Susan M. Manwaring, Toronto
Andrew Valentine, Toronto
On August 27, the Department of Finance released draft legislation which will implement the amendments to the disbursement quota proposed in the 2010 Budget in March. These amendments will eliminate the majority of the disbursement quota by removing the requirement to expend annually on charitable expenditures 80% of all receipted gifts and gifts from other registered charities received in the previous year. The amendments also will eliminate complex concepts such as “enduring property” and the “capital gains pool”. We originally reported on the Budget changes in March, and noted that these changes were welcomed by the charitable sector.
Although these amendments are generally very positive, some uncertainties do remain with respect to how the new rules will be administered. One such area is the treatment of gifts between charities which operate as part of a larger family of separately registered charities. The Budget introduced an anti-avoidance rule which provides that when a charity makes a gift to another charity with which it does not operate at arm’s length, the recipient charity would be required to spend on charitable expenditures 100% of the value of the gift by the end of the following year. The rules further provide that a charity can “designate” any gift made to another charity with the result that the gift would not give rise to this expenditure requirement in the recipient charity. If a gift is so “designated” it would not count towards the satisfaction of the donor charity’s disbursement quota.
The original definition of “designated gift” proposed in the Budget allowed charities to designate gifts to any other registered charity. The draft legislation amends this definition such that a charity can only designate a gift made to a non-arm’s length charity. Whereas under the former wording a charity could designate a gift to another charity in a related group, or to a parallel foundation, without taking a position on whether they operate at arm’s length, it will now be necessary to take a position on this issue. This has the potential to create difficulties. There is uncertainty as to when two entities will be considered not to be operating at arm’s length. Charities may not be commonly controlled, but they may be members of a related group (i.e. would a hospital and a foundation registered to support the hospital be considered arm’s length or not?). Charities could choose to designate all gifts out of an abundance of caution, but it may not be desirable in all cases to take the position that the donor charity is not at arm’s length with the recipient charity.
Another area of uncertainty relates to the anti-avoidance rule which provides for the de-registration of charities which have been determined to have entered into a transaction with a purpose of unduly delaying charitable expenditures. A version of this rule existed prior to the 2010 Budget, but the Budget has expanded its application. With the elimination of most of the expenditure requirements in the disbursement quota, it is possible that CRA may make wider use of this provision if it concludes that a charity has not made sufficient charitable expenditures in a given year. While it is our hope that this provision will not be used to effectively impose a new expenditure requirement, it remains to be seen how CRA will apply this provision and in what circumstances.
Charities should also remember that existing endowments which are subject to ten year hold conditions will in most cases still be subject to these conditions as a matter of trust law, notwithstanding the elimination of the concept of “enduring property” in the Income Tax Act. The question of whether the ten year hold period will continue to apply to existing gifts will depend on the wording of the document that imposed the hold period and whether it provides flexibility for it to be changed. Tax rules operate alongside trust law rules which must also be considered when dealing with existing and future endowments.
Going forward, charities and donors will have greater flexibility in structuring gifts and long-term endowments. The new rules, for example, will make it easier for charities to adopt a “total return” approach to new endowment funds, allowing for the expenditure of a specified percentage annually out of the fund irrespective of whether the funds expended are taken from income or capital.
As noted, the changes in the 2010 Budget are beneficial to the charitable sector. Charities operating in the context of the new rules should remember, however, that in addition to the opportunities created by these changes, compliance issues remain which must be carefully considered when operating. Greater clarity with respect to these rules will emerge as time passes and we see how CRA applies the rules in practice.
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Kate Lazier, Toronto
As discussed in our May 2010 newsletter, Ontario recently introduced Bill 65, the Not-for-Profit Corporations Act, 2010 (the “New Act”), which when passed will replace the current Corporations Act (Ontario). Over the summer, the bill was referred to a Standing Committee which heard submissions from various groups. The Miller Thomson Charities and Not-for-Profit Group was one of many parties who made representations on the proposed bill in hopes of making the bill more responsive to the needs of the charitable and non-profit sector.
