Non-compliance issues and how to avoid them - May 2011

Transcript

Hi. Welcome to the CRA's Non-compliance issues and how to avoid them webcast. This is a webcast that was originally aired in May of 2011. The webcast is no longer live. If you have any questions, we encourage you to call the 1-800-267-2384 Client Assistance telephone line and they'd be happy to answer any questions for you. Thank you very much and enjoy the webcast.

The first slide I would like to bring your attention to is our compliance approach. The compliance approach, first and foremost, it's the mandate of the Charities Directorate to enhance compliance with the provisions of the Income Tax Act Legislation administered by the Canada Revenue Agency. And, of course, to encourage and assist charities to comply with the requirements of the legislation through a balanced program of education, service, and responsible enforcement.

First and foremost, what we try to do is to facilitate voluntary compliance. Second, we want to assist charities comply wherever and whenever possible; and third, we're trying to enforce compliance through penalties and sanctions, whenever necessary. So, that's the compliance approach.

Moving on to our next slide, the compliance tools that we have available. General approach, in keeping with the voluntary compliance approach that I mentioned, I can tell you that all the audits that were completed in the 2009-2010 fiscal period, the majority, that is 65%, resulted in either no change required, by the charity or minor non-compliance issues that were addressed through what we call education letters.

22% resulted in something that I call compliance agreements. This is a formal agreement signed between the CRA and the charity and this agreement outlines the non-compliance issues and remedial actions the charities agree to undertake in order to get themselves back on track.

Only 6% of the audits conducted for 2009-2010 fiscal period resulted in revocation. Where an audit reveals serious non-compliance, such as serious breaches of the core requirements of the Income Tax Act or the Criminal Code or a deliberate or repeat offense, it is likely to result in revocation. And then the remaining 7% are closed for other reasons like voluntary revocation or annulment.

Moving on, then, to our next slide, this is discovering non-compliance. The non-compliance is exposed primarily through audits, the audits that we conduct. However, the Charities Directorate works closely with other areas of the CRA, including the tax centers, where there are many receding issues that are often identified. We'll talk more about the receding issues later on in the presentation. Also, you'll note that the media sometimes exposes compliance issues. Sometimes they do this knowingly. Sometimes they do this unknowingly and the CRA is able to pick up on that. We also may receive leads from the public via our Charities Compliance Division electronic mailbox. This mailbox is available on our website. So, if you wanted to log in to our website, you can log in to the charities compliance electronic mailbox and you can identify concerns that you may have and send that in to us and we do take those matters seriously.

Moving to the next slide, continuing on with discovering non-compliance, we have here, as I mentioned, I take part in the Charities Information Sessions and also at those sessions and also our toll free client assistance line, sometimes reveals areas of confusion, or misapplication of the requirements of charities. So, this is another area that we see non-compliance and that we try to address.

So, what I'm going to do in the presentation is over the next – throughout the presentation, the next slides, I'm going to go through many of the concerns or the most common concerns, or issues that we see as a result of non-compliance. These are not listed in order of severity or frequency, but these are the most common issues that we've seen throughout the sector.

So, our first set of issues that I'm going to enumerate here are, first we have donation receipts, books and records that are not complete and/or books and records that are not accurate or not complete. Failure to file the charity information return, that's the T-3010, or T-3010 errors or omission.

