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You are here: BAILII >> Databases >> The Law Commission >> Capital and Income in Trusts: Classification and Apportionment (Consultation Paper) [2004] EWLC 175(6)(6) (12 July 2004) URL: http://www.bailii.org/ew/other/EWLC/2004/175(6).html Cite as: [2004] EWLC 175(6)(6) |
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CHARITIES
6.1 As we explained in Part I, it was with regard to charities that concerns about the distinction between income and capital in trust law were first raised in Parliament.[1] Many charitable trusts have large permanent endowments but produce insufficient income to further their current charitable purposes adequately; they are, so to speak, "asset rich" but "income poor". The trustees are, however, not entitled to convert that capital into income in order to carry out the charity's purpose or purposes. This inflexibility was criticised in the debates on the Trustee Bill in the House of Lords. Lord Dahrendorf, for instance, asked,INTRODUCTION
6.2 Lord Phillips of Sudbury also supported the adoption of "total return policies", referring to the conclusion reached by a committee of the Charity Law Associationabove all, will it be possible for trustees to adopt what are called "total return policies" in which the rigid and often quite inadvisable distinction between capital and income is abandoned and to look at the total return of investments and thereby have even more freedom to benefit the purposes for which trusts are set up?[2]
6.3 The Lord Chancellor responded to these concerns by making the current reference to the Law Commission noting, however, that the Charity Commission was already conducting a consultation process on this topic and that statutory amendments to the powers of charity trustees should not be made in advance of the completion of the work of the Charity Commission. 6.4 Since the reference of this project to the Law Commission, there have been significant developments. Very shortly thereafter, the Charity Commission published further operational guidance regarding total return investment policies. Then in September 2002 the Strategy Unit of the Cabinet Office carried out a consultation on charity law reform. A draft Charities Bill to implement recommendations flowing from that consultation process has recently been published. 6.5 In this Part, we set out the problems affecting charities in this area of the law, and discuss the above developments. These problems are clearly different from those faced by private trusts in succession and therefore merit separate consideration. While the classification of trust receipts is of just as much concern to the trustees of charities as it is to the trustees of private trusts, the rationale underlying the rules of apportionment (i.e. balancing the respective interests of income and capital beneficiaries) does not translate to the context of charitable trusts. The vital concerns of trustees of permanently endowed charities relate to the expenditure of permanent endowment for current charitable purposes and the possible adoption of a total return approach to investment. 6.6 As a result of the review of charity law currently being conducted by government, it no longer seems appropriate for the Law Commission to make recommendations of its own with regard to the circumstances in which charity trustees should be entitled to distribute the charity's permanent endowment. The Government's proposed legislative changes in relation to this issue are considered below.[4] We do, however, invite views of consultees on provisional proposals relating to the authorisation of total return investment.that the balance of public interest lay in an amendment to the law… The association believes – the evidence is quite clear – that were an amendment to be made, there would be a great advantage to the charity sector because the present confinement in the management of portfolios where there is an endowed element and the inflexibility by which managers of portfolios are currently caught lead to much lower capital and income returns over a long period of time. That can be in no one's interest.[3]
THE SPECIAL POSITION OF CHARITIES WITH A PERMANENT ENDOWMENT
6.7 A charity's "endowment" has been defined as:What is a "permanent endowment"?
6.8 In essence an endowment comprises all the property held by a charity which actually produces income or has the potential to do so. It need not be held in perpetuity. It is possible for a charitable trust to have an "expendable endowment" which, in appropriate circumstances, can be distributed in furtherance of the charity's purpose.[6]All property of every description belonging to or held in trust for the charity, whether held on trusts or conditions which render it lawful to apply capital for the maintenance of the charity, or on trusts which confine the charitable application to income.[5]
6.9 By section 96(3) of the Charities Act 1993:
6.10 This definition reveals that the concept of a permanently endowed charity stretches beyond a charitable trust where capital is held in perpetuity with income alone being distributed in furtherance of its charitable purpose. If the terms of the trust impose any restriction upon the distribution of the charity's endowment it is a permanent endowment.[7] The fact that an endowment is permanent does not, however, prevent it from being converted and re-invested.[8] A charity may also hold a permanent endowment which does not actually produce income. The permanent endowment may, for instance, take the form of a capital asset which can itself be used to further the charity's purposes.[9]A charity shall be deemed for the purposes of this Act to have a permanent endowment unless all property held for the purposes of the charity may be expended for those purposes without distinction between capital and income, and in this Act "permanent endowment" means, in relation to any charity, property held subject to a restriction on its being expended for the purposes of the charity.
