What sort of problems do Canadian abusive charity gifting tax shelters cause?

Abusive charity gifting tax shelters cause many problems for both donors and charities.

Some of the many potential concerns that have been raised with abusive 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?

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 and referral network 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. There are also another two law firms that have been sued for providing allegedly negligent legal opinions. 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 funder who may provide 80-95% of their revenue may think about the activity. You may get in $500,000 today and have a disgruntled funder nix a $100 million contribution to a capital 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 are very problematic.

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 fundraising guidance. 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 guidance provides that “Deceptive fundraising practices cause harm by deceiving donors or potential donors and by impairing the fundraising efforts of other charities. Because of this harm, fundraising activities involving misrepresentations are prohibited even when the misrepresentation is not illegal or fraudulent. There is significant harm associated with a deceptive or misleading statement, regardless of whether the charity’s conduct is intentional or negligent. A registered charity should ensure representations made by it, and those acting on its behalf, are fair, truthful, accurate, and complete. Misrepresentations have a negative impact on public trust and the integrity of the tax regime governing registered charities. The CRA takes the position that this negative impact outweighs the public benefit of the charitable work supported through a charity’s fundraising.”

12) Fraud. CRA is increasingly linking innapropriate receipting with fraud. If you are going to receive a large donation receipt that you know you are not entitled to 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 CRAintends 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 follow-up.