Chipping away at charity

Government plans to raise minimum yearly distributions of charitable trusts to no less than 15 per cent of assets may backfire as returns revert to the mean, slashing the shelf-life of many funds to just a few years.

In last year's federal budget, the Treasurer announced that the government would legislate guidelines to improve the integrity of Prescribed Private Funds (PPF) and provide trustees of PPF’s with greater certainty as to their philanthropic obligations. This commitment would among other things ensure regular valuation of assets at market rates and increase the size of compulsory distributions. The Commissioner of Taxation would also be given greater powers.

In December the Treasury issued a discussion paper Integrity of PPFs. Within the paper there were numerous issues raised and several proposals are regarded by the philanthropic sector as positive. However there was one highly contentious proposal to raise the minimum annual distribution rate to 15 per cent of assets (currently 5 per cent of each gift up to the target capital limit).

Effectively the government appears to believe that because most PPFs are set up by top marginal taxpayers and have hence received a 45 per cent tax benefit, they should give away all the PPF assets during their lifetime. Many donors e.g. Warren Buffett and Bill Gates have determined that this is entirely appropriate as they wish to be around to see the impact of their charity. However there are other donors who may wish to create perpetual foundations that will deliver significant benefit to the community for generations and creating an everlasting philanthropic culture in their family.

Unfortunately the government’s timing for such a proposal could not have been worse. If this had been proposed during the midst of the longest economic boom in Australian history and a recent bull market in equities, the philanthropic sector may not have reacted so strongly. Why, because in the ten years leading up to June 2007, Growth (appropriate for a perpetual foundation) investment portfolios delivered an annual return of more than 10 per cent most of which was capital growth. Consequently paying out 15 per cent of the assets each year would not have rapidly diminished the capital of the PPF.

So let’s assume I sold a business and established a PPF in June 2007 with $5 million and in the following financial year paid out 15 per cent or $750,000. As I have children and wanted to use this PPF to build a philanthropic culture in my family with the desire that they have an involvement during their lifetime and become donors in their own right, we have a growth orientated portfolio with high level of equity exposure. By June 2008 my portfolio has fallen 20 per cent in capital terms and I’ve paid out all the income.

It’s now down to $3.25 million so the following year I pay out $487,500. By January 2009 my portfolio (down another 10 per cent in six months) is now valued at a mere $2.44 million. Sadly $1.3 million or more than 25 per cent of my original capital has been wiped out and given the current economic outlook for the next 18 months, the big losers in this will be the community and the government. Due to the high distribution rate, all the projects I could have funded over the next 20 years will now need to be funded with capital from elsewhere, perhaps including the government.

While we hope that recent synchronised falls in values across virtually every asset class will only be a one-in-a-hundred year event, we do know history repeats itself. We also have no idea how long this global recession will last nor how severe it will be. One could argue that this is precisely the time to lift the minimum distribution as the community is suffering. Whilst in the short term we agree with this preposition, the example above shows that in the long term the community will be the ultimate loser.

It is worth noting that in the US where charitable foundations have been in existence for over 100 years, the minimum distribution rate is 5 per cent of assets. This has allowed the sector to grow and enabled it to distribute $36 billion in 2007.
We would feel more comfortable with a flat minimum distribution of 5 per cent of total assets as valued at June 30 each year for the life of the PPF. This would allow donors to make long term funding commitments to community projects providing certainty for the charity and significant benefits for the community.

Fiona Archer is director of philanthropic services at First Unity

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