A.
INTRODUCTION
A significant measure in the Federal
Government’s 2010 Budget
that will find strong support from across the charitable
sector in Canada is the provision eliminating the 80% disbursement
quota for registered charities and increasing the exemption
from the 3.5% disbursement quota (collectively referred
to as the “DQ”). Over the years, the DQ has created an unnecessarily
onerous administrative burden on registered charities that
few charities and their staff have had the ability to comply
with, let alone understand. These burdensome complexities
include having to wrestle with complicated concepts of enduring
property, ten year gifts, capital gains pools and inter-charity
transfers. The 80% DQ was particularly difficult for small
and rural charities to comply with because they tend to
be more dependent on receipted income than large charities
that often receive more of their income from non –receipted
sources. Eliminating the 80% DQ will therefore be of particular
help to small and rural charities, increased assistance
for which has been a priority for the Canada Revenue Agency
(“CRA”) over the last few years.
B.
DISBURSEMENT QUOTA
The DQ was introduced in 1976 to help
curtail fundraising costs, to limit capital accumulation,
and to ensure that a significant portion of a charity's
resources are devoted to charitable activities, as opposed
to administrative costs. The Income Tax Act (“ITA”)
currently provides that all registered charities are required
to annually expend a portion of their assets in accordance
with a disbursement quota (“DQ”), which is a prescribed
amount that registered charities must disburse each year
in order to maintain their charitable registration. In general
terms, the DQ requires that the amount a charity spends
each year on charitable activities (including gifts to other
charities) be at least equal to 80 per cent of the previous
year's tax-receipted donations (referred to as the "charitable
expenditure rule" or the 80% DQ) and 3.5 percent of
the charity’s investment assets (referred to as the “capital
accumulation rule” or 3.5% DQ). New DQ rules were enacted
in Bill C-33 on May 13, 2005,[2]
and apply generally to taxation years beginning after March
22, 2004, except that, for charitable organizations registered
before March 23, 2004, the 3.5 % DQ only applies to their
taxation years beginning after 2008.
The DQ rules are too complex to detail
here,[3] but the calculation
of the DQ has occured in accordance with a complicated formula
consisting of two parts: the 80 % DQ aimed at limiting administrative
expenses and the 3.5 % DQ aimed at preventing the accumulation
of funds. The main features of the disbursement quota for
charitable organizations and public foundations that have
been in place prior to the 2010 Budget may be summarized
as follows:
1. The
80 per cent disbursement quota is equal to (1) 80 per cent
of gifts receipted in the immediately preceding year (except
gifts of enduring property and gifts received from other
registered charities), plus (2) 80 per cent of enduring
property expended in the year and 100 per cent of enduring
property transferred to qualified donees in the year, less
the optional reduction by the amount of realized capital
gains on enduring property, plus (3) 80 per cent of gifts received from other registered charities (except specified gifts or enduring property).
The primary
concern for most organizations with respect to this part
of the DQ is ensuring that they clearly identify what may
be considered enduring property in accordance with the definition
in section 149.1(1) of the ITA: gifts by way of bequest
or inheritance; 10-year gifts; life insurance proceeds,
registered retirement income funds and registered retirement
savings plans as a result of direct beneficiary designation;
and gifts received by the charity as a transferee of an
enduring property from either an original recipient charity
or another transferee charity.
2. Charities
are also required to expend at least 3.5 per cent of their
assets that are not used directly in its charitable activities
or administration (commonly referred to as “investment assets”).
The value of the assets in this regard is based on the average
value of the charity’s assets that are not used directly
in its charitable activities or administration in the 24
months immediately preceding the taxation year.[4]
The disbursement quota rules for private
foundations have been very similar to those for charitable
organizations and public foundations, except that private
foundations had been required to expend 100 per cent (rather
than 80 per cent) of all amounts received from other registered
charities in the immediately preceding taxation year, other
than specified gifts and enduring property.
C.
