Law on Associations

Country Reports: North America

The International Journal
of Not-for-Profit Law

Volume 2, Issue 4, June 2000


Canada: The Next Step

The Canadian federal government has released its response to the 1999 Working Together – Report of the Joint Tables, a Report which recommended a host of changes to government/third sector relations. The new approach is being referred to as the Voluntary Sector Initiative.

The federal government says it will spend $94.6 million over the next five years to develop its relationship with the voluntary sector. As with the original report, the initiative will focus on three key themes:

  • improving the relationship between the government and the sector,
  • enhancing the capacity of the sector to serve Canadians, and
  • improving the legislative and regulatory environment in which the sector operates.

The plan will be implemented and overseen by a 14-member Joint Co-ordinating Committee of government and sector officials. Organizers also plan to create sub-committees for specific projects. As with the first joint tables, the committees will be composed of both government and sector representatives.

Following from the most recent speech from the throne, one of the key elements of the initiative is the creation of a formal accord between the government and the voluntary sector. The accord will set out mutual obligations and benefits of the government and the voluntary sector in all areas of joint endeavour. Ten million of the overall initiative budget has been allotted to the creation of the accord.

Another $10 million will be set aside to help celebrate the International Year of Volunteers in 2001. In addition to programs during 2001, the initiative proposes to create a legacy fund to help expand volunteer effort and promote volunteering through a social marketing campaign.

To help assess and share information about the sector, organizers will continue to study and release information from the 1997 National Survey of Giving, Volunteering and Participating. Additionally, the survey will be revised and conducted again in the Fall of 2000 and every three years thereafter, so that a more comprehensive set of data will be available to aid in policy-making decisions.

In addition to the renewed public survey, the initiative plans to set up a “satellite account” for the voluntary sector within the framework of the Canadian System of National Accounts. The account will include the sources of revenue, categories of expenditure, and other fundamental characteristics of the sector, including the value of non-market activities.

Aside from increased research about public engagement, the initiative proposes to help create more fellowships and internships to deepen the body of knowledge relating to Canada’s nonprofit sector.

In what promises to be a tangible benefit to the sector, the initiative proposes to review the funding process for organizations that receive a portion of the budgets from government. Organizers plan to keep discussing the relative impact of short-term and longer-term funding horizon for grants and contributions as well as the benefits and drawbacks of core funding and the relative balance of tax support versus direct funding.

Let us summarize what the new report says, and does not say about the key regulatory issues.

First, even the modest suggestions of the Table report for adding new types of organizations to the charity or quasi charity list (see our issue of October, 1999) is not referred to. Finance, which fears any expansion of definition of organizations which can issue tax receipts, prevails again.

Second, the most contentious single issue facing organizations in Canada, the one addressed by the Supreme Court of Canada in the Vancouver Immigrant Women case, political activities, education and advocacy is not mentioned.

Third, the issue of whether the Tax Agency should be shorn of its power to determine social issues by way of charitable registration or deregistration is to be the subject of further study.

The paper says:

“The Joint Regulatory Table will more fully develop the regulatory institutional models outlined in the preliminary work of the 1999 Joint Tables Process. Subsequently, a neutral third party will be contracted to organize and conduct the necessary targeted and focused dialogue with the sector, with interested provincial departments and with other stakeholders (e.g. business, citizens). This is to gain a better understanding of the implications of various approaches, their potential costs and benefits and the degree of support for new institutional arrangements.”

On the more positive side, we have the following “promises.”

  1. Access to Public Information on Charities will be put on the internet.
  2. There will be clarification of guidelines on allowable related business. (Our comment is “don’t hold your breath; the tax authorities have been trying to do this for a decade or more and have been unable to “solve” the dilemma.)
  3. CCRA (the Canadian tax authority) will develop a short version of the annual tax return. Those with revenues under $100,000 (approximately 70% of all registered charities) will be eligible to use the return to reduce the burden of reporting on small charities.
  4. Lack of Transparency, Regulatory Sanctions and Appeal Process: Three Policy Issues Related to Regulation of Charities:

“There are three issues concerning the regulation of charities under the Income Tax Act which have caused concerns for the sector and the government:

  • The current process for determining charitable status requires secrecy and therefore the rationale behind decisions is not publicly known. The sector has expressed frustration at the lack of information to learn from previous decisions and at the perception of arbitrariness in decision-making.
  • The existing penalty for non-compliance, namely de-registration, is considered too severe to be appropriate except in the most extreme cases of abuse. A range of penalties commensurate with the level of violation could be considered.
  • Currently, appeals from the Charities Division are to the Federal Court of Appeal. This avenue is considered expensive, generating too few precedents to adequately guide the sector or the regulator.

