Part One : Charities Act 2005 Modernisation

As previously advised the long awaited post implementation review of the Charities Act 2005 is now occurring.  We look at what and why and provide some initial observations on the scope of this review.

Background

The Charities Act 2005 was a significant piece of legislation when it was enacted.  It essentially introduced the regulation of charities in New Zealand.   To be honest, prior to that there hadn’t been much.  While most people don’t get up in the morning and say; “Hey, I want more regulation in my life”, we suggest it is also fair to say that most thinking people when they looked at the stated purposes of the 2005 Act saw them as sensible and appropriate to help protect this very important sector in New Zealand. 

Those purposes, found in section 3 of the Act, are:

  1. to promote public trust and confidence in the charitable sector:
  2. to encourage and promote the effective use of charitable resources:
  3. to provide for the registration of societies, institutions, and trustees of trusts as charitable entities:
  4. to require charitable entities and certain other persons to comply with certain obligations:
  5. to provide for the Board to make decisions about the registration and deregistration of charitable entities and to meet requirements imposed in relation to those functions:
  6. to provide for the chief executive to carry out functions under this Act and to meet requirements imposed in relation to those functions.

 

Charities receive public support and a considerable public benefit.  This is in terms of their ongoing support from the general public, financial and otherwise, as well as an income tax exemption granted by the Government on the public’s behalf.   However public support only exists if there is public trust and confidence in the charitable sector.  Hence regulation plays an important role in protecting this public benefit for the good of our society.

Since its implementation there has been a huge work effort, firstly by the Charities Commission, and then by DIA Charities Services once the Commission was disestablished, to get the Charities Register up and running, and then get all charities registered.  In your authors’ view they have also done a good job in awareness raising and education around important changes in the sector such as the introduction of new financial reporting requirements for registered charities.  These two actions have significantly improved the transparency of our charities sector in New Zealand, and hence hopefully the ongoing support of it.   

Scope of the Review

It’s been a long time coming but its finally here.  As such, a bouquet needs to be given to the current Government, and specifically the Minister for the Community and Voluntary Sector the Hon Peeni Henare, for commencing this promised review. 

The Charities Act 2005 is legislation that primarily provides for a registration, reporting and monitoring system for charities.   This legislation was modified back in 2012 when the party responsible for administering the Act and acting as regulator was moved from what was a specific Autonomous Crown Entity, (the Charities Commission) to the Department of Internal Affairs (DIA).

The stated intention of the review is to ensure that “…the Act is fit for purpose and suits the different needs of New Zealand’s diverse charities sector.”   However, key to this intention and the review underway is to understand that this is not a complete “first principles” review of charities law in New Zealand.  What we understand as a charity in law actually dates back to 1601 and the Statute of Elizabeth in England.  This has then evolved and been modified and clarified by case law since that time.  

There has been a strong desire from some in the sector for a “first principles” review.  i.e. a deep dive consideration into what should be able to be defined as charitable in New Zealand and whether that remains appropriate in 2019.  This first principles approach is attractive to many (albeit we are reminded of the maxim; Be careful what you wish for!).  However, in our opinion for this to be done in a more independent and considered way, we’d suggest that such a first principles review may be better handled by an independent legal research body such as The Law Commission.  This is in contrast to the current review which is being carried out by the policy arm of the department that is also the regulator of charities in New Zealand, being the DIA.   

Our Opinion

While we cast no aspersions upon the good policy people at the DIA, our view is that ideally for the long-term health of charities and New Zealand Inc, a demonstrably independent view needs to be taken towards charities law in New Zealand.  Charities exist for the long-term good of our society and as such it is preferable in our view that any significant legal reform is considered firstly independent of the Government of the day.  It should also not be hurried. 

The Minister has also made it clear that he wants this to be a pragmatic achievable review and one that gets completed in a reasonable timeframe, and certainly within this term of Government. Hence the terms of reference of this review have been carefully set to achieve these aims and consider whether there are pragmatic changes that can be made to the current legislation to improve it, rather than a wipe the table clean first principles type of review. 

We believe that the current review is a pragmatic and achievable short-term measure to see if improvements can be made and hence, we support it. Partly we hold this view because we don’t see the current system as completely broken.  Sure, there are some areas ripe for improvement, but we are fortunate that our situation in New Zealand is not, in our minds, fundamentally broken.  However, as well as the current DIA led review, we also think that a Law Commission review could be considered in future for the longer-term health of our charity sector in New Zealand. A sector whose importance to the wellbeing of us all in a compassionate society has never been more evident than in these days after the horrific Christchurch terrorist deaths. We have a collective need to get this right!

For more information about the review, discussion document and the public consultation process see the following link:   https://www.dia.govt.nz/charitiesact

Part two: Charities Act 2005 Modernisation – Issues & Thoughts 

We explore a few of the issues raised in the Charities Act 2005 Modernisation Discussion Document and provide some thoughts for your further consideration.

