T he Federal Budget 2010 has introduced significant changes to the disbursement quota obligations imposed on registered charities pursuant to the provisions of the Income Tax Act (Canada) (ITA). These changes have been met with great interest and relief by the charitable sector, which has struggled with an increasingly complex and onerous disbursement quota regime.

The ITA provides that registered charities must satisfy their ‘disbursement quota’ (DQ) in each year in order to maintain their charitable registration. The DQ is a prescribed amount that registered charities must expend each year in a charitable capacity on their own charitable activities or by way of gifts to qualified donees (generally other charities).

The existing disbursement quota regime was originally introduced in 1976 to ensure that registered charities devoted a significant portion of their resources to charitable activities. It was intended to discourage registered charities from spending excessive amounts on fundraising and from accumulating excessive capital.

Briefly, the existing DQ of registered charities, whether they are charitable organisations, public foundations or private foundations, consists of the aggregate of the following:

In addition, the concept of the ‘capital gains pool’ allows registered charities to encroach on the realised capital gains from enduring property, i.e., ten year gifts, to meet their 3.5 per cent DQ obligations.

Over the years there has been much criticism of the disbursement quota regime, both for its complexity and for its disparate impact on registered charities. The government’s commentary introducing Federal Budget 2010 notes that the impact of the existing disbursement quota regime ‘can vary considerably, for reasons unrelated to the manner in which a charity conducts its charitable activities.’ For example, the existing regime requires registered charities to either expend the bulk of the gifts for which receipts were issued or to hold the capital of such gifts for specified periods of time. As a result, the requirements of this regime have often been in conflict with the programme needs and planning goals of registered charities and have bee particularly difficult for those organisations whose income derived primarily from receipted donations.

The introduction by the Canada Revenue Agency (CRA) of a comprehensive fundraising guidance policy on 9 June 2009 (Fundraising Policy), which provided registered charities with examples of acceptable and unacceptable ratios of fundraising to charitable expenditures, also complicated the existing DQ regime. The suggested fundraising ratios provided in the Fundraising Policy are as follows: (i) less than 35 per cent fundraising expenses, little CRA concern; (ii) greater than 35 per cent fundraising expenses, some CRA concern; and (iii) above 70 per cent fundraising expenses, significant CRA concern and potential deregistration. The confusion arises from the fact that these percentages differ from the 80 per cent to 20 per cent disbursement quota ratios. In addition, the introduction of the Fundraising Policy seemed to ameliorate some of the policy concerns behind the 80 per cent disbursement quota requirement.

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 (Concept Paper) to the Department of Finance. The CBA Concept Paper identified four specific regulatory objectives of the current DQ regime: (i) current gifts disbursement; (ii) anti-accumulation; (iii) efficiency; and (iv) fundraising efficiency.

The Concept Paper proposed that the objectives of a DQ regime should be to prevent undue accumulation of donations, income and capital. The Concept Paper noted that the current regime is not an effective instrument to curb fundraising costs and achieve administrative efficiency. It further noted that the fourth objective is better achieved by the CRA Fundraising Policy and the third objective could be monitored through increased transparency.

A number of recommendations for reform were put forward including: (i) repeal of the 80 per cent DQ; and (ii) modification of the 3.5 per cent DQ, with consequent simplification of the DQ calculation and repeal of the complex DQ concepts in the ITA. These recommendations were supported by Imagine Canada, the Canadian Association of Gift Planners and other organisations during hearings before the House of Commons Standing Committee on Finance in the fall of 2009.

In response to these concerns, as well as others raised by the charitable sector, the Federal Budget 2010, and its accompanying draft legislation, has proposed the following significant changes be made to the DQ obligations of registered charities pursuant. These changes will apply to charities’ fiscal years ending on or after 4 March 2010.

The charitable expenditure rule (i.e., the requirement that 80 per cent of all receipted gifts received in the previous year must be expended) will be eliminated. This means that a number of very complex concepts will no longer be required to calculate the disbursement quota of registered charities, including the terms ‘enduring property’, ‘specified gifts’ and ‘capital gains pool’.

Specified exclusions from the calculation of the base of the 3.5 per cent disbursement quota rule will also be eliminated, as these provisions were meant to ensure that funds subject to the 80 per cent disbursement quota rule were also not subject to the 3.5 per cent rule.

The capital accumulation rule (i.e., the requirement that 3.5 per cent of all assets not currently used in charitable programmes or administration be disbursed if such assets exceed CAD25,000) will be modified.