CBA CONCEPT PAPER AND CALLS FOR REFORM
On June 11, 2009, the Charities Directorate
of CRA released its much anticipated Guidance (CPS-028):
Fundraising by Registered Charities (the “Guidance”),
that applies to fundraising activities by registered charities.
The Guidance, which includes 23 pages of additional information,
replaces CRA’s previous policy on fundraising and provides
detailed guidance for charities on acceptable fundraising
practices.
In general,
a registered charity is required to report all fundraising
expenditures in its T3010B annual information return, which
expenditures include “all costs related to any activity
that includes a solicitation of support, or that is undertaken
as part of the planning and preparation for future solicitations
of support.” These expenditures will be evaluated based
on the measurement of the ratio of fundraising costs to
fundraising revenue in a fiscal year (note that the ratio
is unrelated to the DQ):
·
Less than 35% - it is unlikely to generate
questions or concerns
·
Greater than 35% and above - CRA will examine
the average ratio over recent years to determine if there
is a trend of high fundraising costs. The higher the ratio,
the more likely it is that there will be concerns and a
need for a more detailed assessment of expenditures.
·
Above 70% - This level will raise concerns
with the CRA and will likely result in revocation.
With the publication of the Guidance
and other legislative and administrative initiatives, the
80% DQ became less relevant for curtailing fundraising and
other administrative expenses.
In July 2009, the National Charities
and Not-for-Profit Law Section of the Canadian Bar Association
submitted a Concept Paper on the Reform of the Disbursement
Quota Regime to the federal Department of Finance, which
indicated that the DQ regime results in substantial distortions
of the gifting decisions of donors to charities and in investment
decision-making by charities. The CBA Concept Paper addresses
the four specific regulatory objectives pursued by the current
DQ regime: (1) current gifts disbursement; (2) anti-accumulation;
(3) efficiency; and (4) fundraising efficiency. According
to the CBA submission, the only regulatory objective that
should be pursued through a DQ regime is the prevention
of undue accumulation of donations, income and capital.
The Concept Paper argued that the current regime
was not an effective means of achieving administrative efficiency
and limiting fundraising expenses. The CBA proposed that
the third regulatory objective could be more effectively
pursued through increased transparency and the fourth objective
is best dealt with in CRA’s fundraising guidelines.
The Concept Paper made a number
of recommendations for reform, including the complete repeal
of the charitable expenditure rule or the 80% DQ and modifications
to the 3.5% DQ. This recommendation would result in a simplification
of the DQ calculation and the repeal of complex and difficult
to understand concepts whose function was to sort donations
into current and capital components. These recommendations
were supported by Imagine Canada, the Canadian Association
of Gift Planners and other organizations in the charitable
sector during hearings before the House of Commons Standing
Committee on Finance in the fall of 2009.
D.
2010 BUDGET
As a result of recommendations from the
sector and the CBA, the 2010 Federal Budget proposes to
reform the DQ for fiscal years that end on or after March
4, 2010 by completely repealing the charitable expenditure
rule (80% DQ). As a result, charities will no longer be
required to spend at least 80 per cent of the previous year's
tax-receipted donations. With the repeal of the charitable
expenditure rule, many of the complicated concepts discussed
above will no longer form part of the DQ calculation, including
enduring property, the capital gains reduction and the capital
gains pool and specified gifts. Among the proposed technical
amendments to the Income Tax Act included in the
Budget is the repeal of the definitions of “capital gains
pools,” “enduring property” and “specified gift.”
In addition, the existing threshold for
the requirement that charities spend an amount equal to
3.5 per cent of their investment assets each year (the capital
accumulation rule or the 3.5% DQ) if the total investment
assets exceeds $25,000 is increased to $100,000 for charitable
organizations. This will reduce the compliance burden on
small charitable organizations and provide them with greater
ability to maintain reserves to deal with contingencies.
The threshold for charitable foundations will remain at
$25,000.
