CHARITY RESERVE POLICY
Individuals donating money to charities expect the money to be expended on the charitable objects. If they were asked …“Do you mind if we invest the money for the future?” they would probably refuse to make the donation. Trustees are under an obligation to see that the funds raised by the charity are primarily expended for its objects. In a small charity the funds will probably be spent as they come in and the charity will always be short of money. In a larger charity some thought will have to be given to the protection the charity might require in case the funds it receives either slow down or dry up altogether.
The Charities Act 2011 defines Charity Trustees as those people who are responsible for the administration of the charity. They include Trustees, Directors of companies limited by guarantee, Committee Members, Governors, and on occasions Volunteers, who are required to perform a specific piece of work for the charity. It is the responsibility of the Trustees to decide upon the reserve policy. (Herein all referred to as ‘the Trustees’).
What funds are treated as available for the general administration of the Charity?
It is important for the Trustees to know not only which funds are available for general expenditure but also the level of them. This is even though some of the Trustees tend to leave decisions on financial matters to the Treasurer, or the employed staff. Trustees are responsible for the administration of the Charity and they need to know how much money the Charity has and how it can be spent.
- Permanent Endowment has a statutory definition (in section 353(3) of the Charities Act 2011:
- A permanent endowment fund is able to convert the capital represented by it into income. As result the fund must be held indefinitely as capital
- These funds often arise as a result of a donation by an individual or company, which specifically requires the money to be spent for a specific purpose: eg a bursary for school fees; contributions to a building fund etc
- Expendable endowment is an endowment fund where the Trustees have the power to convert the property (ie land, buildings or cash) into expendable income. It is distinguishable from ‘income’ by the absence of a positive duty on the part of the Trustees to apply it for the purposes of the charity, unless and until this power to convert it into ‘income’ is actually exercised. Not all land and buildings are permanent endowment but can become so where they are used specifically for the purposes of the charity (eg School Buildings used specifically for education; hospital buildings used for the care of patients etc)
· Restricted funds are funds subject to specific trusts, which may be declared by the donor(s) or with their authority (eg a public appeal) or created through legal process, but still within the wider objects of the charity. For example grant monies obtained for a specific piece of work for the charity. Restricted funds may be restricted income funds, which are expendable at the discretion of the Trustees in furtherance of some particular aspect(s) of the objects of the charity. Or they may be capital (ie endowment) funds, where the assets are required to be invested , or retained for actual use, rather than expended.
· Unrestricted funds are expendable at the discretion of the Trustees in furtherance of the charity’s objects. If part of an unrestricted fund is earmarked for a particular project it may be designated as a separate fund, but the designation has an administrative purpose only, and does not legally restrict the Trustees’ discretion to apply the funds. Some Trustees have power to declare specific trust over unrestricted funds. If such power is available and is exercised, the assets affected will form a restricted fund, and the Trustees’ discretion to apply the fund will be legally restricted.
What are charitable reserves?
Charitable reserves are those parts of a charity’s income that are freely available. They therefore do not include:-
- Permanent endowment
- Expendable endowment
- Restricted funds
- Any part of unrestricted funds not readily available for spending, specifically: income funds which could only be realised by disposing of fixed assets held for the charity use and
- Programme related investments.
Nor may the Trustees set aside income from the general reserves to create an endowed fund . The reinvested funds remain income funds and must be treated as such; adding them to principal does not overcome this obligation. It is to be remembered that the income funds arise from donations and it was probably no part of the donor’s intention that they should be used other than for the purposes of the charity.
Trustees often want to build up reserves and might designate funds for a particular project. The act of designating the funds neither allows those funds to be used for a purpose for which they could not be used before; nor by itself provide a justification of their use for the designated purpose
Legal basis for holding reserves
Thereis no legal rule about the amount or proportion of the charity’s income funds which it is allowed to hold as a reserve. Trustees are under a general legal duty to expend charitable funds within a reasonable of receiving them. As a result the Trustees have an implied power to retain income if they are able to show that they have thought carefully about the matter, recorded their thoughts and consider the reservation is in the best interests of the charity. If the reserve is created without proper justification the Trustees may be considered to have acted in breach of trust. It is, therefore, essential that the Trustees have prepared a formal written policy setting out the justification for the retention of the income.
Trustees are required to include a statement in the Annual report about the level of the reserves held and the reasons for this. This means that the Trustees must have a written reserve policy based on a realistic assessment of their reserve needs. The policy should not be prepared by the accountant or treasurer but must be considered by the body of the Trustees running the charity. The policy will cover:-
- The reasons why the charity needs reserves;
- What level (or range) of reserves the trustees believe the charity needs; what steps the charity is going to take to establish and maintain reserves at the agreed level (or range);and
- Arrangements for monitoring and reviewing the policy.
As a consequence, at all Trustees meetings, details should be provided of the present cash position, allowing for monies in and out, at the time of the meeting, so that an assessment can be made as to whether sufficient or too many funds have been retained. The assessment will be based on:-
- The forecast for the levels of income in future years, taking into account the reliability of each source of income and the prospects for opening up new sources;
- Its forecast of expenditure in future years on the basis of planned activity;
- Its analysis of any future needs, opportunities, contingencies or risks the effects of which are not likely to be able to be met out of income if and when they arise; and
- Its assessment, on the best evidence reasonably available, of the likelihood of each of those needs etc arising and the potential consequences for the charity of not being able to meet them.
Having established a reserve policy the Trustees are required in the Annual Report to
- describe the charity’s reserves policy
- explain why they hold or do not hold reserves;
- quantify and explain the purpose of the material designated funds, and where set aside for future expenditure , the likely timing of that expenditure; and
- give the level of reserves at the last day of the financial year to which the report relates.
A rule of thumb for a reserve policy might be that the charity should retain out of its general income 3 to 6 months running costs. The charity will have to justify that reserve. If the charity does no more that give away its income for charitable purposes, having no permanent staff, or premises, then there would be no justification for retaining other than a very small amount of the general income. If on the other hand the charity runs a school or Hospice it might need to keep reserves sufficient to allow it to disband its operation in an orderly manner. This could amount to a year or more for the hospice.
Income is usually exempt from direct taxation if it is both applicable and actually applied, for charitable purposes only. If the income is improperly retained by the trustees and improperly invested the revenue may seek to tax it. In those circumstances the Trustees may have to pay the tax personally if they can be shown to be acting in breach of trust. If there is a robust reserve policy in place then the problem should be avoided.
A further benefit of having a reserve policy is that it can be provided with an application for funds from a charitable trust or grant agency. If the accounts show a large amount of money on deposit and no reasons are given to explain the figure, there is every likelihood that the , or grant making body will not help, because they will consider that the charity can fund the request out of the reserves identified on its balance sheet.
David S Porter
See also Charity Commission Guidance CC19 – Charity Reserves