Additional Purposes for the Act

The Charities Act 2005 currently provides the following six purposes of the Act:

  1. to promote public trust and confidence in the charitable sector
  2. to encourage and promote the effective use of charitable resources
  3. to provide for the registration of societies, institutions, and trustees of trusts as charitable entities
  4. to require charitable entities and certain other persons to comply with certain obligations
  5. to provide for the Board to make decisions about the registration and deregistration of charitable entities and to meet requirements imposed in relation to those functions
  6. to provide for the chief executive to carry out functions under this Act and to meet requirements imposed in relation to those functions.

 

While the promotion of public trust and confidence, the encouragement and promotion of effective use of resources are noble in aim, it could be argued that these are a bit fluffy.  By contrast, the remainder of the purposes are very regulatory compliance in nature.

The discussion document floats two potential additional purposes:

To support and sustain a robust, vibrant, independent, and innovative charities sector. 

Our view:  We like this extension.  For the sector to survive and thrive into the future so that we maintain a strong cohesive social, community and environmental fabric in New Zealand the sector does need to be robust, vibrant, independent and constantly innovating.   A focus on providing practical support, such as access to resources, a hub for best practice knowledge etc would therefore be welcomed. 

However as black hat, “always consider the risks” auditor types, we do have a concern about how such a purpose may be interpreted by some. Our concern is how this purpose would be practically delivered upon by the Government and where responsibilities end.Some charities reading such a purpose may interpret that to mean that the Government is committing itself to bailing them out when they get into trouble i.e. to keep them alive and in the sector.Potentially problematic in this regard is the word “sustain”. Perhaps there could be consideration of adding the concept of “effectiveness” to the purpose to counter any “more the merrier” regardless of the cost narrative.

The fiscal reality is that the Government (or “the collective us” as we like to think of it when voting our taxpayer dollars) will never be an endless pot of money.As long as expectations are clear around how such a purpose could be delivered upon then we think this this a very useful extension, and focus for the regulator.

To promote transparency of the charities sector to donors, volunteers, beneficiaries and the public.  

Our view:  We also like this extension.  Albeit on first reading were surprised it was needed given the first purpose is to promote public trust and confidence in the charities sector.  As consumers of many financial reports and other information from charities we are huge advocates of transparency as the effective counter to misconceptions.  Hence, if being more explicit about the need for transparency and to whom allows the regulator to be more proactive in this area, then we are all for it.

Especially for this sector; Sunlight is the best disinfectant. 

Obligations of Charities

We hear complaints about compliance burden from some charities. However, compared to some types of commercial organisations that we deal with we think the impost on charities is quite minor by comparison.  Especially given the significant tax and public credibility benefits obtained by being a registered charity in New Zealand. 

We are also perplexed by some registered charities that seem to obtain no effective benefit from their income tax exempt status, or could achieve the same, as a sporting body for example, under the Income Tax Act without needing to be a registered charity.  Nor do some promote their registered charity status to any great fundraising effect.  Hence one is left wondering whether the benefits to such charities actually outweigh the costs?  Especially if they are complaining about the compliance impost.

Our view is that no-one forces an organisation to become a registered charity.  Yet some appear to complain as if they have no choice.   As with any structure and status; it should only be entered into after a rigorous and objective weighing up of the options, the pros and cons and an appropriate cost/benefit analysis.  Likewise, organisations change over time as do their purposes and hence it is also important to objectively review occasionally the existing structure to ensure it remains appropriate and fit for purpose. 

There are tickets required to any game.  If you want to play, you need to pay the ticket price.  

Reporting Requirements

New Zealand has been revolutionary worldwide in developing a suite of sector specific and size/complexity tailored financial reporting standards for not-for-profit public benefit entities.  

Our enlightened standard setters have recognised that the sector has specific requirements that differ from profit seeking commercial corporations and also that it is inappropriate to try and force a one size fits all model.  As such, the 4-tier system in place provides a “horses for courses” approach; sector appropriate standards to apply to large and complex entities at one end of the spectrum to very simple cash accounting at the other end for the very small and simple entities. 

While it may not be apparent to many in New Zealand, we are the envy of some other jurisdictions in this regard and in what we have achieved with our public reporting for New Zealand charities.  