The Standing Committee made some notable improvements to Bill 65, which we discuss below. In anticipation of the bill being passed, we also discuss how non-share corporations incorporated under the Corporations Act (Ontario) will transition under the New Act.
Changes to Bill 65
One of the issues in Bill 65 was that the definition of “charitable corporation” was too broad and included some entities that may not be charities at common law. Under the New Act, “charitable corporations” are subject to restrictions that do not apply to other corporations. The committee addressed this issue and narrowed the definition of “charitable corporation”.
There was also a concern that a corporation may fall in and out of the definition of “public benefit” corporation. This presented a problem as public benefit corporations are subject to special requirements under the New Act and a switch in status could result in a corporation suddenly being offside the New Act. The bill was amended to provide that a non-charitable corporation is deemed to be a public benefit corporation as of the date of its first annual meeting of members in the next financial year in which it meets the criteria for a public benefit corporation. This will give corporations a chance to make necessary amendments following a change in their status.
The bill was revised to remove the requirement that directors be members. This will allow corporations to organize in the manner of their choosing and it will eliminate the need for a class of non-voting director members for some corporations.
The bill was amended to no longer require that two thirds of officers not be directors. This change will be a welcome relief for smaller charities, who will not need to find additional volunteers for officer positions.
Some corporations would prefer that proxies were not mandatory and that non-members could be restricted from being eligible to hold proxies. In recognition of this concern, the bill was amended to provide alternative forms of voting to proxies. The bill now provides that corporations can provide for voting by mail, telephone or electronic means in addition to or instead of voting by proxy. However, such means of voting requires that the corporation can verify that the votes were placed by the members entitled to vote and that they cannot identify how each member voted.
Under Bill 65, members of a corporation that do not generally have voting rights still have the right to vote on fundamental changes. We suggested that corporations should have the option of providing for a fully non-voting member class, as many corporations grant membership not to provide shareholder type rights on corporate decisions, but rather to recognize a person’s contributions or to encourage some inclusion of a periphery group. For example, some corporations confer “honourary memberships” as a type of award for outstanding service to the corporation. Other examples of members for whom voting rights may be inappropriate are student members, service providers or suppliers to the members of a corporation, and members who pay a small fee to access a cultural institution for the year. Despite our requests and the requests of others, the Standing Committee did not change the proposed rights for these non-voting members. Many groups will have to re-structure their current memberships to avoid granting these rights to those who were not meant to have a say in fundamental corporate changes.
Similarly, while we suggested the need for further liability protection for directors and officers, this was not addressed in the revised bill.
Transition to the Not-for-Profit Corporations Act, 2010
The bill is currently scheduled for third reading. Once passed the Not-for-Profit Corporations Act, 2010 will become effective on a day to be proclaimed by the Lieutenant Governor.
The Act will apply to corporations without share capital incorporated by or under a general or special Act of the Ontario Legislature, the Province of Upper Canada, and Parliament of the late Province of Canada (if it has its registered office and carries on its activities in Ontario and was incorporated with purposes that are within the legislative authority of the Province of Ontario). This includes non-share corporations incorporated under the Corporations Act (Ontario). There are corporations to which the New Act will not apply, including a group of professional corporations listed in Bill 65 and corporations without share capital to which the Co-operative Corporations Act or Part V of the Corporations Act applies (i.e. insurance corporations).
Once the legislation is in force, a corporation may obtain articles of amendment to bring its governing documents into conformity with the New Act. If a corporation does not do so within 3 years, the New Act deems the governing documents to be amended to the extent necessary to conform with the New Act. Once this legislation is passed, we will be assisting non-share corporations over this three-year period to make the necessary changes to their governing documents. However, if a corporation fails to take action during this time, it will be deemed to comply.
Corporations with share capital with objects in whole or in part of a social nature may apply to be continued under the new Act within five years of it coming into force. These corporations will need to take action to ensure the New Act applies.
