Budget targets donation of flow through shares
Over the past number of years, Canadians who wished to donate significant amounts to charity have been turning to flow-through shares as a means of funding their charitable giving at minimal cost.
Flow-through shares are essentially shares issued by oil and gas, mining and renewable energy companies that renounce or "flow-through" their exploration, development and project start-up expenses to investors, who can deduct these expenses personally on their own tax returns.
For tax purposes, flow-through shares are treated as having a tax cost or adjusted cost base (ACB) of zero for the purpose of calculating any capital gain or loss from their ultimate disposition.
As a result, if an investor sells her flow through shares, the full amount of the proceeds received becomes a capital gain. This essentially represents a partial recovery of the tax benefit provided by the government resulting from the deduction for the original tax cost of the shares, rather than a true economic gain resulting from an appreciation in the shares' value.
In a move that would preserve $185 million of foregone tax revenue over the next five years, the government proposed changing the rules to allow the exemption from capital gains tax on donations of flow through shares only to the extent that a flow through investor's capital gain exceeds the amount paid for the shares, ignoring the deemed zero ACB of the flow through shares.
But the minority Conservative government's budget was quickly rejected, and its offerings back on the table, by its political opponents for falling short in helping the middle class, setting the stage for an election campaign that could begin any day.
Under the existing rules, an investor can decide to donate the flow through shares in-kind to a registered charity instead of selling them, the capital gain that would have arisen from a sale of the shares is completely tax-free. According to the government, this special exemption from capital gains tax on the donation of publicly listed securities allows donors "to avoid this second stage of the normal flow-through share rules."
To date, the Canada Revenue Agency has issued several favourable advance tax rulings on the legitimacy of such schemes, dating back to 2007, when the elimination of the capital gains tax on the donation of publicly traded shares to registered charities was introduced.
So, how good was it?
Let's say Jonathan, a top marginal rate Ontario taxpayer, purchases $10,000 of flow-through shares for which he gets a 100% tax deduction. This would save him about $4,600 at Ontario's top marginal rate of 46%, costing him only $5,400 for the shares. His ACB would be ground down to zero from $10,000.
Assuming, once the exploration is complete and the shares are marketable, they are still worth $10,000. Jonathan decides to donate them to a registered charity and gets a tax receipt for $10,000, worth 46%, for another $4,600 in tax savings. His capital gains tax was eliminated since he donated the shares to charity.
So, in total, for a cost of only $800 ($5,400 cost of the shares less the $4,600 donation tax credit), Jonathan has made a donation of $10,000 to charity.
In recent years, several promoters have packaged up these deals, registering them as tax shelters. Some have involved "liquidity providers" that would step in and provide instant cash to charities without the donor having to wait the typical 24 month holding period before selling the flow through investment.
So, following from the example above, if Jonathan were to buy $10,000 of flow through shares issued today, his cost would still be $5,400, allowing for the flow through deduction at 46%. Upon donation, his receipt would still be worth $4,600 (46% of $10,000), but his capital gains tax would be $2,300 (50% x 46% X $10,000) increasing the total cost of his donation to $3,100.