On October 24, 2012 the Minister of Finance tabled a Notice of Ways and Means Motion ("NWMM") that will implement many previously proposed amendments to the Income Tax Act (the "Act"). Many of the amendments have retroactive effect and are already being applied by the Canada Revenue Agency (the "CRA"). Of particular interest to charities are amendments dealing with split-receipting, gifts of depreciable capital property, tax shelters and reportable transactions, the definitions of "charitable organization" and "public foundation", revocation of registered charitable status and the net tax calculation under the Excise Tax Act. This article summarizes these amendments.
The NWMM will implement the split-receipting regime originally proposed by the Department of Finance in draft legislation released on December 20, 2002. The draft legislation was proposed in response to court cases that determined that a gift could be made even where the donor received consideration for his or her donation. Versions of the amendments proposed on December 20, 2002 re-appeared in several later releases of draft legislation, including most recently in draft legislation released on July 16, 2010. The amendments in the NWMM the same as those contained in the July 16, 2010 draft legislation.
Split-receipting allows charities to issue donation receipts for donations where the donor received a benefit from making the donation. Before these amendments, "gift" was not defined in the Act and had its common law definition of a voluntary transfer of property made without consideration. Under the common law definition, a donor who paid $900 to attend a fundraising brunch that normally costs $50 would not be entitled to receive a receipt for his or her contribution. Because the donor received consideration (the brunch) for the contribution, the donation was denied because there was no "gift", even though the value of the contribution was far greater than the consideration received.
The definition of gift under the common law was problematic for several reasons. It was a form over substance approach. Many felt that it was arbitrary to distinguish between an $850 donation, without brunch, for which a receipt could be issued, and the example above. It was also inconsistent with the rationales for giving charitable donations preferential tax treatment, such as subsidizing the work of charities and rewarding generous individuals. Restricting gifts to transfers made without consideration also led to inconsistencies in the law. In Quebec, the definition of "gift" under the Civil Code includes transfers of property where the property transferred exceeds the consideration received. Federal courts also sometimes found that a gift could be made where consideration was received by the donor.
The split-receipting rules are found in new subsections 248(30)-(32), which will be added to the Act by the NWMM. As noted above, these subsections were first introduced by the Department of Finance in draft legislation released on December 20, 2002 and apply retroactively to that day.
The technical notes to the July 16, 2010 draft legislation concerning split-receipting state that new subsection 248(30) provides the transferor with an opportunity to rebut the presumption that no gift was intended if consideration was received for the transfer. Specifically, subsection 248(30) provides that the existence of an advantage in respect of a property transferred to a qualified donee (e.g. a registered charity) does not "in and of itself" disqualify the transfer from being a gift under two situations, namely (a) where the amount of the advantage does not exceed 80% of the fair market value of the transferred property and (b) where the transferor establishes to the satisfaction of the Minister of National Revenue (the "Minister") that the transfer was made with the intention to make a gift.
Subsection 248(31) provides that the "eligible amount" of a gift is the amount by which the fair market value of the property transferred exceeds the amount of the advantage in respect of the gift. The technical notes to the July 16, 2010 draft legislation clarify that the tax benefit available to a taxpayer, by way of a charitable donation deduction or credit, is not considered an advantage or benefit that would reflect a lack of intention to make a gift. However, the technical notes go on to explain that this subsection is not intended "to allow a taxpayer to profit" from the making of a gift, such as in situations where the "primary intention" of the taxpayer for "entering into a transaction or series of transactions" is to "return a profit to the taxpayer by way of a combination of tax and other benefits" so that the taxpayer is not "impoverished" by the transfer of property to the charity.
Subsection 248(32) defines "amount of the advantage" as:
- the value of any benefit that the taxpayer, or a person or partnership who does not deal at arm's length with the taxpayer, has received or is entitled to receive, immediately or in the future and either absolutely or contingently, that is in any way related to the gift; and
- any "limited-recourse debt" in respect of the gift.
The definition of "amount of advantage" is extremely broad. The provision is intentionally drafted to catch any type of advantage that could possibly accrue to a donor upon the making of a charitable gift. Notably, to fall under the definition it is not necessary that the advantage accrue to the donor, nor is it necessary that the advantage be conferred by the donee.