So, moving on to the next slide and jumping right into the first of all, our donation receipts. The Receipting deficiencies, with respect to the donation receipts, are primarily discovered through audits. Charities must abide by the rules that relate to the issuing of official donation receipts and receipts that are missing information may be disallowed. There are 15 elements generally required on the receipt and often a number of these elements are missing. If you want to know which are the elements, I encourage you -- take a look at our website. We have the various elements that are generally required on receipts and we also have, on our website, sample receipts. So if you're a charity and you're running out of receipts or looking for new receipts, we have sample receipts available on the website that have all the required elements. Generally, they're broken into gifts of cash receipts and gifts in kind receipts. The gift in kind receipt, I want to point that out, because gifts in kind is one of the concerns that we often see is fair market value. Some charities are not doing a good enough job assessing the fair market value on gifts in kind. When issuing a receipt for gifts in kind, you must be able to establish the fair market value of the item. You may also, depending on the gift, have to determine the deemed fair market value of that gift. And, so what we're trying to do here is to encourage charities to take a more active role in determining the fair market value of the items they receive and then receipt. Importantly, simply taking the donor's word or the donor's recommendation for the value of the gift -- you should try to avoid that. Charities should maintain documentation to support the fair market value that they receive and here's a really important point that I want to stress. I see this often when I'm on the road shows is if you cannot determine the fair market value of the gift, then no receipt should be issued. Okay, I'll repeat that, if you cannot determine the fair market value of the item, then no receipt should be issued. Additionally, for those of you who have been receipting for many years, you're probably aware that charities cannot issue receipt for services, as services are not tangible property, they don't qualify for a charitable tax receipt.

As regards receipting errors, there are two different financial penalties which apply. The first is incorrect information. Initially, 5% penalty will apply to the eligible amount recorded on the receipt and for subsequent infractions; a 10% penalty will apply on the eligible amount of the receipt. That is the first type that is incorrect information. The second type is false information. As regards to that, there could be 125% penalty for the recorded amount on the receipt. Those are your two penalties for receipting errors; incorrect information and false information.

Moving on to the next compliance issue which is books and records that are not complete, or not accurate or incomplete. Inadequate books and records can range from minor oversights on the part of the charity to very serious infractions, including records that are deliberately altered, destroyed, hidden or concealed in order to conceal non-compliance issues. A registered charity must keep adequate books and records in either French or English at an address located in Canada and, importantly, you must notify the CRA, the Charities Directorate of your location because in order for us to inspect the books and records, they must be located at an address here in Canada and, of course, we must therefore be aware of where the charity's address is. Failure to keep books and records may lead to suspension of tax receipting privileges.

While not all inclusive, the following list of documents that I'll give you must be maintained for charities, books and records. First, copies of official donation receipts. Second, all records concerning ten years gifts, meeting minutes of the directors, trustees or executives. Fourth, meeting minutes of the members. All governing documents and by-laws. General ledgers or other books of final entry containing summaries of year-to-year transactions and the vouchers and accounts necessary to verify those entries. Financial statements, source documents, and copies of T-3010s. Now, if I said those kind of quickly, not to worry. I'm going to refer you to our website. And on our website, it's going to have that list there. But, I just want to make people aware of that list of documents that must kept as part of the books and records at a location in Canada for the registered charity. As well, on the website, when you go there, you'll be able to verify the retention, destruction period for those books and records and as you'll be aware, when you take a look, that retention/destruction period does differ depending on the type of record requested.

Moving on to our next slide, the failure to file a charity information return. This continues to be one of our greatest compliance issues. Registered charities are required to file a T‑3010 with financial statements and applicable schedules six months from their fiscal period end. Despite several reminders to file from the CRA, that is, we do send out continual reminders to charities in order to ensure that they file a return, but despite this, almost 600 charities had their registration revoked for failure to file in a 2009-2010 fiscal period. Most of these organizations subsequently applied for re-registration. As you can imagine, that created a huge workload within the Charities Directorate. So, the issue is serious enough that we've implemented a $500 penalty applicable at the time of application for re-registration. The number of revocations for failure to file decreased as a result, for example in 2007 we had 1673 revocations due to failure to file. However, 600 charities still failing to file their T‑3010 is still a problem so we encourage you, do ensure that you have your address up to date with us so that we can send you and that you're going to receive those reminders and we do encourage you to try to get those books and records in order so that you can file your T-3010 on time with us.

