What does an entrepreneur need to know about making a charitable donation?

Gifts of Private Companies and Real Estate

Entrepreneurs create much wealth in Canada with their businesses and real estate holdings. These dedicated owners are often also very committed to charitable giving.  They seek to pass on their community, not diminished, but better than it was passed on to them.

However, it is challenging to make gifts from their wealth.  Company shares and real estate holdings are often illiquid.

Yet, with careful planning, significant gifts can be made now.  There are also new gifting opportunities coming in 2017.

Consider an example of Daniel and Helen – two successful siblings.  Daniel grew a family business; and Helen assembled a real estate portfolio.   Daniel wishes to create an ongoing endowment to fight poverty issues.  Helen wishes to help a youth community centre.

Daniel’s current gift

Daniel has a challenge.  Complex rules apply to gifts of private company shares.

The default tax rule prohibits a charity from issuing Daniel a tax receipt (to reduce his taxes) unless the charity sells the gifted shares within five years of the donation.

Fortunately, there is an “exempted gift” rule.  The five year sale period is avoided if the shares are gifted to an “arm’s length” public charity such as Daniel‘s community foundation.

The foundation can hold the gift in perpetuity and produce an annual income.  Daniel can advise about distribution of the income to his preferred charities.

However, without further planning, the foundation would have valuable shares but no easy way to produce an income for the annual gifting.

Instead of giving his current shares, Daniel could reorganize to create and donate new preferred shares with a fixed value.  These shares could then be repurchased from the foundation by the company in yearly installments to create a cash flow.

Each repurchase would usually be taxed as a dividend, but the foundation can receive it tax free.  Each repurchase may also allow Daniel’s company to claim a refund of some pre-paid taxes (amounts that may have been collected from past company earnings). The refund may be up to 1/3rd of the repurchase amount.

This gift plan is just one of the options available to Daniel.  In the right circumstances, it reduces taxes now and creates an ongoing annual refund.  It gives the foundation a secure gift and cash flow for the annual income.  Most importantly, Daniel will fulfill his wish to make his community better.

Daniel’s future gift

In the future, Daniel’s long-term plan may be to pass his business on to the next generation, but it might also be sold.  After 2017, in a sale situation, new tax rules may give Daniel extra savings by eliminating the tax on the capital gain in his shares – somewhat like the current rules for gifts of publicly-listed shares.  However, the proposed rules are more restricted.  Still, if Daniel thinks he might sell and also continue his philanthropy, then it is important that he be aware of this option now – as he prepares his company for that possibility.

Helen’s current gift

Helen has learned that the youth centre is searching for a new permanent location.  One of the properties that Helen has held in her portfolio for many years is well-suited to their needs. However, Helen cannot afford yet to gift the full value of the property.

Helen can arrange a “bargain sale.”  The youth centre society will pay up to 80% of the appraised value.  Helen will receive a tax receipt for the difference between the amount paid and the appraised value. The sale proceeds and the tax savings from the receipt will more than offset any taxes triggered by the sale.

Helen’s future gift

The new rules in 2017 may also benefit Helen.  The capital gains taxes that would be triggered by a sale of real estate may be reduced to the extent that Helen gifts proceeds of the sale to a charity within 30 days of the sale.  Again, the proposed rules have complexities, but Helen may want to keep them in mind for future planning.

Entrepreneurs are a driving force in our community.  With careful planning, they can share their success and pass along our community even greater than it was passed on to us.

The 21 Year Deemed Disposition Rule

If you set up a trust as part of your estate plan, one date you don’t want to forget is the 21st anniversary of the trust. This is because in most cases, a trust is deemed to dispose of its assets for fair market value on the 21st anniversary of the creation of the trust, and every 21 years thereafter (there are some modifications to the rule for certain trusts such as spousal trusts, alter-ego trusts and joint partner trusts). If the 21st anniversary of the trust passes without proper planning, the trust may have a significant tax liability with respect to assets that have increased in value in the 21 year period. There are ways to reduce the impact of this deeming rule, but the appropriate strategy will depend on a number of factors, including:

  • Nature of trust property. The impact of the deemed disposition rule will depend on the nature of the property held in the trust. Not all assets are subject to the deemed disposition rule, and some assets (for example, shares of a private company) may require more complex planning.
  • Value of Assets. If the assets subject to the deemed disposition rule have little value, or have not significantly increased in value since they were purchased, the tax consequences of the deemed disposition will be minimal.
  • Beneficiaries of the Trust. In some cases, it may be possible to avoid the deemed disposition by distributing trust assets to beneficiaries prior to the 21st anniversary. Subject to some exceptions, this can be done on a tax-deferred basis if the beneficiaries are resident in Canada. In cases where it’s not appropriate to distribute assets to beneficiaries (due to their age, health, or other reasons), or if all beneficiaries are living outside of Canada, planning around the deemed disposition rule may be more challenging.
  • Purpose of the Trust. If the trust was created for a purpose that is no longer relevant, it may make sense to avoid the deemed disposition rule by distributing the trust property and terminating the trust prior to the 21st anniversary. In other cases, a distribution of trust property or termination of the trust may be inconsistent with estate planning objectives.
  • Terms of the Trust. Some trust deeds may not be flexible enough to accommodate the required planning. In these situations, it may be necessary to consider amending or varying the terms of the trust in addition to any planning that is done in connection with the deemed disposition rule. There are various ways to effect a variation depending on the circumstances, some of which require a court application. Any tax consequences of the variation itself must also be considered.

It’s important to begin planning well in advance of the trust’s 21st anniversary as it may take time to implement the appropriate strategy.

Court allows disinheritance of estranged children

The recent decision of Kong v. Kong confirms (and not for the first time) that in some circumstances the court will support the decision of a parent to exclude an adult child from their will entirely, and deny a claim under BC wills variation legislation. In this case the court disallowed the claims of two disinherited sons, and allowed two others only a 5% share of the estate.

A few observations from this case:

  • Hostile conduct by the child and failing to accept reconciliation when offered can negate the parent’s moral duty to the child.

In this case the evidence showed that one of the sons who was excluded from the father’s will treated his parents harshly in relation to a sale of a residence that they shared; the same son later made strong allegations about the father in the context of a legal dispute over their mother’s estate. These actions angered and offended the father. Nevertheless, the father reached out in his final days and asked the son to visit him in the hospital. The son refused the invitation. The court found that this behavior negated any moral obligation the father may have had to the son.

  • Even where a variation is allowed, the will-maker’s wishes remain influential.

Sometimes people wonder whether leaving a modest gift to an estranged child is more likely to preclude a successful wills variation claim than leaving nothing to the same child. However, in this case the court said that the will-maker’s clear intent to leave everything to one child meant that in the two instances where it allowed variation, the variation ought to be minor.

  • In considering whether a will-maker’s reasons for disinheriting were valid and rational, the court will consider all of the circumstances, not just direct statements made by the deceased.

The claimants tried to argue that evidence of their actions in respect of the father, including in the context of the prior family litigation, should be excluded. They wanted the court to consider whether the father’s decision was “valid and rational” only on the basis of the evidence of what the father had said to his lawyer. The court rejected this approach, stating:

The implication of the plaintiffs’ position in this case would be to limit the court’s analysis to the testator’s expressed, and therefore subjective reasons, rather than making an objective inquiry into the reasons for disinheriting grown children with reference, as necessary, to community standards. In my view the plaintiffs’ approach amounts to excluding important evidence about the testator’s relationship with his grown children.