6.11 The concept of a permanent endowment emerged at a time of low inflation. Investment returns were predictable. There was only a small risk of investment returns unexpectedly taking the form of capital rather than income. Permanent endowments have subsequently become inconvenient as a result of inflationary pressures and low interest rates. Moreover changes to the tax system, such as the abolition of Advance Corporation Tax, have encouraged companies to capitalise rather than distribute their profits. Investments, particularly in equities, have given substantial capital returns. Many permanently endowed charities have become "asset rich" but "income poor" because capital investment returns have accrued to the endowment, and so are unavailable to further the charity's purposes. Some charity trustees have consequently been compelled to distort their investment policies and sacrifice overall economic growth in order to secure a sufficient level of income to meet the present needs of the charity's objects. 6.12 At the same time, charities are subject to the same rules for classification of corporate receipts as apply to private trusts. These rules can (for example, in the case of direct demergers) unfairly favour income over capital. Charities are forced to distribute such unexpectedly large windfalls of income to charitable purposes within a reasonable time,[10] whilst the value of the income-producing permanent endowment is dissipated. 6.13 Despite the administrative inconvenience of permanent endowments, however, they still have strong attractions to settlors. Charitable trusts provide settlors with a unique opportunity to set up a perpetual memorial. Settlors can ensure that their generosity will continue to benefit the charitable purpose of their choice for an indefinite period. In some cases, it might be the perpetual nature of the gift which encourages the settlor to make the charitable donation in the first place.The problems caused by permanent endowments
6.14 In private trusts the distinction between income and capital is of importance when different persons (or classes of persons) are entitled to income and capital. The issue for charitable trusts is rather different. There are no individual beneficiaries with rights of enforcement. Charitable trusts exist for the furtherance of one or more charitable purposes[11] for the "public benefit".[12] Individuals may of course obtain personal benefit from the carrying out of a charitable purpose, but charities are regulated and enforced by the Charity Commission and the Attorney General on behalf of the public. 6.15 Although it is possible for a charitable trust to include a gift over to a second charitable purpose this is unusual. Successive interests are generally a feature of private trusts. A charitable trust with a permanent endowment has been usefully described as a gift of income in perpetuity.[13] The capital of the trust is always kept out of arm's reach. 6.16 The beneficiaries under a private trust in succession have one concern; to maximise the value of their own interest, whether it be in income or capital. This does not translate to the charitable context. The tension is between the current and future needs of the same charitable purpose. The "beneficiary" is at all times the public (although the identity of the individuals who incidentally benefit from the carrying out of a charitable purpose may not remain constant). 6.17 The overall duty of a charity trustee is to serve the best interests of the charity's specified charitable purpose or purposes. It will almost always be possible to further the purpose of a charity through current expenditure. However, the purpose will often also stretch some way into the future.[14] We consider that all charity trustees are under a duty to consider whether the purpose of the charity is best served by current or future expenditure. In other words, even where there is no permanent endowment the trustees are not free to distribute all of the charity's assets "capriciously", without regard to potential future calls on the charity's resources.[15] 6.18 This duty is consistent with a need to protect the permanent endowment. However, it does not in itself lead to the absolute bar on expenditure of permanent endowment. Charity trustees are not entitled to dip into a permanent endowment even if the current income is insufficient to support current needs and the anticipated future needs of the charity are insignificant. The duty to preserve permanent endowment flows from the nature of the settlor's gift on terms rather than the duty to consider the present and future needs of the charity. 6.19 A settlor establishing a permanently endowed charitable trust can therefore be certain that the trustees will be precluded from distributing the permanently endowed funds (unless a statutory power to distribute permanent endowment applies[16]). The duty to consider the present and future demands of the specified charitable purpose does not necessitate such an absolute bar to distribution. When the current needs of charity are great, more public benefit may flow from distributing a significant amount of the charity's assets at one time. In other cases (where the current needs of the charity are not so great) it may be prudent to retain a greater proportion of the charity's assets for future exigencies. It is inevitable in the concept of charity that the level of demand for support will vary over time. Consider, for example, a charity which has as its purpose the provision of housing for the under-privileged. There may well be a greater need for housing following wartime destruction or a natural disaster. It is surely desirable that charities should be able to meet these pressing needs.Charitable trusts and private trusts compared
6.20 Under the current law there are limited circumstances in which a charity's permanent endowment may be distributed as income.When may a permanent endowment be distributed?
6.21 Section 75 of the Charities Act 1993 provides for the winding up of a "small" charity and distribution of its permanent endowment in limited circumstances. The section tackles the problem of permanently endowed charities which produce such little income (especially after the expenses of administration are taken into account) that they are unlikely to be able to further any charitable purpose effectively. 6.22 Section 75 is, however, of limited application. It only applies if:Winding up of small charities
(a) the charity has a permanent endowment which does not include any land;[17]
(b) the gross income of the charity in the previous financial year is not in excess of £1,000;[18]
6.23 If these conditions are met the charity trustees may, if they consider the charity's assets to be too small "in relation to its purposes, for any useful purpose to be achieved by expenditure of income alone", resolve (by at least a two-thirds majority) to distribute the charity's permanent endowment.[20] Before making a resolution under section 75 the trustees must give consideration to whether(c) the charity is neither an "exempt charity" nor a charitable company.[19]
6.24 The trustees must publicly advertise and notify the Charity Commission of their resolution.[23] The Charity Commission must approve (or disapprove) the trustees' resolution within three months of notification before the trustees can proceed.[24]a reasonable possibility exists of effecting a transfer or division of all the charity's property under section 74 [of the Charities Act 1993][21] (disregarding any such transfer or division as would, in their opinion, impose on the charity an unacceptable burden of costs).[22]
