Canadian Budget 2010 announces disbursement quota reform for Canadian charities
Posted under News | What's New from the Charities Directorate of CRA | Canadian Charity Law | Planned Giving and Canadian Charities | Ethics and Canadian Charities
The Canadian federal government announced disbursement quota reform in the 2010 Budget to remove the 80/20 expenditure requirement for registered Canadian charities. For many charities this will have no real impact - they were handily satisfying their disbursement quota requirements and for those that were not (except in extreme cases) CRA was not using the DQ to revoke charitable status. As one observer noted on the changes “No more 80/20 ordinary gift. No more enduring property, including 10 year gifts. No more specified gifts. No more intercharity transfer rules based on original DQ designation. Just a simple obligation to use the equivalent of 3.5% based on previous 24 month market average for charitable purposes. ... The 3.5% obligation doesn’t kick in for charitable organizations until there is $100k in assets, while for foundations it stays at $25k.” We will probably have a revised T3010 at some point to reflect these changes and one can expect with the simpler formula that in the future CRA will more vigorously enforce the DQ provisions as this will be easier to understand. There is no cost associated with this change and a number of other proposals to increase tax incentives from some organizations were not included in the budget, which makes sense in light of the difficult fiscal situation in addition to other reasons.
This change will make it easier for donors and charities to more flexibly endow a charity or create a reserve for either a foundation or a charitable organization. In the past in general if you donated a million dollars to a charity either you needed to have those funds subject to a ten year direction where the capital cannot be spent for ten year or your other choice was by the end of the following year you would need to spend 80% of the million dollars. Now there is greater flexibility. A donor can put in money to the charity or foundation, the charity will only have to spend 3.5% of the average value every year over the $100,000 mark (for charitable organizations) (or over 25,000 mark for foundations) but they can spend more. So the donor and charity could decide to spend 33% in the first year, 33% in the second year and the rest in the third year. On the downside this may result in an accumulation of resources, for example in foundations or charities when those funds would otherwise have been spent. Practically many foundations being set up with endowments and receiving legal advice were using ten year gifts so the funds were being constrained for at least 10 years anyway. There will now probably be greater scrutiny on foundations and certain charities - people will not be able to blame the DQ and ten year gifts for why they are not spending more money.
Charitable organizations will need to expend 3.5 per cent of all assets not currently used in charitable programs or administration, if these assets exceed $100,000. This covers reserves, endowments, investment, buildings owned by a charity but not used in charitable programs or administration. This will make it easier for small charities to accumulate a reserve or have some investments.
According to CRA “Property, for purposes of the 3.5% disbursement quota requirement for a registered charity, is property that:
*was owned by the registered charity at the beginning or end of the fiscal period covered by the return; and
*was not used directly in charitable activities or administration.”
For foundations the 3.5% requirement kicks in after 25,000, not 100,000 as for charitable organizaitons.
Keep in mind that any previous ten year directions or trust restrictions still need to be complied with. Charities need to carefully review their donation/endowment agreements to make sure that they reflect the current DQ regime. Donors and charities must not slavishly follow pre-budget precedents that restrict their flexibility.
Some of the other impacts include:
* There will be less of a bias in favour of sponsorship over a donation as the increase in receipts issued will not affect the disbursement quota;
* With respect to political activities Canadian charities are allowed to spend up 10% of resources on political activities but only so long as they have met their disbursement quota requirements. As it will be easier to meet the disbursement quota requirement it will mean that more Canadian charities will be in a position to conduct allowable political activities in accordance with CRA rules set out in CPS-022;
* One of the other reasons given for the change in disbursement quota rules was the introduction of the Guidance on Fundraising by CRA in 2009. Charities should be aware of the content of the CRA Fundraising Guidance as fundraising practices and costs will probably receive greater scrutiny;
* There will probably have to be a more informed debate in Canada as to what is appropriate spending on non-charitable activities such as administration (overhead), fundraising, political, social and business;
* Some charities that were exclusively doing microfinance activities had complained that the 80/20 requirement had made capital accumulation difficult as lending the funds was not an expenditure (only foregone interest etc) and this change should make it easier for a stand alone charity to do microfinance;
* Charities can focus on other governance, legal compliance and standards issues instead of being caught up in the nuances of the DQ. For ideas as to what those issues are see: http://www.capacitybuilders.ca/clip/clip.php
* With foreign activities when payments were made to an “agent” the funds were only considered spent when the agent spent them, not when they were transferred by the Canadian charity to the agent. This distinction, which does not apply for example to contractor relationships, will be less important now that the dq is less important and much easier to meet.
