Establishing a Private Foundation
A private foundation is a specific type of charity commonly established by individuals or families as a vehicle for philanthropic efforts.
This structure provides an effective way of both giving back to the community while at the same time maximizing control over such giving. However, these benefits come at the cost of particular restrictions and other obligations. This article provides an overview of private foundations as a vehicle for giving and addresses some key issues donors should consider before embarking on the process.
What is a private foundation?
A private foundation is one of three types of charities recognized by the Canada Revenue Agency (CRA) along with charitable organizations and public foundations. Private foundations can be established as either trusts or corporations – though the latter form is most common. Like the other types of charities, a private foundation benefits from a number of tax advantages such as automatic exemption from income tax and the ability to issue receipts to donors for income tax purposes. However, private foundations are distinguished from these other kinds of charities in two ways. First, private foundations are typically managed by related family members (working as trustees or directors) unlike charitable organizations and public foundations which generally have more than 50% of their directors, trustees or like officials dealing with each other at arm’s length. Second, private foundations typically receive more than 50% of their funding from one person or a group of related persons unlike charitable organizations and public foundations which generally receive their funding from a variety of arm’s length parties.
What are the advantages of a private foundation?
Greater control over the distribution of a gift is the primary advantage of a private foundation. This contrasts with other types of charities where donors may be excluded from determining exactly how the gift will be utilized once it is made. Similarly, private foundations allow a potential donor the means to involve other family members in the giving process unlike other kinds of charities which may place restrictions on the participation of non-arm’s length parties in directing the affairs of the charity. Finally, private foundations provide donors with greater and lasting public recognition for their giving whereas other kinds of charities may place conditions upon such recognition.
What restrictions apply to private foundations?
Unlike other kinds of charities, private foundations are prohibited from carrying on business activities even when such activities are ancillary or incidental to their charitable objectives. This restriction is specific to private foundations and prohibits them from mounting fundraising initiatives (e.g. charity golf events).
In addition, where the assets of a private foundation not directly used for charitable purposes or administration exceed $25,000, at least 3.5% of such assets must be disbursed annually. The disbursement quota is intended to ensure that private foundations are not used as investment vehicles but rather that they use their investment assets to actively pursue their intended charitable purpose(s). However, upon specific application to the CRA, a private foundation may be exempted from the disbursement quota if the accumulation of investment assets is intended for a major project or activity related to their charitable purpose (e.g. building a hospital).
Finally, private foundations are prohibited from providing funding to any entities that are not “qualified donees” as defined by the CRA. Qualified donees include other registered charities, registered amateur athletic associations, public bodies and a number of other kinds of entities devoted to accepted good works.
How are private foundations established?
Private foundations are established through a two-step process in which a legal entity is created (e.g. trust or corporation) after which it makes a successful application for charitable status with the Charities Directorate of the CRA. In reviewing an application, the Directorate will determine based primarily on the capitalization of the entity and the relationships among directors/trustees whether it qualifies as a private foundation. As mentioned, private foundations are capitalized by a single or related group of donors and are operated by a non-arm’s directors/trustees (typically family members).
As part of the application process, organizations seeking to be recognized as private foundations must meet the requirements of a charity. This means that they must have a recognized charitable purpose and demonstrate a benefit to the public. There are four recognized charitable purposes: the relief of poverty, the advancement of education, the advancement of religion and other purposes beneficial to the community. The determination of a public benefit is subject to a considerable number of rules, though generally, it requires that an organization provide a tangible benefit to the general public.
The actual CRA application consists of written responses to a series of 21 questions. Once completed, applications are reviewed by the Directorate which divides them into “simple” and “regular” applications. Simple applications are typically processed in around two months while regular applications (which often require additional information) can take up to six months.
What is required to maintain a private foundation?
To maintain its charitable status, a private foundation is required among other things to adequately maintain all books and records (particularly those pertaining to the issuance of donation receipts), file annual information returns with the CRA (T3010), ensure the completion of all filings associated with the foundation’s legal status as a corporation or trust and inform the Charities Directorate of any changes to the foundation’s mode of operation or legal structure.
If you have are interesting in establishing a private foundation or have any questions on this area, please contact Michael Otto.