Private foundations hold about $1 trillion worth of assets in North America. Canada had 5,738 private foundations with assets totaling $56.3 billion in 2018, representing an increase of almost 200% since 2010. The combined assets of the richest 245 Canadian private foundations amounted to $42 billion in 2018, and they spent 3.34% of their assets on expenditures and donations (The Charity Report).
Even as urgent needs due to the Covid-19 crisis go unmet, private foundations continue to spend only a tiny fraction of their wealth on actual charities. This is mostly thanks to the tax laws that permit and encourage the build-up of philanthropic wealth with taxpayers’ money. It is a tax scandal that needs to end.
A few weeks ago, the Canadian government launched consultations on raising the minimum amount charitable foundations must grant to causes annually, and the deadline to submit comments is Sept. 30, 2021. In the 2021-2022 federal budget, which announced these consultations, it was explained that such a measure could bring in $1 billion to $2 billion per year. This is a significant sum, very significant compared to the estimated additional revenues of $3.4 billion over five years garnered by the famous tax on digital services that we have talked about so much.
The problem of non-charitable private foundations is not new, and it is not the first time that governments have tried to solve it, but let’s hope this time is going to be the right one.
A generous tax regime that allows perpetual foundations
Private foundations exist in other countries, but Canada offers one of the most advantageous of tax regimes. In short, the regime grants a donation credit to the founder that may exceed 50% of the donation in the year it was given, regardless of when the money will be spent by the foundation. The foundation benefits from a total tax holiday and its annual charitable obligation is limited to 3.5% of its capital. In the U.S., for example, the tax system is less generous. The foundation is subject to a tax on its investment income, its charitable obligation is 5% of its capital, and the tax incentive to the founder is generally less important.
There was a time in Canada when the “disbursement quota” imposed on charitable foundations was higher than 3.5%. According to Finance Canada’s 2004 budget, “analysis indicates that the current 4.5% disbursement quota is high relative to long-term investment returns. Accordingly, the budget proposes to reduce the 4.5% disbursement quota on capital assets to 3.5%. This rate will be reviewed periodically to ensure that it continues to be representative of long-term rates of return.” The reduction in the disbursement quota allows Canadian foundations to keep their start-up capital and ensure that their foundations last indefinitely.
The problem with private foundations that wish to last indefinitely is that they are not really charitable and thus represent a “bad deal” for public finances because the present value of the charity the foundation is disbursing over the years does not exceed the revenue losses to the treasury resulting from the different incentives given to the founder and the foundation.
The issue of a foundation’s charitable obligation and its perpetuity seems trivial, but it is crucial for major philanthropists, and the Canadian government places it at the center of the consultations it proposes. Specifically, feedback is being sought as to whether the 3.5% rate should be increased “to a level that causes foundations to gradually encroach on investment capital, and would it be sustainable in the long-term for the sector?”
A 50-year-old discussion
In 1965, the U.S. Treasury Department and Congress were troubled by the fact that a donor to a foundation takes a tax deduction at the time of the donation, but the donated funds might not reach actual operating charities until many years later. Congress and Treasury believed that because of this delay, donors were getting a tax benefit worth more than the charitable benefit they produced. This problem was addressed by introducing a 5% charitable obligation into tax law, requiring U.S. foundations to spend at least 5% of their capital on charity each year.
In 1976, in Canada, as part of a broader tax reform flowing from the Royal Commission on Taxation (Carter Royal Commission), the obligation for the foundation to allocate at least 5% (now 3.5%) of its assets to charitable organizations and activities annually was introduced in the Income Tax Act. These rules were designed to ensure that tax-receipted charitable gifts were applied for the benefit of charities and not simply held in investment accounts.
The issue of the charitable obligation of foundations has not been discussed so fundamentally for nearly 50 years here in Canada. This pandora’s box may not be closed for several more years before real changes are made. Please get involved in these consultations.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Brigitte Alepin is a Canadian tax specialist who has worked in practice for 30 years and is now a professor of taxation at the University of Quebec in Outaouais. She is the cofounder of TaxCOOP, the director of the movie “Fast & Dangerous Race to the Bottom,” and cowriter of the movie “The Price We Pay.” The Fast & Dangerous Race to the Bottom” recently won the Outstanding Achievement award at the Best Shorts Competition 2020 Humanitarian Awards.
Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at TaxInsights@bloombergindustry.com.
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