Charitable Gifting

A number of changes to the tax rules affecting both donors and charities have been made in recent years. In this article, we’ll review changes from both perspectives, and will focus on the more important developments that need to be kept in mind.

Tax Changes for Donors

From the perspective of donors, the changes to the tax rules fall into one of two categories—general changes affecting all donations and specific changes the Federal government has introduced to combat donation tax shelters.

Donation Rules in General

What is a Gift?

Although the basic rules that determine whether a gift has been made have not changed, recent court cases have highlighted that simply providing value to a charity will not necessarily qualify as a gift. Historically, by definition and by case law, an eligible donation will only arise where a donor makes a voluntary transfer of property owned to a charity and generally, no benefit or consideration can be given to the donor in return.

Two recent developments show that this definition will be applied strictly. In one situation, a taxpayer owned a commercial property and allowed a charity to use a portion of the property for no consideration. A CRA ruling stated that the value of rent that the charity did not have to pay was not a donation as no property was transferred. Similarly, in a tax case, an individual supplied services to a charity for no consideration. The Canada Revenue Agency (CRA) denied the gift, again arguing that there must be a transfer of property to qualify as a charitable gift. The courts upheld this conclusion.

Split Receipting

As mentioned above, a gift generally only arises where there is a transfer of property for no consideration. On this issue, the CRA has allowed some leeway over the years. A common example is a charity golf tournament. Typically, a flat amount is paid to a charity or an organizer, and in return, the donor is entitled to a round of golf plus perhaps a small gift and a dinner. The amount of the gift reported on the donation receipt would be the amount gifted less the value of the golf round, gift and dinner provided. Strictly speaking, such a gift would not qualify under the historical definition of a gift.

In 2002, the Department of Finance released draft changes to formally amend the definition of what constitutes a gift, and the CRA released revised administrative rules on how this new definition would be applied in certain situations. Under these rules (which are still in draft form), the qualifying gift amount will be equal to the difference between the value of the property donated and the value of the “advantage” received in return. An advantage is broadly defined and can be a property or anything else of value to the donor. To qualify under the new gift definition, the following conditions must be met:

• There must still be a transfer of property, and it must be voluntary;
• The advantage must be clearly identified, and its value must be ascertainable; and
• The value of the advantage can’t exceed 80% of the value of the property gifted.

Note that for administrative purposes, the CRA has stated that relatively minor advantages can generally be ignored (where the value of the non-cash advantage does not exceed the lesser of 10% of the value of the property transferred as a gift and $75).

As mentioned, the CRA updated a number of administrative rules when this revised gift definition was announced, and tax rules will now generally operate as though both the donor and the charity supplied the items on a fair market value basis.

Annuities purchased from a charity (where an individual pays a charity for a stream of future annuity payments) are a good example of how the new rules will be applied. Previously, the CRA would allow a charity to issue a donation receipt equal to the cash paid to the charity less the annuity payments that would be received in return by the donor. When the individual actually received the annuity payments, none of the payments would be taxable. Under the revised gift definition, the donation and the provision of the annuity will be treated as separate items (the annuity being an advantage under the new definition). The gift amount is equal to the cash paid to the charity less the value of the annuity purchased (based on what it would cost to buy such an annuity under commercial terms). As the individual receives annuity payments, a portion of the payment will be taxable under the usual rules that apply where an individual buys an ordinary annuity.

Although you should receive a donation receipt for most payments to a charity where an advantage is provided, there is still one common exception—charity-run lotteries. The CRA has said that buying a lottery ticket from a charity does not qualify since the motivation for buying such a ticket is driven by the desire to play the lottery and not make a gift. Although we don’t necessarily agree that is always the case, it does appear that specifically valuing the advantage (i.e. the right to participate in the lottery) would be problematic at best, which would mean the new gift definition would not apply.

Charitable Bequests

For many individuals, the largest charitable donation they will make will be a gift under the terms of their will— referred to as a charitable bequest. Where the gift is large, it will be crucial to ensure that the gift will qualify as a charitable bequest, and therefore, a creditable donation. Note that where an individual names a charity as an RRSP, RRIF or insurance policy beneficiary, the value of these plans will also be treated as a bequest.

Where a bequest is provided for and the bequest meets certain conditions set by the CRA, it will be treated as a donation made in the year the individual dies, and won’t be treated as a gift made by the estate. In the case of a bequest made in a will, note that the actual funds need not be remitted to the charity immediately. For example, where a charity is named as a residual beneficiary of an estate that will carry on for several years, the value of that residual interest just after death (discounted value of estate assets minus debts) can qualify as a bequest.

As mentioned, the CRA has set some conditions that must be met for bequest treatment, which can be summarized as follows:

• It is clear that the deceased individual intended to make a donation to charity;
• The amount of the donation to be made to charity is set as a fixed dollar amount or as a specific percentage of the deceased's estate or the estate residue;
• Where the bequest is a percentage of the estate residue; the will clearly specifies what is to be paid from the estate in determining the amount of any residue; and
• The will does not provide for discretionary capital encroachments by the trustees of the estate or others.

