Reference Number
CES - 012

Date
October 3, 2000

Introduction

1. Thank you for inviting me to speak with you today. There are a number of topics I would like to bring you up-to-date on:

a.the conversion of Revenue Canada to the Canada Customs and Revenue Agency;

b. some types of charitable giving that can arouse concerns with the Canada Revenue Agency, namely (i) directed gifts and donor-restricted funds, (ii) gifts of art, (iii) charitable remainder trusts, (iv) valuation of gifts of public securities, and lastly, (v) the notion of "sponsorships";

c. legislative changes on the horizon, stemming from the February 2000 budget; and

d. forthcoming issues growing out of the Interdepartmental Task Force on the Voluntary Sector.

The Canada Customs and Revenue Agency

2. Most of you are aware that Revenue Canada has been morphed into the Canada Customs and Revenue Agency. This happened almost a year ago - November 1^st, 1999. The new agency is more independent from government, although it is still accountable to the Minister of National Revenue.

3. What's the difference? Well, we'll all still be paying the same taxes, but the difference will be an administrative one. The purpose of converting Revenue Canada into an agency is

a.to facilitate the collection of various taxes, both for the Federal and the provincial governments,

b. to reduce overlap and duplication between tax collection functions in the Federal government and in the provinces, and in doing so,

c. to reduce costs both to governments, businesses and other taxpayers alike, and

d. to tailor administrative and human resources in order to be more efficient in the management of customs, trade and tax programs.

Board of management

4. How is the Agency going to do that? One of the pivotal changes that is going to ensure a greater provincial voice in the administration of the Agency is the establishment of a Board of Management of fifteen members, on which each of the provinces is represented. Provinces each nominate someone to represent them from the private sector, and it is hoped that the oversight function of such a Board of Management will blend the strengths and best practices of the private and public sectors to make Canadian tax administration as efficient as possible.

Collection of taxes

5. Revenue Canada already provided many services to provinces, but previously could only collect provincial taxes that were harmonized with their federal counterparts. The Agency now has the mandate to collect any taxes on behalf of provinces and territories, whether harmonized or not. The establishment of the Agency addresses provincial concerns for a greater voice in tax administration and increased accountability for programs and services delivered on their behalf.

Advantages of a single tax administration

6. A single tax administration is going to reduce overlap and duplication between the two levels of government, and will reduce the paper burden on business, particularly small and medium-sized companies. It also offers provinces and territories the possibility of making significant annual savings - as high as $62 million - in administration costs. Similarly, businesses could reduce compliance costs by more than $193 million annually.

No change in day-to-day operations

7. On a day-to-day level, the operations of the Agency are no different than those of the former Department. The enforcement powers of Revenue Canada have not changed through the Act creating the Agency¹. These powers are limited by the authority given in the program legislation - for instance in the Income Tax Act. Also, the Minister remains fully accountable for the administration and the enforcement of program legislation. He is still answerable to Parliament, just as before. He has the authority to investigate and ensure that the Agency has acted properly in dealing with any member of the public, and he has the power to make changes when they are called for.

Charities Directorate

8. In addition to the change from Department to Agency, the area that I work in (Charities) within that Agency was changed on June 1^st, 2000, from a Division to a Directorate and is now known as the Charities Directorate. This change in name points to the more prominent status of the Charities program within the larger framework of tax administration.

9. A Director-General rather than a Director now leads the Charities Directorate. Our Interim Director General is Ms Enikö Vermes.

10. Note: New Web site: www.ccra-adrc.gc.ca

11. To reach the Charities Directorate site: www.ccra-adrc.gc.ca/charities www.ccra-adrc.gc.ca/bienfaisance

Types of charitable giving that can arouse concern

12. The notion of a gift for tax purposes is defined at law generally to be "a voluntary transfer of property to another made gratuitously and without material consideration." Every word in this definition carries some weight. Black's Law Dictionary identifies essential requisites of "gift" to be: capacity of the donor; intention of donor to make the gift; completed delivery to or for the donee; and acceptance of the gift by the donee. The Dictionary goes further, but I won't at this time. The definition is also discussed more fully in a number of departmental publications, notably Interpretation Bulletin IT-110R3².

13. It is fair to say that the Canada Customs and Revenue Agency will want to ensure that donors generally comply with the definition of giving that I just mentioned. But certain patterns of giving are of definite concern, because the transactions are substantial, and because our audits have uncovered either significant abuse or the potential for abuse. This abuse has an impact not only on lost revenues for state coffers, but also for the charities that the transaction, on its face at least, intends to benefit.

14. The purpose of this portion of my presentation today is to give you some idea of those areas of charitable giving where the tax administration frequently has concerns, specifically with respect to directed gifts, donor-restricted gifts, gifts of art, charitable remainder trusts, gifts of public securities, and sponsorship arrangements. I won't dwell on gifts between registered charities and other qualified donees - these have to meet somewhat different rules. Instead, the question that I'll try to shed some light on is - What kinds of gifts cause concern for the Canada Customs and Revenue Agency?

