Donor-Advised Fund: Foundations and Borrowed Assumptions
Language matters. When technical terms are borrowed from other jurisdictions, they may be imprecise, confusing, or even irrelevant in a different context.
The term “donor-advised fund” (DAF) has a very different meaning in Canada than it does in the United States. In Canada, a DAF is simply a fund that any charity (usually a foundation) may establish. A donor makes irrevocable donations to fund the account and provides non-binding advice to the charity. A DAF is not a stand-alone entity; funds in the DAF belong to the charity. In Canada, DAFs have existed since the 1950s at community foundations. In Canada, there are only foundations with DAFs, not charities that are DAFs.
In the United States, in contrast, DAFs denote a type of charity that has giving accounts and ties to a financial institution. Canada has imported the US term and, with it, debates about issues that pertain to US DAFs. These borrowed assumptions need to be examined in the Canadian legal and regulatory context.
Senate Committee
The 2019 report of the Special Senate Committee on the Charitable Sector put the spotlight on DAFs. Section 4 of part 2 of the report, while briefly distinguishing between funds and charities, consistently conflates the term DAF with foundations that have established DAFs. Although the report correctly defines DAFs, its substantive discussion seems to regard the relevant charity itself as a DAF—when, as we have mentioned, a DAF in the Canadian context is simply an account established by the charity. The report states that the “primary concerns identified were the delay in benefits being distributed to charities; a perceived lack of transparency; further concentration of assets in the hands of large charities; and the potential for conflict of interest.” The potential “solutions” discussed in the report include proposals largely borrowed from the US context, such as
applying a disbursement quota (DQ) for each DAF;
imposing a “reasonable payout term” (for example, 5 or 10 years);
delaying donation tax incentives until funds are “distributed” to a charity; and
eliminating the donation tax credit (or the parallel corporate deduction) for donations to foundations that have established DAFs.
Testimony from witnesses featured in the Senate committee report misconstrue as DAFs certain foundations that have DAFs associated with financial institutions. Underpinning the proposed solutions discussed in the report is the assumption, articulated by Professor Roger Colinvaux in a recent paper, that “DAFs are not charities but are merely financial accounts housed within an entity, the custodian sponsor.” The report also implicitly assumes that donors unilaterally control grants from DAFs, and that DAFs with long-term purposes are less legitimate endowments than other charities.
The Senate committee did not adopt the above-noted “solutions.” It did, however, recommend the consideration of measures to ensure “that donations do not languish in donor-advised funds, but are instead used to fund charitable activities in a timely fashion.” This recommendation is combined with one that is focused on the DQ.
The issues that the report identifies have relevance in Canada, but the recommendations are premised on foreign circumstances. Not surprisingly, no provisions in the ITA address DAFs. The legal analysis of DAFs in Canada is that they are a type of charitable fund owned by foundations that have exclusively charitable purposes and that exercise direction and control over those funds.
A recent US proposal, discussed below, would carve DAFs out of the system of registered charities and apply more stringent rules. A response more appropriate for Canada would be to focus on the responsibilities of charities that have established DAFs. These charities (usually foundations) are not bare trustees or sponsors. Each of them has a fundamental obligation to ensure that charitable property is used for charitable purposes and that the board exercises control over how those resources are managed and used.
DAFs in the United States
The US situation differs from that in Canada. The US debate stems from the success of the Fidelity Charitable Gift Fund. This fund, launched in 1991, has become the largest public granting foundation in the United States. Similar corporate-branded charitable programs have since been established in that country.
In the United States, US $121 billion in assets were held in DAFs in 2018, according to Investor Economics. Prominent US critics, such as Professor Ray Madoff of Boston College (who gave testimony before the Canadian Senate committee), have labelled as DAFs charities that have DAFs and have ties to financial institutions. These critics have suggested that donors retain control over funds after the donation. In the United States, the term “sponsoring foundation” is sometimes used to describe a charity that holds DAFs. This term implies that the charity is a bare trustee, with minimal intervention. There is a concern in the United States that the financial firm that sponsors the “DAF charity” has a conflict of interest arising from the profit that it derives from managing investments. This may describe the US reality.
The US debate culminated in a law proposed in June 2021, known as the Accelerating Charitable Efforts (ACE) Act. This proposal was introduced in Congress, but, as of this writing, it has not been passed into law and may never be. The ACE Act proposes limitations on advisory privileges to DAFs; these limitations would be based on a choice made by the donor at the time of the gift. A donor’s advisory privileges would last for 15 or 50 years (depending on the precise circumstances), during which period the donor would provide advice and complete the gift. Where the applicable period is 50 years, the donor would be denied an upfront donation tax deduction or credit. The ACE Act would also create four types of DAFs, with each type subject to different donation tax treatment. In addition, distinctions would be made between DAF charities on the basis of the types of DAFs they hold. Community foundation DAFs fare better than charities associated with financial institutions under the ACE Act.
