Casework Guidance

Please read the Important Note on the front page

OG 43 A1 - 14 March 2012 

OG 43 A1 An Overview

 

1. Why do charities have ‘reserves’ and what are they?

Simply put, reserves are funds held back and not spent. A charity receives funds from a variety of sources to fund its charitable work for the public benefit. To ensure their charity operates effectively and can continue in the face of unplanned or unforeseen costs and can financially plan for future work, charity trustees often deliberately hold back some money in reserve. This guidance looks at the legal meaning of reserves and explains how charities should go about identifying and managing their reserves.

Generally we use the term reserves to describe that part of a charity's income fund that is freely available for its general (unrestricted) purposes. ‘Reserves’ are therefore the resources the charity has, or can make, available to spend for all or any of the charity's purposes, once it has met its commitments and covered its other planned expenditure. When considering planned commitments, the trustees may decide to set aside as a designated fund part of the charity’s unrestricted funds. By designating funds in this way they are actively identifying a planned use for these funds. A common form of designation is to identify the value of the functional fixed assets that are part of the charity’s unrestricted funds (for example land, buildings, equipment or vehicles) and designate an amount equal to this value at the year end. By doing this, the trustees show that these assets cannot be readily sold and added to reserves because these assets are essential to the charity’s ongoing work.

You need to be aware that the term ‘reserves’ may be used differently outside of the Commission and so care needs to be taken when communicating about reserves with trustees and advisers to ensure that there is a shared understanding. This is particularly important when you are in discussion with a charity's professional advisers - see OG 43 B1.

Section 2 of OG 43 B1 explains in detail which funds are not included in our definition.

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2. Duty to apply income of charity and need for a reserves policy

Trustees are under a general legal duty to distribute or spend income funds on the objects of their charity within a reasonable time of receiving them.

However, the holding of reserves is not in itself a cause for concern, provided that:

• the charity has the legal power to do so (see OG 43 B2);
• the trustees are satisfied that the retention of reserves is necessary for the charity to function properly; and
• the trustees can justify the level of reserves the charity holds (see OG 43 B2).

There is no legal duty on trustees to have a reserves policy but the Charities (Accounts and Reports) Regulations 2008 do require the trustees to disclose in their annual report if they have no policy. Trustees will find it difficult to justify any significant unspent unrestricted funds if they have no policy, and the absence of a policy is an indicator of poor governance. Where trustees have a reserves policy there is a legal duty to disclose this, the SORP and the Charities (Accounts and Reports) Regulations 2008 set out what should be disclosed.

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3. Why this issue is important

Reserves are an issue of major importance to the charity sector. Issues surrounding reserves can generate difficulties, controversy and conflict.

Reserves which are too large may:

• conflict with the trustees' duty to apply the income of the charity within a reasonable time.
• indicate inefficient administration - income funds which could be used to further the objects of the charity may be retained out of habit or unwarranted caution rather than with a definite end in view.
• cause public concern and bring that charity, or even charity generally, into disrepute - particularly where the charity continues to fundraise (see OG 43 B3).
• cause conflict with other charities working in a similar field but with a lower public profile, or working for a less popular cause, who may find it difficult to raise funds.
• represent an ineffective use of charitable resources which could be better spent on meeting beneficiaries’ needs.

Reserves which are too low may:

• present a risk of insolvency;
• hamper proper medium-term planning and the ability to take advantage of change and opportunity;
• cause charitable funds to be used inefficiently - for instance, in solving crises which could, and should, have been avoided; in entering into short-term contracts for the supply of goods or services when a longer term contract would have been cheaper and more efficient;
• create insecurity amongst beneficiaries, supporters and employees of the charity;
• force the charity to disrupt or abandon aspects of its work as a result of a temporary drop in income or an unexpected expense.

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4. Trustees' responsibilities

Apart from the general duty set out in section 2 above, trustees are responsible for:

• considering the need for reserves;
• establishing an appropriate reserves policy for their charity;
• justifying and explaining that policy; and
• contacting us if their charity has more resources than it could reasonably need to fulfil all of its purposes.

Trustees have a legal duty under s.61 of the 2011 Act to take steps to widen the objects of their charity where they cannot find a way of using their resources within their existing objects. (See OG 2 A1)

More information about amending the objects of a charity can be found in OG 519 for unincorporated charities and in OG 47 A1 for charitable companies.

Trustees are strongly advised to read and understand CC19 Charities Reserves.  This publication contains recommendations about the disclosure of reserves policies in a charity's accounts. There should also be disclosure of the purposes and asset structures of all the different types of funds of the charity.

The preparation of an accurate and informative set of accounts and trustees’ annual report is an important aspect of a charity trustee's duty of public accountability and stewardship. Open and honest reporting of a charity's level of reserves and its reasons for holding them will reassure donors and the giving public generally that the charity is acting responsibly.

Where a charity has no reserves or ‘negative’ reserves (the liabilities exceed the assets held in unrestricted funds), the charity may be vulnerable to disruption or may no longer be a going concern. In these circumstances it is important that trustees take advice and act if the charity is no longer a going concern and they should be referred to CC12 Managing Financial Difficulties and Insolvency in Charities. Accountancy and legal advice should be taken when communicating with charities facing financial difficulties.

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5. Our regulatory interest

The Charities Act 2011 provides statutory objectives that include increasing public confidence, ensuring compliance with charity law, effective use of resources and accountability. These objectives have a bearing on the retention and management of reserves. It is important that trustees understand their duties and get the balance right between retaining reserves and using the funds available to carry out their charity’s activities. The economic context in which charities are operating will affect charities’ decisions about their reserves policy and expenditure. Whilst charities might decide to build up their reserves during favourable economic conditions we would anticipate many charities increasing their draw down of reserves to meet beneficiaries’ needs during an economic downturn.

Our role is:

• to advise charity trustees, and to encourage them to think about an appropriate reserves policy which takes account of the factors outlined above, including the needs of existing and future beneficiaries in the light of current economic circumstances;
• where there are indications that the level or use of reserves might not be justified, to consider the detail of the charity's calculation and policy - this will include reviewing designated funds, restricted funds and expendable endowments where appropriate;
• where mismanagement or misconduct persist, charity resources are at risk, or breaches of the law remain uncorrected, to intervene by using our statutory powers. We have a number of risk indicators to determine if our intervention is required. (The need to use our statutory powers in connection with reserves should be undertaken only after taking legal and accountancy advice. However, it cannot be ruled out if dialogue with the trustees proves unproductive. If trustees insist on the retention of a level of reserves which they are unable to justify then they are failing in their duty to apply the income funds of the charity within a reasonable time.)

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6. What happens if a charity cannot apply its resources?

If a charity has more resources than it could reasonably need to fulfil all of its purposes, the trustees should contact us. We can then consider if it is appropriate to extend the purposes of the charity to enable the charity to use its resources. Alternatively, we could advise trustees if they are considering transferring resources to another charity with similar purposes.

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OG 43 B1 - 15 May 2009

OG 43 B1 What constitutes 'Reserves' and how to identify them

 

1. The definition of the term ‘reserves’

The term is defined in the Charities (Accounts and Reports) Regulations 2008, regulation 2, which provides that ‘reserves’ means:

(a) in relation to a charity, those assets in the unrestricted fund of a charity which the charity trustees have, or can make, available to apply for all or any of its purposes, once they have provided for:

(i) the liabilities of the unrestricted fund; and

(ii) any commitments of the charity or other planned expenditure intended to be met from the assets of the unrestricted fund;

(b) in relation to any body that is not a charity, the net assets or liabilities of the body that are disclosed in the body’s balance sheet for the financial year in question.

