On April 26, 2022, the Government of Canada tabled the Budget Implementation Act, 2022, No. 1 (the “BIA“), which implements a first set of proposals from the very recent 2022 Federal Budget. Canadian charities and not-for-profit organizations will be most interested in the BIA’s proposed legislative language regarding “qualifying disbursements” – new rules that will govern grants from registered charities to non-qualified donees.
These changes are described as being passed in the spirit of a different set of proposals contained in Senate Bill S-216, the Effective and Accountable Charities Act, which had passed all three readings in the Senate and first reading in the House of Commons. Supported by many charities lawyers across Canada, Bill S-216 would have created an accountable but more realistic framework for Canadian charities to fund non-qualified donees and to do so in a less paternalistic and administratively burdensome way.
Although the BIA proposals purport to achieve that same objective for Canadian charities and also to be less paternalistic, there are real questions about whether they actually do so. As we explain below, compared with Bill S-216, the BIA appears to take a more paternalistic and colonial approach to funding activities outside of Canada or that are carried out in Canada through non-qualified donees. The BIA also appears to increase, not reduce, the administrative burden for most Canadian charities that work with non-qualified donees.
The law today: The “own activities” test
Currently, Canadian registered charities can use their resources only on their “own activities” or on gifts to other qualified donees (generally, other registered charities). The CRA will consider a transfer of resources by a charity to a non-qualified donee to be part of a charity’s “own activities” and a permitted activity only if the charity has “direction and control” over the non-qualified donee’s use of the charity’s resources. “Direction and control” is generally evidenced by some form of written intermediary agreement made between the charity and the non-qualified donee that adopts the donee’s activity as the charity’s own and imposes controls on it.
The Canada Revenue Agency (“CRA“) has administrative guidance for charities that lists non-binding examples and indicia of “direction and control” that the CRA expects to see in these written intermediary agreements. However, the CRA’s list is simply a list of factors that the CRA will consider in context. Our experience suggests that the CRA is often quite flexible in applying these factors and endeavours to take a risk-management approach when doing so.
Nonetheless, in many instances, the current rules are inconsistent with how most organizations actually work together and needlessly difficult to administer, not only because charities must satisfy the “own activities” fiction but also because charities need to show “direction and control” over the non-qualified donee’s use of its resources, even if it is through a somewhat flexible list of factors.
The idea of imposing ‘direction and control’ over an Indigenous organization or an on-the-ground international development organization also continues to raise questions about Canada’s attitude to funding such activities. The current Canadian rules are already the most restrictive of any national tax system that we have seen. For Canadian charities working in international development or with non-qualified donee Indigenous organizations in Canada, these rules, especially the “direction and control” requirement, force recipient organizations into relationships that are paternalistic and colonial.
The Bill S-216 proposals
In response to both (i) the problems with the current “own activities” rules; and (ii) the recommendations of the Special Senate Committee on the Charitable Sector, Senator Ratna Omidvar introduced Bill S-216, the Effective and Accountable Charities Act in February 2021.
If enacted, Bill S-216 would amend the definitions of “charitable activities” and “charitable organizations” in the Income Tax Act (Canada) to remove the requirement that the activities be the charity’s “own”. The Bill would instead allow charities to transfer its resources to non-qualified donees, so long as the charity takes reasonable steps to ensure that the transferred resources are used exclusively for a charitable purpose. To ensure accountability, Bill S-216 also requires a charity to conduct due diligence on potential partner organizations. The charity must gather the information “necessary to satisfy a reasonable person that the resources will be used for a charitable purpose,” including information on the partner organization’s identity, experience, and activities.
The Bill S-216 proposals are seen as an improvement to the current rules because the proposals would continue to require reasonable steps to ensure accountability, would remove the artificial “own activities” and paternalistic “direction and control” requirements, and would modernize Canadian charity law and bring it in line with the laws of the United States, the United Kingdom, Australia, and New Zealand.
