Navigating the rocky shores of “control” where a Church may exercise some power over other organisations and the implications that may result in the need for consolidation of accounts and a change in the reporting tier used by that Church.
Many of the most famous charities today have a history that trace back to the Christian Church in some way or other. Think of the Salvation Army, World Vision and the YMCA. But there are plenty of other less famous examples of trusts scattered throughout the cities, towns and communities of New Zealand which originated because someone who attended a Church had an idea and it was then taken on board and supported by the Church.
Those charitable trusts are often doing truly amazing front line work with people out in the community who really need different types of support. They are incredibly wide ranging from helping children, women, the poor, mentally challenged and those with drug or other addictions (to name just a few). Sometimes those trusts are completely independent and separate to the originating Church. Others advance similar purposes to the Church itself or work in the same geographic area. Sometimes they may even generate income which goes back to the Church (through day care centres or cafes). They may also provide in the governing documents that the Church itself (usually through its elders) has the ability to appoint or remove trustees of the charitable trust.
But what does all this mean when you look at the (relatively) new rules that can require financial consolidation of different entities together? Often it can be difficult to navigate the tricky waters that govern this area. Could the Church actually “control” the charitable trust through trustee appointment rights and are they related parties? Most importantly, if there is a situation of control then it may be that financial accounts consolidation is required by the two related entities and that this will then trigger their qualifying for a different set of reporting requirements if they cross over into a higher threshold of income. In this article we will look at what the rules are, what the guidelines tell us and then offer some practical examples of a few different scenarios and how they might be treated.
Part A: What are the accounting standards that apply?
Before looking at the applicable standards that apply let’s first take a look at the different reporting tiers. There are 4 of them ranging from Tier 1 which require full disclosure for larger charities whereas Tier 4 has minimal disclosure. Put very broadly the categories have the following key elements and monetary thresholds:
Tier 1: Full disclosure standards, over $30 million annual expenses;
Tier 2: Reduced disclosure, under $30 million annual expenses;
Tier 3: Simpler reporting but on accrual basis, under $2 million annual expenses; and
Tier 4: Simple format reporting on cash basis, under $125,000 annual operating payments.
The point at which the differences in the tiers become really critical is the distinction between tier 2 and 3 – that is, if an organisation has annual expenses of under $2 million but then is required report on other entities that it controls that could lift its totals to above $2 million. That would result in higher compliance cost and reporting being required and it is that situation and what constitutes control that is the subject of the rest of this article.
When it comes to Charities, it is also important to look at what Charities Services have said about this issue. In their guidance accessible here they state:
“If a Tier 1, Tier 2 or Tier 3 registered charity has control relationships with other organisations, these organisations are considered part of the charity’s reporting entity. Charities in this situation will need to include information about these organisations in their performance reports by providing consolidated financial statements and submitting these consolidated financial statements to Charities Services together with their annual returns.”
The standards are issued by the New Zealand Accounting Standards Board (NZASB) under section 24(1)(a) of the Financial Reporting Act 1993. The particularly relevant standard which we will look at here is IPSAS 6 – Consolidated and Separate Financial Statements.
While we have not gone into them in detail below (because they echo much of what follows in this part) the other two documents that should be on your radar when researching the regime that applies in this area are EG A8 – The Reporting Entity, and EG A9 – Identifying Relationships for Financial Reporting Purposes. We have also written a separate article about Accounting Standard (IPSAS) 20 – Related Party Disclosures regarding what it provides about disclosure of related parties so contact us if that is of interest.
IPSAS 6 – Consolidated and Separate Financial Statements
This standard notes in paragraph 1 the following about the reason it exists: “An entity that prepares and presents financial statements shall apply this Standard in the preparation and presentation of consolidated financial statements for an economic entity.”
Paragraph 39 states: “The definition of control under this Standard requires, subject to two limited exceptions, that there be both a power element and a benefit element…” . The paragraph goes on to note that there is a rebuttable presumption of control where there is the following power: “A unilateral power to appoint or remove a majority of the members of the governing body of an entity.” Based purely on this if a Church has the power to appoint the trustees it looks like there could be a strong argument that there was control (of course it depends on the facts – for example, perhaps the Church can only appoint 1 of 5 trustees).
