Charity Sector is the Focus of Budget 2011
By Adam Aptowitzer
In a budget that focussed on tightening up the tax system the charity sector assumed the brunt of the government’s concerns. Of course, given the recent antagonism the sector faced by all parties in the hearings on Bill C-470, a budget dedicated to tightening the rules on charities is unlikely to create enemies on Parliament Hill. On the other hand, after reading the budget many charities will be secretly hoping for the government to fall so that both the measures in the budget and bill C-470 die without being passed.
Flow Through Tax Shelters
Those in the sector will know that the purchase and subsequent donation of flow through shares has become a big business. While exact figures have never been published it is likely not an exaggeration to say that donations of flow through shares since 2006 exceed 2 billion dollars. Budget 2011 aims to shut down the doubly rich benefits from the donation of flow through shares.
By way of reminder, flow through shares are special shares of mining and exploration companies designed to encourage investment in those sectors. Certain types of shares of qualifying companies entitle the shareholder to deduct up to 100% of the cost of the shares from the shareholder’s personal income. The trade off is that the shares are deemed to have a cost of zero. So, if the shareholder purchased the share for $10 and sold it for $10 the shareholder would nevertheless have a capital gain of $10. (Of course, the shareholder also has a deduction of $10 – but because of the relative tax treatment of capital gains vs. deductions there is still a net positive benefit to the shareholder).
In 2006, the Liberal government introduced an exemption from capital gains tax for shares of publicly traded corporations donated to charity. When combined with the pre-existing flow through regime, shareholders who donated their flow through shares to charity were entitled to the tax deduction, the exemption from capital gains tax and charitable tax receipt equal to the fair market value of the donation. In sum, the donation cost the donor about 5 cents per dollar donated (as opposed to 54 cents for cash in Ontario).
While the CRA has come out with several tax rulings making it clear that the purchase and donation of flow through shares (in various configurations) was allowed, it is clear that the Department of Finance felt that the combined incentive programs was too rich, resulting in Budget 2011’s new treatment.
Effectively, purchasers of flow through shares are still entitled to the deductions otherwise allowed but the amount of the capital gains exemption is limited to the amount of gain the share actually experiences. So someone that buys the share for $10 and donates the share when it is worth $11 will pay capital gains tax on $10, receive a deduction for $10, and a receipt for $11. On the other hand, if that individual had purchased a share of publicly traded corporation for $10 and donated it at $11 he or she would have not paid any capital gains tax but would have received a tax receipt for $11.
The net attractiveness of donating flow through shares will now have to be considered in light of the particular circumstances of a specific share.
Paranoia Persists in New Governance Measures
Perhaps obviously we have been involved in many, many applications for charitable status and from time to time the Charities Directorate has raised questions about the involvement of particular directors in activities which the CRA disliked. At times, this was involvement in political activity (by non charities), sometimes this was involvement in charities which later turned out to be tax shelters. But the CRA is our taxing agency and it had no authority to deny registered charity status on the basis of its institutional dislike or distrust of the directors.
Budget 2011 gives this power to the CRA. Under the proposed provisions the CRA could refuse registration or revoke the registration of a charity where there is risk of abuse rather than where an abuse actually took place. Effectively, charities are being denied the opportunity to be innocent until proven guilty.
The CRA will be entitled to take action where even a single director, trustee, officer or equivalent official or any individual who otherwise controls or manages the operation of the organization:
. has been found guilty of a criminal offence in Canada or an offence outside of Canada that, if committed in Canada, would constitute a criminal offence under Canadian law, relating to financial dishonesty (including tax evasion, theft or fraud), or any other criminal offence that is relevant to the operation of the organization, for which he or she has not received a pardon;
. has been found guilty of an offence in Canada within the past five years, or an offence committed outside Canada within the past five years that, if committed in Canada, would constitute an offence under Canadian law, relating to financial dishonesty (including offences under charitable fundraising legislation, convictions for misrepresentation under consumer protection legislation or convictions under securities legislation) or any other offence that is relevant to the operation of the organization;
. was a member of the board of directors, a trustee, officer or equivalent official, or an individual who otherwise controlled or managed the operation of a charity or Canadian amateur athletic association during a period in which the organization engaged in serious non-compliance for which its registration has been revoked within the past five years; or
. was at any time a promoter of a gifting arrangement or other tax shelter in which a charity or Canadian amateur athletic association participated and the registration of the charity or association has been revoked within the past five years for reasons that included or were related to its participation.
The technical wording of the new law gives the CRA wide latitude to decide what sort of an offence would be unacceptable to a particular charity (or proposed charity) in the circumstances.
