The new rules

(July 2006) The Conservatives made good on their pre-election promise to encourage the donation of publicly traded securities (including mutual funds and segregated funds) to charity by completely eliminating the tax on any accrued capital gains arising from the disposition to charity.

This change opens a huge window for you to broach the topic of philanthropy with your clients in a way that can significantly benefit the client, the advisor, and, most importantly of course, the charity.

Almost 10 years ago, the government introduced enhanced tax assistance for donations of publicly listed securities to charities. Under the old (pre-budget) rules, if an individual donates eligible securities, only 25% instead of the usual 50% of any capital gains triggered by the sale of those securities had to be included in the individual’s income.

To encourage additional donations of listed, publicly traded securities to charitable organizations and public foundations, the budget proposed to completely eliminate any capital gains tax payable on the donation of these securities to charities by reducing the capital gains inclusion rate for such donations to zero.

While there was some speculation that this donation rule would be retroactive to January 1, 2006, the federal government announced these new rules would apply only to donations of eligible securities made on or after May 2, 2006.

Donation Tax Credit

Before reviewing the new opportunity in detail, let’s take a quick look at how the basic donation credit rules work.

Donations to a registered charity in Canada are eligible for the donation tax credit. For the first $200 of donations made by an individual in the year, the federal donation credit in 2006 is 15.25% of the amount given. (This credit is increasing to 15.5% for 2007 and beyond, as announced in the recent federal budget.)

Each province also provides a provincial donation tax credit. For example, the Ontario provincial credit is an additional 6.05%, for a combined total credit of approximately 22%. In other words, Ontarians would be entitled to about $44 back from the first $200 of annual donations.

It gets even better. Once you’ve made at least $200 of donations in any year, the donation credit jumps to 29% federally, plus between 11% and 18% provincially, depending on your income tax bracket and whether you are subject to the high-income surtaxes in your province.

So, for donations in excess of the first $200, you would get back at a minimum, 40% of the amount you donate. Given that the donations are in the form of tax credits (a credit is a reduction of tax owing) as opposed to tax deductions (a reduction of taxable income), the credits are essentially worth the same for low-, middle- and high-income earners (ignoring the effect of any high-income provincial surtaxes).

A Case Study

To understand the impact of the new rule, let’s assume one of your clients, Mark, currently owns mutual funds that have a fair market value of $100,000 that he purchased many years ago for $20,000 (see chart below). He is considering donating these mutual funds to charity.

If he simply sold the mutual funds first, he would realize a capital gain of $80,000 and pay tax of about $18,000 on the gain, assuming a top marginal rate of about 45%. His net benefit, taking into account the value of the donation credit less the tax on the capital gain, would be about $27,000 (Column A).

Under the existing (pre-budget) rules, if he donated the mutual fund units directly to charity instead of disposing of them first, this $18,000 of capital gains tax would have been cut in half for a net tax benefit of $36,000 (Column B).

Under the new rules, since the capital gains tax would be eliminated altogether on the donation of the mutual funds to charity, and since Mark would still be entitled to his full tax receipt for the $100,000 contributed, his net benefit would be $45,000 (Column C).

Note that while the new rules are proposed to be effective for donations made on or after May 2, 2006, as of the time of writing, they are not yet law as they must still be passed by Parliament and the minority government. But it would be highly unlikely (and extremely unpopular) for any party to oppose the passage of these new rules.

What if you and your client want to continue to own this strong-performing mutual fund? No problem. Simply advise your client to repurchase the fund just donated.

By doing so, not only will your client get his donation credit, he won’t pay capital gains tax on the disposition and his adjusted cost base will be “bumped up” or “reset” to the current fair market value, limiting any future capital gains tax on their ultimate sale to subsequent increases in value.

MUTUAL BENEFIT Compare tax-savings pre- and post-federal budget
	Cash Donation (A)	In-kind Donation Pre-budget (B)	In-kind Donation Post-budget (C)
Fair market value of donation	$100,000	$100,000	$100,000
Adjusted cost base (assumed)	($20,000)	($20,000)	($20,000)
Capital gain	$80,000	$80,000	$80,000
Taxable gain (50% vs. 25% vs. 0%)	$40,000	$20,000	0
Tax on capital gain (at 45%)(A)	($18,000)	($9,000)	0
Tax benefit of gift (at 45%) (B)	$45,000	$45,000	$45,000
Net tax benefit (A + B)	$27,000	$36,000	$45,000
Tax savings from donating in-kind instead of cash		$9,000	$18,000
Source: AIM Trimark Investments

This article originally appeared in Advisor’s Edge. Jamie Golombek, CA, CPA, CFP, CLU, TEP, is the vice-president, taxation & estate planning, at AIM Trimark Investments in Toronto. He can be reached at jamie.golombek@aimtrimark.com.

(07/25/06)