NOT FOR PROFIT ORGANIZATIONS
Within the Income Tax, (149)(1), there is an exemption for various organizations from income tax. Included among these is the non-profit organization. A not for profit organization can be in the form of an unincorporated association, a not for profit corporation or even a business corporation (with restricted share provisions). In Ontario, those that do incorporate will incorporate a non share corporation under either the Ontario Corporations Act or the Canada Corporations Act.
Depending on the objects of the not for profit organization, it is possible that the organization will be subject to both the Charities Accounting Act and the Charitable Gifts Act since the majority of non-profits are established for a public purpose. This can have implications on the ability of a non-profit to, among other things, hold land and own shares in businesses. It is important to realize that the public guardian and trustee also asserts jurisdiction over extra provincial corporations that are operating in Ontario. This includes those that are incorporated federally under the Canada Corporations Act.
INCORPORATION
The decision to incorporate by a number of persons joined together for a common purpose means that a new separate and distinct entity will be created separating members and the entity. The new entity can sue and be sued, enter into contracts, hold property and limit liability to itself. It will have a separate legal status with perpetual existence regardless of changes in membership or directors. It is not necessary to incorporate in order to carry out a charitable purpose. Incorporation may not be desirable if the association is intended to exist either for a short period of time or for a single purpose. In Ontario audits are required for each annual meeting whereas Canadian corporations only require unaudited statements. Non-profits obtain "Letter Patent" as opposed to "Articles".
Business must be conducted by resolutions passed by a quorum of directors. Directors must be resident Canadians and in Ontario a director must become a member within 10 days. There is no provision provincially for a minimum or maximum number of directors however federally, while there can be a range in number, there is a minimum set of three. By-laws must be passed to allow for borrowing. Supplementary Letters Patent may be issued if there is a change in name, objects, or location of the head office.
Conversion of a non-profit corporation to a company may not be possible although there is provision. The Director has refused the one attempt to date. Any two corporations provincially can amalgamate but not federally. Both corporations must have similar objects and there must be an agreement approved by 2/3 of the members with approval of the Public Guardian and Trustee also required. The corporation can also surrender its Charter in Ontario and a liquidator can be used if the corporation’s activities are complex. The corporation must have no debts or the consent of the creditors as well as the consent of the Public Guardian and trustee. An audit may be required. Notice must also be published in a newspaper. Corporate Information Act filings must also be complete and it is imperative that the corporation distribute its assets in accordance with its letter patent or by-laws. Any remaining property is forfeited to the Crown. Federally, dissolution calls for an affidavit from the secretary with similar provisions to those mentioned filing, and consent of the Public Guardian and Trustee if a charity. A company can also be continued in another province with appropriate filings however it will be discontinued in Ontario.
CHARITIES
Under the Tax Act an entity must be organized and operated exclusively for charitable purposes to be registered as a charitable foundation, or, devote all its resources to charitable activities to be registered as a charitable organization. As recognized by the courts, charity law is an area in which not much is clear. The basic four divisions of charities deal with the relief of poverty, advancement of education, advancement of religion, or purposes beneficial to the community. These four categories however do not form a complete code as the law of charity is a moving subject but they do provide a useful framework. Poverty, for instance, is defined by current standard. Education does not include private research and only experts can define “artistic taste." Certainly education is not the mere dissemination of information but rather it involves significant training or instruction, develops mental faculties, or improves a branch of human knowledge. Religious purposes are charitable only if they tend directly or indirectly towards the instruction or the edification of the public. There must be a public benefit which is assumed unless the contrary can be shown and it must be concerned with peoples’ relations with God, not one another. Purposes beneficial to the community is a non-exhaustive list that can be reasonably applied from generation to generation to meet changing circumstances. Revenue Canada has listed relief for the sick and disabled, those suffering from old age, victims of disasters, housing for people with special needs, the welfare of children, counselling services, substance abuse, public amenities, safety rescue operations, and humane societies as some of the purposes appropriate to a charity. Political groups are not eligible for registration as a charitable trust cannot have political objects, however, it may employ political means in the furtherance of a non-political purpose. Political activity cannot be the primary activity but only incidental. Revenue Canada has set 10% of resources as the cut-off point. While the activities of a charity cannot offend public policy they need not be supported by a clear public policy. An activity cannot be held to be contrary to public policy where no policy exists. If a charitable trust is created, changing social norms will not nullify the trust. The courts however can change the terms of the trust. (The cy-pres doctrine.)
