What you need to know
- Charity trustees have a duty to manage all of the charity’s assets responsibly, including its reserves, and to ensure that robust financial policies and procedures are in place.
- There is no “correct” level of reserves. The appropriate amount varies by charity size, activities, income and risk profile. A charity must have a written Reserves Policy in place and seek advice where appropriate.
- If investing reserves, a charity must have an Investment Policy addressing objectives, risk appetite and ethical considerations. Investment performance should be kept under regular review.
- To retain its charitable tax exemption, a charity must apply its income to its charitable purposes within five years of the end of the year in which the income is received. The permission of the Revenue Commissioners must be sought if a charity wants to hold its income beyond this five-year period.
- A charity’s annual financial statements and trustees' report should be treated as a tool to communicate openly with the public and potential funders about the financial position of the charity.
Charities and reserves
Charity trustees, whether they are a board of directors, a board of governors, trustees, a leadership team, or known by another name, have an important role. They know that prudent stewardship and oversight of the charity assets are critical to the health of the charity.
It is understandable that a charity trustee’s main focus would be the day-to-day financial position and controls of the charity. However, planning for a “rainy day” as well as longer term financial planning and modelling is an important obligation of charity trustees. Having robust and well implemented financial policies and procedures in place are vital, dealing not only with the everyday operations, but also planning for the future.
Charity trustees must also be mindful of the balance to be achieved between accumulating reserves and applying funds to the charitable purpose. The Charities Regulator expects charity trustees to be able to demonstrate that funds are being used in furtherance of the charity’s stated charitable purpose. Excessive or unexplained reserves might appear to some as a sign of financial strength. However, the purpose of a charity is not to act as a successful bank holding lots of reserves, it is to wisely use its charitable assets to achieve its charitable purpose. Equally, underfunded reserves can leave a charity dangerously exposed. Sound judgement, informed by professional advice where appropriate, is key, but the final decision and responsibility always rests with charity trustees.
As with all charity trustees’ activities, it is critical to remember that charities operate in a regulated sector. Charity trustees must have regard to all rules and guidance in place. The Charities Regulator has issued guidance on reserves, or, more generally, accumulations of funds or investments of funds. This guidance looks at how charity trustees might go about deciding what level of reserves the charity needs, and what should be included in a Reserves Policy.
Critically, the Finance Act 2024 also contains legally binding rules regarding a charity’s ability to accumulate funds. These are reasonably new rules and all charity trustees must familiarise themselves with them. The Revenue Commissioners previously had a requirement that their permission should be sought where it was intended to accumulate funds for more than two years. This was not a legislative requirement, but a condition of the Revenue Commissioners for the retention of a charity’s charitable tax exemption. The Finance Act 2024 has given this condition a formal legislative status. It extended the time period to five years. The Revenue Commissioners' guidance document notes that:
“Finance Act 2024 provides that a charity will retain the charitable tax exemption so long as the income is applied to charitable purposes by the end of the fifth year after the year in which the income is received.”
Charities should seek professional advice and assess whether and when this rule applies to them. If so, charities should consider whether they need to proactively seek permission from the Revenue Commissioners to retain the relevant funds as reserves or otherwise.
We set out below some practical tips around reserves, which are an essential element in planning for the future.
Stewardship in practice
Holding an appropriate level of reserves protects a charity's ability to continue delivering its charitable purpose if income falls or unexpected costs arise. This can include:
- Unexpected cuts in Government or public funding
- Natural disasters or humanitarian crises which a charity may wish to respond to, or
- The general impact of the economic and geopolitical environment.
There is no single correct level of reserves for every charity. The right amount depends on a charity's size, the nature of its activities, its income streams, and risk profile as determined by the charity trustees.
What matters is that charity trustees actively consider and document the rationale for the level of reserves held, seeking appropriate professional advice as required. Factors which might be important here include developing property, scaling up existing services, or developing new services. It is important to note that reserves should not form part of any restricted fund of a charity, as a charity must be permitted to use the reserves or a portion of them, if and when that is required.
Religious charities in particular should be mindful of having appropriate levels of reserves in place. They should also have a clear and robust policy which justifies the level of reserves held. Some Religious Congregations and Orders designate a level of funds for the care of their members, separately from the sum which they have designated as forming the reserves of that charity. This difference in approach is decided upon by charity trustees, usually on taking professional advice.
Having a Reserves Policy is an important document which can clearly set out the rationale behind the level of reserves held. A “needs analysis” or actuarial study is also a very valuable exercise. It helps to inform the decision-making processes around what is an appropriate level of reserves, having regard to the current and future demographic of the Congregation or Order, particularly for those who may be planning for, or contemplating Completion.
The Finance Act 2024 rules are particularly relevant to Religious Congregations and Orders, as reserves are often held in long term investments or cash deposits. This is unlike many secular charities, where there may be a regular turnover in the reserves which are being accumulated. It is likely therefore that in practice these investments or cash deposits will be held for longer than the five-year period. Charity trustees must give this a lot of thought and consideration to ensure compliance with the rules.
The basics – a recap
- Every charity should have a written Reserves Policy.
- The Reserves Policy should set out the charity’s policy on reserves including:
- An explanation of why the charity maintains the level of reserves it holds
- What the reserves can be used for and when, and
- How the charity trustees plan to build towards or draw down from the reserves over time.
- The Reserves Policy should be treated as a living document, guiding charity trustees in their financial planning.
- The Reserves Policy should be revised and reviewed regularly, with a consistent approach, as circumstances change.
Tips for a robust investment policy
- Where a charity invests its reserves, the charity trustees must ensure that an investment policy is in place.
- This policy should set out the charity's objectives for investment, the level of risk it is prepared to accept, and any ethical or mission-related considerations that should inform investment decisions.
- Charity trustees should keep investment performance under regular review and take appropriate professional advice, bearing in mind that the final decision and ultimate responsibility rests with the charity trustees.
Financial statements and the Trustees' report
The financial statements and charity trustees’ Report is one of the most important transparency and accountability documents a charity produces. It is an opportunity to explain, in plain language, what a charity has done over the year, and how its resources have been used to advance its charitable purpose. Charity trustees should engage meaningfully with the drafting of this report and not treat it as a compliance obligation to be met.
For charities that have a particularly high level of reserves, whether in cash, investments or otherwise, it provides an excellent opportunity to explain the level of reserves held and outline the charity’s reserves policy. For charities who do not have sufficient levels of reserves, it gives the charity trustees the opportunity to highlight to the public and potential funders the challenges it faces.
Conclusion
A sound Reserves Policy, Investment Policy (where appropriate) and a well-prepared Charity Trustees' Report are indicators of a well-governed charity. They signal to regulators, funders, and the public that a charity takes its responsibilities seriously.
If you have any queries or concerns related to reserves, our Charity & Not-for-Profit team are happy to assist you on these matters and more broadly on any aspect of your legal, governance and oversight responsibilities.
The content of this article is provided for information purposes only and does not constitute legal or other advice.