The 2011 Federal Budget (the "Budget") contains a number of anti-avoidance measures described below. It does not contain any measures designed to assist with charitable giving or to lessen the regulatory load on Canadian charities. Rather the changes proposed are consistent with the promotion of transparency and accountability, as well as the Government’s long-standing fight against what it views as abusive tax shelters.
What is interesting at this point is that the Budget may not pass. As of publication time, all opposition parties have indicated their intention to vote against the Budget. If this occurs, these budget proposals will be defeated. It is customary for the Department of Finance to propose technical changes to the Income Tax Act, that are not passed for many years, but CRA still treats them as being in effect from date of announcement (on the basis of a retroactive effective date in the eventual legislation). While a subsequent government (of any party) can be expected to bring back some of the charity Budget proposals, it will be very interesting to see whether changes from a defeated 2011 Budget that are sought to be brought back in a second 2011 Budget are given an effective date of the first or the second 2011 Budget.
Charities and donors caught by the Budget changes should seek specific legal advice on whether the changes are likely to have effect on March 22, 2011 or perhaps at a later date.
Federal Budget Changes the Rules Related to Donations of Publicly Listed Flow-Through Shares
In a surprise step, the Federal Government has proposed to limit the availability of the exemption from tax on capital gains where the donated shares are shares acquired pursuant to a flow-share agreement on or after Budget day. The limitation will be that the exemption from tax on the capital gain will only apply to the extent that the cumulative capital gains in respect to the gift or disposition of the shares exceeds the original cost of the flow-through shares.
It is rare for the value of the flow-through shares gifted to be in excess of the original cost. This may therefore practically shut down the use of flow-through shares in these gifting arrangements in most provinces. The following is an example of the tax consequences of the donation of publicly listed flow-through shares under the current rules:
To see table please click here.
The Government has apparently decided that the extent of tax support the Income Tax Act permits for such donations is excessive and has therefore decided to limit the availability of the benefit to the portion of the capital gain realized that is in excess of the amount paid by the donor for the flow-through share prior to the deduction of any expenses which can be renounced on the flow-through shares. This is a significant change which will mean the benefit of flow-through share gifts will no longer be available to taxpayers and charities. The Budget proposals also contain anti-avoidance provisions that are intended to ensure taxpayers are not able to structure around these changes.
Budget 2011 Extends Charity Regulatory Regime to Other Qualified Donees
The Budget has proposed significant changes to the regulatory regime that applies to qualified donees other than registered charities. The Income Tax Act provides that official donation receipts can be issued not only by registered charities, but also by other organizations that meet the definition of “qualified donee.” These include:
- registered Canadian amateur athletic associations (RCAAAs);
- municipalities in Canada;
- municipal and public bodies performing a function of government in Canada (largely First Nations bands);
- housing corporations in Canada constituted exclusively to provide low-cost housing for the aged;
- prescribed universities outside Canada, the student body of which ordinarily includes students from Canada; and
- charitable organizations that have received a gift from the federal Crown in the current or preceding year.
Historically, registered charities have been subject to a stricter regulatory regime than other qualified donees. Under the proposed changes in Budget 2011, RCAAAs will be made subject to many of the rules that apply to registered charities, as well as the associated penalties. The requirement to issue tax receipts in accordance with the Act, as well as to comply with the record-keeping rules and with CRA’s audit powers, will also be extended to all qualified donees, which will now face the possibility of having their qualified donee status revoked if they do not comply.
If the Budget changes are passed, these measures will apply on or after the later of January 1, 2012 and Royal Asset to the enacting legislation.
The Budget proposes that all qualified donees will be required to be on a publicly-available list maintained by CRA. Currently, such a centralized list is maintained only for registered charities. The expansion of the list is designed to better enable members of the public to determine which organizations may issue official donation receipts, as well as to allow registered charities to know which organizations are qualified donees for grant-making purposes. This is a very helpful change.
With respect to the issuing of official donation receipts, the Budget proposes that if a qualified donee issues a donation receipt other than in accordance with the Income Tax Act, CRA may suspend the receipting privileges of that organization or revoke its qualified donee status. Budget 2011 also proposes to extend the monetary penalties associated with the improper issuing of receipts to RCAAAs. All qualified donees will therefore need to ensure that their receipting practices are compliant with the Act and regulations. Query whether CRA has constitutional jurisdiction to impose a fine on a municipality.