Directed gifts

15. The whole area of directed gifts can be of concern to the Canada Revenue Agency. This is not the case when the donor's wish is to apply the gift to a particular project of the charity. However, when the gift is expressly or implicitly structured to provide a direct and private benefit back to the donor, or to persons in whom the donor has a personal interest, we have a concern. These kinds of transactions can vary greatly in terms of their sophistication. They can range from loan-backs, where the donor for instance makes a large contribution to a charity on the condition that the charity reinvest the funds in enterprises controlled by the donor, or situations where the payment is made to the charity as long as a donor's relative is the main beneficiary.

16. Transactions like this can deprive the charity of its ability and indeed its ethical or moral duty to invest and run its programs wisely. The question is, to what extent can or should the state intervene in cases like this and substitute its own judgment for that of the donor or the charity?

17. There have been cases where the donor has benefited from a substantial tax advantage, for instance where the investment back into the donor's enterprise eventually goes sour. A charity can shrug off a minimal return on such an investment by saying that $1 dollar out of $10 is better than nothing at all. It's sad to say that we hear this argument often. Such thinking is tempting in today's world, where competition between charities for donation dollars has grown increasingly fierce. But has the charity really won? In the final analysis, haven't we all lost, as taxpayers and as a community, at the expense of one individual's private gain.

18. Government brought in legislation three years ago to try to shut down the most underhanded schemes - for instance those where the donor also controlled the charity and accordingly was able to postpone repayments or interest payments indefinitely³.

19. Luckily, community charities are more circumspect about these things, and less likely to engage in arrangements that ultimately compromise program growth and delivery. Nevertheless, the problem of donor benefit still crops up. It is less offensive where the donor to a university gets the library named in his or her honor. It is more problematic when, as a condition of the gift, the donor gets to influence the course curriculum or determine which brand of equipment the charity buys. How does that affect the kind of education, or as another example, the kind of hospital care that we get? When these things happen, the only recourse that a tax administration or indeed the community has is the legal definition of a gift: a voluntary transfer of property without consideration. With this in mind, we must ask, for example, to what extent did the promise of a seat on the board of directors, or a contract with a specific pharmaceutical company, or free travel for a son or daughter influence the donor to make a gift?

Using donor-restricted funds

20. As professional advisors to Community Foundations, it is important to understand how foundations deal with donors after the donation is made. As we have just seen, at law, that payment the foundation just received may not be a gift, depending on the extent of the donor's control over the funds after they are transferred to a Community Foundation. If the alleged donor's payment is not a gift at law, then a Community Foundation can't issue tax receipts for it - which significantly affects the purpose of the whole exercise. As well, if certain conditions are attached to the putative donation, the donor may be able to challenge the Foundation's use of his or her funds and ask for a return of monies paid.

21. I'm not going to be able to go into much detail regarding donor restrictions, but I at least want to give you an overview, since properly managing donated funds is such an important aspect of community foundation work.

Unrestricted gifts

22. Let's begin by talking about unrestricted gifts. These are outright gifts to a Community Foundation that are not subject to any restrictions imposed either directly or indirectly by the donor - other than the requirement that the gift be used for the general charitable purposes of the Foundation. Provided the Foundation does not exceed its charitable purposes - whether through breach of fiduciary duties, or by acting beyond its corporate objects, it can use the gift at its discretion.

Donor-Restricted Gifts

23. A donor-restricted gift, on the other hand, is a gift at law -- for a presumably charitable purpose -- that is subject to a restriction, condition or other limitations that constrains the Foundation in determining how the gift can be used. Community Foundations need to identify the nature of the donor restriction; they need to understand what are the legal consequences of the restrictions imposed by the donor, and they need to understand the importance of complying with the restrictions in question.

24. Community Foundations who fail to identify or adequately understand restrictions that have been imposed by the donor can expose themselves and their board of directors to unnecessary and potentially serious liability. From an income tax perspective, some donor restrictions can invalidate the gift and preclude the issuance of a tax receipt. From a more general perspective, the Foundation may not be able to vary the terms of a gift without court direction - so a Foundation needs to be aware of the terms of any donor restrictions and ensure that it can comply with them.

Special Purpose Charitable Trusts

25. One type of donor-restricted gift is the "special purpose charitable trust" - namely a gift held by a Community Foundation for a specific purpose that falls within the parameters of the general charitable purposes of the Foundation as set out in its constituting documents. Gifts that are contributed for a special purpose charitable trust are held in trust by the charity for the stated special purpose and cannot be used for other purposes. Special purpose charitable trusts are commonly referred to as "donor restricted trust funds", "charitable trust property", "special purpose funds", "endowment funds" or "restricted funds". For a special purpose charitable trust to exist, it must be clear that the donor intended to create a trust; it must be clear what assets are to form the trust property, and the beneficiaries of the trust must be ascertained or ascertainable. If the purpose is "charitable", then we are in the presence of a special purpose charitable trust. A typical example of a special purpose charitable trust is money given to a hospital or hospital foundation to build a new hospital wing.

