Articles & Cases
Are Canadian flow-through share donation schemes 'Kleptophilanthropy'?
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May 09, 2008
by Mark Blumberg (May 9, 2008)
The voluntary sector is a vital part of Canadian society and economy. All levels of government directly or indirectly subsidize the voluntary sector out of an appreciation of the importance of the work done by non-profits and charities. There are more than 160,000 non-profits, and about half of such non-profits are registered with the Charities Directorate of the Canada Revenue Agency as registered charities. One of the major differences between being a non-profit and having registered charity status is that a registered charity can issue official donation receipts that allow donors to claim a credit on their donation and in many cases save substantially on taxes.
The common illustration given in Ontario is that if you donate $10,000 to a registered charity you get an official donation receipt for $10,000, and when you file your taxes if you are in the top marginal tax rate you will save about $4,600 in taxes.
The tax deduction in tax public policy is considered a 'tax expenditure'. The government is forgoing tax revenue by providing an exclusion, deduction or credit in order to promote something that the government considers important, namely in this case support for certain parts of the voluntary sector. Depending on the individuals circumstances if an individual is donating funds to a charity the individual is contributing 56% and the government 44%. That is in argued to be a fair deal for government. In a sense it is a partnership in which the donor and government each contribute.
The special status accorded registered Canadian charities has been abused by some. Here are a few types of 'donors' and their 'promoter' friends who one can argue are not contributing to the charitable sector.
1) The Simple fraud - a fraudulent tax receipt is 'issued' by a tax preparer or someone else without there being any donation to a charity. This 'simple' scheme is particularly popular around April and before the deadline for filing donations. The donor fraudulently receives a tax benefit as he or she knows that he or she never made such donation. The tax preparer receives compensation. The charity receives nothing. Other taxpayers and the government suffer from the fraud and resultant loss of tax revenue.
2) The Complicated Tax Evasion Scheme - comes with a 50 page letter from a lawyer saying that maybe (yes maybe) you can donate $10,000 and magically through a whole series of complicated transactions (including signing a confidentiality agreement) you get a $50,000 donation receipt. In these schemes, the investor/'donor' is actually making more money from the donation than it is costing him or her. This is not a donation, and the only thing that is certain is that the investor/'donor' will be audited by the CRA. The CRA has repeatedly promised to audit these schemes, and I understand that this year they will be auditing about 147,000 taxpayers who were involved with such schemes. Investors are looking in some cases at a disallowance of the cash part of the transaction, a disallowance of their receipt plus interest, penalties and substantial legal fees - that is how the $10,000 cash 'gift' becomes a $100,000 multi-year headache for a taxpayer. These schemes are costing about $1.4 billion per year based on $3.4 billion worth of questionable receipts according to the Toronto Star. In a recent speech by the Director-General of CRA he mentioned that the total value of the receipts being audited was $4.7 billion, so even higher than what the Toronto Star had reported last year. You do not need much of an imagination to think of ways that the federal and provincial governments could make Canada a better place if they invested $2 billion more per year.
It seems that a small but determined group are selling products under the guise that they are philanthropic or charitable while having little real interest in charity or philanthropy. They are interested in taking as much as they can - whether it is from charities, other taxpayers including small business, the Department of Finance, etc. This sort of rampant looting of the tax system reminds me of a kleptocracy.
Wikipedia defines kleptocracy as:
A kleptocracy (sometimes cleptocracy) (root: klepto+kratein = rule by thieves) is a term applied to a government that extends the personal wealth and political power of government officials and the ruling class (collectively, kleptocrats) at the expense of the population. A kleptocratic government often goes beyond merely awarding the prime contracts and civil service posts to friends (a common feature of corrupt governments). They also create projects and programs at a policy level which serve the primary purpose of funneling money out of the treasury and into the pockets of the executive with little if any regard for the logic, viability or necessity of those projects.
I think in the charitable area the abusive structures promoted by some financial planners or other professional advisors should be referred to as 'kleptophilanthropy'. In other words, under the guise of doing something for a charitable or philanthropic purpose or entity, the promoters are in fact stealing from the treasury, the donor/investor, the population and the charities as a whole.
There has over the last few years seen the emergence of another beast in the charity area - the scheme that combines the tax benefits of flow-through shares with the tax benefits of donations to registered charities into a packaged transaction that costs the donor either little or in fact the donor may, according to the claims by promoters, actually make money from the -'donation'.
