The Budget proposes to exempt from capital gains tax charitable gifts of cash proceeds from the disposition of private company shares and real estate to the extent the cash proceeds are gifted to charity. This is a significant new donation incentive and will be welcomed by the charitable sector and donors.
Donations of capital property to a qualified donee (such as a registered charity, registered Canadian amateur athletic association, and certain other entities) are generally eligible for donation tax credits or deductions. Unless an exemption applies, these donations of capital property can also result in the donor realizing a capital gain which is subject to tax. The amount of capital gains tax payable can be eliminated by the value of the tax credits or deductions arising from the gift, but overall the tax on the capital gain arising from the gift reduces the donor's tax benefit of making the gift.
The Income Tax Act (the "Act") currently includes exemptions from capital gains tax for charitable gifts of publicly listed securities, as well as gifts of ecologically sensitive land and cultural property. Beginning in 2017, the Budget proposes that an exemption from capital gains tax will apply to gifts of the cash proceeds from the disposition of private company shares or real estate.
This capital gains tax exemption will apply in a different way than the current exemption for gifts of publicly listed securities. In the context of listed securities, the capital gains exemption applies to direct gifts of the securities to a qualified donee. If a donor sells the securities and donates the cash proceeds, then the capital gains exemption would not apply. It appears that the opposite will be true in the context of private company shares and real estate. The Budget states that the capital gains exemption will be available where:
- cash proceeds from the disposition of private company shares or real estate are donated to a qualified donee within 30 days after the disposition; and
- the private company shares or real estate are sold to a purchaser that is dealing at arm's length with both the donor and the qualified donee to which the cash proceeds are donated.
Thus, it appears that it will be necessary for the donor to sell the private company shares or real estate to an arm's length buyer and then donate the proceeds to a qualified donee in order to benefit from the capital gains exemption. It does not appear that the capital gains exemption will be available for direct donations of private company shares or real estate. To the extent that only a portion of the proceeds of disposition are donated, the Budget states that the capital gains exemption will be applied proportionally.
The Budget proposes new anti-avoidance rules to accompany the new capital gains exemption. These anti-avoidance rules will apply where any of the following occurs within five years after the disposition:
- the donor (or a person not dealing at arm's length with the donor) directly or indirectly re-acquires any property that had been sold;
- in the case of shares, the donor (or a person not dealing at arm's length with the donor) acquires shares substituted for the shares that had been sold; or
- in the case of shares, the shares of a corporation that had been sold are redeemed and the donor does not deal at arm's length with the corporation at the time of the redemption.
Where the anti-avoidance rules apply, the exemption will be reversed by including the previously exempted amount in the income of the donor in the year of the re-acquisition by the donor (or the non-arm's length person) or the redemption by the corporation.
The Budget does not include draft legislation to implement these changes. It states simply that the Act will be amended to give effect to the proposal outlined in the Budget. As such, we will need to wait until legislative language is released to understand fully how these new rules will work.
Charities and donors will be pleased at this measure. Sector organizations have long encouraged the government to introduce capital gains exemptions for gifts of private company shares and real estate. The Budget document noted that these measures flow from the 2013 Report of the House of Commons Standing Committee on Finance on charitable donation incentives. It is hoped that this measure will increase the support provided to the charitable sector.
We assume that Finance was concerned about establishing the valuation of gifts of real estate and private company shares in the absence of an arm's length sale. However, the requirement to sell the private company shares or real estate to an arm's length person prior to donating to charity may be difficult in some circumstances. In some cases, it would have been preferable to apply the capital gains exemption to direct donations of the property, similar to the regime for listed securities, rather than to require a sale of the property. In particular, this sale requirement precludes the capital gains exemption for a gift of real estate where the recipient charity wants to hold and use the real estate, rather than receive its cash proceeds. While the details of this measure will become clearer when draft legislation is released, we expect that the sector will seek to extend the capital gains exemption to direct donations of real estate (but not private company shares).
The Budget confirms that this new measure will apply in respect of dispositions occurring after 2016.
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