Moving on to the next slide which is T-3010 errors and omissions. Following the T-3010 of course, is the first half of the battle, if you will. But submitting a T-3010 with incomplete or inaccurate information obviously diminishes the usefulness of that information provided. The public and the CRA use this information to establish the good works or to understand what good works the charity is doing. Common errors on the T-3010 that we've seen include: charities often leave the financial section of the T-3010 blank, indicating that the readers should see the attached financial statements. However, these financial statements are not posted on the website, so what you should be doing is submitting or filling out the T-3010 with the proper financial information. If you're just submitting the attached financial statements, the problem is, of course, those financial statements don't get uploaded to the website and consequently donors, when they go to our website, to check out your charity, they're not going to be able to see what monies were spent on the charity. In fact, it's going to look as though no money was spent by the charity on their charitable good works throughout the year.

Another problem that we're seeing, you'll note this on the slide, is in keeping with the financial section of the T-3010, sometimes people are confusing Section D with Schedule 6. That is on the return, there's two separate financial sections. Only fill out one of those financial sections, either Schedule 6 or Section D, not both. What has happened, is people are filling out Schedule 6, and what happens in our system is as soon as there is information uploaded about Schedule 6, it overrides and deletes all the financial information that might have been included on Section D. Consequently, the information is inaccurate.. So, that's with respect to the financial information on the T-3010.

A final point I'll make out on the T-3010 errors and omissions is Line 5000. This continues to be a concern. People are not filling out this line, so what ends up happening is on Line 5000 there is no amount included and Line 5000 is where you put how much money you spent throughout the year on your charitable programs. If there is a zero there, then it looks to the CRA, and to the donors who are consulting the website, that the charity spent no money on their charitable programs. So, we encourage you to make sure that you have an appropriate amount and include an amount on Line 5000.

So let's jump right into non-charitable activities on the next slide. These usually arise, that is the non-charitable activities usually arise as charities expand their programs and take on activities which are outside of their charitable mandate. Most often we see a mix of charitable and non-charitable activities, in which case what charities can usually do is simply eliminate the non-charitable activities and in such a way they're able to get back on track. However, it sometimes is the case that charities have completely shifted their focus and they are no longer – the organization no longer fits the requirements for a registered charity. As such, it would be – consequently, it would be revoked because it is no longer carrying on charitable programs.

A variety of reasons might account for this including, for example, the organization's evolution over time, funding problems, the changes in the service population. All of these can lead to what we're calling “Organizational Drift.” It is vital for charities to consider that when they take on a new program or when they contemplate a new program, they have to ensure that it meets the requirements for charitable registration. If you're unsure about this and you want to carry out a new program, we encourage you to call in to our 1-800 Client Assistance Line. We can review the program with you over the line, or even, you can write in to our Client Assistance Line and we can review the programme and then, that way we will be able to tell you whether or not this particular program, this particular activity meets the requirements for charitable registration. Also, you can always consult our website and you've got a list of – a whole gamut of educational resources there to let you know what is charitable and what is not. So, that's non-charitable activities.

Moving on to our next issue, this is Gifts to Non-Qualified Donees. Generally speaking, a qualified donee is other registered charities in Canada. There may be other types of organizations, or rather; there are other types of organizations that do qualify, as well. Examples would be a registered Canadian amateur athletic association or registered National Art Service Organization, or even some Universities that are outside of Canada. These Universities would be listed in Schedule 8 of the Income Tax Act Regulations. There are some other types there. For all the qualified donees, I can refer you to our T-3010 and on the T‑3010 we've got a definition of what is a qualified donee. And as well, we also have, on our website the list of qualified donees. If you're a registered Canadian charity, then you are a qualified donee and that's going to make up the vast majority of what is a considered a qualified donee. I'll point out that if an organization carrying on their programs in one of two ways, which is, they are going to be gifting to qualified donees, or, if you're not doing that, then you should be spending your money on your own resources.

