Charitable Giving Tax Guide For Individual Canadian Donors

Charitable donations made through your will are deemed to be made in the year of death, and can be claimed on your final tax return. Any excess donations can be carried back one year, and applied to the extent of 100% of your net income.

While the 100% limit may appear attractive, it may be to your advantage to consider a lifetime gift, taking advantage of the opportunity to claim the credit over six years (see "Lifetime Giving").

You may wish to designate a charity as a beneficiary of your RRSP, RRIF or insurance policy. Upon your death, the charity would receive the proceeds as the designated beneficiary of the plan. Prior to the February 2000 federal budget, this type of a donation did not qualify for a donation tax credit. Under the 2000 federal budget proposals, the charitable donation tax credit will apply to donations of RRSP, RRIF and insurance proceeds that are made as a result of direct beneficiary designations.

This rule will apply to deaths occurring after 1998.

It may be beneficial to donate capital property, rather than first selling the property and then donating the cash proceeds from the sale. This works particularly well for publicly-listed shares and mutual funds, because of the preferential capital gains treatment provided on certain listed securities, as set out below.

In general, the following rules apply for gifts of capital property:

A donation receipt is issued for an amount equal to the fair market value of the property. Be sure that you take due care to establish an appropriate fair market value for the donated property.

You may require the assistance of a valuations expert to determine an appropriate value for donated property. While this may not be an issue for small donations, for larger ones it may minimize subsequent disputes with the Canada Customs and Revenue Agency.

The donation is viewed as a disposition for tax purposes, and if the property has an accrued gain the donation will trigger a capital gain.

The 2000 federal budget included a proposal to reduce the income inclusion rate for capital gains from 75% to 66.6% effective for capital gains realized after February 27, 2000 (50% after October 17, 2000). As a result, the effective top marginal tax rate on capital gains is approximately 30% (25% after October 17, 2000, varying depending on the province in which you reside). A comprehensive list of the top marginal rates, by province, is in the Appendix.

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 and the donation claim limit was increased. The net effect of these enhancements to the incentives is that you will not pay any tax on capital gains arising from qualifying gifts of appreciated marketable securities, and a greater portion of the gift will be available to shelter other income from tax.

The gift must be made before December 31, 2001. 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 until October 17, 2000, the income inclusion rate will be 33.33%, with a 25% rate applying thereafter. As a result, the effective top marginal tax on these post-October 17, 2000 qualifying gifts is reduced to approximately 12.5% (one-half of the ordinary capital gains rate).

The reduction applies to gifts of:

• Shares, bonds, warrants, and options listed on a prescribed exchange;
• Mutual fund shares and units and segregated fund units; and
• Prescribed debt obligations.

A prescribed exchange includes the Toronto, Montreal and Winnipeg exchanges, the former Alberta and Vancouver stock exchanges (now merged as the Canadian Venture Exchange), the NYSE, Nasdaq (excluding the Over-the-Counter Bulletin Board), and most other major foreign exchanges.

The actual securities must be transferred to the charity. The gift will not qualify for the reduced rate if the securities are sold and the cash is gifted. The gift must not be made to a private foundation.

The tax benefits available on gifts of private company shares and debt are limited by recent changes in the income tax rules. A detailed discussion of these rules is beyond the scope of this publication. You should seek professional advice if you are considering this type of donation.

Your estate may be in a better position if you make a bequest in the form of capital property rather than first selling the property and then donating the cash proceeds from the sale. This is because of the reduced capital gains tax rate as discussed under "Gifts of Capital Property".

You may be eligible for a donation credit in respect of a donation of an insurance policy, provided the policy is absolutely assigned to a charity at the time of the gift. That is, the charity must be the owner and beneficiary of the policy and you cannot have any remaining right to the policy. The amount eligible for the credit is the cash surrender value of the policy and any accumulated dividends and interest at the time of the transfer. Your future premium payments will also qualify for a donation tax credit.

In some cases, it may make more sense to name your estate as the beneficiary of the policy and have the estate make the donation, or have the charity designated as the beneficiary of the policy. This way your estate may be eligible to claim a donation for the full amount of the insurance proceeds.

You may transfer property to a trust, name a charity as the capital beneficiary, and claim a donation equal to the fair market value of the trust's residual interest. The residual interest is equal to the present value of the trust's capital.

This could be done during your lifetime, or upon death. The terms of the trust could be such that you, and/or another designated beneficiary ("income beneficiary"), would be entitled to receive the annual income earned by the trust. The capital of the trust ("residual interest") would be paid to the charity upon the death of the income beneficiary.

