Although the idea that charities ought to be more entrepreneurial is frequently lauded these days, the practical difficulties of doing so are easy to underestimate. One aspect of this is the suggestion that charities could or should engage in more revenue-generating activities as a means of advancing their mandates.
More of such activity would not be out of keeping with the long tradition of many charities selling products or services to recoup all or part of their costs, and in some cases to cross-subsidize money-losing programs. However, it is not readily apparent how much of an untapped market there is for charities to undertake more of this type of revenue-generation.
Many charities are established in response to market failures, so looking for a business-like solution doesn’t make a whole lot of sense. If an economic opportunity already existed in a way that could be commercially exploited, there wouldn’t be the need for the charity in the first place.
As well, there are regulatory restrictions on charities engaging in business – stemming both from the charity law prohibition of undue private benefit and from concerns over putting charity assets unacceptably at risk – that limit this type of activity. Not to mention complaints of unfair competition occasionally voiced by members of the for-profit business community.
Another way for charities to become involved in commercial or revenue-generating companies or organizations is through investing. That investing can be in entities focusing on profit-maximization or on a social purpose, environmental purpose or other community benefit. Again, investing by charities in groups mandated for other than purely financial return – commonly known as Program-Related Investment (PRI) – is a practice that has been around for some time. However, it has drawn more attention of late. And given recent ups-and-downs in conventional investments, the appeal of alternatives grows. As with frontline business activity, however, there are regulatory issues to be addressed when charities devote their resources in this way.
In July, the Canada Revenue Agency (CRA) released new guidance on “Community Economic Development Activities and Charitable Registration”.
This guidance features an extended discussion on the rules for program-related investing by registered charities. [Full disclosure: the author of this article, both through work with The Muttart Foundation and Charities and Not-for-Profit Section of the Canadian Bar Association, was involved in providing feedback on earlier drafts of the recently-released guidance).
While the previous guidance dealt with PRIs, there were a number of issues in CRA’s approach to such investing that were unfavourable or discouraged charities from engaging in the practice. At least some of those issues have been addressed in the new version, which should make it easier for charities wanting to explore this area to do so.
There are various ways that charities can structure PRIs. As well as such securities as equities (whether direct share purchases or participation in mutual funds) or bonds, investments can also be configured as loans or loan guarantees.
The previous guidance indicated that PRIs had to be limited to qualified donees. That is, investments had to be in registered charities or other bodies or organizations recognized under the Income Tax Act. The new guidance states that investments can be made in entities other than qualified donees, but where the investment is not in a qualified donee, the charity must put in place sufficient direction and control that the initiative qualifies as the charities’ “own activities”. That ensures that the funds invested will not be diverted from charitable ends. Where the investment is in a qualified donee, use of the resources for public benefit is assumed.
The guidance sets out some examples of PRI investments in entities that are non-qualified donees to illustrate how such arrangements might work. The oversight requirements parallel those that must be present when a charity operates programs or projects through non-qualified donees domestically or abroad. As well as information on expectations with respect to on-going monitoring and ways to constrain use of the investment, the guidance sets out some suggested measures for withdrawing from PRI commitments if required. As the guidance indicates, even where participation is through share purchases, it ought still to be possible to terminate the investment if there is diversion of the resources from what was intended.
A new section of the guidance addresses the issue of specialized intermediaries to facilitate program-related investments by charities, and suggests such groups could potentially qualify as registered charities on the basis of their promoting the efficiency and effectiveness of charities.
A key difficulty encountered in the past was the treatment of PRIs for disbursement quota purposes. Prior to changes in Budget 2010, charities were expected to spend 80% of receipted revenues on charitable work before the end of its subsequent fiscal year. This resulted in a potential problem if PRIs were not recognized as expended on charitable work. With repeal of the 80% rule, however, this problem will likely be encountered less frequently. The retention of a smaller 3.5% disbursement quota on assets not directly used for charitable activities or administration means, however, that this difficulty has not been entirely eliminated.
The guidance clarifies how various investment vehicles should be accounted for, and deals with how transactions should be treated with respect to meeting the 3.5% disbursement quota. In those instances where the charity has made a PRI and fails to meet its disbursement quota, the guidance states that the Charities Directorate may consider the opportunity costs associated with the investment(s) as equivalent to an expenditure.
Because of the division of powers under Canada’s constitution, limitations and procedural requirements for investment decisions by trustees and charities are typically a matter of provincial legislation. The guidance informs charities of this issue, but does not get into specifics.
Even with release of the new guidance, the challenges of charities delving further into the commercial marketplace ought not to be gainsaid. But this is perhaps an opportune time for charities to re-examine PRIs and whether they can play more of role in advancing their work through this type of activity. Doing so may pay off in more ways than one.