The definition of "limited recourse debt" is found in proposed subsection 143.2(6.1), which will be added to the Act by the NWMM. Limited recourse debt is generally defined as any unpaid debt of the donor, a non-arm's length party to the donor or a taxpayer who holds an interest in the donor where recourse is limited. Recourse will be limited where:
- there are no arrangements for the debt's repayment within ten years and/or interest is not paid annually; or
- there is a guarantee, security or similar indemnity or covenant in respect of the debt.
The NWMM also adds subsections 248(33)-(41), all of which deal with split-receipting. Of particular note is subsection 248(40), which provides that the split-receipting rules do not apply to inter-charity gifts.
Subsections (35) to (39) set out deemed fair market value rules, which were first introduced in draft legislation released on December 5, 2003. These provisions are aimed at preventing tax shelter arrangements like "art flips" and other arrangements involving "buy low, donate high" valuations. Subsection (35) applies to gifts made after December 5, 2003 and deems the fair market value of such gifts to be the lesser of the fair market value of the gifted property and the cost of the property to the taxpayer immediately before making the gift if:
- the taxpayer acquired the property under a gifting arrangement that is a tax shelter; or
the gift is not made as a consequence of the taxpayer's death and the donor acquired the property;
- less than three years before making the gift; or
- less than ten years before making the gift if it is "reasonable to conclude" that a main reason for acquiring the property was to make a gift to a qualified donee.
Subsection 248(37) also applies to gifts made after December 5, 2003 and exempts certain property from the application of the rule, including inventory, Canadian real property, ecological gifts, gifts of publically traded securities, certified cultural property and shares where a shareholder transferred property to a corporation that was controlled by the shareholder and/or people related to the shareholder.
Subsections (36), (38) and (39) lay out rules intended to prevent the avoidance of the deemed fair market value rule in subsection (35). Subsection 248(36) applies to gifts made on or after July 18, 2005 and provides that where subsection 248(35)(b)(i) or (ii) applies, and the taxpayer acquired the property from a non-arm's length person or partnership within the relevant three or ten year period, the cost to the taxpayer for the purposes of subsection 248(35) is deemed to be the lower of the cost to the taxpayer immediately before the gift was made and the cost to the person or partnership immediately before the taxpayer disposed of the property.
Subsection 248(38) applies to gifts made after December 3, 2005 and deems the eligible amount of a gift to be nil if it can reasonably be concluded that the gift relates to a series of transactions designed to avoid the application of subsection 248(35) or that would be caught by the general anti-avoidance rule.
Subsection 248(39) applies to gifts made on or after February 27, 2004 and prevents a donor from avoiding the application of subsection 248(35) by selling property to a charity and then donating the proceeds instead of the property itself.
Subsection 248(41) deems the eligible amount of a gift to be nil where the donor fails to provide the charity issuing the receipt with information related to the application of subsections 248(31), (35), (36), (38) or (39). It applies in respect of gifts made on or after January 1, 2006.
As a result of these above-proposed amendments, the NWMM will also amend a number of related provisions of the Act and the Income Tax Regulations, including:
- the definitions of "total charitable gifts", "total Crown gifts", "total cultural gifts" and "total ecological gifts" in subsection 118.1(1) of the Act, which will be amended to provide that the amount of the gift that qualifies for the tax credit is generally the eligible amount of the gift;
- subsection 118.1(7)(d), concerning gifts of art by an artist;
- subsection 118.1(8), which allows gifts made by a partnership to be attributed to its individual members and will be amended to refer to the "eligible amount";
- subsection 118.1(13), which addresses gifts of non-qualifying securities and will be amended to include language complementary to the split-receipting rules;
- subsections 3501(1), (1.1), and (6) and subsections 2000(1) and (6) of the Income Tax Regulations which will be amended to require that official donation receipts reflect the eligible amount and the amount of advantage of a gift if it is made after December 20, 2002;
- subsection 149.1(1) of the Act concerning the definition of disbursement quota; and
- subsection 149.1(9) of the Act concerning the deemed income of the charity if it defaults under the rules concerning the accumulation of property pursuant to subsection 149.1(8).
Gifts of Depreciable Capital Property
Pursuant to the current subsection 118.1(6), where an individual makes a gift of capital property and the fair market value of the property exceeds its adjusted cost base to the individual, he or she may designate a value between the property's adjusted cost base and its fair market value to be treated as the proceeds of disposition for the purpose of calculating the capital gain and the fair market value of the gift for the purpose of preparing a charitable receipt for the gift.