The Budget proposes to extend the requirements regarding books and records – which currently apply only to registered charities and RCAAAs – to all qualified donees. All qualified donees will be required to maintain proper books and records and to provide access to those books and records to CRA when requested pursuant to CRA’s audit powers under the Act. If a qualified donee fails to comply, CRA would be authorized to suspend the receipting privileges of the qualified donee or revoke its qualified donee status. The Budget also proposes to extend the monetary penalties associated with failing to file an information return (which currently apply only to registered charities) to RCAAAs.
Qualified donees such as municipalities, prescribed foreign universities and foreign organizations that have received federal gifts should take careful note of these changes. If the Budget passes, the qualified donee status of these organizations can be revoked by CRA for failure to comply with the above requirements. It is noteworthy in particular that CRA will be empowered to revoke qualified donee status when a foreign organization does not comply with CRA’s audit powers under the Act. Such powers have not been previously recognized under the Income Tax Act, and organizations that would be subject to them will need to take steps to ensure compliance. It should be noted that the federal and provincial Crown, as well as the United Nations and its agencies, are not proposed to be subject to these new rules.
The Budget proposes several changes that apply specifically to RCAAAs. The Budget notes that while registered charities are required to operate exclusively for charitable purposes, RCAAAs currently need have only the promotion of amateur athletics in Canada on a nation-wide basis as their primary purpose and primary function. The Budget proposes that RCAAAs be required to have the promotion of amateur athletics in Canada on a nation-wide basis as their exclusive purpose and exclusive function (rather than merely their primary purpose and primary function). The Budget document states that these changes will not prevent RCAAAs from staging or engaging in international events and competitions, as such activities would normally be consistent with the promotion of amateur athletics in Canada, given the participation of Canadian teams and athletes in such events.
RCAAAs will be made subject to the regulatory rules that apply to registered charities with regard to related business activities and political activities. RCAAAs will be subject to the same penalties in respect of these activities as registered charities. RCAAAs will also be subject to the penalties under the Act as registered charities in relation to the provision of undue benefits (e.g., excessive compensation to staff, fundraisers, etc).
The Budget proposes finally to provide public access to the annual information returns, governing documents, applications for registration and the names of directors of RCAAAs. This information is currently available only for registered charities. The measure is intended to provide greater transparency for the public regarding how charities spend their funds.
The Budget notes that CRA will consult with stakeholders regarding these changes and develop an administrative guidance regarding these measures. In particular, stakeholders are invited to comment on the proposed “exclusivity of purpose and function test” for RCAAAs by June 30, 2011. Stakeholders with concerns about the application of an exclusivity of purpose and function test are encouraged to comment.
If the Budget passes, these changes will significantly change the regulatory landscape within which qualified donees other than registered charities operate. Such organizations, and RCAAAs in particular, will need to ensure that their operations comply with the regulatory requirements that currently apply to registered charities. For many organizations, this will require a thorough review of current operations, receipting and record-keeping practices.
Budget Gives Charity Governance Control to CRA
The Government believes that there is a pattern of the same individuals being involved in multiple abusive charities. However, the Budget materials admit that under the current rules the CRA may be unable to refuse registration even if there is a high risk of abuse because of the past behaviour of the charity’s directors and others involved with the charity.
The Budget proposes to give CRA new powers over a charity’s governance. The proposals will give CRA discretion to refuse to register an applicant or to revoke an existing charity or to suspend its receipting ability if any individual director, officer, or person who otherwise controls or manages the charity has engaged in any of the following:
- been convicted of any crime (in Canada or elsewhere) involving financial dishonesty or that is otherwise relevant to the organization;
- been convicted in the last five years of any regulatory offence (in Canada or elsewhere) involving financial dishonesty (such as securities legislation, consumer protection legislation or fundraising legislation) or that is otherwise relevant to the organization;
- was a director, officer, or person who otherwise controlled or managed a charity or Canadian amateur athletic association that engaged in serious non-compliance for which its registration was revoked within the past five years; or
- was a promoter of a charitable donation tax shelter involving a charity that was revoked in the past five years for participation in the shelter.
