Leveraged donation programs sound like the perfect option for budding philanthropists: Put $100 in, get $160 back, and your favourite charity gets a large donation. A win-win scenario? Not according to the Canada Revenue Agency.
No good deed goes unpunished — that is what Canadian taxpayers might reasonably conclude after the judicial smackdown recently delivered to a donor who participated in a leveraged charitable donation program. In Maréchaux v. Canada, [2009] T.C.J. No. 467 (aff'd [2010] F.C.J. No. 1337), the donor, a real estate lawyer, had claimed a donation tax credit on a $100,000 cash gift made to a registered charity. The Tax Court, in a decision upheld by the Federal Court of Appeal, denied him the credit because most of the donation was financed by a loan made to him on exceedingly favourable terms. The aspect of this decision that surprised many observers is that Maréchaux was not allowed a credit even for the cash portion of the gift paid out of his own pocket.
Maréchaux is not alone. Thousands of Canadians who participated in similar donation programs have been reassessed, and were anxiously awaiting the outcome of this case. Their hoped-for tax refunds will never materialize.
Leveraged donation programs have been very popular. They are often marketed to accountants and financial advisers, who are urged to recommend them to their high-net-worth clients.
The promoters of these programs promise donors an opportunity to make a large donation, either in cash or property, to a registered charity of the donor's choice (or to choose from a list of preselected charities) and receive a donation receipt that will generate a tax refund substantially greater than the cash outlay required. In many cases, the promoter has obtained a written opinion from a reputable law firm, which prospective donors are shown, describing the program as having a "slim" chance of being challenged by the CRA.
In Maréchaux, the program worked this way: In exchange for making a $30,000 cash donation to a charitable foundation, Maréchaux obtained a 20-year interest-free loan in the amount of $80,000 from a lender which was owned by the program's promoter, and created for the sole purpose of providing loans to donors. $70,000 of this amount was donated to the foundation. (The foundation then paid the funds to two charities, one of which had entered into a fundraising agreement with the promoter.) The foundation issued a receipt reflecting a donation of $100,000.
Of the remaining $10,000, Maréchaux deposited $8,000 with the lender as security for the loan, with the intention that it would accrete to $80,000 in 20 years. A further $800 portion was paid for a policy to insure against the risk that the security deposit would not accrete to that amount. The remaining $1,200 was paid as a fee to the promoter. The same day, Maréchaux satisfied the loan by assigning the security deposit and insurance policy back to the lender. Had the CRA accepted his claim for a tax credit for the $100,000 donation, Maréchaux would have received a rate of return exceeding 60 per cent on his initial $30,000 cash outlay.
The CRA scuttled this arrangement. The Tax Court agreed, holding that Maréchaux was not entitled to a tax credit in relation to any of the amount donated, because he did not make a true "gift" to the charitable foundation. Why was it not a true gift? Because, the court said, a "significant benefit" had flowed to him in return for making it.
That "benefit" was the financing arrangement — the $80,000, 20-year interest-free loan, together with the arrangement that enabled Maréchaux to discharge it immediately after he incurred it. The court said it was clear that the $8,000 security deposit could not be expected to accrete to "anywhere near" $80,000 in 20 years, so it could not be said that he had paid sufficient consideration to discharge the loan.
The CRA has already indicated that it is inclined to treat donors who have participated in similar programs like Maréchaux. But donors who wish to have recognized at least the cash portion of their donation (in Maréchaux's case, the $30,000 amount) may yet be able to do so.
What was not argued in Maréchaux is that the loan was not a bona fide financing arrangement. In many of these cases, there is never a true expectation that the donor will ever be obliged to repay the loan. The financing itself is no more than a pretence, the purpose of which is to put fees in the pocket of the promoter and the lender. It does not reflect a true obligation of the donor to the lender.
If the financing arrangement is not bona fide, and the donor never himself obtains the use of the "borrowed" money, what possible benefit could there be to the donor from the extinguishment of this phony liability immediately after it is incurred? None. The cash portion of the gift should not be vitiated.
Of course, this argument would require donors to concede that the borrowed amount will not be recognized as a gift. This means saying goodbye to the prospect of a high rate of return on the cash donation.
As your mother always said, if it looks too good to be true, it probably is.
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