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1 MILLER THOMSON LLP Barristers & Solicitors, Patent & Trade-Mark Agents CHARITIES & NOT-FOR-PROFIT NEWSLETTER October 2005 The Charities & Not-for-Profit Newsletter is published periodically by Miller Thomson LLP's Charities & Not-for-Profit Group as a service to our clients and the broader voluntary sector. We encourage you to forward the delivering this newsletter to anyone (internal or external to your organization) who might be interested. Complimentary subscriptions are available by contacting charitieseditor@ millerthomson.com. Inside Conflict of Interest: One Director, Two Boards - The Difficulty of Serving Two Masters Gaming Funding for BC Charities and NPOs The Australian Government Tackles the Question - What is a Gift? When CRA Auditors Call, Don t be a Nice Guy Around Miller Thomson CONFLICT OF INTEREST: ONE DIRECTOR, TWO BOARDS - THE DIFFICULTY OF SERVING TWO MASTERS Hugh M. Kelly, Q.C. Toronto hkelly@millerthomson.com and Robert R. Berry Guelph rberry@millerthomson.com For a director of a corporation, a conflict of interest arises when the duty of loyalty to the best interest of the corporation compels the director in a direction that is or could be inconsistent with some other interest of the director. The more usual circumstance in which this issue arises pits the interest of the corporation against the personal interest of the director. But a conflict of interest can also arise in situations in which the director may not have an explicitly personal stake. It is not uncommon for a trade or agricultural association or an operating charity to join an umbrella trade, agricultural or charitable organization. The benefits of sharing experiences, and of presenting a common face to the public or the government, are not only well known and well documented, but are in fact one of the principal driving forces for continued participation in the umbrella organization. And equally, it is not uncommon for one of such trade or agricultural associations or operating charities to designate a person (often one of its own directors) to serve as a director of the umbrella trade, agricultural or charitable organization. Accompanying the benefits, however, are the burdens, especially for such directors, when the actual interests of the two organizations diverge. This is a practical example of the difficulty of being the servant of two competing masters, for to actively promote the best interest of one organization may necessarily be to attack the best interest of the other. As pointed out by the author in "Duties & Responsibilities of Directors of Not-For- Profit Organizations", published by the Canadian Society of Association Executives, ( 2004): A fiduciary within an organization is a person who maintains a position of trust. Where such a position exists, there is a higher standard of care. Directors of business corporations and non-share capital corporations alike are subject to common-law fiduciary obligations. The imperative of these obligations in the corporate context requires the person to act honestly and in good faith; to be

2 loyal to and to act in the best interest of the corporation; to avoid any conflict of interest; and to subordinate every personal interest to those of the corporation. (p. 17) A conflict may also arise where a person is a director of two corporations that are involved in the same transaction; the conflict occurs because the director owes a fiduciary duty to both organizations. It should be emphasized that there is nothing inherently wrong with a conflict of interest. Problems arise only when a person who has such a conflict fails to place the personal interest second, behind that of the corporation. It should also be noted that, in the case of a conflict because the person is a director of two corporations involved in the same transactions, the person may not give priority to either corporation, but must remain neutral to both. (p.20) The cardinal principle that should guide the director of two (or more) organizations where their separate interests may diverge is the obligation of neutrality, so as to avoid completely both the fact, and the appearance, of granting priority to either. The application of this principle imposes three rules: Awareness, which obliges a director to be sensitive to the potential that either the director or the other organization may have an interest in a matter coming before the board; Disclosure, which obliges a director to make known, and preferably have recorded in the minutes, the fact of the interest, and the general nature of the interest unless the disclosure of the general nature of the interest would itself breach an obligation to maintain such information in confidence; and Disinterested Review, which obliges the director with the disclosure obligation to refrain from influencing or attempting to influence the outcome of the matter disclosed, and could require a director to be physically absent during discussion and voting. (The titles for above three rules, awareness, disclosure and disinterested review, were identified in the "Guidebook for Directors of Nonprofit Corporations," 1993, prepared by the Legal Guidebook for Directors Subcommittee, Nonprofit Corporations Committee, American Bar Association; the text of the description of the obligations under the three rules is that of the authors of this article.) This principle of neutrality applies, but is not limited, to what takes place at the board and committee tables of both organizations. Perhaps less understood is that this principle of neutrality applies everywhere else with equal force. Thus, a director who has such an interest conflicting between the two organizations of which the person is a director, will not