The Canada Revenue Agency (“CRA”) recently released Technical Income Tax News No. 41 (“TN41”), which sheds light on CRA’s position on certain issues related to the registration of tax shelter arrangements, and in particular tax shelters which involve the donation of flow-through shares to registered charities or other qualified donees. The crucial point arising from this publication is that persons who have made donations of flowthrough shares as part of a tax shelter arrangement must ensure that they obtain a tax shelter identification number from the promoter or will risk having their charitable donation credit or deduction denied.
We discussed the potential tax advantages of donating flow-through shares in the August 2006 issue of Miller Thomson’s Charities and Not-for-Profit Newsletter. The combined benefits of the availability to investors of “flowed through” deductions for exploration costs incurred by the issuer, along with the elimination of capital gains on the donation of publicly-listed securities, makes the donation of flow-through shares highly attractive to donors. In the December 2006 issue of the Newsletter, we noted increased activity by promoters highlighting the attractiveness of charitable donations of flow-through shares. We cautioned that although flow-through shares are generally exempt from the tax shelter identification requirements of the Income Tax Act (the “Act”), certain gift structures may require identification.
The recent CRA publication confirms that flow-through shares will be required to adhere to the tax shelter identification rules in the Act where they are acquired under a “gifting arrangement.” Essentially, a “gifting arrangement” includes any arrangement which would, according to statements made by the promoter, involve participants in the arrangement making gifts to qualified donees (e.g., registered charities). This would include circumstances in which the flow-through share promotion addresses the gifting of the charitable donation from inception and uses the value of the charitable donation tax credit as an incentive to investors to invest in the flow-through share. There is no requirement that the plan be mass-marketed. When this type of plan is proposed by a financial advisor for a specific client, a tax shelter number should be obtained. Where such a gifting arrangement constitutes a tax shelter under the Act – that is, where it will result in an investor obtaining (within the first four years of investing) an aggregate of losses, deductions, credits or a reduction in tax in excess of the cost of the investment (subject to certain reductions) – the promoter of the arrangement must obtain a tax shelter identification number from CRA and investors must provide the identification number to CRA when claiming credits or deductions in respect of the tax shelter.
TN41 also discusses the impact of two court decisions on the definition of a tax shelter. CRA noted that the Federal Court of Appeal held in Maege v. The Queen that a tax shelter can be found to exist even in the absence of explicit representations to specific investors. CRA also noted that the Tax Court of Canada has held in Baxter v. The Queen that a tax shelter may be found on the basis of statements that a promoter proposes to make. CRA states in TN41 that these decisions broaden the circumstances in which a tax shelter will be found to exist, especially where sophisticated investors are involved.
Thus, investors who make charitable donations of flow-through shares are well-advised to inquire whether tax shelter registration is required, as failure to file a tax shelter identification number may result in the disallowance of credits or deductions available under flow-through share arrangements. Furthermore, charities may want to advise donors of the possible tax shelter registration requirements that may result from the donation of flow-through shares to avoid reputational risks if donors are denied deductions for failure to obtain a tax shelter registration number.