periods chosen
may affect the ability of the charity to take into account
changes in the market value of the assets during the 24
month period when calculating the 3.5% disbursement quota.
For example, if a charity chooses 2 periods, it will need
to calculate the value of its assets once a year at the
end of each 12-month period. While the charity would only
need to valuate its assets once a year, the charity would
not be able to take into account changes in the value of
the assets during the 12-month period. For example, if the
market was particularly strong during the 12th
month and therefore resulting in an unusually high value
at the end of the 12th month, this may result
in a higher 3.5% disbursement quota. Instead, if the charity
were to choose 8 periods, it will need to calculate the
value of its assets once every three months. While this
may require more administration for the charity in monitoring
the value of its assets on a quarterly basis, the resultant
3.5% disbursement quota calculated would better reflect
the change in the market value of the assets over the 24-month
period.
Second, the number of periods chosen
may reduce the amount of the 3.5% disbursement quota for
charities that do not have investment assets during a portion
of the 24 month period. Take for example, a charitable organization
that was registered on January 1, 2004, with fiscal year
end being December 31, and not having any investment assets
until June 1, 2008. This charity will need to begin complying
with the 3.5% disbursement quota in its 2009 fiscal year.
Its 3.5% disbursement quota for 2009 is based on the value
of its investment assets for the 24-month period from January
1, 2007 to December 31, 2008. Assume that the charity holds
investment assets in the amount of $100,000 on June 1, 2008,
which value remains unchanged until December 31, 2008. If
the charity chooses 2 periods, the value of the assets would
be $0 on December 31, 2007 and $100,000 on December 31,
2008. The 3.5% disbursement quota will be $1,750 (being
$0 + $100,000, divided by 2, and multiplied by 3.5%). If
the charity chooses 8 periods, the value of the assets would
be $0 for the first 5 periods, and $100,000 for the last
3 periods, being June 30, 2008, September 30, 2008 and December
31, 2008. The resultant 3.5% disbursement quota will be
$1,312.5 (being $0 + $0 + $0 + $0 + $0 + $100,000 + $100,000
+ $100,000, divided by 8, and multiplied by 3.5%). Therefore,
the higher the number of periods, the lower the 3.5% disbursement
quota would be in this fact scenario.
2.
Assets and valuation
The assets upon which the 3.5% disbursement
quota is calculated include those assets that are not used
directly in charitable activities or administration and
will include all real estates and personal property, such
as cash on hand and in bank accounts, stocks, bonds, term
deposits, mutual funds, as well as lands and buildings. If, for example, 25% of a building
is used in the charity’s charitable activities or administration,
then only 75% of the value of the building would need to
be included in the 3.5% disbursement quota calculation.
Regulation 3702 provides specific rules
in determining the value of the assets. In this regard, the value of an asset is generally
the fair market value of the property on the last
day of a period.
However, the value of a publicly-listed share is the closing
price or the average of the bid and asked prices of that
share on that day or, if there is no closing price or bid
and asked prices on that day, on the last preceding day
for which there was a closing price or bid and asked prices.
The value of an interest in a real property is the fair
market value of the interest on that day, less the amount
of any debt incurred in respect of the acquisition of the
interest and secured by the real property, where the debt
bears a reasonable rate of interest.
Regulation 3702 also set out rules on how other types of
assets are to be determined.
D.
CONCLUSION
Based upon the above,
it is important that all registered charities be familiar
with the method by which the 3.5% disbursement quota is
to be calculated. This is specially the case for charitable
organizations that were registered before March 23, 2004.
Furthermore, registered charities should be careful in choosing
the number of periods for the 24 months that apply to the
calculation. Where the charity is not clear on how the 3.5%
disbursement quota is to be calculated, legal and accounting
advice should be sought.
