Sentence Correction

I am TOTALLY confused on the pronoun question in the SC section. Sometimes, a pronoun is wrongly used because it can cause ambiguity.At other times, however, the official answers seemingly tell me that we shouldn't consider about the issue. Here is one from the PREP:


The budget for education reflects the administration's demand that the money is controlled by local
school districts, but it can only be spent on teachers, not on books, computers, or other materials or
activities.

(A) the money is controlled by local school districts, but it can only be spent
(B) the money be controlled by local school districts, but it allows them to spend the money only
(C) the money is to be controlled by local school districts, but allowing it only to be spent
(D) local school districts are in control of the money, but it allows them to spend the money only
(E) local school districts are to be in control of the money, but can only spend it

The correct answer is B, but isn't it possible that "it" can refer to whichever singular words like "the budget", "demand","the money"? PLEASE help me.
Also, I REALLY want to know in GMAT whether a pronoun refers to the closest noun or what. Does GMAT test have a rule in such pronoun questions? Thank you in advance~