The CAD25,000 threshold for when this requirement is imposed will be increased to CAD100,000 for charitable organisations. As the Federal Budget 2010 materials suggest, this increase will ‘reduce the compliance burden on small charitable organisations and provide them with greater ability to maintain reserves to deal with contingencies.’ The threshold for charitable foundations will remain at CAD25,000.

In addition, in order to allow registered charities to accumulate property for particular projects, the CRA will be given the discretion to exclude such accumulated property from the 3.5 per cent disbursement quota obligation.

Anti-avoidance rules will be extended to situations where ‘it can be reasonably considered that the purpose of a transaction was to delay unduly or avoid the application of the disbursement quota.’ Registered charities that engage in such transactions will be liable for penalties equal to 110 per cent of the amount of the expenditure avoided or delayed.

Provisions will be introduced to ensure that amounts transferred between non-arm’s length registered charities can only be used to satisfy the disbursement quota obligations of one of the registered charities.

These provisions will require the recipient charity to either spend the entire amount it receives on its own charitable activities or to transfer the amount to an arm’s length qualified donee in the current or subsequent taxation year. Registered charities that are in violation of such provisions will be liable for penalties equal to 110 per cent of the amount received from the non arm’s length charity but not expended in the current or subsequent taxation year.

Alternatively, the registered charity that transfers the funds will be able to elect that its gift not count toward satisfying its own disbursement quota. This will relieve the recipient charity from being required to make the aforementioned disbursements.

In a recent publication, the CRA has indicated that it will be making several administrative changes in response to the changes to the DQ. The CRA will be providing guidance to registered charities on how to determine their disbursement quotas and will also be revising the annual information return (Form T3010B).

The significant changes to the DQ regime introduced in Federal Budget 2010 will be of great benefit to registered charities.

The expense and time spent by registered charities in order to comply with the DQ regime will hopefully be greatly reduced. In addition, registered charities will no longer have to insert restrictive conditions in endowment agreements in order to allow the gifts comprising the endowment to constitute ‘enduring property’. In the future, one can expect to see more flexible terms and conditions in endowment agreements, which in turn will lead to greater ease of administration of such gifts in the future.

For example, endowment agreements under the existing DQ regime have had to restrict the ability of the charity to encroach on capital for a period of at least ten years from the date of the donation in order for the endowed gift to qualify as enduring property. As a result, the disbursement of the income and capital of the fund has had to be dealt with separately in the terms of the endowment agreement. Under the new regime, endowment agreements can be drafted so that specific references to income and capital are removed in favour of provisions that allow for a total return investment and payout strategy (i.e., a combination of capital appreciation and income returns).

In addition, now that charities will no longer have to struggle with structuring long-term gifts and endowment funds to comply with complex ITA language related to enduring property, both charities and donors will need to carefully consider whether long-term gifts or gifts held ‘in perpetuity’ are either required or desirable. For most charities, the key to most long-term gift planning will be flexibility, provided that the donor’s wishes can be otherwise satisfied.

It should also be noted that as a result of the DQ reform introduced in Federal Budget 2010, existing donor agreements should be reviewed to determine whether it is possible for the charity to encroach on the capital of the gift either prior to or after the requisite ten-year hold period. In addition, template documents used by charities, such as donor agreements and policy statements (e.g., gift acceptance, investment and distribution policies) should be reviewed and updated. For example, references to concepts such as enduring property, ten-year gifts and the capital gains pool can be removed from donor agreements. Education of both staff and donors will also be necessary and communication materials, such as the charity’s website, newsletters etc., will need to be updated.

Notwithstanding the significant simplification of the DQ regime resulting from Federal Budget 2010, registered charities will still need to continue to be diligent about their compliance with all applicable rules and regulations. In particular, the content of the new legislative requirements, and the manner in which they are interpreted by the CRA (and in particular the anti-avoidance provisions), will have to be monitored in order to ensure that the remaining DQ regime continues to be complied with on a going forward basis. In this regard, the transitional policy statements that will be introduced by the CRA will have to be reviewed carefully. For example, there are still questions as to whether those charities that have accumulated DQ excesses can utilise them. Finally, it appears likely that the abolition of the 80 per cent disbursement quota requirement will increase the importance of the CRA’s Fundraising Policy as an audit and compliance tool. Registered charities should pay careful attention to ensuring that they satisfy the requirements set out in these guidelines on an ongoing basis.