be immune from personal liability by maintaining silence only in the board or committee room, while at the same time speaking out in some other setting, such as at a business (related or otherwise) meeting, a social occasion, or a media event. Equally, such principle of neutrality applies before, during and after each board (and any relevant committee) meeting, regardless of whether the director is present when the matter is or was on the agenda. And, if the director was not present during the time when a matter was under consideration, the director must nevertheless disclose the interest (and should insist upon having the disclosure recorded in the minutes of such meeting) at the first meeting thereafter at which she/he is present. There is a related issue that often causes both confusion and difficulty for an appointee of the first board who serves as the designated director (perhaps ex officio, or on the nomination) of a second board, as, for example, the "representative" on the second board that is an umbrella board, and who "speaks for" the first board. This arises from what might be described as the "duty of loyalty" owed to a board; this duty requires a director to accept decisions validly made by such board at the conclusion of its deliberations. While such a director can, and indeed is expected to, vigorously promote the views that have been espoused by the first board, all directors must accept the decision of the majority of the directors of the second board once the vote has been taken, regardless of whether the result does or does not support the stance taken by the first board and the views promoted by the director common to both. Although such a director is free to indicate, even publicly, what views the person holds on the particular topic, he/she should not actively promote a viewpoint that is contrary to the decision made by that second board, while at the same time representing himself/herself as a director or spokesperson of the second board. He/she should make very clear that his/her views are either personal or those of the first board, and not the position of the second. Thus, this "duty of loyalty" is in many respects closely tied to the principle of neutrality noted earlier. 2

3 The current trend for greater accountability of directors in the commercial world of business corporations will inevitably flow, if indeed it has not already done so, into the world of not-for-profit organizations. Directors who serve on the boards of two not-for-profit organizations (and those others who are the representatives of one board as directors on another board) should deliberately make themselves more conscious of the potential exposure they face when the two organizations have an interest in the same matter, and act accordingly. The penalties can be quite uncomfortable, not only for the director who could possibly face civil or quasi-criminal penalties, but also for one or both of the organizations which might likewise face legal consequences. Members of the Miller Thomson LLP Charities and Not-For-Profit Group are available to assist directors who may find themselves sitting on one board as representative of another, or on the boards of two or more organizations, where there are or may be divergent interests in a matter. GAMING FUNDING FOR BC CHARITIES AND NPOS Peter Jarvis Vancouver pjarvis@millerthomson.com Many charities and NPOs in British Columbia, as in other provinces, derive some or most of their operating funding from lottery or gaming sources. In BC, these activities are regulated by the Gaming Policy and Enforcement Branch (the "Branch") which was created pursuant to the Gaming Control Act (the "Act") which came into force August 19, The Branch's mandate includes maintaining the integrity of gaming in the province (including horse racing and oversight of the BC Lottery Corporation), issuing gaming event licences, allocating direct access grants, investigating complaints and conducting compliance audits. The credo of the Branch is "Know your limit, play within it!" which sums up the regulatory approach not only to gambling (or "gaming" as it is referred to in more august circles), but also how the Branch approves and administers the distribution of gaming funds to charities and NPOs. The funds administered by the Branch are significant: in 2005/06, the Province is projected to receive an estimated $900 million in net gaming revenue, of which some $137 million is slated for distribution to non-profit community organizations. These organizations are expected to raise a further $37 million through gaming events licensed by the Branch during this period. So the stakes for charities and NPOs of knowing their limit and playing within it are significant, a significance that is all the sharper given the continually increasing pressure on charitable and NPO funding. In order for an organization to qualify for gaming funds in British Columbia, it must: 1. Be an NPO whose members, officers and directors do not receive remuneration from the organization in their capacity as members, officers or directors; 2. Operate and provide programs of community benefit, that are inclusive and accessible; 3. Have a voluntary and broadly based membership; 4. Deliver programs established and maintained by volunteers; and 5. Have at least 2/3 of its board members residing in British Columbia. The director residency requirement is of particular importance to national or regional charities and NPOs that operate in BC. Three principle sources of gaming funds are: direct access grants, certificates of affiliation, and licensed gaming. Direct Access Grants Pursuant to the direct access program, an organization applies for a lump sum grant. An application may be made annually based on the organization's fiscal year, not the calendar year. The funding timelines are by sector, for example, applications for the environmental sector are between July 1 to August 31 with the 3

