A brewing showdown over disbursement quotas

During the pandemic, as charities have grappled with the double burden of increased demand for services and reduced capacity to fundraise, some have asked why Canada’s foundations – public and private – aren’t drawing more from their investment accounts to support the causes they funded in the before-times.

During the pandemic, as charities have grappled with the double burden of increased demand for services and reduced capacity to fundraise, some have asked why Canada’s foundations – public and private – aren’t drawing more from their investment accounts to support the causes they funded in the before-times.

Earlier this spring, when The Globe and Mail published recent financial details from the endowments of some of Canada’s largest arts organizations, its readers got a glimpse of the sort of data that rarely surfaces in public conversations about philanthropy and charity. The article, by two of the paper’s best-known critics, itemized the eight-figure endowments of organizations like the Stratford Festival and the Banff Centre, as well as their typical disbursement rates, their draws for 2020, and also deficits for the past year.

“Arts endowments are worth millions,” the headline stated. “So why can’t organizations draw on them to survive the pandemic?”

It’s a provocative question, and one that’s been ricocheting around the entire philanthropic sector during this pandemic year. As so many charities have had to grapple with the double burden of increased demand for services and reduced capacity to fundraise, some have asked why Canada’s foundations – both public and private – aren’t drawing more from their investment accounts to support the causes they funded in the before-times.

There’s little doubt some have done just that, as the Globe story acknowledged. In fact, leading figures in the philanthropic world, like social impact investor Bill Young, have sought to galvanize their peers to disburse at least 5% of their assets, and many have done so.

Others have gone further, calling for Ottawa to recalibrate the legislated disbursement quota (DQ) that has for years stood at an annual rate of 3.5%. The formula represents the minimum calculated amount that a charity is required to spend each year on its charitable programs or on gifts to other charities. Also in The Globe last winter, Rudyard Griffiths, co-founder of the Dominion Institute, urged Ottawa to “double private foundations’ minimum annual disbursement from 3.5% to 7% and keep it at this level for three years.”

Meanwhile, in the US, where the DQ is pegged at 5%, the Council on Foundations has pressed its members to loosen restrictions, increase grants, and contribute to community-based emergency response funds. Others have pressed Congress to close loopholes that allow foundations to avoid their payout obligations and provide cash perks to staff and directors – a practice not allowed under Canadian regulations.

The federal Liberals seem prepared to have this conversation, announcing in the April budget a consultation process to begin later this year, with potential changes for 2022; the terms of reference have yet to be revealed. (The Special Senate Committee on the Charitable Sector made a similar recommendation in its 2019 report.) Citing a $1-billion “gap” in charitable expenditures, the budget noted that grant-making has “not kept pace” with a decade of robust increases in foundations’ long-term investments, which totalled $85 billion in 2019 and are likely considerably higher today, given the strong run-up in equity markets since last April. (Of that total, approximately $50 billion is held by about 6,000 private foundations.)

Yet how this process plays out, and whether there will actually be change at the end of it, is by no means clear, especially given the increasing likelihood of a fall federal election. Some insiders are skeptical about the government’s motives and what could be seen as a go-slow approach intended, perhaps, to let the pandemic passions and therefore the political urgency dissipate. Imagine Canada’s position is that policy-makers need more data before they can make informed choices. As Imagine Canada president Bruce MacDonald notes, “We are not opposed to changes in the DQ.”

Yet Philanthropic Foundations Canada (PFC) wants to go further. The group this week released a brief to its members, plus an extensive consultation plan, with a more elaborate response that tethers possible changes in the DQ level to other policy and legislative reforms, including amendments to the rules governing qualified donees and direction-and-control (currently the subject of a bill before the Senate) and possibly a wholesale change that would “incentivize” foundations to expand mission-related impact investing.

In an interview this week, PFC president Jean-Marc Mangin speculated that his organization might recommend “replacing the DQ” with a policy that would allow foundations to meet their obligations through a combination of impact investing and traditional disbursements that go toward charities’ operating budgets – a move that could see philanthropic support shift from grants to equity. “This is a game-changer that could unlock billions of dollars if we can make it work,” he says, adding that the policy evaluation could be completed within a year. Mangin wasn’t aware of other jurisdictions that use this approach. “It might be a Canadian innovation.”