Endowments

26. An endowment fund is generally considered to be a special purpose charitable trust, subject to the express requirement that the capital of the gift be held in perpetuity. Investment of the donated funds or the subsequent use of income are generally regulated in some detail in the endowment agreement. There are three ways in which endowment funds can be created - either (1) by the donor, (2) by the board of the Foundation subsequently inviting donors to contribute toward the endowment, and (3) by the board simply inviting donors to establish individual endowment funds within the charity to reflect the specific wishes of the donor within the parameters of the charitable purposes of the Foundation.

27. Other restrictions that are imposed by a donor do not necessarily require that the capital of a gift be held in trust. Instead, the funds will be expended, perhaps over a period of time or in accordance with certain specific charitable purpose restrictions. These restrictions can deal for instance with a particular project - provided it is charitable, or with pursuing relief efforts in a particular geographic area.

28. In addition, the donor can want to impose restrictions that do not limit what the Foundation can do with the funds, but that determine who is entitled to benefit from the funds. In the latter case, Community Foundations need to be careful that the restrictions are not void as discriminatory, or as benevolence based purely on private considerations personal to the donor. An example of this is a gift made on the condition that it benefit the donor's kin.

Implied Special Purpose Trusts

29. Then there are those gifts that are not made with express conditions attached, but where a special-purpose restriction can be implied from the circumstances surrounding the gift, and the language of the documentation accompanying the gift. In those cases, the circumstances and language have to be construed to determine whether the donor did somehow imply that his or her gift was to be applied in a special way. An example of this is where the donor gives money to a Community Foundation with no accompanying documents setting out his or her intentions.

Donor-Advised Funds - Precatory Trusts - Designated Gifts

30. A donor-advised fund is a form of restricted gift where the donor periodically recommends distribution of assets from the fund to other charities or for certain charitable activities, provided that such restriction does not constitute a binding restriction or obligation upon the Foundation. Donor-advised funds are often referred to as "advise-and-consult funds", "donor-designated funds", "gift funds", "advisory funds" or simply "accounts" or "funds" within community foundations. The difference between a donor-advised fund and a precatory trust or a designated gift, is that in the latter cases, the donor's intentions - although not binding - are stated only once at the time the gift is made, whereas with the donor-advised funds, the donor continues to have input into the distribution of the funds on an ongoing basis.

31. The primary concern with donor-advised funds is that, if too much control is retained by the donor, they will not be considered a gift at law, and could not be receipted under the Income Tax Act. Consequently, Community Foundations need to be careful and warn donors that input by the donor is of an advisory nature only. I can understand there is considerable moral pressure on a community foundation to abide by the donor's express wishes. But a donation is irrevocable, and the donor could not claim that the monies be returned, particularly when the community foundation had advised the donor beforehand that the donor's wishes were not binding.

Conditional Gifts

32. Another area of concern with respect to donor-restricted funds is the conditions that can be imposed by a donor. The difference between a conditional gift, and a special purpose charitable trust is not easy, since a conditional gift can also exist within the context of a special purpose charitable trust. Nevertheless, what matters in conditional gifts is that the condition determines the time of transfer of the gift to the Foundation (and hence, whether the Foundation can issue a tax receipt), and it may operate to defeat the gift. A condition that is illegal, such as one that requires a breach of the law or a discriminatory action, is void.

33. There are two types of conditions that can be attached to a gift: a condition precedent, and a condition subsequent. A condition precedent is one that must be met before the gift takes effect⁴. If the condition precedent is not fulfilled, the gift does not take effect. Since a transfer of property subject to a condition precedent is not a gift at law until after the condition is fulfilled, it would be improper for a Community Foundation to issue a charitable receipt for income tax purposes for a gift that is subject to a condition precedent, until such time as the condition is met.

34. A condition subsequent is one that operates to defeat a gift that has already been made⁵. If a gift is made with a condition subsequent, and the condition fails and the gift reverts back to the donor, then the donor will have received a double benefit, namely a tax receipt coupled with the return of the gift. To avoid a double benefit in such situations, it is incumbent upon the charity to advise the Canada Revenue Agency that the original gift is being returned to the donor in accordance with the failure of a condition subsequent. In this way, the Canada Revenue Agency can ensure that the donor reports the return of the gift. Since a condition subsequent may result in a tax liability to the donor in the event that the original gift is returned, it would be prudent to the charity to recommend that the donor intending to make a gift subject to a condition subsequent to obtain legal advice and evaluate the potential tax consequences of the gift or its failure.