Miller Thomson’s Charities and Not-for-Profit Group will continue to update our readers on this legislation.
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Patrick Déziel, Toronto
A number of charities in Canada operate “thrift stores”, loosely defined as not-for-profit stores selling low-cost clothing or other items with the aim of providing affordable shopping alternatives to those in need. Inventory is often composed of donated previously used items, constituting “in-kind” donations to the charity for which donation tax receipts may be issued. Because the organized sale of such goods may be considered a business for the purposes of the Income Tax Act (the "Act"), and because the Act imposes strict limits on business activities by charities (and significant penalties for charities that do not operate within these limits), charities that operate thrift stores must ensure that they operate within the provisions of the Act.
There are several instances in which a charity will be permitted to sell goods and remain compliant with the Act. Charities may sell goods when such sales are for the purpose of fundraising and do not constitute a business for the purposes of the Act. Charities may also sell goods where the sales constitute a charitable activity. This could include, for example, relief of poverty, or where the operation provides a sales outlet where economically disadvantaged citizens may sell products.
With respect to fundraising events, many such events will not be viewed by CRA as the carrying on of business. CRA states that although many fundraising events such as concerts will constitute business activities (in that they involve the sale of goods and services to generate income), fundraising events that do not recur regularly or frequently will not constitute “carrying on a business” for the purposes of the Act. As the restrictions in the Act generally apply to the carrying on of a business by charities, such irregular fundraising events will not generally cause a charity to be offside these restrictions.
In certain circumstances, charity-operated sales outlets selling goods produced by those in need will also be found to comply with the Act. CRA states that charities working to relieve extreme poverty in developing countries may sell items made by poor artisans in third-world countries without such sales being considered an unrelated business under the Act. Rather, such sales are viewed as “ancillary and incidental” to charitable programs. The sale of items produced by Canadian artisans is generally excluded from this exception. However, certain “social businesses” that employ Canadians with disabilities may also sell goods without being considered an unrelated business of a charity.
Finally, the operation of certain stores, including thrift stores, may be recognized as a charitable activity if certain conditions are met. In order to constitute a charitable activity, CRA takes the position that such stores should:
- be located in sections of a community inhabited largely by the poor;
- sell donated goods at a low price; and,
- operate on a break-even basis.
Despite this guidance from CRA, the status of thrift stores under the Act remains somewhat uncertain. CRA states that stores which are run as “fundraising vehicles” will not be separately registered, but may constitute related businesses. However, CRA states elsewhere that selling donated goods is not a commercial activity “because businesses do not depend on donations to create their inventories.” The line between selling/liquidating donated goods and fundraising is not always clear. Furthermore, case law on the issue has sent mixed signals as to what will and will not be considered a business, what will be considered a “related business”, and what will be deemed an “unrelated business”.
A recent CRA advance income tax ruling discussed a particular corporate structure proposed by a registered charity. The charity sought to create a new corporation (“Newco”) that would sell goods donated to the charity on a consignment basis. In other words, the charity would retain ownership of the goods until they were sold, but all aspects of the sales would be handled by Newco. The purpose of the proposed structure would be to allow Newco to efficiently liquidate in-kind donations received by the charity, and return any funds to the charity in order to fund the charity’s programs. The charity requested the CRA’s opinion on two issues:
- Whether Newco would be exempt from income tax as a non-profit organization; and,
- Whether the charity would be carrying on a business by virtue of the consignment sale arrangement.
CRA stated that provided certain conditions were met, Newco would be considered a non-profit organization. On the second issue, the CRA stated that the charity would not be carrying on a business solely by virtue of the consignment sales arrangement.
This ruling is important in that it provides additional guidance as to what business arrangements will be acceptable to CRA. For charities, a consignment arrangement like the one described above may provide advantages over simply liquidating donated goods themselves. The charity will have more time to focus on its charitable activities and not be bogged down in the mechanics of efficiently liquidating in-kind donations. It will also not have to concern itself with running afoul of the “related business” restrictions applicable to charities. Such consignment arrangements may be an attractive structural option for charities with significant thrift store operations.