The NWMM restructures this provision into new subsections 118.1(5.4) and 118.1(6). Subsection 118.1(5.4) outlines the circumstances under which amended subsection 118.1(6) will apply to allow the taxpayer to designate an amount as the proceeds of disposition and fair market value. These circumstances remain generally unchanged, with one notable exception. When the property donated is depreciable capital property, amended subsection 118.1(6) will apply where the value of the gifted capital property is between the undepreciated capital cost of the class the property belongs to and the property's fair market value.
The amount designated by the individual under the new subsection 118.1(6) may not be less than the greater of:
- the amount of the advantage, if any, received in respect of any gift made after December 20, 2002; and
- in the case of depreciable property, the lesser of the undepreciated capital cost of the class the property belongs to and the property's adjusted cost base; and
- in all other cases, the adjusted cost base of the property.
This effectively allows an individual to reduce the amount of recaptured depreciation that might be calculated in respect of a gift of depreciable property, with a corresponding reduction in the eligible amount of the gift. The amendment was recommended in a Comfort Letter dated February 15, 2000 and appeared in the December 20, 2002 draft legislation.
Definitions of "charitable organization" and "public foundation"
The NWMM codifies definitions for "charitable organization" and "public foundation" that have been applied by the CRA for many years. The amendments were first suggested in Comfort Letters dated September 11, 2001, for charitable organizations, and December 13, 2002 for public foundations. The February 18, 2004 and July 16, 2010 draft legislation included similar proposals. The amendments apply retroactively beginning January 1, 2000.
The current definitions of "charitable organization" and "public foundation" in subsection 149.1(1) require, among other things, that at least 50% of the directors, trustees, officers or other like officials deal with each other and with each of the other directors, trustees, officers or other like officials at arm's length. For public foundations and charities that are public or private foundations a "contribution test" must also be met: not more than 50% of the organization's capital may be contributed by a person or group of people not dealing at arm's length with one another.
The NWMM replaces the "contribution test" with a "control test" for charitable organizations and public foundations. As a result of this amendment, an organization will no longer be disqualified as a charitable organization or public foundation if it receives more than 50% of its capital from a single contributor. Instead, the "control test" requires that the organization not be controlled by:
- any person or group of people who have contributed more than 50% of the capital of the organization; or
- any person or group of people who do not deal at arm's length with a person or group in (a). A group is considered to not deal at arm's length with a person or group in (a) if any one of its members does not deal at arm's length with such a person or group.
In addition, the directors, officers, trustees and like officials of the charity or public foundation, as the case may be, must deal at arm's length with the people listed in (a) and (b). The requirement that they deal at arm's length with each other and the other directors, officers, trustees and like officials is still in place.
Tax Shelters and Reportable Transactions
The NWMM amends the definition of "gifting arrangement" under subsection 237.1(1) of the Act to include an arrangement in which a donor incurs a limited-recourse debt, as defined in subsection 143.2(6.1), which can reasonably be considered to relate to a charitable donation. The current section refers to a "limited recourse amount" instead of a "limited-recourse debt." The amendment was introduced in the July 2010 draft legislation and implements a change proposed in the Federal Budget released on February 18, 2003. It applies to gifts and monetary contributions made after 6:00 pm EST on December 6, 2003.
The NWMM also implements the reportable transactions regime in section 237.3 that was initially proposed in the 2010 Federal Budget released on March 4, 2010. The amendments are the result of considerable public consultation and are intended to help the CRA identify tax avoidance measures in a timely fashion. They apply to transactions that were entered into or ongoing in 2011.
There are some differences between the amendments in the NWMM and the draft legislation released on August 27, 2010 that originally contained these proposals. These changes have largely been made to address concerns over the impact of the new reporting regime on relationships where solicitor-client privilege exists. Subsection 237.3(17) now also expressly provides that a lawyer who is an advisor in respect of a reportable transaction is not required to disclose information about the transaction that the lawyer has reasonable grounds to believe is protected by solicitor-client privilege. A definition for "solicitor-client privilege", which refers to subsection 232(1) of the Act, has also been added. Changes not related to solicitor-client privilege have been noted in the footnotes below.
