Donation of Flow-Through Shares
By: Arthur Drache C.M., Q.C.
A recent letter published by the CRA[1] offers a comprehensive view of the tax treatment 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).
These had been extremely popular, both with donors and charities and the CRA had issued several rulings saying that such donations were acceptable and not in the same class as other tax shelter donation schemes.
But in the 2011 Budget, steps were taken which would make the donations much less attractive to donors though still acceptable. The letter we referred to in our opening paragraph essentially sets out the CRA’s views of a particular transaction but should be of general interest.
The transaction was pretty much standard. The investor bought the shares, got the associated tax benefits and then donated the shares to registered charities.
After setting out the basic rules, the letter continues.
“Under recently enacted (subsection 40(12) of the Act, generally, where a taxpayer disposes of one or more capital properties included in a “flow-through share class of property” to a qualified donee and subparagraph 38(a.1)(i) or (iii) of the Act applies to the disposition, the taxpayer will be deemed to have an additional capital gain from the disposition of another property equal to the lesser of:
* the amount of the taxpayer’s “exemption threshold” in respect of the “flow-through share class of property”; and
* the total capital gains from the disposition of the actual property.
As a result, the taxpayer will report, in computing income, a taxable capital gain equal to one-half (1/2) of this additional capital gain. ”
The letter then goes on to discuss the rules where such shares were held on the federal budget date, March 22, 2011.
In the circumstances described, to the extent that a taxpayer has acquired publicly-listed shares issued pursuant to a FTS agreement entered into on or after March 22, 2011 (and in respect of which the taxpayer may become entitled to a deduction in computing income) and provided that such shares are held as capital property, the taxpayer will be required, by virtue of subsection 40(12) of the Act, to pay tax at normal capital gains rates on capital gains realized on the donation of those shares to a qualified donee. Those capital gains will reduce the balance of the taxpayer’s exemption threshold. To the extent that the exemption threshold is reduced to nil, a capital gain from the donation of the FTS to a qualified donee is exempt from tax. ”
The letter then goes on to discuss the capital dividend account in the case where the donation was made by a private corporation.
“In general, the CDA keeps track of various tax-free surpluses accumulated by a private corporation. The rules for determining the balance in the CDA of a private corporation are provided in the definition of that term in subsection 89(1) of the Act and are calculated on a cumulative basis for a particular period.
Generally, under paragraph (a) of the CDA definition, the non-taxable portion of capital gains that exceeds the non-deductible portion of capital losses in respect of dispositions of capital property by a private corporation is included in the CDA.
The CDA definition in subsection 89(1) of the Act was recently amended consequential on the addition of subsection 40(12) of the Act, to ensure that only the non-taxable portion of the capital gain resulting from a gift of publicly-listed securities by a private corporation, to which subsection 40(12) of the Act applies, is included in the corporation’s CDA. (our emphasis.) This result is accomplished by the following amendments to the CDA definition in subsection 89(1) of the Act:
* amending clause (a)(i)(A) of the CDA definition so that the CDA is computed without reference to dispositions that are deemed to occur under subsection 40(12) of the Act, and
* adding clause (a)(i)(B.1) to the CDA definition to provide that the corporation’s CDA is reduced by the amount of the taxable capital gain in respect of a deemed gain under subsection 40(12) of the Act.
In the circumstances described, where a private corporation holds publicly-listed FTS as capital property and that disposes of such FTS by way of a gift to a qualified donee, the corporation will include, in computing its CDA, the capital gain from the gift. However, as a result of the recent amendment to the CDA definition, the corporation will deduct, in computing its CDA, an amount equal to the taxable portion of the deemed capital gain under subsection 40(12) of the Act. ”
So the Act has been amended to essentially reduce the benefits to donors in a very substantial fashion and the “small print” applies to the benefits which might otherwise be achieved by a donation through a private corporation. Insofar as we are aware, the 2011 rules have pretty much killed off a scheme which was of mutual benefit to both donors and charities even though the CRA had given its imprimatur to such donations earlier.
The legislation is a classic example of how governments will react if taxpayers find legal ways to achieve major tax benefits. If it is “rich” and legal, use the statute to kill it off no matter how much the scheme benefitted the mining industry and the recipient charities.
[1] 2012-044115