35. When a gift to a Foundation is subject to either a condition precedent or a condition subsequent, and the condition is unfulfilled, then the gift will revert back to the donor unless there is a gift over to another charity. In cases where the condition is clear, the Court cannot intervene and extend the donor's initial charitable intent through a cy-près scheme. This is a major drawback to conditional gifts, and it is important that a charity ensure that the donor is aware of the inability to seek court relief if a condition fails, and further, it is important to ensure that there is a clause specifying a gift over to another charity in the conditional gift, in the event of a subsequent failure.

Conclusion on Donor-Restricted Gifts

36. This may be a lot of material to digest, especially given the number of topics that I'm covering. Suffice it to say at this stage that you should be wary of the kinds of provisos that donors can include in gifts to a community foundation. For those of you who would like more detailed information on donor-restricted gifts, I would suggest you consult an excellent article on which I've relied extensively to give you this brief overview. The article is by Terry Carter, entitled "Donor Restricted Charitable Gifts - A Practical Overview". It was written for the Canadian Bar Association, Ontario Division, continuing legal education program.

Gifts of art

37. Closer to tax matters, the Canada Revenue Agency is particularly concerned about gifts of art. Not that giving art to a museum or for a charity auction is a bad thing. But what we are seeing is that the art is often substantially over-valued. Sometimes, it's garbage. For example, I know of a particular case where our auditors went and inspected the artworks, and found one in particular with a neat crease down the middle, and staple marks from its former existence as a magazine centerfold. Frequently, the donor doesn't even see the art. An art dealer approaches and convinces the donor that an advantageous tax receipt can be garnered by purchasing a painting at a bargain price, and then donating it to a willing charity for a substantially higher and presumably "true" value.

38. The attractiveness of this kind of scheme is that none of the immediate parties to the series of transactions is a loser. The artist - presuming that the art is legitimate - gets to sell his inventory. The donor gets a tax credit that is substantially higher than his purchasing costs, and the charity gets at least some return on the sale of the art. Sure, the disproportion between the amounts for which the charity has issued tax receipts, and the re-sale value of the artwork, if any, can affect the charity's disbursement quota. This has happened, but it's not always the case. The real loser here is the state, and ultimately those taxpayers that have to pay because - relatively speaking - someone wanted to get something, for having given nothing.

39. There are cases where art is legitimately obtained at bargain prices and where its value increases, and the donor gets a legitimate windfall in terms of a greater tax advantage. The Canada Revenue Agency has won and lost some cases in this area. But what is important is that the provisions against art scams, intended to shut down abusive practices, are now law.⁶ The Bill C-25 legislative proposals concerning third party civil penalties became law as of June 29^th. Canada Revenue Agency is currently working on administrative policy regarding those provisions and is committed to consulting the private sector in so doing.

Charitable Remainder Trusts

40. Another area both the Canada Revenue Agency and the Department of Finance are currently interested in is charitable remainder trusts and gifts of residual interest. I use the two terms synonymously here, although there are slight differences between the two⁷. Essentially what happens is that the donor constitutes a trust to which he gives shares. The trust pays the interest income to the donor and at the donor's death, or after a certain term, the capital of the trust goes to a charity⁸. The donor can benefit from a tax receipt and a resulting credit at the time the shares vest into the trust. This type of deferred giving (getting a tax benefit now for a gift later) carries with it a host of problems that have not been fully addressed yet, but which are both in the interest of the charitable sector and the Canada Revenue Agency to resolve.

41. First and foremost are valuation problems: how does one reasonably determine the value of the residual interest at the arrival of the term? Does one use Canadian Life Tables, Annuity Tables, or Life Insurance Mortality Tables? Donors are known to shop for the most favourable rates, and it is tempting for a needy charity to acquiesce to a better if more distorted rate to entice the donor to give.

42. Also, who is responsible for insuring the trust property? Since there are no rules against trustees converting trust assets, how do we prevent the assets from being degraded over the course of the trust's term so that the charity actually receives less than what was originally intended? How can the charity ensure the proper administration of the trust if it cannot access trust property?

43. The Canada Revenue Agency and the Department of Finance have embarked on a series of consultative meetings with leading sector organizations on this issue. The purpose is not to shut down charitable remainder trusts - as a legitimate fund-raising tool, they are here to stay. But the purpose is to come up with legislation and policy that benefit and protect both the sector and the fisc.

Gifts of public securities

44. In valuing a gift of securities, the specific time of gifting becomes a debatable issue. While it is generally established that the value of the securities for purposes of the gift is the closing price on the date of the gift,⁹ in a fluctuating market, the mid-point between the high and the low trading prices for the day, provides an adequate basis for determining the fair market value.¹⁰

45. Generally speaking, the date of the gift-in-kind is the date on which the legal transfer of ownership takes place, with the transfer normally being established by way of deed of gift, or physical possession in the case of moveable property. While we might agree that the valuation of securities should coincide with the time at which title to the securities is effectively transferred to the charity, and the charity is registered as the title-holder, there can be a discrepancy of days. For example, between the date the donor signs over the securities to the charity, and the time the securities are registered in the company books in the name of the charity.