6.25 The Charity Commission has powers under section 16 of the Charities Act 1993 to establish "a scheme for administration of a charity".[25] The Charity Commission may only exercise this jurisdiction on the application of the charity or following a reference from the High Court or (provided the charity is not an "exempt charity"[26]) on the application of the Attorney General.[27] If the charity's total income does not exceed £500 per year the section 16 powers can additionally be invoked on the application of one or more of the trustees or of any person "interested" in the charity or of two or more inhabitants of an area served by a local charity.[28] If the Charity Commission is satisfied that the trustees of a charity, other than an "exempt charity",[29] ought "in the interests of the charity" to apply for a scheme but have "unreasonably refused or neglected to do so" they may proceed as if an application had been made, provided that the trustees are given an opportunity to make representations.[30] 6.26 By section 26(1) of the Charities Act 1993, the Charity Commission has jurisdiction to authorise "any action … in the administration of a charity" which is "expedient in the interests of the charity … whether or not it would otherwise be within the powers exercisable by the charity trustees in the administration of the charity".[31] 6.27 The Charity Commission's power is very broad. Section 26(5) provides:Other powers of the Charity Commission
6.28 The power is not, however, unlimited:An order under this section may authorise an act notwithstanding that it is prohibited by any of the disabling Acts[32] … or that the trusts of the charity provide for the act to be done by or under the authority of the court …
6.29 The Charity Commission's powers to authorise the spending of a charity's permanent endowment were considered by the House of Lords at the Committee stage of the Bill which later became the Charities Act 1985. The relevant exchanges in the House[34] illustrate that the provisions of the 1985 Act relating to the expenditure of capital by small permanently endowed charities (now re-enacted in sections 74 and 75 of the 1993 Act)[35] were seen as a limited incursion into the principle that a settlor should be free to set up a charitable trust with a perpetual existence. Lord Brightman described the provision as "a last resort".[36] Much of the debate focussed on how small the charity would have to be before the powers would be engaged. This might suggest that the Charities Act 1993 is not intended to give the Charity Commission any broader powers to authorise the distribution of permanent endowment than those granted by sections 74 and 75. 6.30 However, the Charity Commission currently uses its powers under sections 16 and 26 to authorise expenditure of a charity's permanent endowment when it is expedient to do so, on the condition that the capital is recouped from future income.[37] Alternatively the Charity Commission might authorise a permanent endowment to be used to meet a particular capital disbursement. It is, however, quite a different matter to allow the trustees to distribute permanently endowed capital without an obligation to replace it. This results in the permanent depletion of the charity's assets and might undermine the charity's long-term stability.[38] It is also contrary to the settlor's intention settlor that his or her charitable donation should be held in perpetuity.… but no such order shall authorise the doing of any act expressly prohibited by Act of Parliament other than the disabling Acts or by the trusts of the charity or shall extend or alter the purposes of the charity.[33]
6.31 The Strategy Unit of the Cabinet Office published a consultation document outlining possible reforms of charity law in September 2002.[39] The consultation document made several recommendations in relation to permanent endowments.[40] The Home Office's response to the Strategy Unit's consultation document approved all these proposals.[41] The Strategy Unit's recommendations on the expenditure of permanent endowment find their expression in the draft Charities Bill which (if enacted) will amend section 75 of the Charities Act 1993 and introduce two further sections whose effect would be to allow charity trustees, in prescribed circumstances, to distribute permanently endowed capital as if it were income.[42] 6.32 The proposed amendments to section 75 would allow more charities to fall within the provisions which enable "small" charities to distribute permanent endowment. The trustees of charities with annual income in excess of the £1,000 threshold would be permitted to distribute permanent endowment, provided that the value of the endowment fund does not exceed £10,000. The requirements for passing a resolution to distribute permanent endowment would also be relaxed; a simple majority of trustees would be sufficient[43] and the trustees would only need to be satisfied that "the purposes of the charity could be carried out more effectively" by the expenditure of capital as well as income.[44] The existing obligations of charity trustees to advertise the resolution publicly[45] and to obtain a notice of concurrence from the Charity Commission[46] would also be removed. 6.33 It is also proposed to add a new section 75A which would allow larger charities to distribute permanent endowment in specified circumstances. Section 75 (as amended) and section 75A would be mutually exclusive since the latter section would only be applicable if the financial condition laid down in section 75 were not met. Section 75A (like the amended section 75) would allow charity trustees, on the basis of a simple majority, to pass a resolution to distribute permanent endowment as if it were income where this would allow the purposes of the charity to be carried out "more effectively". The consent of the Charity Commission would not be required.[47] Section 75A(5)-(10) would introduce certain safeguards where the capital of the endowment fund came entirely from a particular individual or a particular institution. Broadly, these provisions would resurrect the "notice of concurrence" procedure which applies under section 75 of the Charities Act 1993 as currently enacted. The aim of these safeguards is to prevent charity trustees from subverting the settlor's intention to create a perpetual charity. Section 75A(8) would require the Charity Commission, when deciding whether to concur with the trustees' resolution, to consider the wishes of the donor as well as any changes in the circumstances relating to the charity including "its financial position, the needs of its beneficiaries, and the social, economic and legal environment in which it operates". The Charity Commission would not be permitted to concur with a resolution unless it were in keeping with "the spirit of the gift".[48] It should be noted that this is an "all-or-nothing" provision; it would not be possible to limit a resolution under this section to a particular part of the charity's permanent endowment. 6.34 The Charities Bill is currently in draft form. We therefore do not think it appropriate to comment on its provisions in this Paper. Since that part of the Lord Chancellor's reference which refers to permanently endowed charities has been largely overtaken by developments we do not propose to say anything further about this issue in this Consultation Paper.Proposed changes to the circumstances in which a permanent endowment may be distributed
6.35 There are problems with applying our provisional proposals for private trusts in their entirety to charitable trusts. As noted above, it does not really make sense to talk about the duty to balance in the context of charitable trusts.[49] Instead, charity trustees are subject to a duty to consider the present and future needs of the charity (flowing from the overriding duty to promote the best interests of the charity's objects). In the absence of the duty to balance it is neither possible nor appropriate for charity trustees to exercise the statutory power of allocation as it is framed for private trusts.THE APPLICATION OF OUR PROPOSED CLASSIFICATION AND APPORTIONMENT SCHEME FOR PRIVATE TRUSTS TO CHARITIES
We provisionally propose that charity trustees should not be subject to any duty to balance.
