By Canada Life | Nov. 8, 2022
John Yanchus, CPA, CA, TEP, Director of Tax and Estate Planning
Philanthropy has helped to build strong and vibrant communities across Canada. Take the case of Mike (53) and Joanne (53). They’re former business owners who support their community by attending events dedicated to their chosen charity. It’s their way of giving back. At a recent event, the charity launched a major fundraising campaign and they wanted to help.
Mike and Joanne own mutual funds and segregated fund policies. Their private holding company also has a stock portfolio of publicly traded securities. At first, Mike and Joanne thought to simply write a personal cheque (make a cash donation) from their company. But, after exploring other options, they found that having their company donate securities from its portfolio would have additional benefits. It would allow them to give more to their charity and provide tax efficiency in their estate planning.
Mike and Joanne’s company holds securities that have grown in value. Selling these securities for cash for the donation would trigger capital gains. These gains have an inclusion rate of 50% and are taxed at the highest corporate investment tax rate (generally around 51%, depending on the province of residence). But, if a person donates certain types of capital property to a registered charity, the company would be entitled to a 0% inclusion rate on any capital gains realized from the donation. The 0% inclusion rate applies if the person donates publicly traded securities. These include:
- A mutual fund trust unit
- An interest in a related segregated fund trust
- A share, debt obligation or right (e.g., stock option) listed on a designated stock exchange
- A prescribed debt obligation (e.g., a bond, debenture, note, mortgage or similar obligation guaranteed by the Government of Canada or a province).
- A share of the capital stock of a mutual fund corporation
Strategy for donating corporately owned securities
If Mike and Joanne sell their company’s securities and donate the cash proceeds, the gift won’t qualify for the 0% inclusion rate. It’s the company that would have to make the in-kind donation for this rate to be applicable.
Mike and Joanne’s charitable gifting efforts will create immediate tax savings. Their company would be entitled to a charitable donation deduction equal to the full fair market value of the securities. They could apply this deduction to offset taxable income for up to five years, until it’s fully utilized. The company would also receive a credit to its capital dividend account (CDA) equal to the full non-taxable portion of the capital gain. As shareholders, Mike and Joanne can immediately receive a tax-free, capital dividend from the company in an amount equal to the accrued capital gain on the securities (because of the CDA credit that was generated with the donation), assuming there are no prior capital losses affecting the CDA balance.
Example of donation alternatives
Here’s a comparison of Mike and Joanne’s gift-giving options. Either their company makes an in-kind donation of $500,000 of corporately owned securities. Or, Mike and Joanne make an in-kind donation of $500,000 of personally held securities. For these scenarios, assume:
- The securities were purchased for $100,000
- The company’s investment tax rate is 50%
- Mike and Joanne’s personal tax rate is also 50%
- Their tax rate for dividends is 35%
- Both the company and the individuals can deduct the entire gift the first year.
|
Corporate
|
Personal
|
|
|---|---|---|
| Fair market value of donated securities |
$500,000
|
$500,000
|
|
Capital gain realized
($500,000 - $100,000) |
$400,000
|
$400,000
|
|
Taxable capital gain
($400,000 x 0%) |
nil
|
nil
|
| Corporate/personal income |
$675,000
|
$675,000
|
|
Donation deduction
Limited to 75% of income |
($500,000)
|
($500,000)
|
| Taxable corporate/personal income |
$175,000
|
$175,000
|
|
Amount credited to capital dividend account (which can be paid to the shareholders tax free)
($400,000 x 100%) |
$400,000
|
N/A
|
| Tax free capital dividend to shareholders |
$400,000
|
N/A
|
|
Corporate/personal tax savings on gifting securities
($400,000 x 50% x 50%) |
$100,000
|
$100,000
|
|
Corporate/personal tax savings on income
($500,000 x 50%) |
$250,000
|
$250,000
|
|
Personal tax savings on dividend
($400,000 x 35%) |
$140,000
|
N/A
|
|
Capital gain savings to estate
($900,000 x 50% x 50%) ($400,000 x 50% x 50%) |
$225,000
|
$100,000
|
- Ownership of the securities must be transferred to a registered charity (in-kind donation). Securities can be transferred to a charity in one of two ways:
- The donor delivers endorsed certificates to the charity. The gift is complete the day the certificate is delivered. A donation receipt is based on the value of the security that day.
- The donor transfers the securities from a brokerage account to the charity's account. The gift is complete when the securities are transferred to the charity's account.
- The company will receive a donation receipt for the market value of the securities.
- The company is exempt from being taxed on the capital gain.
- The donation transaction results in an income deduction for the company (under subsection 110.1(1) of the Income Tax Act), limited to 75% of its net income for the year. The company has the added benefit of carrying forward the deduction for the next five years, until it’s fully used.
- The tax-free portion of the capital gain – 100% of the amount – is included in the calculation of the company’s CDA balance. This amount can be paid tax free to shareholders via capital dividends under subsection 83(2) of the Income Tax Act.
- In Mike and Joanne’s case, by donating the $500,000 securities in-kind and paying a $400,000 tax-free capital dividend to themselves, they’ve reduced the value of their company by $900,000. As a result, they’ve reduced the capital gain tax liability of $225,000 for their estate.
- Mike and Joanne didn’t have to reorganize the financial structure of their company to come up with the “cash” for the donation (reduced complexity).
- The charity can immediately sell the securities for cash that will go toward its fundraising efforts.
The benefit
By gifting publicly traded securities, donors may be able to realize their philanthropic dreams right away. Tax benefits arise whether a donation is made personally or from a company. But, using a company to make the gift generates a credit to the CDA, which allows donors to extract equity from their company tax free. When properly structured, a gift of publicly traded securities is truly a gift that keeps on giving.
This material is for information purposes only and should not be construed as providing legal or tax advice. Reasonable efforts have been made to ensure its accuracy, but errors and omissions are possible. All comments related to taxation are general in nature and are based on current Canadian tax legislation and interpretations for Canadian residents, which is subject to change. For individual circumstances, consult with your legal or tax professional. This information is provided by The Canada Life Assurance Company and is current as of October 2022.
A description of the key features of the segregated fund policy can be found in the information folder and important information about mutual funds is found in Fund Facts. Please read these documents carefully before investing. Mutual funds are not guaranteed. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund and segregated fund investments. Mutual fund and segregated fund values change frequently and past performance may not be repeated. Any amount that is allocated to a segregated fund is invested at the risk of the policyowner and may increase or decrease in value.
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