Philanthropy is the giving of time, information, goods and services, voice and influence, as well as money by individuals, families or businesses to improve the wellbeing of humanity and the community with no expectation or desire to receive anything in return. Given that Australians are currently experiencing the largest handover of inter-generational wealth in Australian history, the trend towards philanthropy is rapidly growing.
In addition to the commonly known gifts during a lifetime or gifts to established charitable foundations by Will, public or private charitable funds, a private ancillary fund (PAF) can be established at an affordable entry cost on the basis that it will be making all donations only to ATO approved deductible gift recipients (DGRs).
A PAF can be extremely beneficial in situations where, for example, you have a lump sum of money and would like to make charitable gift distribution decisions over time. A tax deduction is available on the lump sum in its entirety immediately upon making a gift to the PAF, however distribution to various charitable funds can come at a later time.
What follows is an overview of PAFs in Australia and the role of their trustees.
Private Ancillary Funds
A PAF is a fund established by trust instrument to which businesses, families and individuals can make tax deductible donations. The fund may make distributions only to other DGRs that have been either endorsed by the ATO or are listed by name in the income tax law or use them for their establishment.
Additionally, PAFs must not fundraise from the public. There must be a close relationship between the founder of a PAF and its donors. In particular, the founder and associates of the founder have to donate to the PAF at least 80% of the value of the fund in any one financial year.
The sole purpose of a PAF must be to provide money, property or benefits to funds, authorities or institutions, which are DGRs, or establish those charities.
These include public benevolent institutions, health promotion charities, overseas aid funds, organisations on the register of cultural organisations and organisations on the register of environmental organisations. A PAF cannot have other purposes.
A PAF can be controlled by an individual, family or corporate group and are generally quite easy and cost effective to establish. The use of a PAF gives the donor control over which eligible charities or causes are supported and how. The donor defines the purpose of the fund and chooses how donations are to be used.
There are generally a number of income and capital gains tax incentives associated with PAFs.
The trustee of a PAF must be a corporate entity and each its director must agree to comply with the rules in the Private Ancillary Fund Guidelines (Guidelines). At least one of the directors must be an individual with a degree of responsibility to the Australian community as a whole (Responsible Person) who is not a founder, or a donor to the PAF who has contributed more than $10,000 (major donor), or an associate of a founder or such a donor. This does not preclude a person linked to the founder by business (such as the founder’s accountant or lawyer) being the ‘responsible person’.
The Guidelines include the following example: school principals, judges, religious practitioners, solicitors, doctors, chartered or certified accountants and other professional persons, mayors, councillors, town clerks and members of parliament, persons who have received formal recognition from the Government for their services to the community (for example, an Order of Australia award). The Responsible Person must be active in the ongoing management of the fund, but there is no additional defined role beyond that of other directors.
Directors should acquaint themselves with the remuneration provision set out in the trust deed as that determines what the trustee can be paid. Where remuneration is permitted by the trust deed, the Guidelines require any trustee remuneration to be ‘reasonable’ (with the explanatory material referencing state trustee legislation and the Model Trust Deed suggesting a maximum of 1.056% of fund value — the maximum allowed under Victorian Trustee Company legislation). Where the deed is silent, only statutory trustee companies can be paid trustee fees which are governed by the provisions of the relevant state Trustee Companies Act.
PAF Trustee Duties
The trustee has the ultimate responsibility for the governance of each PAF. Directors of the trustee are accountable for directing the affairs of the fund to ensure it is well run, compliant with the law and the Guidelines, and supporting the eligible organisations for which it was established. Directors have a fiduciary responsibility to protect and prudently invest trust assets and avoid any personal conflict of interest or real possibility of conflict of interest. They must exercise their powers with integrity and good faith and show care, diligence and skill in managing the affairs of the trust.
The duty of care and responsibility is higher where a trustee’s business or profession includes being a trustee or managing investments, for instance a statutory trustee company. This is the case even if there are other co-trustees.
Directors of the trustee must act personally and not delegate or fetter trustee powers; “it is for advisers to advise and for trustees to decide” (Robert Walker J in Scott v National Trust, 1998). This does not preclude directors appointing, and paying for out of trust income, staff and or agents to do administrative tasks, prepare material or provide advice. Directors must not fetter future decision making by, for instance, entering into contracts that cannot be reviewed.
Competent administration is central to the good governance of PAFs. It includes record keeping, documenting all trustee meetings by minutes, issuing receipts, preparing annual financial accounts, claiming franking credits, lodging an annual income tax return, reporting to ASIC if the trustee is a company, submitting to the ACNC an Annual Information Statement (and, for medium and large charities, an Annual Financial Report) every year, managing grants to DGRs.