Generally we use the term reserves to describe that part of a charity's income fund that is freely available for its general (unrestricted) purposes. ‘Reserves’ are therefore the resources the charity has, or can make, available to spend for all or any of the charity's purposes, once it has met its commitments and covered its other planned expenditure. When considering planned commitments, the trustees may decide to set aside as a designated fund part of the charity’s unrestricted funds. By designating funds in this way they are actively identifying a planned use for these funds. A common form of designation is to identify the value of the functional fixed assets that are part of the charity’s unrestricted funds (for example land, buildings, equipment or vehicles) and designate an amount equal to this value at the year end. By doing this, the trustees show that these assets cannot be readily sold and added to reserves because these assets are essential to the charity’s ongoing work.

In communicating with trustees or the charity’s advisers it is important to clarify what is being talked about to ensure a shared understanding because the term reserves can be used very loosely. The term ‘reserves’ may be used very widely indeed and is likely to include funds listed in section 2 below as excluded from our definition. Reserves as defined by us might more commonly be referred to as free, general or unrestricted reserves outside of the Commission. You need to be aware of this when speaking or writing to a charity or its professional advisers, and you need to make it clear that you are using the term as defined in CC19 Charities Reserves.

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2. What is NOT included in our definition

Our definition of reserves excludes:

• permanent endowment;
• expendable endowment (CC19 explains why - but see section 3 below about the income from such a fund);
• the value of total gift element of permanent endowment together with the unapplied total return where permanent endowment is managed on a total return basis;
• restricted income funds (but see section 4 below);
• designated funds (CC19 explains why); and
• fixed assets held for charity use which could only be realised by disposal.

There are, however, exceptions. For instance, designation needs to be properly justified. If not, it may be simply a device to hide reserves. The amount set aside needs to be realistic: designated funds in excess of the amount required should properly be treated as reserves. A charity will not be justified in creating, or transferring resources to, a designated fund where the main purpose of doing that is to allow the charity to show a reduced level of reserves.

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3. Income from expendable endowment

Re-investing income generated from endowment funds does not have the effect legally of converting the income into extra endowment, unless there is a power or a duty to add the income to the endowment. The reinvested funds remain income funds and need to be taken into account when deciding what constitutes an appropriate level of reserves.

Where a charity is replacing borrowed permanent endowment this reinvested income is added to the endowment.

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4. Restricted income funds (special cases)

For the purposes of applying the principles in this guidance, we recommend that trustees treat each material restricted income fund as if it were a separate charity and consider what, if any, level of reserves they need to hold. 

For instance, some NHS Trusts have a number of charitable funds restricted in that each may be applied for the benefit of a particular hospital amongst a group of hospitals managed by the same NHS Trust. We strongly recommend that each of these funds should have a policy on reserves which should be justified and explained in its own right.

(See also section 5.4 of OG 43 C1)

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5. How to identify a charity's income reserves

Our definition of reserves is set out in section 1 above. There is no one figure in a charity's accounts which will normally be expressly labelled ‘income reserves’ - you will need to examine both the trustees' annual report and its accounts to obtain a true picture. When analysing the accounts it is important to obtain accountancy advice either to confirm your analysis or provide the analysis of reserves. It is also useful to look at trends in reserves by looking at previous years.

 

5.1 Trustees' annual report

The SORP recommends that the trustees' annual report should include a statement of the charity's policy on reserves stating the level of reserves held and why they are held. This, therefore, should normally be the first place to look to check both the amount held in reserve and the policy adopted by the trustees.

(All registered charities must prepare an annual report)

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5.2 The accounts

The accounts will provide you with figures which should support and be consistent with the narrative in the trustees' annual report. It will also indicate whether the level of reserves has increased or decreased since the last accounting period and how much is held in designated and restricted funds. (Although not included in our definition of reserves the amount and purpose of these other funds may have a bearing on the overall position - see section 5 of OG 43 C1). You will, however, need to bear in mind that the balance sheet in the accounts represents a snapshot of the position of the charity at a particular point in time - the end of the accounting year. (For instance, the unrestricted funds carried forward may be inflated by a significant grant or donation received by the charity at the very end of the accounting year.) This is why it is important to read what the trustees say in their annual report about their reserves policy, what the charity is trying to do and how it is going about it.

 

Accounts prepared on the accruals basis

The charity's Statement of Financial Activities (SOFA) should show all the charity's incoming resources and expenditure over the accounting period. It should differentiate between restricted, unrestricted and designated funds and reconcile all changes in these funds. In relation to each fund, it should show the balance brought forward from the previous financial year and the balance carried forward to the next financial year.

The balance sheet provides a high-level snapshot summary of the charity’s financial position at close of business on the last day of the accounting period. It lists and analyses all the assets and liabilities of the charity including the value of all the various funds (where restricted or designated funds exist).

You will need to look at both the SOFA for levels of incoming and outgoing resources and the balance sheet to examine the asset structure.

It may be that the unrestricted fund balances as shown on the balance sheet are represented by fixed assets held for the charity's use - such as a village hall in the case of a community charity. This would not fall within our definition of reserves and its value would need to be deducted from the ‘fund balance’ to give a more accurate picture of the assets freely available for immediate use.

The notes to the accounts should provide any additional explanation and information necessary to gain a proper understanding of the financial activities and financial position of the charity.

 

Accounts prepared on the receipts and payments basis

The Receipts and Payments Account (RPA) of a charity preparing accounts on the receipts and payments basis should distinguish clearly between the unrestricted (general) funds of the charity and any restricted funds (separate statements can be provided if the trustees wish). The receipts and payments, the net receipts, and the cash and bank balances carried forward for each fund should be shown. Corresponding figures for the previous year should be provided as a comparison.

The Statement of Assets and Liabilities summarises the assets and the liabilities of the charity at the end of the accounting period. It should indicate to which fund each asset or liability disclosed belongs. (It is not obligatory for values to be provided for non-monetary assets.)

You will need to study both the RPA and the Statement of Assets and Liabilities to obtain a reasonable picture of the charity's position.

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OG 43 B2 - 14 March 2012

OG 43 B2 The law and our policy

 

1. The position in law

1.1 Duty to apply incoming resources

In our view, it is well-established that:

• the incoming resources of a charitable trust should be applied as income unless the trusts attaching to them identify them as endowment/capital; and
• charity trustees are under a general legal duty to apply the income of their charity for its purposes within a reasonable period of receipt (subject to any valid provision in the charity's governing document which may authorise the conversion of income resources into endowment/capital).

For precedents which support this view see sections 1 and 2 of OG 43 P1.

It is recognised that trustees in the charity’s interest may need to retain some reserve of income to ensure the smooth and effective operation of the charity in order to ensure the continued furtherance of its objects. This is reflected by the inclusion of the word ‘reasonable’ in the phrase ‘within a reasonable period of receipt’. But it is clearly not ‘reasonable’ to retain income, to the detriment of beneficiaries which the charity should be assisting, where there is no connection between doing so and ensuring the proper administration of the trust.

 

1.2 Power to hold reserves may be express or implied

The governing documents of a small number of charities contain an express legal power to hold income in reserve instead of expending it promptly but, much more often, they will have to rely on their implied power to take actions which are necessary for the charity to function properly.

