The following article prepared by Jill H. McAlpine, a consultant to PricewaterhouseCoopers LLP in Canada, provides an overview of the federal budget’s enhancements to the tax incentives for certain donations to charitable organizations.
DONATIONS OF PUBLICLY LISTED SECURITIES
A few years ago a new tax incentive was introduced for qualifying gifts of appreciated marketable securities (qualifying gifts are discussed below). The capital gains inclusion rate for such gifts was cut in half (from 75% to 37.5%) and the donation claim limit was increased. The net effect of those enhancements to the incentives for charitable giving has been that donors do not pay any tax on qualifying gifts of appreciated marketable securities and a greater portion of the gift is available to shelter other income from tax.
The 2000 federal budget included a proposal to reduce the income inclusion rate for capital gains from 75% to 66.67% effective for capital gains realized after February 27, 2000. For qualifying gifts of appreciated marketable securities, the income inclusion rate drops to 33.33%. As a result, qualifying gifts of marketable securities will generate even more tax shelter to offset taxes on other income. The bottom line is that a qualifying gift of appreciated marketable securities when compared with other types of gifts can result in the maximum benefit to the charity and the minimum cost to the donor. This is a real WIN - WIN opportunity for donors and their charities of choice.
Qualifying Gifts of Appreciated Marketable Securities
The following are the criteria that must be met in order to qualify for this very favourable tax treatment.
Qualifying securities include:
- shares, bonds, warrants, and options listed on a prescribed stock exchange (includes the five Canadian exchanges, the NYSE, the NASDAQ and most other major foreign exchanges);
- mutual fund shares/units and segregated fund units; and
- prescribed debt obligations.
- The gift must be made between February 19, 1997 and December 31, 2001 inclusive. For gifts made on or before February 27, 2000, the income inclusion rate in respect of any capital gain realized on the gifted securities will be 37.5%. For gifts made after that date, the income inclusion rate will be 33.33%.
- The actual securities must be transferred to the registered charity or other qualified donee. The gift will not qualify for the reduced capital gain inclusion rate if the securities are sold and the cash then gifted.
- The gift must not be made to a private foundation.
Donations of Publicly Listed Securities Acquired through Employee Stock Options
To parallel the favourable treatment of qualifying gifts of publicly listed securities, the income inclusion rate in respect of qualifying donations of publicly listed securities that were acquired on the exercise of employee stock options has been reduced to 33.33%, effective for donations made after February 27, 2000.
Employees with stock options in public companies and mutual funds should be made aware of this new incentive for charitable giving. It will enable them to support their favourite charities without incurring any tax on the appreciation on the optioned securities and in addition, to shelter other income from tax.
This favourable treatment of donations of securities acquired through employee stock options is achieved through the operation of several complex provisions of the Income Tax Act. A brief overview of the rules follows. However, as with any gift planning, particularly where the amounts involved are significant or the rules are complex, donors considering gifting to charity securities acquired under an employee stock option plan should obtain professional income tax advice to ensure the desired results are achieved.
OVERVIEW OF THE EMPLOYEE STOCK OPTION RULES
Employees are required to include in their employment income a "stock option benefit" equal to the difference between the fair market value of the shares and the option price plus any amount paid to acquire the option. (The timing of this income inclusion may vary depending on the particular circumstances.) Employees are then entitled to a deduction of one third (increased from one quarter by the February budget) of the benefit provided certain conditions are met ("employee stock option deduction"). The special rule for qualifying gifts of publicly listed securities acquired through employee stock options allows donors an additional deduction of up to one third of the stock option benefit.
The additional deduction for charitable gifts will be based on the fair market value of the shares on the date of the donation, if this is less than their fair market value on the date of exercise. Therefore, if the shares decline in value from the date of exercise to the date of donation, the deduction will actually be less than one-third of the stock option benefit.