Do consultees agree?
We provisionally propose that the statutory power of allocation which is proposed for private trusts should not be available to charitable trusts.
Do consultees agree?
6.36 The absence of a power of allocation has a "knock-on" effect on the proposed new rules of classification. In the interests of consistency and simplicity we consider that the same rules of classification should be applicable to charities as apply to private trusts.[50] However, the new rules of classification, which we have provisionally proposed for private trusts, only give a default classification which can be displaced by exercise of the trustees' statutory power of allocation. As a result of the absence of a power of allocation, the new rules of classification would not be subject to the exercise of a statutory power or to any time limit when applied to charities.[51]We invite the views of consultees on whether the duty of charity trustees to consider the present and future needs of the charity and its objects should be placed on a statutory footing.
We provisionally propose that our proposed rules of classification for the receipts and expenses of private trusts should also apply to charitable trusts but should apply to give conclusive rather than default classifications.
6.37 Although charities are not expressly excluded from the scope of the Apportionment Act 1870 there seem to be few circumstances in which it would actually apply in practice. In the rare cases where the destination of the income of a charitable trust changes from charitable purpose A to charitable purpose B this is likely to result from the determination of the A's interest on the occurrence of a determining event. The private trust cases on protective trusts indicate that the 1870 Act has no application in this context.[52] There is no authority on the point but it also seems unlikely that the equitable rules of apportionment, which grew as practical aids to the administration of private trusts in succession, apply to charities. 6.38 As noted above,[53] the rigid technicalities of the statutory and equitable rules of apportionment have been heavily criticised and they are routinely excluded in well-drawn trust instruments, but we believe that the basis of these rules, i.e. the duty to balance, remains valid for private trusts. This rationale of the rules totally falls away in the charitable context. The draft terms of reference for this project noted that the problems of charitable trusts come from "a different kind of rigidity". That rigidity is a result of the charity trustees' inability to spend the charity's permanent endowment as if it were income.[54] The Government's proposals in relation to the distribution of permanent endowment are outlined above.[55] We now turn to consider whether investment by permanently endowed charities should be liberalised through mechanisms to permit the adoption of total return investment policies.Do consultees agree?
6.39 In 2000 the Charity Commission published a consultation document on investment by endowed charities.[56] The consultation offered three paths for the future:DEVELOPMENTS TOWARDS THE ADOPTION OF TOTAL RETURN INVESTMENT
(1) Continuation of then-current approach.
(2) Total freedom for charity trustees to spend or save capital as they please.
(3) "Total return".
6.40 The Charity Commission noted that their (at that time) current approach caused few problems for charities which have only income funds or expendable endowments. They did, however, recognise that the current rules force the trustees of permanently endowed charities to take investment decisions on the basis of the anticipated form of investment returns when they should be aiming to produce the best overall economic return. Moreover trustees' best efforts to secure a balance between income and capital may fail. The rules are most deficient when dealing with extraordinary (and thus unexpected) investment returns.[57] The rules for classification of extraordinary dividends (i.e. the rule in Bouch v Sproule) can cause problems for endowed charities (whether permanent or expendable) as a charity may find that a large proportion of its capital value must be distributed as income at one time.[58]The then-current approach
6.41 The Charity Commission rejected the possibility of giving trustees complete and unfettered freedom to distribute capital (whether permanently endowed or not) or to accumulate income.[59] They stated that this would "effectively eliminate" the duty to consider the present and future needs of the charity, and that it would not "keep faith with those that set up charities with capital funds". This would fundamentally alter the nature of permanently endowed charities. 6.42 As we have noted, the inability to spend a charity's permanent endowment does not flow from the trustee's general duty to consider the present and future needs of the charity. The issues of expenditure of permanent endowment and the balancing of present and future needs via investment returns are separable. The Charity Commission could, therefore, have given trustees "total freedom" to allocate investment returns between income and capital without regard to the possible future requirements of the charity whilst leaving the permanent endowment intact. It is submitted, however, that this approach would not have been desirable because the trustee's duty to consider the present and future needs of the charity is an important aspect of the prudent administration of charities.Total freedom
6.43 The Charity Commission favoured total return investment policies which abolish the distinction between capital and income for the purposes of distributing investment returns.[60] Such policies would allow trustees to invest with the aim of maximising economic returns without regard to their likely form. Trustees would be obliged, however, to exercise their discretion to distribute investment returns in accordance with a duty to consider the present and future needs of the charity. 6.44 The Charity Commission therefore proposed to use its powers under section 16 or section 26 of the Charities Act 1993 to authorise permanently endowed charities (on an individual basis) to allocate investment returns between income and capital, subject to the duty to take account of the charity's present and future needs.[61]Total return investment
6.45 In May 2001, the Charity Commission published some "operational guidance" regarding its policy in relation to total return.[62] This stated that authority to invest on the basis of total return may be given to charity trustees on an individual basis using the Charity Commission's powers under section 26 of the Charities Act 1993.[63] Broadly the requirements for authorisation are threefold:THE CHARITY COMMISSION'S CURRENT APPROACH TO INVESTMENT BY PERMANENTLY ENDOWED CHARITIES
(1) The charity must have a permanent capital endowment.
