28 December 1989 Income Tax Severed Letter 5-8491 - Tax treatment of several arrangements which charitable organizations are either using or contemplating using in connection with their fund-raising activities

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.

Dear Sirs:

This is in reply to your letter of August 10, 1989, requesting our views on the tax treatment of several arrangements which charitable organizations are either using or contemplating using in connection with their fund raising activities. We apologize for the delay in replying.

• 1) The Life Income Agreement:
• You describe an arrangement whereby an individual described as the "donor" gives an amount to the charity. The agreement terminates with the last payment made preceding the death of the donor. In consideration for the capital contribution, the charity undertakes to pay the donor a specified amount for the life of the donor. The amount to be paid each year would be fixed by a reference to the Bank of Canada interest rate on January 1st of each year.

Your Understanding of the Arrangement:

• The contribution by the donor would not be a gift in law nor would it qualify as a gift for income tax purposes. Notwithstanding the statement in the agreement that the contribution would become absolute property of the charity on the death of the donor, the capital contribution would in fact vest in the charity at the time such contribution was made to the charity. The charity would not be required to hold or invest the capital contribution.
• In your view, the capital contributions would not be held in a trust in which the donor had an interest. The capital contributions would not be a deposit or a loan to the charity, would not be held in trust by the charity and the charity would not be under any legal obligation to invest or hold the capital contribution. It is your opinion that the obligation of the charity to provide periodic payments to the donor throughout his life should be regarded as an obligation of the charity to provide an annuity to the donor. The annuity provided under the arrangement would not qualify as a prescribed annuity since the agreement does not provide for equal annuity payments.

Our Comments

• We agree that the annuity would not qualify as a prescribed annuity; the annuity payments would vary from year to year depending on the Bank of Canada rate on January 1st of each year thus the criteria in clause 304(1)(c)(iv)(A) of the Income Tax Regulations (the "Regulations") would not be met. In order to calculate the supposed donation, we must also be able to determine the expected payout over the life of the annuity. This would not be possible where the annuity is calculated on a variable rate of interest. Furthermore, no portion of the contribution would be regarded as a gift under the Act. In our view, IT-111R is not applicable; other than paragraph I which was written before the enactment of subsection 12.2(3) and paragraph 56(1)(d.1) and means only that the ordinary rules will apply. Thus, paragraph 56(1)(d.1) and subsection 12.2(3) of the Act would apply to determine the tax treatment to the donor.
• You mention that the consideration for the issue of an annuity would be the lesser of the capital contribution and the amount that would be charged by a commercial annuity issuer. Although the difference between the capital contribution and the consideration for the issue of the annuity by a commercial annuity issuer may be considered by some annuity issuers as being the gift component, this is not recognized for tax purposes. Moreover, if we refuse to regard any part of the donor's payment as a gift because the donor receives as consideration the annuity payments, it follows that the cost of the annuity is not less than the payment to the charity. We find it difficult to agree that this amounts to preferential tax treatment for annuities issued by charities as opposed to annuities issued by commercial issuers. As you note, the annuitant foregoes the benefit of an immediate tax credit for a gift to a charity; in a sense, he is deferring the tax benefit of his "gift" to later years, which would not usually be seen as advantageous.

1A) The Alternative

• If the arrangement were altered to provide for a constant annuity payment, the annuity would qualify as a prescribed annuity. If there was a gift to the charity, paragraph 3 of IT-111R would apply and the excess contribution over the aggregate of the expected annuity payments could be considered a gift to the charity for income tax purposes, and the remainder of the payment (ie. in excess of the "gift") is the cost of the annuity. Where the aggregate of the expected annuity payments exceeded the capital contribution where no gift element is recognized, the regular accrual rules pertaining to annuities apply.