The BIA changes
Rather than adopt the proposals in Bill S-216, the BIA introduces a different proposal which is described as intending to achieve the same objective. The BIA introduces a new “qualifying disbursements” regime, with five key components:
1. “Qualifying disbursements” and “Grantee organizations”
The BIA introduces a new concept of “qualifying disbursements.” A qualifying disbursement is a disbursement by a charity either to a qualified donee or to a “grantee organization” (i.e. a non-qualified donee). Registered charities can disburse funds to grantee organizations so long as (i) the disbursement furthers one of the charity’s charitable purposes, (ii) the charity ensures that the grantee organization applies the funds to charitable activities that further one of the charity’s purposes, and (iii) the disbursement meets a specific set of mandatory accountability requirements (see our next point).
2. Accountability requirements for qualifying disbursements
Qualifying disbursements must meet a series of mandatory accountability requirements set out in the Income Tax Regulations (the “Regulations“). These accountability requirements are:
- A requirement for a written agreement with the grantee organization that includes the following:
- the terms and conditions of the disbursement, including a requirement that all resources be used exclusively for charitable activities in furtherance of a charitable purpose of the charity;
- a description of the charitable activities that the grantee organization will undertake;
- a requirement that any resources not used exclusively for the purposes for which they were disbursed be returned to the charity;
- a requirement that periodic reports be made by the grantee organization, at least annually, which are to include details on the use of the disbursed resources, compliance with the terms of the agreement and progress made toward the purposes of the disbursement;
- a requirement for the provision to the charity, in a timely manner, of a written final report from the grantee organization, which includes a summary of the results achieved with the charity’s resources, details on how the resources were used and documentary evidence to demonstrate that resources were used exclusively for the purposes for which they were disbursed;
- a requirement that the books and records relating to the use of the disbursement be transferred to the charity or be kept by the grantee organization for a minimum of six years following the end of the last taxation year of the charity to which the books and records of account relate, and
- a requirement that, upon request by the charity, books and records relating to the use of the disbursement be made available in a timely manner to the charity to inspect, audit, examine or copy;
- Specific due diligence requirements to obtain reasonable assurances that the required provisions in the written agreement will be complied with, including a review of the identity, prior history, practices, activities and areas of expertise of the grantee organization and its principals.
- The charity must carry out ongoing monitoring, including receiving periodic reports and verifying the appropriate use of its resources.
- If the charity becomes aware that the agreement is not being complied with in full, the charity must undertake “adequate remedial action,” including, where appropriate, withholding funds or attempting to recover disbursements.
3. Reporting qualifying disbursements on annual information returns
A charity must disclose on its T3010 annual information return (i) the name of each grantee organization that received more than $5000 in qualifying disbursements in the year, (ii) the purpose of each such disbursement, and (iii) the total amount disbursed to each grantee organization in the year.
It is unclear whether this disclosure will be publicly accessible or will be included in the confidential section of the T3010 that is available only to CRA.
4. Anti-directed giving rule
Registered charities will be prohibited from accepting gifts where the gift was given on the express or implied condition that the charity would be “making a gift to another person, club, society, association or organization other than a qualified donee.”
Based on our reading of the draft legislation, registered charities would be prohibited from accepting gifts where the donor implicitly or explicitly directs the charity to use the gift to make a qualifying disbursement to a grantee organization. The new rule change would not prevent a charity from accepting a gift where the donor implicitly or explicitly directs the charity to use the gift on the charity’s “own activities,” including making grants or resources available to a non-qualified donee where the charity exercises direction and control over the donee’s use of the charity’s resources.
This anti-directed giving rule currently applies to registered Canadian amateur athletic associations and registered journalism organizations. The BIA extends the rule to registered charities. Breaching this rule could result in deregistration of a charity.
5. Repeal of Bill S-216, if enacted
In the clearest indication that the Government of Canada intends for the “qualifying disbursement” rules—not Bill S-216—to be the preferred basis on which disbursements to non-qualified donees are facilitated, the BIA provides that, if Bill S-216 passes, it will be subsequently repealed when the BIA receives Royal Assent.