CCRA and Finance Canada will lead a Joint Regulatory Table and a project of research and consultation to determine the best method of addressing these issues and the acceptability of a fully transparent regime, new intermediate sanctions and an alternate appeal route.” (Author’s note: the foxes are in charge of the hen house on these issues.)

  1. The issue of directors’ liability is of great concern to community and national groups across Canada. Industry Canada will expedite and augment planned research and consultations to prepare proposals for legislative action. Collateral discussions with the sector could be used to help develop innovative and collaborative approaches, which could be taken by voluntary organizations themselves, working with insurance providers, to access affordable insurance coverage and improve measures to reduce potential liability.” (Author’s Note: This proposal doesn’t help the liability issues of provincial corporations and unincorporated entities such as trusts, but it is a start.)

On the assumption that something is better than nothing, the Report is positive. But it is a bitter blow to those who thought that there would be swift action taken on issues which are pressing, to say the least.


New Law on Promotion of Social Development Activities in Mexico City

For Consuelo Castro
Centro Mexicano para la Filantropía (CEMEFI)

An adequate legal framework is certainly one of the most important sources of reinforcing the nonprofit sector in many countries. Mexico is no exception.

In response to this need, since 1995, a coalition of nonprofit organizations has been promoting a project entitled “Law on Promotion of Social Development Activities.”

The bill was presented in the Mexican Congress in 1998 and in the Mexico City House of Representatives in 1999. The law has just been passed in Mexico City.

This law recognizes nonprofit organizations as social interest entities. Therefore, it aims to promote a clearer relation with the government and other sectors, transparency of the sector’s activities as well as the possibility of creating tax exemptions and other types of incentives.

Having a new regulatory framework for nonprofit organizations in Mexico City represents an important step in enhancing the city’s role in social change. By standing as a regulatory role model, the new law may assume a national scope in the near future.

the United States

Donor-Advised Funds

By Georgina McCaughan
ICNL Legal Intern American University, Washington College of Law, 2002

The Clinton Administration’s budget proposals for 2001 include provisions that would affect donor-advised funds (DAFs). The new legislation was proposed to reduce potential abuses of donor-advised funds available under current law. DAFs allow a donor to make a charitable donation, claim a deduction for the contribution, and then provide advice regarding the investment of the amount given and the eventual donees. This sort of giving is typically used effectively by community foundations. However, abuses have arisen with respect to DAFs, which the Treasury and various members of Congress are seeking to eliminate.

The proposed legislation would provide that a charitable corporation, which operates DAFs as its primary activity, may qualify as a publicly charity only if:

  1. No material restriction or condition prevents the organization from employing the assets in the funds
  2. Distributions are made from the funds only as contributions to public charities, private operating foundations, or governmental entities; and
  3. Annual distributions equal at least five percent of the net fair market value of the organization’s aggregate assets held in donor-advised funds.

If the organization does not comply with these requirements, the organization would be regarded as a private foundation and thus subject to the rules and excise taxes applicable to private foundations.

There has been significant criticism about the breadth of the proposals, in large part because they are viewed as too restrictive (the first qualification; listed above would not permit gifts to be made to foreign charities that are section 501(c (3) equivalents or by using expenditure responsibility). It is doubtful that any changes will be enacted this year, but some legislation in this regard can be expected in the future. IJNL will continue to keep its readers apprise of developments.

Private Letter Ruling 200010056

By Shannon R. Eskow
ICNL Legal Intern George Washington University, 2002

United States grantmakers who are interested in making cross-border grants must be aware of the existing restrictions in the tax laws on grants to non-US organizations that have not obtained Internal Revenue Service section 501(c)(3) determinations of charitable status. To avoid penalties under the law, the grantmaker must either make an equivalency determination, that is, determine that the grantee organization is the equivalent of a US public charity, or exercise expenditure responsibility. The grantmaker must exercise expenditure responsibility if the foreign organization is the equivalent of a US private foundation or if the grant maker is unable to assess whether the grantee is a public charity or private foundation. (For more information concerning the requirements for equivalency determinations and exercising expenditure responsibility, please see D. Aitken, Determining Whether to Make an Equivalency Determination or to Exercise Expenditure Responsibility, in this issue of IJNL)