The Budget
also contains proposed measures extending existing anti-avoidance
rules to situations where it can reasonably be considered
that a purpose of a transaction was to delay unduly
or avoid the application of the DQ. The purpose of these
amendments is to ensure that amounts transferred between
non-arm’s length charities will be used to satisfy the DQ
of only one charity. The Budget proposes that the recipient
charity will be required to expend the full amount transferred.
Alternatively, the transferring charity will be able to
elect that the amount transferred will not count toward
satisfying its DQ, in which case the recipient charity would
not be subject to the immediate disbursement requirement.
The Budget contains penalty provisions for registered charities
that participate in such avoidance transactions. A registered
charity that has entered into a transaction (including a
gift to another registered charity) and it may reasonably
be considered that a purpose of the transaction was to avoid
or delay unduly the expenditure of amounts on charitable
activities; the registered charity will be liable to a penalty
equal to 110% of the amount of expenditure avoided or delayed.
In the case of a gift to another registered charity, both
charities are jointly and severally, or solidarily, liable
for the penalty. In addition, if a registered charity has
received a gift (other than a designated gift) from a non-arm’s
length charity, and has not expended, before the end of
the next taxation year an amount at least equal to the amount
of the gift on its own charitable activities or as gifts
to other arm’s length qualified donees, in addition to its
DQs for those taxation years, the charity will be liable
to a penalty equal to 110% of the amount by which the fair
market value of the property exceeds the total of such amounts
expended.
The repeal of the charitable expenditure
rule will necessitate amendments to the rules regarding
the accumulation of property for a particular purpose, such
as a building project. Currently, any property accumulated
after CRA approval has been obtained and any income earned
in respect of that property is deemed to have been spent
on charitable activities. The Budget proposes an amendment
under which CRA will be given the discretion to exclude
the accumulated property from the capital accumulation rule
calculation (the 3.5% DQ).
Another proposed
measure in the Budget of interest to Charities is an extension
of the mineral exploration tax credit, an important component
of many flow-through share gifting arrangements. Further,
in its discussion of the DQ, the federal government
noted that it will monitor the effectiveness of CRA’s guidance
on "Fundraising by Registered Charities" and take
action if needed to ensure its stated objectives are achieved.
E.
STEPS BY CRA
CRA has indicated that it will be required
to make several administrative changes in response to the
DQ reform proposed by the 2010 Federal Budget.
CRA will produce new instructions on how to calculate the
DQ for fiscal years that end on or after March 4, 2010 and
charities should watch for new information expected to be
posted to CRA’s website soon. In addition, the Registered
Charity Information Return, Form T3010B will also need to
be revised to reflect the new DQ calculation and CRA has
indicated that charities must continue to use the existing
form until a new form is released.
F.
CONCLUSION
The proposed repeal of the charitable
expenditure rule and increase to the threshold for the application
of the capital accumulation rule will have a substantial
positive impact on charities, decreasing substantially the
administrative complexity of complying with the DQ, particularly
for small and rural charities. No longer will charities
have to struggle with structuring long-term gifts or endowment
funds to comply with complex Income Tax Act language
related to enduring property. They will, instead, be able
to focus their efforts on balancing donor desires for long-term
financial stability with the need for flexibility to meet
changing economic conditions. Charities and their financial
advisors will not have to spend scarce resources accounting
for and allocating expenses between those related to carrying
on charitable activities and overhead or administrative
expenses. Instead, the focus will be on complying with CRA’s
guidance with respect to fundraising expenditures to ensure
that excessive fundraising costs are avoided.
As a result of the proposed changes,
it is likely that charities and their advisors will see
changes to the Registered Charities Annual Information
Return (T3010B) reflecting the simplification of the
DQ regime. In addition, charities and their advisors will
have to carefully monitor compliance with the CRA fundraising
Guidance and review future deeds of gift or endowment agreements
to eliminate any restrictions specifically related to the
exemption from the charitable expenditure requirement, although
other restrictions in existing deeds of gifts or endowment
agreements will still need to be complied with. Finally,
charities and their advisors will have to carefully consider
transitional issues and any guidance provided by CRA in
this regard.
