TaxMatters@EY – September 2022

Yves Plante and Sharron Coombs, Toronto

As part of the April 7, 2022 federal budget, the federal government announced two long-awaited important sets of measures relating to charities: one to allow charitable disbursements to organizations other than qualified donees, and the other to update the disbursement quota rules.

While the former measures were recently enacted through Bill C‑19, Budget Implementation Act, No. 1, 2022, on June 23, 2022, the latter is part of income tax legislative proposals that were released on August 9, 2022 for comment by September 30, 2022.

Although the measures included in Bill C‑19 came into force on June 23, 2022, further clarification or guidance is needed to know how the CRA will administer them. The August 9, 2022 measures are to be effective for taxation years beginning on or after January 1, 2023.

The following summarizes the two sets of measures.¹

Expanding allowable charitable disbursements to organizations that are not qualified donees

Background

To maintain their status as registered charities, charitable organizations and charitable foundations have been essentially restricted to devoting their resources to charitable activities they carry on themselves or providing gifts to qualified donees — that is, generally, other registered charities. Although charities could conduct activities through an intermediary organization other than a qualified donee, they had to maintain sufficient control and direction over the activity such that it could be considered their own.

This own-activities requirement and the related direction-and-control requirement have been raising concerns in the charitable sector for a number of years, since it makes it particularly difficult for Canadian charities to operate internationally with local partner organizations in foreign countries or to cooperate and collaborate with non-charities in Canada.

Recognizing these concerns, the Senate Special Committee on the Charitable Sector in its June 2019 report, Catalyst for Change: A Roadmap to a Stronger Charitable Sector, recommended the federal government direct the CRA to revise its guidance to shift the focus from direction and control to careful monitoring through the implementation of an expenditure responsibility test.

Following the Senate report, the Advisory Committee on the Charitable Sector similarly recommended in its January 2021 report that the Minister of National Revenue work with the Minister of Finance to remove the own-activities test from the Income Tax Act (the Act), and require through this amendment a focus on resource accountability.²

These recommendations and other advocacy eventually led to private member’s Bill S‑216, Effective and Accountable Charities Act. In line with the recommendations, well-received Bill S‑216 essentially removed all occurrences of the own-activities test from the Act and added provisions so charitable organizations and charitable foundations would be allowed to make their resources available to non-qualified donees, provided reasonable steps were taken to ensure the resources were used exclusively for a charitable purpose.

Reasonable steps would have required funder charities to carry out due diligence prior to providing the resources, and to establish measures, impose restrictions or otherwise take the actions necessary to satisfy a reasonable person that the resources are being used exclusively for a charitable purpose by the recipient. Although adopted by the Senate, Bill S‑216 has not been enacted.³

Enacted changes

In the 2022 federal budget, the government announced its own set of changes which were intended to implement the spirit of Bill S‑216, which Parliament was considering at the time. However, the federal budget proposals, as later incorporated into Bill C‑19, were seen as more onerous than the direction-and-control requirement.

In response to these concerns, some of the changes were removed from Bill C‑19 before the final version was adopted by the House of Commons. The following is a summary of the enacted changes:

• Qualifying disbursements/grantee organizations: Introduction of an additional regime under which charitable organizations and charitable foundations are permitted to make disbursements to grantee organizations (i.e., entities and natural persons other than qualified donees) under certain conditions.
  
  More specifically, to maintain their status as registered charities, charitable organizations and charitable foundations now have to either devote their resources to charitable activities they carry on themselves — thereby keeping the own-activities requirement as before Bill C‑19 — or make qualifying disbursements. A qualifying disbursement is a disbursement by a charity, by way of gift or by otherwise making resources available, to either a qualified donee (subject to the same limits as before Bill C‑19) or, provided the following three conditions are met, to a grantee organization:
  • The disbursement is in furtherance of a charitable purpose
  • The charity ensures the disbursement is exclusively applied to charitable activities in furtherance of a charitable purpose of the charity
  • The charity maintains documentation sufficient to demonstrate the purpose for which the disbursement is made, and that the disbursement is exclusively applied by the grantee organization to charitable activities in furtherance of a charitable purpose of the charity.