Moving on to your next slide, this is Gifts to Qualified Donees. We've got some more information here for you. What we're seeing is charities are often getting into trouble in this regard because they are eager to support a worthy cause in their region and they often assume that because the cause sounds charitable that it meets the definition of a qualified donee. However, this is not always the case. Charities should avoid this where possible by understanding which organizations fit the definition of qualified donee and ensuring before they give money to an organization, that it is, in fact, a qualified donee.

Charities can also avoid trouble by not issuing receipts for or lending their registration number to other organizations. As highlighted on this slide, there are penalties as a result of gifting funds to a non-qualified donee. So, just be aware of that.

Moving on to our next issue and next slide which is Failure to Maintain Direction and Control of the Charity's Resources. When a charity is carrying out activities through an intermediary, often times this is done with an intermediary outside of Canada, but this applies equally to organizations, that is registered charities operating through intermediaries inside of Canada.

In order to remain sure that they're following all the steps, we recommend the following things be in place. For example, they should be creating a written agreement with the intermediary and implement its terms to ensure the charity is maintaining direction and control. Communicate a clear and complete and detailed description of the activities to the intermediary. Monitor and supervise the activity. Provide clear, complete, detailed, ongoing instructions to the intermediary.

For agency relationships, if this happens to be your case, make sure that you segregate the funds as well as maintain separate books and records. As well, make periodic transfers of resources based on demonstrated performance, not just one lump sum, but periodic transfers. And, of course, maintain adequate books and records at an address located in Canada.

A charity must maintain a record of its steps taken to direct and control the use of its resources in order to comply with this requirement. If they aren't doing so, then the CRA is unable to verify that all of the charity's resources are being used in its own activities. So, in short summary, a written agreement alone is not enough. An agreement along with a record of its implementation is needed. For more information about that, I'll refer you to our webinar 20 Activities Outside of Canada, also, we have our Guidance, Canadian Registered Charities Carrying on Activities Outside of Canada. In Appendix F of that Guidance, you will find a list of those items that I have just gone through. So, that's Failure to Maintain Direction and Control.

Moving on to the next issue of compliance, which is Fundraising. I should say that, from the media's perspective, this is the number one compliance issue. The amount of money spent on fundraising and the resulting amount netted by organizations tends to be a measuring stick for how well a charity is managed and whether an organization is worthy of donations by the Canadian public. While the CRA recognizes that, of course, charities have to incur reasonable administrative and fundraising expenditures in pursuit of their charitable programs, bear in mind that a fundraising expenditure is not a charitable expenditure. So, when fundraising becomes a disproportionate amount of the charity's resources relative to its charitable programs, then this, or for example, it takes on unreasonable or unacceptable fundraising, this could jeopardize the charity's status. For the ratio of fundraising expenses to revenue, it's important to consult our Guidance that has recently come out, I'd say in the last couple of years, that Guidance is CPS-028, Fundraising by Registered Charities, CPS-028, Fundraising by Registered Charities. And in that Guidance, we're going to indicate the thresholds there between how much should be spent on charitable programs versus how much can be spent on fundraising expenditures.

Moving on to the next slide to continue our information about fundraising, I just want to stress it again, that a fundraising expenditure is not a charitable expenditure. So, excessive fundraising expenses often lead to misallocation of expenses – or, sorry, misallocation of the charity's expenses in an attempt to disguise or offset the costliness of a fundraising activity. This is something that we have seen in the sector. Recently, this trend in over-valuing property received or acquired in order to, if you will, bump up the appearance of expenditures on charitable programs, this is something we've seen and it's a concern for us. The issue is serious enough that it could result in the suspension of a charity's tax receipting privileges or even its revocation. I should also mention that the same issue we have noted in the U.S. and, as well, in Australia. So, that's with respect to fundraising issues.

Let's move on to our next slide in the presentation, and these five points, these final five issues are going to comprise the last set of issues that we're going to discuss in this presentation. They are: Political Purposes and Activities, Business Activities, Transactions with Directors, Tax Shelters, and Fraudulent Donation Receipts.