Quite apart from the policy minutiae, the adequacy of the current DQ rate as the primary tool for regulating the management of tax-exempt charitable assets has raised tough questions about the political legitimacy of philanthropy in a period of crisis. “Canada has a low DQ compared to other countries,” observes Carleton University political scientist Susan Phillips, who specializes in third sector policy. “I have urged foundations to step up.”

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The DQ dates back to a tax-reform package passed by a Liberal-led Parliament in the mid-1970s. The move responded to sensational media reports of charities or enterprising start-ups calling themselves foundations that were raising money for various causes but spending the lion’s share on their own operations. As an investigative story published in The Globe and Mail in 1975 pointed out, “Charitable foundations are under no obligation to disclose their affairs. Most don’t, yet they can be used for tax deductions while Government officials refuse details and defend a policy of secrecy.”

The ensuing changes led to more transparency and brought in rules governing disbursements that applied to both charities and foundations. These were based on complicated formulas for determining the minimum spending rates. For foundations, the DQ rate held at 4.5% until the dot-com bust in the early 2000s triggered a plunge in endowment asset values. Philanthropic organizations banded together and pushed for a cut in the DQ. “It was a crisis because charities couldn’t meet the target,” says Margaret Mason, a Vancouver charities lawyer for Norton Rose Fulbright Canada and chair of Imagine Canada’s board.

Ottawa responded in 2004 by lowering the rate to 3.5% – a move described as the “most significant revision of the tax rules affecting charities” in the last 20 years by two lawyers commenting in The Philanthropist. Just six years later, in the wake of the 2008 credit crisis, the Stephen Harper government further adjusted the rules, exempting foundations with assets under $25,000 and further simplifying the formula for calculating the rate as a means of reducing legal and accounting fees, Mason says.

Adding a wrinkle, the government exempted the Mastercard Foundation, Canada’s only mega-endowment, from the 3.5% DQ requirement, allowing the charity to spread out its giving because of the size of its holdings ($9 billion). The arrangement will end this year, however.

The move to reduce the DQ has been contentious for a long time. “A bad decision,” says Alan Broadbent, founder of Maytree and CEO of Avana Capital. “I’ve always been opposed to that. If your purpose in philanthropy is impact, this isn’t a good approach.”

Others point to the fact that charitable donations to foundations represent forgone tax revenues, including those on capital gains, that would be otherwise available for public spending on government services. “My issue is that 96% of assets are still intact,” says Jehad Aliweiwi, executive director of the Laidlaw Foundation. “We are subsidized by the public. These are no longer private dollars.”        

But some foundation leaders and charity lawyers question the premise of the push by critics to increase the DQ. “They really need to think about whether there’s a problem to address,” says Robert Hayhoe, a partner at Miller Thomson. “Most people who run charities want to do charitable things. This isn’t an area where I see a tremendous amount of abuse.”

Mangin says the latest data culled from T3010s filed in 2017/2018 indicate that the actual disbursement rate was about 4.1%: “[3.5] is a floor, but most foundations are above that floor.”

While data for 2020 are only beginning to come in, one detail almost certain to emerge is that many foundation assets will have seen significant growth as a result of the bull market that has continued almost unabated since last spring – a point referenced in the budget documents. The increase in portfolio valuations, says Mason, brings its own challenges. When markets are surging, she notes, some organizations can’t spend the proceeds fast enough.

Others have warned about the risks of over-granting. As the Lucie and André Chagnon Foundation pointed out in a pre-pandemic statement about its disbursement policies vis à vis its commitment to reducing inequality, “A foundation can do more harm than good by paying out large amounts of money over a short period to communities that are ill-prepared to receive them and then entirely depriving them of funding when they withdraw. A long-term perspective is one of the characteristics of foundation funding.” Mangin adds that if the DQ is too high compared to market performance, some endowment financial managers will be forced to make riskier investment choices simply to generate enough return to get over the threshold.

Broadbent doesn’t buy these arguments and notes that the foundation sector was far more active in persuading the federal government to pull back the DQ when markets tanked than it has been about easing up on the rate when they are strong. “When we have robust returns of 12 to 15%,” he says, “we aren’t making similar arguments about raising the DQ.”