As a result, charities will be allowed to make qualifying disbursements — either by way of gifts or by making resources available — not only to grantee organizations but also to qualified donees instead of simply making gifts to qualified donees under the previous regime.

• Directed gifts: Prohibition for charities on accepting gifts that are expressly or implicitly conditional on making a gift to a person other than a qualified donee. This anti-directed gift measure was adopted with the intent to reduce the risk that a charity could act as a conduit for making gifts to grantee organizations.
  
  
• Public information return: Requirement for charities to disclose in their annual public information return (Form T3010) the following additional information where the total qualifying disbursements made by a charity to a grantee organization in the taxation year is above $5,000:
  • The name of the grantee organization
  • The purpose of each qualifying disbursement made to the grantee organization in the taxation year
  • The total amount disbursed by the charity to the grantee organization in the taxation year

Until further guidance or a revised Form T3010 is released, it is unknown whether this new information will be made available to the public in its entirety or whether some or all of it may be treated as confidential, but could still be shared with other government agencies and departments.

All the above measures apply as of June 23, 2022, the Royal Assent date of Bill C‑19.

Implications

Although it’s a welcome change to allow charities to make disbursements to non-qualified donees, some issues will need to be clarified. For example:

• To satisfy their disbursement quota, discussed below, charities are required to expend in a taxation year on charitable activities they carried on or by way of gifts they made that are qualifying disbursements. As a result, does this mean qualifying disbursements made by making resources available will be excluded when considering whether charities have met the annual disbursement quota?
• Similarly, disbursements made in a taxation year by charitable organizations by way of gifts to qualified donees are generally not considered qualifying disbursements if they exceed 50% of the charitable organization’s income for the year. As a result, does this mean qualifying disbursements made by making resources available to qualified donees — or any qualifying disbursement made to grantee organizations for that matter — are not subject to the restriction? And further, what are the implications, if any, on a charitable organization’s registered charity status of exceeding this limitation?
• In addition, clarification will be required on how the CRA will administer and interpret the resource accountability conditions to be met for a disbursement made to a grantee organization to be a qualifying disbursement. For example, what action will satisfy the CRA that a charity has ensured the disbursement is exclusively applied to charitable activities in furtherance of a charitable purpose, and what documentation will the CRA consider sufficient to demonstrate that a disbursement is exclusively applied by the grantee organization to charitable activities in furtherance of a charitable purpose of the charity?

Until further guidance is obtained, charities should proceed with caution in applying the new qualifying disbursements regime. Moreover, before proceeding with making any qualifying disbursement to grantee organizations, registered charities — especially charitable foundations — may have to first update or amend their legal purposes described in their articles of incorporation or governing documents and notify the CRA, as their articles of incorporation or governing documents may preclude making gifts to non-qualified donees.

In addition, further guidance will also be needed to interpret the new anti-directed gifts measure and determine which gifts it will catch, particularly in the context of implicitly conditional gifts, and what impact these measures will have on fundraising activities. Again, charities should proceed with caution if they wish to accept directed gifts and may want to wait for the additional guidance to be able to properly inform donors.

Disbursement quota changes

Background

The disbursement quota is the minimum amount a charity is required to expend in a taxation year on charitable activities it carried on or by way of gifts it made that are qualifying disbursements. In general terms, the disbursement quota, which is expressed as a formula, is 3.5% of the value of all properties the charity owned in the preceding 24 months that are not used directly in charitable activities or administration, provided this value amount exceeds $25,000 (for charitable foundations) or $100,000 (for charitable organizations).

Following a recommendation of the Senate Special Committee on the Charitable Sector in its June 2019 report, and as subsequently announced in the 2021 federal budget, the Department of Finance launched public consultations on various aspects of the disbursement quota rules with the intent of boosting charitable spending in communities, reducing or eliminating existing relief from the rules, and better enforcing the rules.