So, jumping right in to Political Purposes and Activities, on the next slide. CRA usually steps up monitoring of activities of a Registered Charity during election campaigns and we will take appropriate measures if a registered charity undertakes excessive or partisan political activities. Registered charities may take part in some political activities as a way of furthering their charitable programs. However, partisan political activities, that is the direct or indirect support of or opposition to any political party or candidate, that's prohibited. That is, to repeat, some political activities are allowable. Generally, that rule is up to 10% of a charity's resources may be spent on allowable political activities, and there are some political activities which are prohibited, and these are partisan political activities. If you're looking for more information about political activities, if this is a concern for your charity or you just want more information, I'm going to refer you to our website and there you'll see our Political Activities Policy, which is CPS-022, CPS-022. And, on – there's a good breakdown on the differences between allowable political activities, partisan political activities, and what are the limits.

The next issue, then, is Business Activities. A charity can carry on limited related business activities. What is a related business activity? It is an activity that is subordinate or linked to the charity's programs or run substantially all by volunteers. That is, it's a business that is linked or subordinate to the charitable programme, or an activity run substantially all by volunteers. If the business ceases to be subordinate or linked to the charitable program, or is not run substantially all by volunteers, then this would be a contravention of the Act. This usually occurs, or we've seen this occur, with fundraising programs that start off small, but then evolve and become an end in itself. Examples of unrelated business that may have started out like this, tournaments, gaming activities, or the sale or rental of properties, are some examples that we have seen. If you're carrying on an unrelated business activity, this could lead to financial penalties or revocation, so bear that in mind. As well, if you're designated as a private foundation, this is key, there's not too many private foundations of all the charities out there, but if you're designated as a private foundation, then you are prohibited from carrying out any business activity. If you are looking for more information about this, I refer you, again to our Guidance on our website, CPS-019, CPS-019. . What is Carrying on a Business for more information about that.

Moving on to our next compliance issue, Transactions with Directors. First of all, transactions with Directors, it should be approved at the board level. Factors which should be considered when considering this type of transaction is A, is it in the best interest of the charity? And is it the best deal for the charity? As well, I should note, it's generally recommended that the Director involved in such a transaction should remove him or herself from these discussions in order to ensure that there is no undue benefits which could occur. Charities, as I mentioned about the above due benefits, they need to be careful that they aren't conferring these types of benefits because were they to do so, this, as well could lead to financial penalties or revocation.

Moving on to our next slide, what we're seeing in the sector -- the charitable sector, is some issues that become prevalent. So, we shifted our focus in recent years, the Charities Directorate has seen two issues in particular, that have become a significant concern. The first is tax shelter arrangements and fraudulent donation receipts. As a result of this concern, we've shifted our focus to look at these issues.

So, let's jump right into the first one which is tax shelter arrangements. A tax shelter gifting arrangement is, like I said, a serious concern and these arrangements are generally schemes that involve donation receipts worth three or four times the actual cash payment. As a result, charities are being exploited for their tax receipting privileges to the benefit of the promoters associated with these schemes. Little to no benefit is flowing to the charities or to the charities intended beneficiaries. So, you can see why it's a concern. In fact, generally based on some of our findings, generally only 1% is retained by the charity. That is, the advantages flowing through to the charity. The prevalence of these schemes of course is a detriment to the charity but also to the integrity of the charitable sector. Registered charities that get involved in the schemes may be suspended or revoked.

So, the next slide, we're going to talk a little bit more about the tax shelters. What we've done is in order to inform the public, the CRA has issued many fact sheets and tax alerts on the issue of tax sheltered gifting arrangements. The CRA is also publicly expressed that it intends to audit tax shelter arrangements and those registered charities involved. In most cases, the CRA has denied the gift completely which means that the donors are not even getting credit for their cash outlay. Canadian courts have also continued to confirm our position, the CRA's position, with respect to these tax schemes. As a result, there have been -- excuse me, a 75% decrease since the peak of participation in 2006. Not only in donor participation but also in the amounts donated. However, these issues continue to be concerns so we are advising charities, be cautious and you should avoid becoming involved in these types of arrangements.