For example, you could transfer a bond to a trust. Under the terms of the trust, you would be entitled to receive the interest income. Upon maturity, the principal amount of the bond would be paid to the charity. As long as the trust is irrevocable, the charity can issue a receipt at the time the bond is transferred to the trust. The amount of the receipt will be a function of the present value of the principal amount of the bond.

In many cases, a valuation will be required in order to assign a value to the residual interest. The value will be a function of various factors, such as the nature of the underlying assets, the investment policy, and the anticipated timing of the distribution of the trust's assets. If a value cannot be reasonably determined (e.g. when the terms of the trust allow for the withdrawal of capital), no donation tax credit is allowed.

Exercising an employee stock option may result in taxable employment income. On qualifying shares, this income is taxed like a capital gain. In accordance with the reduction in the capital gains inclusion rate, the 2000 federal budget also calls for a reduction in the income inclusion rate on the exercise of these stock options to 66.67% (50% after October 17, 2000).

The 2000 federal budget also provides that, under certain circumstances, the donation of such shares to charity will be subject to the lower income inclusion rate of 33.33% (25% after October 17, 2000). Assuming the shares qualify, to take advantage of the reduced capital gains inclusion rate, the shares must be:

• Acquired after February 27, 2000 and donated before 2002;
• Donated within the year they are acquired; and
• Donated within 30 days after their acquisition.

The fair market value of gifts of "Canadian Cultural Property" is to be determined by the Canadian Cultural Property Export Review Board. Donations of Canadian Cultural Property can be claimed to the extent of 100% of net income. Excess donations can be carried forward five years (and back one year, to the extent of 100% of net income, if made in the year of death).

In addition, capital gains arising on the deemed disposition of the property are not taxable.

Encouraging gifts of ecologically sensitive land has been a government objective in recent years. The annual claim limit for gifts of such property to Canadian municipalities and certain registered charities is 100% of net income.

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. Therefore, the income inclusion rate will now be only 33.33% of the gain (25% after October 17, 2000).

To qualify for this reduced 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 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 a private foundation), one of the main purposes of which is the conservation and protection of Canada's environmental heritage.

The 2000 federal 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 two years.

You may prefer to have greater control over your charitable contributions. One method of accomplishing this is to establish your own private charitable foundation.

Private foundations can be an effective tool for charitable giving, but changes to the Income Tax Act have severely limited the tax planning strategies available. For example, the reduced capital gains rate for the gift of publicly-listed securities is not available for gifts to private foundations (see "Gifts of Capital Property"). In addition, the Income Tax Act now contains various "anti-avoidance" provisions that may apply. In light of the changes, you should consider carefully any charitable planning strategies using private foundations.

Many Canadian communities have established "community foundations" that accept gifts from donors.

A community foundation is a public foundation, typically established to build a permanent endowment to support a designated geographic area and support all sectors of the community (arts, social services, education, environment and health).

A community foundation is not subject to the same restrictions and anti-avoidance rules as a private foundation. Depending on your specific philanthropic objectives, your local community foundation may be an appropriate alternative to establishing a private foundation.

Tax incentives similar to those for individuals are available to corporations. Corporations, however, receive tax deductions rather than tax credits.

Specifically, a corporation:

• Can deduct an amount up to 75% of its annual net income, and can carry forward excess donations for five years;
• Is eligible for the reduced capital gains rate on gifts of certain capital property (see "Gifts of Capital Property"); and
• Is eligible for an additional donation limit of 25% of any taxable capital gains triggered on the donation of capital property (see Gifts of Capital Property).

You may hold investments in a private holding corporation. The income tax rules are intended to leave you indifferent as to whether it is you or your holding corporation that makes a donation. This, however, is not always the case. If you are contemplating a large gift from a holding corporation, you should consult your tax advisor.

The examples presented in this commentary show how tax planning can result in significant savings for the donor. We emphasize that tax is only one consideration in developing your donation strategy. A variety of innovative and creative methods are available, which should allow you the flexibility to develop a plan that meets all your objectives.

This guide provides general information but is no substitute for professional advice. We welcome your enquiries and will be delighted to help you pursue effective charitable giving options.

Throughout this commentary the examples have assumed that you will receive a tax credit equal to 45% of your donation (or $0.45 for each dollar donated). In fact, for annual donations in excess of $200, the system is designed to grant a tax credit at the top marginal tax rate. A lesser credit will apply to the first $200 of donations made during the year ($2,000 for Quebec tax).

Your top marginal tax rate depends on the province in which you reside at the end of the year.

The following table shows the top marginal combined federal and provincial tax rates (including all surtaxes and flat taxes) for each dollar of income earned in the top marginal tax bracket. It will help you determine the actual amount of your donation tax credit. For example, if you reside in British Columbia, you will receive a tax credit of approximately $0.51 for each dollar donated.