Canadian Context
In Canada, there are approximately 250 registered charities, primarily public foundations, that have established DAFs. In 2018, total assets held in DAFs were estimated to be approximately $5.7 billion. In a recent report, Investor Economics said that 18 foundations had ties to financial institutions, that these foundations accounted for approximately 37.5 percent of total assets held in DAFs in 2018, and that this percentage was growing.
In another report, Philanthropic Foundations Canada found that in 2018, Canadian private foundations had total assets of approximately $56.3 billion, and public foundations held $35.6 billion. Canadian universities held more than $20 billion in endowments in 2020-21, according to public reporting. The $5.7 billion held by foundations with DAFs represents a small portion of the overall mix of registered charities with significant investment assets, and they are a heterogenous group.
As noted above, DAFs are not stand-alone entities. They have no rights or features independent from those of the foundations that established them. Nor are they standardized products. Foundations with DAFs have various policies and missions. The community foundation movement, for example, emphasizes perpetual endowments. Other foundations have a range of approved fund mandates, including short-term, spend-down, flexible granting, and perpetual mandates.
Not all DAF donors provide active granting advice. Some foundations with DAFs receive up to 50 percent of their annual donation revenue from estate donations. Many have well-developed discretionary granting systems that address the absence of a living grant adviser. Finally, some foundations with DAFs have charitable purposes that enable activities such as community-based scholarship programs.
The purported mischief of funds “languishing” in Canadian DAFs, as identified by the Senate committee, is in my view questionable. The word “languish” is provocative, especially in the context of charity and trust law. Charitable endowments are recognized in trust law as serving long-term or perpetual purposes, and this requires capital to be protected so that it can assist future beneficiaries. Charitable funds have immediate and long-term mandates, and in law they are equally valid. This is a fundamental feature of charity law that underpins the ITA. Foundations with DAFs grant to a much broader cross-section of registered charities than do endowments at large institutional charities, such as universities.
DAFs Should Pay Out Annually Subject to Some Flexibility
Despite the fundamental role of long-term charitable funds, it is reasonable, in my view, to require DAFs to grant annually at a minimum payout rate that is tied to the DQ in most circumstances, subject to some flexibility, as discussed below. Any such requirement, in any event, should be imposed not by the ITA but by the foundation that holds the DAF.
Donors’ rights are merely advisory, and of course neither the donor nor the donor’s adviser owns the funds in the DAF. A donor cannot prevent a fund from granting. A requirement of minimum annual grant amounts by each DAF is a basic policy of most Canadian foundations with DAFs. These policies stem from the ITA requirement that a charity’s purposes be “exclusively charitable” and from the board’s obligation to exercise “direction and control” over charitable resources.
I would nonetheless consider it imprudent to require all DAFs to grant a stipulated minimum amount each and every year. There are legitimate reasons to provide more flexibility. For example, a grant for a capital project at a charitable organization may be delayed two years, but the ultimate grant may be greater than the accumulated DQ minimums. Alternatively, a fund may temporarily hold illiquid property. Current regulations under the ITA already provide charities with flexibility in determining fair market values when they are determining compliance with the DQ; for example, the regulations contemplate the ability to hold certain types of illiquid charitable property.
From my experience in working at hospital foundations and at a major university, I am aware that not all restricted or endowment funds are used annually. Charities, including foundations with DAFs, need to have the discretion to manage charitable property prudently in order to advance their charitable purposes.
Recommendations
For the reasons discussed in this article, any reform of the provisions related to DAFs should recognize the differences between the Canadian and US contexts.
That said, I do believe some changes are warranted, and I would recommend the following:
The CRA’s Charities Directorate should publish administrative guidance on foundations with DAFs. As with other administrative policies, the directorate should outline its interpretation of charity law, obligations, and best practices. The guidance should also address CRA audits.
Foundations with DAFs should publish “best practices” to help educate boards, donors, and regulators.
The CRA should conduct an audit program of the major foundations with DAFs. These charities are few, and large in value. A key challenge is to ensure that suppliers, including affiliated financial institutions and investment advisers, do not receive undue private benefit through the mispricing of contracts or through other means.
The government should consider raising the annual DQ rate in the ITA to no more than 5 percent for all charities with investible assets. This would set a bar that individual foundations might also apply at the DAF level, subject to some flexibility.
Foundations with DAFs are a fast-growing part of the charitable sector. In my view, there is no crisis of rampant private benefit, languishing funds, or reduced public benefit. Enhanced regulatory checks and balances are needed in Canada, but we should resist the temptation to borrow either US rhetoric or that country’s complex tax policy. Solutions to any perceived issues should be made in Canada.