By Les Ross
Based on a recent survey released in 2018 by the Rideau Hall Foundation [link to https://www.rhf-frh.ca/wp-content/uploads/2018/04/RHF_30years_Report_eng_FNL.pdf], Canadians donate $18.5 billion to charity per year, with $14.3 billion coming from individuals and $4.2 billion donated by corporations, both privately and publicly owned. The report concluded that the greatest motivators to give are personal and ideological reasons, with tax savings ranking as a very low motivator for giving. However, among those who give, the one factor that had the greatest impact on the size of donation, is tax savings.
Before jumping into the tax discussion, let’s acknowledge that many companies choose to make a difference by supporting charities in Canada for reasons other than tax savings. Imagine Canada [link to https://www.imaginecanada.ca/caring-companies/list ] recognizes “Caring Companies” that give at least 1percent of pre-tax profits back to their communities”. PearTree Canada is proud to be one of those Caring Companies.
Just like individual donors, companies receive a charitable donation tax receipt for the value of their gift. In both instances the donation tax receipt can be carried forward for up to five years to reduce future years’ income tax payable.
The income tax rates for individuals and companies vary by province, so for the purposes of this discussion, I will focus on our most populous province, Ontario, and assume a Canadian Controlled Private Corporation (CCPC) to be a donor. For an operating company earning over $500K of income in Ontario, the income tax rate is 26.5 percent, so a $100 cash donation would generate $26.50 in tax savings. For a holding company earning passive investment income, the [usual] income tax rate is 50.17 percent, so a $100 donation would generate $50.17 in tax savings. For an individual paying tax at the top rate of 53.53 percent in Ontario, a $100 cash donation would generate tax savings of 50.41 percent, or $50.41. So the order of tax efficiency for the donor making a cash donation is: 1. Holding company; 2. Individual; and 3. Operating company.
However, consider the significant savings that could be achieved if the donation was made through PearTree’s Flow Through Share Donation (FTSD) Format. When looking at the savings achievable with a corporate FTSD, we calculate the integrated after-tax cost of giving, which takes into account tax savings available to both the shareholder and the corporation. Here is a comparison of the after-tax cost of a cash donation and of a FTSD in Ontario, assuming a $100,000 donation.
After-tax Cost of Giving Comparison in Ontario using $100,000 Donation (assumes donors are subject to the highest marginal income tax rates)
Because the tax rates for individuals in the top tax bracket are so punitive, many accountants suggest that business owners generating active business income pay out sufficient T4 income or dividends to fund lifestyle expenses and invest the balance of the corporate earnings in a holding company. As a result, many very successful business owners are not in the top tax bracket personally and therefore not in a position to obtain maximum tax benefit from a personal donation. In addition, Alternative Minimum Tax (AMT) is a constraint that needs to be addressed. With a FTSD, the $100,000 donor would need almost $900,000 of T4 income in order to realize all of the tax savings in the current taxation year. However, AMT is very rarely a constraint on corporations making donations with a FTSD, so the same $100,000 donation by a corporation would require less than $400,000 of taxable income.
It is worth noting that less than half of the flow through share deductions relating to a corporate FTSD, are able to be written off in year one. The remaining pool of deductions are available to write off against future years’ income to continue to reduce the integrated after-tax cost of giving. Another significant benefit of the corporate donation format is the creation of almost $2 of Capital Dividend Account (CDA) room for each $1 of donation. The CDA enables private company shareholders to withdraw capital from the company tax free, something very attractive to business owners. In our experience, given the choice, most business owners will make their FTSD in their corporation rather than personally, in order to maximize the tax savings. Even though the integrated after-tax cost of giving in an operating company is greater than the personal cost of giving in year one, the tax savings in future years result in a cost of giving much less than the 19.95 percent after-tax cost of giving personally, with a FTSD. A FTSD by a holding company will immediately result in a much lower cost than the personal after-tax cost of giving, when using a FTSD. With an operating company, the same is true, although not immediately in the year of donation.
Importantly, it is worth pointing out that whether making a gift personally or in a corporation, a FTSD materially reduces the after-tax cost of the gift, compared to a gift of cash.
Les Ross is vice president of business development for PearTree Financial.
Disclaimer: The analysis presented herein is based on a number of assumptions. PearTree recommends all clients work closely with their advisors to test for applicability of our format to their gifting. It is important that prospective donors are advised to obtain independent tax, legal, and/or wealth management advice on the planning implications for making a gift of flow through shares.
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