1. Summary of policy

1.1 What is total return?
1.2 How does total return work?
1.3 Is it compulsory?
1.4 How we will give authority
1.5 What the power does and does not do
1.6 Changing back to the standard rules
1.7 New charities

1.1 What is total return?

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

In this guidance, the 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) is referred to as the "unapplied total return".

1.2 How does total return work?

Under the standard rules the form in which investment returns arise is important. By contrast, under the total return approach the form in which investment returns are received is irrelevant. Instead, investments are managed so as to optimise the investment return generated by them regardless of whether this is obtained by way of dividends, interest or capital gains. With this approach it is the level of the investment return rather than the composition of the return that is important. Of course, any investments made must be compatible with the trustees’ duty to make prudent investments.

Part of this investment return is then allocated to the trust for application (income) to meet the needs of present beneficiaries, while the balance is retained to help meet the needs of future beneficiaries. The total return approach to investment is illustrated at OG 83 C2.

Investors operating this approach to investment are able to make investment decisions based on investment criteria alone, without being concerned about the form the return will take. Because the return received from investment is not "labelled" as either income or capital (as it would be under the standard rules), trustees can allocate the return between the present and future beneficiaries in the way they consider best gives effect to their duty to be fair to all beneficiaries.

1.3 Is it compulsory?

Trustees are free to decide whether to apply for authority to adopt the total return approach to investment. We will not compel or pressurise trustees to apply for such authority.

1.4 How we will give authority

The power will normally be given by Order under section 26 of the Charities Act 1993. The model Order to be used to do this is set out in OG 83 C5. The provisions in the model Order take the form of a power, accompanied by directions which must be followed in the use of the power. The purpose of the directions is to ensure that the interests of both present and future beneficiaries are properly protected and that the donor's wish to establish an enduring charity is respected.

Where trustees press for variations to the model Order the case should be referred to Legal Division for advice.

We will normally send trustees the authorised Order, with a copy of the Order to each of their number. The authorised Order should be accompanied by a letter reminding trustees of their duties and responsibilities in the use of the power. An example of this letter can be found at OG 83 L1. This letter is to be sent out with all Orders giving trustees this power.

Please note: Specialist Casework Division no longer seal orders and schemes. As from the 1 August 2009 these are authorised by the signature of the Authorising Officer. Compliance Division will continue to seal orders and schemes for the foreseeable future.

1.5 What the power does and does not do

By introducing an adjustment to the administrative framework of charities with permanent endowment we aim to help them to more effectively balance the needs of present and future beneficiaries. The power we will give trustees will create flexibility in the process of allocating an appropriate part of the investment return to the trust for application (income).

The power does not extend beyond the allocation of part of the investment return to the trust for application (income). Once a part of the investment return has been allocated to the trust for application (income) (in accordance with the directions in the model Order), that part must be applied for the purposes of the charity within a reasonable period of allocation in just the same way that a charity’s income must be applied under the standard rules.

The power does not authorise trustees to add any part of the total return allocated to the trust for application (income) to the resources representing the actual gifts to the charity. A separate power of accumulation will be required for this purpose, as is the case under the standard rules.

Trustees will not normally need to retain funds for any length of time in the trust for application (income). This is because any part of a charity’s unapplied total return may be allocated to the trust for application (income) at any time. However, on each occasion the allocation must be compatible with the discharge of the trustees' duty to be even-handed in their treatment of present and future beneficiaries. There is therefore no need for trustees to build up reserves in the trust for application (income) to cover a year when the investment returns for that year are minimal or negative (see OG 83 C4). But if funds are retained in the trust for application (income) this should be done in accordance with a proper policy on the maintenance of reserves. Our publication CC19 provides guidance in this area.

In making each allocation from the unapplied total return to the trust for application (income), the trustees must have regard to their duty to be even-handed and to the other duties attached to the use of the power - see section 2 of OG 83 B2. Under-allocation to the trust for application (income) would prejudice the interests of current beneficiaries. Over-allocation to the trust for application (income) would prejudice the interests of future beneficiaries.

The power does not authorise the expenditure of the charity’s investment fund. A separate power will be required to authorise the expenditure of any part of this fund. Our policy on authorising the expenditure of part of the investment fund of a charity that is operating a total return approach to investment is set out in OG 83 B4. The model Order to be used to provide such authority is given in OG 83 C6. It is therefore clear that the concept of permanent endowment (ie assets held on trust for investment (capital)) is not affected by the power we propose to give trustees. We recognise a donor’s right to create a charity that will have future as well as present beneficiaries.

1.6 Changing back to the standard rules

Once trustees have started to use the power given by clause 1 of the model Order they cannot use any other method of allocating the investment return of the charity without the prior approval of the Commissioners.

It may be impractical for trustees to go back to analysing the investment return on the basis of the standard rules. During the period when the total return approach was used, investment returns would have been received and allocated to the trust for application (income) without drawing any distinction between income and capital. It would therefore be difficult to say, at the date the trustees chose to return to the standard rules, which part of the unapplied total return held at that time was retained income and which part was capital.

However, we do acknowledge that there may be special circumstances in which it would be appropriate for trustees who have begun to use the total return power to then revert to an approach to investment based on the standard rules. The model Order states that the prior approval of the Commission is required to do this.

1.7 New charities

New charities may be established with a power to operate a total return approach to investment, rather than the standard rules approach. In such circumstances we would recommend that the charity’s governing document includes trustee duties similar to those set out in the model Order. The promoters of such a charity will need to recognise that where a total return approach to investment is adopted and there is no unapplied total return, then there will be no resources that can actually be applied for the purposes of the charity.

The following words and phrases are defined in the Glossary of Terms:

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Governing document
Order
Permanent endowment
Trustees

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