I was merrily reading the Business Section of the Globe and Mail on February 7, 2009, and there was an advertisement stating: “Donation Tax Shelters Still Make Financial Sense”.  The advertisement does not say who it is from.  There is no e-mail address.  There is no website.  There is only a telephone number and extension.  The last time I saw an advertisement for a legitimate business in the Globe without a website was probably 15 years ago!  Anyway, the description says: “The program is based on simple everyday, commercial transactions; enabling participants to receive a donation receipt for NOT MORE THAN the purchase price of the items donated to charity”.  It then says to arrange a “confidential one-on-one meeting please call”.  The advertisement seems to be geared toward professional advisors who will be earning commissions, or donors (I mean “investors”) who hope to save some money on taxes.  I guess I could call and find out details, but I just feel a little sordid calling a company that provides a lot less details, and feels trashier, than an escort agency. 

How many times has CRA warned Canadian taxpayers not to get involved with tax shelter donation arrangements?  For a list of some of the warnings, you can see: http://www.cra-arc.gc.ca/nwsrm/lrts/2007/070813-eng.html How many times do I read posts on the internet or receive e-mails from people who say they did not understand what they were doing and they in hindsight were duped into “investing”?  Sorry I cannot help you.  I try to help legitimate donors who want to help legitimate charities with real donations that are not abusive of the provisions of the Income Tax Act. 

Some Canadians are gluttons for punishment – or maybe gluttons for tax evasion! 

Let me reproduce a few choice quotes for those who have been living in a hut without electricity in Papua New Guinea for the last six years.

“Warning: Participating in tax shelter gifting arrangements is likely to result in a tax bill!” (Looks to me like a 16-point font but I think CRA may need to increase it to 20-point to get anyone’s attention.)

“The CRA is auditing all gifting arrangements.  Taxpayers should be aware that the CRA plans to audit all tax shelter gifting arrangements. Every audit completed to date has resulted in a reassessment of tax, plus interest. In many cases the CRA has denied the “gift” completely. Penalties will be considered, especially where an investor was audited and reassessed for previously participating in a gifting arrangement.”

“Get professional, independent advice.  If you are still thinking about participating in a tax shelter gifting arrangement, it is very important that you get independent legal and tax advice. Independent advice means advice from a tax professional that is not connected to the scheme or promoter. If property is involved, you should also get independent advice on its true value. Packages from promoters will often claim to have legal or tax opinions from a law firm. You may find that these opinions contain very general comments and do not provide unconditional support for the scheme. Ask to see them, and have them reviewed by an independent professional.”

“Not been contacted by the CRA yet?  The CRA generally has three years from the date of assessment to reassess taxpayers, and these audits can take over a year to complete. The fact that investors in these tax shelters have not been contacted and/or reassessed should not be interpreted as the CRA’s acceptance of their claim.”  (Why does CRA say “generally” three year? – Well as I note below there are cases were they will go beyond three years)

Today, the flavour of the month is packaged flow-through donation tax shelters that offer more benefits than costs in some cases.  It used to be art flips and gifting trust programs.   

Some of the many potential concerns that have been raised with the donation tax shelters from either a donor or legitimate charity point of view are:

1) Determining the correct amount for the donation receipt.  If the donation receipt is incorrect the charity may have its charitable status revoked, or there could be substantial penalties for the charity.  A tax receipt can never be for more than the value of the items that the donor gave.  If the donor is out of pocket $5000, it cannot ever be more than $5000 irrespective of the number of transactions and games played.  If you are buying drugs in India, you cannot say I bought them for $1 per pill in India, but they are worth $20 per pill when they are donated in Ontario and therefore the fair market value of the drugs you paid for last week is $20.  How stupid do you think tax court judges are?  With flow-through shares there are a number of complexities relating to valuation of shares. For example, if there is a hold period or other restrictions, the amount of the donation receipt needs to be reduced accordingly.  If the donor has obtained any “advantage” because of the packaging of this transaction the donation receipt needs to be reduced.  To the extent that anything cannot be appropriately valued the receipt must not be issued at all.  Some of the new fangled flow-through share schemes have “liquidity providers” who will purchase the shares and pay cash to the charity and then at least it solves the hold period problem, although not the valuation problem because if a charity receives a million dollars from a liquidity provider for the shares it does not mean that the fair market value of the shares is a million dollars.  Just like if I say I will give you a thousand dollars for a popsicle does not mean that the fair market value of the popsicle is $1000.  There may be other transactions taking place or relationships existing that you may not be aware of at that point in time.

