Income Tax Act Update: Exploring New Rules Allowing Charities To Work More Freely With Non-qualified Donees

The landscape of charitable giving and operations within Canada experienced significant transformation with amendments to the Income Tax Act (Canada) ("ITA") that received royal assent on June 23, 2022.

These amendments have fundamentally altered how Canadian registered charities can allocate their resources and engage with both qualified and non-qualified donees, which in turn broadens the scope for innovative partnerships and philanthropic endeavours. These changes mark a shift from traditional models of working with non-qualified donees, aiming to enhance the effectiveness and reach of charitable efforts within Canada and beyond.

The following discussion delves into the pre-amendment legislative landscape, our understanding of the catalysts for legislative change, and the new provisions introduced by the amendments. We will offer our thoughts on the present-day implications for charities while examining the administrative guidance provided by the Canada Revenue Agency ("CRA") regarding this regulator's interpretation of these changes.

Historical context

Qualified donees are defined in the ITA as organizations that can issue official donation receipts for gifts they receive from individuals and corporations. Qualified donees include registered charities, Canadian amateur athletic associations, housing corporations based in Canada aimed at offering affordable housing for seniors and registered Canadian municipalities, among others. CRA maintains a list of qualified donees which can be found here. Non-qualified donee is not statutorily defined.

Prior to the 2022 ITA amendments, a Canadian registered charity could fulfill its charitable mandate by:

1. Carrying on its own charitable activities through its (a) staff and volunteers, or (b) an intermediary (i.e. a non-qualified donee), subject to the charity exercising direction and control.
2. Making gifts to qualified donees.

Organizations that did not qualify as "qualified donees" were barred from receiving resources unless the gifting charity entered an agreement establishing "direction and control" over the activities and use of their assets by the non-qualified donees.

The direction and control model demands a stringent and continued amount of administrative oversight from the gifting charity. Exercising "direction and control" requires a charity to retain decision-making power over their resources given to non-qualified donees. While charities can take advice from the non-qualified donee, or delegate day-to-day operational decisions to them, the charity must hold the power to intervene in any decision. The charity is also responsible for recording all steps taken to exercise direction and control over their resources as part of their books and records obligations.

The requirement for charities to carry out their own activities and maintain direction and control can create impractical situations. For example, if a charity was the Canadian affiliate of a large, non-qualified donee organization outside of Canada, the requirement for direction and control would apply to any payments made to the parent organization.¹

Many people are likely familiar with Red Cross, and more specifically, the Canadian Red Cross. The Canadian Red Cross is a registered charity in Canada, belonging to the International Federation of Red Cross and Red Crescent Societies, which is not a qualified donee. In order to transfer resources to the Federation, the Canadian Red Cross would need to follow the rules relating to direction and control, regardless of how reputable, sophisticated, and robust the international network of Red Cross societies is.

The direction and control requirement lends itself to unequal power dynamics instead of powerful partnerships. Rather than empowering local community organizations, the direction and control requirement necessitates decision-making power being withheld from local actors who may be more familiar with the communities the charities seek to better.

For clarity, the direction and control model is still relevant post-amendment. Where a charity wishes to carry out its own charitable activities through a non-qualified donee intermediary, they still must exercise direction and control over the relevant resources. These ITA amendments simply provide another avenue for partnering with non-qualified donees.

Advocacy within the charitable sector itself was the driving force behind the 2022 ITA amendments. For years, charities and charity law academics and practitioners across Canada have advocated for change to the ITA to allow for more practical partnerships with non-charities in an empowered and accountable manner. An earlier version of the bill that eventually resulted in the ITA amendments contained a much more prescriptive list of requirements for charities to work with non-charities, regardless of the size and nature of the partnership. Continued work on the part of the charitable sector led to the House of Commons removing such prescriptions, allowing for accountability measures to be determined by the CRA in consultation with the charitable sector instead.²

There is now a new pathway for registered charities in Canada to fulfill their charitable mandate: they may make grants to non-qualified donees The final administrative guidance was released by CRA on December 19, 2023, offering comprehensive direction on these grants made to non-qualified donees ("Guidance").³

The Guidance was issued following continued engagement from the charitable sector during a period of public comment on previous draft guidances. This new regime allowing Canadian registered charities to engage in "qualifying disbursements" is a direct result of admirable efforts of the charitable sector in advocating for ways to address some practical issues plaguing registered charities for many years.