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Amanda J. Stacey, Toronto
It may surprise international organizations to learn that the Canadian International Development Agency (“CIDA”) does not limit its funding to Canadian organizations. International organizations engaged in development work worldwide may be eligible for CIDA funding for their work abroad. CIDA’s stated mission is to lead Canada’s international effort to help people living in poverty. Its mandate is to manage Canada's support and resources effectively and accountably to achieve meaningful, sustainable results and engage in policy development in Canada and internationally, enabling Canada's effort to realize its development objectives. As such, it should come as no surprise that it is willing to work with international partners to achieve this goal. CIDA states that any organization, company, or individual with the required expertise and experience to either supply projects administered by CIDA or its partners, or to receive funding for their own projects, is eligible to work with CIDA. CIDA provides funding for international development programs and projects through contributions to Canadian and international institutions of many kinds. It also enters into contracts with Canadian companies for the implementation of their programs and projects.
Organizations interesting in applying for CIDA funding should visit CIDA’s website at www.acdi-cida.gc.ca. Miller Thomson’s Charities and Not-for-Profit lawyers can advise on all aspects of international charitable activities, including CIDA-funded projects.
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Arthur B.C. Drache, Toronto
One of the most anticipated Commons Finance Committee hearings in many years – those dealing with Bill C-470 – has been put off to allow for more hearing time and presumably more witnesses. Bill C-470 is the private member’s bill which would allow CRA to revoke the registration of charities if any employee has total remuneration of more than $250,000. We originally reported on this bill in the April edition of this Newsletter.
Based on what we have heard, numerous individuals, charities and umbrella groups are lining up in opposition to the bill and are awaiting the hearings at which they can testify in opposition to this proposed legislation.
The Committee stated as follows with regard to the extension:
“Your Committee’s request for an extension is due to the fact that in order to give the Bill proper consideration, it will be necessary to schedule additional meetings to hear the views and comments of a wide-range of witnesses prior to the clause by clause study of Bill C-470.”
Our hope continues to be that the bill will receive a report from the Finance Committee which leads either to its non-passage or substantial amendment. We will continue to update you on the progress of Bill C-470.
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David W. Chodikoff, Toronto
Tax shelters have been around for a long time. The developers and marketers of these arrangements do extremely well. For years, CRA has been trying to shut down the more undesirable tax shelter arrangements. Who doesn’t know someone that has been reassessed by CRA for participation in a leveraged donation plan and been denied the applicable tax credit? Now, CRA is vigorously pursuing those individuals that promoted and marketed the schemes by utilizing the third party civil penalty provisions of the Income Tax Act (the "Act").
The Act empowers the Minister of National Revenue to impose civil penalties on third parties who knowingly, or in circumstances amounting to culpable conduct, make false statements or omissions in respect of another person’s tax matters. The section is designed to apply to tax planners involved in the preparation, promotion or selling of tax shelters, tax shelter-like plans and/or arrangements. The section is also squarely aimed at tax preparers and advisors that either give advice or helped others in the making of a false statement or who are willfully blind to obvious errors when preparing a filing or assisting a taxpayer in filing a tax return.
There are two different types of third party civil penalties. The first is referred to as the “planner penalty”. This penalty potentially applies to any person who makes, furnishes, participates in the making of or causes another person to make or furnish, a “false statement” that could be used by another person for the purposes of the Act.
There are a number of factors that CRA may consider relevant when determining whether planner penalties will be assessed. These considerations include: whether the position was obviously unreasonable or contrary to well established case law; whether the advisor had knowledge of the relevant subject matter and the extent of the advisor’s participation, deliberate or otherwise, in the making of false statements; the degree to which the culpable conduct represents the most aggressive and blatantly abusive behaviour; the extent to which there is a pattern of repeated abuse; and whether the reduction of taxes is significant.