Whether their power is express or implied, trustees are justified in exercising it only if, in their considered view, it is necessary in the charity's best interests to do so. If it is done without justification, the holding of income in reserve may amount to a breach of trust and may justify the use of our regulatory powers.

 

1.3 Converting income into endowment (accumulation)

A small number of charities have in their governing document a power to convert income into capital/endowment (that is, a power to accumulate). This is not the same as a power to hold income in reserve. Converting income into endowment takes the converted resource outside of the scope of reserves (since our definition of reserves does not include any endowment (capital) funds).

The exercise of an express power to accumulate should be the result of a conscious decision on the part of the charity trustees; such a power should, like any other power, be exercised only in the interests of the charity.

Sometimes charity trustees who do not have a power to accumulate may ask us to authorise them to do so, by Scheme, or by Order under s.105 of the 2011 Act. Before doing so we need to be satisfied that this would be expedient in the charity's interest.

An example of a special case is the power to accumulate as part of a total return approach to investment of permanent endowment (see section 1.5)

If you receive an application from a charity for authority to accumulate you should seek legal and accountancy advice at an early stage to ensure the case made is justified by the circumstances of the charity and takes proper account of its effect on both current and future beneficiaries.

 

1.4 The corporate property of charitable companies

The principles outlined in section 1.1 above apply to trust property administered by a charitable company or where a non-charitable company is a corporate trustee of a special trust or endowment.

Company law imposes no explicit duty on the directors of a charitable company to apply its corporate property within a reasonable time of its receipt but that does not sanction its accumulation. It is legitimate to expect that a charitable company's incoming resources should be used to further its objects - see section 3 of OG 43 P1 for a case where the legitimate expectations of the members of a trading company were recognised.

 

1.5 The total return approach to investment

Please see our guidance - Total return investment for permanently endowed charities for current position. Charity trustees no longer need authority from the Charity Commission to adopt a total return approach to investment

 

When we authorise a charity to adopt a total return approach to investment this does not authorise trustees to convert income into capital (endowment). The return on the investment (gain or loss), in whatever form it is received, is treated for technical reasons as permanent endowment, unless and until the trustees allocate it to a trust for application (income).  A gain is added to the unapplied total return and must then be applied for the purposes of the charity whereas a loss reduces the total unapplied return available for application.

Adopting a total return approach will give trustees greater flexibility in the allocation of investment returns. But once any part of the investment return has been allocated to the trust for application (income) then it should only be retained in the trust for application (income) in accordance with a proper policy on the maintenance of reserves - see section 3. There is generally no need for trustees to build up reserves in the trust for application (income) to cover a year when the investment funds for that year are minimal or negative. This is because any part of a charity's unapplied total return may be allocated to the trust for application (income) at any time.  However, when trustees utilise the flexibility under a total return approach they must act consistently with the underlying duty to be even-handed between the interests of current and future beneficiaries. Under-allocation to the trust for application (income) would prejudice the interests of current beneficiaries. Over-allocation to the trust for application (income) would prejudice the interests of future beneficiaries.

If trustees exercise their discretion to allocate investment return to the trust for application (income) or alternatively retain it on trust for investment (capital). this will be a justified use of their power. The reasonable exercise of their total return power is sufficient to justify any retained unapplied total return and is compatible with our policy in relation to establishing and justifying reserves.

 

1.6 Defined benefit pension schemes and reserves

Where accounts are prepared on the accruals basis, the Charities (Accounts and Reports) Regulations 2008 require these to be prepared in accordance with the methods and principles of the SORP on a true and fair basis. Accounting standards and the SORP require the balance sheet recognition of pension assets or liabilities relating to a defined benefit pension scheme. Further information on this can be found in our guidance note Charity Reserves and Defined Benefit Pension Schemes.

A defined pension asset is where the assets of the pension fund (or the charity’s share of them) exceeds the pension liabilities of that fund to current and future pensioners. More commonly with volatile world equity markets there is a reverse situation and a defined pension liability.

We should refer to Charity Reserves and Defined Benefit Pension Schemes when considering the circumstances of a charity with a defined benefit pension scheme and its reserves. In short, pension schemes are long term obligations and whilst the existence of a pension asset or a pension liability will affect the reserves policy and the reserve balances held, when calculating the reserves, the pension asset or liability should be excluded from the reserves calculation.

In handling a case involving a pension liability or asset, due to the complexity of pension arrangements and obligations, legal and accountancy advice should be taken at all stages of the case handling.

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2. Our regulatory stance on reserves

If a charity can demonstrate to donors and others that it has good reasons to retain a particular level of income as a reserve (that is, if it can justify its position) then we consider it is acting responsibly. A charity which has no  reserves does not avoid the need for justification – ‘nil’ or ‘negative’ shows that a decision has been taken regarding reserves and a charity in this position needs to be clear that this is right in the circumstances and it must have a policy for the future.

Justifying reserves does not mean excusing or being defensive about reserves. It means being able to demonstrate, by reference to a charity's current position and future prospects, why holding a particular level of reserves is right for the charity at that time.

Our regulatory stance is:

• To encourage charities to have, maintain and review a reserves policy.
• To be proportionate and expect a brief statement of reserves for a small charity (below the audit threshold) which is consistent with an adequate explanation of the reserves held and reasons for holding reserves. We would expect greater detail and consideration from larger charities commensurate with the complexity and size of the charities involved.
• To encourage charities to disclose and explain their reserves in a transparent way.
• Not to become involved in third party disputes about reserves eg with funders, and instead expect charities to resolve disputes through dialogue with those who are challenging or complaining about their reserves.
• To expect charities to deal directly with those challenging or complaining about their reserves levels, before making any regulatory interventions, if required.
• To refer charities, in cases where their reserves are too low, to our guidance CC12 Managing Financial Difficulties and Insolvency in Charities.

Section 5 of OG 43 B1 explains where to look in a charity's accounts and annual report for a statement of its reserves policy and position. OG 43 C1 explains how we apply a number of risk factors when assessing whether our regulatory intervention is required and how to use information from the annual report and accounts to carry out an assessment of the charity's policy and practice.

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3. Putting policy into practice

3.1 General approach

We expect charities to comply with their obligations and make such disclosures as required by SORP. This self regulatory approach allows:

• each charity to tell its story;
• trustees to explain how their plans for reserves have developed and changed;
• reserves held to be placed in context;
• stakeholders to have an informed view about a charity’s reserves.

This self regulatory approach is proportionate and avoids the Commission imposing arbitrary norms, bands or targets which might distort trustee behaviour and impede good governance.

NB. We do not wish to overburden small charities, and you should not expect or require such a charity to produce a sophisticated reserves policy. The following general guidance from CC19 Charities Reserves needs to be tailored to the size and complexity of the charity.

 

3.2 Justifying reserves

To justify their holding of reserves, trustees should have a reserves policy based on a realistic assessment of their reserves needs. It should explain clearly to donors, financial supporters and other stakeholders why the reserves are needed. Where a charity decides to proactively reduce the level of its reserves, for example, to maintain its activities during an economic downturn, it should also explain this approach. Transparency and accountability are essential in maintaining public confidence and countering any impression of a charity hoarding funds.

Apart from providing justification for trustees to exercise their legal power to hold reserves, many charities believe this process to be an essential part of good financial management practice.

A charity which builds up reserves by retaining, as a matter of habit alone, any annual surpluses it makes will scarcely be able to justify holding those reserves and this practice may justify our regulatory intervention.