The Guidance outlines the commitments, practices, and tools to be applied by the CRA in interpreting the new ITA provisions. These guidelines serve as a non-binding reference, offering insight into how the CRA interprets the legislative changes. A summary of the Guidance shortly follows.

The basics

Gifts are amounts given to qualified donees without any additional requirements placed on them. When a charity makes a gift to a qualified donee, it has no residual responsibility to continue to oversee the use of their gift. Grants, in contrast, are amounts given to a non-qualified donee, or grantee organization.

A grantee organization under the ITA includes a person, club, society, association, organization or prescribed entity (but does not include qualified donees).⁴ When charities make grants to grantee organizations, they have a level of continuing responsibility to ensure their grant is used appropriately by the recipient, and that it continues to further the charity's charitable purpose.

Prior to making the grant, charities should review their governing documents—particularly their charitable purposes—to ensure they align with one or more of the four ITA mandated categories of charitable purposes (relief of poverty, advancement of education, advancement of religion, other purposes beneficial to the community) which may support qualifying disbursements to non-qualified donees, even if such disbursements are not explicitly referenced.

Before this qualifying disbursements regime was included as part of the 2022 ITA amendments, a charity could only involve non-qualified donees by carrying on their own charitable activities using the non-qualified donee as an intermediary, subject to the direction and control requirement discussed above.

Qualifying disbursement rule

The 2022 changes to the ITA included the addition of the qualifying disbursement rule. Gifts to qualified donees and grants to non-qualified donees are both types of qualifying disbursements. Gifts are a disbursement made by a charity to a qualified donee, which have no additional requirements. Grants are disbursements made to non-qualified donees, which are subject to the following qualifying disbursement rules:

1. Disbursements must be in furtherance of a charitable purpose of the charity.
2. The charity must ensure that the disbursement is exclusively applied to charitable activities in furtherance of a charitable purpose of the charity.
3. The charity must maintain sufficient documentation 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.

The effect of the qualifying disbursement rule and the Guidance surrounding it is the creation of a spectrum of administrative oversight requirements based on the circumstances of the grant. Prior to the ITA amendments, the direction and control requirements applied to all resources given to non-qualified donees by charities, no matter the size of the grant, the relationship between the charity and donee, or any other consideration to circumstances or practicality.

While the administrative oversight requirements under the qualifying disbursement rule can still be quite strict, there is no longer a one-size-fits-all regime charities must follow for overseeing grants; there is some flexibility in oversight practices and tools, which we see as a good thing.

Below is a summary of the key points noted in the Guidance. It should be noted that the Guidance is CRA's interpretation and application of the law and is very helpful – but it is not law itself, and individual assessment of the law is still necessary.

Assessing risk

Under the Guidance, the CRA provided tools to determine "levels of risk" for grants, which assess the details of the grant itself, as well as the charity and grantee involved in the grant. Assessing risk is important, because it will affect the level of record-keeping and administrative oversight a charity will need to provide in executing the grant with the grantee.

The Guidance suggests that charities weigh grant conditions to decide if the overall risk level is low, medium, or high, and provides a matrix with considerations charities may weigh in their risk assessment. These considerations include factors such as the amount of the grant, the type of resources granted, the charity and grantee's experience, and the grant duration, among others.

Accountability requirements

The Guidance provides that the grant disbursement must be made in furtherance of at least one charitable purpose of the giving charity, and that the charity must maintain sufficient documentation of such disbursement. Thorough records are necessary to:

1. Monitor the intent of the grant.
2. Confirm that the grantee used the funds solely for the intended purpose.
3. Validate that the charity conducted proper diligence in its grant making processes.