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While there are strong opinions on both sides, it seems clear the federal government will be looking at the latest data to determine how, or if, to proceed with legislative changes. Certainly, PFC and Imagine Canada officials are both pushing for decision-making based on up-to-date information about grant-making and returns. Susan Phillips, at Carleton, says a member of her research team is in the midst of a study on disbursement levels.

A 2019 paper in Public Finance Review, by University of Regina economist Iryna Khovrenkov, offers some clues about what sector and government analysts might find. Looking at the returns of almost 5,700 social welfare and community charities between 1997 and 2008 – a period that straddled the reduction in the DQ – Khovrenkov found that foundation disbursements spurred individual donations to such organizations by signalling credibility, a conclusion that suggests policies to boost foundation granting produce spinoff benefits.

Although she points out in an email interview that the impact of changes in the DQ remain unclear, Khovrenkov cites other research showing that larger foundations (assets over $1 million) reduced their granting after 2004 to the DQ threshold, while medium-sized ones boosted theirs above it. “As a result,” she says, “charity recipients would have received smaller grants from larger funders, especially private foundations.” Khovrenkov also estimates that if the DQ had been pegged at 4.5% instead of 3.5%, it could have increased granting by as much as $2 billion in 2018 – a year in which foundations disbursed about $7 billion in donations.

She acknowledges that the calculation is “crude” and that other factors play a role. Some involve other elements of the regulations governing charitable foundations; for instance, the restrictions on donations to only qualified donees, which limits the pool of potential recipients, or the impact of the outdated direction-and-control rules, which constrain international aid. “When you open the hood,” Mangin says, “it’s a lot more complicated than when you first start.”

Mason, for her part, points to the culture of philanthropy, and especially how some donors insist on protecting the principal at all costs. She urges clients setting up family foundations or those donating to institutions, such as hospitals, to avoid placing restrictions on their contributions. “If you own all the money, why would you voluntarily restrict yourself not to spend the capital?” she says. Donors do, however, and that practice significantly constrains the flexibility of a foundation’s investment managers and its directors in periods of greater need. “To me, it’s not about the percentage,” she says. “It’s about the calculation.” On this point, Broadbent agrees: “Perpetuity,” he says, “is not all that it’s cracked up to be.”

In some cases, the work-around takes the form of social investing by the foundation. “Granting is not the only way to create impact,” says Allison Felker, executive director of the Vancity Community Foundation. VCF and some other foundations, for example, have set up their investment policies to allow them to offer low-cost mortgages to non-profit housing providers. The DQ is “a tool we have to create change,” she observes, adding, “Ideally, when we’re looking at the DQ, we’re looking at the broader context.” Even before the release this week of PFC’s policy brief, some observers were bruiting the possibility of counting impact investments as part of a higher DQ in order to create more alignment between grants and the kind of investing that funds like VCF are doing. As Mangin points out, a PFC task force a decade ago recommended that 10% of foundation assets should be invested in mission-related projects, such as affordable housing. “We’re nowhere close to 10% as a sector,” he says.  

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It remains to be seen how narrow or far-reaching the DQ consultations will be, if they will produce more than just busywork for policy-makers, and what becomes of this file after a federal election. Broadbent is cautiously optimistic that the coming review is “a real thing.” But Jehad Aliweiwi says the exercise looks, to him, like a signal that reform is still low on the government’s list of political priorities. “The optics of this are very bad,” he says. “‘Let’s do a consultation.’ For what? We know communities are hurting.”

Robert Hayhoe, for his part, says he’s not opposed to adjusting the DQ but doesn’t want more regulations to come with any changes. Margaret Mason, however, feels that it’s worth going back to first principles and asking why the DQ even exists. “Do we need to continue with it?” she asks. “What is its regulatory purpose?”

In fact, as Khovrenkov notes, “most European foundations are not required by government to disburse any portions of their revenues or assets. (The exceptions are foundations in Finland, Germany, Spain, Sweden, and the United Kingdom). These foundations willingly make significant grants to support their respective charitable sectors. The question, then, is what policies should be in place to encourage foundation giving in Canada.”

Within months, the factions that make up Canada’s charitable and foundation sectors will know whether or not Ottawa intends to confront a demonstrable financial squeeze, and what the details of DQ reform may look like. As Phillips says, “it’s a critical moment.”


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