 

3.3 A reserves policy

In some charities the policy will be proposed by senior employees or by a sub-committee of the trustee body, but it should be formally agreed by the trustees acting as a Board, and recorded in writing.

The policy should cover as a minimum:

• the reasons why the charity needs reserves (or does not need them);
• what level (or range) of reserves the trustees believe the charity needs;
• what steps the charity is going to take to establish or maintain reserves at the agreed level (or range); and
• arrangements for monitoring and reviewing the policy.

It is stressed that the amount of time spent preparing the policy, and the detail with which it is set down, should be in proportion to the scale and complexity of the charity's affairs.

 

3.4 Mismatched levels of reserves

Without a reserves policy, trustees cannot be confident that their reserves level matches the charity's needs at the time. The charity could be holding reserves that are too high or too low for its needs.

If a charity's reserves are too high, it is accumulating income funds without justification. Those funds ought to be expended for charitable purposes. Other charities in the same field may have an urgent need for funds, or current beneficiaries could have outstanding needs that can be met. Retaining excessive reserves in such circumstances could be detrimental to the public benefit and may justify our regulatory intervention. While the funds remain in the trustees' hands the charity's current users or beneficiaries - actual or potential - are not being as well-served as they could be.

If a charity's income is volatile or insecure, it has high commitments, and its state of affairs is highly susceptible to factors outside its own control, it may find that its reserves are too low to protect it from the risk of insolvency or serious disruption to its charitable work.

 

3.5 Charities with small or no reserves

Some charities will be able to justify holding a certain level of reserves but will be unable to build up reserves to that level, or perhaps to any level at all. Many recently established charities in particular, will be in that position. While we accept that some charities will simply not have had the resources to establish a reserve, we would still expect a charity to have a reserves policy even if it currently holds no reserves.

Established charities with low reserves may have incorrectly designated funds or may be facing financial difficulties (see section 3 of OG 43 A1). Where reserves are low (nil or negative) we would expect a reserves policy to make it clear that there are no financial difficulties (referring to and explaining any designated funds where appropriate) or to stress that there are financial difficulties which the trustees are (or are not) addressing.

A conscious decision to hold no reserves of income does not mean that a charity does not need a reserves policy. ‘Nil’ shows that a decision has been taken regarding reserves and this needs to be justified by the charity’s circumstances.

 

3.6 Realistic assessment of need for reserves

A charity's reserves policy should be informed by:

• its forecasts for 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 forecasts for 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;
• 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.

Trustees who hold reserves without making any attempt to relate their need for reserves to factors such as these will probably have difficulty explaining in any convincing way why they hold reserves.

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4. Satisfying public concern and scrutiny

Underlying much public discussion of charity reserves is the belief that holding reserves is tantamount to hoarding.

This belief is likely to persist unless charities justify and explain their reserves position. The giving public are not generally concerned with the legal and accounting technicalities. But they are entitled to be reassured that a charity with reserves has good reasons for keeping funds in reserve, and to know what those reasons are.

Any charity could find its reserves subject to scrutiny and comment in the public arena. Charities which:

• operate in areas where there is clear evidence of immediate human need; or
• rely on a strong emotive appeal involving vulnerable groups or animals; or
• are running public appeals emphasising the urgency of their own need for donated funds,

are likely to attract the most attention, especially if they hold sizeable sums as reserves.

Charities applying to statutory or voluntary funders are also likely to have their reserve levels closely assessed.

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5. Role of funders

Some charities can have difficulties with the way their reserves are viewed by funders. If the reserves appear too large, there may be an assumption that the charity does not have a proper need for additional funds. If the reserves appear too low, there could be a refusal to fund on the basis that the charity's finances are unstable and might expose the charity to insolvency.

Generally speaking, we should encourage funders to apply the same kind of criteria in assessing reserve levels as we do ourselves: that is, on the basis of proper justification rather than the application of any arbitrary rule.

See section 3 of OG 43 C2 if a charity asks us to intercede between it and a potential funder.

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OG 43 B3 - 8 June 2012

OG 43 B3 Fundraising

 

1. Charity's responsibility

Every charity is responsible for ensuring that its appeals - whether for voluntary public donations, corporate donations, legacies, grants, or any other form of income or endowment - and whether they are made by advertising, direct mail, in person, or by any other method - do not misrepresent the charity's financial position.

If a charity is widely believed to have large reserves, appeals for further funds may provoke resentment against the charity and risk damage to both its reputation and more generally the reputation of the sector where an appeal is seeking funds which it apparently does not need. In wording appeals, and in dealing with any reaction to the appeals, it should take care not to give anyone the wrong impression about the extent or urgency of its need for funds.

A charity's fundraising policy is largely a matter for the judgement and good sense of individual charities, provided that they operate within the law.

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2. When might we become involved?

We might become involved:

• Where we receive complaints from members of the public - perhaps concerning a larger charity with a high profile, or after the question of reserves has been highlighted by the media.
• Where we have reason to query a charity's level of reserves in this case its fundraising practice and policy may be a factor in our discussions.
• Where, exceptionally, an appeal appears to be so seriously misleading, or so materially incorrect - particularly when allied with other issues of concern - as to warrant the opening of a statutory inquiry.

Generally, a member of the public who complains about the content or tone of an appeal should be advised to take the matter up first with the charity concerned and we would only intervene where the charity’s response to their complaint is judged insufficient and our intervention is both appropriate and proportionate.

If a number of complaints are received about the same charity, or about a particular appeal, examine the charity's accounts to see whether the level of reserves is a matter for concern - see OG 43 C1. It is important to take accountancy advice before corresponding with the charity to ensure your analysis and findings are reasonable and conclusions justified.

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3. When might an assessment be appropriate?

We might consider taking further action where:

• We have taken up this issue with the charity in the past but it is refusing to follow our advice.
• The appeal is so seriously misleading as to call into question the motives and integrity of the charity, eg, it contains significant and material factual errors, or is clearly designed to deceive.
• The appeal is one of several factors causing concern about the charity.

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OG 43 B4 - 15 May 2009

OG 43 B4 Donations and legacies - Income or endowment?

 

1. Donor’s or testator’s intentions

Occasionally charities and their trustees may contact us for advice on whether a gift is income, expendable endowment or permanent endowment. Whilst the Commission does not have power to determine the status of a particular gift, we do have a statutory objective to promote compliance by charity trustees with their legal obligations. This means we may have a role in advising trustees on how to go about identifying whether a gift is income, expendable endowment or permanent endowment. This guidance examines some of the factors relevant in determining the status of a gift.

People who give or leave money to charities do not always specify whether their donation or legacy should be treated as income or as permanent or expendable endowment.  If any evidence of the donor's or testator's intention does exist, the charity must treat the gift or legacy accordingly.

Where the formal terms of a gift are silent as to how it should be treated, the first thing to do is consider any available evidence relating to the donor’s intentions. For example:

• any indications expressed by the donor in correspondence with the trustees, or with their advisers, or with the donor's own advisers, or which may be recorded in interview or telephone memoranda; or
• if the gift was in response to a public appeal, the terms of that appeal.

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2. Circumstantial evidence

If there is no direct evidence as to what the donor had in mind, circumstantial evidence may be relevant. Trustees should not classify a gift as endowment without reasonable grounds and we would expect any interpretation to be consistently applied. The decision to simply classify gifts as endowment to avoid inclusion in reserves is unacceptable. Whilst the size of the gift in relation to the size of the charity may be a factor in considering what the donor intended, the trustees must consider additional points before classifying a gift as endowment.

