Charities – Be Careful What You Ask For!
Adam Aptowitzer, March 19, 2007
After the 2006 Budget, many observers expected that the elimination of tax on the donation of publicly listed securities to “public” charities would be extended to private foundations, and, indeed, Budget 2007 lived up to this prediction. Unfortunately, with the wise extension of the tax break to donations to private foundations came a series of anti-avoidance rules which will leave some private foundations in a perpetual state of ignorance as to whether or not they are in compliance with the law.
The new Excess Business Holding rules are intended to eliminate the possibility that a foundation, together with non arm’s length individuals, could exercise more than 20% control of any particular class of shares issued by a corporation, whether publicly listed or not. In order to accomplish this, the Budget proposes that the foundation would be responsible for reporting its own holdings in a corporation (whether purchased or acquired by donation) and for monitoring those owned by non arm’s length people.
Unfortunately, the rules do not compel all non arm’s length taxpayers to divulge the necessary information. So, while foundations must make reasonable enquiries to investigate the holdings of others, they may still be offside the new rules whether they know it or not.
In addition, the foundation will be required to report any “material” transactions during the year by the foundation or non-arm’s length entities for any period in which the foundation owned more than 2% of the issued and outstanding shares of the corporation. A material transaction is one involving more than $100,000 worth of shares of a particular class or more than 0.5% of all outstanding shares of that class. Where the foundation owns more than 2% of the outstanding shares of a particular class of the corporation, the foundation will be required to report its holdings on the yearly charity information return and the CRA will post the information on its website. The shareholdings of the non arm’s length entity must be reported but will not be made publicly available.
Given that the foundation has a positive obligation (unless it has less than 2% of the issued and outstanding shares of a particular class) to monitor and report shareholdings and transactions, it is unclear how the foundation can ever be secure in the knowledge that it is not required to divest a portion of its shares (again assuming it has more than 2% of outstanding shares). Moreover, as the penalty for breaching the new rules is 5% of the value of the excess holdings for a first infraction and 10% for a second infraction, one can imagine a charity paying a penalty for transgressing a rule it could not have avoided.
As of March 19, 2007, any foundations which fall afoul of the excess business holding rules will be required to divest 20% of its shares every 5 years until it complies with the new rules. Compliance is reached when the foundation either has less than 2% of the outstanding shares of any particular class or the foundation and any non arm’s length entity together have less than 20%. Foundations will not be required to divest gifts of shares held by foundations that were made subject to a trust or direction to hold.
Of other interest to a small subset of charities may be the additional incentive for pharmaceutical corporations to donate medicines from their inventory in order to claim a special additional deduction equal to the lesser of the cost of the donated medicine or 50% of the difference between the fair market value and the cost of the medicine. The deduction is only available when the donee is a registered charity that has received funds from CIDA and the donation is in respect of activities of the charity outside of Canada.