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The ABCs of Fund Agreements and Estate Gifts

Community Foundations of Canada ConferenceMay 8, 2015

Andrew Valentine, Partner, Miller Thomson LLPavalentine@millerthomson.com416.595.2980

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Fund Agreements

• Known by many names…– “Gift Agreement”

– “Fund Agreement”

– “Pledge Agreement”

– “Endowment Agreement”

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General

• Fund Agreements: Agreement between donor and charity establishing the terms that apply to gifted property:– Establish restrictions on the specific purposes for

which gifted funds may be used

– Establish terms around holding, investment, and disbursement of funds

– May address recognition of and accountability to donor

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General

• Fund Agreements can be limited to a single gift, or can set terms of a fund to which many future gifts may be made

• May establish terms of a fund that will last very long time

• Individuals other than the donor may contribute to such a fund

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Source of Legal Rules

• Provincial trust law– Governs and enforces restrictions applicable to gifted

funds

– Imposes investment standards

• Income Tax Act– Imposes disbursement quota

– Rules re issuing official donation receipts

– Establishes limits on providing benefits to non-qualified donees

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Gift vs Pledge

• Gift: a voluntary transfer of property from a donor to a donee for which no consideration flows to the donor (subject to tax rules re advantage)– i.e., a current transaction

• Pledge: a promise to make a future gift

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Current and Future Gifts

• Fund Agreements often document combination of gifts and pledges– E.g., initial donation with further instalments to be

made over time

• Fund Agreements may also establish the terms of a fund with a current gift and provide for open-ended possibility of future gifts

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Enforceability

• Pledges generally not enforceable

• Brantford General Hospital Foundation v. Marquis Estate (2003)– Donor executed gift agreement with Hospital

Foundation, pledged $1 million gift in 5 instalments

– Made first instalment, then died

– Foundation sought enforcement of remaining installments

– Court held not enforceable

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Enforceability

• Court held that absence of consideration prevented enforcement of pledge– Could not rely on partial performance

– Naming, recognition rights to be provided to donor were not essential part of agreement

– Hospital could not show detrimental reliance

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Enforceability

• How can a pledge be made enforceable– Put agreement under seal

– Confirm naming rights are essential term

– Confirm intended reliance by foundation on gift

– Include language expressly confirming intention that agreement is to be binding

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Establishment of Fund

• Include term confirming that a fund is to be established with the gift of the donor

• Indicate name of fund, if desired

• Confirm that all funds held in fund are subject to terms of agreement

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Gift Provisions

• Timing: Fund agreement should confirm when gift is to be made, including timing for instalments (if applicable)– Establish specific due dates

• Confirm whether future gifts to the fund may be made from general public– If yes, should confirm that terms of the agreement will

apply to all such gifts

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Minimum fund balance

• Some fund agreements provide for minimum fund balance before any grants will be made from fund

• Confirm threshold amount

• Agreement can specify that if fund remains below threshold for set period of time, may be converted into unrestricted funds or granted to pre-determined grantee

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Gift Conditions

• Confirm whether any conditions apply to the gift– Condition precedent – pre-requisite that must be met

before gift will be made (e.g., securing approval for naming rights, raising of matching funds)

– Condition subsequent – event that undoes the gift after it has been made (e.g., building project cancelled)

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Conditional Gifts

• Ensure receipts issued properly for conditional gifts– Condition precedent – no receipt until condition

fulfilled

– Condition subsequent – receipt can be issued for initial gift, but charity likely required to inform CRA if condition subsequent occurs and property is returned

• Donor may be reassessed for any credits claimed

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Purpose

• If gift is to be restricted to specific purpose, this should be specified in fund agreement, for example:– Scholarship fund

– Field of interest (e.g., to support research in field of …)

– Designated recipient (specific charity to be supported)

• Ensure that purposes are acceptable to foundation and workable in practice

• If unrestricted, confirm that fund will support the charitable purposes and activities of foundation

