This year's Federal Budget (the "Budget") proposed new rules that would exempt from capital gains tax charitable gifts of cash proceeds from the disposition of private company shares and real estate, a measure that sector organizations had long encouraged the government to introduce. The details of how the new rules would be implemented were not entirely clear at the time the Budget was released since the Department of Finance ("Finance") did not publish any draft legislation with the Budget announcement.
The Budget also proposed a new measure to remove the restriction on registered charities investing as passive investors in limited partnerships. Charities had argued for some time that they would benefit from greater flexibility in structuring their investments. Draft legislation dealing with this measure was released with the Budget on April 21, 2015.
On July 31, 2015, Finance published draft legislation that explains how it proposes to implement the capital gains exemption. With respect to investments in limited partnerships, Finance did not make any changes to the draft legislation that was released with the Budget. However, it did publish explanatory notes that were not released with the Budget. The notes contain similar information to what was in the Budget and also confirm that under the new rules, the calculation of a private foundation's excess corporate holdings, if any, will be determined by effectively looking through the partnerships of which the foundation is a member.
Below is an overview of the more detailed draft proposals put forward by Finance on July 31 in respect of the capital gains exemption.
Basic Operation of the New Rules
The new capital gains exemption will be in paragraph 38(a.4) of the Income Tax Act (the "Act") and will provide that a taxpayer's taxable capital gain from the disposition of a property is zero if certain conditions are met. The basic conditions are as follows:
- The property disposed of is either a share of the capital stock of a private corporation, or real or immovable property situated in Canada;
- The disposition occurs after 2016;
- The disposition is a sale to a person or partnership;
- The gift is made in money by the taxpayer to a qualified donee not more than 30 days after the disposition; and
- The taxpayer is a resident in Canada at the end of the taxation year of the disposition.
Finance included a number of anti-avoidance rules that will deny the availability of the capital gains exemption in certain circumstances, including:
- Where the purchaser of the shares or the real estate is non-arm's length or affiliated with either the person selling the property or the qualified donee to which the cash proceeds of the sale are donated;
- Where the disposition is a transaction or part of a series of transactions or events that include one or more agreements or other arrangements that can reasonably be considered to have been entered into for the purpose of avoiding the application of the non-arm's length or non-affiliation requirement;
- Where the property that was sold is reacquired within 60 months;
- Where the property is a share and that share is redeemed, acquired, or cancelled in the taxation year; or
- Where the loanback rules in subsection 118.1(16) of the Act apply.
Where an anti-avoidance rule is found to apply in a particular circumstance, there will be new rules in the Act that will reverse the exemption so that the capital gain becomes taxable. In such a case, a taxpayer maybe be liable for interest on the taxable portion of the gain.
Finance has also proposed to amend subsection 40(12) of the Act such that the new exemption will apply to donations of the proceeds of dispositions of flow-through shares.
All of the new rules will apply to taxpayers' 2017 taxation year and subsequent taxation years.
Some charities and donors may be disappointed to learn that the new rules do not contemplate a capital gains exemption for direct gifts of private company shares and real estate, which is currently available for direct gifts of publicly-listed securities. Given the scope of the proposed anti-avoidance rules, we can assume that Finance was concerned about establishing the valuation of gifts in the absence of arm's length and non-affiliated transactions.
However, the requirement to sell the private company shares or real estate to an arm's length person prior to donating the proceeds to charity may be difficult in some circumstances. In particular, the requirement to sell 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 the cash proceeds. On the other hand, the requirement to sell and donate the cash proceeds makes it easier for smaller charities to receive gifts of the value of real estate and private company shares since they may not otherwise have the resources to deal with in-kind gifts of such property, which would require them to obtain valuations, identify buyers, etc.
Finance has invited the public to provide comments on the draft proposals by September 30, 2015. For more information where to send comments see here.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.