We are aware however of challenges experienced by many charities in complying with the (now not so new) financial reporting standards.  Our observation is that these challenges are primarily the result of two factors;

  1. The transition to new standards – In a few cases this reflects a strong resistance to change. This is sometimes driven by fear of the extra transparency, such as requiring a full picture of an organisation’s resources (through the consolidation of all controlled entities) and the need to report what it has achieved (through the service performance reporting).   However generally this is an awareness, education, systems change/implementation, and transition challenge.  It is the same challenge experienced in any change of system.  It is also pain that is generally one-off and short-term in nature; or
  2. A lack of understanding, capacity and resources in some very small entities.   In our experience in assisting such entities we appreciate that some simply do not have the capacity, and ongoing assistance will always be needed.   For very small entities this assistance impost can also be disproportionate when compared to what they are achieving.

Some people complain to us that the tier 4 Simple Format Cash Reporting is too onerous.  Yet at its essence this is a record of cash in, cash out, what’s left over, and putting this into a specified format/spreadsheet.

Our view:  Transparency of financial information is critical to public trust and confidence in the sector.  Complying with consistent financial reporting standards by charities allows understandability and comparison.  It is also a quid pro quo for the considerable taxation benefit, as well as special trusted status, bestowed on registered charities by the regulator on behalf of all taxpayers.   

Our hard-line view is that if an entity finds recording money too hard; then perhaps they just shouldn’t be handling money on behalf of others.  (Tickets to the game argument).

However, we also appreciate that there are numerous micro entities registered as charities in New Zealand.  While we sometimes question the efficiency of their operations (and whether joining with others and economies of scale would not produce much greater and more effective outcomes) we also appreciate it is inappropriate in a well-functioning democracy to inhibit civil society from the ability to establish and operate new entities.

As auditors and advisors to many organisations we also appreciate and apply the concept of materiality.  That is; when does something get big enough to really worry about it?   The concept of materiality is an art and there is no perfect or “correct” answer to it.  However, with regard to micro charities, (and as much as it pains us to do it as accountants) we are coming to a view that perhaps there should be a de minimis threshold.  i.e. under which we all agree just not to care about financial reporting.  Possibly that is something like $10,000 of annual expenditure or income?   

Possible Benefits:

  • Reduced compliance impost for micro charities
  • Removing considerable assistance time by accountants, & Charities Services staff

Possible Risks:

  • Reduction in transparency allowing bad behaviour
  • Charities growing in scale and this not being apparent due to their lack of financial reporting compliance

Our thoughts above only cover a small sample of issues in the discussion document that are very worthwhile of debate. We have views on many other aspects and that’s the point – a robust democracy needs to allow a range of views to be expressed and considered hence we urge you to engage in the debate.

For more information about the review, discussion document and the public consultation process see the following link:   https://www.dia.govt.nz/charitiesact

 

Part Three: Charities Act 2005 Modernisation – Issues & Thoughts - Accumulation

We explore one of the issues raised in the Charities Act 2005 Modernisation Discussion Document and provide some thoughts for your further consideration.

Accumulation of Funds

The Appendix to the discussion document poses the following two questions to submit on in relation to the topic of accumulation of funds by charities:

  1. Should charities be required to be more transparent about their strategy for accumulating funds and spending funds on charitable purposes (e.g.for example, through a reserves policy)? Why? Why not?
  2. Should certain kinds of charities be required to distribute a certain portion of their funds each year, like in Australia?

We consider some aspects to this very important, interesting and somewhat controversial topic below.

Funding the long-term nature and objectives of charity

Typically charities are established, operated and supported by groups of people who are passionate, or at least highly motivated, to enhance societal outcomes. They are often born out of an identified need to address deeply-rooted challenges or issues, such as poverty, ill-health or disability (physical and mental), social inequity,  or other issues which marginalise sectors of our community. In recent times we have seen a growth in charities seeking to address environmental degradation.  All big and complex issues.

As such, it is uncommon for charities to be established with the anticipation of having a short life cycle. In many cases, there is an expectation that to achieve positive, lasting progress in these difficult areas will take many years, decades or, as with some charities in New Zealand that were established in the 1800’s, even centuries.

As a consequence, there is an inherent need for financial sustainability, as long as the charitable purpose continues to be a relevant one. In addition there are drivers that support the notion that a charity, in many cases, should seek growth. That is, to maximise the impact of “doing good” requires a commitment to delivering positive, relevant outcomes to a broad pool of beneficiaries. The need for relevance, wide spread of benefit and growing a critical mass that improves access to and negotiating power with funders, customers and other key stakeholders comes at a cost. This cost is the investment in people, assets, innovation and relationships with key stakeholders.  

The question is how should this investment be funded?

Our view: Charities cannot be expected to live “hand-to-mouth” each year. The uncertainty that this type of existence provides often leads to “short-termism” of thought, behaviours and action. In this environment there is little incentive or opportunity to fund innovation or growth. Short term thinking and actions also often result in less impact. As a result, there is a need for charities to consider long-term financial sustainability.

It would therefore appear logical that charities should be able to “save for the future” and hence not have to fully deplete reserves through spending or distribution each year.

