Forcing charities to erode capital is not a solution

  • October 27, 2021

A charity’s disbursement quota, or DQ, is the minimum amount of money it must spend on its charitable activities or gifts to qualified donees. This minimum is set to ensure funds collected by charities are used for charitable activities and not accumulated indefinitely. The DQ is calculated as a percentage of a charity’s property value that is not used for charitable activities or administration.

The Charities and Not-for-Profit Law Section of the Canadian Bar Association says, in a letter to Finance Canada (and in a previous letter to the Minister of Finance), that raising the DQ in a low interest environment would be challenging for many charities.

The DQ was first introduced in 1975. In 2004, thanks to low interest rates and the difficulties charities faced in meeting their DQ, it was lowered from 4.5% for private and public foundations to 3.5%, a rate that was also extended to charitable organizations.

A Senate Committee report in 2019 raised concerns about the DQ, including whether allowing charities to hoard funds met the public need, that charities could be more transparent and accountable, and that the public good should supersede private interests when determining how and when to disburse funds.

The CBA Section says raising the DQ is not the right way to address those concerns and adds that before making any changes to the regime we should ensure there is sufficient relevant data available to determine exactly what problems may exist.

“The main source of information is the T3010 annual return, which all charities must complete and file with the Canada Revenue Agency (CRA) and which collects information on a charity’s DQ and whether it has been met,” the Section writes, adding that issues go further than whether the DQ has been met.

“For example, are the investments held by larger charities skewing the average percentage of disbursements? How are charities expending their funds to meet their respective DQs?” The CBA Section recommends conducting a thorough study to understand whether “raising the DQ will meet the goal of increasing support for other charities as well as non-profit organizations that collectively provide services to local communities.”

Overcomplicated compliance

For many years, charities had to contend with an onerous compliance burden due to a DQ regime that was difficult to understand.

At the moment, the DQ applies at the charity level and not at the donor advised fund or individual endowment levels. One suggestion is to apply the DQ at the individual fund level and require a minimum disbursement per fund held by the charity. “While this leads to greater transparency, it also significantly increases administrative costs for calculation and reporting obligations,” writes the Section, adding that we should first determine if a problem really exists before applying a remedy that may not be suited to the situation.

Need for sustainability and predictability

Because charities sometimes use their capital asset base to generate income which in turn can be spent on charitable activities, an increased DQ would have a significant impact on them, including the erosion of their capital base.

“Charities cannot plan if they do not know whether and to what extent annual funds are available to fund existing and future programs,” the Section says. “Charities must invest charitable funds prudently to allow funds for current activities yet conserve the investment portfolio value against inflation. Increasing the DQ expenditure challenges this balance and encourages riskier investments.”

A possibility to consider is expanding what is a charitable disbursement for the purposes of meeting the DQ. Investments that achieve an organization’s charitable purpose while generating a financial return, such as social investments, are not currently considered charitable disbursements to meet the DQ. According to the CBA Section, this lack of recognition discourages charities with large investment assets from using them to make a difference for good in achieving their charitable purpose.

The DQ simply directs a charity to spend, it says nothing about how to spend those funds. “A higher DQ and increasing immediate expenditures and disbursements will have consequences for available funding in future years. We cannot assume that if charities spend more now, their capital base will be replenished or there will be other support avenues in future years. The issues are complex. A nuanced and balanced approach is needed,” the Section says.