Will the changes to the DQ mean that charities can stop allocating expenditures? No. Activities of a charity fall into different categories such as charitable, overhead (admin), fundraising, political, business and other such as social. The CRA fundraising guidance discusses allocation of fundraising expenditures in great detail. As long as there is a DQ (even if only 3.5%) charities will need to account for whether the expenditure fits into charitable or something else. Irrespective of the DQ, many other stakeholders such as funders, boards, employees, the public, media etc require information and charities that do not provide that information can suffer as a result.
One downside of the elimination of the 80/20 rule is that CRA has one less tool in their arsenal for getting rid of the few really bad charities. However, the really bad charities are usually non-compliant with many provisions of the Income Tax Act or common law and this change should not hamper their efforts to remove such charities. In the past when CRA went after a charity involved for example in a tax evasion scheme they went after the charity on a number of fronts, perhaps including the DQ. That being said I hope that Finance adds some other tools to the ability of CRA to get rid of extremely bad charities and to inform the public of concerns that CRA has, for example with charities involved with massive tax evasion schemes.
Another downside in some cases will mean that operating charities may receive less from foundations as their dq requirement is less and some foundations seem to only spend the minimum they are required to spend by law. We will have to see and I think there will be greater scrutiny on foundations as to how much they are disbursing. Whereas in the past foundations that used 10 years gifts had justified their 3.5% disbursement by relying on the restrictions in a 10 year gift to not encroach on capital so now this particular support for such a practice will not exist.
Here is a bit from Finances website:
“Helping Charities: Disbursement Quota Reform
The Government is proposing significant reforms to the disbursement quota to reduce administrative complexity and better enable charities to focus their time and resources on charitable activities.
The disbursement quota, introduced in 1976, was intended to ensure that a significant portion of a registered charity’s resources is devoted to its charitable purposes. Many observers have noted that the disbursement quota has been unable to achieve its intended purpose, as it does not take account of the varying circumstances of individual charities. Stakeholders such as Imagine Canada have also noted that the disbursement quota imposes “an unduly complex and costly administrative burden on charities—particularly small and rural charities.”
In recent years, the Canada Revenue Agency’s ability to ensure the appropriateness of a charity’s fundraising and other practices has been strengthened through the introduction of new legislative and administrative compliance measures and the provision of additional resources. These actions provide a more effective and direct means to fulfill many of the objectives of the disbursement quota.
Budget 2010 proposes to eliminate all disbursement quota requirements except those related to the requirement to annually disburse a minimum amount of investments and other assets not used directly in a charity’s operations. This requirement is being updated to provide charitable organizations a greater ability to maintain reserves to deal with contingencies.
The reformed disbursement quota rules will apply to charities for fiscal years ending on or after March 4, 2010. These changes will have no fiscal impact.”
HERE IS FURTHER INFORMATION:
ANNEX 5: TAX MEASURES: SUPPLEMENTARY INFORMATION AND NOTICES OF WAYS AND MEANS MOTIONS
Table of Contents - TABLE OF CONTENTS - TAX MEASURES: SUPPLEMENTARY INFORMATION - CHARITIES: DISBURSEMENT QUOTA REFORM
It is estimated that Canadian individuals will receive $2.4 billion in federal tax relief on charitable donations of $8.8 billion in 2009. In addition, corporations benefit from a deduction with respect to charitable donations.
Charitable activities are not defined in the Income Tax Act; instead, the meaning of charitable purposes and charitable activities in Canada is largely determined by jurisprudence. Charities must devote their resources to charitable purposes. The Income Tax Act specifies requirements for registration as a charity as well as grounds for revocation of that status. The Canada Revenue Agency determines the eligibility of an organization to be a registered charity for federal income tax purposes, based on an examination of the organization’s purposes and activities. In addition, charities are subject to corporate and trust law.
The disbursement quota was introduced in 1976 to help curtail fundraising costs and limit capital accumulation. The disbursement quota is intended to ensure that a significant portion of a registered charity’s resources are devoted to charitable purposes.
In general terms, the disbursement quota requires that the amount a charity spends each year on charitable activities (including gifts to qualified donees) be at least the sum of:
• 80 per cent of the previous year’s tax-receipted donations plus other amounts relating to enduring property and transfers between charities (in other words, a “charitable expenditure rule”); and
• 3.5 per cent of all assets not currently used in charitable programs or administration, if these assets exceed $25,000 (in other words, a “capital accumulation rule”).
