Planned giving

Donating to charities is always smiled upon, but with the right plan, it can also be a valuable tax benefit for both individuals and corporations

By Jean-Richard Laurence

The charity industry is flourishing in Canada: both individuals and corporations give billions of dollars every year to thousands of charities and charitable foundations. These donations are made in the most diverse forms, from change deposited in coin boxes to legacies worth millions, from used clothing and household articles to works of art and buildings. These gifts are the expression of a desire to help a cause that is dear to the hearts of the donors. For governments, these gifts constitute a collective method of achieving social and community goals.

But planned giving can go far beyond such spontaneous gestures. Aggressive planning by donors involves optimizing a specific situation that will benefit the donor or the corporation to which he is linked, or both. Our discussion considers one specific type of donation: donation inter vivos.

Inter vivos donation

Any taxpayer who wishes to make a substantial donation should consider planning its consequences according to his or her personal tax situation and determine whether it’s possible to obtain some personal advantage if the donation is made by a corporation in which the donor is a major shareholder. This is an advantageous way of transferring the assets of the company to individuals while benefiting from major tax credits.

Before choosing such an option, the taxpayer should make sure that the charity he intends to favour can accept the gift, since some charities don’t have the administrative or physical resources to accept certain assets. With that proviso, what follows are a few different types of planned giving. This is by no means an exhaustive survey of donation options, merely a sample.

Gift of a residual interest

A taxpayer can decide to donate an asset he cares a great deal about, for example a work of art or his house, but retain its possession for a specified period of time or as long as he lives. This is generally referred to as the gift of a residual interest in an asset.

The donor receives a receipt for the gift recognizing the market value at the time of the gift and reflecting the value of the asset less the fraction representing the reduction because possession and use remain with the donor. This fraction is determined according to life expectancy tables for Canadian citizens, and the older the donor, the smaller the fraction deducted from the market value will be.

The consequences are nevertheless significant: the charity will receive full possession of the asset (until that time, it had only title to the asset) upon the death of the donor or at any other time agreed to, and can dispose of it at its discretion or use it for its own purposes. The donor, at the time of making the donation, will receive a receipt that can be used against his income taxes in the year of the donation and the five following years, without the asset being in the full possession of the donee.

This scenario is especially suitable for professionals nearing the end of their career who receive substantial retirement payments generating high income taxes and who wish to remain in their home. The donation will enable them to avoid the payment of income taxes and preserve their cash. This scenario is equally possible for the donation of artworks with retention of possession.

For example, a 70-year-old donor wants to give a collection of art works worth $100,000 to a charity but retain the use and possession of the collection for the rest of his life. According to the actuarial mortality tables, he is projected to live another 15 years. This would reduce the value of the donation to $55,526.45, according to the following calculation:

Discounted value:    Fair value of the asset
                                            (1+i) n 
                                in which: i = interest rate of government
                                bonds for the same time period and
                                n = the life expectancy in number of years.

This value will be the one that appears on the receipt that entitles the recipient to the tax credit in the year of the donation. In addition to this benefit, the donor can enjoy the possession of his assets, subject to agreements between the donor and donee so that the proper insurance is obtained. Such planning is relatively simple and benefits both the donor and the donee. If the donor were to invest an amount equal to the tax savings resulting from the donation for the same period as the life expectancy, the benefit would be about twice that of the amount saved.

However, remember that after the donation, any appreciation of the asset (capital gain) goes to the donee.

Gifts of capital or environmental assets

There are various forms of planned giving that offer interesting ways of transferring tax benefits to individuals who are the principal shareholders of their corporation. Here are two with alternatives that deserve some attention.

Gift of a capital asset by the corporation

A gift by a corporation owned entirely by one or two shareholders could generate some substantial benefits to the shareholders if the donation involves capital assets generating a capital gain.

Donations by the corporation would enable it to deduct from its revenues an amount equal to the fair value of the donated assets and be taxed on only 25% of the capital gain at the applicable rate. However, and here is where the importance of planning can be seen, the non-taxable surplus portion of the capital gain will be credited to the capital dividend account (CDA) of the (private) corporation¹ and can then be distributed, tax-free, as a dividend to its shareholders.

For instance, let’s look at the case of a corporation that has given environmental assets or shares of a public corporation to a public foundation worth $10,000, with a cost base of $2,000 (capital gain of $8,000). There will be taxes payable on the taxable capital gain of one quarter of its value, or $2,000, and the surplus $6,000 will be credited to its capital dividend account (CDA), which can be paid to shareholders tax-free. The corporation will benefit from a charitable deduction against its income for the year from taxes reduced to one fourth of the capital gain, and the shareholder will receive the difference in the form of non-taxable dividends.

This strategy is very interesting for a private corporation (the CDA exists only for private corporations), and it offers a neat way of transferring the corporation’s assets to its executives tax free, as long as it has the liquidity necessary to do so.

Gifts of shares to a charity

This next strategy is very attractive for any shareholder who wants to make a donation to a public foundation — the “public foundation” distinction is important because the option doesn’t apply to private foundations, for obvious reasons of a potential non-arm’s length relationship.

In one scenario, the individual donor can donate shares of a public corporation for which the disposal will result in a capital gain, 25% of which is taxable, while receiving a tax credit for the fair value of the shares. The tax effects are those analyzed above.

In a second scenario, if the individual donor gives shares of a private corporation (usually his own), the same tax treatment will apply, with the difference that the capital gain inclusion will not be reduced to one quarter of its value. Moreover, it’s obvious that the public foundation will be reluctant to accept this gift, which is not very liquid. For these reasons, this individual donation must be the subject of planning,  to create a market for the shares and make the donation liquid at some point.

Donating the shares of a private corporation (generally the private corporation of the executive) is of pecuniary interest only if the shares can be bought back by the issuing corporation. Thus, the parties, the donor and the donee, will agree that the shares of the corporation are given to the charity at their fair market value, for which the donor issues a receipt at the time of receiving the shares. A reliable accounting valuation is required for this. The corporation will then agree to buy back its shares from the public foundation according to a precise schedule or upon the death of the donor. The amount received by the foundation will be a redemption dividend for which the foundation, as a charity, does not have to pay a tax.

The tax consequences are obvious: the donor will receive a credit applicable against his income taxes at the time of the donation, but the corporation will pay the cost of the dividends. This scenario could be even more relevant if the paying corporation had a refundable dividend tax on hand  for which it could receive 33 1/3 % of the full dividend paid to the donor.

Even better, to avoid making the corporation pay anything to buy back the shares donated by its principal shareholder, the donor and donee could agree that the time of the redemption is upon the death of the donor, with the planned redemption amount covered by the donor’s life insurance. This form of planning is preferable for any executive reaching retirement who is considering the transfer of his corporation to his children.

The planning of donations for a tax-payer, an individual or a corporation, is based on a number of assumptions that reflect the asset to be given and when it is given. Planned giving is the essence of the process.

Gifts of money by their nature generate benefits only when they are made and are limited to credits or deductions, depending on whether they originate from an individual or a corporation. Because of the absence of restrictions, assets are much more suitable for planning scenarios related to the personal situation of the donor. Such donations make it possible to manage the tax consequences for the taxpayer and optimize the benefits.

Jean-Richard Laurence, LL.M. (Exon), LL.M.Fisc (HEC) (Jean-Richard.Laurence@ctb.ulaval.ca) is a tax lawyer, professor of tax issues and director of the Groupe Investors Chair in financial planning at Université Laval, in Quebec City.

¹ CDA: Balance sheet account for tax-free amounts received by the private corporation, such as insurance coverage or non-taxable capital gain applicable solely to private corporations.

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