4 grant to be paid by November 30. In applying for a grant, it is important to emphasize the programs and benefits to the community as a whole, and not solely the members' interests. The policy behind the program is to support BC-based programs. Certificates of Affiliation These certificates grant an organization an affiliation with a commercial bingo hall whereby the organization commits volunteer time to the bingo hall in exchange for funding for their programs. Grant payments are issued monthly (which assists with budgeting) and the certificates are generally issued for a three year period. Current practical concerns are that a number of bingo halls have closed, and others do not have the revenues to support the number of current affiliations. Licensed Gaming Licensed gaming permits a licensee organization to conduct a variety of gaming events including ticket raffles, independent bingos, wheels of fortune and social occasion casinos. A separate licence is issued for each type of gaming event. A Class A licence is issued for a series of gaming events that will generate more than $20,000 in gross revenue and a Class B licence for a gaming event that will generate $20,000 or less in gross revenue. For an activity to be considered gaming it must include three elements: "consideration" which means players must pay or provide something of value; a "prize" which includes money or something of value; and "chance" which means the outcome is not determined. As an example, offering a door prize at an event might be gaming and may require a licence. Tips for Qualifying and Maintaining Funding: Practical Issues Organization: To be eligible for gaming funds, it is essential that volunteers are involved in the management and control of an organization and its programs. To encourage broad based membership, the number of voting members should be more than double the number of board members. An organization does not have to be incorporated to receive funding, but if it is incorporated then ensure that it is in good standing with the Corporate Registry. The Branch will check the standing if incorporated, the philosophy being that an organization in good standing is more likely to be well organized and adhere to the requirements and guidelines of the Branch than one which is not. Paint a clear picture: Provide a detailed description of how your program benefits the community (as opposed to the membership). The Branch supports ongoing programs, not developmental or start up situations. Also, grant funds generally must be disbursed within 12 months of receipt. However, if funds are to be accumulated and restricted for a specific purpose, then explain the reason why, as the Branch may approve retaining grant funds for a longer period. Reports and Timelines: Know which reports to file and file on time. Gaming Event Revenue Reports are due 60 days after an event licence expiry. Gaming Account Summary Reports are due 90 days after the fiscal year end of an organization. Ensure disbursements and transfers are authorized by the proper authorities. Gaming Accounts: Create a separate gaming bank account, the exclusive purpose of which is to receive, hold and disburse gaming funds. Cheques should be imprinted with the words, "Gaming Account". Ensure that the current board has properly authorized any electronic transfers or automatic debits, including specifying the purpose and maximum dollar amount to be transferred. Adhere to proper cheque signing practices which means cheques must be signed by at least two of the organization's signing officials, at least one of which must be an officer of the organization. Gaming Records: Retain gaming records for five years. Financial Statements: Ensure that gaming revenue is a separate item on the income statement and submit your financial statements annually. Summary Knowledge of the gaming guidelines and Branch policies is essential to problem free gaming funding and events in B.C. Properly administering the application for and expenditure of gaming funds will go a long way in turn to supporting a positive and difficulty free relationship with the Branch. Further information and assistance can be found at the Branch website at which provides up to date information on grant and licence guidelines and applications. Among other items, recently updated Standard Procedures for Ticket Raffles and Guidelines for Applying for a Class A or Class B Gaming Event Licence have been posted to the site. 4

5 THE AUSTRALIAN GOVERNMENT TACKLES THE QUESTION - WHAT IS A GIFT? Susan M. Manwaring Toronto smanwaring@millerthomson.com A review of a recent tax ruling published by the Australian Taxation Office Tax Ruling 2005/13 confirms that all common law jurisdictions grapple with the definition of "gift" and its meaning for purposes of giving to charitable organizations and for purposes of calculating tax receipts. A review of the ruling demonstrates that the issues that face both the Australian tax authorities and Australian donors are similar to those that Canadian tax authorities and donors address on an ongoing basis. The ruling does not attempt to define the term "gift", but again refers to the usual and normal use of the term. It also confirms that the following characteristics and features are generally considered to be required if a Court is going to find that there has been a gift: there is a transfer of the beneficial interest in property; the transfers are made voluntarily; the transfer arises by way of benefaction; and no material benefit or advantages received by the donor in return. The ruling gives a number