The purpose of all trusts is to manage assets for the benefit of others. In considering trust investments, the trustee must exercise ‘the care, diligence and skill that a prudent person would exercise in managing financial affairs of others’.
Each PAF must have an Investment Policy which includes the objectives of the fund. The tax exempt status of foundations (enabling the refund of franking credits) increases ceribus paribus the attractiveness of Australian shares paying franked dividends relative to other asset classes. This means for instance, consideration of the diversification benefits of investing in overseas shares or bonds needs to be balanced against the reduction in income from not getting any franking credits attached to foreign dividends.
A review of investment assets is required at least annually, examining performance of the entire portfolio and individual assets. Directors can take outside advice on investment matters, which can be paid for by the fund.
PAFs cannot run a business. Investment transaction with founder, donor, trustee, directors, employees or associates thereof must be at by way of arm’s length transactions on commercial terms, or terms more favourable to the fund.
Distribution / Grantmaking
Making distributions to eligible organisations, often called grantmaking, is therefore a core activity for every PAF. Grantmaking can range from funding organisations providing immediate relief to those afflicted by poverty, sickness etc., to advancing education or the fine arts, through to funding organisations and research projects to identify new ways to solve long term social or environmental problems.
PAFs must distribute at least 5% of the net value of the fund at 30 June during the following financial year (with a minimum annual distribution of $11,000 unless expenses of the fund are being met from outside the fund). Distributions do not include expenses of the fund but may include provision of “in kind” services; for instance, where subsidised accommodation is provided to an eligible DGR, the value of that subsidy is part of the fund’s distribution.
A charitable PAF can only fund DGR organisations with charitable purposes, i.e. for the relief of poverty, sickness or the aged, the advancement of education or religion or other purposes beneficial to the community within the terms set out in its deed.
PAFs can only distribute to ‘eligible organisations’: Determining which organisations are eligible to receive distributions is one of the trustee’s key compliance duties. As a tax deduction has been given on donations to PAFs they can only grant to organisations that are also DGRs. In effect, from the ATO’s perspective PAFs are seen as a holding vehicle in the process of donations passing from individuals to DGR entities. Many other charitable trusts are not so restricted in their distributions because donations to them are not tax deductible.
In no circumstances can PAFs distribute to other PAFs or public ancillary funds (even though they are DGR).
With the requirement for an annual audit (now also including an audit of compliance with the Guidelines) plus an information return to the ATO, PAFs are more tightly regulated than other trusts and foundations in Australia. What follows is as number of common items to consider when managing a PAF:
- Distribute to correct organisations – PAFs are only able to distribute to type 1 DGRs. While this comprises around 90% of the almost 30,000 DGRs, some funds also distribute to type 2 DGRs which are either public or private ancillary funds;
- Complete an audit of the Guidelines compliance – one of the more recent changes to PAF regulation is that the annual audit must now show compliance with the Guidelines. This is not a familiar area for all auditors;
- Submit an information return on time – these simple returns must be completed and supplied by 28 February for the previous financial year and while the audit is not required to be sent, it must be completed prior to the information return;
- Have an Investment Policy – the Guidelines (and their audit) require that a PAF has an annually reviewed Investment Policy which takes into account the objectives of the fund and its method of achieving them;
- Have appropriate investment diversity – as part of the Investment Policy, diversification of investments will be important. PAFs may have been gifted a single physical asset or one company shareholding. This needs to be diversified and some assets such as collectables are not able to be held;
- Avoid high level of expenses – PAFs can and would be expected to have costs of operation including financial management, audit costs and assistance with grant making (such as membership of PA). Although there are no legislative limits on these costs, the ATO can query the legitimacy of costs and in cases of high costs relative to distribution levels, will investigate;
- Have a succession plan for a PAF – with many PAFs in operation for over a decade now, questions of succession and planning for control and knowledge transfer are becoming more common; and
- Considering whether a PAF is still the right philanthropic vehicle – situations evolve and many have found that a PAF was not the correct structure for their needs. Therefore consider your continuing need for a PAF carefully.
Business Lawyers Sydney at Pavuk Legal can assist you on many legal aspects in relation to your philanthropic requirements including ascertaining how your philanthropic agenda is best achieved, review and advice on which vehicle is most suited to your state of affairs as well as establishing philanthropic structures to suit your needs. This should be determined by balancing out the pros and cons associated with making direct donations to an operating charity of your choice as compared to making direct donations to an existing charity. Pavuk Legal can advise you on the various range of structures and the ‘charities only’ tax concessions that are available to support your personal and philanthropic agendas.
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