In considering whether the relative size of the gift is a factor, it might be reasonable to assume that the donor:

• would probably not have expected a charity necessarily to spend promptly a sum of money substantially greater than its normal annual outgoings; and (where the donor has been a long established supporter of the charity and is familiar with its work);
• would have expected the charity to invest the gift as expendable endowment and use the income, unless and until the trustees chose to embark on some major project on which the endowed funds could reasonably be spent.

In considering relative size, the trustees will need to establish their own criteria which should act as a mechanism to review large gifts where the information provided at the time of the gift is not specific about its use. Rather than automatically classifying the gift as income, the trustees should seek direct evidence of the donor’s intentions and consider circumstantial evidence to see if this may reasonably point to the gift being endowment. This policy should be disclosed in the accounting policy section of the notes and any changes to this policy also disclosed with reasons to justify the change in accounting policy.

It might also be possible to infer the basis upon which the donor intended a gift to be held from the nature of the property given. For example, a work of art given to an art gallery without any specific indication of the trusts attaching to the gift is likely to have been intended as an endowment, rather than as something which could be converted into expendable income by sale.

Where the trustees of a charity have decided that a gift should be treated as an addition to endowment there should be a note in the accounts. (Paragraph 72 of the SORP provides for the initial gift and all subsequent increases and decreases in the amount of any endowment funds to be distinguished in the charity's Statement of Financial Activities.)

If a gift is to be treated as endowment, any tax recovered by the charity (under gift aid or as a covenant) should also be regarded as endowment.

You should seek accountancy and legal advice as to the legitimacy of such decisions in the context of the accounts.

 

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3. No evidence, either direct or circumstantial

If there really is no evidence, either direct or circumstantial, as to the donor's intention, the gift should be applied as income consistently with the terms of the charity's governing document in a way the trustees think will benefit the charity.

You should ask Legal Services for advice in any case where it appears that trustees are treating, or proposing to treat, a gift in a manner which is not consistent with what the donor had in mind.

 

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OG 43 C1 - 14 March 2012

OG 43 C1 Risk factors for triggering regulatory intervention and scrutinising a charity's reserves policy

 

NB. Always check the charity’s case history before querying the level of reserves held by a charity. Even if the reason for the communication or case appears to be unconnected with income reserves, previous correspondence may still have a bearing on any enquiries you make.

Bear in mind that it is not for us to substitute our own judgements for those of reasonable trustees who know the business of their charity, who have taken care to plan properly, and who have justified their plans. It is very important for us to interfere as little as possible with the trustees' discretion to run the charity.

However, the funds of a charity and its reserves policy can be viewed objectively and challenged from this objective perspective.

 

1. How cases may arise

• A complaint may be received from a member of the public - either by letter or by telephone - perhaps via our Helpline.
• The subject may arise during a visit to the charity.
• A scrutiny of the accounts for an unrelated reason may reveal a potential problem.
• The charity itself may raise the question - perhaps in connection with a possible change to its objects.
• A press cutting may indicate a possible problem.
• It may come to light as a side issue in the course of unrelated correspondence or enquiries.

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2. General approach

Our regulatory stance is one where we expect charities, via their trustees’ annual report and accounts, to explain to donors and financial supporters their circumstances.

A charity should:

• tell its own story about reserves;.
• explain how its plans for reserves have changed and put their reserves in context;
• be transparent and provide information which allows stakeholders to form their own views;
• set their own reserves level for their own unique circumstances and avoid creating any artificial norms or targets that may be inappropriate.

With the economic cycle it is likely that reserves may fluctuate from year to year. During an economic downturn, giving may fall and whilst charities take action to ensure their ongoing financial sustainability, their reserves levels may fall. They may also decide to proactively dip into their reserves in order to maintain their activities to assist their beneficiaries during the downturn. Conversely reserves may rise or be rebuilt during favourable economic conditions. Some charities operate in a competitive environment where operational assets are financed by loans and so they may indeed have ‘negative’ reserves. By force of circumstances some charities may have a need for reserves but be unable to build them up and these charities may therefore be at a high risk of disruption or winding up if circumstances become unfavourable.

It is important that you approach the question of reserves with an open mind. You should not presume that reserves are a bad thing (or that the lack of reserves is a good thing). The level of reserves should be the result of a well thought out and prudent policy developed by the trustees.

Neither can you look at the level of reserves in isolation. Before making any judgement, you will need to look objectively at all the circumstances of the particular charity and consider both the regulatory risk factors and mitigating factors when deciding upon on any intervention.

Our initial approach where a complaint has been received is to refer the complainant to the charity, unless the complainant has already contacted the charity and had a response. Until this has happened it is not proportionate for us to be involved because the trustees have not had the opportunity to explain their position and justify their reserves policy.

Where the reserves issue has come to light from our own action or where a complainant, having been in communication with the charity, brings the situation to us, we would normally seek to understand the charity’s circumstances and resolve the issue through dialogue rather than the use of our regulatory powers. The case handling will be by Operations.

Only after the initial dialogue has taken place, or a fresh dialogue has taken place (if the reserves issue has come up again), and this has shown not to have addressed the matter satisfactorily, would regulatory intervention be a proportionate option (see OG 43 C2).

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3. Charitable companies

Company law does not impose an explicit duty on the directors of a charitable company to apply its corporate property within a reasonable time of receipt - see OG 43 B2. But that does not mean that a company is entitled to retain income indefinitely. Potential beneficiaries are entitled to expect that the charity's property will be applied to further its objects unless there are good operational reasons against this. The case referred to in section 3 of OG 43 P1 concerns a trading company rather than a charitable company, but it illustrates a similar principle in that the comparable expectations of the members were recognised. Charitable companies will therefore need to have a reserves policy in relation to their corporate property, and we recommend that they disclose that policy in their annual report.

Where a charitable company is a trustee of material charitable funds (normally reported as restricted funds in the company's accounts) the reserves policy in relation to those funds should also be produced.

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4. Initial action by Operations

You should check the charity’s case history for any previous cases on reserves or communication on this so that the current matter before you is placed in context of previous dealings with the trustees.

You will also need to look at the charity's governing document to ensure there is no provision which expressly prohibits the holding of reserves or, alternatively, which expressly allows this for specified periods.

You will then need to look at details of any complaint in the context of the charity's accounts and annual report - see section 5 of OG 43 B1 and sections 5 and 6 below. A first step is to consider all the funds available to the charity (see section 5 below)

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5. Looking at fund balances not included in our definition of reserves

There are three areas where a charity can normally show with authority that its fund balances are not reserves. These are where it holds endowment funds, restricted income funds or has funds represented by functional fixed assets. Although you will not normally need to examine these in detail, you need to be aware that they can hide significant reserves, for instance, if funds have been incorrectly classed as restricted (see section 5.1 below). This can sometimes be difficult to pick up from the accounts alone, but may be indicated by something in the trustees' annual report, or come to light in discussion with the charity, or be the subject of some sort of ‘whistleblowing’.

If any of the points set out in sections 5.1 to 5.5 appear to warrant further enquiry, you should seek the advice of a Commission accountant before taking any action.

 

5.1 Are funds authorised?

Has the charity created restricted income and/or endowment funds inappropriately? These can be difficult to find, although correctly produced accounts should detail the objectives of funds.

Gifts and legacies should be treated as income unless there is evidence to the contrary (see OG 43 B4). Normally such fund restrictions are created by the donor but a charity can settle property into restricted income or endowed funds if it has the power to do so.