Note that the CRA has said that a gift can qualify as a bequest even if the deceased’s will does not spell out specifically which charities will benefit from the gift (as long as it is clear the amount set out does have to be donated).

Where a gift does not meet the CRA conditions above, the gift will likely be allowed as a gift made by the estate when the amount is actually paid. However, this will not be beneficial if the income of the estate is not large enough to allow the charitable donation credit to be utilized in the year of the gift and the following five years (under the general donation rules, a donation claim cannot exceed 75% of a taxpayer’s income for the year). Bequest treatment is beneficial because the 75% rule is waived in the year of death and the prior year, and because deemed dispositions arising on death of property and deferred income plans can create a large income inclusion where rollovers are not available. So, bequest treatment is often crucial for larger donations.

Donation Tax Shelters

Another area where there have been many changes is the government’s continuing strategy to combat donation tax shelters. Note that even if you don’t plan to participate in such a shelter, you should still read this section of the article. The measures the government have introduced are broad, and can produce unintended results.

There have been two basic types of shelters marketed in recent years—buy-low, donate-high strategies, and leveraged donation strategies. In the buy-low, donate-high strategies, shelters basically involved grouping participants together so that certain property, such as art, could be purchased using volume discounts and then donated by the participants at a higher value as individual properties. A positive cash flow would arise if the value of the donation credit exceeds the tax on the gain from gifting the property and the cost of the property itself. The government has attacked these plans in two ways—they have challenged the valuations in court (with success recently), and they have also implemented new rules that will adjust the gift amount where assets are acquired and gifted.

In the leveraged plans, part of the gift was made using borrowed funds, which would be repaid in the future under the terms of the plan (the participant would not be called upon to repay the amount out of personal funds). These plans have been attacked by denying the gift related to the debt until a payment against the debt is actually made.

If either set of direct anti-avoidance rules doesn’t apply, a general donation anti-avoidance rule was also added. Because of these changes and the fact that these arrangements must be disclosed to the CRA as tax shelters, participation in these arrangements is generally not recommended.

As mentioned, these developments may affect ordinary donations. In particular, legislative changes to combat the buy-low, donate-high strategies are the largest concern. Rather than having to engage in court battles over value, the legislation deems a gifted property to have a value equal to its cost when it is gifted within a certain period after its acquisition, as follows:

• For property in general—where it is gifted within 3 years of its acquisition; and
• There it can be shown that the property was acquired with the intention of gifting it, where the property is gifted within 10 years of acquisition.

Note that exceptions are available (which were broadened on July 18, 2005) and include:

• Gifts made as a consequence of death;
• Gifts of real property or immovable property situated in Canada, inventory, qualifying securities and cultural property; and
• Property gifted as part of certain rollovers involving corporations.

Otherwise, if you acquire a property and gift it within 3 years, the gift amount will be restricted to the cost of the property.

There was some good news recently on the compliance side. As part of the enforcement process for the buy-low, donate-high rules, a change had also been proposed that would basically require a charity to obtain enough information from donors to determine whether the gift at cost rule would apply for any gift over $5,000. However, the Department of Finance has relented, and has stated in a recent comfort letter that they will recommend to the new government that this rule should be dropped when the draft legislation is reintroduced in the House of Commons.

Rules for Charities

As first announced in the 2004 Federal Budget, a number of rules have been amended from the point of view of charities. These changes include:

• A reduction of the asset disbursement quota rate for foundations from 4.5% to 3.5% and extending this quota to all charities;
• Updating other quota problems, such as the impact of capital gains and the absence of rules for certain bequests; and
• The introduction of intermediate sanctions.

The new rules have now been legislated, and there are very few changes when the final law is compared with the original proposals (a Tax Bulletin discussing the original proposals entitled New Tax Rules Introduced for Charities is available). However, there was one fairly major change that affects “money-related” penalties—repeat infractions will be based on a five-year look back period. In addition to our Tax Bulletin, a full description of the changes is available on the CRA’s Charities Directorate web page.

Finally, in a piece of good news for charities, the CRA has announced that it will not penalize charities that have not been following the new rules for receipt documentation. As also announced in 2004, charities must include a reference to the “Canada Revenue Agency” and their web site (http://www.cra- arc.gc.ca/charities) on all receipts issued after 2004. However, it would appear that the change was not fully understood as there was some confusion as to whether the inclusion of a CRA reference removed the need to show the charity’s address (both the CRA information and the charity’s address is required). Some charities also had a large supply of receipts and wanted to exhaust that supply before printing compliant receipts. Consequently, charities that did not make the required changes for 2005 will not be penalized. However, the CRA expects full compliance beginning on January 1, 2006.