Donations involving Private Company Shares and Real Estate

The announcement in the 2015 Federal Budget that capital gains would be eliminated on donations involving private company shares and real estate was short on detail. As a result the measure, which would be effective beginning 2017, was not passed by Parliament. In mid-summer, the Department of Finance released the technical details and invited public comment. Feedback is due on September 30, 2015.

The Federal election makes the future of the incentive uncertain, but a number of professional organizations are commenting nonetheless. As a believer in the incentive, and the person who proposed the “proceeds of sale” structure being used, I remain confident that the incentive will be made law regardless of the party in power.

This donation incentive turns on a structural twist. Unlike previous donation incentives involving in-kind transfers of public securities, the new incentive would only apply to cash gifts delivered within 30 days of the sale of the private shares or real estate. The gain related to the amount donated would be exempt on the sale of the property. This mechanism is helpful for charities, which generally prefer cash to complex property that require independent valuations and create ongoing liabilities. Donors have a valuable incentive to plan and make significant gifts after the sale of a company or real property. The Government gets valuation certainty. Below are a few comments on the draft proposals:

• The incentive is designed to encourage giving by long-term owners of private businesses and real estate who sell to arm’s-length parties. Selling to families or business partners is blocked, despite the fact that this kind of business succession is common. While still helpful, the incentive will frustrate some donors and their advisors due to these anti self-dealing mechanisms. That limitation is the reason we have the incentive and represents a valid – albeit not universally popular – policy decision. Regular in-kind donations without the capital gains exemption are still an option in some cases.

• Proposed section 38.4(1)(a)(i) states that real estate must be situated in Canada to qualify. This will help with cottages, commercial and investment properties, but closes the door to, for example, U.S. vacation homes. While the domestic limitation makes some logistical sense, charities would benefit from U.S. real estate owned by Canadian tax payers to be added to the list.

• There is no mechanism to address recapture of the capital cost allowance that may be owed on buildings. At the time of a disposition, CCA recapture is taxed as income and can be greater than the capital gain tax. My view is that recapture should not be exempt. The taxpayer has enjoyed a benefit over a number of years and after a sale occurs at a profit should be reasonably be expected to repay CRA. Beyond the basic tax credit or deduction, there is no precedent in the Income Tax Act to exempt taxpayers from donated property taxed at income rates. Donations involve a measure of impoverishment, which is an important principle to keep tax policy in balance.

• A mechanism for estate donations has been introduced. The executor will have 30 days to transfer cash after selling the underlying asset in the estate. Time, however, will be of the essence. The new estate donation rules stipulate that the property must be transferred within the first 36-months after death (the graduated rate estate). This is yet another reason for Finance to consider extending the 36-month limit for transferring estate donation to charities.

• While making these donations easy and more common for charities, the incentive will probably be the most complex donation measure in the Income Tax Act. The complexity is due to a couple of factors. First, the provisions to prevent self-dealing are seemingly exhaustive, and include the reversal of the capital gain exemption. Second, other charity, securities and donation measures apply to this incentive, including split receipting, excess business holding rule, taxpayers ceasing to exist, estate donations, and the existing capital gain exemption rules.

Despite the underlying complexity and design limitations, on balance I believe the incentive will be positive for charities and a genuine encouragement for many prospective donors. After another round of revisions in Ottawa, I hope the new Government, whatever the party, makes it law by 2017.