2) Disbursement quota issues.  Some charities may have disbursement quota problems if they receipt the donation of items that for whatever reason cannot be sold, or the amount is inflated, and the charity cannot spend the necessary funds on charitable activities in the following year then they can ultimately lose their charitable status.

3) Fundraising by using commissions.  Many charities and businesses have subscribed to ethical codes that prohibit commission fundraising.  Are the promoters being paid by commission?

4) Tax Shelter Identification Numbers.  Is the donation arrangement registered with the CRA as a tax shelter?  If so, this does not mean that the CRA approves of the shelter.  Tax shelter identification just assists the CRA if they decide to audit a tax shelter to easily compile a list of audit targets and almost certainly guarantees you will be audited.

5) Promoters. Charities if they are not careful could be considered “promoters” of the tax shelter with all the attendant liability that it entails.  Certainly some donors when their “gift” is set aside may say they to some extent relied on the charity which was involved in the scheme.  Check if your insurance policy covers the provision of negligent advice.

6) Legal Opinions.  Donors should be concerned when in order to be “comfortable” with a donation you need to see 2 or 3 legal opinions.  As well, be wary of relying on self-serving legal opinions with respect to the donation tax shelter arrangements unless you have obtained your own independent legal opinion from a law firm that has no involvement with tax shelters that is consistent with the facts on hand, and there is no equivocation on the part of the lawyer or law firm as to all of the issues.  Equivocation in this case can result in the charity losing its status or substantial fines and you having a substantial tax bill, far greater than any potential savings.  The history of tax litigators, either guessing what the CRA will do with respect to what they consider abusive tax schemes, or knowing what the courts will decide, is very poor.  If you look at recent court cases such as the Lipson case and the Millennium Charitable Foundation case, I think a betting man would bet with CRA because the courts have had very little patience over the last few years with what they perceive to be abusive transactions, whether involving charities or not.  Some people think that a legal opinion is like a guarantee – it is not – most of the time in a legal opinion is typically spent putting in material, assumptions, caveats etc that are there to protect the lawyer and not the charity or the donor.  As some experienced tax lawyers say these opinions are “rather thin soup” or they defy gravity.  Furthermore, lawyers know that if the advice they give is ever found to be negligent that the costs of suing the lawyer are so great that to make it worthwhile to sue, your damages need to be probably over $500,000.  So if your $10,000 donation in the end only costs you out of pocket $100,000 it is not worth suing the lawyer whose professional liability insurer will generally defend the negligent lawyer vigorously.  The only real solution to this problem is a class action lawsuit which is a very expensive proposition, although we have now seen Fraser Milner Casgrain, one of Canada’s largest law firms,  being sued for its involvement with a charity donation tax shelter, the Banyan Tree Foundation.  If the law firm is so confident that the scheme is safe, you should ask the lawyers for an indemnity covering all your costs and see what their response is.  I frequently hear from senior partners at major law firms that they cannot speak out honestly in public on tax shelters because another partner is making a killing off being involved with them.  The most important question that a charity or donor needs to ask their legal advisor before paying them to give a legal opinion on the matter is “Do you, or anyone else at your firm, represent donation tax shelters that CRA has alleged are abusive?”
7) Civil Penalties.  There may be various types of penalties for professional advisors, financial planners, charities, and employees of the charity involved with such schemes.