46. A gift of marketable securities transferred by mail or electronically poses new obstacles in valuation when the specific time of the gifting is questionable. Our staff have seen instances where a charity received a gift of shares electronically that took four days from the time the amount was debited from the donor's account, to the time that it was credited to the charity's account. The shares dropped in value by $10 per share during the four-day period. This presents a problem to the charity receipting the gift, as they could face an ensuing shortfall, as they would be receipting the shares at x$ but receiving x-10$.

47. Frank Minton outlines three scenarios for determining the date of the gift.

a.For situations where the donor has given a firm order to his broker to transfer securities to a separate account for the charity, the date of the gift is the date on which the securities are actually transferred to the charity's account. This normally occurs within a day or two after the order is given.

b. If the security is received registered in the name of the donor and is (a) properly endorsed or (b) accompanied by a separate stock or bond power assignment, the date of the gift is the date on which the security was mailed or, if hand-delivered, received.

c. If the security is received registered in the name of the charity, the date of the gift is the date on the certificate.

48. You will recall the Black's Law Dictionary definition of "gift" that includes as requisites (1) the completed delivery to or for the donee, and (2) the acceptance of the gift by the donee. Can we say with certainty that these elements have been met when the securities have been mailed? Have the securities been delivered to and accepted by the donee? It is understood that when cheques are mailed they are considered at common law to have been received by the donee.¹¹ Even if we were to apply this provision of the Income Tax Act to gifts of securities mailed, could one say that the securities have been accepted by the donee? What happens when the values of the donor and donee clash?

49. There is no cut and dried answer to these questions. The Canada Revenue Agency has not yet taken an administrative position. We are presently investigating these questions and would welcome informed submissions from legal experts in the field on how to deal with these valuation issues.

Sponsorships

50. One area that is of concern to me is that of sponsorships, more particularly as they relate to arrangements between businesses and charities. The term "sponsorship" is poorly defined, and it can mean any number of things.

51. The issue, as I understand it, is that there is some confusion as to the proper use of the term, and some question on the part of recipient charities as to whether they should be issuing receipts or not, in light of the proposed arrangement between them and the putative sponsor.

52. The Concise Oxford Dictionary gives several definitions of "sponsorship". Notably, a sponsor is one who makes himself responsible for another, or a person who subscribes to a charity in return for a specified activity by another (e.g., walk-a-thons). But perhaps the most suitable definition found in the Oxford Dictionary that applies in the context of this discussion, is that a sponsorship refers to an advertiser who pays for a programme into which advertisements of his wares are introduced.

53. Indeed, some charitable funding comes from businesses' corporate giving programs. Other funding comes from advertising or publicity accounts. Regardless of where the funding originates within the business corporation, some funds are transferred to the "charity gratis", and in other cases, the funds are transferred with some expectation of benefit back to the business. This benefit can take various forms, from a simple donor recognition in the charity's published literature, to great banners strung across the road, trumpeting the presence of the business corporation - and everything in between.

54. Sponsorship arrangements can be quite complex and often involve an intermarriage of the charity's and the business corporation's interests. As an example, let's say the local McDonald's franchises decide to enter into a "sponsorship" arrangement with the ABC Opera Company. ABC Opera is planning an outdoor program for this summer, called ABC "Summer Opera in the Park". It approaches McDonald's for funding, and both of them develop the following arrangement: ABC Opera will place McDonald's banners near the stage, and it will undertake to associate McDonald's name with the "Opera in the Park" program, and use the McDonald's logo in its literature and advertising. The program will be referred to in all communications as "ABC McDonald's Summer Opera in the Park". McDonald's, on the other hand, provides a generous subsidy for the program, and undertakes to display ABC Opera's pamphlets in its outlets, and to sell tickets to the buyers of "Big Mac Meals" at half price. It also gets to advertise itself locally as "proud sponsor of ABC McDonald's Summer Opera in the Park".

55. To begin to understand the extent of this problem and possible solutions, we need to know the difference between a sponsorship and a gift at law. It is a settled matter that advertising or publicity on the one hand, and the concept of a gift or a donation on the other, are mutually exclusive concepts at law. In one case, Olympia Floor and Wall Tile Co. v. M.N.R.¹², a corporation gave a substantial amount to a charity, well above its donation limit. It claimed the full payment as a donation, up to the acceptable limit, and claimed the excess as an advertising expense. The Tax Court disallowed the portion of the deduction related to advertising, saying that one could not on the one hand claim that a payment was a donation, and then claim that it also had a publicity value for the company.