Other Tax issues - Annuities

• The gift component that is recognized by IT-111R is less than the gift that could be recognized if the individual used a portion of the amount that would otherwise be contributed to the charity as a gift. In your view, IT-111R appears to treat the excess of the individual's contribution over the gift recognized as the consideration for the annuity issued by the charity, and as such you assume that the gift component that is not recognized (the difference between the consideration for the annuity as determined in IT-111R and the amount that would be charged by a commercial annuity issuer) is considered to be an annuity reserve. You feel that if the charity took certain steps to eliminate such annuity risks, that gift portion could be recognized. You suggest that if, on receipt of a contribution for an annuity, the charity immediately used a portion of such contribution to purchase the required annuity from a commercial annuity issuer, irrevocably assigned annuity payments to the individual contributor equal to the annuity payments that the charity was required to make and obtained a release from the individual of the charity's obligation to make such annuity payments, the charity would not have any continuing liability to provide the annuity. The gift component not recognized by IT-111R will thus be available to the charity without restriction. You feel that since the charity would continue to be the annuity issuer, it could qualify as a prescribed annuity. You question whether the department would consider the excess of the amount contributed by the individual over the amount paid by the charity to the commercial annuity issuer as a gift to the charity for income tax purposes.

Our Comments

• The position in IT-111R is an administrative position that is only available where the individual pays (donates) more for the annuity than the total amount expected to be received as annuity payments to the charity; the Department is not prepared to go beyond the position set out in paragraph 3 of IT-111R. In the situation you describe the charity arranged the annuity funding with the annuity issuer rather than the individual doing so directly. If the individual were to purchase an annuity from an annuity issuer and gift the remainder to the charity, the gift would be recognized for income tax purposes and the annuity would be subject to the regular rules for annuities. his more direct approach could be pursued by an individual who wished to claim a tax credit for a larger gift than would be calculated pursuant to IT-111R, without the need to interpose a charity as issuer of an annuity.

Business Activity and Related Business

• Whether a business is carried on for profit or with a reasonable expectation of profit is an issue which is supplementary and distinct from that of whether or not a business exists. In this respect "business" includes an undertaking of any kind. Thus we regard the issue of annuities by a charity as a business activity.
• Provided that the activity yields the charity a significant gift portion, it is our position that the annuities issued by the charity would be considered a related business. However, you may wish to discuss this with Mr. Gordon Murray, Director of Charities Division who could best answer this question.
• 2) Irrevocable Charitable Agreement
• You describe an arrangement whereby a donor purports to make an irrevocable contribution to a charity. The contribution is made to the charity as trustee. The trustee is instructed to invest the contribution in property in which a trustee in Ontario is permitted to invest and to pay the net income from such investment to the donor. On the death of the donor the contribution and accrued income would fully vest in the charity.

Your Understanding of the Arrangement

• In your view, the Agreement would create a settlement trust in which the charity would be the trustee and residual beneficiary and the settlor would be the income beneficiary. The contribution would be a transfer of property to a trust which is not a charity. The donor would be the income beneficiary and the charity would be the residual beneficiary. The value of the residual interest would vest in the charity and would be recognized as an immediate gift in accordance with IT-226. Amounts received by the donor would be received as income from the trust. Income from the trust would be subject to tax to the extent that such income was not paid or payable in the year to a beneficiary.

Our Comments

Generally, we agree with your understanding. We agree that IT-226 would apply and IT-111R has no relevance. Where there is a gift of a residual interest to a charity, IT-226 would apply. The value of the residual interest must be determined. Since the annuity payments are to be paid from income, it would appear that subparagraph 60(a)(ii) of the Act would deny any deduction to the taxpayer, except to the extent that the payment contained a portion paid out of capital. In our view, the trust would be subject to tax and subsection 12(3) would apply to the trust if one or more of the beneficiaries were a corporation.

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Your Understanding
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Our Comments
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The foregoing comments represent an expression of opinion and accordingly are not binding on the Department. We note that, in preparing these comments, we have not considered representations from taxpayers utilizing the arrangements which you have described.

We trust our comments are of assistance.