8) Reputational issues.  A charity’s reputation is usually its biggest asset.  Each charity should carefully consider how the acceptance of a type of gift or a gift from a particular donor with strings attached affects the reputation of the charity.  For charities such as hospitals and universities who receive a large amount of funding from government, those charities should consider not only public opinion and public trust, but also what their government funders who provides sometimes 80-95% of their revenue may think about the activity.  You may get in $500,000 today and have a disgruntled funder nix a $300 million contribution to a project next year.  The decision to participate in or not participate in a tax shelter donation arrangement is such an important risk management decision that the board of directors should make and be responsible for the consequence of such decision.  It should not be left to a fundraiser within the organization who may be gone in a year or two while the charity is left holding the bag.  There have been a number of large donations over the last five years where the charity regrets ever having taken the donation.  In one extreme case covered by the media the charity so badly wanted to distance itself from the donation that even after issuing a tax receipt the charity gave back the funds (This is by the way not a good idea, but I think you get the picture as to how important reputation is).

9) Professional Advisors.  A professional advisor should assume that any person that they put into one of these schemes will have significant resentment later on, and you will probably lose that client and the client will bad mouth you around town to everyone they know as payback.  The actions of some lawyers, accountants and financial planners in organizing and supporting abusive donation tax schemes is shameful. 

10) Advanced Tax Rulings.  I have seen CRA issuing a number of advanced tax rulings (ATR) on flow-through donation tax shelters recently which are being circulated like candy at a kid’s birthday party.  These ATRs are essentially meaningless for many reasons including that some of the actual donation arrangements being publicized are actually slightly different than the ATR facts and incorporate elements not covered in the ATR. Does the advance tax ruling have any meaning? Is the advanced tax ruling binding or non-binding?  If the subject matter of the advanced tax ruling is draft legislation then it may not be binding on CRA in certain circumstances.  Most of the issues that are the subject of the recent ATRs are related to draft legislation.  Also, does the advanced tax ruling have your name on it? Does the ATR transaction have to be completed by a certain date?  Look at all the caveats – it only takes one misrepresentation or even minor change to throw the whole scheme offside.  Most importantly with advanced tax rulings look at what is not included.    For example, many of the schemes talk about obtaining with a corporate donation another benefit in that there is an increase in the Capital Dividend Account (CDA) of the Canadian controlled private corporation (CCPC).  Is this in the Advanced Tax Ruling?  Could this be an “advantage”?  That is where you should get proper legal and tax advice from a trusted and impartial advisor who is not involved with representing in any capacity promoters and their donation schemes.  Remember that ATRs are requested by promoters – the promoters provide the facts that they want CRA to review – CRA does no independent investigation as to whether the facts and fair market values etc are correct.  Then CRA provides a draft to the promoter and if the promoter does not like the answer to a particular question they can retract that question and CRA removes the reference to the matter!!  Perhaps you should ask the promoter for copies of all correspondence from CRA perhaps for the last three years.  Is the “liquidity provider” really arms length?  Are the Canadian exploration expenses/flow-through mining expenditures real or just a figment of someone’s imagination like those yachts in the Caribbean that were neither yachts nor in the Caribbean.  I like the wording in the ATRs like “independent of the flow-through share offering (and without the knowledge of the Corporation…” – who in their right mind believes that the corporation after spending years arranging the scheme does not know about some important aspect of the transaction. 

11) CRA’s draft fundraising policy.  Is this a sole-sourced fundraising contract without proof of fair market value?  Is this Commission-based fundraiser remuneration or payment of fundraisers based on amount of donations?  Is the Fundraisers receiving disproportionate compensation relative to non-fundraisers in your organization?  Is this conduct that results in excessive or disproportionate private gain by individuals or corporations?  These are some questions that charities should be asking from the fundraising angle.  As well, I am concerned that some of the promoters are less than forthright in making representations about their work.  For example, one of them in an e-mail to me wrote “there is “absolutely no present or future risk to the Donor or the non-profit organization”.  Zero risk?  There is very little in this world that has no risk.  The fundraising policy provides that “Fundraising activities that are harmful because they are deceptive or misleading are prohibited and may result in revocation of registered charity status. … Fundraising activities that include misrepresentations can result in harm that detracts from the public benefit of a charity’s work. The harm caused by such misrepresentations includes deception of donors or prospective donors and impairing of the fundraising efforts of other charities. More broadly, such misrepresentations erode the voluntary private support for public benefit work that the tax treatment of charitable donations in the Income Tax Act is designed to promote.  Because of this harm, fundraising activities involving misrepresentations are prohibited even when a statement is not illegal or fraudulent. If there is significant harm associated with a deceptive or misleading statement, it does not matter whether the charity’s conduct is intentional or negligent. It does not matter whether the fundraising is done by the charity itself or by a third party on its behalf. A registered charity should take all necessary steps to ensure representations made by it, and those acting on its behalf, are fair, truthful, accurate, and complete.”