Over the last eleven years, the Canadian government has given enhanced tax incentives, for example by allowing donations of marketable securities without the donor having to pay any tax on the donation as the capital gains inclusion rate is reduced to zero. Donors who have significant appreciation in their public company shares have been able to donate them to charity and the actual cost to the donor is only 35 or 40 cents with the government contributing 60 or so cents per dollar. Although this has cost government even more funds to raise a dollar, and it has disproportionately benefitted wealthy donors with substantial holding of public company shares, most would say that this has been a positive development and it has resulted in greater funding of the charitable sector.
It seems that some promoters and 'donors' are not satisfied that their 'donations' actually cost them money at all. The packaged flow-through share donation transaction - this greedy 'donor'/investor is not satisfied to receive either a donation tax credit or the benefit of flow-through shares, but instead through a packaged transaction wants to receive both. By buying flow-through shares, combined with a donation tax receipt, the actual cost to the 'donor' of the 'gift' may only be 5-10 cents on a dollar, and they may actually make money off the scheme if combine the donation with the use of a private corporations and its capital dividend account. I will let other opine as to whether this legal. There is no question in my mind that it abuses the tax system, undermines the charitable sector and maybe disastrous for some charities. By the way, the packaged transaction is not the same as a person who bought flow-through shares five years ago and decides to donate those shares to a charity which is arguably less offensive from a public policy point of view. The intent of the latter is different from someone who is motivated by the combining of the two incentives at once.
As one entity explains:
"In Ontario, a donating investor would actually be ahead (i.e., in the money) by 2 cents on the dollar and, in some provinces, an investor would be ahead 4
cents on the dollar. On the other hand, donating cash means that an investor is typically �behind� 50 cents on the dollar. Put another way, it costs an investor real money to donate cash, whereas an investor can actually make a little money by donating [Name of scheme removed] super flow-through rollover investments."
There have been a few articles on flow-through shares recently, and they have raised various types of concerns with the donation of flow-through shares. You may wish to see “Donation Tax Shelters involving Flow-through Shares” by Theresa L.M. Man, Karen J. Cooper, and Terrance S. Carter. As well Susan Manwaring “Charitable Donations and Flow-through Shares”.
Some of the many potential concerns that have been raised with the acceptance of flow-through shares by charities include:
1) Determining the correct amount for the donation receipt. If the donation receipt is incorrect the charity may have its charitable status revoked, or there could be substantial penalties for the charity. There are a number of complexities relating to valuation of shares. For example, if there is a hold period or other restrictions, the amount of the donation receipt needs to be reduced accordingly. If the donor has obtained an "advantage" because of the packaging of this transaction the donation receipt needs to be reduced.
2) Disbursement quota issues. Some charities may have disbursement quota problems if they receipt the donation and the shares for whatever reason cannot be sold, or the amount is inflated and the charity cannot spend the funds on charitable activities in the following year.
3) Hold periods. Some flow-through shares have a hold period, which can create problems for a charity - are flow-through shares appropriate and prudent investments for a charity? Obtaining a legal opinion will be of little consolation if when you sell the shares you get substantially less than the amount of the receipt.
4) Tax Shelter Identification. Is the flow-through arrangement registered with the CRA as a tax shelter? If so, this does not mean that the CRA approves of the shelter. Tax shelter identification just assists the CRA if they decide to audit a tax shelter to easily compile a list of audit targets.
5) Promoters. Charities, if they are not careful, could be considered 'promoters' of the tax shelter with all the attendant liability that it entails.
6) Legal Opinions. Donors should be concerned when in order to be �comfortable� with a donation you need to see 2 or 3 legal opinions. As well be wary of relying on self-serving legal opinions with respect to the donation of flow-through shares to charity unless you have obtained your own legal opinion that is consistent with the facts on hand, and there is no equivocation on the part of the lawyer or law firm as to all of the issues. Equivocation in this case can result in the charity losing its status or substantial fines. The history of tax litigators, either guessing what the CRA will do with respect to what they consider abusive tax schemes, or knowing what the courts will decide, is not great. The best that can be said of packaged flow-through share gifting arrangements is that the tax benefits have not yet been determined by the courts.
7) Civil Penalties. There may be various types of penalties for professional advisors, planners, charities, and employees of the charity involved with such schemes.
8) Reputational issues. A charity�s reputation is usually its biggest asset. Each charity needs to carefully consider how the acceptance of a type of gift or a gift from a particular donor with strings attached affects the reputation of the charity.
Because of the seriousness of the policy issues associated with the donation of packaged flow-through share donation arrangements, I would argue that no charity officer should accept these gifts without thorough review of the gift AND unless the board of the organization has by written resolution explicitly agreed to do so or the gift acceptance policy of the charity explicitly accepts this exact vehicle.