56. As we have noted a few times now, a gift is a voluntary transfer of property without consideration. The relevant part of the definition for our purposes is the last one: "without consideration". If a payor is getting something in return, normally the payment is not a gift. There are allowances for purely nominal considerations, for example, if the payment to the charity is significantly out of proportion with the consideration given to the payor. These would allow, for example, the name of the donating company to show up in a list of donors found inside a printed programme. But at the other extreme, the rules do not allow for extensive publicity or other benefits.

57. It is at least clear that a true sponsorship, like other quid pro quo arrangements, involves a benefit of some kind accruing to the sponsor. In the usual case it is publicity, which a sponsor is already entitled to claim as a deduction in the calculation of taxable income, and which it should not be claiming as a second deduction as a charitable donation. Sponsorships in this context are not gifts, nor should they give rise to a tax receipt. Moreover, even if it could be argued that a component of a larger business arrangement between a charity and a sponsor was in fact a gift, it would not be acceptable to the extent that its execution is tied to the larger arrangement. If a sponsor does decide to make a gift "on the side", it should not be tied in any way to the sponsorship.

58. The tax difference between a deduction for sponsorship as advertising, and a charitable tax deduction, is that the charitable tax deduction can be carried forward for a period of five years, while the sponsorship must usually be deducted within the fiscal year in which it was made.

What draws the tax man's attention?

59. It's important to say here that what triggers the Canada Revenue Agency's attention is not necessarily conspicuously devious behaviour. But in uncovering tax abuse, the Canada Revenue Agency recognizes that people usually behave in certain predictable ways that are consistent with their income and their overall lifestyle. We are also aware of the equation that results in tax abuse or abuse of charitable dollars: fraud = need + opportunity.

60. Moreover, it is obvious that the tax administration would normally be concerned about important leakage, as opposed to relatively smaller amounts. It's therefore natural that we tend to home in on indications of large gifts. This is not to say that we don't sweat the small stuff, but it usually gets handled in other ways - through random audits, through informants, or through our monitoring of fund-raising approaches. We tend to track the media. We often go on the Internet to look at fund-raising Web sites. We react to unusual patterns of giving or inconsistent reporting. We react to consistently large donations in relation to the taxpayer's income.

Conclusion - Overall Philosophy

61. In conclusion, I'd like to offer my personal attempt at expressing the Agency instinct. It has not found its way into official policy pronouncements but, subject to the proper application of the law, it is probably a good description of the "smell test". To sum it all up, a good guideline in determining whether the Canada Revenue Agency is concerned about a particular tax receipted transaction is:

Given the monies that are eventually applied to charitable programs and given the foregone revenues for the state, is the transaction under review intended primarily for the public good or does it result in a disproportionate benefit being given to a private individual?

Legislative Changes on the horizon

62. As you know, the February 2000 Federal Budget announced some legislative changes that affect charities. These deal with the reduction in the capital gains inclusion rates; gifts of stock option shares; charities as beneficiaries of life insurance policies; gifts of personal-use property to charities; and gifts of ecologically-sensitive land. Note that the proposed budget items are not law, and that it is accordingly difficult at this time to speculate as to detailed issues, or the possible content or outcomes of the legislation.

Capital Gains Inclusion Rates

63. When a donor gives appreciated capital property to a charity and claims a resulting tax credit or deduction, the donor must declare the capital gains resulting from the disposition of the property - subject to ss. 118.1(6), or ss. 110.1(3) of the Income Tax Act.

64. As you may already know, the February 2000 Budget reduced the taxable capital gains inclusion rate from 75% of capital gains, down to 66%. This will lead to a number of consequent amendments, one of which will deal with gifts of listed securities. Gifts of such securities made before February 28, 2000, will continue to be subject to a 3/8 (or 37.5%) inclusion rate. Gifts of such securities made after February 27, 2000, and before 2002, will have an inclusion rate of 1/3 (or 33.3%).

65. I have been queried about statistics concerning gifting public securities to charities and on whether the Canada Revenue Agency believes there are any issues that would prevent the Department of Finance from extending the preferential tax treatment past 2001. The question of whether the tax measure will be extended beyond 2001 is strictly a policy issue for the Department of Finance. The1997 Budget stated that the measure would be looked at after 5 years to determine whether it should be extended. While Finance has collected some raw data, they are not making this data public.

Gifts of stock-optioned shares

66. A stock option is the right to buy a designated stock, if the holder of the option so chooses, at any time within a specified period, at a determinable price. Such options are often granted to management and key employees of corporations as a form of incentive compensation.

67. Effective for publicly-listed shares or mutual fund units acquired after February 27, 2000 and before 2002, under stock options that are exercised and donated in the year of acquisition and not later than thirty days after the acquisition to a registered charity or other qualified donee, the Budget proposes to allow an individual to deduct an additional amount in calculating taxable income: When an individual disposes of capital property after February 27, 2000, the Budget proposes to reduce the inclusion rate for capital gains and capital losses from the current 75% to 66.6% - or two thirds. What happens in the case of an individual who exercises stock options is that, because of the subsequent and timely donation, the inclusion rate will be reduced by an additional third, and therefore will only result in 1/3 of the employment benefit being subject to tax¹³.

