15 November 1994 External T.I. 9415225 - LOAN TO A CHARITY

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.

			    941522
XXXXXXXXXX	    B.Kerr

Attention: XXXXXXXXXX

November 15, 1994

Dear Sirs:

Re: Subsections 56(2) & (4) of the Income Tax Act (the "Act")
Indirect Payments & Transfer of Rights to Income

This is in response to your letter of May 13, 1994, sent to our Charities Division and forwarded to us for reply wherein you requested our views in respect of loans to a charity.

You have indicated in your letter that you have become aware of a charitable giving technique that is designed to maximize a gift to a charity, which would otherwise be restricted by the 20% limitation.

You have described a situation involving an individual that has $100,000 in passive investments which return 10% annually and represent the individual's only source of income, the amount being $10,000. By virtue of the definition of total gifts, the amount that may qualify for a tax credit in the year would be restricted to $2,000 under subparagraph 118.1(1)(a)(ii) of the Act. However, if the individual loaned the $100,000 to the charity at no interest and the charity invested the money, the charity would be able to earn $10,000, although the individual would not be entitled to a charitable donation tax receipt. In addition, the individual would not have any income.

You feel that such a situation would not be subject to the rules of subsection 56(4) since one of its conditions requires a non-arm's length relationship to exist. However, you are not sure whether the provisions of subsection 56(2) would apply.

You have asked whether such an arrangement would be considered an avoidance transaction that would be subject to the provisions of subsection 56(2) or any other provision of the Act. You have also asked whether our answer would be any different if the property loaned were shares of a public company that pays dividends.

Our Comments

Whether the provisions of any section of the Act would apply to a transaction is dependent on the circumstances which can only be determined by reviewing all the facts and other information pertaining to a particular situation. Therefore we can only provide the following general comments.

As stated in paragraph 1 of Interpretation Bulletin IT-335R entitled "Indirect Payments", subsection 56(2) of the Act will cause an amount to be added to the taxpayer's income, except certain pensions, if the following conditions are met:

(a)there is a payment or transfer of property to a person other than the taxpayer;

(b)the payment or transfer is pursuant to the direction of or with the concurrence of the taxpayer (this may be implicit);

(c)there is a benefit to the taxpayer or a benefit the taxpayer wishes to confer on the other person;

(d)the taxpayer would have been taxable on the amount under some other section of the Act if it had been paid to the taxpayer.

These are the tests identified in the case of Fraser Companies Limited v. Her Majesty the Queen, (81 DTC 5051). In the case of Herbert H. Winter and David Herbert Outerbridge Winter v. Her Majesty the Queen, (90 DTC 6681) an additional test has been identified at page 6684 "...that the validity of an assessment under subsection 56(2) of the Act when the taxpayer himself had no entitlement to the payment made or the property transferred is subject to an implied condition, namely that the payee not be subject to tax on the benefit received." The test in the Winter case was recently cited in the David N. Smith case, (93 DTC 5351).

Paragraph 3 of IT-335R states that a taxpayer to whom subsection 56(2) applies need not be legally entitled to the property paid or transferred but must have some degree of control over its payment or transfer.

The first condition requires a "payment" or "transfer of property" which is a question of fact and a review of the loan agreement would be required to determine whether a payment or transfer of property has been made and this would also depend on whether a genuine loan has in fact been made. A genuine loan between arm's length parties usually includes interest, repayment terms and security. The nature of the property transferred would also have to be considered. A loan of cash that was then invested would probably not be considered a transfer of property nor would the resulting payment appear to be caught by the provisions of subsection 56(2). On the other hand a non-redeemable 5-year GIC issued in the name of the taxpayer that is loaned to another person and the taxpayer directs the financial institution to make the interest payments to the other person would be subject to the provisions of subsection 56(2). In the case of shares it is the registered owners who are usually entitled to the dividends and it would appear that subsection 56(2) would apply to any dividends that are paid to another person when the shares are in fact owned by the taxpayer. In either situation, the test identified in the Winter case would clearly be met in the case of a payment to a person that is tax exempt such as a charity.

Where a "loan" has been made by a taxpayer to a charity that is a public or private foundation, it is our view that a debt would have been incurred such that the foundation's registration may be revoked by virtue of paragraph 149.1(3)(d) or 149.1(4)(d), respectively. Paragraphs 149.1(3)(d) and 149.1(4)(d) exclude debts for current operating expenses, debts incurred in connection with the purchase and sale of investments and debts incurred in the course of administering charitable activities. However, in our opinion, the debts which are excepted by these paragraphs are those which arise directly in the course of acquiring investments or incurring operating expenses in the course of administering charitable activites. We do not consider a debt to be excepted when it arises in the course of borrowing money unless it is incurred directly in the process of acquiring investments or in funding continued operations. We would not consider a debt to be excepted even where proceeds from borrowings were being used to discharge debts which were, when incurred, excepted debts.

As to whether the provisions of subsection 56(4) of the Act will apply, paragraph 1 of Interpretation Bulletin IT-440R states that the provisions will apply where a taxpayer (transferor) has transferred or assigned to a person (transferee) with whom the transferor was not dealing at arm's length the right to an amount which, had the right not been so transferred or assigned, would be included in the income of the transferor. However, subsection 56(4) does not apply to an amount that is income from property where the transferor has also transferred or assigned the property that generated the income. The right to an amount as referred to in subsection 56(4) is commonly called a right to income. The subsection serves as an obstacle to switching income from the transferor to the transferee by providing that the amount arising from the right be included in the transferor's income in the taxation year in which, or in respect of which, it would have been received or would have been receivable by the transferor. The Act does not define the term "arm's length", although subsection 251(1) deems related persons not to deal with each other at arm's length and provides that it is a question of fact whether non-related persons are dealing with each other at arm's length. Paragraphs 10-14 of Interpretation Bulletin IT-419 entitled "Meaning of arm's length" provides comments in this regard.

Finally, an "Avoidance transaction" is defined in subsection 245(3) to mean "any transaction

(a)that, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit, or

(b)that is part of a series of transactions, which series, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit."

Again this determination is dependent on the facts of a particular case. Its possible that a loan arrangement such as that described may be an avoidance transaction and therefore subject to the provisions of subsection 245(2), unless excepted by subsection 245(4) of the Act. Information Circular IC-88-2 may be referred to for additional comments on the application of subsection 245(2).

We trust that these comments will be of assistance.

Yours truly,

R. Albert
for Director
Business and General Division
Rulings Directorate
Policy and Legislation Branch