I want to float a trial balloon about charitable trusts. A clause stipulating that a trust should be limited to using income for charitable purposes, meaning that capital is untouchable, should be viewed as an administrative clause and not part of the charitable objects. The charitable purposes of the trust may be perpetual, but making the trust “income only” is a historical drafting convention that no longer serves the charitable purposes. “Income only” is a scheme that is a means to an end (i.e. the charitable purpose) that is no longer serving the end.
This position may have little support in trust law, which views an “income only” clause as an inalterable direction that is integral to charitable purpose. The only way to change this clause is to make a cy-pres application to court or in Ontario to make a Section 13 application under the Charities Accounting Act that enables the Public Guardian and Trustee to issue a Consent Order. Both authorities are loathe to grant cy-pres without the trust facing an active crisis, such as prolonged failure to meet the disbursement quota when the trust is also a registered charity.
Trustees of older charitable trusts face a very practical issue. Trust law and outdated trust clauses make it difficult to ensure that there are sufficient funds to support the charitable purposes of the trust. Yields are low. Only interest and dividends may be used for both charitable purpose and administrative expenses. The charitable purposes, often named charities, suffer by receiving paltry annual distributions.
And the problem is compounded when the charitable trust is also a registered charity in Canada, which makes it subject to the disbursement quota in the Income Tax Act. The trust needs to devote a minimum of 3.5% of the average prior 24-month market value to its charitable purposes. For many years, income of 3.5% net of expenses has been very difficult to achieve. This is especially so when the trustee, mindful of being a prudent investor, has a balanced portfolio of fixed income and equity. Distributing income only means falling short of meeting the disbursement quota, which potentially means being deregistered and losing trust assets. Trustees are caught in a conflict of laws. Both can’t be met.
My view is that an “income only” clause should be viewed less as a trust fundamental and more as indication of outmoded legal thinking. The drafting convention used to achieve perpetuity in charitable trusts was to make capital sacrosanct because in a higher yield environment adequate income could be generated to ensure evenhandedness. But in the current low yield environment the benefit is skewed heavily towards the future beneficiaries.
As Edmonton lawyer Laird Hunter once told me the trust law definition of capital and income once aligned with the concepts used in the finance world, and then they diverged. In times past, trusts were fully invested in bonds or real estate and annual income was adequate to produce a healthy annual payout. Modern investment techniques can now better serve the charitable purpose of perpetual trusts if a total return methodology and fixed payout approach is adopted. This has been recognized in a number of cases in Canada, such as Re Stillman (2003), Re Killam Estate (1999) and more recently Re Fenton Estate (2014 BCSC 39). We need more such decisions and greater willingness by the Public Guardian and Trustee in Ontario to follow the direction they provide.