of examples, and reviews a number of situations that clearly evidence the fact that concerns over material benefits being received by donors and inappropriate gifts to charity are issues of great concern for the Australian tax authorities in the way they are with the Canadian tax authorities. I have noted however, that the Australian tax authorities seem to have accepted the idea that a charitable organization may support and fund organizations by grant in a manner which is consistent with the organization's charitable objects but which may not be otherwise registered charities and qualified donees. It is unfortunate that our taxation policy and regulator has not been able to see the wisdom of that position. The recent amendments confirming that the Department of Finance believes that it is never appropriate for a qualified donee to support activities of non-qualified donees, even where such support is consistent with the qualified donee's objects is unfortunate. Congratulations to the Australian government for seeing the wisdom in the position they have taken. WHEN CRA AUDITORS CALL, DON'T BE A NICE GUY Arthur Drache C.M., Q.C., Toronto adrache@millerthomson.com One of the real nightmares of those who are deeply involved with charities is a letter or phone call saying that the CRA wants to conduct an audit. At best, it is an inconvenience; at worst, it may be the first step to a possible revocation of status. The first thing to accept is that the CRA auditors have the right to see most of a charity's records. There may be some technical exceptions to this rule relating to (among other things) donor records but sophisticated legal advice is necessary in order to determine what can be refused. While the auditor usually assures the charity that the review is "just routine" we believe that there is some value in having a lawyer "on call," or in some circumstances, present during the audit in case issues arise. The second thing to remember is that no matter how pleasant the auditor may be, he is not there in any friendly capacity. He or she is there to determine whether the charity is breaching the rules. One problem here, we might add, is that some of the CRA auditors are unsophisticated. For example, there is a difference between transferring funds to an agent who carries on activities abroad on behalf of a charity and a gift to an organization. The former is not a gift, but imprecise language by either or both of the auditors and the representative of the organization can create the notion that there has been a gift to a non- 5

6 qualifying donee as opposed to a transfer of resources to an agent to do work on behalf of the charity. This is just one simple example of the type of miscommunication which can arise which can lead to problems in the future. The third thing to remember is that nothing is "off the record." The auditor makes extensive notes that will include comments made by employees of the charity or others who are involved. The best general rule is to keep silent on matters which seem to have the possibility of being contentious. In particular, if the auditor suggests that a particular practice is "wrong," do not admit that this is (or may be) the case. The correct answer should normally be that you will take up the matter with your lawyer or accountant to determine if the assertion by the auditor is correct. While you should always be careful in the situation where the auditor comes to your offices, the need for caution is much greater if and when you have to respond in writing. In the normal course of event, at some stage after the audit, the CRA will write to the charity to set out what it considers to be the problem areas. If you do not hear for a while (and a year is not unheard of) do not assume that the auditor has given the organization a clean bill of health. Despite CRA public relations, they are not devoting scarce resources to find that the charity is operating exactly as the law requires. Once that letter arrives, it may point out myriad deficiencies in operations, whether real or imagined. The charity's reply has to address each and every allegation. Before that letter is sent out, it is imperative that it be reviewed by knowledgeable professional advisors. If after consultation with your professional advisors, it is found that indeed the organization has breached the rules in some way, of course it is appropriate to acknowledge this and to indicate that steps will be taken to rectify the situation. If you use this approach, it may be prudent to either request advice on the appropriate change in procedures or to suggest such changes and ask whether they will suffice. Keep in mind that if a charity agrees to a change in order to placate the CRA auditor, it is almost certain that there will be a follow-up audit to check to see whether the changes were actually made. Before the reply is prepared, it is important to understand that the charity has a right to see not only the audit report but also copies of the auditor's notes. Generally, these should be procured before a letter is written. If the letter from the CRA provides a time frame for response, this can almost always be extended pending receipt and review of the CRA's file documents from the audit. Typically, a letter will give the organization 30 days to respond. We have had cases where the "thirty day letter" from the CRA took four or five months to answer with the prior agreement of the CRA - which cannot risk appearing unreasonable without putting any potential litigation in jeopardy. Charities must be careful not to simply accept whatever the audit letter says as "gospel," to apologize and to promise to do better. Good legal or accounting advice may be that the organization is not in breach of the rules