A gift is generally defined as a voluntary and gratuitous transfer of property, without any consideration given in exchange. A personal gift made in Canada may or may not be made on a tax-free basis, depending on the nature of the relationship between parties. A deed of gift can be a useful estate planning tool for crafty Canadian taxpayers when arranging for a gift, and to protect a personal gift from re-assessment as personal income by the Canada Revenue Agency ("CRA").
If you are intending to make a gift during your lifetime to a friend, family member, or any other associate, you should speak to an expert tax lawyer in Canada to investigate whether you should draft a deed of gift for the transfer and to arrange for the best possible tax outcomes for your gift.
The Source Principle of Canadian Income and Taxation of Gifts
Section 3 of the Canadian Income Tax Act provides that for a given taxation year, a tax resident in Canada will be taxable on all income from sources inside and outside of Canada. The Income Tax Act does not otherwise define income, and for Canadian tax law purposes, the concept of "income" does not line up with the traditional economic views of income. The language of Section 3 generally follows the "source theory" of income tax, which restricts taxable income to income derived from productive sources. Tax case law has recognized that some sort of organized effort or pursuit by the taxpayer to earn income, or a pursuit of profit, is required in order to produce taxable income. Income that is simply a transfer or accretion of wealth by a taxpayer is thus treated differently than income resulting from some organized use of capital or labour.
Drawing the line between income and non-income can be difficult, and it has fallen to the Canadian tax courts and the common law to determine when income is taxable outside of specific sources otherwise included or excluded by the Income Tax Act. Personal gifts are a prominent exclusion from taxable income for Canadian tax purposes.
Gifts are generally not perceived to have a source for income tax purposes, since a true voluntary gift is simply an accretion of wealth without any organized effort to earn or expectation of profit. Thus, a personal gift like cash to a family member or friend would not qualify as income for tax purposes to the recipient. In contrast, a gift made with an expectation of reward of compensation or made in recognition of a business or employment relationship, will, in contrast, typically create a taxable benefit for the recipient.
As well, under subsection 69(1), a gift of capital property will result the recipient being deemed to have received proceeds equal to the fair market value of the property, which may result in a hefty tax bill from the resulting capital gain.
Where Does a Valid Gift Exist, and How Does a Deed of Gift Help?
Under the Canadian common law, where an inter vivos ("during the life of the taxpayer") gift is made, there are several preconditions that must be satisfied for the gift to be a valid gift. The three main conditions are that:
- The donor must actually intend to donate the gift;
- The donor must actually deliver the gift to the recipient; and,
- The recipient must accept the gift.
Without a voluntary transfer of property that satisfies the above three conditions, then an inter vivos gift may be deemed to not have occurred. Where a gift appears to be invalid in the hands of a recipient, the CRA may choose to re-assess the taxpayer and consider the gift unreported income. A donor can certainly gift property directly to a recipient, but for any substantial gift any failure to document the gift will carry an inherent risk that the gift may be later challenged.
A deed of gift is an unambiguous written document that shows a donor's intent to make a particular gift. Using a deed of gift to effect a gift is not only strong evidence of a donor's true intentions to gift property, but gives effect to the transfer as though it were a contract. This allows the donor to provide for some instruction on subsequent use of the gifted property, where the donor is interested in doing so, to prevent misuse or misattribution of the property.
A donor may wish to transfer property to a beneficiary to settle an estate matter before passing, as part of an estate freeze, to transfer property to a trust, to protect property from claims as part of a separation, or for many other reasons. For example, a donor could tailor a deed of gift to specifically exclude the gifted property from forming part of net family property in Ontario, to protect it from any equalization payment in the event of a divorce. Using a deed of gift allows the donor flexibility to arrange for their affairs, while protecting against possible re-assessments by the CRA.
Pro Tax Tip - Exercise Caution When Gifting Property by Way of Deed
A deed of gift can be a very useful tool to avoid an unforeseen tax bill when gifting personal property. However, not every writing or instrument is a valid deed of gift simply because it expresses a donor's intent. Even if the deed is signed and witnessed, if the gift made does not satisfy legal principles, then it may nevertheless be ineffective.
The language involved in drafting a deed of gift is very particular and intended to protect the donor and recipient from future scrutiny. One of our expert Canadian tax lawyers, familiar with both contract law and Canadian tax laws, is best suited to advise you on the language involved in drafting a deed of gift, the process for officiating a deed., and to help prepare a deed of gift for you if you plan on gifting your personal property.
What is a deed of gift?
A deed of gift is a document that gives effect to a gift and any conditions related to that gift. A deed of gift helps to evidence a donor's intention to make a gift, rather than simply a transfer of property, and that no consideration was received for the gift. A deed of gift can help evidence a true and voluntary gift that will not give rise to a tax liability.
When are gifts not taxable in Canada?
Section 3 of the Canadian Income Tax Act imposes tax on income from all sources inside and outside of Canada. The "source theory" of income tax limits Canadian tax to income that is the result of organized efforts to use capital or labour, rather than every accumulation or receipt of wealth by a taxpayer. Generally, a gift is not a result of using capital or labour, and is simply a transfer of existing wealth, which means that the gift is not taxable for Canadian tax law purposes.
What are the conditions for making a valid gift during a taxpayer's lifetime?
In order to make a valid inter vivos gift: 1) The donor must actually intend to give a gift to the recipient; 2) The donor must actually deliver the gift, or a deed of gift, to the recipient; and, 3) The recipient must accept the gift. A gift that does not satisfy all three conditions may be void and subject to re-assessment as unreported income by the CRA.
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.