Reducing the risk of not being able to operate in the event of funding cuts also drives many prudent charities to put aside some funds as a financial buffer. 

This may require a change in mindset for some in the sector, who have historically thought of accumulated surpluses being a potential red flag to funders along the lines of “we don’t need to give them financial support as they already have money”.

In reality, many major funders are seeking to fund fewer charities, but deeper and for longer, and as part of assessing their support they look for evidence that the charity is firstly achieving positive charitable outcomes and secondly showing a commitment to its financial sustainability.

Should charities be required to be more transparent about their strategy for accumulating funds and spending funds on charitable purposes (for example, through a reserves policy)? Why? Why not?

Our view:  Yes! As auditors we live by the mantra “Sunlight is the best disinfectant”.

For the vast majority of charities that accumulate reserves to allow them to deliver better outcomes in the future, there should be nothing to hide in their financial statements. If funds are being accumulated and tagged for a specific purpose (e.g. development of a new facility) then the amount of surplus transferred to a separate reserve can be clearly disclosed in the financial statements.Of critical importance though is that this should be supported with the purpose and policy in respect of the build-up of the reserve, and why, how and when it is intended to be used. Such disclosure about reserves is already a requirement in other jurisdictions, such as England and Wales.

This leads to the very important consideration of inter-generational decision-making and impact. Should we be spending today to help people now, or to what extent are we develop long-term solutions to future generations? There is no magic answer to this question, but through transparency of disclosure at least stakeholders can understand the charity’s philosophy, goals and strategy in this regard.

There is another critical aspect of transparency that has been introduced by the new accounting standards.That is, the requirement to report on the outputs delivered in a year, linked to outcomes, in the statement of service performance.

If the charity’s vision, mission and outcomes are clearly communicated, supported by reporting on outputs achieved linked to those outcomes, then the reader of the performance report has the context with which they can evaluate the financial performance and position of the charity. This includes the achievement of any surplus and the decision the charity makes around accumulation of surpluses.

The performance report is designed to give an integrated, holistic view of performance. A charity that is seen to be accumulating funds without delivering much by way of outputs, and hence not achieving outcomes, and without any other explanation as regards future plans should expect questions to be raised as to the appropriateness of their policy.

Should certain kinds of charities be required to distribute a certain portion of their funds each year, like in Australia?

Our view:  While we see the attraction in certain situations on balance we believe; No.

We have seen a few examples of charities with very large asset bases where there appears to be a ridiculously small proportion of funds applied or distributed for charitable purposes.  And with no explanation. Unfortunately this type of behaviour can taint the work of the vast majority of charities that commit themselves to trying to maximise their impact on achieving good for the wider society.

A natural reaction to the non-distribution of funds may be to force the distribution of funds through legislation or the exercising of regulatory powers.

A suggestion we have heard is that charities could be required to distribute surpluses to the extent of any equivalent tax rate. This appeals from a viewpoint of equity insofar as it means that charities distribute wealth for charitable purposes to the same level that for-profit entities pay government taxes to fund the country’s critical service portfolios such as housing, transport, justice etc.

While we can understand this argument, and believe it does have merit, (albeit it would likely keep accountants busy with the compliance and cost of taxation calculations), our view is that a mandatory distribution threshold could trigger some unhelpful behaviour and/or unintended consequences such as:

 

  • Not recognising or appropriately accommodating the significant variety of operating models of charities in the sector. 
  • A disincentive to the effective and efficient use of resources (“if we make surpluses we will just have to give them away”)
  • An incentive to manipulate financial statements to suppress surpluses and/or the value of assets controlled by entities
  • A restriction on the development of long-term innovation and growth, given the longer timeframes that it will take to build up necessary reserves for investing in innovations
  • Related to above, the unintended support for short-term thinking and behaviour
  • More reliance on external funders rather than building increased self-sufficiency
  • Potentially even charities deciding that the diminishing impact of the tax benefit means that they no longer should exist

 

In our view, New Zealand would be better served to force transparency of disclosure.  This then leaves it to stakeholders to evaluate the appropriateness of the accumulation of funds and the related distribution policy. Funders, with multiple options as to where they put their money, will no doubt take this into consideration as part of that decision-making process.

Of course there is also the power for DIA Charities Services to challenge the charitable purposes being carried out by organisations. We would expect that the level of distribution is one of the considerations in making this assessment.

Final Comment

Our thoughts above only cover some aspects of one of the issues in the discussion document, with so many others that are very worthwhile of debate. And that’s the point – a robust democracy needs to allow a range of views to be expressed and considered hence we urge you to engage in the debate.

So when considering a continuum of the appropriateness and wisdom of charities accumulating funds….. where do you sit?

For more information about the review, discussion document and the public consultation process see the following link:   https://www.dia.govt.nz/charitiesact