The tax benefits that arise from cash donations and the donation of publicly-traded securities are quite well-known and are often used by taxpayers to meet their charitable objectives and reduce their tax bill. However, the tax benefits that can arise to taxpayers from the donation of private company shares are often overlooked and are not widely considered as part of tax planning strategies.
The Tax Results
At first glance, it would appear that the donation of private company shares can never be beneficial. Unlike the case where publicly-traded securities are donated, any difference between the fair market value (“FMV”) and the adjusted cost base (“ACB”) of the private company shares will be subject to a capital gain and taxed accordingly upon the donation. However, the tax benefits can still be significant.
Consider an example where Mr. A owns fixed value preference shares of a private company with a FMV of $1,000,000, an ACB of $1,000, and paid-up capital (“PUC”) of $1,000. Mr. A falls within the highest tax bracket in Ontario and is looking to donate to his favorite charitable foundation.
Mr. A has the option of either redeeming his shares and donating the after-tax funds to the foundation (“Alternative 1”), or he can donate the shares directly to the foundation (“Alternative 2”).
Under Alternative 1, there is a net tax cost of $208,1301. Under Alternative 2, there is net tax savings of $236,7682. The significant difference in savings of almost $450,000 under Alternative 2 arises for two reasons:
Key Benefits
Estate Benefits
In a typical estate freeze involving a family-owned private company, the first generation will be left with fixed value preference shares (with high value, low ACB, and low PUC). If nothing is done with the shares following the estate freeze, the inherent gain on the shares will be taxable on the death of the taxpayer3. Further, the FMV of the shares will be subject to provincial probate fees4. Donating the shares during the life of the taxpayer will avoid tax on death, probate fees, and any further estate planning requirements with respect to the shares since the shares will not form part of the estate.
Other Key Benefits
Important Considerations
There are many issues that need to be considered before a taxpayer decides to donate his/her private company shares:
Conclusion
The tax benefits that can arise from the donation of private company shares can be significant. However, there are a myriad of rules and considerations that would need to be managed to ensure that the donation of the shares afford the benefits that have been described above.
1
Tax on Redemption |
$ (473,526) |
[$999,000 deemed dividend * 47.40%*] |
Donation Tax Credit |
$ 265,396 |
[($1,000,000 - $473,526) * 50.41%] |
Net Tax Savings (Cost) |
$ (208,130) |
|
*Assuming the company has no amount in its General Rate Income Pool (“GRIP”) account.
2
Tax on Capital Gain |
$ (267,332) |
[$999,000 capital gain * 26.76%] |
Donation Tax Credit |
$ 504,100 |
[$1,000,000 * 50.41%] |
Net Tax Savings (Cost) |
$ 236,768 |
|
3 Unless a loss-carryback strategy is utilized, in which a taxable dividend will likely arise to the estate in its first taxation year.
4 Unless planning is undertaken to include the shares of the private company as part of a secondary will.
5 Anti-avoidance rules that could deny the dividend refund do exist and must be considered.