The term “person” used in the language of the planner penalty includes a partnership for the purposes of the third party civil penalties. The planner penalty can also apply regardless of whether the false statement is actually used and regardless of whether the person who could use the information can be identified.
The term “false statement” is defined to include a statement that is misleading due to an omission. CRA takes the position that a person need not have the intention to deceive to make a false statement. However, there is case law that suggests that the person making the false statement must actually know the statement is false.
In addition to a false statement, there must also be actual knowledge, or culpable conduct on the part of the advisor in order for the third party civil penalty to apply. The Act provides a definition for culpable conduct that would appear to exclude an honest error of judgment or a failure to exercise reasonable care. The Act defines culpable conduct as an act or failure to act that:
(a) is tantamount to intentional conduct;
(b) shows indifference as to whether the Act is complied with; or
(c) shows a willful, reckless or wanton disregard of the law.
The second type of civil penalty is referred to as the “preparer penalty”. It is virtually identical to the penalty for false statements in tax planning schemes except that it strictly applies to statements that are “to, or by or on behalf of another person”. This means that there must be an actual taxpayer who can be identified. For this penalty to apply, there must be a “false statement” that is made either knowingly or in circumstances amounting to culpable conduct. The preparer penalty also applies to third parties who assent to or acquiesce in the making of a false statement. Therefore, from CRA’s point of view, tax preparers could be liable for this penalty in circumstances where the preparer does nothing, if he/she knew or would reasonably be expected to have known that their client made a false statement.
The penalty provisions are harsh and the dollar amounts can be incredibly high.
In connection with the imposition of third party civil penalties, CRA is using its audit and investigation powers in order to obtain the necessary evidence to support the penalties. The Act confers on the Minister broad powers of audit and inspection of a taxpayer’s books and records. Under the Act, the Minister can by notice served personally or by registered or certified mail require that any person provide, within such reasonable time as is stipulated in the notice, information or additional information, including a return of income or supplementary return, or any document.
Fortunately, there is a good faith defence built into the statutory framework for the civil penalty provisions. Penalties will not apply where the advisor relied in good faith on information provided by or on behalf of the person for whom he/she acted. The good faith defence also applies where the advisor did not verify, investigate, or correct information.
In the event that you and/or your client are served with a CRA requirement, the optimal course of action is to discuss the specifics of the requirement and the appropriate response with tax counsel. These are “treacherous waters” and a sailor that knows how to navigate through this difficult passage will save the inexperienced from disaster.
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What's Happening at Miller Thomson
Iain Benson published “Why 'public' should not mean 'atheist'” in the Ottawa Citizen on September 16, 2010.
Gail Black spoke on “Charitable Giving” at the Calgary branch of Advocis on September 16, 2010.
Susan Manwaring, together with Jill McAlpine of PricewaterhouseCoopers, presented “How to Structure & Plan for the Future – Revisited Post Budget 2010” for the Ontario Bar Association on September 21, 2010.
Robert Hayhoe spoke at the Amercian Bar Association Tax Conference in Toronto on “Crossing the Border: A Comparative View of Philanthropy” on September 24, 2010.
Susan Manwaring gave presentations entitled “Endowments Under the New Disbursement Quota Regime” and “Gifts-In-Kind: What to Watch Out For”, and Robert Hayhoe spoke on “Practical Structuring of Foreign Activities”, at the Canadian Council of Christian Charities (CCCC) Leadership & Stewardship Conference in Winnipeg on September 26-29, 2010.
Robert Hayhoe spoke at the Pacific Business & Law Institute in Vancouver on “Audits & Appeals” on September 28, 2010.
Arthur Drache wrote “Charities Speak Out in Ottawa”, “Pakistan Relief Efforts Faltering”, “Briefly Noted in September”, “Small Treatise on Potential NPO Liability”, “Directing Fees to a Charity”, “What is Meant by ‘Aged’”, and “Bad Legal Drafting Means No Charitable Tax Credits” in the October 2010 issue of Canadian Not-for-Profit News.
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