And, a final note on our next slide regarding tax shelters, registered tax shelters are given tax shelter I.D. numbers by the Canada Agency. The tax shelter I.D. number, however does not legitimize these arrangements or guarantee that the donor is entitled to receive the proposed tax benefits. The I.D. numbers simply allow us here at the CRA to identify the participants, as well as the value number of the transactions entered into. To date, the CRA has reassessed more than 100,000 taxpayers and denied over 4 1/2 billion dollars in donations in respect of these tax shelter gifting arrangements. Not only may the charities face revocation, but those involved in promoting these arrangements may face monetary penalties.

So, that's the tax shelter arrangements, there's also something else that's cropping up in the sector.

I moved on to the next slide and that's Unregistered Tax Shelters. Unregistered Tax Shelters arrangements are becoming more popular as a means to kind of get under CRA's radar. Charities should, in this case, as with registered tax shelters, the same goes for unregistered tax shelters. Charities should be cautious and should avoid participating in these arrangements. We've listed a couple of tips on that slide for identifying these types of unregistered tax shelter arrangements. The first point talks about there being justified with legal opinions and the second point is that they usually involve gifts in kind, often in the forms of shares or lesser known foreign public stock exchange. So, the message here again is whether it's a registered tax shelter or an unregistered tax shelter, charities should be cautious and should avoid becoming involved in these schemes.

The next issue is Fraudulent Donation Receipts. This type of scheme works in a variety of ways. For example, a charity can be set up to sell inflated tax receipts but perform little to no charitable work. Charities fraud can also be performed with the help of unscrupulous tax preparers. This happens when registered charities sell false donation receipts to taxpayers for a commission and the taxpayers, in turn, are selling these false donation receipts to taxpayers themselves. There's a higher incidence of individuals and other organizations falsifying receipts of registered charities in recent times and that's why we've stepped up our monitoring of this particular sector. The volume of the fraudulent receipting is more difficult to measure, but we estimate that this could involve between 100,000 and 135,000 donors between the years 2004 and 2008 and more than $290 million during that time has been reassessed or denied to date. The best offense in this regard is diligence, especially in maintaining full and accurate books and records. The CRA , in order to ensure that the charity is not involved in these types of arrangements, what they could be keeping -- charities should be keeping, bank records and the receipt books in order to verify that the receipts that they are issuing are accurate.

And then, moving on to another slide, I'm just going to cover off, again this fraudulent receipting again, but we're going to talk about proof of payment. As a result of these receipting schemes, the CRA, as mentioned, is aggressively pursuing and verifying donation amounts. That is, the actual amounts on the receipts issued. You should be aware that the CRA may request proof from either the donor or the charity for the particular donation that was made. Charities may be contacted by the CRA to verify that a particular receipt was issued and to verify the amount on the donation -- or the amount of the donation. Donors may be contacted and asked to provide the receipt and other supporting documentation. Examples of this could include cancelled checks, credit card slips, statements, credit card slips or statements or bank statements. Again, the best defense for charities in this regard is diligence, especially in regarding the books and records, as I mentioned. Do ensure that you are keeping your bank records, receipt books, in order to avoid these kinds of troubles.

Thank you very much and I hope you enjoyed the webcast. If you would like more information about webinars, we encourage you to visit our Charities website, in particular, the Educational Resources for Charities section. Also, if you haven't already signed up for our electronic mailing list, we encourage you to do so. Just go to our website by selecting "Educational Resources for Charities" and then the electronic mailing list, you'll be able to register there. Once registered, we send out about one or two emails per month, and it gives you such information as future webinars that we will be holding.

If you would like more information on non-compliance issues and how to avoid them, we invite you to call our Client Assistance Line at 1-800-267-2384.