OPERATIONAL GUIDANCE

ENDOWED CHARITIES: A TOTAL RETURN APPROACH TO INVESTMENT SERIES

GLOSSARY

OG 83 G1-30 May 2001

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Capital gain means the difference between the purchase price of an asset, and the higher price at which the asset is sold or re-valued, and capital loss means the difference between the purchase price of an asset and the lower price at which it is sold or re-valued.

Endowed charity means a charity which has some assets held on trust for investment (capital).

Investment assets are any assets held by the trustees for the purpose of producing an economic return for the charity through the process of investment.

Investment fund means the resources which represent the value of the gifts to the charity held on trust for investment (capital), and any other additions to those resources which are not the result of investment, plus that part of the unapplied total return which, consistent with discharging the duty of even-handedness, cannot be allocated to the trust for application (income).

Investment income means the returns from investment which are "income" under the standard rules.

Investment return, means the return from investments which represent the assets given to the charity on a trust for investment (capital) and includes:

• any interest receivable; plus

• any net rent and other income or gains derived from the use or exploitation of assets; plus

• any dividends; plus

• all forms of capital gain resulting on, or from, the disposal, redemption, or revaluation of investment assets (including the issue or repayment of share or loan capital); less

• any capital losses resulting on or from the disposal, redemption, or revaluation of investment assets.

The Statement of Recommended Practice on Reporting and Accounting by Charities ("the SORP") continues the previous requirement that investment assets will be reported in a charity’s balance sheet at market value. This will mean that retained investments will need to be re-valued at least annually.

Investment return does not include

• the value of the original gift that established the endowment;

• the value at the time they are received of any additional gifts which have been added to the endowment; or

• the value at the time of any additions to the endowment which is the result of the use of a power of accumulation; or

• the value at the time of any additions to the endowment which is the result of an order of the Commissioners or the court that certain assets should be treated as part of the endowment.

Negative investment return A charity will have a negative investment return in a particular financial year when its losses on the realisation and revaluation during that year of assets held on trust for investment (capital) exceed the total of the gains on the realisation and revaluation during that year of assets held on trust for investment (capital), plus the value of the rent, interest and dividends which the charity has received during that year.

Negative total return A charity will have a negative total return at any time when the resources in its permanent endowment fund are worth less than the total of:

• the value of the original gift that established the endowment ;

• the value at the time they are received of any additional gifts which have been added to the endowment; or

• the value at the time they are received of any additions to the endowment which are the result of the use of a power of accumulation; or

• the value at the time they are received of any additions to the endowment which are the result of an order of the Commissioners or the court that certain assets should be treated as part of the endowment.

Permanent endowment is defined in the Charities Act 1993 as assets which may not be expended for the purposes of the charity without distinction between capital and income. Even though "unapplied total return" may be allocated to the trust for application (income) it is still "permanent endowment", because it cannot be freely allocated to the trust for application (income). It can only be allocated to the trust for application (income) if the trustees are satisfied that to do so would be consistent with discharging the duty of even-handedness.

Results of investment means an incoming resource which has been produced by the investment of an asset, as distinct from an incoming resource which is a gift.

Standard rules means the trust law rules which govern the allocation of investment returns (between capital and income) from a trust for investment (capital). These rules have been developed to ensure that the interests of all beneficiaries (present and future) are protected.

The rules have been criticised for failing to keep pace with developing investment practices. Generally speaking, the rules dictate that interest, rents and licence fees, and cash dividends from a company carrying on a business are income and are subject to a trust for application (income). Capital gains, and dividends paid on the liquidation of a company are capital and are subject to a trust for investment (capital). Further information on these rules and the way they apply to non-cash distributions by a company can be found in a trust law textbook.

Statutory thresholds means the provisions of the Charities Act 1993 and the Charities (Accounts and Reports) Regulations 1995 and 2000 which impose legal duties by reference to the amount of "income" which a charity has in a particular financial year.

Total return means the whole of the investment return received by the charity, regardless of when it has arisen.

*The initial calculation of the total return may have to be performed in accordance with guidance set out at section 1.2 of OG 83 B1.

Total return approach to investment is an approach to investment which gives trustees flexibility in the way they allocate the total return realised from the trust for investment (capital). Funds are invested for the best total level of economic returncompatible with the trustees’ duty to make safe investments, but regardless of the form (either capital or income under the standard rules) which the return takes.

A trust for application (income) attaches to charity property which the trustees have to apply for the purposes of the charity within a reasonable period of receipt (ie the income of a charity).

A trust for investment (capital) is created when a donor to the charity has indicated that his gift should not be directly applied for the purposes of the charity, but instead should be invested to produce a return, which is then to be applied for the purposes of the charity. Property held on trust for investment (capital) is the endowment of a charity.

Unapplied investment return means the totality of the resources a charity holds which represents its investment return at the point when the total return approach is first adopted. It includes both retained income and capital gains. It excludes investment income which has already been applied for the purposes of the charity.

The unapplied investment return will become the unapplied total return, once trustees have identified these resources as the product of investment, rather than the value of gifts which are invested to produce the return.

Unapplied total return means total return less any part of the return which the trustees have previously applied for the purposes of the charity, or have previously allocated to the trust for application (income).

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