(July 2006) The Conservatives kept their pre-election promise to encourage the donation of publicly traded securities (including mutual funds and segregated funds) to charity by completely eliminating tax on any capital gains made as a result of a donation charity.
This change opens up enormous opportunities for you to broach the topic of philanthropy with your clients in a way that can provide significant benefits to the client, the advisor and, most importantly, of course, the charity.
Almost 10 years ago, the government introduced increased tax assistance for donations of publicly traded securities to charities. Under the old (pre-Budget) rules, if an individual transferred qualifying securities, only 25% was to be included in that person’s income, instead of the usual 50%, of any capital gains derived from the sale of those securities.
To encourage additional donations of publicly traded listed securities to charities and public foundations, the budget proposes to completely eliminate all capital gains taxes payable on donations of these securities to charities by reducing the inclusion rate to zero capital gains on such donations.
Although there was speculation that this donation rule would be retroactive to January 1, 2006, the federal government announced that these new rules would only apply to donations of qualifying securities made on or after May 2, 2006.
Donation tax relief
Before we dive into this new opportunity in detail, let’s take a quick look at how the basic donation rules work.
Donations to a registered charity in Canada are eligible for gift tax relief. For the first $200 in donations made by an individual in a given year, the 2006 federal gift credit is 15.25% of the amount donated. (This credit increases to 15.5% for 2007 and beyond, as announced in the last federal budget.)
Each province also provides a provincial gift tax credit. For example, Ontario’s provincial credit is an additional 6.05%, bringing the total credit to approximately 22%. In other words, Ontarians would be eligible for a refund of about $44 of the first $200 of annual donations.
It’s even better. If you make donations of $200 or more in any year, your donation amount increases to 29% at the federal level and 11% to 18% at the provincial level, depending on your tax bracket and whether you are subject to high-income surtaxes in your province.
So for donations exceeding the first $200, you will receive a refund of at least 40% of the amount donated. Given that donations come in the form of tax credits (a credit means reducing the tax you pay) as opposed to tax deductions (reducing your taxable income), the credits are essentially of the same value to low-, middle- and high-income earners (ignoring the impact of any additional taxes at the level of high-income provinces).
Case study
To understand the impact of the new rule, assume that one of your clients, Mark, currently owns mutual funds with a fair market value of $100,000 that he purchased many years ago for $20,000 (see chart below). He is considering donating these funds to charity.
If he had simply sold the mutual funds first, he would have made a capital gain of $80,000 and paid taxes on that gain of about $18,000, assuming a top marginal rate of about 45%. His net benefit, taking into account the value of the gift less capital gains taxes, will be approximately $27,000 (column A).
Under current rules (pre-Budget), had he donated his mutual fund units directly to charity rather than disposing of them first, his $18,000 capital gains tax would have been halved, resulting in a net tax benefit of $36,000 ( column B). .
Under the new rules, since capital gains tax would be completely eliminated when donating mutual funds to charity and Mark would still be entitled to a full tax bill for the $100,000 contributed, his net benefit would be $45,000 (column C)) .
It should be noted that although the new rules are proposed to apply to donations made on or after 2 May 2006, at the time of writing they have not yet come into force as they have yet to be passed by Parliament and the minority government. However, it would be highly unlikely (and extremely unpopular) for either party to oppose the adoption of these new rules.
What happens if you and your client want to continue owning this high-performing mutual fund? No problem. Simply advise your client to redeem the fund just donated.
This way, your client will not only receive a gift credit, but will not pay capital gains tax on the disposition, and their adjusted cost basis will be “raised” or “reset” to the current fair market value, limiting any future capital gains tax on their final sale for subsequent increase in value.
This article originally appeared on Advisor’s Edge. Jamie Golombek, CA, CPA, CFP, CLU, TEP, is vice president of tax and estate planning at AIM Trimark Investments in Toronto. He can be reached at jamie.golombek@aimtrimark.com.
(25/07/06)
