On August 27, the Department of Finance released draft legislation which will implement the amendments to the disbursement quota proposed in the 2010 Budget in March. These amendments will eliminate the majority of the disbursement quota by removing the requirement to expend annually on charitable expenditures 80% of all receipted gifts and gifts from other registered charities received in the previous year. The amendments also will eliminate complex concepts such as “enduring property” and the “capital gains pool”. We originally reported on the Budget changes in March, and noted that these changes were welcomed by the charitable sector.
Although these amendments are generally very positive, some uncertainties do remain with respect to how the new rules will be administered. One such area is the treatment of gifts between charities which operate as part of a larger family of separately registered charities. The Budget introduced an anti-avoidance rule which provides that when a charity makes a gift to another charity with which it does not operate at arm’s length, the recipient charity would be required to spend on charitable expenditures 100% of the value of the gift by the end of the following year. The rules further provide that a charity can “designate” any gift made to another charity with the result that the gift would not give rise to this expenditure requirement in the recipient charity. If a gift is so “designated” it would not count towards the satisfaction of the donor charity’s disbursement quota.
The original definition of “designated gift” proposed in the Budget allowed charities to designate gifts to any other registered charity. The draft legislation amends this definition such that a charity can only designate a gift made to a non-arm’s length charity. Whereas under the former wording a charity could designate a gift to another charity in a related group, or to a parallel foundation, without taking a position on whether they operate at arm’s length, it will now be necessary to take a position on this issue. This has the potential to create difficulties. There is uncertainty as to when two entities will be considered not to be operating at arm’s length. Charities may not be commonly controlled, but they may be members of a related group (i.e. would a hospital and a foundation registered to support the hospital be considered arm’s length or not?). Charities could choose to designate all gifts out of an abundance of caution, but it may not be desirable in all cases to take the position that the donor charity is not at arm’s length with the recipient charity.
Another area of uncertainty relates to the anti-avoidance rule which provides for the de-registration of charities which have been determined to have entered into a transaction with a purpose of unduly delaying charitable expenditures. A version of this rule existed prior to the 2010 Budget, but the Budget has expanded its application. With the elimination of most of the expenditure requirements in the disbursement quota, it is possible that CRA may make wider use of this provision if it concludes that a charity has not made sufficient charitable expenditures in a given year. While it is our hope that this provision will not be used to effectively impose a new expenditure requirement, it remains to be seen how CRA will apply this provision and in what circumstances.
Charities should also remember that existing endowments which are subject to ten year hold conditions will in most cases still be subject to these conditions as a matter of trust law, notwithstanding the elimination of the concept of “enduring property” in the Income Tax Act. The question of whether the ten year hold period will continue to apply to existing gifts will depend on the wording of the document that imposed the hold period and whether it provides flexibility for it to be changed. Tax rules operate alongside trust law rules which must also be considered when dealing with existing and future endowments.
Going forward, charities and donors will have greater flexibility in structuring gifts and long-term endowments. The new rules, for example, will make it easier for charities to adopt a “total return” approach to new endowment funds, allowing for the expenditure of a specified percentage annually out of the fund irrespective of whether the funds expended are taken from income or capital.
As noted, the changes in the 2010 Budget are beneficial to the charitable sector. Charities operating in the context of the new rules should remember, however, that in addition to the opportunities created by these changes, compliance issues remain which must be carefully considered when operating. Greater clarity with respect to these rules will emerge as time passes and we see how CRA applies the rules in practice.