(2) It must be possible to distinguish between unapplied investment returns and the original gift and its accretions.
6.46 The trustees must determine how to allocate investment returns between the "trust for application" (i.e. income) and the "unapplied total return" (i.e. capital). Any returns which are allocated to the trust for application must, in accordance with the usual rules, be distributed in furtherance of the trust's charitable purposes within a reasonable time. The charity's unapplied total return may be allocated to the trust for application at any time. The trustees' decisions to allocate investment returns and/or unapplied total return to the trust for application must take account of their duty to consider the present and future needs of the charity. 6.47 The authorisation does not give the charity trustees a power to add funds which have already been allocated to the trust for application to capital. A separate power of accumulation is required to achieve this. Moreover the authorisation does not allow the expenditure of the charity's investment fund, i.e. its original permanent endowment. A separate authorisation is required for this, recognising the distinction between distributing a charity's original endowment and allocating the returns on that endowment between capital and income. This distinction was less apparent in the original consultation where the Charity Commission stated that they did not intend to undermine the principle of permanent endowment[64] but made proposals which seemed to go further and extend to the distribution of the permanently endowed capital.[65] At the same time the Charity Commission has concluded that it does have the power to authorise the expenditure of the charity's original permanent endowment. It should be noted, however, that this would ordinarily be on the basis that the expended capital should be recouped over a fixed period from future investment returns. 6.48 An order authorising total return investment will include certain directions to ensure that the present and future interests of the charity are protected. In particular there will be directions:(3) The power must be in the charity's interests.
(1) Placing a duty of care on the trustees.
(2) Imposing a duty to identify the total return.
(3) Requiring the power to be exercised in accordance with the duty to balance the present and future needs of the charity.
(4) Imposing a duty to take advice.
(5) Imposing a duty to follow the directions of the Charity Commission.
6.49 The upshot of these directions is that the trustees must establish a rational policy by which they periodically determine what proportion (if any) of the unapplied total return should be reallocated to the trust for application. This policy must take account of the need to balance the current and future needs of the charity. Relevant factors will include past and anticipated future changes in both the value of trust assets and the demands on the charity for support.(6) Imposing a duty to publicise the use of the power.
6.50 Our goal of encouraging total return investment by charities has already been adopted by the Charity Commission and has been endorsed by the Government.[66] It may nevertheless be appropriate to consider the possible advantages of enacting legislation of general application to replace the current ad hoc approach to authorising charities to invest on a total return basis. 6.51 In British Columbia legislation already permits the Vancouver and Victoria Foundations to invest and distribute their investment returns on a total return basis.[67] These non-governmental charitable foundations hold permanent endowments and distribute their investment returns to further a wide range of charitable purposes throughout British Columbia. 6.52 The legislation requires the Vancouver Foundation to distribute, at least once in each tax year, "the portion of returns that it considers proper".[68] The governing board of the foundation is statutorily obliged,[69] when exercising its dispositive powers, to develop "retention and distribution policies" which take account of:FACILITATING TOTAL RETURN INVESTMENT BY PERMANENTLY ENDOWED CHARITIES: THE WAY FORWARD
(1) the need to maintain an appropriate balance between the capital endowment and the level of annual distributions;
(2) expected investment returns;
(3) the current and potential future needs of the foundation;
(4) the level of distributions required by any applicable tax laws;
6.53 The total return provisions of the Vancouver Foundation Act apply to all property held by the Vancouver Foundation whether received before or after their enactment.[70] The provisions do not apply if the terms of a particular donation express a contrary intention.[71] No contrary intention will be manifested solely because a donation is designated as an endowment[72] or is subject to a direction "to use only 'income', or 'interest' or 'dividends, or to 'preserve capital', or [is subject to] any term or terms of similar import".[73] 6.54 The Victoria Foundation operates on a different model of total return investment. The governing board of the foundation may distribute any proportion of the annual investment returns (whether received in the form of income or capital) "for purposes consistent with the objects of the foundation".[74] This discretion is absolute[75] except insofar as the governing board must respect all terms and conditions expressed by the donor in the trust instrument governing the donation in question.[76] After the death of the donor (or the winding up of a corporate donor) the board may ignore any such terms or conditions "to the extent necessary to further the objects of the foundation".[77] 6.55 The Victoria Foundation Act goes somewhat further than the Vancouver Foundation Act insofar as it provides authority for the board to "borrow" from the permanent endowment and to distribute capital in order to further the foundation's objects.[78] This power is available where the terms of the gift in question expressly require it.[79] The power may also be exercised following a unanimous resolution of the governing board provided that:(5) any other factors which it deems to be relevant.