Sometimes charities incorrectly classify designated funds created by the trustees as restricted income funds.

 

5.2 Functional assets

Functional assets are not reserves; unrestricted investment assets may be reserves (or they may be part of the charity's designated funds - see section 5.5 below). Are any assets described as functional actually investment assets - for example a property let at a commercial rate?

 

5.3 Expendable endowment

The charity may have expendable endowment funds. These funds are outside our definition of reserves because there is no obligation to spend them within a reasonable period of receipt. However, their existence may have a bearing on the level of reserves which it is appropriate for the charity to hold since the trustees are able to convert expendable endowment into income and spend it.

If there is no authority to add income to the endowment (see section 3 of OG 43 B1) and it is not spent, it should form part of the unrestricted reserves of the charity.

 

5.4 Restricted funds

A charity must use restricted funds for their specified purpose. However, there is still a positive duty on the trustees to spend those funds within a reasonable time of receipt otherwise they may be in breach of trust.

Trustees may cite proposed expenditure that could properly be met from restricted funds as part of their justification for holding a particular level of unrestricted income reserves. Where the restricted funds held back are material, this will not normally be acceptable unless these intentions are reflected in firm plans and explained in the trustees’ annual report.

(Each restricted fund is a separate trust. Any particular restricted fund may, therefore, include reserves of its own - see section 4 of OG 43 B1).

 

5.5 Designated funds

Designated funds are described in the Charities SORP as unrestricted funds designated or allocated for identifiable future expenditure. The intention of the SORP is that the future expenditure is identified and a clear reason given but you may find that trustees have designated funds but not provided clear explanations.

Where designated funds form a large part of the unrestricted funds, you should look at them in detail. If the charity's accounts have been properly prepared in accordance with the Charities SORP, they should show the value and precise purpose of any designated funds. If they do not and the amount of the funds is material, you will need to question the charity.

Purposes for which designated funds are clearly acceptable include:

• provision for a grant which the charity is not legally bound to pay but which it has a clear intention of paying;
• a repairs and renewals fund where there is an asset or group of assets clearly identified and the amount is reasonable in relation to the expected repairs account. (There may, for example, be a five yearly property inspection to which the fund builds up.) Such a fund may even have been set up on our advice - for example, an Emergency Repair Fund or Cyclical Maintenance Fund for an almshouse charity that is neither required nor authorised by the charity's governing document. (Where trustees are required or authorised by the charity's governing document to set up a fund for a particular purpose, it is restricted not designated);
• a fund to save for an event which takes place every so often and is of such a size that it cannot be financed from the income in any particular year - for example, a conference taking place every ten years;
• money put aside for a building project that is planned to be carried out in the future but for which the resources needed cannot be found all at once;
• a fund to provide for the winding down of a project where there is a strong possibility that this might happen though the exact plans have yet to be determined timing is not known. Such a fund may need to take account particularly of possible redundancy costs.

Items which might need to be challenged include:

• provision for some extremely unlikely event;
• a fund set aside to generate income to cover future expenditure (rather than to spend as income). This is because, had the money been intended for this, it would have been sought or given as an endowment;
• a sum clearly in excess of the amount required for the intended purpose, eg, a repair fund which greatly exceeds the rebuilding cost of the building.

It will not always be immediately apparent whether designation is appropriate. You will need to:

• Consider the purpose of the designation. Is it within the objects of the charity? Is it plausible? There is no point in a small charity putting aside funds for a grandiose scheme which it has no realistic chance of bringing to fruition. Equally, there is little point in a charity designating funds for minor purposes which it could expect to fund from current and future income.
• Compare the value of the designated assets with the stated purpose. Does it appear reasonable or are the two clearly at odds?
• Look at the normal income and expenditure of the charity - the charity may have designated funds for a routine purpose presently funded from current income. If so, why do they consider funding from current income will not be possible in the future?

If a charity has designated funds such that it has a nil (or very low) level of reserves, a reserves policy will still be required to explain why the trustees think this level of reserves is appropriate.

Often such consideration will be inconclusive, but where it suggests that the designated assets might be significantly greater than is needed to discharge the purpose or project for which they are designated, or where the purpose itself seems bogus or unrealistic, you should seek advice from a Commission accountant before communicating with the trustees.

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6. Initial action, consider the reserves levels and policies

As a first step consider the following 5 matters when considering the reserves or handling a complaint about a charity’s reserves.

Once you have concluded your review take the advice of a Commission accountant before communicating with the charity trustees. The Commission accountant can confirm that your analysis is reasonable and findings justified by the information available to you.

 

6.1 Reserves policies

Section 3 of OG 43 B2 reproduces our guidance to trustees on the importance of having a reserves policy and how it should be formed. The policy should be explained in the trustees’ annual report – CC19 sets out what information we consider should be included. SORP paragraph 55a sets out the required contents for the annual report.

Does the policy seem to be in line with our guidance and realistic? Does the level of reserves seem reasonable in relation to the stated policy? Does the complaint made about the reserves policy or the level of reserves seem fair?

 

6.2 Possible reasons for holding reserves

Any item mentioned in section 5.5 above as being a valid reason for a designated fund could also be regarded as valid for an element within a charity's reserves policy. In addition, a charity may need to maintain reserves at a certain level in order to:

• protect against a decline or interruption of future sources of income - discretionary grants, for example, may cease, or be reduced, and new sources of revenue have to be found;
• provide for regular fluctuations in income and expenditure - incomings and outgoings are unlikely to coincide exactly. Money may need to be set aside to meet regular quarterly or annual bills. Income may peak at a particular time of the year - perhaps as a result of a regular and successful annual appeal - and need to be set aside to cover leaner months;
• ensure continuity in its provision of a service. The service provided by many charities is an integral and essential part of the lives of beneficiaries. To have to withdraw or cut back with little or no notice could cause very real hardship;
• assimilate an abnormally large windfall profit (one which perhaps fell just short of being capable of being treated as a partial return of capital investment).

Trustees need to decide what level of reserves are reasonable and appropriate for their charity and keep that policy under regular review.

 

6.3 Working capital

The only item which you might find in reserves which should clearly not be found in a designated fund is a sum to cover working capital. (Working capital is that amount of funds needed by the charity to enable it to pay debts (creditors and loans) as they become due, and to finance stocks and debtors.) All of these are identified within the current assets and liabilities on a charity’s balance sheet.

The amount of working capital that can be justified will vary from charity to charity. As a very general guide, few people would take issue with working capital levels representing three to four months gross expenditure. More than this could probably be justified if, say, grant income arrived in six-monthly or twelve-monthly amounts. But this is a matter for consideration by the trustees. There is no ‘norm’; many charities have very little working capital and some will rely on an overdraft or short term loans to provide this. What is important is that the level has been properly considered and is reasonable in relation to the needs and particular circumstances of the charity.

Accountants are best placed to give guidance in this area.

 

 

6.4 Indications that reserves may be excessive

The following are indicators that reserves may be excessive. But, again, these figures are not ‘norms’ – trustees cannot avoid the need to consider and justify their position merely by ensuring their reserves are within these limits:

• reserves in excess of three years’ expenditure;
• the expected income return on unrestricted investments is significantly above the charity's current gross annual expenditure - say, more than twice as much. (In the event of a ‘total return’ approach to investment being adopted (see section 1.5 of OG 43 B2), the trustees are responsible for identifying how much of the return is spent in the year and how much is retained to meet the needs of future beneficiaries to fulfil the duty of even-handedness. If little seems to be being spent this may indicate that current beneficiaries are being detrimentally treated and that any reserves shown in the accounts and the amount of unapplied total return remaining require our scrutiny.)