A corporation can be formed but non-profit corporations do not need to be charitable. If your corporation seeks charitable status Ontario requires approval first from the Office of the Public Guardian and Trustee whereas a Canadian non-profit corporation need only provide notice. Often Canadian registration is favoured for this reason.
REVENUE CANADA - REQUIREMENTS FOR A CHARITY
Charities are able to issue receipts for income tax purposes and are tax exempt. Revenue Canada deals with registration, runs an audit program, operates the client Assistance Section, deals with inquiries from the general public, and makes sure the cost of running the program is no more than necessary to achieve the policy objective. To register they will need copies of governing documents such as Letters Patent or a trust deed as well as a statement of activities which is more than a restating of objectives. They will also need financial statements and list of directors. Roughly 60% are routine applications clearing within 6 weeks. The remainder average about a 6 month wait. If a final letter of denial is received an appeal lies to the Federal Court of Appeal. A Notice of Registration letter will contain an assigned number and the date the first return is due. Three designations exist. Charitable organizations do hands-on work, public foundations raise funds for front-line groups, and private foundations are typified by a non-arm’s length board or single funding source.
Form T3010 or the annual information return has two parts, one public and one confidential. Financial Statements and a series of schedules dealing with accounting for future expenses and disbursement quotas are confidential. Five elements make up a disbursement quota and generally it assures that 80% of the amount issued in receipts are used for charitable purposes. Private and Public foundations have separate rules dealing with cash on hand, valuables, receivables, and investment vehicles. Permission must be granted to accumulate funds for a special project. Excesses in spending can be applied either backwards one year or forwards five years but one must "use it or lose it." The information open to public inspection in the annual return deals with what the charity’s programs are, how it spends money, and who its’ officers are.
There is a new requirement that all registered charities maintain duplicates of receipts, and sufficient documentation they are meeting their requirements under the Act. A toll free line at 1-800-267-2384 is available for assistance from Revenue Canada’s Charity Division.
CHARITABLE GIVING
For individuals, charitable giving tax benefit exists in the form of tax credits. For corporations, a charitable gift is a deduction from net income for tax purposes.
When issuing receipts it is important to remember a gift is not a gift of services. There can be no consideration however a thank-you gift such as a poppy with no re-sale value is appropriate. The giver cannot dictate how the money is being spent nor ask for a refund if they disagree on management of the funds. Before 1996 the overall limit on donations claimed for credit was 20% of net income. The donation could be carried over for five years but you could still not exceed 20%. It also applied in the year of death. Crown gifts however were at 100% of net income including Crown agencies such as Universities, museums, hospitals and foundations.
Commencing for the tax year 1996 the annual limit went from 20% to 50% of net income representing donations a person could claim in a year, plus half of the taxable capital gains arising from donations of capital property. If donations exceed this amount, receipts can be saved and claimed within the following five years. Greater credit could be utilized in the year the gift was made and the excess donation could be minimized in terms of carrying forward to subsequent years. Another budget change was to increase the donation limit for the year of death and the preceding year to 100%. Many estate gifts could then enjoy full tax credits. A small change was to reduce the threshold for gifts enjoying the higher credit rate from $250.00 to $200.00. This meant additional savings for a client donating smaller gifts, while encouraging an increase in overall giving.
For those who donate small amounts it is worth considering combining two or more years of donations into one because of the two-tier credit. The first $200.00 of donations provides a 17% federal tax credit and above $200.00 yields a 29% credit. The latter translates into about 50% when provincial tax is factored in. Married couples can combine their receipts on one return. Obviously a December gift is preferable rather than early in the new year because this enables them to receive the tax savings a year earlier.
Bill C-69 and Bill C-28 were introduced on July 31, 1997 and December 10, 1997 respectively. The annual donation limit was further increased to 75% from 50% for 1997 and subsequent years. For Crown gifts which had enjoyed a 100% of net income limitation, the limit was reduced to 75% to "level the playing field.”
The following tables summarize the donation limits as a percentage of net income for the various types of charitable donations:
| A. Lifetime Gifts | |||
|---|---|---|---|
| Type of Gift | Pre-'96 Rules | '96 Budget | '97 Budget |
| "Regular" Gifts | 20% | 50% | 75% |
| Crown Gifts | 100% | 100% | 75% |
| Certified Cultural Property | 100% | 100% | 100% |
| B. Gifts in the Year of Death (Limit applies to income in the year of death and preceding year) | |||
|---|---|---|---|
| Type of Gift | Pre-'96 Rules | '96 Budget | '97 Budget |
| "Regular" Gifts | 20% | 100% | 100% |
| Crown Gifts | 100% | 100% | 100% |
| Certified Cultural Property | 100% | 100% | 100% |
Alternatives to gifts of cash are called "gifts in kind" such as securities, art work, life insurance, annuities, computer hard and software, etc. The gift is valued at fair market value. The credit will generally be worth about 50% of the value but the donor must recognize any capital gain or income applying had the property been sold for that price.
