To accumulate funds, or not to accumulate funds? A question for charities

It is common for many charities to set aside monies received for spending at a future date. Some charities might generate healthy surpluses and accumulate considerable funds over time. There are often good reasons for this. For instance, a charity may accumulate funds to:

  • Carry out specific or large projects

  • Reinvest the funds within the charity to deliver greater community services or

  • Establish a pool of money for future grant distribution.

In other cases, a charity may accumulate funds over many years with no clear rationale.

Charities Act 2005
The Charities Act requires that charities apply their funds to charitable purposes in order to maintain charitable status. But what does ‘apply’ mean and has a charity that has been accumulating funds, rather than spending them, ‘applied’ those funds to charitable purposes? A charity that accumulates cash to spend later can still be said to be applying those funds to charitable purposes so long as there has been an affirmative act in dealing with the funds. An ‘affirmative act’ is the result of a decision by a charity to set aside funds for a specific charitable purpose, that:

  • Is evidenced in writing

  • Is made at the appropriate level for a decision of that type and

  • Contains enough detail so that it is clear the application of those accumulated funds is for the advancement of charitable purposes within New Zealand.

  • For example, the trustees of a charitable rugby club formally resolving to set aside money in the trust’s savings account, pending a purchase of a van to transport players to and from games, is clear indication of an affirmative act with respect to using their funds.

The Charities Act does not expressly limit the extent to which a charity can accumulate its funds. However, accumulating funds over a long time presents certain risks for charities. A charity that has accumulated ‘excessive’ funds over a long period, and without clear explanation, may cause public concern that it is not using the funds for charitable purposes. The charity might have difficulty in showing that its charitable purpose is being met, which could, therefore, bring its charitable status into question. Further, accumulating funds in a business or other investment over a long time can increase the risk that charitable funds are lost if the venture fails.

Financial reporting
The New Zealand not-for-profit public benefit entity accounting standards set out the reporting requirements for accumulated funds. Tier 1-3 charities must report annually on the funds they have accumulate over their lives. They also need to state their reserves (i.e. funds set aside for a particular purpose) and must describe the restrictions or purposes for their reserves. In contrast, Tier 4 charities do not need to report on the funds they have accumulated over their lives but must report on the amount of cash they have and other resources they own. In addition, there is an obligation to continually assess and consider the use of funds for all tiers.

Other countries
Other countries have taken different approaches to accumulated funds. In England and Wales, all charities must include in their annual reports their policy on reserves, stating the level of reserves held and why they are held. The charity needs to state if it does not have a reserve policy. In Canada, charities are required to spend a minimum amount each year on their own ‘charitable programmes’ or on gifts to other charities. While closer to home, Australian private foundations that are registered private ancillary funds need to meet specific rules. If a private ancillary fund is a charity, it is required to have a minimum annual distribution of five percent of assets to charitable organisations.

Best practice
It is important for charities to be transparent about the purpose of their accumulated funds and the related spending. Charities that have, or are considering, accumulating funds in investments or setting aside cash reserves, should ensure that:

  • The decision to do so is made in writing, at the appropriate level within the charity, and with the charitable purpose for doing so clearly outlined and

  • They review how their funds are being applied, at least on an annual basis.

Moreover, best practice dictates that each charity should document a formal Reserves Policy, detailing the charity’s strategy and rationale for its accumulated funds. Such transparency helps charities demonstrate their stability and effectiveness to funders, the public and other key stakeholders. It also builds trust and confidence in the charitable sector.

Future developments
The Department of Internal Affairs is currently considering the issue of accumulated funds as part of their review and modernisation of the Charities Act. Initial discussion has hinted at the introduction of mandatory governance standards for charities. These governance standards are likely to include additional accumulated funds transparency requirements. Watch this space – mid 2020!

If you’ve got any concerns about anything above, please get in touch.