The drawbacks of a sharp rise in minimum annual disbursement quotas
The law of unintended consequences is usually applied with ruthless precision when it comes to public policy. Governments often employ common sense solutions, only to understand months, years or decades later how their decisions created significant challenges for the very stakeholders or institutions they sought to help. And so it is with some federal political parties’ commitment to raise the minimum annual disbursement quotas for private foundations and Donor Advised Funds.
As with any federal election, this one has presented Canadians with a number of important ballot box decisions. On the charity front, just prior to the election call, the Liberals launched a review of annual disbursement quotas—which are currently set at 3.5 per cent of a registered charity’s property. That property might include cash, investments or real estate. The widely-held belief was that the Trudeau government was readying to increase the quota in the near future. Once the writ was dropped, the Conservative Party of Canada surprised some political pundits when it released a platform that pledged to increase the annual quota to a whopping 7.5 per cent annually.
In the whirlwind of a time-limited election campaign, the promise is proving popular and, at first glance, seems utterly rational—particularly given the economic devastation wrought by COVID-19. The fact is that a small cohort of very large foundations in Canada is sitting on nearly $28 billion in assets. Yet they disburse less than the 3.5 per cent minimum, thereby creating what could be interpreted as a financial drag across the charitable sector. At a time when many non-profits are desperate for aid, why not force these entities to give away more?
But what may seem like an obvious answer—adjusting legislation to force increased annual disbursements—could easily cause a ripple effect that we believe would exacerbate long-term funding challenges across the sector. Giving away more now is almost certain to leave non-profits with less later.
Perception vs. reality
The common misconception is that foundations are a kind of lucrative tax shelter. This is not the case. Private foundations and public foundations offering Donor Advised Funds (DAFs), such as Canada Gives, are subject to significant oversight and reporting requirements under Canada Revenue Agency rules. While they can spend on their own administration and charitable activities, the vast majority of foundations limit those expenditures to the bare necessities. Most also meet or exceed the current 3.5 per cent disbursement minimum. To be clear (and contrary to popular belief), there simply is no mechanism for ‘the rich’ to use a foundation—private or otherwise—as a personal piggy bank.
Now, do those same foundations build sizeable endowments? Of course. In fact, one of the top foundations in Canada had assets of approximately $23 billion in 2018. Private foundations and DAFs invest their donated capital with the intention of growing those assets over time. This is perfectly legal and ethical, even if it’s raised the ire of some federal parties. So, why grow those assets?
A sustainable, longer-term impact
The simplest analogy is to look at universities, particularly those in the U.S. Ivy League schools are perhaps the best example. They maintain massive endowments, sometimes in the billions of dollars. These are funded by everything from tiny annual alumni donations to massive contributions from wealthy benefactors. Endowments such as these are the lifeblood of many educational institutions because they tend to subsidize a range of costly line items including student tuition, bursaries and scholarships, athletics and arts programs, capital and other miscellaneous expenditures—and more. Without them, the student experience would be vastly different.
Foundations and charitable organizations with large, growing endowments operate on the same principle. They invest donated capital to help fund one or more charitable organizations over time. Eventually, as the laws of mathematics dictate (and even at the current disbursement quota), those foundations will be entirely liquidated. The goal is to stretch out that period for as long as possible to ensure that a philanthropist’s preferred causes have access to stable, reliable and long-term sources of funding. Ultimately, it’s about maximizing the value of a charitable gift(s) to create a multiplier effect where the eventual charitable impact far exceeds the sum of the original donation(s).
Foundations that aim to be active in near-perpetuity (remembering that every foundation will eventually be spent down to zero) will be unable to achieve that mandate if the annual disbursement quota is increased to 7.5 per cent—or as much as 10 per cent, as some are currently advocating. Those targets are overly aggressive. It would be nearly impossible to increase the size of an endowment other than through continued donations, especially when foundation administration fees are taken into account.
The losers here will be the tens of thousands of non-profits in Canada that rely on that funding to continue delivering their life-changing work at home and abroad.
Could rules be tightened to ensure that the very large foundations disburse more each year? Perhaps, but if these same large foundations are not even disbursing 3.5 per cent in annual funding, how is raising the level for the many active grant-makers going to change the situation? Perhaps enforcing the existing quota is the first step. Donors should also be able to choose how and when they make grants from their private foundation or DAF. Additional red tape could discourage some from engaging in philanthropy altogether.
There is always room to improve tax laws governing the management of private foundations and DAFs in Canada. And we’re all for making the system work better and increasing funding to the charitable sector. But it must be done with foresight and an understanding of what’s at stake. Those calling for a dramatic increase in disbursement quotas should look ahead and be mindful of the possible unintended consequences.
The Canada Gives team
To learn more about Canada Gives Foundation accounts, contact a member of our team.
