What Does "At Arm's Length" Mean for Canadian Charities and Nonprofits?

If you are involved with a charity or nonprofit in Canada, you might hear the phrase "at arm's length." But what does that mean? Understanding this term is important because it affects how organizations follow the rules, especially when dealing with money or property.

What Is "At Arm's Length"?

"At arm's length" means two people or organizations are acting independently and are not connected in a way that might affect their decisions. Imagine two strangers making a deal. Neither one controls nor influences the other. They each look out for their own best interest.

This is important because it ensures fair and honest transactions. When two parties deal at arm's length, the deal is made as if they are unrelated.

Why Does This Matter for Charities and Nonprofits?

Charities and nonprofits must follow special rules to keep their status and make sure they use their resources properly. If they buy or sell something, or make agreements with other people or groups, they need to make sure these deals are fair.

For example, if a charity buys something from a person who is very close to someone in the charity, like a family member or a business partner, this might not be an arm's length deal. This could lead to questions about whether the charity is paying a fair price or if someone is getting special treatment.

What Are "At Arm’s Length Directors"?

Directors help run charities and nonprofits. They make important decisions and must act honestly and fairly. At arm’s length directors are people who are independent of each other. They do not have close relationships or personal ties that might influence their decisions.

Having directors at arm’s length is important because it helps prevent conflicts of interest. For example, if two directors are family members or business partners, they may not be considered at arm’s length. This could lead to decisions that benefit a few people instead of the whole charity.

Examples of At Arm’s Length Directors

• Two directors who have never met before and do not know each other personally are at arm’s length.
• A director who works in a different city or profession and has no family connection with other directors is at arm’s length.
• If a director is a volunteer from a different community group with no business or family ties to the charity’s other directors, they are at arm’s length.

Examples of Directors Not at Arm’s Length

• Two directors who are siblings or close family members are not at arm’s length.
• Directors who own a business together or work in the same company are not at arm’s length.
• If one director controls the charity and appoints other directors who are close friends or family, those directors are likely not at arm’s length.

Who Is Considered "Related" and Not at Arm's Length?

People who have close connections usually do not deal at arm's length. This can include family members, business partners, or companies controlled by the same person.

For charities, this means they must be careful when dealing with these related people or organizations. The Canada Revenue Agency looks closely at these deals to make sure everything is fair and legal.

What Happens If the Deal Is Not at Arm's Length?

If a charity or nonprofit makes a deal that is not at arm's length, the Canada Revenue Agency might review it to check if the terms were fair. If not, the charity could face penalties or risk losing its status.

How Can Charities Stay Safe?

• Always try to make deals with people or organizations at arm's length.
• Make sure directors are independent and do not have close relationships that affect decisions.
• If a deal involves related parties, keep clear records and proof that the terms are fair.
• Ask for professional advice if unsure about a situation.

"At arm's length" means dealing fairly and independently, without close connections that could influence decisions. For Canadian charities and nonprofits, this includes having independent directors who make unbiased decisions. Being careful with these rules helps charities keep their good reputation and serve their communities better.

Conclusion

Understanding arm's length relationships is essential for Canadian charities and nonprofits to maintain their registered status and avoid serious tax consequences. The rules around legal control, de facto control, and related parties can be complex, and getting them wrong can result in penalties or loss of charitable status.

If you're uncertain about whether a relationship qualifies as arm's length or need guidance on structuring compliant transactions, don't navigate these waters alone. Contact B.I.G. Charity Law Group today for expert guidance. Reach us at dov.goldberg@charitylawgroup.ca or call  416-488-5888, visit CharityLawGroup.ca, and schedule a FREE consultation to discuss your organization's needs.

Frequently Asked Questions

Here are answers to common questions about arm's length relationships for Canadian charities and nonprofits.

What is charity arm's length?

Charity arm's length means two parties operate independently without one controlling or influencing the other. For Canadian charities, this applies to relationships with directors, donors, related organizations, and service providers. When parties deal at arm's length, they negotiate fairly and act in their own separate interests, just like strangers would in a business deal.

What is the difference between arm's length and non-arm's length?

Arm's length parties are independent and make decisions separately. Non-arm's length parties have connections that affect their independence, including family relationships or one party controlling the other. The key difference is whether parties can act completely independently. Non-arm's length relationships need extra scrutiny because there's higher risk of conflicts of interest.

What is the difference between a nonprofit and a charity in Canada?

A charity must have exclusively charitable purposes and register with the CRA. Charities can issue tax receipts and must follow strict rules. A nonprofit is broader and includes organizations like sports clubs or social groups that cannot issue tax receipts unless they're registered charities. Both must operate without private profit, but charities face more regulations.

Why is the concept of at-arm's-length relationships important for charities and nonprofits?

The concept protects charities from being misused for private benefit. The CRA uses arm's length rules to ensure charities serve public purposes, not personal interests of insiders. Violations can lead to penalties, loss of tax receipts, or losing charitable status. Understanding these rules helps organizations maintain independence and compliance.

What are best practices for board composition to support independent decision-making and avoid non-arm's-length concerns?

Recruit diverse board members without family ties or business relationships with each other. Limit related individuals serving together and avoid letting family or business partners dominate your board. Create clear conflict of interest policies requiring directors to declare connections and step out of decisions where they have personal stakes. Ensure a strong majority of independent members and document all decisions carefully, especially those involving payments to connected parties.