Some have observed that the impact of the charitable expenditure rule can vary considerably, for reasons unrelated to the manner in which a charity conducts its charitable activities. For example, some charities have a wide range of revenue sources from which to fund their charitable activities, such as grants received from governments and revenues from related business activities. Since all charitable expenditures count toward meeting the disbursement quota, these charities have little difficulty satisfying it even if they do not spend their tax-receipted donations on charitable activities. In contrast, the rule is much more constraining on many small and rural charities that rely mainly on tax-receipted donations.
Stakeholders such as Imagine Canada have called for the elimination of the disbursement quota because it imposes “an unduly complex and costly administrative burden on charities - particularly small and rural charities” and it constrains the flexibility of charities, without achieving its core purpose of limiting spending on fundraising and non-charitable activities.
Recent legislative and administrative initiatives have strengthened the Canada Revenue Agency’s ability to ensure that a charity’s fundraising and other practices are appropriate. For example, the Canada Revenue Agency publication “Fundraising by Registered Charities” provides guidance for charities on acceptable fundraising practices.
The Canada Revenue Agency may impose sanctions or revoke the registration of a charity in situations where charities use their funds inappropriately, such as in cases where there is undue private benefit. These tools provide a more effective and direct means to fulfill the objectives of the charitable expenditure rule of the disbursement quota.
Budget 2010 proposes to reform the disbursement quota for fiscal years that end on or after March 4, 2010. Specifically, Budget 2010 proposes to:
• repeal the charitable expenditure rule;
• modify the capital accumulation rule; and
• strengthen related anti-avoidance rules for charities.
The Government will monitor the effectiveness of the Canada Revenue Agency’s guidance on “Fundraising by Registered Charities”, and take action if needed to ensure its stated objectives are achieved.
Repeal of Charitable Expenditure Rule
Budget 2010 proposes to repeal the charitable expenditure rule. Consequently, provisions relating to a number of concepts will no longer be required to calculate the disbursement quota:
• enduring property (gifts to a charity for endowments or multi-year charitable projects which are not subject to the charitable expenditure rule);
• the capital gains reduction and the capital gains pool (provisions that ensure that capital gains realized from the disposition of enduring property are not subject to the charitable expenditure rule and the capital accumulation rule);
• specified gifts (a provision that allows charities with disbursement excesses to help charities with disbursement shortfalls to meet their disbursement quota requirements); and
• exclusions from the calculation of the base to which the 3.5-per-cent disbursement rate is applied (provisions that ensure that funds subject to the charitable expenditure rule are not also subject to the capital accumulation rule).
Budget 2010 also proposes to amend the existing rule that provides the Canada Revenue Agency with the discretion to allow charities to accumulate property for a particular purpose, such as a building project. The existing provision states that property accumulated after approval from the Canada Revenue Agency and any income earned in respect of that property is deemed to have been spent on charitable activities. This rule will require amendment in the absence of the charitable expenditure rule. In order to allow a charity to accumulate property for a particular project, the Canada Revenue Agency will be given the discretion to exclude the accumulated property from the capital accumulation rule calculation.
Modify the capital accumulation component
There is currently an exemption from the capital accumulation rule for charities having $25,000 or less in assets not used in charitable programs or administration. Budget 2010 proposes to increase this threshold to $100,000 for charitable organizations. This increase 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 amount of all assets not currently used in charitable programs or administration, for the purpose of the capital accumulation rule in the disbursement quota, is subject to a calculation provided for in the Income Tax Regulations. This calculation requires a technical amendment to clarify that it applies both to charitable foundations and charitable organizations.
Strengthen anti-avoidance rules
Budget 2010 proposes to extend 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 disbursement quota.
Budget 2010 proposes provisions to ensure that amounts transferred between non-arm’s length charities will be used to satisfy the disbursement quota of only one charity. It is proposed that a recipient charity, in such circumstances, be required to spend the full amount transferred on its own charitable activities, or to transfer the amount to a qualified donee with which it deals at arm’s length, in the current or subsequent taxation year. Alternatively, the transferring charity will be able to elect that the amount transferred will not count towards satisfying its disbursement quota, in which case the recipient charity would not be subject to the immediate disbursement requirement under the anti-avoidance rules.
PREVIOUSLY ANNOUNCED MEASURES
Budget 2010 confirms the Government’s intention to proceed with the following previously-announced tax measures, as modified to take into account consultations and deliberations since their release:
• The income tax technical and bijuralism amendments that were previously released but not yet implemented.