As indicated above, this guidance should be treated with extreme caution. These are a guide to what you might expect to see, not hard and fast rules. Reserves set at this level are not right for every charity; holding reserves considerably less than this level may well be excessive, and reserves of considerably more could also be justified and prudent. You must take into account the circumstances of the particular charity you are dealing with, and the considered views of its trustees. For example:

• a charity with significant endowments and a steady and reliable income from property or other investments may need minimal reserves;
• a charity with a less reliable source of income - perhaps depending heavily on donations from the public - may need reserves as a hedge against fluctuations in this income;
• the objects of the charity and its activities will also affect its need for reserves. An endowed grant-making charity might easily be able to plan and control its expenditure in line with its income. A charity which responds to emergency situations may need considerable reserves to ensure its ability to respond immediately to costly and unpredictable demands for its services;
• a charity whose expendable endowment has grown significantly above inflation may consider that this growth provides an appropriate underpinning to their activities without the need to establish any reserves. (Trustees, of course, have the power to convert endowment into income.)

 

6.5 Indications that reserves may be too low

It is quite difficult to identify charities with reserves that are too low. Many charities have little or no working capital but this may not be a problem. (However, too low, or no, reserves may indicate financial difficulties for the charity.) Particular areas where low reserves are not a problem are where:

• an endowed grant making trust spends all of its income each year; or

a self help charity with no staff uses up all of its income each year.

Where charities are believed to have low reserves, it is important to get a feel for whether this is a regular state of affairs or one that has developed over time. Analysis of several years' accounts is needed in these cases.

Situations where a charity's reserves are too low are likely to include those that hold little or no reserves but have continuing commitments, such as:

• assets to maintain;
• employees;
• continuing programmes.

An aggravating feature is if the charity also has an unreliable income stream. A charity with these sorts of commitments needs to have a few months’ expenditure in hand in order to be able to comfortably carry on business.

The main problem with reserves that are too low is that the charity spends much time and effort dealing with the lack of working capital (chasing grants, dealing with irate suppliers, etc) rather than getting on with the main purposes of the charity. There is also a danger that the charity will not be able to continue working and, in a non-company charity, the trustees may face a greater risk of having to make payments from their own resources.

On the whole, trustees are well aware when reserves are too low. In this case the reserves policy should indicate this and explain what, if anything, the trustees are doing about it - it is still appropriate to specify a level of reserves that the trustees believe they should hold. If trustees are not aware there is a problem then we might wish to take action to ask them to consider producing a reserves policy.

There are many charities with low reserves that manage to continue from year to year without remedying the reserves problem. In these circumstances, provided the trustees demonstrate through the annual report that they are aware of the charity’s situation, then there is no reason for us to take further action.

Where the situation is serious, a case officer should consider whether the charity needs advice on managing financial difficulties, and our publication CC12 may help.

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7. Opening the dialogue about the level of reserves

If, having looked at the charity's accounts, you are unsure of the position, or you have reason to consider that the charity's level of reserves may not be justified, you should check with a Commission accountant.

Once you have:

• carried out your initial review of the charity’s reserves policy;
• considered the level of current reserves;
• reviewed the factors that may affect the level of reserves;
• considered any information provided in a complaint, and;
• obtained accountancy advice;

you are in a position to contact the charity trustees.

In the initial dialogue, either by setting out a summary of your findings or the contents of the complaint, informing the trustees of the issue(s) where an explanation or clarification is needed.

Ask the trustees to explain their reserves policy in detail - if necessary providing them with a copy of CC19. The best way of doing this will depend on the circumstances of the case, but may be by letter, email, telephone call, or exceptionally, by visiting the charity.

It may be that, rather than an overall reserves policy, there is some specific use for the income being retained. To establish this, ask whether the trustees do in fact have any clear plans for the funds, requesting details of:

• the purposes for which the money will be used;
• how these will further the charity's work;
• the amount of funds needed; and
• when they expect to carry out the activities concerned.

Ask the trustees to let you know if they are experiencing difficulties in applying the income - perhaps because of limitations on the charity's area of benefit, or because of a significant decline in the number of beneficiaries. You can point out that this is something that we can assist with by advising on amending the relevant provisions in the charity's governing document. Alternatively, we could advise trustees if they are considering transferring resources to another charity with similar purposes.

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8. Follow-up action

Depending on their reply, you may need to challenge the detail of the policy. Does it:

• accord with the guidance set out in this OG and CC19;
• sit easily with any future plans outlined in the charity's annual report;
• take account of a realistic estimate of future income and expenditure, and any restricted or designated funds already set aside?

If, having considered the trustees' response, you consider the charity’s reserves are excessive or if you are still unsure whether the reserves policy is justified, you should take accountancy and legal advice.

If this advice confirms that the charity's reserves appear to be excessive or too low, see OG 43 B2.

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9. Governing document prohibits holding of reserves

Where the trustees can, in fact, make a sufficient case for holding reserves, but there is a clause in the charity's governing document which prohibits them from doing so (although this is unlikely to be the case), we will need to consider whether Scheme action (or action under s.280 of the 2011 Act - the statutory power of amendment for unincorporated charities) should be taken to rectify the situation. (See section 1.2 of OG 43 B2 which explains the need for an express or implied power to hold reserves.)

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OG 43 C2 - 14 March 2012

OG 43 C2 The use of our regulatory powers and charities judged to have reserves inconsistent with our guidelines

 

1. Liaison with trustees

If professional advice confirms that the charity's policy or practice on reserves is inconsistent with our published guidelines, you should attempt to secure the trustees' agreement that they will comply with those principles in future. For many charities, the fact that we have noticed the level of reserves and asked for something to be done about them will be sufficient to persuade the trustees to rectify the position.

If this is not the case, you may need to consider offering to meet the trustees and/or their professional advisers to discuss our concerns in detail - this will often be the most effective way to deal with the issue. In this case, be careful not to give the impression that we are satisfied with explanations if we are not. You should always follow up the visit with a letter explaining our post-meeting position.

If such liaison has proven unfruitful or the charity has a history of ignoring our advice on reserves and/or has failed to adequately disclose and discuss its retained reserves and reserves policy in the trustees’ annual report, then our intervention may be a proportionate response.

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2. Amendment of charity's governing document

You may need to help the charity widen its objects or otherwise change its constitutional arrangements in order to help the trustees to spend resources that are excessive. Alternatively, we could advise trustees if they are considering transferring resources to another charity with similar purposes.

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3. Requests from charities for us to intercede with a third party

You may receive a request from a charity to intercede on their behalf with a third party who considers their level of reserves to be inappropriate. For example, the charity may have been refused a grant by a funding institution on the grounds that their reserves are so high that they do not ‘need’ extra funding, or that they are so low that the charity is unstable. Alternatively, the charity itself may be being pressed to fund a project by reducing its reserves to a level the trustees consider imprudent.

We cannot intercede in any individual case. However, there may be instances where some general advice or guidance from us could be warranted – perhaps where a large funding institution, such as a local authority, was taking a line very much at odds with our policy. You should always seek accountancy advice before responding to a request of this sort.

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4. Risk factors as triggers for regulatory intervention

Exceptionally, where advice and encouragement have failed to persuade trustees to modify their policy in line with the principles set out in CC19 Charities’ Reserves, we may need to consider whether there are grounds for intervention into its affairs.