The regime requires "reportable transactions" to be reported to the CRA. A transaction will be a reportable transaction if it bears at least two of the three following hallmarks:
A promoter or tax advisor in respect of the transaction is entitled to fees that are to any extent:
- attributable to the amount of the tax benefit from the transaction;
- contingent upon obtaining a tax benefit from the transaction; or
- attributable to the number of taxpayers who participate in the transaction or who have been provided access to advice given by the promoter or advisor regarding the tax consequences from the transaction;
- A promoter or advisor in respect of the transaction requires "confidential protection" concerning the transaction, while acting in his or her capacity as a promoter or advisor.
- The taxpayer or the person who entered into the transaction for the benefit of the taxpayer obtains "contractual protection" in respect of the transaction.
An advisor is defined as a person who provides, directly or indirectly, "contractual protection" in respect of a transaction or any assistance in planning or carrying out the transaction. It is not intended a person be an advisor to himself or herself.
A promoter is defined as a person who promotes or sells a transaction, or represents that a tax benefit could result from a transaction, that is or is related to an avoidance transaction. A person will also be considered a promoter if he or she receives consideration for promotional work or sales carried out by someone else.
Contractual protection is any form of insurance (other than standard professional liability insurance) or other protection, such as a guarantee, against the failure of an arrangement to produce a tax benefit. It includes any undertaking provided by a promoter or a person who does not deal at arm's length with the promoter that assists a person engaged in a dispute over a tax benefit arising from the transaction in any way.
Confidential protection means anything that prohibits disclosure about the details or structure of the transaction to any person, and particularly to the Minister. The protection afforded by the prohibition must flow to the advisor or promoter.
The following people must report the transaction to the Minister by filing an information return in a prescribed form:
- Any person receiving a tax benefit from a reportable transaction;
- Any person who has entered into a reportable transaction for the tax benefit of another;
- Any advisor or promoter entitled to a fee in respect of a transaction; and
- Any person who does not deal at arm's length with an advisor or promoter who is entitled to a fee in respect of atransaction.
The information return must be filed on or before the taxpayer's filing-due date for the taxation year in which the tax benefit arose. Where there is no filing-due date, it must be filed before June 30th of the calendar year following the calendar year in which the tax benefit arose.
Upon discovering that a reportable transaction has not been reported as required, the CRA could deny the tax benefit resulting from the transaction. If the taxpayer still wanted to claim the tax benefit, it would be required to file with the CRA any required information and to pay a penalty. The amendments expressly state that the disclosure of a reportable transaction is not considered an admission that the general anti-avoidance rule applies to the transaction.
A due diligence defence is provided that protects any person who fails to report a transaction from being liable for a penalty under the amendments. The defence applies where a person has exercised the degree of care, diligence and skill to prevent a failure to report the transaction as a reasonably prudent person would have exercised in comparable circumstances.
Both charities and their advisors should ensure that they are familiar with the new rules relating to reportable transactions. Depending on a charity's role in the transaction, it may meet the definition of a promoter or advisor and have an obligation to report the transaction.
Revocation of Registered Status
Subsections 149.1(2), (3), and (4) set out the circumstances under which the Minister may revoke the registered status of a charitable organization, public foundation or a private foundation, respectively. The NWMM adds a new paragraph to each section, which provides that the organization may also have its registered status revoked if it makes gifts to persons or entities other than qualified donees.
These amendments enact a longstanding CRA policy that charities and foundations may not make gifts to foreign charities that are not qualified donees. The amendments appeared in the July 16, 2010 draft legislation and apply retroactively to gifts made after December 20, 2002.
The Excise Tax Act - Net Tax Calculation for Charities
Existing subsection 225.1(4.1) of the Excise Tax Act prohibits a charity from including in its net tax calculation as an input tax credit an amount that would otherwise qualify as an input tax credit but became refundable under an Act of Parliament or was remitted to the charity under the Financial Administration Act or the Customs Tariff. The NWMM changes "refundable" to "refunded" and applies for the purpose of determining the net tax of a charity for reporting periods beginning after December 31, 1996.
The NWMM enacts many important changes for charities that have been in draft form for many years. Given the CRA's practice of applying proposed amendments with retroactive effect as law, the NWMM is unlikely to have much practical impact on the day-to-day affairs of charities. However, it is comforting to see that the letter of the law will now accord with its application.