Any bequest in a person’s will is treated as though a gift were made in their final year and is claimed for credit on their final tax return. The new rule is that the charitable donations limit in the year of death and the preceding year is 100% of the deceased’s net income. Caution should be used by the testator in making large bequests as they may become unusable for tax purposes.
DONOR’S RIGHTS
With the new changes, the structure of charitable giving can be as important as the amount given, both to the charity and to the donor. The options to the donor are much broader than simply signing a cheque or leaving a sum of money to a charity in a will.
In many cases, a donor needs professional advice to assist in assessing the options. Many donors are unaware of the giving alternatives. For professionals providing estate planning advice - whether it is will preparation, tax planning, insurance assessment or investment planning - it is becoming incumbent upon them to include a discussion of charitable giving.
Planned gifts can take many forms including cash gifts and bequests, gifts of property, gifts of publicly-traded securities, life insurance, charitable annuities, charitable remainder trusts and gifts of remainder interests in property. Professional advisors will often need to work together with the charity to structure a gift that provides maximum tax savings to the individual while providing effective assistance to the charity.
The 100% of net income donation limit in the year of death and in the preceding year may create a bias toward estate gifts. However, this will depend on the size of the gift and the donor’s net income for the relevant years.
The lifetime limit of 75% provides opportunities to increase lifetime gifts. Each donor’s situation must be analyzed to determine which is more beneficial: giving now or deferring the gift to the estate.
Given the existing tax environment in Canada, more and more clients are looking for opportunities to minimize the final tax they are going to pay at death. A number of estate planning strategies use charitable giving as a means to reduce the terminal tax bill. As well, planned giving provides a tool by which donors of modest means can leave their favourite charity a sizeable bequest with minimal impact on their beneficiaries.
Life insurance is a vehicle that is often used to provide a solution. To be effective, firstly, the policy must be permanent in nature. It must continue to be in effect until the client dies. There are many types of policies that can be used.
Depending on how the contract is structured, life insurance can have numerous advantages when used as a charitable gift:
- The client can create a large donation on death for a relatively small premium;
- The client can leave an entire estate intact for the estate’s beneficiaries;
- The life insurance policy can generate a larger gift than an investment in a taxable vehicle would;
- The life insurance policy can be paid directly to a charity thus avoiding probate fees;
- Should the charity require money before the donor’s death, the charity may be able to borrow against the policy, or cash it in if the charity has ownership;
- If a charity has been named as the beneficiary of the life insurance policy, the policy cannot be contested, whereas a will may;
- The life insurance policy can generate an immediate tax credit for the estate to offset capital gains tax payable on death; and
- The donor can remain anonymous if so desired.
Life insurance in a charitable giving environment can be structured in a number of ways:
- If the donor makes the charity both the owner and the beneficiary of the policy, then the premiums the donors pays each year will generate a tax credit each year. The proceeds payable on death will go directly to the charity, no probate fees will be payable and it will have no effect on the donor’s estate.
- The donor could own the policy personally, make the estate the beneficiary, and leave directions in the will that the proceeds of the policy should be paid to the charity. This will not generate an annual tax credit for the donor, but it will allow the entire proceeds of the policy to be claimed against deemed income in the year of death. It is in that year that most donors will be faced with the highest tax bill. Tax must be paid on all accrued capital gains, all money remaining in the donor’s RRSP and RRIF and all recaptured depreciation. The tax credit on the charitable bequest could be used to offset the tax otherwise payable by the client’s estate.
If a donor dies with RRIF or RRSP holdings and the donor does not have a spouse to whom the assets can be rolled over, or dependent child or grandchild, then the full amount of that RRIF or RRSP will be taxable income in the year of death.
Often, if the donor wished to pass the money on to a beneficiary, the donor would purchase life insurance in an amount equal to the potential taxes payable. The insurance would be used to pay the tax and the assets would pass in whole to the intended beneficiary. The government would get its tax dollars and the beneficiary would get the asset.
