Tax Managed Strategy 25
As more and more corporations invest their retained earnings directly in various investment vehicles such as mutual funds and publicly traded securities, the value of their portfolio continues to grow. And as business owners build their corporation’s portfolio, they may also want to give back while taking advantage of the tax benefits of donating investment funds to charity.1 However, what many business owners may not know is that where corporate investments have increased in value, a corporate donation in kind results in a more favourable tax consequence than selling the investment and donating the cash. Let’s take a look at why this is the case and how the numbers stack up.
Sell investment and donate cash vs in-kind donation
Sell investment and donate cash
To obtain cash from an investment for the purpose of making a charitable donation, it must be liquidated. And in cases where the fair market value (FMV) of the investment exceeds the adjusted cost base (ACB), this will result in a capital gain — 50 per cent of which is taxable (subject to any unused capital losses) and 50 per cent, the non-taxable portion, is added to the corporation’s capital dividend account (CDA). Following this, once the cash is donated to a registered charity, the corporation is allowed a deduction equal to the amount donated.
The donation of an investment to a registered charity allows the corporation a deduction equal to the FMV of the investment donated and a capital gains inclusion rate that’s reduced to zero per cent.2 In other words, the tax on any capital gain arising from the disposition is eliminated — a significant savings. An additional benefit is that 100 per cent of the capital gain is added to the corporation’s CDA.3 This can result in an additional tax savings given that the amount in the CDA can be distributed as a capital dividend to the corporation’s shareholders tax free.
Here’s how the numbers stack up
To illustrate the advantage of a corporation donating an investment in kind versus selling the investment and donating the cash, let’s look at an example where a corporation holds an investment with a FMV of $10,000 and an ACB of zero.
As illustrated in the table below, liquidating the investment and donating the cash to a registered charity results in a $2,550 corporate tax liability.4 Alternatively, if the corporation donates the investment in kind, the capital gain will be eliminated resulting in no taxes owing. Furthermore, the full capital gain on the donated investment of $10,000 will be added to the corporation’s CDA.
Now, if the corporation were to distribute $10,000 to shareholders, you’ll see that in the case of an in-kind donation, 100 per cent of the dividend could be paid in the form of a capital dividend and the shareholders would receive $10,000 tax-free. Alternatively, the shareholders would only receive $8,000 after tax if the corporation sells the investment and gifts the cash. This is because only $5,000 could be paid in the form of a tax-free capital dividend and $5,000 of the distribution would need to be in the form of an ineligible dividend that would be taxed in the hands of the shareholders.5
Taking into consideration both the corporate tax (net of the refundable tax portion) and personal taxes, a total of $3,016 of taxes will be paid where the investment is sold and the cash subsequently donated versus no tax in the case of an in-kind donation. Thus, the total net tax savings of making an in-kind donation versus selling the investment and donating the proceeds is $3,016 in taxes paid at both the corporate and personal level.
By donating an investment in-kind, a corporation can:
- Avoid triggering capital gains on the donated amount
- Increase its CDA by 100 per cent of the non-taxable portion of the capital gain, which can be paid out tax-free
- Realize tax savings and make a tax-efficient distribution to its shareholders.
Corporations that are:
- Looking to liquidate an investment that has a fair market value above its adjusted cost base
- Planning to donate to charity and give back to their community
- Looking for more flexibility in terms of how and when they donate.
To take advantage of the tax savings associated with in-kind corporate donating:
- Review the corporation’s portfolio to determine which investments have a fair market value that exceeds their adjusted cost base.
- Work with the registered charity of your choice to donate an investment in kind.
1 The maximum amount of charitable donations that a corporation can claim as a deduction is equal to 75% of its net income for the year, but this limit may be increased if the corporation donates certain capital property. The corporation can’t deduct charitable donations to create or increase a loss, but unused charitable donations can be carried forward and used in any of the following five tax years. 2 Subsection 38(a.1) of the Income Tax Act (Canada) provides that there’s no capital gains tax on publicly-traded securities donated to a charity. 3 Subsection 89(1) of the Income Tax Act (Canada) allows for the non-taxable portion of the capital gain to be added to the corporation’s capital dividend account and can be distributed to shareholders tax free. 4 Assumes a 51% tax rate on investment income. Only 50% of realized capital gains are taxed at this rate (25.5%). 5 Assumes the CDA balance was zero before the in-kind donation or sale and donation
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