Gifts of private company shares are becoming an increasingly important component of charitable giving and estate planning in Canada. While these gifts can involve unique legal and tax considerations, they may also provide charities with access to significant philanthropic support that would otherwise not be available, and should not be dismissed out of hand, as much of Canadians’ household wealth is tied up in private companies.
In this article, we provide an overview of some of the issues charities need to consider when determining whether to accept a gift of private company shares.
Before accepting such a gift, however, charities should be aware that receipting for private company shares involves complications that may, in some cases, give pause. Understanding these rules at the outset will help your charity evaluate whether, and on what terms, to proceed.
Gifts in kind
As gifts of shares are non-cash gifts (or gifts in kind), generally the donation receipt for such gifts will be based on the fair market value (“FMV”) of the gift.
The FMV is the highest price an arm’s length person would pay on the open market for the shares and may not be the same as the underlying value of the assets of the company (for example, the company may have liabilities and obligations that affect the FMV of the shares). As such, before the charity issues a receipt for a gift of private company shares, the charity will generally need to obtain a professional appraisal to determine the shares’ FMV. In the case of preference shares, the valuation will likely be based on their redemption amount, and the charity may wish to obtain a professional opinion to confirm the valuation.
As such, before the charity issues a receipt for a gift of private company shares, the charity will need to obtain a professional appraisal to determine the shares’ FMV.
What value should my charity put down?
Deemed FMV rule
Charities should be aware that the FMV of a gift of private company shares will not always be the amount that can be receipted for tax purposes.
With respect to gifts of shares (or other gifts in kind) to charities, there will also be times where the FMV for receipting purposes will be deemed to be a lesser amount than the FMV, namely, the cost of the property to the donor.
Particularly, this applies where the donor acquired the shares:
- as part of a tax shelter arrangement;
- less than 3 years before the donation; or
- less than 10 years before the donation, with a main purpose being to gift the shares to a charity (or other qualified donee).
Certain gifts are exempt from this rule, including gifts made as a consequence of a donor’s death, and gifts of shares listed on a designated stock exchange.
Gift at cost
Normally, when a donor gifts capital property, the donor will be deemed to have disposed of the property at its FMV, which can trigger a capital gain where the FMV exceeds the adjusted cost base (i.e., cost). However, a donor can instead make the gift at cost by electing the proceeds of disposition to be at cost or between cost and FMV, in which case the FMV of the gift will be deemed to be the same amount for receipting purposes as well.
This results in both the capital gain and eligible amount of the donation receipt being reduced. A donor may want to make this election where the capital gain is significant and having the donation receipt at FMV may not be enough to shelter that gain. Your charity’s legal counsel and the donor’s tax advisor should coordinate early to determine whether this election is being considered, as it will affect the receipt your charity issues.
Non-qualifying securities rules: When is receipting deferred?
One of the most important considerations for charities and donors is whether the gifted shares constitute a non-qualifying security (“NQS”) under the Income Tax Act (Canada). Gifts of NQS generally cannot be receipted immediately.
Accordingly, charities should determine early in the process whether the proposed gift may constitute a NQS, as this can significantly affect the donor’s receipting expectations and timing.
What is a NQS?
Gifts of NQS are generally gifts with a FMV that is difficult to determine because there is likely little to no market for the securities due to their nature. A gift of NQS includes a gift of shares of a corporation not listed on a designated stock exchange, with which the donor does not deal at arm’s length immediately after the gift is made. For example, a scenario where the donor continues to be the majority voting shareholder after the donor makes a gift of shares to a charity.
Gifts of NQS are not eligible for donation tax credits unless and until a certain triggering event occurs. Accordingly, these NQS rules essentially defer the recognition of the gift for receipting purposes.
Redemptive rules
A gift of NQS will be eligible for the tax credit/deduction if, within 60 months, either:
- it ceases to be a NQS (e.g., because the donor becomes arm’s length); or
- the recipient charity disposes of the NQS for consideration other than another NQS.[1]
If one of these triggering events occur, then for receipting purposes:
- the donor is deemed to have made a gift at the time of the triggering event; and
- the FMV for the receipt is the lesser of the FMV at the time the gift was made and the FMV at the time of the triggering event.
As the donor actually made the gift at the time the gift was made, there may be a mismatch between the value of the gift at the time of disposition and for the receipt if there has been a change in value during that time. The capital gain arising from the gift may also arise in a different year than the one in which the donor can use the tax credit if the trigger event occurs in a different year.
