On May 1, 2013 the Federal Court of Appeal delivered its judgement in Prescient Foundation v. M.N.R.: 2013 FCA 120. The judgement was delivered by Mr. Justice Mainville. This case was an appeal brought by the Prescient Foundation against a Notice of Revocation of its charitable registration delivered by the Minister of Revenue. The revocation was based on four grounds:
- that the Foundation had participated in a tax planning arrangement for the private benefit of others;
- that it had transferred an amount of $574,000 for a share purchase that was in fact a non-charitable gift;
- that it had made a gift to a non-qualified donee (a 501(c)(3) nonprofit organization in the United States); and
- that it failed to maintain adequate books and records.
The Foundation lost its appeal and the revocation was upheld. That said, the Court made some very interesting comments and conclusions in connection with the four grounds of revocation proposed by the Minister.
Tax planning arrangement
With respect to the tax planning arrangement, the Court reviewed a corporate transaction whereby certain farm assets owned in a company by one couple were to be sold to another couple in an arms-length transaction. The transaction, however, was structured using a number of charities, one of which was the Foundation. The impact of using the charities was to eliminate tax that would otherwise have been owing on the sale of the assets, both by the vendor corporation and its owners. The purchasers ending up owning assets which they had intended to purchase but the transaction involved transferring shares and assets through several foundations and ultimately to the purchasers.
The taxpayers argued that they were simply organizing their affairs in the best way possible to minimize tax payable, as has often been accepted by the courts. The Minister, however, disagreed and felt that the use of the charities was improper, given that the charities received minimal benefit from the transactions (the charities received a small percentage of the transferred funds, which the Court described as a commission). The Federal Court of Appeal stated that:
The special advantages extended to charities under the Act are meant to assist them in pursuing their charitable purposes. Under subsection 149.1(1) of the Act, charitable foundations must thus be operated exclusively for charitable purposes. Prescient broke that important rule through its participation in the Farm Sale Transactions. (para. 38)
The Court went on to conclude that farm sale transactions were not to benefit the charities but rather to use the tax privileges of the charities to confer unwarranted tax benefits on the private individuals and corporation involved. The Court accepted that the Foundation’s participation in the farm sale transactions was grounds for the Minister to revoke the Foundation’s registration.
Notwithstanding this conclusion, the Court made helpful and interesting comments on the other grounds of appeal as well as the standard of review. On the standard of review to be applied by the Court when reviewing the Minister’s decision, the Court stated that where the question is a question of law, including the interpretation of the Income Tax Act (ITA), the standard to be relied on is a standard of correctness. The Minister had argued that its decisions should be reviewed on a more limited standard of reasonableness but the Court clarified that that is only applicable where the Court is looking at questions of fact or mixed fact and law. This result is supported by case law and is not surprising, but it is useful to have the Court make that statement.
Gift to non-qualified donee
With respect to the gift to the 501(c)(3) organization in the United States, the Minister had tried to argue that a gift to a non-qualified donee was grounds for de-registration of the Foundation. In making this argument, the Minister relied on a proposed amendment to section 149.1(3)(b.1) of the ITA which provides that the Minister may revoke the charitable status of a public foundation if it makes grants to non-qualified donees. This section, however, has not been enacted and has been a proposed amendment to the ITA for several years.
The Court clearly stated that the Minister could not rely on the draft amendment to revoke the charitable registration of the Foundation. The Court went further and held that a grant to an organization that has charitable purposes – such as a US 501(c)(3) organization – would not be inconsistent with the Foundation’s obligation to devote its assets for exclusively charitable purposes and did not give rise to a ground for revocation. The Court’s comments on the provisions of the ITA which are not yet in force were extremely interesting given that there are a number of provisions and proposed changes to the provisions in the Act dealing with charities that have been outstanding for almost 10 years.
Books and Records
The final issue on which the Court commented was with respect to the Minister’s allegations regarding inadequate books and records. It is not uncommon for the Minister of Revenue to cite “failure to maintain adequate books and records” in letters proposing revocation in cases such as the Foundation’s. The charity is generally not provided with any information outlining the specific information that was missing. The Court reviewed subsection 230(2) of the ITA, which outlines the pertinent requirements regarding books and records. The Court stated the provision is vague, particularly at 230(2)(a) which requires charities to maintain information “in such form as will enable the Minister to determine whether there are any grounds for the revocation of its registration under this Act”. The Court stated:
- natural justice requires that the registered charity be properly and adequately informed of the particulars of the allegations so as to allow it to respond in a meaningful way to those allegations; and
- this Court must be in a position to clearly understand why the Minister is revoking the registration on this basis so as to allow it to determine whether that sanction was reasonable in the circumstances. (para. 47-48)
The Court went on to say that, regardless of who bears the initial burden of proof as part of this reasonableness inquiry, the Court must be satisfied that it was reasonable in the circumstances for the Minister to require the records or information at issue and that the revocation of the charity’s registration must be a reasonable response to failure to maintain or provide them.
We welcome this language and the clarification from the Court, because inadequate books and records is commonly cited by the Canada Revenue Agency when it proposes de-registration of a charity and often appears to be an “add on” to other grounds for revocation which may or may not be valid. There is often an “everything but the kitchen sink” approach to revocation proposals. The CRA seems to be of the view that if it includes many grounds for de-registration rather than one or two, they would be more likely successful in the event the matter is appealed. We applaud the Court for clarifying that this is not a reasonable approach and that charities deserve full disclosure of the reasons for the Minister’s conclusion. Furthermore, it is helpful that the Court confirmed that the Minister must step back and consider on each separate ground whether it is reasonable to revoke for that particular issue.
It is unknown at this date as to whether there will be any appeal by the Foundation from the decision. The decision as it stands contains a number of comments and statements about the law that would be relevant to charities responding to the CRA on audits and proposals to either impose sanctions or revoke the charity’s status in the future.