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Donor Advised Fund

• If fund structured as DAF, confirm terms of donor advice

• Agreement should identify who is authorized to make recommendations

• Agreement should confirm that donor advice are recommendations only – board of foundation has final decision

• Should specify default granting provisions if recommendations not receive by specified deadline

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Restrictions on Holding/Spending

• Agreement may include terms imposing limits on how and when the foundation must hold and spend funds– E.g., Hold capital in perpetuity, with income only

available for spending/granting

– Hold capital for specified period, with income only available for granting

– Total return – spend percentage of fund each year, with no differentiation between income and capital

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Restrictions on Holding/Spending

• Take care when drafting restrictions on holding and spending out fund– If subject to requirement to hold “capital”, define:

• What is meant by capital? (initial gift only, capital growth included, inflation adjusted?)

• What is meant by income? (interest, dividends, capital gains?)

– Can the charity encroach on capital under any circumstances?

• Recommend permitting encroachment on capital to extent necessary to meet disbursement quota

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Restrictions on Holding/Spending

• Consider whether perpetual hold is necessary– Often recommended by charities, not requested by

donors

• Consider total return rather than capital hold

• Ideally, provide that holding and disbursement from fund will be subject to relevant policies of the foundation, as amended from time to time

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Investment of Fund

• Provincial Trustee Acts provide for investment standard

• “Prudent investor standard” applies in many jurisdictions– In investing trust property, a trustee must exercise the care, skill,

diligence and judgment that a prudent investor would exercise in making investments (Ontario Trustee Act, s. 27(1))

– A trustee must invest trust funds with a view to obtaining a reasonable return while avoiding undue risk, having regard to the circumstances of the trust (Alberta Trustee Act, s. 3(2))

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Investment of Fund

• Prudent investor standard focuses on financial return on investment at portfolio level

• Trustee legislation sets out factors to be considered when investing trust property– Generally, refer to financial considerations

– May permit consideration of special relationship between trust property and trust purposes

• Diversification requirement

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Investment of Fund

• Foundation must also consider Income Tax Act issues

• Cannot make grants to non-qualified donees

• Investments on below-market terms (having regard to risk and expected ROI) may constitute gift to non-qualified donee

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Investment of Fund

• Mission related investing– invest assets in ways that will fulfill mission, especially

direct investments in communities or in businesses with a social purpose.

– Not just money in stocks and bonds for financial return alone

• May still be consistent with prudent investor standard within overall portfolio

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Investment of Fund

• Program-related investments (PRI)– A PRI is an investment (not a grant) that directly

furthers the investor charity’s charitable purposes

– Usually at below-market terms

– Common types or forms of PRIs include:• loans; • loan guarantees;• share purchases; or • leases of land or buildings.

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Investment of Fund

• PRIs – CRA has issued guidance in CG-014– If made to a qualified donee – requirements are

minimal

– If made to a non-qualified donee, the investor charity must prove that the arrangement meets the “own activities” requirement of the ITA by:

• maintaining direction and control over the program; and

• showing that any private benefit is incidental

• Exit mechanism if investee ceases to use funds for charitable purpose

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Investment Power

• Recommendation– Fund Agreement should reference Foundation

policies regarding investment, as amended from time to time

– Gives maximum flexibility

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Donor recognition

• Fund agreement may provide for naming rights or other recognition to donor

• Naming rights should be set out with sufficient specificity to ensure clarity as to foundation’s obligations

• Fund agreement should confirm when naming rights are effective – what happens if donor does not complete full pledged gift?

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Donor Recognition

• Foundation should consider developing policy around donor recognition– Threshold gift amounts for different recognition levels

– Procedures for approval of proposed/requested recognition at different levels (e.g., Board approval, ED, fundraising officers?)

– Protocols around donor communication

– Risk management issues

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Donor recognition

• Fund agreement should address contingencies and issues around naming:– Donor input on/approval of signage?

