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Australian donors making large charitable gifts are increasingly specifying the purpose for which their donated funds can be used by the recipient charity through detailed gift agreements. As a result, these gifts with strings attached – or restricted charitable gifts – have become the predominant method of structuring large philanthropic donations. Restricted charitable gifts can be contrasted with outright gifts containing no restrictions, which provide the charity with full discretion and flexibility over the use of the donated funds.

In my recent Australian Tax Forum article, The Tax Treatment of Donor-Restricted Charitable Gifts, I consider the implications of the tax treatment accorded to these gifts for charities and their donors.

Tax treatment of gifts

Government policy seeks to encourage philanthropy through the tax deduction for gifts to Deductible Gift Recipients (‘DGRs’), while ensuring that the tax system provides appropriate oversight of charitable giving such that the boundary between what is public and benefits the community and what is private and benefits the individual is preserved.

The prevalence of restricted charitable gifts highlights a tension in the tax law between a donor’s desire to assert control of the donated funds and the public interest in controlling the extent to which a donor receives a private benefit. Maintaining a balance between these two competing objectives presents challenges as to how restricted charitable gifts should be treated for tax purposes. Provided that the ultimate control of the property interest in the gift resides with the recipient charity, a donor should be able to specify the use of the donated funds consistent with the charitable purposes of the organisation.

In order to qualify for an income tax deduction under the Income Tax Assessment Act 1997, a donation must meet the definition of a gift. The tax legislation in Australia does not define a gift. Instead, a definition has developed through the common law, which has been incorporated into two public tax rulings on income tax and goods and services tax respectively. Pursuant to these rulings, a gift must have the following characteristics: there is a transfer of the beneficial interest in property; the transfer is made voluntarily; the transfer arises by way of benefaction; and no material benefit or advantage is received by the giver by way of return (at [13]). These characteristics are evident in restricted charitable gifts as they involve a voluntary transfer of a beneficial interest property and there is no quid pro quo in the form of a material benefit received by the donor in return for making the gift.

Importantly, in order to qualify for an income tax deduction, a gift must also be complete, such that a DGR ‘receive[s] full title, custody and control of the property transferred [and] is entitled to deal with the property in its own right to the entire exclusion of the giver’ (at [77]). There is an issue as to whether a restricted charitable gift satisfies this requirement given that the donor is specifying how the donated property is to be used by the DGR, which may create a legally enforceable obligation. The income tax ruling cites Re Australian Elizabethan Theatre Trust, where Justice Gummow stated that where a gift is made by way of a donor ‘preference’, the DGR receives the property in its own right and has an unfettered discretion in deciding whether or not to apply the property (at [33]).

That is, no legally enforceable obligation is created on the part of the DGR to apply the funds as directed by the donor. Instead, the charity merely has a moral obligation to do so. This reasoning has been widely interpreted to mean that to qualify as a ‘gift’ for Australian tax purposes, donors should not specify the use of the donated funds, but instead should only indicate a non-binding preference as to how those funds are to be used by recipient DGRs.

Could restricted gifts be deductible?

In my recent article, I argue that a close reading of the income tax ruling and the case law reveals that a restricted gift to a DGR for its own use is not required to be made by way of a preference in order for it to be unconditional. Instead, the ruling clarifies that a ‘preference donation arrangement’ involves a situation where a donor gives money to a DGR ‘expressing a preference that the money be passed on to an affiliate organisation preferred by the giver to fund projects or events nominated by the affiliate and approved by the DGR’ (at [133]). This is also the effect of the case law on the topic.

This suggests that a donor mandating the use of the funds for a DGR’s own use can constitute a ‘gift’ under the tax law without the need for preferencing. In other words, ‘preference’ donations are only needed in situations where a donation to a DGR is to be transferred by the DGR to a second organisation, in order to safeguard the DGR status of the first organisation that is serving as a giving intermediary. As a result, it should be permissible for a donor to receive an income tax deduction for a restricted charitable gift that specifies the use of the donated funds by the DGR. Not to mention it is otherwise consistent with the criteria to constitute a gift for tax purposes, and with the charitable purposes for which the DGR was established and operates.

Given that the preferred method for donors making large charitable gifts is to specify how their donated funds are to be used by the recipient charity, preference donations may serve to disincentivise donors from making these gifts as there is no guarantee that the donated funds will be used in accordance with the donor’s wishes. If philanthropy is to be encouraged in Australia as a matter of public policy, interpreting the income tax ruling as not mandating preference donations when a gift is made to a DGR for its own use facilitates restricted charitable gifts within the parameters of the tax laws.

While this change in perspective raises normative concerns involving weakening the limits on the private behaviour of donors, given that restricted charitable gifts must meet a number of criteria to constitute a gift for tax purposes and must ultimately be consistent with the charitable purposes for which the recipient charity was established and operates, the tax laws provide appropriate safeguards to ensure that the public interest is protected.

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