Czech Endowments: An Improving Framework
Endowment building and endowment management are the basic conditions for the long-term stability of the foundation sector allowing it to fulfil its basic role: to be a financial resource for other non-profit organisations and needy individuals.
Two Major Developments
In this respect the year 2002 saw two important steps in the development of the foundation sector in the Czech Republic. The first was the Foundation Investment Fund (FIF) and the distribution of the second part of its resources to Czech foundations - 64 foundations obtained 849 million Czech korunas (CZK) (27 million euros) and a share of future gains in the second round. The second was the adoption of Amendments to the Law on Foundations and Law on Income Tax reflecting changes in the foundation community. One-third of foundations obtained significant contributions from the FIF for their endowments and needed a legal instrument to manage them. The amendments also resulted in closer cooperation between the foundation and financial sectors.
The Czech Law on Foundations, adopted in 1997, stipulates that a foundation must have an endowment with a value of at least 500,000 CZK (approximately 16,000 euros) which can never decrease below this value. All kinds of property (money on a separate bank account, securities, real estate, author or patent rights, pieces of art) may be registered as part of the endowment and can generate regular income. Any income generated by an endowment is fully exempt from income tax. There are 338 registered foundations in the Czech Republic, with the value of their endowments exceeding 2.5 billion CZK (around 80 million euros).
The Need for Change
With the growth of property in endowments after the FIF distribution, it was clear that the Law on Foundations was blocking effective endowment management. The Law prohibited the investment of assets from endowments. The assets had to be kept in monetary form in a separate bank account, real estate, state bonds, patent or author rights, and works of art which generated a steady income. However, once bonds or any other form of assets were sold, the money received could only be put on a bank account or invested in state bonds.
Even though Czech foundations criticised this restriction, there was no will within government institutions to change the law. Therefore, Czech foundations - members of the Czech Donors Forum (CDF) - got together and started working on changes themselves. A CDF legal task force was created comprising experts on law, taxation, management and investment in order to prepare the groundwork for amendments to the Law on Foundations and Law on Income Tax.
The enacted amendments provide Czech foundations with several investment possibilities, as well as defining rules for foundation management. In particular, they provide a wide range of investment instruments for foundations, rules for safe investing, professional management of endowments by financial institutions, tax-free capital gains, and an easier registration procedure for endowments.
New Investment Instruments
Czech foundations can now use a wide portfolio of investment instruments, which in the long-term perspective can bring higher yields. The amended law allows the following instruments:
- investment instruments emitted in an OECD state valued in CZK or any other currency
- financial market instruments
- bonds registered on capital markets in any OECD state
- shares of pooled investment funds (maximum 30% stocks in portfolio)
- securities emitted by central banks or states
- real estate
investment instruments in foreign currency
shares of investment funds other than collective investment funds
bonds with a lower rating than the rating of the Czech Republic with no state guarantee
Monitoring the Value of Endowments
Foundations in the Czech Republic are required to have an independent annual audit. Auditors will now monitor the market value of endowments. This requirement will enable anyone to check the results of investments and endowment management as well as the current value of an endowment.
Expanded possibilities for investing entail increased responsibility of the boards of directors of foundations. The law stipulates that the board is responsible for effective endowment management. In case the market value of an endowment drops below the value registered in the court register, the Board has to take certain measures determined by the law.
The newly amended law also stresses the role of a foundation as a financial institution (assets and grants). The law provides for liquidation of a foundation if the market value of its endowment permanently drops under 500,000 CZK (the minimum endowment) or if the foundation is not making grants.
As a result of the amendments, exchange rate gains and capital gains (the difference between the purchase and sale price) are now tax-free, which significantly promotes endowment building.
Professional Endowment Management
The amendments give foundations the option of signing a contract with a professional financial institution to handle their investments and provide asset management consulting. In this case, foundations do not have to register individual stocks purchased, although all profits from such financial operations remain tax-free. Asset management using a conservative strategy can bring foundations higher yields than bank deposits.
Cooperation with the Financial Sector
As mentioned above, the total value of registered endowments of Czech foundations exceeds 2.5 billion CZK. Hopefully, this value will increase in the future. At least half of the endowments are in monetary form or in other instruments managed by Czech banks. Today, five big Czech banks offer special products for managing foundation endowments. Two of them have even established special pooled investment funds only for foundations. All these banks have come to understand that partnership with foundations is not only about good management of assets but also about the role that banks play in supporting the development of the whole foundation sector.
Long-term cooperation in the area of financial management and legislation and growing interest in offering specific products for foundations has created conditions for stable communication between financial institutions and the foundation sector. The Czech Donors Forum has launched a new initiative to build a permanent platform for cooperation between banks and foundations. Banks need to learn more about the needs of Czech foundations, while foundations have to acquire more skills and know-how in investments. For both groups there are still more steps to be made.
Pavlína Kalousová is Executive Director of the Czech Donors Forum in Prague.
First published in SEAL (Social Economy and Law Journal), Winter 2002-2003. See http://www.efc.be/publications/sealabstract.html .