Registered charities have traditionally been unable to invest in limited partnership units without jeopardizing their tax-exempt status. This year, the federal government proposed changes to the Income Tax Act to allow charities to invest in limited partnerships but there are rules and restrictions that must be understood before such an investment is made.
Subject to various rules and limitations in the Income Tax Act, registered charities are able to invest in corporations by acquiring and owning shares or other securities. Many business ventures that attract charities as potential investors are structured as partnerships. These investment opportunities have traditionally been offside for registered charities because of the legal meaning of partnership.
At law, a partnership is a relationship between two or more parties that carry on business in common with a view to generating profit. This definition poses a problem for registered charities because every partner in a partnership is deemed to be carrying on the business of the partnership. This means that if a charity is a partner, it is deemed to carry on business.
To date this has been a problem because registered charities can only carry on business activities in limited circumstances. Private foundations cannot carry on any business activities at all. Charitable organizations and public foundations can only carry on business activities that are "related" to their charitable purposes. If the business activity is not so related, the charity's registration is at risk. Most businesses conducted by partnerships are unlikely to be related to a charitable purpose.
In the 2015 federal budget, the government announced that it would amend the Income Tax Act to allow registered charities (and registered Canadian amateur athletic associations ("RCAAAs") to invest in limited partnerships in certain circumstances. The draft legislation to implement these changes was released on July 31, 2015.
Section 253.1 now provides that a registered charity or RCAAA that holds an interest as a member of a partnership will not, for that reason alone, be considered to carry on the business of the partnership provided certain conditions are met, specifically:
- the partnership must be a limited partnership and the charity must be a limited partner in the partnership.
- the charity must be at arm's length with each general partner of the partnership.
- the charity, in combination with any other parties that are not arm's length to the charity, must not collectively hold interests with a fair market value of more than 20% of the total fair market value of all interests of the partnership.
The first two conditions should not create an issue in most cases. The third condition will require careful consideration at the time of the investment and ongoing due diligence. It is hoped that the Canada Revenue Agency will provide guidance as to how the 20% interest will be measured. At the time an investment is made, a charity should be able to determine that the 20% test has been met having regard to the limited partnership units that are outstanding. As currently drafted, however, the 20% test must be met at all times.
An investment in a widely-held publicly-traded limited partnership should not be problematic. If the investment is in a limited partnership where the units are not widely held, charities will need to proceed cautiously before the investment is made. The limited partnership agreement will need to be reviewed for circumstances when there can be a redemption of units. A redemption by a third party could result in a change in the charity's percentage interest in the partnership. In addition, consideration will need to be given to the charity's ability to have its units redeemed if continued investment in the limited partnership could result in a revocation of its status as a registered charity.
The draft changes are deemed to have come into force on April 21, 2015. As such, registered charities should be allowed to invest in limited partnership units now. The draft changes will not be enacted until the House of Commons convenes after the federal election in October. It is possible that there may be changes to the proposed amendments before they are enacted.
The ability of registered charities to hold limited partnership interests is a positive development for the charitable sector, creating new possibilities for investment and for social enterprise. Like all rules for charities, however, the devil is in the details and charities will need to ensure they fully understand the restrictions and obligations they take on in investing in limited partnerships.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
