CRA offers advice on charity plans

(November 25, 2004) The Canada Customs and Revenue Agency (CRA) has issued a warning to investors considering participation in certain charitable tax shelters, pointing out they could face possible audits, penalties and interest payments.

The plans in question are often referred to as “buy low, donate high” schemes, in which tax-filers receive a tax credit worth three to four times the amount they actually donated.

“Potential investors should be aware of the risks associated with participating in certain tax shelter donation arrangements, including gifting trust arrangements, leveraged cash donations, and buy-low, donate-high arrangements,” read a press release issued by the CRA. “The CRA recommends that anyone considering participating in tax shelter donation arrangements obtain independent legal and tax advice.”

In December 2003, the government introduced legislation to close the loophole, which presumably allowed the practice, and while that bill has yet to pass, it will be retroactive and cover participation in such arrangements throughout 2004.

But a new crop of similar plans has sprouted up this year and this time, they take advantage of trust structures which apparently follow the current rules.

“The CRA is aware that some donation arrangements continue to be promoted. Two such arrangements are identified as gifting trust arrangements and leveraged cash donations,” the CRA statement said. “It is the CRA’s position that the December 5, 2003 amendments apply to these arrangements and will reduce their associated tax benefits.”

The CRA explains these two forms of arrangement as follows:

Gifting trust arrangements

In these arrangements, the investor becomes a beneficiary of a trust and receives property as a distribution from the trust. Often, but not always, the property has a lien attached. The investor then donates the property along with an amount of cash (to pay off the lien where applicable) to a registered charity and receives a donation receipt for the total of the cash and purported fair market value of the property. Typically, the total cash paid by the investor is about 30% of the amount on the donation receipt.

The December 5, 2003 amendments provide that the donation amount on which the tax credit is based will be reduced by any “advantage” that is in any way related to the gift. It is the CRA’s position that the receipt of such property from the trust is such an advantage, and the donation amount will be reduced accordingly.

Leveraged cash donations

These arrangements involve an investor applying for and receiving a loan to facilitate a cash donation (comprising the investor’s own funds and the proceeds from the loan) to a charity. Usually, the investor makes another cash payment to the promoter or another entity as an investment, and the investment will be used to repay the loan. Typically, the total cash paid by the investor is about 30% of the amount on the donation receipt.

As explained above, the December 5, 2003 amendments reduce the donation by the amount of any advantage. The definition of advantage for this purpose includes a limited-recourse debt in respect of the donation. A limited-recourse debt is broadly defined to include any unpaid amounts if there is a guarantee, security, or similar indemnity or covenant in respect of the debt. It is the CRA’s position that debts incurred as part of a leveraged cash donation constitute limited-recourse debts if they are to be repaid under such arrangements structured as part of the donation arrangement. The donation amount will be reduced accordingly.

Tax experts contacted earlier in the week by Advisor.ca declined to speak on the record, but one said certain charitable tax shelter schemes “did not pass the smell test,” while another simply said he would not go near the structures.

The rules the feds have in place make it pretty difficult for participation to go unnoticed.

“All tax shelter promoters are required by law to report all sales of their arrangements to the CRA,” the release points out. “The CRA will challenge any arrangement that does not comply with the Income Tax Act and will audit the tax returns of investors with respect to their participation in such an arrangement.”

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com