4 June 1992 Income Tax Severed Letter 9207465 - Gifts of Residual Interest

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.

SUBJECT: GIFTS OF RESIDUAL INTEREST SECTION: 118.1(3)]

920746
L. Holloway
(613) 957-2104

Attention: XXX

June 4, 1992

Dear Sirs:

Re: Gifts of Residual Interest

This is in reply to your letter dated December 23, 1991 concerning the valuation of a gift of residual interest to a charity.

Your letter referred to paragraph 3 of Interpretation Bulletin IT-226 Gift of Residual Interest to a Charity which is now IT-226R. Paragraph 5 of this revised IT states:

• "5. The method of valuing a residual interest in real property or an equitable interest in a trust, whether it be for the purpose of determining the amount of a charitable donation or other tax consequences, will vary according to the type of gift, other interests in the property or trust and the documentation providing for the gift. The general approach is to value the various interests taking into consideration the fair market value of the property itself, the current interest rates, the life expectancy of any life tenants, and any other factors relevant to the specific case.

In the case of property other than real property, the longer the period before full ownership of the property is passed to the charity, the more difficult it is to establish its value."

Specifically you had asked what was the Department's definition of "current interest rates" if trust investments made during an individual's lifetime were typically short term and therefore tended to fluctuate.

Our Comments

As you have noted, the Department's administrative position with respect to gifts of residual interests made to charitable organizations is found in Interpretation Bulletin IT-226R. Essentially, a "gift", eligible for tax credit treatment, is considered to have been made:

• i) in circumstances where the gift vests at the time of the giving of the gift, and
• ii) where the value of the residual interest is reasonably ascertainable.

The Department interprets vesting, in the context of IT-226R, to have occurred when a person obtains a right to absolute ownership of a property so that this right cannot be defeated by any future event, even though that person may not be entitled to the immediate enjoyment of all benefits from that right. The transfer must be irrevocable.

In this respect, when property is considered to vest, it must in all cases vest indefeasibly. In cases where property is transferred to a trust under an irrevocable trust agreement, there must be "iron clad" agreements under which no encroachment could be made on the capital of the trust. Where a taxpayer transfers a property to a trust and the trustee is instructed to pay all the income earned by the trust to the taxpayer during the taxpayer's lifetime and, on the death of the taxpayer, to transfer the property to a registered charity and provided all the other requirements for a valid gift have been satisfied at the time of transfer, an inter vivos gift is considered to have been made at that time. Where encroachment is possible under the arrangement referred to above, no gift would be considered made to the charity.

The valuation of the residual interest for the purposes of determining the amount of the charitable donation and the resultant capital gain or loss will vary according to the type of gift, the interest retained and the wording of the document that sets out the gift. The general approach will be to value the life interest or other interest retained, using the present fair market value of the whole property, current interest rates and the life expectancy of the life tenant, or current term certain tables, and to deduct this amount from the total value to arrive at the residual interest.

Paragraph 6 of IT-226R states that:

• "In cases where the size of a residual or equitable interest at the time of the donation cannot reasonably be determined, such as when the life tenant or trustee has the right to encroach on capital of the trust, no deduction in respect of charitable donations will be allowed. "

In ascertaining the residual value, one would determine what an arm's length person would pay today in order to have the capital of the trust "x" years from now. The appropriate discount rate to use or the "current rate" would be a question of fact in each case, however these rates would approximate market rates for similar risk instruments. These "current rates" would likely be determined by a qualified appraiser or valuation specialist.

We trust our comments will be of assistance to you.

Yours truly,
A. G. Thornley
for Director
Business and General Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch

• c. c. Charities Division c.c. Winnipeg District Office