Qualifying Gifts of Publicly Listed Securities Acquired through Employee Stock Options
To qualify for the additional deduction for donated employee stock option securities, a series of conditions must be met, including:
- the conditions for the first described deduction (i.e. the employee stock option deduction);
- the conditions described above to qualify for the one third income inclusion in respect of gifts of publicly listed securities ; and
- some additional conditions.
These conditions include the following:
- the securities must be either "prescribed" shares (which is generally defined as a common share (voting rights are not required) with no preferential rights or entitlements and no limit on the right to participate in dividends or on a winding-up or liquidation of the corporation) or a units in a mutual fund trust;
- the amount payable by the employee to acquire the shares or the mutual fund trust units under the agreement, together with any amounts paid to acquire the option, must not be less than the fair market value of the shares or mutual fund units at the time that the options were granted;
- the employee must deal at arms length with the grantor of the option, the employer, and the entity the shares or mutual fund units of which are the subject of the option;
- the option must have been issued after February 1984;
- the shares or mutual fund trust units must be:
- acquired after February 27, 2000; and
- donated within the same year they were acquired and within 30 days after their acquisition; and
- the conditions outlined above for qualifying gifts of marketable securities must be met.
Life Insurance, RRSP, and RRIF Designations in Favour of a Charity
Under the current rules, donations that are made by way of a donor’s will qualify for the charitable donations tax credit on death. Donations made as a consequence of a direct designation made under the terms of an RRSP, RRIF or an insurance policy do not qualify for the credit.
Under the budget proposals, the charitable donations tax credit will now be available in respect of donations of RRSP, RRIF and insurance proceeds made through direct beneficiary designations. This new rule will apply for deaths occurring after 1998.
Donations of Ecologically Sensitive Lands
Effective for ecological gifts made after February 27, 2000, the income inclusion applicable in respect of capital gains arising from qualifying gifts of ecologically sensitive land and related easements, covenants and servitudes is reduced by one-half. As for qualifying gifts of appreciated publicly listed securities, the income inclusion rate for qualifying ecological gifts will now be one third of the gain realized on making the gift.
In order to qualify for this reduced income inclusion rate, the following conditions must be met:
- the land that is the subject of the gift must be certified by the Minister of the Environment or a person designated by that Minister, to be ecologically sensitive land, the conservation and protection of which is important to the preservation of Canada’s environmental heritage; and
- the gift must be made to Her Majesty in right of Canada or a province or a municipality in Canada, or a registered charity (other than private foundation) one of the main purposes of which is, in the opinion of the Minister of the Environment, the conservation and protection of Canada’s environmental heritage.
The budget also introduced a new requirement regarding the valuation of ecological gifts. Effective for gifts made after February 27, 2000, the value of all ecological gifts will be determined by a special process to be established by the Minister of the Environment. If there is a disagreement regarding the value, the donor has the right to appeal to the Tax Court of Canada. Once determined, the value will apply for a period of two years.
Gifts of Art and Other "Personal-Use Property"
The Income Tax Act will be amended so that the $1,000 deemed adjusted cost base and deemed proceeds of disposition for "personal-use property" (as defined in the Income Tax Act) will not apply for property acquired after February 27, 2000 as part of an arrangement in which the property is donated as a charitable gift. This amendment was introduced to address a perceived abuse in respect of donations of art and other personal use property valued at less than $1,000.
The information provided herein is for general guidance on matters of interest only. The application and impact of laws, regulations and administrative practices can vary widely, based on the specific facts involved. In addition, laws, regulations and administrative practices are continually being revised. Accordingly, this information is not intended to constitute legal, accounting, tax, investment or other professional advice or service.
While every effort has been made to ensure the information provided herein is accurate and timely, no decision should be made or action taken on the basis of this information without first consulting a PricewaterhouseCoopers LLP professional. Should you have any questions concerning the information provided herein or require specific advice, please contact your PricewaterhouseCoopers LLP advisor.
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