(1) the capital distribution does not exceed five per cent of the total endowment held by the foundation;
(2) the capital which is distributed must be replaced from investment returns unless a donation is made to the foundation for the purpose of replacing the distributed capital; and
6.56 In November 2001, the British Columbia Law Institute ("BCLI") published a report on "Total Return Investing by Trustees".[81] The BCLI recommended that any trustee who holds property on charitable trusts or as an endowment for a charitable or non-profit making organisation should be able to invest so as to maximise investment returns without regard to the form which returns might take.[82] Total return investment would be available automatically in the absence of contrary provision in the terms of the trust or legislation governing the investment of the property. These proposals would apply to all charitable trusts and endowed non-profit making organisations regardless of the date of their creation. Similar recommendations have been made by the Manitoba Law Reform Commission[83] and the Saskatchewan Law Reform Commission.[84] 6.57 In the context of our provisional proposals, the absence for charities of a statutory power of allocation (equivalent to that which we propose to make available for private trusts) means that an alternative mechanism will need to be provided if permanently endowed charities are to enjoy the advantages of total return investment. 6.58 We see three ways of allowing charitable trusts to invest on a total return basis. The first option is to maintain the current system whereby trustees of permanently endowed charities must apply to the Charity Commission for authorisation on an individual basis.[85] We do not believe that the proposal to place the existing rules of classification on a statutory footing will prevent the Charity Commission from authorising total return policies on the basis that such an authorisation would "cut across" statutory provisions. Although the rules of classification are expressed to be "conclusive" we envisage that any legislation would make clear that this classification was subject to the power of the Charity Commission to authorise investment on a total return basis. This first approach to total return investment has the benefit of focussing the minds of charity trustees on the need to maintain the value of the permanent endowment in real terms. It also allows the Commission to confirm that, for the particular charity in question, it is possible to draw a distinction between the investment returns to which the power applies and those which should be considered as accretions to the original gift. This approach notifies the Charity Commission of the trustees' intentions and also gives the trustees ready access to the Charity Commission's operational guidance. The obvious disadvantage of this approach is that, despite the best efforts of the Charity Commission to make the procedure as expeditious as possible given the inevitable complexities in this difficult area, making an individual application for authorisation may be relatively costly, time-consuming and inconvenient. 6.59 If the first option is preferred charity trustees who do not apply to the Charity Commission for total return investment powers will have no means of adjusting investment returns and expenses in cases where those returns or expenses fail to balance the current and future needs of the charitable objects. However, in exceptional cases where the rules of classification produce an illogical result the trustees would, we believe, be able to ask the Charity Commission to authorise them to restore an appropriate balance. Moreover, it may be desirable (given that some doubts have been raised about the legal basis for the authorisation of total return policies by the Charity Commission) for some legislative confirmation of the scope of the Charity Commission's powers in this area. For this reason, we invite the views of consultees on whether, should the first option be adopted, the procedure for applying for and obtaining authorisation from the Charity Commission for total return investment should be placed on a statutory footing. 6.60 The second option is to grant a general statutory power to all permanently endowed charities on similar terms to that currently granted by the Charity Commission.[86] This would have the advantage of authorising all charities to invest on a total return basis without requiring each charity to make an individual application.[87] We do not think that charity trustees would necessarily commit a breach of trust by failing to make use of this general power. Trustees would be under a duty to consider using the power but we believe that a properly considered decision not to use the power would discharge this duty.[88] The Charity Commission has already considered the fiduciary duties to which charity trustees who are authorised to invest on a total return basis are subject.[89] In particular, charity trustees are under a duty to consider the present and likely future needs of the charity before deciding what is in the best interests of the charity. We consider that any general statutory power should be subject to this duty. Moreover, in the context of permanently endowed charities it is necessary to maintain the value of the original endowment in real terms in order to give effect to the settlor's intention that the charity should have a perpetual existence. This would preclude giving trustees the power to allocate freely all investment returns between income and capital. Some of the investment returns would have to be "ring-fenced" in order to maintain the value of the endowment. 6.61 A third, and in our view the best, option is a hybrid of the first and second options. Charity trustees would be given a general statutory power to invest on a total return basis.[90] If the trustees do, however, decide to avail themselves of the power they would, on an annual basis, be required to report this decision and (even if they are not otherwise required to do so) submit the accounts of the charity to the Charity Commission.[91] This would allow the Charity Commission to monitor, scrutinise and, if appropriate, query the decisions of charity trustees investing on a total return basis. We consider that this would reduce the burden on the Charity Commission (by comparison with the system of individual authorisations envisaged in the first option) whilst retaining some control over the activities of charity trustees.(3) no further distributions of capital can be made until the distributed capital has been replaced.[80]
We provisionally propose that charity trustees should have a general statutory power to invest on a total return basis. If the trustees chose to invest on a total return basis, they would be required to report this decision and submit the charity's accounts to the Charity Commission each year.
Do consultees agree?
We invite the views of consultees on whether or not, if the current system of individual authorisations by the Charity Commission is maintained, the procedure for applying for and obtaining authorisation should be placed on a statutory footing.
