• Private Charitable Foundations: An Effective Tool for Managing Charitable Giving By Family Businesses
  • April 30, 2010 | Author: James K. Cruickshank
  • Law Firm: Stewart McKelvey - Halifax Office
  • Many family businesses and their owners are generous donors to charitable causes. For these enterprises and the families involved with them, a private charitable foundation (a “Foundation”) can be an effective tool for managing charitable giving. A Foundation provides a means of building a private family endowment for future charitable giving, with tax credits earned as the endowment is built up. With a Foundation the donor(s) maintain control over the investment and charitable donation decisions of the endowment fund, and a Foundation is relatively simple and cost-effective to form and operate.

    The Tax Rules

    A Foundation is formed as a trust or non-profit corporation, with powers and objects limited to making gifts to registered charities, or carrying out other charitable activities. Once registered with Canada Revenue Agency as a registered charity, the Foundation falls under the same tax rules as other registered charities: donors to the Foundation receive a charitable donation tax receipt for their gifts; the Foundation is not taxed on its investment income; and the Foundation must use its assets in charitable activity, by making gifts to other registered charities, or carrying out direct charitable activity.

    The March 2010 federal budget made a major change to the tax rules for all charities, which will be very beneficial to Foundations. Under the old rules, charities (including Foundations) were required to spend 80% of gifts received in a year by the end of the following year. This “disbursement quota” did not apply to gifts where the donor required the gifted funds to be held for at least ten years. These rules created significant complications for Foundations, forcing them to manage their spending based on whether gifts were made with a ten year hold requirement or not. The disbursement quota rules in some circumstances made it difficult for a Foundation to accumulate an endowment. The 2010 federal budget abolishes this disbursement quota concept, giving Foundations much more flexibility as to when they spend donated funds. Now, the only rule that applies is that the Foundation must spend at least 3.5% of its invested assets each year: provided this requirement is met the Foundation can keep the balance of its funds invested indefinitely. The 3.5% spending requirement only applies to Foundations with invested assets greater than $100,000.

    Forming a Foundation

    A Foundation can be formed as a trust or non-profit corporation, and once formed the Foundation applies for registration with Canada Revenue Agency as a charity. A Foundation is quite easy to create: standardized precedents for a charitable trust agreement can be used as a model, and registration with Canada Revenue Agency is generally a routine procedure (although it can take six months or more for CRA to process the application).

    The trust agreement sets the procedures and rules for the administration of the Foundation, and can be tailored to each family’s circumstances. Often the initial founder of the Foundation will maintain control of the Foundation during his or her lifetime, but involve other family members and outside advisors as additional members of a board of trustees. The agreement will provide for replacement and successor trustees, and a charitable trust can continue in perpetuity.

    Operating a Foundation

    Once the Foundation is formed, its trustees will make decisions on how to invest and spend funds that are donated to the Foundation. So long as the funds are spent on charitable activities, gifts to other charities or on legitimate administrative expenses, the trustees will have full discretion as to how the funds are spent. The founder of the trust can limit this discretion by imposing rules or guidelines as to which charities are to be supported by the Foundation, or by maintaining direct control over the decisions of the Foundation during the founder’s lifetime. A charity information return must be filed annually by the Foundation with Canada Revenue Agency.

    As an example of how a Foundation can operate, the founder of a family business might form a Foundation with a board of trustees consisting of the founder and the founder’s spouse and children, with provision for additional or replacement trustees in the future, allowing successive generations of the family to manage the Foundation as trustees, along with outside advisors who can also be appointed as trustees. The founder may retain control over all Foundation decisions during the founder’s lifetime. The founder may make a large initial donation to start the Foundation, and will receive an immediate charitable tax credit for this donation. The founder’s family business can also donate to the Foundation, receiving a charitable donation tax deduction. It is not necessary to start the Foundation with a large gift: instead the business or family members can make donations on a periodic basis over time. As an endowment fund is accumulated, the Foundation can decide from time to time to make charitable gifts to other charities, satisfying the 3.5% spending requirement, and can otherwise leave the endowment fund to grow over time.

    Alternatives to a Family Foundation

    For donors who like the concept of building an endowment with flexibility as to future donations, but who do not wish to go to the trouble or expense of forming a private family Foundation, an alternative is to contribute to a public foundation that will hold the donated funds in a separate endowment fund. While the decision-making authority over the investment of the fund, and the future charitable gifts to be made out of the fund, rests with the public foundation’s board of trustees, the public foundation makes a non-binding commitment to follow the “advice” of the donor as to where the endowment funds should be spent from year to year. In practice, these “donor-advised funds” give the donating family a large degree of control over the future of the fund. The public foundation will typically charge an administration fee for holding the endowment funds. Several of Canada’s chartered banks sponsor such public foundations (see for example the Aqueduct Foundation sponsored by the Bank of Nova Scotia: www.aqueductfoundation.com), and there are a number of community-based public foundations that operate in a similar manner (e.g., The Community Foundation of Nova Scotia: www.cfns.ca). While the donor loses technical control over the funds donated, the donor’s “advice” as to which charities are to be supported from the endowed funds will in almost all cases be followed by the board of directors of the public foundation. When considering this alternative, a donor should weigh the administration fees charged by the public foundation against the costs for a donor to manage a private Foundation.

    Pros and Cons of a Foundation

    The advantages of a Foundation can be summarized as follows:

    • a charitable donation receipt is issued as soon as funds are donated to the Foundation, even though the Foundation may decide to not spend the funds on other registered charities until many years in the future;

    • the Foundation allows for tax planning by the donor, who can make large donations in years where the donor has high taxable income, without worrying about a decision at that time as to which charity will be supported;

    • a long-term endowment fund can accumulate, allowing a family to support charities over an indefinite period, well after the death of the founder, and the donor’s family can retain complete control over the investment and donation policies of any endowment fund that is accumulated;

    • the Foundation can be a useful “training ground” for younger family members in aspects of business governance, as the trustees of the Foundation function much like the board of directors of a business, giving family members experience in board governance procedures and investment decision-making;

    • family businesses that receive numerous requests for support from charitable organizations can refer these requests to an affiliated Foundation, taking pressure to make donations off the managers of the family business, and allowing the family to set policies and procedures for deciding which requests will be supported; and

    • the Foundation is relatively inexpensive to form and operate on an ongoing basis.

    The disadvantages of a Foundation are:

    • there are annual costs of maintaining the Foundation, filing the annual return with Canada Revenue Agency, and ensuring compliance with the tax rules for registered charities; and

    • a Foundation is required to report in its annual return the specific gifts it has made to registered charities, and this information is available to the public on Canada Revenue Agency’s website. This results in public disclosure of the charitable gifts being made by the family through its Foundation.

    Conclusion

    A Foundation can be an attractive tool for families in business who make significant charitable gifts, or plan to make such gifts in the future, and can be a good alternative to ad hoc gifting to charities on an annual basis.