The Budget papers confirm that the revocation/refusal is discretionary and that CRA will consider the circumstances. Although the Budget suggests that background checks will not be necessary, we suggest that cautious charities begin to obtain them for board members and management. The Budget also confirms that the above provisions are not to take effect until the later of January 1, 2012 and Royal Assent and suggests that CRA will consult with the charitable sector in developing its policy on these governance proposals.
Tax Consequences of Returning Gifts
Occasionally a charity or a donor will want to return a gift. For example, a charity may wish to return a gift to a donor whose association with the charity may harm the charity’s reputation or where the gift turns out to be proceeds of a crime. Donors may also seek the return of a gift where the gift was not used as the donor originally intended. Typically, gifts are irrevocable transfers of property and therefore, at law, it is rare that a charity can legally return a gift. Where gifts are returned improperly in Ontario, the Public Guardian and Trustee may seek the return of the returned gift. Charities should seek legal advice to determine if it is legally possible to return the gift before taking action.
Before the 2011 Budget, the Income Tax Act and CRA policy were relatively silent on the tax consequences that arose when a charity returned a gift to a donor. The Budget now addresses this issue directly with the following rules:
If a qualified donee issues a charitable tax receipt to a donor and then subsequently returns the gift to the donor, the donor is deemed not to have made the gift at the time the gift was originally made. The donor is also deemed not to have disposed of the property at the time the gift was made. Essentially the gift is undone retroactively for tax purposes.
If the returned property is identical to the original property, it is deemed to be the same property. Thus, if a $100 gift is returned, it will be considered the same $100 and the tax consequence is limited to disallowing the donation credit or deduction. However, if the returned property is not the same or identical property, then the person is deemed to have disposed of the original property at the time the person acquires the returned property. For example, if the donor donated securities and receives cash in lieu of the securities (presumably because the charity sold the securities), then the donor is deemed to have disposed of the securities on the day the cash is received by the donor. Thus, the donor will have tax consequences with respect to the disposition of the securities at the time the gift is returned.
Where the returned amount exceeds $50, the new rules require the charity to issue a revised official donation receipt and file a copy of the receipt with CRA.
The government now has the authority to reassess a return of income in respect of a return of property from a qualified donee. Thus, even if a taxpayer’s return for a particular taxation year is statute-barred -- that is, CRA cannot otherwise reassess the taxpayer for the year in question -- the proposed change will allow CRA to reassess the taxpayer in respect of the returned gift and disallow the deduction or credit in the earlier year. Further, if as indicated above, the rules cause a deemed disposition because the returned property is not identical to the gifted property, the taxpayer may have a tax liability in the year the gift is returned.
The changes do have a certain logic as they will prevent donors from obtaining windfalls. However, they do have the possibility of imposing hardship on donors in limited circumstances.
2011 Federal Budget – Granting Options to Qualified Donees
The Budget has introduced provisions designed to delay the recognition of a gift where an option to acquire a property is donated to a qualified donee. Prior to the introduction of these provisions, where a donor granted an option to acquire a property to a qualified donee, a receipt could be issued and the gift was recognized immediately for the value of the option.
Parallel provisions are proposed for gifts by individuals and corporations. Generally, where a donor issues an option to a qualified donee, the recognition of the resulting gift is delayed until the option is exercised by the qualified donee.
Where an option is given to a qualified donee and is exercised by the qualified donee to enable the qualified donee to acquire property, it will be deemed to be a gift at the time of exercise where one of two conditions is met:
- 80% of the fair market value of the property exceeds the total of
- any consideration received by the donor from the qualified donee to acquire the property, plus
- any consideration received by the donor from the qualified donee to acquire the option; or
- the donor establishes to the satisfaction of the Minister that the granting of the option and the disposition of the property subject to the option was made by the donor with the intention of making a gift.
