Contribution to Indirect Costs Nilda Bullain European Center for Not-for-Profit Law (ECNL) January 31, 2011

Issue Statement There is 7% cap on the indirect expenses chargeable to an EC project. This does not cover the actual indirect costs of CSOs in the majority of cases. No indirect costs eligible at all when CSO receives operating grant, even if that is only a small part of its overall budget. This affects negatively the delivery of the project; the sustainability of the CSO; and transparency and accountability of the stakeholders.

What are indirect costs? No general definition (legal, fiscal or otherwise) – Every organization applies its own system for determining and allocating indirect costs, in line with the internationally accepted accounting principles. EC definition – most often used: – The eligible indirect costs for the action are those costs which are not identifiable as being directly attributed to the performance of the action and which could therefore be booked to it direct, but which can be identified and justified by the beneficiary using his accounting system as having been incurred in connection with the eligible direct costs for the action. Subject to interpretation – inconsistently applied – E.g., costs incurred in EU-based HQ of INGO

Problem of 7% cap The 7% cap is unrealistically low to be able cover indirect costs of the majority of CSOs. – UK (2005): CSOs incur 15-20% indirect costs to deliver a public contract – US (2009): CSO range 17-35% of indirect costs – similar to corporate sector’s 25% average, in which services sector (most comparable) 20% – ECNL survey (2009): 15-30%, CSOs from CEE – Even foundations and INGOs with a high turnover generally assume 10-12% indirect cost rate.

Problem of 7% cap The 7% means a built-in financial loss for the CSO. – The difference between actual indirect costs and 7% cannot be charged to the project (not eligible cost)  – It results in an inevitable deficit for the project that the CSO undertakes. EXTREMELY COUNTER-PRODUCTIVE!

Consequences of 7% cap Negative effect on service quality Negative effect on service quality – cutting back on programme support lowers effectiveness (consistently confirmed by several studies) Undermines CSO sustainability Undermines CSO sustainability – weakened organization and budget deficit in the long-term Unfair imposition on other donors Unfair imposition on other donors – usually loss is compensated for from funding of other donors – without recognition May lead to transparency issues May lead to transparency issues May drive away capable organizations May drive away capable organizations – ECNL survey (2009): 36% of respondents cited the 7% cap as a reason not to apply for EU funds

Why 7%? No justification has been presented (if any exists at all) Fear of “profit” reaped by CSOs? – At 7%, and even 15%, this is unfounded fear. – Studies confirm that a lower overhead rate is not an effective means to control unwarranted cost. – EC consistently covers indirect costs and profits of for-profit companies for the same type of work.

Why 7%? Ensuring “good practice”? – Studies confirm that lowering indirect costs have adverse effects on CSO performance. – Good practice would be to fully recover indirect costs that are duly justified and transparently allocated. – UK: full-cost recovery – US: NICRA (Negotiated Indirect Cost Rate Agreement)

Conclusion Contradiction between EC expectations that NPOs will reduce indirect costs, while at the same time become more professional in financial management, accounting and reporting. Managing taxpayers’ funds and complying with sophisticated reporting schemes demands organizational capacities that come at a cost. Donors, including the EC should bear their fair share of such costs.

Recommendations A general flat rate of 15-20% - in the short term. Ideally, a system that covers the actually incurred indirect costs in the longer term. For operational grants, allow to claim indirect costs: – When the overall rate increases, e.g. due to new projects – During the time of ‘degressivity’ (phasing out) of the EC support