12) Fraud.  CRA is increasingly linking donation tax shelters with fraud. If you are going to invest in a tax shelter I would suggest you find a criminal lawyer who can assist you in case you require that assistance later.  You may want to read about CRA’s new initiative called “Project Trident” in which they are targeting the “Triple Threat Tax Fraud” namely “identity theft, charities-related fraud, and tax preparer fraud.”  They state in that press release “Charities-related fraud can be committed on its own, without involving identity theft or unscrupulous tax preparers. For example, a charity could be set up to sell inflated tax receipts, but perform little to no charity work.  The CRA audits charities to put a stop to such fraudulent schemes and intends to prosecute tax preparers, directors of charities, and donors who are found to be involved.”  Again I fault CRA for putting out the press release in 12 point font.  Some people do not read material in 12 point font – it needs to be bold and bigger that CRA “intends to prosecute tax preparers, directors of charities, and donors who are found to be involved.”  That means they have not done it, but they will.  Generally, when CRA threatens something they do followup.  I am not a criminal lawyer but I don’t think there is any time limitation on prosecutions for fraud.  So after three years from the assessment of your return you cannot breathe easily with some donation tax shelters.

Just in case you think that a particular charity donation scheme is “different” from the others why don’t you read about many “different” schemes that have had their charitable tax status revoked and their “investors” audited:

In summary, I don’t want to be totally unfair to donation tax shelters so I should mention that there are some legitimate reasons to “invest” in a donation tax shelter. 

1) The promoter is your deadbeat son and finally he is trying a business and you want to support him because the tax shelter is not going well.

2) You like the promoter and their half truths or in some cases outright lies and you want to make the promoter very wealthy no matter what the consequences.

3) You are lonely and you want to have a much more intimate relationship with CRA that will make the visit to the proctologist seem non-invasive. 

4) You feel you pay too little taxes and you want to pay more because when the arrangement is disallowed you will certainly be paying more to CRA in back taxes, interest and penalties (as well as the not so moderate fees to your legal advisors and your psychotherapist.  Oh you don’t have a psychotherapist – you may not have one now but perhaps later after a few years of being audited by CRA it could be a good idea).

I really wonder in many of these cases what the investor is getting?  CRA has essentially promised that any taxpayer who invests in these schemes will be audited.  It is likely that when CRA conducts the audit they will not only focus on the donation tax shelter scheme but CRA will look at other aspects of their tax and financial situation and will flag the taxpayer for future scrutiny.

Also I should not be seemingly making fun of people who have been living in a hut in Papua New Guinea for the last six years without electricity and their lack of information.  First of all, they probably would go to an internet cafe and work out the dangers of schemes like this in about 20 minutes.  Secondly, they probably have a lot more common sense than anyone who would think that investing in an abusive donation tax shelter would be legal and allowable in Canada or that it would actually be helping anyone except the promoter. 

In these tough economic times remember to support real Canadian charities with real donations.  There are so many great charities out there and the need is great.

Mark Blumberg is a lawyer at Blumberg Segal LLP in Toronto, Ontario.  He can be contacted at mark@blumbergs.ca or at 416-361-1982. To find out more about legal services that Blumbergs provides to Canadian charities and non-profits please visit www.canadiancharitylaw.ca or www.globalphilanthropy.ca

This article is for information purposes only. It is not intended to be legal advice. You should not act or abstain from acting based upon such information without first consulting a legal professional.