68. The fair market value (FMV) of the security in such a case is based on the lesser of

(a) its FMV at the time of acquisition, or

(b) its FMV at the time of the donation to the charity.

69. In order to qualify for the additional 1/3 deduction, the donation

(a) must meet the current rules for donations of publicly listed securities (i.e., not be a non-qualifying investment pursuant to s. 118.1 of the Income Tax Act);

(b) cannot be to a private foundation; and

(c) must be by an individual entitled to a deduction of amounts included in income in respect of shares acquired under employee stock options. An eligible employee deals at arm's length with the employer, and does not own 10% or more of the corporation's shares.

Death of donor, and charities designated as beneficiaries in Registered Retirement Savings Plans (RRSPs), Registered Retirement Investment Funds (RRIFs) or insurance policies

70. Currently, charitable donations made in an individual's will qualify for the charitable donations tax credit when the individual dies. However, a donation to a registered charity as a result of its being designated as a beneficiary under an RRSP, RRIF or insurance policy, do not qualify for the charitable donations tax credit.¹⁴

71. Effective for deaths after 1998, the Budget proposes to allow a charitable donation tax credit for a donation to a registered charity (or other qualified donee) of a direct distribution of proceeds to the charity from an RRSP (including a group RRSP), RRIF or insurance policy (including a group life insurance policy) as a consequence of beneficiary designation. This is distinct from the policy concession found in Interpretation Bulletin IT-244 where the recipient charity becomes the policyholder.

Capital gains and gifts of personal-use property to charities

72. You are undoubtedly acquainted with several fund-raising schemes involving donations of artworks to charities. While gifts of art are valid gifts and can legitimately result in a tax receipt and ensuing tax credit, we have lately been seeing a spate of promoters who entice donors to buy art at what is touted as a bargain price. The promoters then arrange to have the art evaluated, on the pretense that its true fair market value (FMV) is much higher than the bargain price paid by the donor.

73. The recipient charity, often identified by the promoter in advance, accordingly issues a receipt for the FMV of the donated art, and turns around and sells it. As a result, the donor walks away with a tax credit that is well above the price paid for the art.

74. While this type of tax-windfall does legitimately occur occasionally, what we typically find is that the charity only manages to sell the art at a fraction of the alleged FMV. The new purchaser of the art sometimes even turns out to be the original promoter; the donor never did get possession of the art in the first place. Sometimes the donor only buys a "share" in an unspecified artwork. This scheme is typically sold to donors as a way of getting a tax benefit rather than as a way of giving to charity. The art turns out to be a sham. One additional wrinkle on this scheme is that the artworks being flogged were deliberately valued under $1,000, thereby enjoying the exemption from capital gains tax for personal-use property of $1,000 or less.

75. The Income Tax Act has been amended so that this exemption for personal-use property will not apply if the property is being purchased as part of an arrangement for giving it to a charity.

76. This amendment may be only the beginning as far as gifts of art are concerned, and perhaps further legislative amendments will be needed to stop the deliberate exploitation of the tax system in this manner. Legislation being a rather blunt instrument, what may happen is that the baby gets thrown out with the bathwater. All charities should be fairly circumspect when receiving donated art that appears to be part of a promotional scheme.

77. The February 1999 Budget contained proposals to penalize those who knowingly overvalue tax receipts for gifts of art. This legislative amendment was passed as law on June 29^th of this year as part of Bill C-25. The proposed penalties will likely affect the donor, the promoters, the appraisers and the charity. We are currently seeking internal input to develop guidelines on the administration of the penalties.

Gifts of ecologically sensitive land

78. The issue of ecologically sensitive land applies mainly to charities whose purposes include the conservation and protection of the environment, although it may be of passing interest to Community Foundations as vehicles for gifts.

79. The February 2000 Budget proposed that effective for gifts of ecologically sensitive land made after February 27, 2000, the income inclusion rate on capital gains arising from such gifts will be reduced from 75% to 33 1/3%.

80. Donors will be required to file with their return of income for the year in which the gift was made, a certificate obtained from the Minister of the Environment determining the fair market value (FMV) of the gift for all purposes of the Income Tax Act relating to charitable gifts.

81. The valuation of such gifts will apply for a two-year period following the time of the last determination or re-determination. Donors will have the right to appeal a re-determination of FMV to the Tax Court of Canada.

Issues on the horizon (Memo to Cabinet)

82. As you know, the voluntary sector has been the object of closer scrutiny in recent years, and there have been on-going discussions between the Federal Government and voluntary sector representatives on a number of issues, not all of which touch on taxation.

