Flow-Through Share Donation: A Powerful Way to Multiply Your Charitable Donations
If there was a way that you could donate $100,000 to a charity at an after-tax cost of only $13,000, rather than the $50,000 after-tax cost of a cash donation, would you consider it?
This is exactly what happens when you use a Flow-Through Share Donation (FTSD) gifting arrangement.
Flow-through shares have been around since the 1970s. These are special shares of mining, oil and gas, renewable energy and energy conservation companies designed to encourage investment in those sectors by enabling investors to write off the financed exploration and development expenses against their income, as well as accessing Federal and Provincial Investment Tax Credits, in certain circumstances.
Canada’s Income Tax Act allows issuers to agree that they will transfer or “renounce” their exploration expenses to individual investors. Companies that have revenue may not wish to do this, since they would want to apply those expenses against their income to reduce or eliminate their own tax liabilities. But junior exploration and mining companies, which usually have no significant revenue, won’t need those expenses because it is likely that their exploration expenses exceed their income and they won’t be paying any income tax.
It therefore makes sense for this type of companies to pass on those expenses to individual investors, who will happily apply them against their personal incomes. The higher the income tax bracket of the investor the higher the tax benefits of investing in flow-through shares would be.
If you purchase flow-through shares of qualifying companies, you can deduct up to 100% of the cost of the shares from your personal income. Flow-through shares, however, are deemed to have a cost base of zero. Therefore, if you purchased the share for $1 and sold it for $1, you would have a capital gain of $1. Due to the fact that you will have an income tax deduction of $1 as a result of the purchase of the flow-through share, and because only 50% of capital gains is included in your taxable income you would still have a net after-tax benefit from purchasing Flow-through shares.
Major gift donors to Canadian charities have been using the Flow-through Share Donation gifting format to significantly reduce the after-tax cost of their charitable gifts while ensuring that the charities of their choice receive the full pledge amount immediately on closing, net of all fees and expenses.
The first structured FTSD gifting arrangement took place in 2007 and received Advanced Tax Rulings from Canada Revenue Agency (CRA) and Revenu Quebec. Since then billions of dollars have been raised by natural resource companies using the Flow-through Share Donation format, funding exploration and development, while also enabling various Canadian charities to help donors achieve their philanthropic intentions at a fraction of the after-tax cost of a cash donation.
This strategy is available to accredited investors who intend to make major gifts to Canadian charities. Each gifting arrangement is registered as a tax shelter with the CRA and involves a series of simultaneous transactions. The investment banking arm of the FTSD provider first negotiates a bought deal financing with a natural resource company. Using this strategy, the Issuer raises equity capital in the least dilutive manner possible, because the subscriber pays a premium to market price to access the tax benefits.
These transactions typically close within four weeks from announcement. In the meantime, the FTSD provider contacts charities, advisors and investors requesting participation in the deal. The donors who are interested in participating in the deal must have their documentation and financing in place before the deal closes. The donor subscribes to flow-through shares thus accessing the Canadian Exploration Expense (CEE) and associated Federal and Provincial investment tax credit benefits and can write off the entire purchase amount against income. The donor then immediately donates the shares to the charity of their choice.
Upon receipt of the shares, the charity immediately sells the shares to pre-arranged institutional investors and the donor receives a charitable donation tax receipt for the full value of the shares donated equal to the net intended gift plus the closing costs. All transaction costs are funded by the donor and paid by the charity, resulting in receipt of the intended gift amount in full.
The format enables the donor to also simultaneously sell some of the shares to the same end buyer that will purchase the shares from the charity at the same price that the shares are sold by the charity according to a deal pre-arranged by the FTSD provider. The donor and the charity receive the proceeds of sale of their shares simultaneously.
This strategy can multiply major gift donations. In all Canadian jurisdictions, a $100,000 gift will cost between $5,000 and $15,000 (5% – 15%) after-tax depending on the province. In Ontario the net cost of a personal donation is about $12,950, for a donor in the highest marginal tax bracket.
This donation strategy can be as powerful for Canadian Controlled Private Corporations. Corporations have a notional account called the Capital Dividend Account. The non-taxable portion of capital gains can be credited to the CDA and flowed out of the company to the shareholder on a tax-free basis. As a result of income tax changes that were implemented in 2012, capital gains tax is payable on donation of flow-through shares to charities. This generates Capital Dividend Account creation of almost $2 per each one dollar of donation, with the amount varying by province.
While the major portion of the deductions are achieved in the first year of the donation, the ability to write off the CDE pool over time continually reduces the cost of giving over future years.
Here is an example of the tax savings on a $100,000 donation using the FTSD strategy versus a cash donation for a donor who is in the highest marginal tax bracket in Ontario:
Source: PearTree Canada
FTSD structures use tax incentives available to all Canadians but the market risk normally associated with a flow-through share purchase is mitigated by arranging for the immediate sale of the shares, on date of issuance, to an end buyer, at an agreed price, negotiated at arm’s length by the FTSD provider. The Advance Tax Rulings by CRA and Revenue Quebec have also confirmed that this strategy works from a tax perspective, so long as the format set out in the rulings is strictly adhered to.
Currently there are a few providers of the FTSD gifting arrangement in Canada, including PearTree Canada, Oberon, WCPD, and Bertov. It is important for you and your tax advisor to perform due diligence on the providers and ensure that their strategy complies with CRA Advance Tax Rulings and that proper risk management protocols are in place.
A properly structured FTSD gifting arrangement can not only benefit Canada’s economy and Northern and Aboriginal communities by increasing investments in mining, oil and gas, renewable energy and energy conservation industries, but can also benefit the charitable sector and help Canadian philanthropists multiply the impact of their donations, by giving more, while maintaining or reducing their after-tax cost of giving.
Tina Tehranchian, MA, CFP®, CLU®, CHFC®, is a FP CanadaTM Fellow and a senior wealth advisor and branch manager at Assante Capital Management Ltd. in Richmond Hill Ontario. She can be reached at (905) 707-5220 or through her website at www.tinatehranchian.com. Assante Capital Management Ltd. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada.