By Terrance S. Carter and Jacqueline M. Demczur

As reported in our Charity & NFP Law Bulletin No. 492, the 2021 Federal Budget released on April 19, 2021 proposes launching public consultations with charities to potentially increase the disbursement quota, as well as update the related tools at the CRA’s disposal beginning in 2022. The Budget anticipates that these steps could possibly increase support for the charitable sector and those who rely on its services by between $1 billion and $2 billion annually.

The “disbursement quota” is the minimum amount that a charity must spend on its charitable activities or gifts to qualified donees to ensure that charitable funds are used for charitable purposes and are not simply accumulated indefinitely. At present, each charity must disburse 3.5% of its assets not used directly in its charitable activities and administration (referred to as the “3.5% disbursement quota”). Prior to 2010, charities were also required to disburse 80% of the receipted donations by the following year (referred to as the “80% disbursement quota”), subject to a number of complex exceptions.

As background, the disbursement quota used to apply to charitable foundations (but not charitable organizations), and was set at 4.5% before it was reduced to 3.5% for taxation years that began after March 22, 2004. This 2004 change to a 3.5% disbursement quota was an important amendment to the Income Tax Act (“ITA”) because, charities were finding it difficult to meet the 4.5% disbursement quota due to low interest rates at the time. In 2004, the 3.5% disbursement quota was also extended to charitable organizations, with the 80% disbursement quota subsequently being eliminated in 2010.

It is expected that there will be many differing opinions in the charitable sector about what the disbursement quota should look like in the future. In this regard, Philanthropic Foundations Canada on June 16, 2021, released a thoughtful Policy Brief entitled, Renewing Our Social Contract: Private Philanthropy for the Public Good. It recommended that a holistic approach should be brought to the disbursement quota change discussions in order that those changes will be made part of a larger conversation concerning “how can foundations better fulfill their missions and better serve the common good”.

The Canadian Bar Association (“CBA”), through its Charity and Not-for Profit Law Section, has also weighed in on the discussion. In a June 15, 2021 letter to the Honorable Christa Freeland, Minister of Finance, the CBA described the possible problems that a disbursement quota increase could have on endowments that are subject to capital expenditure restrictions. The letter points out that if, contrary to the terms of any endowment agreement, a total return approach (e.g. the expenditure of realized capital gains as well as interest and dividend income) or expenditure of any original capital is required in order to meet an increased disbursement quota, then charities may have to commence potentially expensive court applications in order to obtain formal authorization to vary the terms of existing endowment agreements.

There will, no doubt, be much discussion over the coming months regarding what specifically needs to be “fixed” with regard to the 3.5% disbursement quota and what that “fix” should look like. It will be important for charities, particularly public and private foundations holding sizeable investment assets, to carefully monitor these discussions and participate in the consultations once announced by the Department of Finance. During these consultations, it might be helpful to consider the following questions amongst others that may be proposed:

1. What data exists about compliance or lack of compliance by charities with the 3.5% disbursement quota?
2. What is the tax policy objective to be achieved by amending the disbursement quota?
3. Are there other tax policies that need to be considered in amending the disbursement quota, such as eliminating the “its own activity” test in the ITA and the related CRA “direction and control” regime as proposed in Bill S-222, the Effective and Accountable Charities Act, that recently passed Third Reading in the Senate?
4. Should an increase in the 3.5% disbursement quota be accompanied by a change in administrative policies by the CRA to allow impact investment (e.g. program related investments and social investments) to be counted as charitable expenditures in meeting the disbursement quota?
5. What consideration should be given to donor intent where donors impose restrictions on the expenditure of capital, including realized capital gains, that might otherwise need to be varied through a court order to meet an increased disbursement quota?
6. What are the advantages and disadvantages of placing the disbursement quota into regulation, rather than the ITA?

Read the June 2021 Charity & NFP Law Update