Note 1 See above, paras 1.5 – 1.8. [Back] Note 2 Hansard (HL) 14 April 2000, vol 612, col 385. [Back] Note 4 See below, paras 6.31 – 6.34. [Back] Note 5 Re Clergy Orphan Corp [1894] 3 Ch 145 (CA), 150–151, per Davey LJ. [Back] Note 6 Re Gilchrist Educational Trust [1895] 1 Ch 367 (Kekewich J). [Back] Note 7 On this basis the “unapplied total return” of a charitable trust under the Charity Commission’s approach to total return investment (see below, paras 6.45 – 6.49) would be a permanent endowment because its application for charitable purposes is subject to a duty to consider the present and future needs of the charity. [Back] Note 8 In Oldham Metropolitan Borough Council v A-G [1993] Ch 210 (CA) the trustees were not obliged to retain a recreation ground, held on a permanent endowment. They were permitted to convert the property and reinvest the proceeds. [Back] Note 9 In Re Adams [1968] Ch 80 (CA), a permanently endowed gift to provide beds in a hospital was used both to buy the beds and to provide income for their maintenance. [Back] Note 10 An analogy can be drawn here with the duty of trustees of a discretionary trust to exercise their dispositive discretion within a reasonable time: Re Locker’s Settlement [1977] 1 WLR 1323 (Goulding J). [Back] Note 11 Special Commissioners of Income Tax v Pemsel [1891] AC 531 (HL). [Back] Note 12 According to the Cabinet Office’s Strategy Unit stronger emphasis should be placed on the concept of “public benefit”: Private Action, Public Benefit: A Review of Charities and the Wider Not-For-Profit Sector (September 2002) p 38–40. The Draft Charities Bill 2004 (Cm 6199) proposes to abolish any presumption of sufficient public benefit flowing from the nature of the charitable purpose in question. [Back] Note 13 Leahy v A-G of NSW [1959] AC 457 (PC), 464. [Back] Note 14 Consider, for example, a charity for the relief of poverty. It is unlikely that this purpose will be successfully achieved in the foreseeable future. [Back] Note 15 It should be noted that if the original charitable purpose is exhausted or fails the charity trustees are under an obligation to seek a cy près scheme: see Charities Act 1993, ss 13 14. Trustees cannot therefore assume that a permanently endowed charity will have no need for income in the future. [Back] Note 16 See below, paras 6.20 – 6.34. [Back] Note 17 Charities Act 1993, s 75(1)(a). [Back] Note 18 Ibid, s 75(1)(b). [Back] Note 19 Ibid, s 75(1). “Exempt charity” is defined by section 3(5) of the Charities Act 1993 as any charity listed in Schedule 2 of that Act. “Charitable company” is defined by section 75(10) as “a charity which is a company or any other body corporate”. [Back] Note 21 Section 74 allows trustees to pass a resolution to bring about the merger of two or more charities or the modification of a charity’s purposes or terms of administration. The section applies if: (1) the charity’s gross income in the previous financial year did not exceed £5,000; (2) it does not own any land “on trusts which stipulate that the land is to be used for the purposes, or any particular purposes, of the charity”; and (3) it is neither an “exempt charity” nor a charitable company (for definitions see above, n 19). There are certain considerations which the trustees are statutorily obliged to take into account before passing a resolution under the section (section 74(4)–(5)). The trustees must publicly advertise and notify the Charity Commission of their resolution (section 74(6); the Charity Commission must approve or disapprove of the trustees’ resolution within three months of notification before the trustees can proceed (section 74(8)). [Back] Note 22 Charities Act 1993, s 75(4). [Back] Note 25 Ibid, s 16(1)(a). [Back] Note 26 See definition above, n 19. [Back] Note 27 Charities Act 1993, s 16(4). [Back] Note 29 See definition above, n 19. [Back] Note 30 Charities Act 1993, s 16(6). [Back] Note 32 Section 26(6) of the Charities Act 1993 defines the “disabling Acts” as the Ecclesiastical Leases Acts 1571, 1572, 1575 and 1836. [Back] Note 33 Charities Act 1993, s 26(5). [Back] Note 34 Hansard (HL) 28 January 1985, vol 459 cols 518–526. [Back] Note 35 See above, paras 6.21 – 6.24. [Back] Note 36 Hansard (HL) 28 January 1985, vol 459, col 522. [Back] Note 37 See “CC 38 – Expenditure and Replacement of Permanent Endowment” and “OG 83 B4 – Replacing Expenditure from a Charity’s Investment Fund” (both available fromwww.charitycommission.gov.uk). [Back] Note 38 The trustees are under a duty to take account of current and future needs of the charity. The unpredictability of the investment market means, however, that even a trustee who diligently discharges the duty when spending the trust’s permanent endowment places the charity’s future at risk. [Back] Note 39 Private Action, Public Benefit – A Review of Charities and the Wider Not-For-Profit Sector (September 2002). [Back] Note 40 Ibid, p 48, paras 4.65 – 4.67. [Back] Note 41 Charities and Not-For-Profits: A Modern Legal Framework (July 2003), p 14, para 3.51. [Back] Note 42 This Paper does not consider the second new section (section 75B) which deals with the particular case of a charity which is a “special trust” and is to be treated as a separate charity. The structure of section 75B broadly matches that of the proposed section 75A: see below, para 6.33. [Back] Note 43 As opposed to the two-thirds majority of trustees required by the Charities Act 1993, s 75(3). [Back] Note 44 Under Charities Act 1993, s 75(2), the trustees could only resolve to distribute permanent endowment if they concluded that “the property of the charity is too small, in relation to its purposes, for any useful purpose to be achieved by