Fluid giving

(September 2006) Starting with donations of publicly listed securities made after May 1, 2006, there will be no capital gains to report in relation to most appreciated securities that have been gifted to a registered charity.

The fact there is no income inclusion resulting from the donation of eligible securities means that the larger the accrued gain on the security prior to donation, the greater the tax benefit for the donor.

That’s why flow-through shares make particularly good gifts.

Many investors have benefited from significant deductions afforded by one of Canada’s few remaining tax shelters — flow-through shares, and flow-through share limited partnerships.

The tax deductions for exploration costs, renounced to investors, reduce the investor’s cost base usually to the point of a nominal amount or even zero. Once the exploration is complete, the flow-through shares are usually converted on a tax-deferred basis, to publicly traded securities. And in most cases, the limited partnership is then converted to a mutual fund for easy marketability.

When these securities are sold, the full proceeds would be a capital gain. However, they are eligible for capital gain exemption if they are gifted to a registered charity.

Consider Reggie Largmont, who would like to donate $100,000 to the Red Cross. He currently owns a resource mutual fund investment that he received on a flow-through share limited partnership exchange. It’s worth $100,000 with an adjusted cost base of zero. He can donate the mutual fund units directly or sell them and then donate the $100,000 in cash. As the chart indicates, he saves $23,000 (or 23% of the value of investment) by donating the securities directly. The chart assumes Largmont is taxed at a top marginal rate of 46%.

In addition to the initial savings, the resource deductions he’s already claimed for tax purposes will combine with the donation tax credit claimed on his return to make the out-of-pocket cost of the charitable gift just a fraction of its ultimate value. In the chart’s example, assume he originally purchased the flow-through units for $100,000 and claimed $100,000 of resource expenses, providing a tax benefit of $46,000. By donating the resulting securities (received on the exchange to a mutual fund) valued at $100,000, he will receive an additional tax benefit of $46,000. In effect, Largmont receives $92,000 in tax benefits relative to his $100,000 initial investment.

That adds up to a great value proposition to recommend to your clients. By gifting flow-through share investments, they effectively pay only $8 for every $100 of value donated to their favourite charity. Everybody wins.

This article originally appeared in Advisor’s Edge. Gena Katz, FCA, CFP, is an Executive Director with Ernst & Young’s National Tax Practice in Toronto. “Tax Break” appears monthly.

(09/14/06)