In its last annual budget, the Federal Government announced that proceeds from the sale of private company shares and real estate would be free from tax if donated to charity. That is pretty much all they said on the subject. Readers of our budget column will recall that we were somewhat guarded in our enthusiasm at the time of the announcement because (unusually) the technical details of how this would be accomplished were not then revealed. In fact, our article was entitled Budget 2015 Has Great News for Charities…Maybe. At the time, we felt like somewhat of a party pooper, but the government’s release of the technical legal amendments on July 31st has undoubtedly vindicated our lack of enthusiasm.
On page 270 of Budget 2015, the Government has announced:
At present, donations of private shares and real estate to registered charities and other qualified donees can give rise to taxable capital gains. To help Canadians provide more gifts, Economic Action Plan 2015 proposes to exempt individual and corporate donors from tax on the sale of private shares or real estate to an arm’s length party if the proceeds are donated within 30 days. If a portion of the proceeds is donated, the exemption from capital gains tax would apply to that portion. This measure will apply to donations in respect of dispositions occurring after 2016.”
Readers of the original budget believed, with some justification, that when an individual sells a property and donates the profits to charity there would be no tax payable from the entire sale. However, it seems that the document instead refers to the ‘proceeds of disposition’ of the sale, i.e. the entire sale price. Based on the proportion of the entire sale price donated, the donor would be entitled to a proportionate reduction in the taxable capital gain. In other words, the only way to ensure that the entire amount is not taxable is to donate the entire sale amount to charity.
For example, if a donor has an adjusted cost base of $500,000 and sells it for $2,500,000, there would, under normal circumstances be a $2,000,000 taxable capital gain. If the donor donates $1,000,000 to charity the actual amount that would be exempt from tax would be $400,000, because $1 million is 40% of the $ 2.5 million selling price. That would leave a taxable capital gain of $1.6 million and taxes owing of approximately $320,000. Of course, the donor also has a charitable donation tax receipt which, to an individual, would be worth approximately $460,000 and so well more than make up for the tax owing.
The problem with this is that the donor is not only giving up the capital appreciation earned by the property, but also the original principal used to purchase the property. Depending on whether the donor can make use of the additional donation tax credit to offset taxes owing from other sources, the loss of the original principal may prove to be a difficult consideration for certain donors.
The new rules, which will apply to sales after 2016, apply when a taxpayer sells shares of a private company or real estate to a third party. There are two main conditions which must be met:
- The donation must take place within 30 days after the disposition of the property; and
- The taxpayer must be resident in Canada.
The good news about these conditions is that they do not seem to limit the sale to Canadian property. While this may be good news for those with foreign real estate holdings, working out the tax consequences in the foreign jurisdiction is likely to cause migraines for accountants.
While there are only a few provisions that apply to the sale, there are numerous anti-avoidance provisions designed to prevent “mischief”. To our mind, the Department of Finance seems to equate mischief with tax planning and is basically, at least on a superficial view, ruling out any type of tax planning related to the disposition of these properties and their donation (although with time, one would imagine clever tax planners will find ways to use these provisions to greater advantage.) Fundamentally, the anti-avoidance provisions seem to only allow situations where the property is sold and the funds donated to charity.
The truth, though, is that there are a number of practical problems that become clear on a deeper look at the new provisions.
First, the proposed provision requires that the proceeds of disposition be donated within 30 days of the ‘sale’. In some cases this is easy, such as when the purchaser pays the entire amount immediately on sale as is typically the case on the sale of residential real estate. On the other hand, many sales, particularly the sale of businesses, are often based on a longer term payout. If the proposed donor wanted to take advantage of these new provisions, she would be required to borrow the money to make the donation within 30 days and pray that the purchaser actually pays her the amount owed. It seems unlikely in this case that anyone would take that kind of risk (and we would point out that the interest is not deductible.) The same principle applies to those trying to get the donation done before their fiscal year end.
Second, the sale of any large asset will result in a large income inclusion. To the extent that the capital gain is donated to charity, there would not be any inclusion or tax owed, but the portion that is not donated is taxable in the normal course. We have already discussed how the charitable donation tax credit would offset some of this tax owing. However, in certain provinces, notably BC and Ontario, the tax rate at the highest brackets is not completely offset by the charitable donation tax credit. The effect is magnified with larger income inclusions. So, in some provinces, if donors donate part of the proceeds of their sale they may find that the tax credit available to offset tax owing from other sources diminishes as the size of the donation rises.
Third, corporations own a great deal of property in this country. Where the property is held as capital property (i.e. they are not in the business of buying and selling land or shares), the treatment of a donation would be the same as for individuals described above. However, the use of the donation tax receipt changes, because it can only be a deduction for the corporation and not a tax credit. The most important difference is that the deduction can only be used if there is other income in the corporation and it cannot be used to offset the tax owing as a result of only a partial donation of the proceeds of disposition. Consequently, many corporations, particularly those winding down and therefore most likely to consider a donation, will be faced with an all-or-none proposition when considering their circumstances.
Fourth, generally business owners are entitled to deduct the depreciation of a building from their income. This is known colloquially as CCA. The value minus the CCA equals the book value of the building. If the building eventually sells for more than the book value, the difference is considered income to the building’s owner and income tax must be paid on it. If the building has been in the same hands for a long time, this income inclusion can be large. The proposed provisions do not address the disincentive presented by the inclusion of CCA in the donor’s income. One would hope that the charitable donation tax receipt could offset the CCA included (both for corporations and individuals). But, keeping in mind the 100% inclusion of CCA and leftover capitals gains tax (if only part of the proceeds are donated), the utility of the receipt in providing a tax incentive to donate may be hugely diminished.
Finally, with respect to the sale of shares, we have some concerns that the tax incentives to donate really only works for larger shareholdings. Every Canadian is entitled to $800,000 lifetime capital gains exemption on shares in Qualified Small Business Corporations ($1 million for farm and fish corporations) – an amount that keeps rising. And tax advisors have ways of multiplying this exemption among members of a family. These people can sell the shares of their business and keep the funds tax free anyway, rather than donate it to generate a tax receipt whose only benefit exists if they have income from other sources.
The same principle applies to donations of principal residences. As these sales occur without tax owing, the proposed provisions do nothing to stimulate donations of the proceeds from the country’s active residential real estate market.
On the other hand, if the tax value of donating is entirely based on using leftover tax credits (if any) to offset income from other sources, it would seem that the proposed provisions may be very useful for business and those engaged in estate planning.
The Department of Finance has asked for comments on the provision by September 30th, 2015, and has made clear that the proposals are a first attempt. We are confident the Department of Finance is aware of the issues cited above and that attention will be given to resolving the problems.