Based on the above, a gift will not be recognized where the total of the amount paid by the qualified donee for the property and the option exceeds 80 per cent of the fair market value of the property at the time of acquisition by the qualified donee. These rules are designed to be in keeping with the (still proposed) split-receipting "80/20 rule" that provides that where an advantage associated with a gift exceeds 80 per cent of the value of the property transferred, there is no gift.
When either of these two conditions is met and the exercise of the option triggers the recognition of a gift, the donor is deemed to have disposed of property (i.e., the option) for proceeds equal to the underlying property’s fair market value at the time of exercise. As well, the donor is deemed to have made a gift to the qualified donee equal to the amount by which the fair market value of the underlying property exceeds the amount of any consideration received (as described in 1 above). We note that there appears to be a technical error in the drafting of this particular portion of the proposed legislation but we believe that this is what was intended by these new rules.
Where an option to acquire property is gifted to a qualified donee and subsequently disposed of by the qualified donee (i.e., it is sold prior to being exercised), the donor is deemed to have disposed of property:
- at an amount equal to the cost of any consideration paid by the qualified donee to acquire the option in property in the first place; and
- for proceeds of disposition equal to the fair market value of any consideration (other than a non-qualifying security) received by the qualified donee for disposing of the option in property (i.e., the sale price, if any).
In these circumstances, the donor is also deemed to have made a gift for receipting purposes equal to the proceeds of disposition in 2 above (i.e., the sale price if the option is sold) less any consideration paid by the qualified donee to acquire the option in the first place.
In light of these complicated new rules, charities and other qualified donees that are approached by a donor with a potential gift of options should seek specific advice before accepting such gifts.
Non-Qualifying Security Anti-Avoidance Rules
The non-qualifying security rules are designed to prevent a person from receiving a donation tax receipt where the person’s gift to a qualifying donee is a share, debt obligation or other security of the person or of a person not at arm’s-length from the person. This type of gift is known as a non-qualifying security (“NQS”). In general, the rules provide that the person can receive a donation tax receipt for a gift of a NQS when within 5 years either: (i) the qualifying donee sells the NQS (for consideration other than another NQS of the individual) or (ii) the gift is no longer a NQS.
For example, if a person issues a personal debt to a charity for $1000, they do not receive a charitable tax receipt for $1000 at that time. If within the 5 year period, the person pays the charity $1000 for the gifted debt obligation, they receive a charitable tax receipt of $1000 at that time.
The Income Tax Act currently provides that a donor receives a receipt when the qualifying donee sells the NQS for consideration other than another NQS of the donor. The Budget proposes to broaden this to deny receipts where the qualifying donee sells the NQS in exchange for a NQS of any person.
Further, the Budget proposes new rules to catch situations in which a donor avoids the application of these rules by implementing a series of transactions, where at the end of the series of transactions the qualifying donee holds a NQS of the donor. The Budget proposes two rules. The first rule catches a specific series of transactions. The second rule is a more general rule to catch any series of transactions where a person makes a gift to a qualifying donee, the qualifying donee receives a NQS, and it is reasonable to consider that a purpose or result of the qualifying donee’s acquisition of the NQS was to facilitate the person’s gift.
Tax Court Charitable Jurisdiction Not In Budget
There have been a number of charity tax proposals put forward in the last year by the charitable sector as suggestions for change. One change that we thought had a real chance of success (because it had no real tax revenue cost, unlike various proposals for expanded donation recognition) was the proposal to move charitable registration and revocation appeal jurisdiction from the Federal Court of Appeal to the Tax Court of Canada. This change was the only one suggested by the Joint Regulatory Table of the Voluntary Sector Initiative that was not passed into law as part of the 2004 Budget. It has been requested by charity sector organizations and others on a number of occasions since.
Charity registration appeals go directly from CRA to the Federal Court of Appeal by way of judicial review. This is less than ideal because the procedure of the Federal Court of Appeal (the second highest court level in Canada) is not designed for ease of access. We had therefore hoped and the sector had requested that charity appeals would go first to the Tax Court, and only proceed to the Federal Court of Appeal after first being heard at the Tax Court.
Unfortunately, original jurisdiction over charity registration appeals was not moved in the Budget and remains with the Federal Court of Appeal. We can only hope that this change will be included in a subsequent budget.