If someone mentions “the DQ” in casual conversation, most Canadians likely conjure up images of Dairy Queen’s soft serve ice cream cones or its trademarked Blizzard drink. But I assume the person must be talking about the disbursement quota and the tax law governing charities in Canada, rather than the fast-food chain.
What’s a disbursement quota? And why has it resurfaced as a hot topic in tax and philanthropic circles in recent weeks, both here in Canada and the United States.? Let’s dive in.
One of the requirements under our tax law is that registered charities must spend a minimum amount each year on their own charitable programs or on gifts to other charities. This required spend is known as the disbursement quota (DQ) and is based on the fair market value (averaged over a 24-month period) of a charity’s property, such as real estate or investments, that are not used for charitable activities or administration. Currently, the DQ for Canadian charities is set at 3.5 per cent.
The DQ was originally put in place in 1976 to ensure that a significant portion of a charity’s resources were actually devoted to its charitable purposes. Initially, the DQ included two requirements.
The first was an obligation for charities to spend a minimum amount (80 per cent for charities and 90 per cent for foundations) of the funds for which it issued a donation receipt in the immediately preceding year. In addition, foundations had to spend a minimum of five per cent of the fair market value of any property not used in charitable programs or administration, which was lowered to 4.5 per cent in the 1980s. In 2004, the DQ was further reduced to its current level of 3.5 per cent, the rationale being that this lower rate “was considered at the time to be more reflective of historical long-term real rates of return earned on a typical investment portfolio held by a registered charity.”
In 2010, the DQ rules were substantially reformed to make them simpler and more equitable for all charities by removing the requirement that charities disburse amounts based on the previous year’s tax-receipted income, leaving the DQ at a simple 3.5 per cent of the assets held by a charity or foundation.
In this year’s federal budget, the government noted that most charities meet or exceed their DQs, but a gap of at least $1 billion in charitable expenditures exists. The government also noted the tremendous growth in foundational investment assets in recent years, remarking that charitable foundations in 2019 held more than $85 billion in long-term investments. No new changes were announced in the budget, but the government announced its intention to potentially increase the DQ for 2022, which could “boost support for the charitable sector, benefiting those that rely on its services.”
To that end, the government this past week launched a public consultation process, seeking feedback on potentially increasing the DQ, as well as “updating the tools at the Canada Revenue Agency’s disposal in order to enforce the … rules.”
Specifically, the government is seeking the public’s input as to whether the 3.5-per-cent DQ rate still reflects the expectations of long-term real rates for portfolio returns among charities and foundations, and whether the DQ “strikes the appropriate balance between providing long-term, sustainable funding for the charitable sector and on ensuring that tax-assisted donations are deployed towards charitable activities on a timely basis.”
The government would like feedback on a number of specifics, such as whether the DQ should be raised and, if so, to what extent, as well as whether it would be desirable to increase the DQ to a level that causes foundations to gradually encroach on their investment capital, and whether this would be sustainable in the long term for the charitable sector. It is also curious as to whether any temporary changes to the DQ should be considered in the context of the pandemic recovery.
Proponents of raising the DQ have long argued that tax-assisted donations, which benefit from immediate tax assistance in the form of a donation tax credit for individuals ($11 billion in individual donations in 2019) or a tax deduction for corporations ($4 billion) take too long to deploy towards charitable programs and that the current DQ “is unduly allowing the accumulation of capital.”
Some stakeholders in the charitable sector have advocated that larger foundations with significant investment assets should be forced to draw upon their reserves in order to increase current support for charitable organizations.
On the other hand, a lower DQ allows some organizations that rely on regular donations to build an endowment to sustain the organization through years where donations, and returns, may be low.
This issue is not unique to Canada. Earlier this week, in an interview with CNBC, billionaire philanthropist John Arnold attacked donor-advised funds (DAFs), which have emerged over the past couple of decades as a popular alternative to setting up private foundations. DAFs essentially piggyback on public foundations, such as community foundations or foundations established by some of the major financial institutions or investment management firms, allowing a donor to create a “mini-foundation” as a subset of the larger, public foundation.
In the interview, Arnold called U.S. DAFs “wealth-warehousing vehicles” that provide tax benefits to the wealthy without the funds ever making their way to charity. He said his goal was to “insure that philanthropic donations that receive a federal tax benefit actually make it to the community in a timely manner.”
Arnold has been lobbying the U.S. Congress to pass legislation requiring DAFs to make more grants. In June 2021, a bill called the Accelerating Charitable Efforts Act and sponsored by Senators Angus King and Chuck Grassley was introduced. It would provide DAF donors with two options: they could continue to get an upfront tax deduction, but be required to distribute the funds within 15 years, or donors who want more time can choose the “aligned benefit rule,” which gives them up to 50 years to distribute the funds, but only get a tax deduction upon distribution.
To have your say on Canada’s DQ rule, you can join the public consultations by submitting your comments by email to charity-bienfaisance@fin.gc.ca using Charities Consultation as the subject line. The deadline for comments is Sept. 30, 2021.