Such cases are likely to be rare and you should always seek legal and accountancy advice at as early a stage as possible.

 

You will need to consider all the circumstances of the case along with the following risk factors:

• the charity has declined our previous request to explain its reserves policy and justify the level of reserves held in spite of our encouragement;
• from the evidence available, the charity appears to have misused designated funds or altered its target for reserves to conceal a growing accumulation of funds without providing a satisfactory explanation to justify any fund designations or any change made to the target reserves level;
• the level of reserves in the context of the charity’s recent activities currently appears, based on the latest information filed with us, excessive and is not satisfactorily explained;
• complaint or complaints received about the charity’s fundraising literature and campaigns provide evidence that the charity has misrepresented the charity’s financial position concerning its reserves and this misrepresentation can reasonably be construed as deliberate (as opposed to accidental) deception of donors and potential donors;
• the charity has a history (demonstrated by annual accounts or Annual Return data for more than three years) of accumulating unrestricted funds without a power, the accumulated funds are material, and are not satisfactorily explained and justified by its reserves policy;
• there are no mitigating factors that mean that intervention would not be helpful and in the charity’s interest or the interests of the public or the charity’s beneficiaries.

Having considered the risk factors, now consider the mitigating factors. It is a question of judgement and, central to your decision, is the potential damage to the reputation of the charity and public confidence in the sector if the situation continues unchanged. A subsidiary question is the implication for our regulatory role if trustees continue to disregard and ignore our advice but this should not be the conclusive or deciding factor in reserves cases. Having considered the reserves issue, the information available, your analysis and findings, any communication with trustees and the presence of one or more of both risk factors and mitigating factors, decide whether to;

• close the case;
• consider enforcement action, or;
• continue the dialogue with trustees.

We will normally intervene and consider enforcement action where two or more of the risk factors are present and there are no mitigating factors present.

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5. Mitigating factors that may mean our intervention would not be proportionate

Mitigating factors may be in place where reserve levels, which might otherwise appear disproportionate and merit our intervention, would not justify an intervention because the intervention would either be disproportionate or would not promote a beneficial outcome. These mitigating factors are:

• the charity is not of sufficient size or public profile to justify regulatory intervention and its non disclosure or its reserves position will not have significantly detrimental impact to public confidence in charity;
• the excess reserves are fairly presented without distortion and the charity is transparent about its financial position to its donors and financial supporters and other stakeholders in all its communications and the annual report;
• the charitable objects of the charity are so specific and constrained that the application of our cy-pres powers is unlikely to materially affect the situation; and
• the trustees are aware of the excess reserves and are reasonably attempting to address this through a review of the charity’s operations and activities.

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6. Referral for regulatory intervention

Where advice and encouragement have failed to persuade trustees to modify their policy in line with the principles set out in CC19, and two or more of the regulatory risk factors are present (and there are no mitigating factors present), Operations should consider what enforcement action might be appropriate. This need not necessarily involve a formal section 46 statutory inquiry.

Such cases are likely to be exceptional and you should always seek legal and accountancy advice.

 

The likely effectiveness of a range of sanctions will need to be considered. Depending on the circumstances, these might include:

• an Order under section 84 directing the creation of a reserve or an Order under section 85 to secure a proper application of charity property;
• suspension or removal of trustees;
• vesting of property in the Official Custodian;
• the appointment of an interim manager; or
• new constitutional arrangements.

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7. Publicity

The effectiveness of public criticism as a sanction (with or without the support of other sanctions) should not be overlooked. This might involve liaison with Press Office to consider suitable options - you will need the approval of your Head of Function before exploring this possibility.

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OG 43 P1 - 15 May 2009

OG 43 P1 Precedents - Trustees' duty to apply incoming resources 

 

None of the precedent cases set out in this OG relate to a particular charitable institution as such. However, precedents 1 and 2 illustrate the trust law principle that the incoming resources of a trust should be applied within a reasonable time of receipt. Although there is no directly similar case involving a company, precedent 3 illustrates the analogous principle that the incoming resources of a company should be used to further its objects.

 

1. A-G v Alford

In the case of A-G v Alford (1854) 4 De G,M & G 843 there was a gift of capital to a trustee on trust to apply the income for relief in need purposes. The trustee was clearly considered to be in breach of trust for failing for 13 years actually to apply any income of the trust for those purposes, and the case clearly supports the proposition that charity trustees ought to apply the income of the trust for the purposes of the charity within a reasonable period of receipt.

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2. Private discretionary trusts

More modern precedents exist in cases relating to private discretionary trusts. The duties of the trustees of such a trust are, in this context, essentially the same as those of the trustees of a charitable trust. The trustees have a duty to apply the trust income for the benefit of a class of individuals, or a class consisting of individuals and charities or other institutions, in such proportions as they decide.

In re Locker's Will Trusts (1977) 1 WLR 1323, the trustees were required to distribute the income of a discretionary trust between a number of individuals and charitable and other institutions. The trustees were slow to do so. Goulding J said:

‘It is common ground that it was the duty of the trustees to distribute the trust income within a reasonable time after it came into their hands …. In the case of a compelling trust to distribute income the failure to execute the trust promptly is an unfulfilled duty still in existence.’

The judge referred to an earlier case, Re Gourju's Will Trusts (1943) Ch 24 in which Simonds J had said in relation to the discretionary trusts in s.33(1)(ii) of the Trustee Act 1925:

‘A further question is raised upon this summons, which involves the construction of the Trustee Act 1925, s.33(1)(ii), that is whether, the discretionary trust having arisen, under the terms of that section the trustees may retain all or any part of the income, if they think proper, and postpone the application thereof for so long as they think fit; or, alternatively, whether they are bound to expend in each year the income of that year for the purposes indicated in the subsection. The language of the subsection appears to be clear. The obligation is to apply the income:

‘…. for the maintenance or support or otherwise for the benefit of …’

all or any persons indicated. Following the decision of Eve J, in Re Peel, I think I must come to the conclusion that the obligation of the trustees is to apply the trust income as and when they receive it for the purposes indicated in the subsection, with, of course, such necessary limitations upon absolute obligation as the practical necessities of the case demand. Putting it in a negative way, they are not entitled, regardless of the needs of the beneficiaries, to retain in their hands the income of the trust estate.’

It is clear from the words in italics that the understanding of the nature of the duty to apply the income of a trust promptly takes account of the fact that income may need to be retained in order that the trustees can properly discharge the purposes of the trust.

There was more explicit focus on this issue in the case of Re Berkley (1968) Ch 744. In this case the rights of a beneficiary to receive trust income were held to have been properly postponed by the trustees. They needed to retain that income in order to guard against the risk that an annuity, which was charged on the trust income, might, in the future, need to be paid partly out of retained income if current year trust income was not sufficient.

The process was not considered to be an accumulation of income (that is the conversion of income into capital) - had it been it would have been prevented by statute. It simply involved the exercise of an implied power of the trustees to retain income where that was considered necessary in order to be able properly to carry out the objects of the trust.

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3. The corporate property of a charitable company

Legislation exists to enable a company to be compulsorily wound up on just and equitable grounds.

In re A Company No 370 of 1987 (1998) 1 WLR 1068, it was recognised that the members of a trading company had a legitimate expectation that the profits of a trading company would be distributed by way of dividend, except to the extent that a business case existed for the retention of the dividends in the company.

The parallel legitimate expectation in the case of a charitable company would be that its incoming resources would actually be used to further its objects.

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