Introduction – Charitable Donation Tax Credit under the Income Tax Act.
Canadians who donate to registered charities and other qualified donees can claim Charitable Donation Tax Credit under section 118.1 of the Income Tax Act. The Charitable Donation Tax Credit can reduce a taxpayer's tax burden substantially as up to 33% of the total charitable donation amount can be claimed as a refundable tax credit at the federal level through the Charitable Donation Tax Credit system with some exceptions.
The CRA has been actively auditing donations to various registered charities for what is called "tax shelter donation schemes". CRA describes tax shelter donation schemes as syndicated donation arrangements that were deemed to have the primary or secondary purpose of reducing the taxes of the donors.
While some tax shelter donation schemes are blatantly and obviously fraudulent in their operations, there are others that appear to operate as legitimate charitable organizations, especially to the donors without training or background in tax law. These charitable organizations often offer reasonable arguments as to why their donation scheme complies with the Income Tax Act. However, once the audit and the judicial review ruled that a charitable donation scheme violates the Income Tax Act, donors who claimed Charitable Donation Tax Credits could face substantial penalties from the CRA on top of being denied their previously claimed Charitable Donation Tax Credits. This could lead to a second round of objections and litigation regarding the fairness of CRA imposing onerous penalties on a donor who claims they had no reason to suspect the legitimacy of the charity they were giving their money to.
In the recent Tax Court of Canada's decision of Abreo v. the Queen, the question of whether the donor of such a donation tax shelter scheme was willfully blind to the impropriety of the donation scheme was decided by the Court.
Abreo v. the Queen – Background on the Tax Shelter Donation Scheme and CRA Audit
The charity involved in Abreo v. the Queen was the National Children's Burn Society. It carried out a "buy low, sell high" donation scheme. Donors of the National Children's Burn Society would purchase software CDs from a selected group of companies at a relatively low cost base. The donors would in turn donate these software CDs to the National Children's Burn Society at a Fair Market Value substantially higher than the cost base and would receive receipts from the National Children's Burn Society based on the alleged Fair Market Value.
For example, in the first year under audit, 2001, a corporation called Vitex would purchase software known as Lotus Smart Suite from the software company for $17. Vitex would then sell the software to donors of the National Children's Burn Society for $120 per copy. The donors would donate these copies to the National Children's Burn Society at an alleged Fair Market Value of $600, which was the retail price of the software.
When CRA audited this donation scheme in 2003, it alleges that although the Lotus Smart Suite does have a retail fair market value of $600. The version purchased by Vitex and eventually donated to the National Children's Burn Society was the Original Equipment Manufacturer version of the software, which did not come with the license to use. CRA argues since the version of the software donated to the National Children's Burns Society did not come with a license, it could not have had a fair market value that exceeded the $17 Vitex originally paid for the software. CRA reassessed the donors participating in this program and reduced their Charitable Donation Tax Credit to the price they paid for the software, which was $120.
The 2002 and 2003 tax years were dealt with by the CRA in a similar manner for any donor who provided documentation of the price they paid for the software. In reassessing the donors, the CRA took the position that the donors had no donative intentions. While CRA claimed they could deny all Charitable Donation Tax Credit for participating donors, they only reduced the donors' Charitable Donation Tax Credit to the extent of each donor's cost base of acquiring the software.
Willful Blindness of the Donors
While much of the judicial review revolved around the technical issue of the fair market value of the software, the taxpayers raised the additional objection that even if the fair market values claimed by the donors were incorrect, the donors nevertheless acted in good faith and were deceived by the promoters of the scheme. More interestingly, the taxpayers argued the CRA has a duty to warn and flag potential donors of suspicious donation schemes, failing to discharge this duty here meant that CRA could not go after the donors, but only the charity and the supplier corporation Vitex.
In rejecting the argument, the Court made two points:
First, the Taxpayer had to have been willfully blind as to how they can be sold the software at a fraction of their alleged fair market value. This willful blindness is proven by the fact none of the donors took any active steps to investigate whether the promoters of the donation scheme were valuing the software excessively.
Second, and perhaps more importantly, even if the taxpayers were not willfully blind, being deceived does not provide a ground for judicial consideration in deciding this appeal. The Court cited the Federal Court of Appeal case Chaya v. Canada:
It is not open to the Court to make exceptions to statutory provisions on the grounds of fairness or equity. If the applicant considers the law unfair, his remedy is with Parliament, not with the Court.
Tax Tips – Due Diligence Before Donation is Important
The takeaway from Abreo for Canadian charity donors and taxpayers is that the onus is on the donor to investigate the charity he or she is getting involved with is not an improper donation tax shelter. However, just doing one's due diligence might not be enough. The Court in Abreo suggested the absence of statutory exceptions and defenses; it is not up to the Court to consider the fairness and equity of imposing liabilities for taxpayers under the Income Tax Act. This seems to suggest even if a Canadian donor was not as willfully blind to the improprieties of the donation scheme he or she was involved with; such donor would nevertheless be at the mercy of the charity's compliance with Income Tax Act as well as for CRA's audit of the charity.
As the law currently stands, the best course of action is for Canadian donors to retain professional tax lawyer's advice when planning to donate to charities and claim the Charitable Donation Tax Credit. Our experienced Canadian Tax Lawyers will conduct a comprehensive review to minimize your risk of inadvertently participating in a donation tax shelter, which could result in considerable financial hardship down the line.