Under the new charitable giving rules this application of life insurance can be taken one step further. A donor could buy life insurance coverage equal to the value of the RRIF or RRSP and leave that insurance benefit to a favourite charity via the donor’s will. Upon the donor’s death the life policy will be paid to the estate of the deceased, the estate will transfer the proceeds to the charity, and the charity will issue a tax receipt to the estate. The end result is that the tax credit available as a result of the charitable donation will offset the tax payable due to deemed disposition on the RRIF or the RRSP. The donor avoids the payment of taxes on the RRIF or RRSP at death, and will have made sure that the beneficiary takes the full amount of the asset, while the charity receives a sizable donation.
The changes to the charitable giving rules are perhaps the most significant to this area of tax planning that have been seen in a decade. They have arisen from a desire for the government to shift the funding burden from itself to the general public. Both charities and individual and corporate donors stand to gain tremendously from the new rules.
| Owner | Beneficiary | Revocable | Subject to Probate | Creditor Proof | Tax Credit |
| Donor | Charity through estate | Yes, by changing your will | Yes | No | After tax in final return, based on death benefit |
| Donor | Charity | Yes, by changing the beneficiary | No | No | No tax credit available. No gift has been made under subsection 118.1(5) or 118.(6) ITA |
| Charity | Charity | No | No | Yes | As you pay each premium, based on annual premium |
| Donor | Absolute assignment to charity | No | No | No | As you pay each premium, plus the value of the policy at the date of assignment |
CHARITIES USING NON-PROFITS
The main reason for a charity to use a non-profit is to protect its own charitable status while at the same time carrying out activities which are important to the mandate of the charity as envisaged by the charity’s Board of Directors. For example, while charities can carry out some limited political activity, extensive lobbying by a charity would likely be prohibited as mentioned within this paper. If lobbying is important to accomplish that charity’s objectives in whole or in part, it may make sense to establish a non-profit.
In some cases, an organization that is already registered as a charity will not be dependant on raising money through donations which requires receipts for income tax purposes. Such an organization may wish to retain its charitable registration in order to accommodate donors that historically expect a receipt from past charitable giving to the organization. In those circumstances, it may be advantageous to establish a separate parallel non-profit organization which can operate without any of the restrictions that apply to charities under the Income Tax Act. This could allow, for example, extensive fund raising by the non-profit in Canada for charitable work aboard since non-profits (unlike charities) have no constraints on transferring funds out of the country.
In many cases a non-profit will have been in existence for years before deciding to apply for charitable registration. Upon seeking the advice of a professional, it may become clear that while some of the activities of the organization are charitable, others are not. If the organization does not wish to abandon those activities, then it often makes sense for the organization to continue as a non-profit and transfer the charitable activities out of the organization into a separate and newly established entity would will then make application for charitable status. Once registered as a charity, the two organizations would then operate in tandem.
The issue also arises in the contents of establishing a new entity. Clients wishing to establish a charitable organization will often have very sound reasons why they wish to carry out a certain non-charitable activity, which if reflected in the objects and statement of activities of the applicant organization would result in the application being rejected by Revenue Canada. In those circumstances, it can be advisable to establish both a charity and a non-profit at the same time. There are a few major pitfalls that should be avoided:
- Financial books and records of the charity and the non-profit must be kept entirely separate;
- The charity may not transfer funds or provide resources to the non-profit;
- The non-charitable activities must in fact be carried out by the non-profit and not the charity;
- Funds may not be donated to the non-profit with a receipt being issued to the donor by the charity; and,
- The letters patent of the non-profit must be drafted in such a way that it would not otherwise qualify as a charity.
As in the case of foundations and business vehicles, it is recommended that the charity control the non-profit and that the control provisions be enshrined in the letters patent and/or by-laws of the non-profit. At a bare minimum, the non-profit should either have a mirror board or should be constituted in such a way that the members of the non-profit are the same individuals as the board or executive committee of the charity. Depending on the perceived need to include outsiders in the management of the non-profit, the members may or may not be required to elect the board from among themselves. It goes without saying perhaps that upon any dissolution of the non-profit, any remaining assets would normally be transferred to the charity which would be named in the letters patent of the non-profit. Dissolution and winding up will be discussed more thoroughly later in the paper.
The use by a charity of a business vehicle, foundation and/or not for profit organization then enhances the charity’s viability as an organization and can serve to expand the breadth of services offered by the charity. In some cases, it can also serve to protect the charitable status of the operating charity. However, the decision regarding whether to establish any of these vehicles is not one that should be taken lightly. A charity should consult with both its legal counsel and accountants before taking any of the above steps. From a practical prospective, the charity must be ready to form a separate entity and recognize that it will probably be necessary to hire new and skilled individuals to take the new entity forward.