Over the last few years Australians have become more generous with donations and gifting to charities. Keat Chew explains why some are taking the extra step of self-managing their charitable legacy and ensuring their donations are tax effective.
We have seen good evidence of Australians giving a helping hand in a number of well-publicised appeals such as the Pacific Tsunami Appeal, the annual Good Friday appeal and the bushfire appeals of last year.
Unlike the United States, where the gifting industry is a lot more mature and Americans have been gifting for a long time, donating to a charity here in a structured way is still a relatively new concept for the ordinary Australian. Having said that, the increasing trend in Australia to gifting and greater generosity is most encouraging.
Leaving a legacy – Private Ancillary Fund
The simplest way to donate is direct gifting to our favourite charities or through specific charitable events, including dropping spare change into collection boxes. Tax deductions are generally available for donations of more than $2.
Many are, however, unaware that they are able to set up their own ‘self managed’ charitable fund, an attractive tax-exempt vehicle known as a Private Ancillary Fund (PAF).
Like self-managed superannuation funds, the donor/trustee in this case has involvement with the management of the fund’s investments if so desired.
The objective is for the initial donation to the fund to be invested and the income earned each year distributed to charities. Over the years, the capital is nurtured so that the fund grows to provide a significant and lasting legacy.
What is a Private Ancillary Fund?
A PAF (previously known as a Prescribed Private Fund) is a fund established by trust instrument to which businesses, families and individuals can make tax-deductible donations. It is prescribed by law.
The fund may make distributions only to other deductible gift recipients that have been either endorsed by the Australian Taxation Office (ATO) or are listed by name in the income tax law.
There is no need for gifts to a PAF to be sought and received from the public, and a PAF can be controlled by an individual, family or corporate group.
What are the benefits of a Private Ancillary Fund?
Generous tax deductions are available for donations made to the fund. Any income earned in the fund will be completely tax free.
On setting up the fund, there is flexibility to name the fund and control the operation of the fund within ATO guidelines.
Furthermore, each year there is an opportunity to nominate the charities that will be receiving distributions from the fund. The fund can be maintained over family generations and is ideal for individuals wanting to leave an ongoing legacy.
What are some of the requirements of a Private Ancillary Fund?
There is a minimum annual distribution rate of 5 per cent, with an added requirement that the fund must distribute at least $11,000 per annum, whichever is higher.
This rate of distribution allows funds to be distributed to the relevant charities on an annual basis and the remaining capital to accumulate to generate future returns.
There is a requirement to develop and maintain an investment strategy, taking into account investment risk and objectives.
PAFs are required to make regular valuations of their assets and valuation rules will be introduced for funds to follow. It is a requirement that the trustee of a PAF is a corporate.
Is there a minimum amount to set up a Private Ancillary Fund?
There are costs associated with the operation and administration of a PAF. Given the tax concessions associated with PAFs, there are also strict compliance guidelines imposed by the ATO that need to be complied with, and this adds to the cost of running the fund. As a general rule of thumb, an initial donation in the region of $500,000 is needed to make a PAF cost effective.
Stretching and spreading your tax-deductible gifts
Who can claim a tax deduction for a gift?
A donor can be an individual, company, trust or other type of taxpayer. The donor can only claim a tax deduction against taxable income for gifts made to Deductible Gift Recipients (DGRs). DGRs are endorsed by the ATO to receive income tax deductible gifts.
Claiming a tax deduction
The amount of deduction available depends on the type of gift. Deductions for a gift of money are simply the amount donated. For other assets, there are various valuation methods that may apply. To ensure the gift is tax deductible, it must meet a number of conditions:
- the gift must be made to a DGR;
- it is genuinely a gift;
- it is a gift of money or a certain type of property; and
- it may need to meet certain specific gift conditions.
When can a tax deduction claim be made?
A claim for deduction is generally made in the tax return for the year in which the gift is made. Unfortunately, the tax deduction cannot create a tax loss, which means any excess deduction not utilised to offset assessable income in an income year will be wasted and cannot be carried forward.
Example
Adam’s assessable income for the 2008 year is $30,000. During the year he made a cash donation of $40,000 to a DGR. The maximum deduction that he can claim is $30,000, with the remaining $10,000 excess wasted as a tax loss cannot be created. Ideally, Adam would like to claim only $24,000 as a tax deduction, with $16,000 carried forward, leaving no tax payable on the remaining $6,000 of income as it falls within the tax-free threshold.
Spreading tax deductions
While it is not possible to create and carry forward as a tax loss any excess tax deduction for gifts, consideration should be given to spreading the tax deduction over a five-year period.
A tax deduction for a gift can be spread over a five-year period if the gift meets one of the following conditions:
- it is a gift of money, the amount being $2 or more;
- for property valued by the ATO to be in excess of $5,000; and
- gifts that fall within the categories of cultural or heritage gifts.
The donor must make an election in the approved form before lodging the tax return for the income year that the gift was made.
The election must start in the year of gifting and continue for up to four years immediately following. In the election, the donor must specify the percentage to be claimed in each year, with the total over the five-year period not exceeding 100 per cent.
Variation to the percentage to be claimed from an election previously made can be made for any year that a tax return has not been lodged and must be made in the approved form.
Example
The same facts as the previous example, but with Adam electing to claim 60 per cent ($24,000) of the deduction in the 2008 year and the remaining 40 per cent ($16,000) in 2009.
Through this exercise, Adam is able to use the $16,000, which would otherwise be wasted, in the following year.
Before lodging the 2009 tax return, Adam realises he can only use $8,000 of the $16,000 tax deduction that he elected for.
At this stage, he can still vary the percentage to be claimed for 2009 and end up claiming 60 per cent of the deduction for 2008, 20 per cent for 2009 and the remaining 20 per cent now varied for 2010.
Keat Chew is the head of technical service at netwealth group.