Whether or not there is a benefit to the Church is also a criteria that needs to be met to show control. Even if there is a power element that is proven can it be said that the Trust provides a benefit to the Church? This will likely come back to the purposes of the Trust and how it fits within the scheme of the ministries of the Church. Paragraph A31 of the guidance notes: “it is common for special entities such as trusts to be established to provide certain services to support the operating objectives of another entity. In such circumstances, a controlling entity may benefit from complementary activities”. Is the Trust considered another arm of the Church itself that is used to reach out to the community or is it considered to be distinct and separate? This will need to be analysed in each situation to determine if there is some benefit to the Church or not.
Paragraph A6 of the guidance in the appendix to this standard draws out another dimension as it specifically talks about trusts and raises the idea of a fiduciary relationship. It states: “In the case of trusts, careful consideration is required to determine whether the relationship between an entity and a trust is such that the entity has control over the trust. If the entity’s only relationship with the trust is as a trustee of the trust, the entity is unlikely to have control over the trust because its relationship with the trust is likely to represent a fiduciary relationship rather than an ownership relationship (refer to paragraph A11).”
This goes on to note a different point which is worth also considering: “Where the entity is a beneficiary of the trust and has the ability to direct/determine the operating and financing policies of the trust (or those policies have been irreversibly predetermined), for the benefit of the entity, as a trustee of the trust or by way of an autopilot mechanism.” It is easy to imagine the scenario where a Trust does benefit the Church along the lines of that description with policies irreversibly predetermined and so there could be control.
Returning to the mention of fiduciary relationships in paragraph A6 above, could this also be used as an argument that any trustees appointed to the trust are in fact acting for the best interest of the Trust they have been appointed to? Paragraph A11 of the same guidance seems to allow for this possibility as it states: “The decision-making power of a trustee does not meet the power element of the definition of control. While a trustee may have the ability to make decisions concerning the financing and operating activities of the trust, this ability is governed by the trustee’s fiduciary responsibility at law to act in the best interests of the beneficiaries of the trust.“
It is likely that the circumstances of appointment and overall context will need to be examined to determine whether there is actually control or not. For example, one aspect we have not gone into here is what happens on a winding up of the Trust – do the assets go back to the Church (or could they)? That could impact the analysis as well. But the main point to make is that if there is control and a benefit to the Church then this could mean that consolidated reporting in accounts will be required. Knowingly failing to report according to the financial standards can also result in a maximum $40,000 fine.
Part B: What does Charities Services have to say?
In the guidance issued by Charities Services there is some commentary on the issue of what they consider control to be. Let’s take a look at that before we turn to an analysis of some hypothetical scenarios which could face Churches.
Regarding control Charities Services summarise the key elements already mentioned and analysed above in the following short form:
“Control for financial reporting purposes is the power to govern the financial and operating policies of another organisation in order to benefit from its activities. There must generally be both power AND benefit for a control relationship to exist. The benefits can be both financial and non-financial in nature.”
They go on to specify the following as indicators of power and benefits:
Indicators of Power:
- Ability to veto, overrule or modify decisions of organisation’s governing group.
- Appoint or remove members from the organisation’s governing group.
- Set or modify policy about how revenue is raised or how money is spent by the organisation;
- Close or wind up the organisation.
Indicators of Benefit:
- Receiving all or a portion of the organisation’s profits/surplus, or even being responsible for the organisation’s losses (negative benefit),
- The organisation provides goods or services which contribute to the charity’s objectives.
As you can expect their conclusion is tied in with how difficult a judgement call often can be:
“Determining whether charities have this control relationship can be complex. It involves an exercise of judgement, after considering the definition of control and the nature of the relationships between the organisations concerned. Control of an organisation can be attained in a variety of ways, and the underlying circumstances will vary.”