The review included a potential increase in the 3.5% rate, given that the rate had not changed since 2004 (the rate being intended to reflect the long-term real rates of return earned on a typical investment portfolio held by a charity) and the growth observed in the investment assets of foundations in recent years (compared with grant-making and spending on charitable activities). The objective was to strike the appropriate balance between providing long-term, sustainable funding for the charitable sector and ensuring that tax-assisted donations are deployed towards charitable activities on a timely basis.

Proposed changes

Stemming from the 2021 Department of Finance consultations, the 2022 federal budget announced the following changes to the disbursement quota rules, as incorporated into the August 9, 2022 legislative proposals:

• Disbursement quota rate: Increase in the disbursement quota rate, from 3.5% to 5%, but only for the portion of property not used directly in charitable activities or administration that exceeds $1 million, to promote the timely disbursement of funds by larger charities. For example, assuming the property not used directly in charitable activities or administration is $11 million, the disbursement quota will be $535,000 (i.e., (3.5% x $1,000,000) + [5% x ($11,000,000 - $1,000,000)]) compared to $385,000 currently (i.e., 3.5% x $11,000,000).
  
  
• Relief – arbitrary reduction of the disbursement quota: Amendments to the current relieving provision that allows a charity, on approval by the CRA (and only in special or extraordinary circumstances that were unforeseen and beyond a charity’s control), to report a deemed charitable expenditure for a taxation year if it cannot meet its disbursement quota. Instead, to better reflect actual expenditures on charitable activities, the CRA will have the discretion to grant a reduction in a charity’s disbursement quota obligation for any particular taxation year. As is the case with the current relieving provision, the CRA will be allowed to publicly disclose information relating to an approved reduction in a charity’s disbursement quota.⁴
  
  
• Relief – Permission to accumulate funds: Removal of the relieving provision, which is no longer considered necessary, relating to the accumulation of property by a charity. This rule currently allows, on approval from the CRA, an accumulation by a charity for a particular purpose by permitting the specific property, and income earned in respect of the property, to be excluded from a charity’s disbursement quota.
  
  
• Qualifying expenditures: Following the CRA’s current administrative practice, amendment to clarify and ensure that expenditures for administration and management of a charity are not considered qualifying expenditures for the purpose of satisfying a charity’s disbursement quota.

The disbursement quota changes will be effective for taxation years beginning on or after January 1, 2023. However, the removal of the accumulation of property rule will not apply to approved property accumulations resulting from applications submitted prior to January 1, 2023. The provision dealing with the public disclosure by the CRA of an approved disbursement quota reduction will come into force on January 1, 2023.

Implications

The above changes will no doubt have implications on registered charities, particularly those larger charities that will be subject to the new graduated rate. For example:

• These larger charities will have to ensure they can find ways to fund as well as to satisfy the increased disbursement quota. To that end, the ability to make gifts to non-qualified donees discussed above could help. However, such increased spending may need to trigger a review of, or may have an impact on, the charity’s existing investment policy, portfolio mix and access to liquidity (e.g., through encroachment on capital).
• These larger charities may also want to take a closer look at how they determine the value of the properties they own that are not used directly in charitable activities or administration, as well as the number of valuation periods⁵ they have been using, for the purpose of the disbursement quota calculation, as these two factors have a direct impact on the amount of the disbursement quota. However, the CRA would need to pre-approve any change to the number of valuation periods.
• Charities that were thinking of relying on the relieving permission to accumulate funds will have to either ensure they apply before the repeal of the relieving measure on January 1, 2023 or find alternatives.

Given that the period to provide comments on the August 9, 2022 legislative proposals is to end on September 30, 2022, it is expected that the implementing legislation will be enacted before the disbursement quota provisions are scheduled to apply.

It should be noted that the 2022 federal budget indicated that the disbursement quota changes will be reviewed after five years, thereby signalling, combined with the current work done by the Advisory Committee on the Charitable Sector, potentially more developments to monitor in the coming years.

For additional information on the amendments discussed above, please contact your EY advisor.