– Future changes to named buildings

• To extent possible, fund agreement should reference policies around donor recognition and naming rights

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Receipting

• Fund agreement should confirm that receipts will be issued for eligible amount of the gift in accordance with Income Tax Act

• Avoid committing to provide receipts without qualifier that the receipt must comply with the Act

• Among other things, receipt must take account of any advantage in respect of the gift

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Receipting – advantage

• Income Tax Act requires that receipts must be issued for the “eligible amount of gift”

• “Eligible amount” = fair market value of gifted property less amount of advantage to the donor

• Advantage = all property, services, compensation, or other benefits that a person is entitled to receive in relation to the gift, now or in future

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Receipting – advantage

• Common issue in fund agreements: when do naming rights constitute an advantage?

• In general, CRA takes position that individual naming rights do not constitute an advantage that must be subtracted from FMV of gift

• Corporate naming rights generally do constitute advantage because economic benefit to corporation– Propose that corporation deduct gift as marketing expense

rather than taking official donation receipt

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Variance Clause

• Important to include variance clause in fund agreement

• Variance clause confirms that in the event the foundation determines that it cannot comply with the terms of the fund because it has become impractical, illegal or inadvisable, foundation may vary terms of fund as necessary, having regard to donor’s original intention

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Variation of Fund Agreement

• If no variance clause, cannot amend terms of fund without court authorization

• Donor agreement alone is insufficient

• Cy pres – where donor has general charitable intent and terms of gift have become impossible or impractical to fulfill, can apply to court to vary terms of charitable trust – expensive and uncertain

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Administrative Fees

• Agreement should confirm whether administrative fees will be retained by foundation

• Ideally, confirm that administrative fees set in accordance with policies of foundation, as amended from time to time

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Will Gifts

• Current rules in ITA distinguish “gifts by Will” from gifts by estate

• Gift by Will– Deemed to be made by testator immediately before

death

– Credits can be used in last two tax returns of testator• i.e. in year of death and one year prior

• Gift from Estate– Credits can only be used against estate income

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Gifts of Designated Proceeds

• Similar rules apply to direct designation of proceeds on death from an RRSP, RRIF, TFSA or life insurance policy

• When qualified donee is designated, and the donation occurs within 36 months of death, gift is deemed to have been made by the individual immediately before death

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Will Gifts (cont’d)

• New rules applicable from January 1, 2016– Gifts by Will and direct designation gifts, will be

deemed to have been made by estate

– Gift deemed to be made when the property is transferred to the qualified donee

– But, for “Graduated Rate Estates”• executors will have flexibility to allocate credits against

current or prior estate return, and against last two years’ tax returns for the donor

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Graduated Rate Estate

• Applicable for a maximum of 36 months after death

• For deaths occurring on or after January 1, 2016, estate can enjoy benefits for full 36 months

• For death occurring before January 1, 2016, more limited

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Graduated Rate Estate (con’d)

• Why the distinction?

• Prior to proposed changes, testamentary trusts enjoyed graduated income tax rates (like individuals)

• After January 1, 2016, unless an estate qualifies as a Graduated Rate Estate, will be taxed at highest marginal rate (like current rules applicable to inter vivos trusts)

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Graduated Rate Estate (cont’d)

• Implications– To maximize benefits, will want to ensure gift will be

made while estate is a Graduated Rate Estate:• can use credit on deceased’s return in year of death or

previous year

• can use credit on estate return in year of gift

• carryback to previous estate return

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Valuation

• Implications– Valuation date changes from date of death to date of

transfer

– How to value gift for inclusion on terminal return?• potential need to predict future value

– Increased need for filing adjustments?• deduction carryback rules may apply

• limitations

• no interest paid on refunds for interim period

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Gifts of Publicly-Listed Securities

• No capital gain recognized on gift of shares

• Now: gift must be made by a GRE

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Conclusion

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• Questions??

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