It is perhaps also worth noting the following comment about the interaction between the Charities Act 2005 and the accounting requirements being discussed here. The document EG A 8 – The Reporting Entity, states this at paragraph 14 and 15:
“The Charities Act 2005 permits entities that are affiliated or closely related to register as a ‘single entity’ and Charities Services decides how those entities are to report. For the purposes of the Charities Act 2005, the entity that requests the registration and treatment of several entities as a single entity is described as the ‘parent’ entity. This is the entity that Charities Services deals with for the purposes of the Charities Act 2005.
The term ‘parent’ entity in the Charities Act 2005 is not necessarily the same as a ‘parent’ entity (or ‘controlling entity’ as it is referred to in PBE Accounting Standards) for the purpose of preparing financial statements in accordance with GAAP. A ‘parent’ or ‘controlling entity’ for financial reporting purposes is an entity which has one or more controlled entities.”
Part C: Analysis of different hypothetical situations
In what follows we have tried to think of three different hypothetical scenarios in order to illustrate how some of the concepts already discussed could play out in reality. Of course these are made up situations to emphasise certain points. Every situation will be unique and so you need to look at all the circumstances to perform a proper analysis and determine the likely outcome. But it is hoped that this will give a feel for the different permutations which can exist in this area. As well as this you can start to see that there are different models which can be adopted which will be more or less likely to raise issues when considering if there is really control.
Scenario 1: Full control
Church elders appoint or remove all trustees of the charitable trust. This ensures that the Trust continues in the direction that the Church intends. The Trust performs a role which aligns very closely with the mission of the Church (advancing religion) and operates out of the Church facilities. The Senior Minister of the Church is also the Chair of the Trust and most of the trustees are elders of the Church or at least attend the Church.
Analysis: In this situation there are clear indications that the Church is in control of the Trust. While the use of the same facilities is probably not so important it is a symptom of the other clues here – the ability to appoint and remove trustees, the blurring of the leadership of the Trust and the Church, the purposes basically being the same. It seems very likely that this would result in a need for consolidation of the accounts (but it depends on all the circumstances).
Scenario 2: Some control
Church elders appoint 2 of the 5 trustee positions of the charitable trust. While it operates in the same geographic area and the Church refers people in need to the trust they are focussing on different purposes to the Church. The Chair of the Trust is appointed by the other trustees and currently that person attends a different Church.
Analysis: This is likely the scenario which is most closely aligned with reality – it is more of a ‘grey’ area which is where reality often sits in between the two extremes above and below. In this situation there is still some involvement by the Church in the Trust and yet it also has moved to be more independent. To provide a conclusion we probably need additional information (for example whether the Church receives any benefit from the Trust) but based on this factual situation presented it looks like the Church probably does not control the trust so there will not be a need to consolidate the accounts.
Scenario 3: Little control
The Church has no control over appointment or removal of trustees. The Trust purposes (advancing education for disadvantaged children) do not align with those of the Church. The Trust has spread beyond the original boundaries of the geographic area of the Church and now works throughout New Zealand. All the Trustees involved come from different areas and none attend the Church.
Analysis: In this situation there is clearly no control by the Church over the Trust. While it may have its origins in that one place it has moved on from those origins and now operates independently so there is no real question of needing to consolidate accounts in this situation.
We hope that this overview of the key issues to think about when looking at the issue of control has been helpful. Every situation is unique and cannot be looked at in isolation. While some elements may be present that indicate control others may not be present. It pays to discuss the situation with your advisers in order to be able to come to the right conclusion and ensure that your organisation is reporting under the correct tier.
And a final word…
We often find that clients who are looking into this area realise two things. Firstly, that records for the Trust are poor and need to be improved going forward and secondly that the original documents which they have were often written decades ago and can be outdated in terms of their terminology and language. Often they are difficult to understand. Sometimes processes that were meant to be followed have never been looked at – eg how to appoint trustees. Such documents can very often use a refresh in terms of presentation and ensuring they are easier to understand. Very often the purposes themselves (which are the core of what the entity stands for) will still be applicable and need little amendment but it may be appropriate to look at updating the rest of the document.
This article is not a substitute for legal advice and you should talk to a lawyer about your specific situation. Reproduction is permitted with prior approval and credit being given back to the source. Contact Steven Moe at email@example.com to request this or for any other questions.
Copyright © Parry Field Lawyers 2017.