Kelsey Horning and Winnie Szeto, Toronto, Gael Melville, Vancouver

This case addressed whether two shareholders received a benefit through the personal use of a boat owned by their corporation. While not explicitly stated in the decision, it appears the CRA concluded that the amount the shareholders paid to their corporation for their personal use was insufficient to reflect the benefit they received through that use and assessed shareholder benefits. The appeal was successful, and the court found that the amount paid was sufficient to account for the personal use of the boat.

Background and facts

J Co. operated a diversified business in an island community off the coast of British Columbia. The business included a marina that had originally served as a fuel dock. J Co. owned the boat in question, which was a pleasure craft in the sense that it was not constructed or equipped as a work boat such as a tugboat or tanker.

The shareholders, Mr. and Mrs. J, used the boat to visit other local marinas and bays to connect with boaters who might also patronize J Co.’s marina, as well as with the operators of those other marinas. This included building personal connections and providing information on the region and J Co.’s services. The shareholders also used the boat to travel to and entertain at boat shows and occasionally to transport materials for the business.

The shareholders did use the boat personally on an infrequent basis, fewer than a dozen times during the period at issue. The personal use included going into the harbour with family and friends to get a better view of whales and staying in the boat instead of a motel during a stop en route to the mainland. The shareholders consulted with their accountant and paid J Co. $18,000 per year for the personal use of the boat.¹ This was done through adjustments to shareholder loans. They felt this was a conservatively high amount.

The court made a number of specific findings. One was that J Co. acquired, owned and used the boat primarily for business purposes. The court also found that there was no evidence to support the position that the shareholders had used their roles as shareholders to influence the corporation to buy the boat for their personal use. Furthermore, the court accepted that the personal use of the boat was in the 5% range and that the amount the shareholders paid to J Co. was not below the reasonable fair market value for that use.

Tax Court analysis

The court noted that the sole issue was the value of the benefit the shareholders received; other provisions such as restrictions on certain types of expenditures (e.g., meals, golf, etc.) were not at issue. The court concluded that there was virtually no evidence to support more than incidental personal use and certainly not exclusively personal use as the CRA alleged.

The court emphasized the principle that the CRA is not permitted to second guess a taxpayer’s business judgement such as its choice of marketing strategy. It affirmed the validity of reasonable expenses related to a good-faith marketing strategy undertaken primarily for business purposes.

The court addressed a number of arguments that, in its view, did not prevent the expenses from being valid business expenses. Expenses are not excluded because the marketing activity involves socializing or is pleasurable. Nor are they excluded from being valid business expenses because of collaboration with other marinas. The court noted that collaboration is common, for example, in trade associations and chambers of commerce.

Finally, the court also found that the expenses were not excluded because the boat was used to go to some locations more than others. It noted that focusing more effort on marketing in locations that had proven more successful would be a valid reason for this.

The court accepted that the boat and related expenses were used primarily in the business and that the personal use that did occur was adequately addressed through the payments the shareholders made. As such, the amount the shareholders paid to the corporation was sufficient to account for any personal benefit that was received. The appeals were allowed.

Lessons learned

This case reiterates that taxpayers are entitled to exercise business judgment. The CRA cannot deny a genuine business expense or treat that expense as a personal shareholder benefit merely because the CRA officer does not agree with the taxpayers’ business decisions.

It is also noteworthy that the shareholders had consulted their accountant and paid for the personal use. This demonstrated an effort to ensure the matter was properly accounted for and may have supported their credibility. The shareholders had already considered the situation and were not left seeking to adjust or devise explanations in response to questions from the CRA.

The determination made in this case is fact specific. As such, other taxpayers may have a different outcome even with respect to somewhat similar expenses. There have been situations where other taxpayers were not successful in arguing that expenditures were for business marketing purposes or the business component was found to be a smaller portion of the expense than claimed. Examples of this include expenses related to a trip to the International Space Station (Laliberté v The Queen, 2020 FCA 97) and expenses related to a residential property that was argued to be a base for the business’s US operations (McHugh et al v The Queen, [1995] 1 CTC 2652 (TCC)).

Taxpayers are advised to consult a tax practitioner regarding the potential deductibility of an expense or whether an expense may give rise to a shareholder benefit.

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