New laws, court decision put an end to charitable donation tax shelters
By Arthur Drache
Over the past few years, tax shelter promoters have tried to develop
charitable donations as a method of sheltering income. This technique
was fuelled by the fact that Canada has one of the most generous tax regimes
in the world to encourage charitable donations. But the fact of the matter
is that the benefits of such tax-driven schemes have all relied upon the
donor acquiring the property – whether it be art, drugs, comic books
or anything else – at a price that is much lower than the value
assigned to the goods when they are donated to the charity.
The government responded by introducing a range of legislative changes
designed to limit the ability to use the “buy low, donate high”
schemes. These have included a change to the listed personal property
rules that had given a big capital gains break for low value gifts (under
$1,000 per item); a requirement that promoters register the schemes as
tax shelters; third-party penalties when appraisals are egregiously high;
and a provision introduced at the end of 2003 that generally requires
that the value of the donation must be set at the purchase price if the
donation is made within three years of acquisition.1
In addition to these initiatives, the Canada Revenue Agency (CRA) has
challenged the validity of donations made in earlier years before these
various statutory amendments were enacted. The vast majority of these
cases, about 5,000 at a minimum, involved so-called art flips in which
promoters sold packages to “investors,” arranged for donations
to registered charities and also arranged for appraisals of the works.
The challenges by the CRA took a number of forms, but most of them essentially
said that there was no gift because the donor never had possession of
the property and the gifts were not personal listed property (which would
have meant that capital gains taxes would have nullified much of the value).
It also challenged the appraisals. In almost every case, the tax authorities
also imposed penalties and interest.
In February, the first major art flip case was decided and to all intents
and purposes, it shapes up as bad news for those who bought low and donated
high. What still has to be determined is whether it has negative implications
for those organizations that received donations of art under the schemes.
The case nominally involved Toronto brokerage executive Frank Klotz’s
claim that 250 original prints he purchased for about $75,000 US on Dec.
28, 1999, had increased in value by 300% two days later when he made a
charitable donation of the prints to Florida State University2 in Tallahassee.
In fact, this case was a surrogate for about 660 similar cases.
In a decision handed down in mid-February, Associate Chief Justice D.G.H.
Bowman of the Tax Court of Canada found against Klotz on the issue of
valuation, though the taxpayer was successful on a couple of key legal
points. As we have always said would be the case, the whole issue revolved
around the appraisals.
The prints in question, bought for about $300 US each, were subsequently
appraised as to their “fair market value” by Kathleen Laverty,
an accredited member of the International Society of Appraisers from Edmonton,
and Roger Woltjen, another Edmonton appraiser.
However, Woltjen’s appraisal was “not tendered as an expert
witness report,” nor was Woltjen called as an expert witness. As
a result, Justice Bowman concentrated much of his attention on Laverty’s
appraisals, which he deemed inadequate and unworthy of acceptance. “I
am prepared to assume, without any real evidence, that the odd print of
a particular artist might sell for $1,000. I am not, however, prepared
to leap from that speculative assumption to the conclusion that, on Dec.
30, 1999, 100 of that artist’s prints would sell for $100,000 in
the open market,” he wrote in his decision in which he accepted
CRA’s argument that the prints should be valued at their purchase
price of $75,000.
Laverty, Justice Bowman argued, “picked the wrong market. ... We
are not valuing an individual print. We are valuing 250 prints given en
masse to a university. What is to be valued is the totality of that gift
and one must look to what those 250 prints would fetch on the open market.”
There are two “bright sides” to the Bowman judgment insofar
as art donors are concerned.
First, the judge refused to impose penalties that CRA was asking for,
saying that Klotz, although “careless about verifying the value”
of the prints he bought and donated, shouldn’t have to pay a penalty
because he relied in good faith, rather than fraudulently, on the opinions
of a trusted financial adviser as well as those of a certified appraiser
and two law firms. Bowman’s comments on the legal opinions offered
to potential buyers were acerbic, noting that they were long on generalizations
and short on any opinion that could be relied upon.
Second, he accepted the fact that the pictures were personal use property,
meaning that gains on works valued at less than $1,000 would not be subject
to tax. Bowman ruled that, in his opinion, the 250 works of art met the
test of personal-use property since “one way of using an object
is to give it away, whether the motive be altruistic, charitable or fiscal.”
The Klotz case was the first big test of the art flip schemes. The lawyers
involved were first rate and the judge arguably the best of those sitting
on the Tax Court. The result, we have to say, was predictable. The taxpayer
won the key points of law and the Crown won the important issue, namely
whether the valuations did reflect fair market value.
This case does not settle all of the other pending cases, numbered in
the thousands. The legal issues may have been settled (in favour of the
taxpayer), but it is highly likely that an appeal will be filed. Each
of the other cases can potentially be fought on the specifics of the appraisals
and their qualities. It remains to be seen what approach the CRA will
take in dealing with the balance of the taxpayers who have filed objections
or notices of appeal.
However, given the case law and the legislative initiatives, it seems
that the era of using charities as vehicles for personal tax planning
has ended. From now on, those who donate to charities will be motivated
by a desire to help the organizations and will take comfort in the fact
that the tax system ensures that they will not be penalized for their
generosity even if they get no additional financial bonuses.
1The provision has not as yet been enacted but will be retroactive in effect
to December 5, 2003.
2 This is a Schedule VIII university and thus is a “qualified donee”
under Canadian law.
Copyright © 2004 by Arthur Drache. All rights reserved.
Arthur Drache is a partner of Drache, Buchmayer, LLP and specializes in all areas of personal tax and estate planning. The opinions and views expressed herein are those of the author and not those of CI Investments Inc. CI Investments Inc. does not necessarily endorse or encourage any specific tax strategies. Please consult a tax professional for advice specific to your particular situation.