Lower taxes on donations

“There may be individuals who are charitably inclined, but they’re reluctant to sell a private company or real estate because they don’t want to pay the capital gains taxes,” says Jamie Golombek, managing director of tax and estate planning with Canadian Imperial Bank of Commerce’s wealth advisory services division in Toronto. “Here’s a way for [those individuals] to get rid of that [asset], reallocate that wealth, donate proceeds to charity and get a tax break for doing so.”

The initiative, set to begin in 2017, essentially would put charitable-minded individuals whose wealth is held mostly in private-company shares or real estate in the same position as individuals whose wealth is held mostly in publicly traded securities. Since 2006, individuals who donate stocks, mutual funds and other securities donated “in kind” to a charity do not have to pay capital gains taxes on those assets.

“[The initiative] brings a certain degree of equity to the system,” says Malcolm Burrows, head of philanthropic advisory services, private-client group, with Bank of Nova Scotia in Toronto.

Burrows has long advocated for the federal government to provide a tax incentive to owners of private-company shares and real estate who have charitable intent, having written two reports for the C.D. Howe Institute on the issue.

The proposal, which is still in the form of draft legislation, provides investors with an exemption for capital gains when the cash proceeds of private-company shares and real estate are donated to one or more registered charities within 30 days of the asset’s sale.

The taxpayer also will receive a donation tax credit based on the amount of the cash value of the gift.

The portion of the capital gain taxes that is exempt is determined by referring to the proportion of the cash proceeds that are donated in relation to the total amount of the proceeds of the sale.

For example, consider an individual who sells private-company shares with an adjusted cost base of $100,000 for $1 million. If the individual donates the entire $1 million of proceeds within 30 days of the sale, he or she would receive an exemption on taxes for the entire $900,000 capital gain.

If the individual instead donates $500,000 – half the proceeds from the sale – he or she would receive a prorated capital gains exemption on half of the capital gain (i.e., on $450,000).

“You’re only getting the benefit of the reduced capital gains taxes on the portion of the cash proceeds that you actually donate,” says David Ablett, director of tax and estate planning with Investors Group Inc. in Winnipeg.

Unlike donations of publicly traded securities, donations of private-company shares or real estate to a registered charity do not receive a capital gains exemption when made in kind – the assets must be sold first.

This rule is meant to address the difficulty that often is involved in valuing private-company shares or real estate, Golombek says: “When it comes to private-company shares or real estate, who knows what the value is? It’s only when you have a sale to an arm’s-length party that you really know the true fair market value of private company shares or assets.”

The rule that only a donation of proceeds receives a capital gains tax exemption also may be an attempt to prevent abuse of charitable donations for tax planning purposes, in that individuals could obtain a valuation for private-company shares or real estate that is artificially high, thus generating an inflated donation tax credit.

“The concern is that if you got a receipt from a charity, you’d find a friendly valuator and get a very high tax receipt, and you’d save yourself a whack of taxes,” Golombek says.

The proposed rule also would make matters simpler for registered charities, particularly smaller ones. Charities will be receiving cash donations instead of receiving potentially difficult to manage private-company shares or real estate and having to sell those assets directly, Burrows suggests: “There was a concern that only large charities could receive these assets [directly], because you need a level of sophistication to address the issues associated with management [of the assets].”

There are several anti-avoidance provisions in the draft legislation that prevent donors from receiving the capital gains exemption on donations in certain circumstances. These circumstances include the sale of a private company’s shares or real estate to a non-arm’s-length party, or when the donor or a non-arm’s-length party reacquires the shares or property within five years following the initial sale.

“If you’re trying to play games, in which you sell [the assets] to your brother and then donate the cash to try to avoid the capital gains taxes while the assets stay in the family, you’re not going to be able to do that,” says Wilmot George, vice president of wealth planning at CI Investments Inc. in Toronto.

For clients who own private-company shares or real estate, and who have charitable intentions, the decision will be whether to delay the sale of such an asset until after 2016, when the capital gains exemption becomes available, or to lock in a sale price before then.

“You might have that discussion [with a client] – ‘If we hold off on selling this until 2017, we can get a big tax break’ – if the client is charitably inclined,” Golombek says. “On the other hand, the risk is that the value of the asset declines and offsets the value of any tax benefit available.”

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