83. In particular, before the last election, the Liberal Party announced in its "Red Book" that it was going to work more closely with the voluntary sector in ways that would enhance support for the sector. That commitment was reiterated in a subsequent Speech from the Throne. There were also a number of court decisions that called on a legislative reform of the regulatory system for charities. The Voluntary Sector Roundtable commissioned a panel, headed by Ed Broadbent, to report and make recommendations on improving governance and accountability in the voluntary sector. The Panel produced its final report in February 1999¹⁵, and during the spring and summer of 1999, voluntary sector representatives and government officials met to discuss some of the issues in what came to be called a "joint table process". There were in fact three joint tables, or sub-committees of the Joint Table: one dealing with regulatory issues; one dealing with capacity-building, and the other dealing with partnership between the sector and government. The Joint Table issued its own report in the fall of 1999¹⁶, and the 26 recommendations in it were reviewed by government officials and presented to Cabinet in December 1999. The February 2000 budget did not specifically allot funds to the recommendations flowing out of the Joint Table report, but in fact the funds in question were allocated under existing estimates. There is a respectable amount of money available, although not as much as originally requested. New joint tables have started work this fall pushing the policy issues forward to completion. An ad hoc committee of Ministers has been set up to oversee the process on the government side, and sector representatives met with these Ministers, and with government officials, in early April. The Government is committed to seeing this through and to working jointly toward positive solutions that reaffirm the voluntary sector's role in Canadian society. If everything goes well, you should start seeing positive results during the coming year.

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1. Cf. Canada Customs and Revenue Agency Act, 46-47-48 Eliz. II, c.17.
2. IT-110R3 - Gifts and Official Donation Receipts, Revenue Canada, Income Tax Interpretation Bulletin, June 20, 1997.
3. Non-qualifying securities. See ss. 118.1(13) I.T.A. and ff
4. For example, A capital gift of $100,000 to build a community centre, provided the construction begin before July, 2000; or a gift of $100,000 provided that the Foundation is able to raise an equivalent sum of money from other donors within a stated period of time.
5. An example of a condition subsequent is a gift made to a charity on the condition that the funds be used to operate a particular shelter for the homeless.
6. Misrepresentation of a Tax Matter by a Third Party. See ss. 163.2(10) I.T.A. on Valuations, tabled as law June 29, 2000. This provision applies civil penalties to third parties that make false statements or omissions in relation to tax matters. In particular, it is intended that the penalty apply to a person who plans, promotes or sells an arrangement that the person knows or would have known includes a false statement that could be used for tax purposes. The penalty would be the greater of $1,000 or 100% of the gross revenue derived by the person from the arrangement, and would apply to the promoter of an art donation scheme, the appraiser, and in some cases where the charity knew or ought to have known of the arrangement, to the charity itself.
7. Residual interest usually refers to a gift of land. No residual interest on chattels (personal property). Charitable remainder usually refers to the equitable interest in a trust. Equitable interest in a trust = interest of a beneficiary, as opposed to a trustee, who has a legal interest in a trust. The term "charitable remainder trust" is of foreign coinage, coming to us from the American fund-raising industry. It is found nowhere in the Income Tax Act or in departmental publications.
8. IT-226R, Gift to a Charity of a Residual Interest in Real Property or an Equitable Interest in a Trust, Revenue Canada Interpretation Bulletin, November 29, 1991.
9. Frank Minton, Planned Giving for Canadians, page 380.
10. Opinion, Valuation Services, Canada Revenue Agency, May 1998. This policy was designed to apply a position of neutrality in respect of market trends, so that we would not apply the highest price on a rising market or the lowest price on a falling market.
11. Receipt of things mailed. ss. 248(7)(a) I.T.A. "Anything (other than a remittance or payment described in paragraph (b)) sent by first class mail or its equivalent shall be deemed to have been received by the person to whom it was sent on the day it was mailed."
12. 21 D.T.C. 358.
13. There is some question as to whether the income inclusion rate resulting from the gift of shares to a charity is going to change - presumably from 37.5% to 33.3%. This was not mentioned in the Budget Analysis prepared for the Canada Revenue Agency, and s. 38(a) of the Income Tax Act does not refer to the inclusion rate as "half of the taxable capital gain", but rather as 3/8 of the capital gain.
14. Under IT-244R, "Gifts by individuals of life insurance policies as charitable donations," the life insurance policy must be absolutely assigned to the charity, and the charity must be the registered beneficiary of the policy. The value of the gift is equal to the cash surrender value of the policy at that time, less any policy loans outstanding. To the extent that the value of the gift exceeds its ACB, the resulting gain has to be included in income.
15. Building on Strength: Improving Governance and Accountability in Canada's Voluntary Sector, Panel on Accountability and Governance in the Voluntary Sector, February 1999, 126 p.
16. Working Together: A Government of Canada/Voluntary Sector Joint Initiative, September 1999.