In a recent Private Letter Ruling, the Internal Revenue Service addressed the importance of making either an equivalency determination or exercising expenditure responsibility when it issued an opinion on whether a cross-border grant from a private foundation to a foreign organization that has not obtained section 501(c)(3) status is a “qualifying distribution and does not constitute a taxable expenditure.” The Service issued an opinion upon a request from B, a private foundation. B is funded by D, a substantial contributor and disqualified person with respect to B under section 4946 of the Code. D works with B to fund, from B’s assets, deserving charitable projects in areas where D has an interest. B proposed to modify its C program to make charitable grants to smaller foreign charitable organizations. The C program does not have any specific grant application form. Neither D nor any of Ds employees would obtain any personal benefit from the grants, and funds from the grants cannot be used to purchase goods or services from D.

Under the program, the foreign charity applicant would submit an application, which would include an “Affidavit for Equivalency Determination,” if one were available. For those organizations that do not furnish an affidavit, the grant approval board would exercise expenditure responsibility with respect to the grant. An employee of D would be involved in monitoring the grant.

If expenditure responsibility were required, the grantee would sign a written grant commitment promising, among other things, to:

  • submit full annual reports on the manner in which the funds are spent and the progress made in achieving the purposes of the grant;
  • make its books and records available to the grantor at reasonable times;
  • not use the funds to promote propaganda or for lobbying or influencing legislation;
  • not make any grant that does not comply with the individual requirement of section 4945(d)(3) of the Code or the organization grant requirements of section 4945(d)(4); and
  • not undertake any activity for a non-charitable purpose.

B would keep records which include the name and address of the grantee, the date and amount of the grant, the purpose of the grant, the amounts spent by the grantee, whether the grantee has diverted any portion of the funds from the purpose of the grant, the dates of any reports received from the grantee and the date and results of any verification of the grantee’s reports.

The Service found that distributions under the C program would be qualifying distributions by B under section 4942(g) of the Code. Section 4942 of the Code requires a private foundation to pay an excise tax unless the foundation annually makes qualifying distributions equal to or greater than 5% of the fair market value of its assets. Section 4942(g) of the Code defines “qualifying distributions” as any amount paid to accomplish one or more of the charitable purposes described in section 170(c)(2)(B) other than contributions to a controlled organization or a private non-operating foundation. Under B’s proposal, the grants from B to the foreign charities are intended to be used to accomplish one or more of the charitable purposes described in section 170(c)(2)(B) and are not contributions to a controlled organization or private non-operating foundation. That the charitable activity of B would take place in a foreign country is irrelevant to determining whether the grants may be considered qualifying distributions, according to Rev. Rul. 71-460. Furthermore, the Service believes B’s plan includes specific guidelines and measures which will allow B to be reasonably assured that the grants will be used by the foreign charity for charitable purposes within the meaning of sections 501(c)(3) and 170(c)(2)(B) of the Code.

The Service also determined that distributions under the C program would not be taxable expenditures by B under section 4945(d) of the Code. Section 4945 provides for the imposition of taxes on each taxable expenditure of a private foundation. Section 4945(d)(4) of the Code requires that any amount paid by a private foundation to any organization other than a public charity will be deemed a taxable expenditure unless the private foundation exercises expenditure responsibility. “Expenditure responsibility” is defined in 4945(h) as the responsibility of the private foundation to exert all reasonable efforts and to establish adequate procedures to see that the grant is spent solely for the purpose for which it was made; to obtain full and complete records from the grantee on how the funds are spent; and to make full and detailed reports with respect to such expenditures to the Secretary.

The Service found that B’s proposal includes adequate steps to ensure that the grants used by foreign charities will be used for their intended purposes. First, under B’s proposed guidelines and procedures, where the foreign charity can avail itself of the equivalency determination letter process, it is required to do so, and must satisfy the requirements set forth in section 53.4945-5(a)(5) of the regulations and Rev. Proc. 92-94. Second, if the foreign charities cannot avail themselves under the “qualified affidavit” or equivalency determination procedure under Rev. Proc. 92-94, then B will exercise expenditure responsibility in accordance with the terms of C’s program guidelines and procedures. C’s program guidelines and procedures require that these foreign charities provide specific information through the grant application and the grant agreement, which allows B to exercise expenditure responsibility as required under section 53.4945(b) of the regulations.