Beware legal and tax traps when gifting

You have two main options for transferring wealth. You can gift during your lifetime or bequeath on death. Many of you will do both. This article deals with gifting during one’s lifetime.

You may not be aware such gifts can be subject to legal strictures and challenges. This is most likely when the gift has significant value and the person gifting is elderly and vulnerable.

Definition of gift

A gift is a voluntary and gratuitous transfer of property from one individual to another. For a gift to be legally valid, three conditions must be met. There must be:

• an intention to gift the property;
• delivery of the property; and
• acceptance by the intended recipient.

Intention is the element most often in dispute. The onus is on the recipient to prove a gift was intended by the donor.

Grounds for attacking a gift

Lack of capacity

Intention has been at issue in a number of recent court cases. The case of Servello v Servello (2014 ONSC 5035) involves a transfer of real property from mother to son. The mother was led to believe the title transfer documents she signed were power of attorney documents, so the court found she did not intend to gift the property. The gift to her son was therefore void.

Forming an intention to gift requires a degree of mental capacity. The threshold for testamentary capacity (the minimum mental capacity to make a valid will) has been reasoned in many cases over the years. Broadly stated, the testator must understand the nature of a will and the extent of the property he is disposing of, and be aware of any claims to which he ought to give effect.

Courts have applied a similar standard to significant gifts made during life. “Significant,” in this case, means large relative to the size of the donor’s overall assets, but there is no standard percentage of overall assets that’s considered significant.

In Foley v McIntyre (2014 ONSC 194), a son challenged lifetime gifts made to his sister, alleging his father (since deceased) lacked the requisite capacity. Expert witnesses conducted retrospective capacity assessments and reached different conclusions. The court was swayed by the evidence of the daughter’s witness and found the father was in fact capable of forming the necessary intent. The gifts were therefore upheld.

Undue influence

Undue influence is another common ground for challenging a gift. When a gift’s recipient has exerted undue influence on the donor, the court will view the transfer as not truly voluntary, and the gift will be void. The onus to prove undue influence is on the person(s) challenging the gift.

Gifts may be deemed void due to actual or presumed undue influence. The former is relatively rare and generally more difficult to establish. Presumed undue influence is more common and frequently arises in situations involving parent and child.

Of course, not all gifts from parent to child give rise to concerns about undue influence. However, undue influence may be found where the parent is elderly, frail, has diminished capacity or is dependent to some degree on the child.

In Servello v Servello, undue influence was alleged in addition to lack of intent. The following supported the allegation: the mother was recently widowed; her comprehension of English was poor; her son was living with her; and her son told her she was signing a document that would allow him to look after her.

There are also cases where a court upheld property transfers because it found that a child did not unduly influence his or her parent. In the case of Lorintt v Boda (2014 BCCA 354), relevant considerations included the fact the son did not live with his father, was not dependent on his father, and that the parties had an “amicable relationship.”

Other grounds

There are a number of other grounds for voiding gifts. In Ontario, a gift may be declared void under the Fraudulent Conveyances Act. In such cases, the court determines the transfer was made with the “intent to defeat, hinder, delay or defraud creditors or others [….]” Provincial family law and dependant’s relief law may also allow for a gift to be voided if a deceased person, prior to her death, engaged in careless transfers. Gifts may also be void due to lack of delivery or acceptance by the intended recipient.

Don’t overlook joint tenancies

Gifts do not need to involve an immediate transfer of the entire interest in an asset. In fact, many recent cases involve the transfer of property (real estate, bank or investment accounts) from sole ownership by the parent to joint tenancy, with right of survivorship with an adult child.

Lack of intent and undue influence are the most common grounds for challenging such transfers. Non-recipient children frequently allege their now-deceased parent did not intend for their sibling to inherit the property by right of survivorship. They argue the parent intended all beneficiaries of the estate to share the property. Alternatively, the siblings may allege that the recipient child unduly influenced their parent to make the transfer. Transfers undertaken in the absence of objective, expert advice and without any documentation as to the donor’s true intent, provide fertile ground for legal challenges.

Pros and cons

Lifetime gifting can give donor great pleasure, but the downsides should not be overlooked. There are potential adverse tax consequences, such as accelerated taxation of capital gains and income/capital gains attribution. There’s also the simple fact that a valid gift cannot be unilaterally undone should the donor change her mind. Consequences for the recipient (including tax and creditor issues) should also be weighed.

In sum, significant lifetime gifting should always be viewed as part of a comprehensive estate transfer strategy.