These provisions result in several practical implications for charities. The most frightening one is that charities are revoked all the time for what the Charities Directorate deems ‘serious non-compliance’. This is a completely subjective analysis and could conceivably require litigation to determine if another charity’s revocation was or was not ‘serious’. This is not to mention that the Charities Directorate’s own guidelines only allow for revocation in cases of ‘serious’ non compliance. Another problem is that directors often serve on the boards of charities that get revoked for ‘serious’ non compliance without understanding the implications of their actions. It is only after an audit and an explanation of the CRA’s position that they become aware of the implications (let alone the seriousness) of their actions. Directors in such a circumstance could now be forbidden from ever again serving as a director of a charity.
These measures should be wholly unacceptable to Canadians. We do not proactively punish charities where there is only a risk of wrongdoing. We should not give such non tax related power to our taxing authority. We do allow Canadians the chance to redeem themselves where they have previously been guilty of wrongdoing. And we do not need any more reasons for good, well meaning Canadians to refuse service as the director of a charity.
Closing the Fist
The Income Tax Act has a list of organization to which donations will result in donation tax credits, registered charities are only one type of this organization. The full list is as follows:
1. A registered charity,
2. A Registered Canadian Amateur Athletic Association (“RCAAA”),
3. A corporation operated to provide low cost housing to the aged,
4. A municipal or public body performing a function of government in Canada,
5. The United Nations or an agency thereof,
6. Certain universities outside Canada (listed on Schedule VIII to the Income Tax Regulations),
7. A charitable organization outside Canada to which the Canadian government has made a gift in the year or in the 12- month period preceding the year (a process which itself is shrouded in mystery), or
8. The Federal or Provincial governments.
While donations to any of these organizations will result in donation tax credits, until now, only registered charities were subjected to the strict regime with which the sector is familiar. Budget 2011 proposes that all organizations except the United Nations and the Federal and Provincial governments now be subjected to the same regime as charities.
That other organizations to which public funds are directed should be subject to stricter rules is not entirely unwarranted. In particular, foreign universities have in the past been part of ‘art flip’ donation plans and several high profile RCAAAs have had their status revoked for involvement in charitable donation tax shelters. However, this reasoning was offset by the difficulties in imposing Canadian rules on foreign organizations (and by the general need to fund municipalities). It seems that the Department of Finance has now determined that the consequences of unregulated registration for these organizations outweigh the potential enforcement problems. On the other hand, the CRA is just as likely to force foreign organizations to justify their continued registration thereby shifting the burden to the foreign group.
Shifting the Ground on RCAAAs
Registered Canadian Amateur Athletic Associations have in the past been registered when the promotion of amateur athletics in Canada was their primary purpose and function. Budget 2011 proposes that RCAAAs now be registered (or continue in their registration) if the promotion of amateur athletics in Canada is their exclusive purpose or function. The primary intention of this move seems to be to put RCAAAs on the same footing as charities which can only be registered if their assets are used exclusively for charitable purposes. The CRA uses this test consistently to, amongst other things, revoke the charitable registration of charities involved with tax shelters. By changing this fundamental rule for RCAAAs the CRA will have a major tool in ensuring that such groups are not involved in donation tax shelters.
Realizing that changing the rules mid game can present some unfairness, Budget 2011 proposes that stakeholders provide feedback on or before June 30, 2011 on the introduction of an “exclusivity of purpose and function” test for RCAAAs.
Returned Gifts Returned Credit
In the normal course of making a gift, the charitable receipt issued is used on the donor’s tax return in the year the gift is made or in the ensuing five years. However, where the gift is returned by the charity (usually where some malfeasance on the part of the donor has become public) the CRA’s ability to ensure that the tax credit has not been retained is constrained. Budget 2011 proposes to expand the CRA’s ability to ensure that tax credits are not improperly retained in these circumstances.
Gifts of Non Qualifying Securities (“NQS”) and Stock Options
As usual, Budget 2011 contains certain measures which are unintelligible except to those who have seen a particular situation the provisions are intended to address. Two of the more obscure ones in Budget 2011 involve the donation of NQS (i.e. securities of a corporation not dealing at arm’s length with the donor – generally shares of private corporations) to charities, and the donation of stock options to charities.
There are already strict rules in place involving the donation of NQS. Budget 2011 proposes to augment these by including a provision that the donor of NQS is not entitled to the charitable donation tax credit or deduction if the charity sells a particular NQS for other NQS. These rules seem to be directed to situations where two charities trade NQS in order that their respective donors can receive the related tax credits.
Finally, Budget 2011 also proposes that where a donor donates stock options to a charity, the donor is not entitled to the charitable donation tax credit (or deduction) until the charity exercises the options. These provisions follow on the wholesale changes to the taxation of stock options introduced in Budget 2010.
In sum, if these provisions pass into law in their current form, a new era will dawn for all organizations which receive charitable donations. While the immediate budget reaction from the opposition parties is that they will vote against the budget and bring the government down, common wisdom would suggest that these provisions will be brought forward again at some point in the future and so the sector would be wise to consider them regardless of whether or not Budget 2011 receives Royal Assent.