The depth of this documentation will vary according to the grant's assessed risk level. Documents for low-risk grants may require a simple agreement or e-mail records while high-risk grants may require a formal written agreement with comprehensive terms. It may be prudent for charities to develop internal policies on how to assess risk and implement accountability measures to ensure consistency in the grant-making process with all applicants.

Accountability tools may include:

• Research and review.
• Noting a description of grant activity or drafting agreements.
• Forming a reporting plan.
• Creating transfer schedules.
• Separately tracking funds.

A detailed discussion on interpreting and applying specific provisions of the qualifying disbursements rule can be found in paragraphs 13 and 66 of the Guidance.

Due diligence

The Guidance outlines five critical diligence practices for charities to follow when issuing grants:

1. Establish how the grant activity furthers the charity's charitable purpose.
2. Assess the grant's risk level (low, medium, or high) based on factors that may affect the charity's ability to meet the ITA requirements.
3. Determine how much due diligence the charity needs to apply through accountability tools based on the risk level.
4. Apply the accountability tools in collaboration with the grantee.
5. Document the charity's due diligence over the grant's duration in its book and records.

While reviewing a charity's records, the CRA must be able to determine whether

1. The charity's grants meet accountability requirements.
2. The grantee's use of resources can be verified.
3. The grantee continues to use the grant's resources for the purposes and activities set out in the grant's terms.

Charities should ensure that they are continually tracking and documenting their charitable activities and donation processes to ensure seamless CRA reporting processes are in place, especially upon audit.

We have provided a very brief summary of the high points contained in the Guidance. Due to the complexities of the Guidance and the application of the qualifying disbursement rule, developing internal tools such as checklists have been helpful for many charities who want to develop a consistent approach to their grant-making process. Indeed, it may be prudent for charities who will be participating in qualifying disbursements to develop internal processes for assessing risk and assigning correspondingly appropriate accountability tools.

Further considerations

Below is a brief summary of some additional considerations that apply to the qualifying disbursement regime.

Conclusion

The transformative ITA amendments resulting from years of charitable sector advocacy carve out a more flexible pathway for Canadian registered charities in directing their resources to non-qualified donees. A short summary of the current pathways available to charities is below:

The qualifying disbursement rules offer charities greater ability to partner with other organizations, especially non-qualified donees, which is seismic shift from the paternalism embedded in the direction and control test.

The new regime allows for graded levels of oversight that can be guided by trust developed over time in a partnership. The regime still requires a high level of administrative oversight; some may argue rightfully so, as grants from charities deserve to receive time, energy, and due diligence. However, there is no longer a "one-size-fits-all" approach to administering charity resources directed through non-qualified donees, which is a positive change in favour of facilitating stronger partnerships.

While these changes beckon a broadened horizon for charitable activities, they also underscore the need for meticulous adherence to regulatory requirements. In making grants, charities must carefully assess the level of risk involved and ensure their accountability measures are correspondingly appropriate. Internal policies may be prudent to ensure a diligent and consistent grant-making process.

As charities embrace these opportunities, the clarity brought forth by the CRA's Guidance serves as an indispensable roadmap. Charities that wish to implement these new arrangements should seek assistance from their trusted legal advisors for advice and support on the qualifying disbursement rules and how to apply them.

Footnotes

1 Canada Revenue Agency, "Canadian registered charities carrying on activities outside Canada" (November 27, 2020) at Appendix C.

2 "Bill C-19, An Act to implement certain provisions of the budget tables in Parliament on April 7, 2022 and other measures", 2^nd reading, Senate Debates, 44-1, No 53 (14 June 2022) at 1648 (Hon Ratna Omidvar).

3 Canada Revenue Agency, "Registered charities making grants to non-qualified donees" (December 19, 2023).

4 "Grant" is often used in the charitable sector and may describe other arrangements such as transfers from one qualified donee to another (which is what we would refer to as a "gift" in this article). For the sake of clarity in the qualifying disbursement context, and to be consistent with the CRA Guidance on the topic, we specifically use "grant" in this article to describe a disbursement made to a non-qualified donee.

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