If you’ve ever helped a client set up or manage funds in a private foundation or a donor-advised fund, you’ll no doubt be familiar with the concept of the disbursement quota. Under Canadian tax law, registered charities must spend a minimum amount each year on their own charitable programs or on gifts to other charities. This disbursement quota (DQ) is based on the fair market value (averaged over a 24-month period) of a charity’s property, such as real estate or investments, that are not used for charitable activities or administration. Currently, the DQ for Canadian charities is set at 3.5%.
The DQ was originally introduced in 1976 to ensure that a significant portion of a charity’s resources were actually devoted to its charitable purposes. Initially, the DQ included two requirements: an obligation for charities to spend a minimum amount (80% for charities and 90% for foundations) of the funds for which it issued donation receipts in the immediately preceding year, and for foundations to spend a minimum of 5% of fair market value of any property not used in charitable programs or administration, which was lowered to 4.5% in the 1980s.
In 2004 the DQ was further reduced to its current level of 3.5%, the rationale being that this lower rate was considered at the time to be “more representative of historical long-term real rates of return earned on the typical investment portfolio held by a registered charity,” according to the Finance Department.
In 2010 the DQ rules were substantially reformed to make them simpler and more equitable for all charities by removing the requirement that charities disburse amounts based on the previous year’s tax-receipted income, leaving the DQ at a simple 3.5% of the charity’s or foundation’s assets.
In this year’s federal budget, the government noted that, while most charities meet or exceed their DQs, a gap of at least $1 billion in charitable expenditures exists today. The government also noted the tremendous growth in the investment assets of foundations in recent years, remarking that in 2019, charitable foundations held over $85 billion in long-term investments. While no new changes were announced in the budget, the government announced its intention to potentially increase the DQ for 2022, which could “boost support for the charitable sector, benefiting those that rely on its services.”
To this end, over the summer the government launched a public consultation process seeking interested parties’ feedback on potentially increasing the DQ, as well as “updating the tools at the Canada Revenue Agency’s disposal in order to enforce the […] rules.”
Specifically, the government is seeking the public’s input as to whether the 3.5% DQ rate is still reflective of expectations of long-term real rates of portfolio returns among charities and foundations, and whether the DQ “strikes the appropriate balance between providing long-term, sustainable funding for the charitable sector and on ensuring that tax-assisted donations are deployed toward charitable activities on a timely basis.”
The government would like feedback on a number of specifics, such as whether the DQ should be raised and, if so, to what extent. It also would like input on whether it would be desirable to increase the DQ to a level that causes foundations to gradually encroach on their investment capital, and whether this would be sustainable in the long term for the charitable sector. The government is also curious whether there should be any temporary changes to the DQ that should be considered in the context of the pandemic recovery.
Proponents of raising the DQ have long argued that tax-assisted donations, which benefit from immediate tax assistance in the form of a donation tax credit for individuals ($11 billion in individual donations in 2019) or a tax deduction for corporations ($4 billion), take too long to deploy toward charitable programs and that the current DQ “is unduly allowing the accumulation of capital.” Some stakeholders in the charitable sector have advocated that larger foundations with significant investment assets should be forced to draw upon their reserves in order to increase current support for charitable organizations.
On the other hand, having a lower DQ allows some organizations that rely on regular donations to build an endowment to sustain the organization through years where donations — and returns — may be low.
To have your say on Canada’s DQ rule, join the public consultation by submitting your comments by email to firstname.lastname@example.org with “Charities Consultation” as the subject line. The deadline for comments is Sept. 30.
Jamie Golombek, CPA, CA, CFP, CLU, TEP, is the Managing Director, Tax & Estate Planning with CIBC Private Wealth Management in Toronto.