For successful business owners, donating shares in their private corporation to a registered charity can provide the opportunity to fulfil significant philanthropic goals. The charity can be either a charitable organization or a public or private foundation. When executed with careful, thought through planning, the donation can attain such goals while significantly reducing capital gains tax exposure.
Successfully achieving the goals of making a major charitable donation and reducing tax exposure involves integrating estate planning with strategic donations of securities from a private corporation. By leveraging the tax benefits associated with charitable giving and the unique attributes of private corporation securities, individuals can create a legacy that benefits both the community, and their heirs.
In Canada, donations made to registered charities are eligible for non-refundable tax credits, resulting in a reduction of the donor’s income tax payable. While publicly traded securities are commonly donated, high-net-worth individuals who own shares in private corporations can also leverage this strategy effectively.
By donating preferred shares with a fixed value from a private corporation, donors can potentially benefit by more than 36% of the value of the donation.
Jeffrey Miller, PartnerIn the example below, we explain how careful planning can potentially save a business owner in Ontario $3,648,500 in out-of-pocket costs when donating $10,000,000 to a registered charity.
Scenario #1 – Donating Cash from an Active Business
In this scenario, the owner of the business donates $10,000,000 in cash to the charity directly from the active business. The cash donation from the business saves the business 26.5% of the $10,000,000 in corporate tax, or $2,650,000; that makes the net after-tax cost of the donation $7,350,000.
In this scenario, the business owner retains all their shares in the business. Upon death of the shareholder, their estate will, with proper planning, pay estate tax of 39.34% on the $10,000,000 value of the shares, or $3,934,000. The estate tax, combined with the net $7,350,000 paid by the company, brings the combined net out-of-pocket costs to $11,284,000.
Scenario #2 – Owner Donates Preferred Shares
In this scenario, instead of the business donating $10,000,000 to the charity, the business owner donates $10,000,000 worth of their preferred shares in the business; the company then redeems the shares to provide the charity with $10,000,000 in cash.
The year the donation is made, the business owner will have to pay 26.765% tax on the value of the donated shares as it is to be reported as a capital gain on the filing of their personal tax return. In this scenario, the tax payable would be $2,676,500. However, they will also be entitled to a tax credit of 50.41% of the donation, or $5,041,000. This tax credit can be used in the same year as the gift, and any credit not used can be carried forward to be used in subsequent years. Assuming, with advanced planning, that the owner will have sufficient income to use this tax credit either in the year of the donation or in future years, their net out-of-pocket costs in this scenario would be $7,635,500. There would be no additional estate tax on the passing of the business owner as they no longer own those shares.
By donating the preferred shares to the charity instead of making a cash donation from the business, the business owner is ahead by $3,648,500!
The two donation options are illustrated in the table below.
| Scenario #1 Business Donates Cash | Scenario #2 Owner Donates Shares | ||
| Company donates cash | $10,000,000 | Owner donates preferred shares redeemed by company | $10,000,000 |
| Corporate tax savings | -$2,650,000 | ||
| Personal tax paid on share disposition | $2,676,500 | ||
| Personal charitable donation receipt | -$5,041,000 | ||
| Estate tax on death of $10M in preferred shares | $3,934,000 | ||
| Total out-of-pocket cost | $11,284,000 | Total out of pocket cost | $7,635,500 |
Net benefit from scenario #2 is $3,648,500
In both scenarios, the charity receives $10,000,000. The cost to the Ontario business owner in scenario #2 is $3,648,500 less than if the company made a straight cash donation.
While every business owner’s situation is different and influenced by factors such as on-going annual income, the potential savings are significant and worth exploring. Note that while the Alternative Minimum Tax regime may apply in certain cases, this tax is normally recovered over future years and is regarded as a timing difference.
Preferred Shares Required
For scenario #2 to work, the donation should be made with preferred shares that have a fixed value. Fixed value preferred shares are often generated during estate freezes, but a freeze is not absolutely necessary as these shares can be created at any time, as long as there is value in the company. If you do not already have preferred shares, they can be created for you in advance of the donation.
Making a substantial donation to a registered charity is an important way to give back for many successful business owners. With careful planning, a donation can be done in a tax effective manner that provides the charity and heirs with the best possible outcome.
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