Commentary: The right approach?
Rather than follow the approach of Bill S-216 which enjoyed wide support across the Canadian charitable sector, the BIA goes in another direction.
If the proposals in the BIA are enacted without amendment, charities will have two ways to fund or make their resources available to non-qualified donees: (i) through gifts that are “qualifying disbursements,” or (ii) through the current “own activities” rules (which the BIA does not displace).
Fundamentally, if a Canadian charity makes a qualifying disbursement, the charity no longer needs to treat it as its “own activity”; however, all of the accountability measures that the CRA would look at in the context of “direction and control” would become mandatory with respect to the disbursement.
As mentioned earlier, this qualifying disbursement approach was proposed as an alternative to Bill S-216. Bill S-216 had two purposes: (1) to create a mechanism for Canadian charities to fund non-qualified donees (while still maintaining accountability) without creating fictional structures to do so; and (2) to make those funding structures less colonial and paternalistic while providing for a principled approach that ensured appropriate accountability and transparency.
By providing an alternative to the “own activities” test, the BIA could have benefited many existing and future registered charities seeking to facilitate grants and other transfers to non-qualified donees without being required to carry out its “own activities” as part of the transfer of resources.
However, we worry that the usefulness of the qualifying disbursement approach will be undercut in many cases because the BIA formalizes all of the contextual indicia of direction and control as being mandatory, without accommodating the multitude of different contexts in which charities work and collaborate and without allowing charities to factor practical issues like materiality and their experience with a given partner in the accountability measures they employ. In fact, by making the “direction and control” indicia mandatory for qualifying disbursements, the BIA might actually cause the CRA to take a more rigid approach to “direction and control” in the “own activities” context as well, thereby reducing flexibility across the board (and not just for qualifying disbursements). In other words, our main concern is that the BIA could make it more difficult, not easier, for many Canadian charities to work with non-qualified donees. Turning a list of contextual factors into a prescribed list of items that must all be met, increases the administrative bar considerably. It could be suggested that this gives certainty, but certainty was already available to a Canadian charity by ensuring that it met all of the factors that CRA could look to under the own activities approach.
Similarly, the new qualifying disbursements regime increases, rather than decreases, the degree of paternalism and colonialism required of Canadian charities to comply with the CRA rules. In our experience, the complaints about paternalism and colonialism in the current rules stem more from the heavy-handed “direction and control” requirements (which the new rules increase dramatically) than from the requirement that the Canadian charity formally adopt the activities as its “own” (which the new rules remove).
There are other problematic rule changes in the BIA that we think would limit the usefulness and widespread adoption of qualifying disbursements.
For example, the extension of the anti-directed giving rule to registered charities would discourage charities from making qualifying disbursements. Most charities that wish to make qualifying disbursements to non-qualified donees will likely solicit and receive donations from the public on this basis and for this purpose; however, the BIA would pre-emptively put an end to directed gifts that are qualifying disbursements without reasonable justification. Such a rule change, in our view, will only force more charities to make their funds and resources available to non-qualified donees as part of the charities’ “own activities.”
Likewise, the requirement that charities disclose the identities of grantee organizations receiving qualifying disbursements over $5,000, as well as the purpose of such disbursements, adds to the already-high administrative load for charities. The requirement is also problematic for many Canadian charities carrying out sensitive charitable work at home or abroad (e.g. churches funding missionaries in countries where missionaries are persecuted, or women’s charities and LGBTQ+ charities supporting individual activists in regions where women’s rights and LGBTQ+ rights are severely curtailed). If this information is to be disclosed on the T3010, it should be treated as confidential and not made public.
In summary, we think that the BIA approach does not meet all of the policy goals of Bill S-216 which it is designed to pre-empt. Subject to further changes to the BIA itself and subject to further administrative guidance from the CRA, we expect that many Canadian charities seeking to work with non-qualified donees will continue to do so through the current “own activities” approach and not through the new qualifying disbursements rules.