17 January 2000 Internal T.I. 2000-M020417 - GIFT PLANNER SYMPOSIUM Q&A

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Round Table questions relating to various charitable gifting issues. Please refer to document

Position: Please refer to document

Reasons: Please refer to document

Gift Planning Symposium - Round Table Questions & Answers (September 1999)

Q1. Can you provide any guidance as to what mortality tables and discount rate should be used when valuing residual interests?

A1. The Department does not advocate a specific mortality table or discount rate in valuing residual interests in real property or equitable interests in trusts. What matters is that the values determined by donors and recipients are reasonable having regard to all the facts. IT-226R provides some assistance by indicating some considerations that would be relevant in making such a valuation. However, it is the Department's view that considerations unique to the property gifted, to particular life tenants, and to market factors should be reflected in the valuation of residual interests, and therefore, that such valuations should not be constrained by the Department adopting preferred mortality tables and discount rates.

Q2. Interpretation Bulletin IT-226R indicates that when a settlor transfers appreciated property to a trust and the settlor is the income beneficiary, that the settlor recognizes only the capital gain attributable to the residual interest. (He is disposing of the residual interest and retaining the income interest). Others have suggested that the settlor should recognize all of the capital gain when the trust is created. Do you have any comments on this issue?

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A2. The opening statement in the question, that is, that IT-226R provides for recognition only of the capital gain attributable to the residual interest when a settlor transfers appreciated property to a trust of which the settlor is an income beneficiary, is not correct. Personal property cannot be severed into life and remainder interests. That is why trusts are used to gift residual interests in personal property - the life interest is severed from the residue by creating beneficial interests in both the charity and the settlor. To effect this severance, it is necessary for the settlor to legally dispose of the entire property to the trust. The language of IT-226R does not provide for any derogation from this legal necessity.

It is true that, in the past, the Department had an administrative position in place which allowed a settlor to realize only the capital gains attributable to the portion of the property transferred to a trust that would not benefit the settlor. This position was originally established in the Department's reply to Question #33 of the 1988 CTF Round Table. However, the reply to that Question was formally withdrawn by the Department in the 1996 Technical News #7. The Department's current view is that there is a disposition at FMV of the whole property transferred to a trust, even where the settlor takes back an income interest in the trust.

Subsection 118.1(6) of the Act provides rules relating to gifts of capital property, allowing for an elected amount, not greater than the fair market value and not less than the adjusted cost base of the property, to be considered as both the proceeds of disposition of the property and the amount of the gift. This enables the donor to make the gift without realizing any capital gains.

Where a gift is made of an equitable interest in a trust, the gift is different from the property transferred to the trust. Paragraph 8 of IT-226R allows a taxpayer to make the election in subsection 118.1(6) in respect of the property transferred to the trust, as opposed to the gift of the interest in the trust itself. In absence of this administrative policy, the settlor of the trust would have to recognize all of the capital gains accrued in respect of any property contributed to the trust.

The administrative policy in IT-226R is presently under view, as it does not reflect the actual wording of subsection 118.1(6). Pending the completion of this review, donors who gift remainder interests in charitable trusts are entitled to rely on the current wording of the IT.

Q3. When listed securities are given outright to a charity, only 37.5% of the gain is taxable. When they are transferred to a trust where the residual interest is irrevocably given to charity, is 37.5% or 75% taxable?

A3. Paragraph 38(a.1) of the Act provides for a reduced inclusion rate of 37.5% in respect of gains realized on certain types of property disposed of to qualified donees. A gift of listed securities to a charity would generally qualify for the reduced inclusion rate in that paragraph.

However, in the circumstances described, the taxpayer would be disposing of the listed securities to a trust, which is not a qualified donee for this purpose. The gift to the charity is the residual interest in the trust. A trust interest is not a property that would otherwise be subject to the reduced inclusion rate.

Thus, the gains realized on transferring the listed securities to the trust would be subject to the full inclusion rate of 75%.

Q4. If a foundation receives a contribution for a charitable gift annuity and then covers its payment obligation by using a portion of the contribution to purchase an annuity from an insurance company, is the foundation considered to be incurring a debt?

A4. Yes. Paragraph 2 of IT-111R2 states that "A charitable foundation, as defined in that subsection, should not enter into any arrangements to issue annuities. The registration of a charitable foundation may be revoked if the foundation has, at any time since June 1, 1950, incurred debts other than certain debts described in subsection 149.1(3) and (4). An undertaking to make annuity payments is considered to be a debt incurred by the charity which, in the case of a charitable foundation, is cause for the revocation of its registration."

Q5. Suppose a charity invests its endowment in a portfolio of 50-60% equities and the balance in bonds and cash, and the total return (interest, dividends and gain) is 10%. However, interest and dividends alone are only 4%. The charity would like to spend each year 5% of the fair market value of the endowment, but to do so it would have to spend not just interest and dividends but also some realized gains. The question is whether spending anything other than interest and dividends would be a distribution of capital and thus would subject the gift to the 80% disbursement requirement, which would mean that an endowment could not be maintained.

A5. We are of the view that realized gains could not be distributed within the parameters of the 10-year trust exception to the 80% disbursement requirement. This exception excludes from the disbursement quota property that must be held for 10 years or more under a trust or other direction. Property substituted for such excluded property is also excluded from the disbursement quota.

The terms of a trust or direction would determine whether a gifted property is required to be held for 10 years. Theoretically, this raises the possibility of a trust specifically providing for an exclusion of realized gains from the 10-year holding period. The problem, in practice, is how to extract gains without disposing of property subject to the 10-year rule.

It is possible for the terms of a trust or direction to permit donated property to be substituted ie. to give discretion to the trustees to change the form of the property such that the trust need only hold property having value equivalent to the original gift. However, it does not appear that gains could be severed from donated property for distribution in this manner because, under the Act, a "substitute property" is the total proceeds of disposition of the property for which it is substituted. In other words, notwithstanding the terms of the trust or direction, a distribution of any portion of the proceeds realized on the substitution of a donated property is, for tax purposes, equivalent to a partial distribution of the gift.

Thus, it appears that gains accrued to property subject to a 10-year trust, or property substituted therefor, cannot be distributed without removing the original gift from the exception to the disbursement quota.

Q7. Whether a registered foundation can issue gift annuities. (See also question 4, above).

A7. No. The registration of a charitable foundation may be revoked if the foundation has, at any time since June 1, 1950, incurred debts other than certain debts described in subsection 149.1(3) and (4). An undertaking to make annuity payments is considered to be a debt incurred by the charitable foundation, which is cause for the revocation of its registration

Q8. Charitable Remainder Trusts - Cross-border Issues. If a charitable remainder trust is resident in the US, does the policy in IT-226R apply in the same manner as it does in respect of a trust resident in Canada?

A8. A donor's ability to claim a charitable gift tax credit in respect of a charitable gift may be dependent upon the residence of the intended recipient of the gift because a gift made to a recipient that is not resident in Canada generally would not be included in the donor's "total charitable gifts" for the year as defined in subsection 118.1. The residence of the donor, and the situs of the gift, do not affect the donor's entitlement to a tax credit. Similarly, it is the Department's position that a donor's entitlement to a tax credit for gifting an interest in a charitable remainder trust would not be dependent upon the trust's place of residence, as long as the criteria set out in IT-226R defining where a gift has been made for the purposes of subsection 118.1(3) are satisfied.