or at least that the rules may be subject to interpretation or unwritten administrative policies. Organizations should fight the temptation to try to placate the CRA in situations where the organization believes (after consultation with its advisors) that it is operating properly. The important thing is not to try to be pals with the CRA but to get the charity's position across. The reason for caution in dealing with the CRA stems from the revocation appeal process. If the situation deteriorates to the point where there is a proposed revocation and an appeal is being considered, the key point to bear in mind is that appeals do not provide an opportunity for you to clarify on a witness stand what you "really meant" in the letter you wrote, nor that the auditor misunderstood the verbal comments you made in your office. The Court will make its decision based purely on the paper that is in the file, including the audit report and the audit papers (where your comments might be included). Too often, for the sake of "reasonableness," the author of a letter takes a soft line in letters to the CRA, trying to show a level of co-operation. In any litigation which ensues, this will be used as evidence that the organization knew it was doing wrong. Of course, we are in favour of civility in dealing with the CRA but one must never forget that the auditors are not your friends and that whatever they may say, the CRA's interests are not the same as your interests. Keep all that in mind if you get the dreaded call. 6

7 AROUND MILLER THOMSON Martin Rochwerg spoke in late September on "Tax and Estate Planning for Special Need Individuals" at the annual conference of the Canadian Tax Foundation in Vancouver. In late September, Hugh Kelly presented, for the 12th consecutive year, a legal seminar to candidates enrolled in the Supervisory Officers' Qualification Program, a series of courses required for school principals and vice-principals who seek to become Supervisory Officers in Ontario schools." Susan Manwaring published "Proposed income tax amendments affect charities in a number of ways" in the Lawyers Weekly in early September. In September Robert Hayhoe presented (with Lisa Mellon of World Vision) on "Carrying Out Agency Agreements in the Field" and moderated a panel on "Advancing Religion in the Public Square" and Susan Manwaring presented on "Canadian Fundraising Laws: An Overview" at the Annual Conference of the Canadian Council of Christian Charities in Mississauga. Robert Hayhoe participated in a panel on "The Mysteries of the New Disbursement Rules Revealed?" sponsored by the Ontario Bar Association Charities and Not-for-Profit Section in September. Robert Hayhoe presented on "Canadians and Americans Working Together" at the annual conference of the IFMA in Minneapolis in September. Susan Manwaring was quoted in a Lawyers Weekly story titled "Uniform Charitable Fundraising Act may come to pass". Robert Hayhoe's article in the August issue of this Newsletter "New Compliance Obligations For Charities Issuing Large Receipts" was re-published in The Update published by the Canadian Cancer Society, Ontario Division. Arthur Drache published "Foreign charity begins at home: Give to funds set up by Canadian agencies if you want tax relief" in the National Post in September. Arthur Drache published "Receipting Volunteer Expenses" and Robert Hayhoe published "Gifts to U.S. Religious Schools" in the Canadian Taxpayer in late September. Susan Manwaring published "Charitable Split Receipts et al." In the September issue of Canadian Tax Highlights published by the Canadian Tax Foundation. The September 2005 issue of Canadian Not-for-Profit News contains the following articles by Arthur Drache: "Umbrella Organization Discussion Document Now Available", "Definitional Differences Cause Problems", "Brits Debate Definition of Religion", "Remuneration Charitable Trustees", "Foreign Organization Both a Corporation and a Trust", "A Reminder of Responsibility", "Associating Charities" and "Non-Profits Have Filing Obligations." Dragana Sanchez Glowicki published "From the Courts: Disappointment Is Not a Reason to Sue: Graham v. Bonnycastle" in a recent issue of Info Exchange published by the The Conference for Advanced Life Underwriting. 7

8 MILLER THOMSON LLP CHARITIES & NOT-FOR-PROFIT GROUP Toronto/Markham Jennifer E. Babe Rachel L. Blumenfeld Arthur B.C. Drache, Q.C., C.M Mark R. Frederick Kathryn M. Frelick Robert J. Fuller, Q.C Eugene J.A. Gierczak, P.Eng Robert B. Hayhoe Hugh M. Kelly, Q.C Jacqueline L. King Peter D. Lauwers Susan M. Manwaring Nora F. Osbaldeston Rosanne T. Rocchi Martin J. Rochwerg Brenda Taylor (Corp. Services) Steven L. Wesfield Michael J. Wren Vancouver Sandra L. Enticknap Martin N. Gifford Alan A. Hobkirk Peter M. Jarvis Eve C. Munro Donald H. Risk, Q.C Calgary William J. Fowlis Sandra M. Mah Gregory P. Shannon Edmonton Bruce N. Geiger Dragana Sanchez-Glowicki Waterloo-Wellington Frank O. Brewster Stephen R. Cameron Lorelei Graham John J. Griggs J. Jamieson K. Martin Richard G. Meunier, Q.C Robin-Lee A. Norris Montréal Ronald Auclair Richard Fontaine Marie-Michele Lavigne Lysane Tougas Louise Tremblay Note: This newsletter is provided as an information service to our clients and is a summary of current legal issues. These articles are not meant as legal opinions and readers are cautioned not to act on information provided in this newsletter without seeking specific legal advice with respect to their unique circumstances. Miller Thomson LLP uses your contact information to send you information on legal topics that may be of interest to you. It does not share your personal information outside the firm, except with subcontractors who have agreed to abide by its privacy policy and other rules. 8