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Written by: Alexandra (Ali) Spinner, CPA, CA, Partner, Tax, Crowe Soberman LLP
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For the last number of years, philanthropic Canadians have been able to utilize a tax incentive when making a donation to charity by giving the charity a gift of publicly-traded securities. If a donor gifts publicly-traded securities that have an appreciated value to the donor, the inherent capital gain that would normally be recognized by, and taxable to, the donor at the time the gift is made would be eliminated pursuant to Canadian income tax law. As a result, donors are able to make gifts of appreciated securities to charities without having to pay the underlying taxation on the inherent gain.
The 2015 Federal Budget, tabled this past April, provided a welcomed measure to the charitable sector by indicating that a similar tax incentive that has existed for the donation of publicly-traded securities would be afforded to donations involving private corporation shares and Canadian real estate. Draft legislative proposals were released in July 2015, and comments were welcomed from the public on the draft legislation until September 2015.
The draft legislation provides an exemption from capital gains taxation for the disposition of private corporation shares or Canadian real estate where the cash proceeds that were generated from the sale of the shares or the real estate are donated to a charity within 30 days of the sale. The private corporation shares and Canadian real estate must have been sold by the donor to a particular purchaser that was dealing at arm’s length with both the donor that sold the asset and the charity that received the donated cash proceeds. It is important to note that the draft legislation does not provide an exemption from taxation on any recapture that may be realized upon the sale of Canadian real estate.
Philanthropic Canadians will find the broadened proposed donation incentives to be enticing. Let us consider a simplistic situation for a donor that is subject to a 50% tax rate on income (and 25% tax rate on capital gains) and owns a Canadian real estate investment property (consisting of land only) with a value of $1,000,000 and an original cost of $200,000. Prior to the existence of these rules, if the donor sold the real estate, and subsequently donated the cash proceeds of $1,000,000 to charity, the donor would have a net tax position of a $300,000 refund. After the proposed draft rules become law, if the donor donates the cash proceeds of $1,000,000 to charity within 30 days of the arm’s length sale of the real estate, the donor should have a net tax position of a $500,000 refund (as the taxation on the underlying capital gain that arose upon the sale of the real estate has been eliminated.)
It is important to note that not all of the cash proceeds from the sale of private corporation shares or Canadian real estate are required to be donated to charity to take advantage of this tax incentive. The draft legislation provides that where a portion of the cash proceeds are donated to charity within 30 days following the disposition of the asset, an equivalent portion of the capital gain that resulted from the sale of the asset will be exempted from taxation.
The draft legislation requires that in order for the donor to be able to exempt their capital gain from taxation, the private corporation shares or Canadian real estate must be first sold to an arm’s length party. This is in contrast to the legislation that exists for publicly-traded securities wherein the donor may make an in-kind gift directly to the charity. Given that private corporation shares and Canadian real estate are often illiquid or difficult to value, it is clear why the draft legislation requires an arm’s length sale to determine the valuation of the asset before the proceeds are donated to charity.
The draft legislation is written as being applicable to the donation of cash proceeds where the sale of private corporation shares or Canadian real estate occur after 2016. Although the draft legislation is not yet law, Canadians will be hopeful that these new rules are passed into law after the fall Federal election and will be effective for 2017.
Professional advisors should ensure that they discuss these proposed tax incentives with clients who may be selling their private company shares or Canadian real estate to arm’s length parties. Canadians who are considering making a donation or creating an endowment should be aware of the tax efficiencies to do so when coupled with the event of selling their private business shares or Canadian real estate. Estate planners should consider these incentives when reviewing a client’s estate plan to maximize the potential benefits of donations that made by a Graduated Rate Estate.
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