Senate of Parliament Building, Ottawa, Canada

A recent report from the Senate of Canada urges the federal government to examine whether donor advised funds (DAFs), which have increased in popularity, are distributing a large enough percentage of their donations annually to charities.

“[We need to] consider the public policy implications of rapid growth in the DAF [sector],” says independent senator Ratna Omidvar, deputy chair of the Special Senate Committee on the Charitable Sector, which issued Catalyst for Change: A Roadmap to a Stronger Charitable Sector in June. Right now, Omidvar suggests, the DAF sector is operating “without the required transparency, and without any particular time limits on [DAF] disbursements and without any particular disbursement quota per DAF.”

A DAF is an account within a registered charitable foundation, whether public or private, that is established when a donor makes an irrevocable donation to the foundation. The donor receives a tax receipt immediately upon making the donation, and receives administration and investment services from the foundation. According to the Income Tax Act, the foundation must distribute at least 3.5% of total monies annually to individual charities, but no minimum disbursement rate applies to individual DAFs.

In general, investment professionals familiar with the charity sector disagree with the Senate report’s recommendations, arguing that donations are flowing from DAFs to charities at a rate many times higher, in aggregate, than the minimum of 3.5%. Many critics of the report also suggest that introducing a time limit on DAFs would be unnecessary and ill-considered.

The Senate report’s two DAF-related recommendations weren’t “very rigorous or evidence-based,” says Malcolm Burrows, head of philanthropic advisory services, private client group, with Bank of Nova Scotia in Toronto, who testified before the senate committee on charitable issues in general. He suggests, for example, that the committee relied too heavily on the testimony of U.S.-based DAF experts: “We have different rules, different traditions and, frankly, different concerns [in Canada].”

Investment industry participants say clients choose DAFs because they offer a simple and efficient way to establish a charitable account without the cost associated with setting up their own private foundation. DAFs give clients the flexibility to grow the monies within their charitable account, often with the help of a financial advisor, and to direct money to charities at a time and in amounts of their choice. Clients also can receive tax and estate planning, as well as charitable-giving advice in relation to the DAF.

Keith Sjögren, managing director of consulting services with Strategic Insight in Toronto, and who testified before the Senate committee, estimates $4.5 billion is invested in DAFs in Canada, up from $3.2 billion as of the end of 2016: “There’s growing awareness of [DAFs], growing use and growing availability.”

Omidvar says that the growth of the DAF sector is a positive development for the charity sector overall. However, she has several concerns, which is why the committee’s report recommends that the government ask its Advisory Committee on the Charitable Sector to study the advantages and disadvantages of amending the disbursement quota for registered charities and to consider means of ensuring donations “do not languish” in DAFs.

Omidvar says that while distribution rates are relatively high for foundations – Sjögren’s research suggests that annual payout percentages are in the teens – “you don’t actually know on an individual [DAF] basis whether, in fact, the money is just sitting there or moving out [to charities].”

Investment professionals familiar with the charity sector say that many foundations impose a minimum annual payout ratio on DAFs, and that clients are more interested in distributing money to charities than in holding money in the account.

“It’s a red herring [to say] that we need to change the distribution quota,” says Janine Davies, executive director of the Raymond James Canada Foundation at Raymond James Ltd. in Port Coquitlam, B.C. Davies says her foundation typically meets the minimum distribution by February every year. “This is an extraordinary year for us,” she says, “but we’re going to give well over 20% of our opening balances this year.”

Omidvar also suggests there’s a “mismatch” between the fact that donors receive a tax receipt when the DAF is established and funded, but donations flow out to charities over time: “I think setting a time limit for disbursement is reasonable.”

Charity sector insiders suggest that a sunset provision for distributions will be impractical and unnecessary. “Administratively, [it would be] a nightmare,” Sjögren says, adding that such a provision would be hard to monitor, administer and enforce, and would have the effect of turning people away from DAFs.

Says Carol Bezaire, vice president of tax, estate and strategic philanthropy planning with Mackenzie Investments in Toronto: “People are [establishing DAFs] for the right reasons. They’re doing it because they’re philanthropic. I don’t think a sunset clause is a good idea.”

Omidvar adds that there is a concern that a conflict of interest could arise between foundations associated with financial services institutions managing money held in DAFs for a fee and the public-policy benefit of encouraging charitable donations.

Sjögren says that while institutions earn management fees on the assets held in DAFs, research indicates DAFs are flowing out money to charity. “We’re probably seeing $800 million to $1 billion being donated out of DAFs every year,” he says.

Sjögren agrees that more data and transparency are needed on the DAF sector, but “until we actually know more specifically about the size of the market and the dynamics of the sector, one shouldn’t rush to regulate it.”