Excepted gifts
There are certain NQS, known as Excepted Gifts, that are exempt from the NQS rules outlined above. A NQS will be exempt where:
- the security given is a share;
- the charity is not a private foundation;
- either: (i) the donor is a graduated rate estate (“GRE”) that is at arm’s length with the charity and the deceased was at arm’s length with the charity at the time of their death; or (ii) the donor is not a GRE and is at arm’s length with the charity; and
- the donor is at arm’s length with each director, trustee, officer or like official of the charity.
What does my charity need to consider if a deceased donor or their estate has gifted private company shares?
Generally, donation tax credits can be applied to the year the gift is made or any of the five following tax years. However, a GRE has additional flexibility. A GRE is an estate that meets certain requirements and only exists up to 36 months from the date of an individual’s death.
If a gift is made by an estate that is a GRE or within two years after the GRE ceases to be a GRE (provided the estate would qualify as a GRE, but for the fact that more than 36 months have passed since death), the donation tax credit can be claimed in:
- the donor’s terminal tax year;
- the donor’s tax year immediately preceding the terminal tax year;
- the tax year in which the donation was made; or
- any prior tax year of the GRE.
The gift also has to be property that was acquired by the estate on and as a consequence of the death (i.e. generally property owned by the deceased) or property substituted for that property.
Notably, a GRE can carry back the gift to the donor’s terminal tax year, which can help offset the significant tax consequences that may arise in that year. When a person dies, they are deemed to have disposed of all their capital property at FMV immediately prior to death, meaning that any capital gains or losses on that property are realized in that terminal tax year.
Accordingly, an estate has 60 months from the date of death (36 months of being a GRE plus 24 months after) to make charitable gifts and take advantage of this flexibility.
However, there is a mismatch: if the gift is made within the two years after the GRE ceases to be a GRE, it will not qualify as an Excepted Gift (which is a gift made by a GRE or other donor that is at arm’s length with the charity). At that time, the estate would no longer be a GRE and the estate (the donor) and the recipient charity would be deemed to not be at arm’s length by virtue of the charity being a beneficiary of the estate.
Accordingly, this gift would be subject to the NQS rules and deemed to not have occurred for receipting purposes until the gift either ceases to be a NQS or the charity disposes of it in return for consideration that is not another NQS (i.e., one of the triggering events occur). If the triggering event occurs within the two years after the estate ceased to be a GRE (such that it is within the 60-month time frame), the estate can still carry back the gift under the GRE rules. However, if the triggering event occurs after, then the estate cannot.
If your charity has decided to accept: Additional considerations
Gifts of private company shares can present significant receipting complications — including deferred recognition, deemed FMV reductions, and timing mismatches between capital gains and available tax credits. For some charities, these complexities alone may be reason to decline a gift or to negotiate different terms with the donor before proceeding.
Even if your charity is ready to accept a gift of private company shares, there are a number of additional considerations to work through before doing so. A charity should conduct appropriate due diligence regarding the corporation, the rights attached to the shares, any restrictions on transfer, and the charity’s ability to realize value from the gift. In many cases, one of the most significant practical considerations will be whether and when the charity can monetize the shares and convert the gift into funds that can be used to further its charitable purposes.
A charity that is considering a gift of private company shares should first determine its intended strategy for such shares (including whether it intends to hold them, and if doing so is consistent with its investment and governance obligations). In doing so, the charity may wish to consider the following:
- Whether it intends to sell the shares or hold the shares as a long-term investment;
- If the shares will be held long-term, how its relationship with the corporation and any other shareholders will be structured. Where there are other shareholders, this may include entering into a shareholders agreement that addresses future sales of shares and election of directors.
- Whether holding the shares long-term is consistent with the charity’s legal and regulatory obligations, including whether they are shares that a prudent investor could hold, and how the shares will impact the charity’s disbursement quota obligations.
- If the charity is a private foundation, whether the excess corporate holdings rules apply, and whether the foundation may be required to divest itself of some or all of the shares over time.
Gifts of private company shares can be an effective philanthropic and estate planning tool, but they raise a number of unique tax, governance, and operational considerations for charities. Understanding these issues at the outset can help charities evaluate opportunities appropriately while ensuring compliance with applicable legal and regulatory requirements.
If you have any questions about receiving a gift of private company shares and how it might affect your charity, please reach out to a lawyer from Miller Thomson’s Charities and Not-for-Profit Group.
