Charitable tax shelters

Sunday, 01 February 2009
Considering some of the more aggressively marketed tax products.

Prior to December 31 (the end of the taxation year for all individuals and most trusts in Canada), much last minute personal tax planning will have occured in order to ensure effective personal tax management. One of the most common tax planning techniques is to look at charitable donations.

Most taxpayers who are philanthropic give willingly to charities. While the tax benefit is certainly welcome, it is my experience that the tax effect of a charitable donation is secondary as opposed to the primary objective of simply benefiting charities. Unfortunately, there are many ‘tax products’ that are marketed aggressively that promote tax benefits in order to encourage donations to charities.

‘Old’ examples of charitable tax shelters involve donations of property where the cost of acquiring such property is apparently less than the corresponding fair market value (with the charitable receipt being issued for the higher fair market value). A common example would be a taxpayer acquiring art with a cost that is apparently significantly below its fair market value. Canadian income tax rules previously allowed for the charitable receipt (and thus the usable donation amount) to be the fair market value of any property donated. Accordingly, a position would be taken by the taxpayer (who acquires art at a significant ‘discount’ but donates it to a charity at an apparently higher fair market value) that the donation amount would be the higher amount as opposed to the lower cost amount. Generally, the disposition of such property would also trigger a capital gain if the fair market value was higher than the cost amount but certain provisions in the Income Tax Act used to enable personal use property to be exempt from a capital gain up to the first CAD1,000 of realised proceeds. Some clever plans were designed so as to take advantage of such a rule, especially in the art cases, such that each piece of art was considered to be a personal use property, exempt from taxation upon disposition, since the fair market value (and thus the capital gain) was always less than CAD1,000 per piece. Such charitable tax shelters expanded to include other products such as software, drugs, books, etc. The Canada Revenue Agency (CRA) was not amused and, prior to 2003, routinely attacked such structures on the basis that the fair market value of the donated property was equal to its cost amount (or some other lower amount). A number of income tax cases have since appeared in the courts (see Klotz [2005] 3 CTC 78 (FCA); Malette, [2004] 4 CTC 24 (FCA) and Nash et al [2006] 1 CTC 158 (FCA) with such cases generally finding that the fair market value of the donated property was not equal to the asserted higher value but rather its lower cost amounts or a much lower amount).

The above example of a charitable tax shelter has been eliminated from technical effectiveness given some amendments to the Income Tax Act made approximately five years ago. See, for example, proposed new subsection 248(35) of the Act, which will apply retroactive to gifts made after 5 December 2003. Generally, this new provision provides that the fair market value of a property that is the subject of a gift is, for the purposes of determining the ‘eligible’ amount of the gift, deemed to be the lesser of the actual fair market value of the property and its cost to the donor. There are certain exceptions to this rule that are beyond the scope of this article. In addition, see subsection 46(5) of the Act, which now does not exempt personal use property from capital gains treatment in charitable tax shelter arrangements.

However, unfortunately, various versions of such plans still exist that attempt to circumvent the new rules. One such example of a plan involves the utilisation of a trust whereby the donor ‘applies’ to become a beneficiary of a trust, and through various machinations of transactions ends up ‘donating’ various assets to a registered charity. The CRA has commented publicly on these types of donation arrangements in a November 2004 ‘Fact Sheet’ entitled ‘Tax Shelter Donation Arrangements’. The ultimate ‘tax benefit’ as compared to the cash outlay by the donor is significant. Notwithstanding that this particular plan may have at least some technical merit, it is extremely aggressive and one queries whether the general anti-avoidance rule (GAAR) pursuant to section 245 of the Income Tax Act or other technical attacks could be made. The CRA certainly thinks so and has commented publicly many times that it is not impressed. For example, in a CRA news release dated October 20, 2008 it stated:

‘The CRA is reviewing all tax shelter-related donation arrangements (for example, schemes that typically promise donors tax receipts worth more than the actual amount of the donation), and it plans to audit every participating charity, promoter, and investor.’

The CRA also released a similar warning in its CRA Taxpayer Alert series of news releases in August, 2007. The old cliché ‘if it seems too good to be true, it likely is’ certainly applies to charitable tax shelters. At the very least, seek professional advice as to whether or not the marketed charitable tax shelter has technical merit (or would be considered aggressive).

For the philanthropic, there are many tax effective, yet conservative, charitable donation plans that can increase the after tax effect of each charitable tax dollar. For example, one may consider a donation of shares, or flow through shares, that have a fair market value in excess of its adjusted cost base (the adjusted cost base of flow through shares is generally nil). The realised capital gain on a direct donation of shares to a charity is no longer taxable. Such plans are very tax effective and can achieve, conservatively, a client’s philanthropic objectives. Regarding charitable tax shelters, my advice is to tread carefully!

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Kim Moody

Kim Moody TEP is a partner at Moodys LLP Tax Advisors and STEP Canada National Board Treasurer.

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