NOTICE OF WAYS AND MEANS MOTION TO AMEND THE INCOME TAX ACT AND INCOME TAX REGULATIONS
That it is expedient to amend the Income Tax Act and Income Tax Regulations to provide among other things:
Charities: Disbursement Quota Reform
(18) That, for taxation years of registered charities that end on or after March 4, 2010,
(a) the definitions “capital gains pool”, “enduring property” and “specified gift” in subsection 149.1(1) of the Act be repealed;
(b) the formula in the definition “disbursement quota” in subsection 149.1(1) of the Act be replaced by the following:
A x B x 0.035 / 365
A is the number of days in the taxation year, and
(a) the prescribed amount for the year, in respect of all or a portion of a property owned by the charity at any time in the 24 months immediately preceding the taxation year that was not used directly in charitable activities or administration, if that amount is greater than
(i) if the registered charity is a charitable organization, $100,000, and
(ii) in any other case, $25,000, and
(b) in any other case, nil;
(c) the following definition be added in alphabetical order in subsection 149.1(1) of the Act:
“designated gift” means that portion of a gift, made in a taxation year by a registered charity, that is designated as a designated gift in its information return for the year.
(19) That, for taxation years of registered charities that end on or after March 4, 2010, the word “specified” in subsection 149.1(1.1) of the Act be replaced with the word “designated”.
(20) That, for taxation years of registered charities that end on or after March 4, 2010, subsection 149.1(4.1) of the Act be amended
(a) by replacing paragraph 149.1(4.1)(a) with the following:
(a) of a registered charity, if it 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;
(b) by adding the following after paragraph 149.1(4.1)(c):
(d) of a registered charity, if it has in a taxation year received a gift (other than a designated gift) from another registered charity with which it does not deal at arm’s length, and if it has not expended, before the end of the next taxation year, in addition to its disbursement quotas for those taxation years, an amount at least equal to the total amount of the gift, on charitable activities carried on by it or by way of gifts made to qualified donees with which it deals at arm’s length.
(21) That, for taxation years of registered charities that end on or after March 4, 2010, subsection 149.1(8) of the Act be replaced by the following:
(8) A registered charity may, with the approval in writing of the Minister, accumulate property for a particular purpose, on terms and conditions, and over such period of time, as the Minister specifies in the approval, and any property accumulated after receipt of and in accordance with that approval, including any income earned in respect of the accumulated property, is not to be included in the amount described in B in the formula in the definition “disbursement quota” in subsection (1) for any taxation year that the Minister specifies.
(22) That, for taxation years of registered charities that end on or after March 4, 2010, subsection 188.1(11) be replaced by the following:
(11) If, in a taxation year, a registered charity 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 is liable to a penalty under this Act for its taxation year equal to 110% of the amount of expenditure avoided or delayed, and in the case of a gift to another registered charity, both charities are jointly and severally, or solidarily, liable to the penalty.
(12) If a registered charity has in a taxation year received a gift of property (other than a designated gift) from another registered charity with which it does not deal at arm’s length, and if it has not expended, before the end of the next taxation year, in addition to its disbursement quotas for those taxation years, an amount at least equal the amount of the gift, on charitable activities carried on by it or by way of gifts made to qualified donees with which it deals at arm’s length, the registered charity is liable to a penalty under this Act for that subsequent taxation year equal to 110% of the amount of by which the fair market value of the property exceeds the total of such amounts expended.
The CCCC in a newsletter noted as follows:
CRA to Revise T3010B Form
In consultation with Charities Directorate officials today, CCCC has confirmed that a new T3010B will need to be released by CRA. The Directorate is hopeful that only a portion of the form may need to be redrafted, rather than a whole new form being produced. For now, charities should continue to use the existing T3010B. CRA will continue to accept these forms until a new form, or portion of a new form, is available.
CRA to Provide Instructional Insert
A priority for the Directorate will be the production of an insert containing instructions on how to calculate the disbursement quota in light of the changes. For example, the insert will direct charities to now ignore the concept of a specified gift, as specified gifts no longer exist. The Charities Directorate has advised that a new question and answer release will be available later today on the “What’s New” section of the CRA website.
Compliance with CRA Guidance Still Required
CRA will continue to monitor and enforce appropriate and adequate spending by charities through several new administrative guidances which have recently been introduced or are anticipated, along with existing audit and enforcement measures. For example,
• CPS-028, Fundraising by Registered Charities
• CPS-019, Related Businesses
• CPS-022, Political Activities
• RC4106, Registered Charities Operating Outside Canada (a new guidance is expected later this year)
Charities are reminded that the basic rule for spending on charitable activity has not changed. In accordance with the Income Tax Act, charities are still required to spend all of their resources on charitable activity. As long as charities adhere to CRA administrative guidance applicable to the activities of each specific charity, charities will remain in compliance.
This article is for information purposes only. It is not intended to be legal advice. You should not act or abstain from acting based upon such information without first consulting a legal professional.