Donation of Flow-Through Shares

Many Tax Alert readers probably have heard or read something about a plan to reduce dramatically the after-tax cost of donations by using flow-through shares.

The plan involves a donor wishing to make a sizeable donation first purchasing shares listed on an exchange that are "flow-through shares" as defined in subsection 66(15) of the Income Tax Act (the Act) pursuant to a subscription agreement with the corporate issuer. The donor immediately donates these shares to the desired charity, and the charity then immediately sells the donated shares to a pre-arranged third-party buyer. By proceeding in this way, the donor is able to deduct Canadian Exploration Expenses (CEE) renounced in respect of the flow-through shares, and claim investment tax credits and charitable tax credits or deductions. All of this, combined with the elimination of income tax on capital gains from gifts of public company shares, results in a significant reduction in the cost of an intended donation.

For example, the after-tax cost to an individual donor, resident in the Province of Ontario, making such a donation would be less than 21% of the cash received by the charity. The net after-tax cost of the cash paid by a corporate donor would be about 13%.  Put another way, an individual donor wishing to gift $100,000 to a charity will have reduced the after-tax cost of that gift from approximately $53,600 to approximately $20,600. If provincial tax credits are available the cost may be reduced even further.

Recently, the Canada Revenue Agency (CRA) issued an advanced tax ruling regarding this planning strategy. In general terms, the CRA ruled as follows:

• The arrangement is a gifting arrangement pursuant to paragraph (a) of the definition of "gifting arrangement," and is a tax shelter pursuant to paragraph (b) of the definition of "tax shelter" in subsection 237.1(1) of the Act.
• The donation of the flow-through shares to a charity by the donor will not prohibit the donor from deducting the CEE renounced prior to the donation in computing the donor's income, or deducting any investment tax credit the donor would otherwise be entitled to deduct pursuant to subsection 127(5) of the Act in computing the donor's tax otherwise payable.
• Assuming the parties deal at arm's length, the donation of the shares to the charity will not cause the shares to be prescribed shares thereby disqualifying them as flow-through shares.
• An amount equal to the fair market value on the day of donation of the shares donated by an individual donor to the charity will qualify as a gift for the purposes of the definition of "total charitable gifts" in subsection 118.1(1) of the Act.
• An amount equal to the fair market value of the donation of the shares donated by each corporate donor to each charity will qualify as a gift under paragraph 110.1(1)(a) of the Act.
• If the shares are capital property to a donor, no portion of the capital gain arising from the gifting of the shares will be included in computing the donor's taxable capital gain.
• If the shares would otherwise be considered capital property to the donor, participation in the arrangement, in and of itself, will not result in the shares not being considered capital property to the donor.
• Any CEE and investment tax credit renounced to the donors will not constitute an "advantage" under proposed subsection 248(32) under Bill C-10, so there will be no restriction on the charitable tax credit or deduction.

The CRA did not rule on the fair market value of the gifted shares, whether the parties dealt at arm's length with each other, whether the shares were flow-through shares, whether any of the expenses renounced by the issuer to a donor would qualify as either CEE or as flow-through money expenditure, or whether the property held by the donor was on income or capital account.

Now that the CRA has effectively blessed this planning, individuals and corporations contemplating significant donations should consider seriously using this plan either to reduce the cost of the donation or to increase greatly the amount the intended charity will receive. As always, you should consult with your Collins Barrow advisor before implementing such planning.

This article was contributed by Philip Friedlan, LL.B, MBA, Friedlan Law, Toronto/Markham, Ontario. Philip practices taxation law and estate planning and has specific knowledge of this planning strategy and this ruling.