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Private Ancillary Fund (PAF) for making charitable gifts and donations to deductible gift recipients (DGRs)
In Part 1, we concluded that if you are considering making a charitable gift, there is merit in you making the gift before you die, rather than your estate making the gift postmortem. The reason is tax.
In Part 2, we now demonstrate that the use of your own private charitable foundation (the ATO terms this a Private Ancillary Fund – PAF) can further optimise the net outcome for you. This is achieved by delinking (a) the timing of when tax deductions are obtained from (b) the timing of gifting to charitable causes. This can enhance not only your personal position but also the net benefit available to distribute amongst charitable causes.
Private Ancillary Funds
A PAF is in essence your own investment vehicle that allows you to set aside capital for the specific use of making charitable gifts and donations to deductible gift recipients (DGRs).
Once it has been endorsed by the ATO, a PAF provides two main tax advantages,
(1) contributions to the PAF will be tax deductible, and
(2) accumulated earnings from capital within the PAF are exempt from taxation.
At a high level, amongst other requirements, a PAF must:
a. be a trust with a corporate trustee;
b. be operated on a not-for-profit basis;
c.have governing rules in place;
d. have a ‘responsible person’;
e. not indemnify a trustee, employee or officer for loss attributable to certain conduct; and
f. distribute at least 5% of its net assets, or at least $11,000, each year to DGRs.
How a PAF ought be used
A PAF provides the opportunity to separate the timing of when a tax deduction can be obtained from that of when distributions are made to charitable causes. Otherwise, the tax deduction can only be claimed within the same financial year as when the charitable gift or donation is made.
The use of a PAF opens up the potential to contribute and claim tax deductions when it is most tax effective to do so, i.e. in years when a personal taxable income is higher, which in turn increases the value of the deduction.
It also allows for the ability to stagger and manage distributions to charitable causes over time, to cater to your individual preferences.
A PAF may also allow for a more tax effective accumulation of capital, due to the tax-free nature of asset earnings. If the earnings can sustain a rate of return that is higher than the flat distribution rate of 5%, both the capital and subsequent years’ distributions will continue to grow.
They own a rural property, in joint names, that has served as a holiday home for many years but, with their adult children pursuing careers interstate, the property is seldom used. They have decided to sell the property and set aside the proceeds for now. There is $400,000 of taxable capital gains they will incur on the sale of the property.
If they establish the PAF prior to selling the property, they will be able to donate $200,000 from the property sale into the PAF. This will give them an immediate $200,000 tax deduction.
They have:
1. Set aside the $200,000 for charitable gifting in the future;
2. Established an investment fund that will grow in the future; and
3. Saved more than $70,000 of otherwise payable tax.
Less effective uses of PAFs
We have become aware of clients being informed of some ancillary advantages of PAFs. For the benefit of a full discussion, we have included these. But we do caution that these are merely incidental benefits and should never be the primary purpose for which a PAF was established.
- A PAF as a learning tool. The objective here is for families to encourage family members to take an interest in not only philanthropy but also finance and investment.
- A postmortem PAF. Certainly, a PAF can be established under a will rather than during a lifetime. Whilst certainly true, this then perpetuates the same issue that we raised in our prior article. That is, the estate won’t be entitled to a full deduction, and it is therefore sub optimal from a taxation perspective.
Conclusion
We are seeing an increasing number of estate plans and wills that include various provisions for bequests to be made. Often the intent of the deceased has been to support specific causes, and sometimes, but not always, specific charities have been named.
This approach often misses the opportunity for effective tax deductions. The value of these can either accrue to the donor or increase the capital for the charitable cause.
A PAF is a sensible structure that successfully blends tax efficiencies with philanthropy.
If you wish to consider adding a PAF to your wealth management structure please contact your First Samuel Private Client Adviser.
If you want to know more about how we can help you manage your taxes, talk to your
Private Client Advisor or book an obligation-free consultation.
Read last month’s Wealth Intelligence: Better Tax Management with charitable giving.
Interested to learn more? Read Trusts: Understanding Appointors and Successor Appointors
The information in this article is of a general nature and does not take into consideration your personal objectives, financial situation or needs. Before acting on any of this information, you should consider whether it is appropriate for your personal circumstances and seek personal financial advice.
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