Boards are generally supposed to deal with big policy issues. What can be more of a policy issue than involvement with a gifting vehicle resulting in the loss of your tax status or, just as bad, the loss of your charity�s reputation? Terminating the employment of your major gift officer or planned giving officer, who arranged the 'gift' under duress from the management of the charity and the promoters, is not going to insulate the charity from liability. As an aside, charities should make sure they have a gift acceptance policy.
I think that these donation flow-through schemes are also 'kleptophilanthropy'. In other words, under the guise of doing something for a charitable or philanthropic purpose or entity, the promoters are in fact stealing from the Department of Finance, the donor/investor, the population and the charities as a whole.
You might say how are they stealing from the donor/investor? Well, these schemes assure the donor/investor that they are legal. That is anything but clear - and only one thing is clear - that many of the investors will be having a much closer relationship with the CRA than they might have hoped for over the next five to ten years.
Flow-through share donation schemes, if "legal", need to be shutdown by the Canadian government. Specifically, the Ministry of Finance needs to act. They should not allow a donor to receive both the benefit of the flow-through provisions and the donation of marketable securities provisions (plus in some other cases other donations). Just like regular Canadian who clip coupons that say 'this offer cannot be combined with any other offers' should apply to packaged flow-through share transactions. This promises to be a multi-billion dollar disaster.
Why should Canadians care whether a taxpayer/investor donates to their favourite charity and it does not cost them anything? After all with the flow-through shares at least the charity is actually getting money which is not the case with some scams.
If legal, this type of 'gift' devalues philanthropy. It devalues the gifts that most Canadians make. After all, it makes the average Canadian who only may save 46 cents on the dollar seem like an idiot and a dupe for not being involved in one of these packaged transactions when they "can" save 95% or even make some money off the 'donation'. It wastes a lot of time and resources of charities and places a lot of stress on them to worry about whether it is acceptable to issue a receipt for such a donation. It puts charities in a potentially precarious situation in that the Charities Directorate may in a few years question receipts relating to these flow-through shares.
It undercuts the ability of government to raise taxes, which undercuts some of the very important charities that receive substantial government funding for education, health, international development and social services. We may or may not be heading into a recession. If government revenues fall in order to maintain promises of maintaining a balanced budget some governments may again slash certain programs like education, health, foreign aid, and the social safety net. Every billion dollars in less tax revenues may result in an additional billion dollars in cuts. These schemes undercuts other honest taxpayers who will ultimately have to contribute more to the tax pie or who will receive less from their government.
One of the reasons I wrote this article is that I had the opportunity to recently attend a charity conference in which a number of charity representatives privately talked to me about the pressure and threats that they have received from promoters of certain schemes to accept the particular scheme. These charity representatives are not prepared to go public with these matters, as they are not interested in losing their jobs or alienating people from the charity and the work that it does. I guess when a promoter stands to make 10 - 20% (in some cases much more) in a commission on the sale of these products there can be a lot of pressure. Making $1 - 2 million on the donation, I mean sale, of $10 million is very appealing to the promoters, if not to others.
Some academics have argued that the system of charities issuing tax receipts should be abolished and if people wish to donate to charity they should be able to do so without any hindrance or support from the government. After all most studies show that tax savings are far down the list as to the motivations as to why people donate to charity. If these schemes are allowed to proliferate then there may be more calls to reduce tax incentives for charities, not increase them. Some will argue why not cut out the middle man who is taking 10-20%. Let the government raise the funds and directly provide it to the charities or government programs that are providing health care, helping the homeless, educating our children, providing a social safety net, supporting our troops, helping those suffering from famine etc..
If something seems too good to be true, in charity, just like in life, it is probably too "good" to be true. If you want to benefit the charitable sector take a pass on schemes and instead try volunteering or making a real donation. If you really want to save some extra taxes, look at your stocks that have appreciated considerably and consider donating them instead of cash. But, please do not call these abusive schemes a "donation" or "philanthropy".
Mark Blumberg is a lawyer at Blumberg Segal LLP in Toronto, Ontario. He can be contacted at mark@blumbergs.ca or at 416-361-1982 x. 237. To find out more about legal services that Blumbergs provides to Canadian charities and non-profits please visit the Blumbergs' Non-Profit and Charities page at www.blumbergs.ca/non_profit.php
or www.globalphilanthropy.ca
This opinions expressed in this article are those of the author and is for information purposes only. It is not intended to be legal advice. You should not act or abstain from acting based upon such information.