Publicly traded gifts

By Michael A. Walker

Donating listed securities to a charity offers income tax incentives, but before doing so, understand the terms and concepts

The federal government provides a variety of incentives to encourage taxpayers to make gifts to registered charities (qualified donees). Prospective donors and their advisers should pay particular attention to the very generous tax provisions contained in the Income Tax Act related to gifts of certain publicly traded securities (listed securities) made to qualified donees.

Over the past 10 years, a number of changes have been made to the act to reduce (and eventually eliminate) the amount of any income inclusion resulting from gifts of listed securities made to qualified donees (as summarized in the table above).

In order to determine the income tax consequences of a gift of listed securities made to a qualified donee, it is necessary to understand a number of terms and concepts.

The term “gift” is not defined in the act. Until recently, the courts and the Canada Revenue Agency (CRA) have followed the common law definition, i.e., a gift is a voluntary transfer of property for no consideration. Thus, where the transferor of a property is entitled to receive any form of consideration or benefit, the transfer is not a gift. CRA has reconsidered this policy as a result of a number of court decisions where it was found that a transfer of property to a charity was made partly in consideration for services and partly as a gift. As a consequence, the minister of finance has proposed changes to the act that will apply to determine whether an official receipt can be issued when a donor receives consideration in return for making a gift to a qualified donee and the amount of the receipt is generally equal to the fair market value of the gift less the total value of the consideration, if any, to which the donor is entitled.

Listed securities include shares, bonds or rights listed on a designated stock exchange; shares of mutual fund corporations; units of a Canadian mutual fund trust; interests in segregated (insurance) trusts; or prescribed debt obligations (such as certain government bonds).

A qualified donee is an organization that can issue official receipts for gifts it receives from individuals and corporations and generally includes a registered charity; a registered Canadian amateur athletic association; a Canadian tax-exempt housing corporation that only provides low-cost housing for the aged; a Canadian municipality; a municipal or public body performing a function of government in Canada; the UN and its agencies; a prescribed university outside Canada; a charitable organization outside Canada to which the government of Canada has made a gift during the taxation year or in the previous taxation year and; the government of Canada, a province or a territory.

In general, the donation date of a gift of property is the date on which beneficial ownership of the property is transferred to and accepted by the donee. This date is not always easy to determine because securities can be transferred to a donee in many different ways, e.g., hand delivery, mail or electronic transfer. Furthermore, the receipt and acceptance of a gift do not always occur on the same date because a donee may have to review its policies to determine whether the gift is acceptable, e.g., some gifts may be rejected for moral or business reasons. It is CRA’s view that ownership of shares has been transferred on the day the donee has the right to receive dividends declared on them, the right to receive amounts on the liquidation of the corporation, and the right to exercise the votes attached to them. Where an individual makes a gift by his or her will, the gift is deemed to have been made by the individual immediately before the individual died (not when ownership of the gifted property is subsequently transferred to the donee).

Once the donation date has been established,a donee can proceed to determine the fair market value of the gifted property. Each situation requires a careful review because the determination of the fair market value of a property may be influenced by a number of factors. In the case of shares, CRA will generally accept the use of the closing bid price of a share or the mid-point between the high and the low trading prices of the share on the donation date, whichever provides the best indicator, given the circumstances, of fair market value on normal and active market trading.

Where a taxpayer has made a gift of listed securities to a qualified donee, the taxpayer is deemed to have received proceeds of disposition equal to the fair market value of the securities at that time. However, assuming the securities are capital property, the taxpayer has the ability to designate any amount between the cost and fair market value of the securities to be used as the proceeds of disposition and in determining the amount of the gift. In the past, a taxpayer might have designated proceeds less than fair market value to reduce the taxable capital gain; however, this also reduced the amount of the gift. Since any taxable capital gain for a taxation year from the disposition of listed securities to a qualified donee is now equal to zero, there isn’t any reason to make such a designation. Any designation that reduces the proceeds of disposition has no effect on the amount of the taxable capital gain but does reduce the amount of the gift (and any corresponding tax credit/deduction).

The table on page 39 demonstrates (assuming an income tax rate of about 46%) that by donating securities directly rather than selling them and making a cash donation, the tax savings will always be 23% of the difference between the fair market value of the securities and their tax cost (i.e., 23% of the gain). Therefore, where the option is available, prospective donors should donate listed securities to qualified donees because of the potentially significant tax savings. If the donor wishes to keep a listed security in his or her investment portfolio, the same security can be repurchased after making the gift. In this case, the donor’s tax cost of the security will be increased to the fair market value at the time of the repurchase. The increased tax cost may reduce a capital gain/increase a capital loss on a future sale.

When an arm’s length employee acquires a listed security under an option granted by the employer and donates the security to a qualified donee within 30 days, the employee may be eligible for a special deduction, the general effect of which is to exempt the associated employment benefit from tax. This deduction is also available where an employee, exercising an option to acquire a listed security, directs a broker or dealer who is appointed or approved by the grantor of the option (or by an entity not dealing at arm’s length with the grantor) to sell the listed security immediately and donate the proceeds of the disposition to a qualifying charity. To obtain these additional deductions, donations must be made inter vivos; they are not available in respect of a listed security acquired under an employee stock option agreement after a taxpayer’s death and then bequeathed to a qualified donee. Corporations are entitled to the same reduction in the calculation of the taxable capital gain, but instead of a tax credit, they receive a deduction from their net income for an amount equal to the fair market value of the listed securities (or lesser amount, as indicated on the donation receipt) in determining taxable income. In general, a corporation’s deduction for charitable gifts is subject to a deduction limit equal to 75% of the corporation’s net income plus 25% of any taxable capital gain resulting from the gifts plus 25% of any recapture of depreciation included in income as a result of the making of a gift of depreciable property.

Where a donation of listed securities is made to a qualified donee by a private corporation, 100% of the capital gain on the disposition of the securities can be added to its capital dividend account. The capital dividend account has several components and its balance must be determined at a point in time. Any balance in the capital dividend account can be distributed as a tax-free capital dividend to Canadian-resident individual shareholders.

Michael A. Walker, CA, is executive director with Ernst & Young LLP, in London, Ont. He can be reached at mike.a.walker@ca.ey.com; or 519-646-5555

Technical editor: Trent Henry, partner, Ernst & Young, Toronto