the expenditure of income alone…” (emphasis added). [Back] Note 45 Charities Act 1993, s 75(5)(a). [Back] Note 46 Ibid, s 75(5)(b), (7), (8). [Back] Note 47 It should be noted that in this regard section 75A gives somewhat wider powers to charity trustees to distribute permanently endowed funds than were envisaged by the Strategy Unit’s original recommendations. The Strategy Unit recommended that any resolution of the trustees of a “larger charity” to distribute permanent endowment should be subject to the “notice of concurrence” procedure: see Private Action, Public Benefit – A Review of Charities and the Wider Not-For-Profit Sector (September 2002), p 48, paras 4.65 – 4.67. [Back] Note 48 See the proposed section 75A(9)(a). [Back] Note 49 See above paras 6.14 – 6.19. [Back] Note 50 See above, paras 5.3 – 5.18. [Back] Note 51 There is also no need to adopt the default classification approach in the charitable context because no adverse tax consequences flow from the reclassification of receipts or outgoings from income to capital or vice versa. [Back] Note 52 Re Sampson [1896] 1 Ch 630 (Stirling J); Re Gourju’s Will Trusts [1943] Ch 24 (Simonds J). [Back] Note 53 See above, paras 3.36 – 3.43, 3.53, 3.63, 3.81 – 3.87. [Back] Note 54 The distinction between the duty to balance and the bar on the expenditure of permanent endowment is considered above, paras 6.7 – 6.19. [Back] Note 55 See above, paras 6.31 – 6.34. [Back] Note 56 Endowed Charities – A Fresh Approach to Investment Returns? (July 2000). [Back] Note 59 Ibid, para 18 – 19. [Back] Note 61 The trustee would only be able to reallocate investment returns between income and capital if it would not prejudice the charity’s perpetual existence to do so. [Back] Note 62 See OG83; available fromwww.charitycommission.gov.uk. [Back] Note 63 The Charity Commission notes that it might need to rely on its scheme-making powers (i.e. Charities Act 1993, s 16) where the trust instrument expressly prohibits the total return approach to investment. The Charity Commission also states that the trustees would be able to give themselves the authority to invest on a total return basis if the trust instrument contained a power to amend administrative provisions. [Back] Note 64 Endowed Charities – A Fresh Approach to Investment Returns?, para 27: “…[w]e will not relax the concept of a permanent fund in ways that will undermine the primary object of a charity. Our policy in this area will need to recognise a donor’s right to create a charity that will have future as well as current beneficiaries. It will also need to take into account the volatility of investment markets.” [Back] Note 65 Endowed Charities – A Fresh Approach to Investment Returns?, Appendix C, para C2 – C3. [Back] Note 66 Private Action, Public Benefit – A Review of Charities and the Wider Not-For-Profit Sector, p 48, para 4.68. [Back] Note 67 Vancouver Foundation Act, SBC 2000, c 32, s 10; Victoria Foundation Act, SBC 2000, c 33, ss 8 9. [Back] Note 68 Vancouver Foundation Act, s 10(1). [Back] Note 72 Ibid, s 10(7)(a). [Back] Note 73 Ibid, s 107(b). [Back] Note 74 Victoria Foundation Act, s 8(1). [Back] Note 81 This paper is currently being considered by British Columbia’s Ministry of the Attorney General. No firm indications have been made concerning the prospect of legislative implementation of its proposals. [Back] Note 82 (2001) BCLI Report No 16, p 22. [Back] Note 83 Trustee Investments: The Modern Portfolio Theory (1999) MLRC Report No 101, p 32. This report is currently being considered by the Manitoban Department of Justice. There has so far been no indication as to whether or not and, if so, when legislation to enact its recommendations will be brought forward. [Back] Note 84 Proposals for Reform of the Trustees Act (2002) SLRC Report. This report is currently being reviewed by the Saskatchewan Department of Justice but, as yet, there has been no indication as to whether the proposals have been accepted. [Back] Note 85 See above, paras 6.45 – 6.49. [Back] Note 86 See above, paras 6.45 – 6.49. [Back] Note 87 The Charity Commission has no power to lay down general authorisations. [Back] Note 88 It should also be noted that the draft Charities Bill confers on the Charity Commission a power (akin to that provided to the court under section 61 of the Trustee Act 1925) to excuse charity trustees from an honest and reasonable breach of trust for which the trustee “ought fairly to be excused” from personal liability. [Back] Note 89 See above, para 6.48. [Back] Note 90 As with the second option, trustees would be under a duty to consider whether it was appropriate to make use of the power. We do not consider, however, that it would inevitably be a breach of trust not to do so. Total return investment may not be suitable for all charities therefore trustees will be able to discharge their duty through a properly considered decision not to use the power. The exculpatory powers to be conferred on the Charity Commission by the draft Charities Bill (see above, n 88) should also be noted. [Back] Note 91 Section 41 of the Charities Act 1993 obliges all charity trustees to keep “accounting records”. Section 42 requires all charity trustees to prepare an “annual statement of accounts”. However, under section 45(3) of the Charities Act 1993 only charities with a gross income or total expenditure in excess of £10,000 are required to submit an “annual report” to the Charity Commission. This “annual report” should include the statement of accounts prepared under section 42 of the Charities Act 1993. Nothing in the draft Charities Bill appears set to change this position. [Back]
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