Tax changes in the 2015 Federal Budget may bring real value and a level playing field for investments under the stewardship of a charity, making it easier for the good work they do to have a more immediate impact on pressing social and economic needs in Canada. Specifically, registered charities may now hold an interest as high as 20% in a limited partnership, which provides a new diversification opportunity in portfolio management.
Prior to the budget, charitable organizations and public (not private) foundations could engage in business-like activities, as long as they qualified as a related business, linked but subordinate to the main purposes of the charity, and run substantially by volunteers.
Further, investment activities themselves have not been considered “business activities,” but rather an “administrative function” under current law. But a charity that held an interest in a partnership had been considered to be carrying on a business, with the result that few registered charities were able to hold an interest in a limited partnership.
The new rules have relaxed, but restricted, this exception for charities. Specifically, the following criteria must be in place to qualify for investments in a limited partnership:
- Limited Liability: As a member of a partnership the liability of the charity is limited under any law governing the partnership arrangement.
- Limited Interest: The charity and all non-arm’s length entities may hold only 20% or less of the total interests in the limited partnership.
- Deeming Rule: In addition, to determine this ownership percentage, the fair market value of each member’s interest in the partnerships must be compared to the fair market value of all interests in the partnership. These rules are similar to those governing interests held by private foundations.
- Non-Arm’s Length Relationships: The charity must deal at arm’s length with each general partner of the limited partnership.
- CAAAs: Investments in limited partnerships by registered Canadian amateur athletic associations will also qualify under these rules.
Other rules of note: Programs remain charitable as long as they enable the two essential characteristics of charity—altruism and public benefit. If these two elements are lost, then the activities become business activities.
According to Policy Statement CPS-019, business activities are defined as commercial activities carried on by entity on a regular or continuous basis. Charities can carry on certain business-like activities, provided they are not conducted on a regular or continuous basis, although, by CRA’s own admission, the rules are unclear on the matter. They cite a one-time sponsorship as an example of a non-business activity, but “making sales or providing services on a regular daily or even weekly basis, with the operation requiring ongoing care and attention, would likely be viewed as ‘carrying on’ a business.”
Under the new rules in the Income Tax Act, a registered charity will not be considered to be carrying on a business solely because it acquires or holds an interest in a limited partnership. These rules apply for investments in limited partnerships made or acquired on or after Budget Day.