Maintaining charitable status by complying with the disbursement quota

To maintain charitable status under tax rules, a charity is required to spend an annual minimum dollar amount on its programs or on gifts to other qualified donees, generally other registered charities. This is the disbursement quota (DQ).

The DQ applies to property not used in charitable activities or administration of the organization, and for about two decades leading up to the end of 2022 it was 3.5%. Effective January 1, 2023, the DQ is 5% on the portion of a charity’s property over $1 million, with the 3.5% rate continuing to apply below that level .

Threshold for application of the disbursement quota

The DQ only applies once non-active property exceeds a certain level, but then it is calculated on all property not used in charitable activities or administration of the organization:

• • For operating charities, the DQ applies once non-active property exceeds $100,000; or,
  • For charitable foundations (those funding operating charities or other qualified donees), the threshold is $25,000.

Purpose of the DQ

Registered charities are allowed to issue receipts to donors, who in turn may claim a tax credit for their donations. For the charity, the full amount of the donation is available to use (i.e., it pays no tax on the donation), and there is no tax on income generated by the charity on invested funds.

The DQ is the device used by the Canada Revenue Agency (CRA) to assure that the charity consistently applies a portion of its funds to its charitable purposes on a current basis, while allowing it to grow its remaining principal so that it may continue to act on its mandate into the future. To be clear, the DQ is a mandatory minimum, leaving it to the charity’s discretion to spend more if desired.

While adhering to its primary responsibility to deliver on its charitable purposes, commonly a charity will then try to keep as close as it can to the DQ. This will allow it to meet its CRA regulatory obligation, while maximizing the amount that can be invested to produce income and growth that will fund future operational needs and capital projects.

Example before and after the change

Consider a charity that has $1.5 million of property not used in charitable activities or administration.

We’ll look at the scope of property in that calculation a little further on, but for now let’s assume it’s the same amount to begin each
year in 2022 and 2023. 

DQ comparison:	2022	2023
First $1,000,000	$35,000	$35,000
Next $500,000	$17,500	$25,000
Total	$52,500	$60,000
Required extra spending resulting from 5% DQ		$7,500

Scope of affected property

For the DQ calculation, property includes real estate not used in charitable activities or administration, and passive investments such as chequing and savings accounts, inventory, stocks, bonds, mutual funds, term deposits, land and buildings.

To distinguish the treatment of real estate, take a charity operating a drop-in centre for at-risk youth on the first floor of a plaza, with rental units on the second floor and its own office in the basement. The value of the rented space would be part of the DQ calculation, but the rest of the property fits its charitable activities or administration.

Of course, investment and real estate values can fluctuate, which can then affect a charity’s spending requirements. Fortunately, valuation is not at one point in time, but instead is based on average property value over the 24 months before the beginning of each fiscal year. This smooths out the impact of short-term market movements, leading to more predictable and confident planning for the charity, and for the community it serves.

Impact on investment practices

It’s important to reiterate that the DQ change will only affect charities with property over $1 million. As well, if a charity already grants 5% or more annually, then the new rate will have no practical impact.

Still, it’s a wake-up call that CRA and other government bodies are more actively scrutinizing the activities of Canadian charities. It presents an opportunity for all charities to review, and possibly revise, one or more parts of their governance, investment management or operations. Some discussion points follow.

Spending/gifting

Where might more gifting have the greatest effect? For example, are there any worthy projects of existing grantees that could be expanded, or can you identify other/prospective grantees who are presently underserved?

Investment policy

Review the investment policy statement (IPS) to determine whether a re-draft may be in order. Should a higher priority be given to preservation of capital and consistency of returns?

Asset mix

Are there asset classes that better align with this new regulatory regime?

Alignment with values

Would an environmental, social and governance (ESG) investment approach make sense, to make a measurable impact on society generally and to better serve the charity’s own purposes specifically?

Communications

Will endowed gifts be able to keep pace in this new regime? Will donors need to be contacted? What should the message be?

Donations

Will fundraising efforts need to ramp up to help narrow any shortfall in years to come?