Donate a gift you paid ten thousand dollars for to a charity and receive a tax receipt for fifty thousand dollars. That’s the sales pitch of some donation organizations that are increasingly using broker and investment advisor distribution channels. But experts warn that you need to first verify if the donation program is legitimate or not before recommending them to your clients.
The donation programs are based on the federal government’s tax incentive program known as “gifts-in-kind,” where property other than cash is donated to a registered charity. The goal of this tax incentive is to ensure that charities are able to raise sufficient funds or receive gifts needed for their charity.
Canadians receive a tax receipt for the fair market value (FMV) of the gift (see inset text: “What is the Fair Market Value?”). An appraiser, not associated with either the donor or the institution receiving the gift, must determine the FMV.
These strategies are nothing new, but the fact that these donation-type programs are looking to recruit life brokers is. Some of these organizations’ goals are to target brokers who would be interested in pitching tax relief strategies to their high net worth clients. In return, they would be compensated with high commissions and bonuses.
CCRA: “It’s legit!”
Before brokers begin taking part in tax shelter initiatives, Canada Customs and Revenue Agency (CCRA) warns of deals that seem too tempting. It says: “if it sounds too good to be true, it probably is.”
The CCRA explains that donating gifts-in-kind to registered charities is a legitimate charitable activity. Nonetheless, taxpayers should be aware of the risks associated with certain donation schemes, which have the effect of cheating the government out of taxes that should be paid. Many of the schemes involved artwork donations, often referred to as “art-flipping.” New schemes involving different goods are also now being used (see inset text “Art flipping”).
Tim Cestnick, tax author, expert and Managing Director of National Tax Services for AIC Limited, says it makes sense for these organizations to target life insurance brokers. “People who sell strictly mutual funds and stocks are probably not allowed to sell this. They cannot be compensated for it because of strict regulations of what they can and cannot receive commissions for, unless the product is on the company approved list. As well, they are not allowed to accept gifts such as trips. So the only people who can sell it are people who work for themselves and can take commission payments.”
Vic Jindal, President of Jindal Financial Group in London, Ontario, is one brokerage that was recently visited by a donation group from Guelph, Ontario looking to recruit life brokers. Mr. Jindal preferred not to disclose the name of the group.
He explains that the group’s representative managed to schedule an appointment with Mr. Jindal by telling his secretary he was an insurance company representative and making it seem he was a referral. “My assistant gave him an appointment, and two minutes into it, I felt very uncomfortable with the concept,” he says.
This particular organization’s strategy is to offer goods such as vases to charities, which the charity could then resell to purchase things such as food, beds, etc.
The example the organization used to describe its system was as follows, says Mr. Jindal. It would offer to donate 1,000 units of glass vases to a charity. It would then purchase one glass vase at a store such as Sears for $20, to prove the FMV. However, the organization would then import 1,000 units of an imitation version of the vase from Asia that they instead paid $10 for each. In return, the organization would receive a tax receipt for $20 times 1,000 vases.
“Plain and simple, it seems more than sketchy to me, and I cannot even believe that it would be legal. If there was ever an audit of a charity and or person that was doing this, I would feel CCRA would completely disallow it because the true intent of the gift is really more of bending the rules,” says Mr. Jindal.
“I cannot possibly go to a client and suggest something like this because it is morally and ethically wrong,” he states.
“Even if there is one broker that falls into this, there is no protection for that individual right now. I feel that there has to be some sort of regulatory body or it should fall under an insurance and/or security law. But there is no regulation,” he remarks.
Upon the visit, Mr. Jindal posted a notice on the chat list For Advisor’s Only and received a lot of broker feedback concerned about such initiatives. As well, he called the Financial Services Commission of Ontario (FSCO) to inform it of the offer he received. He has yet to receive a response.
The Insurance Journal also contacted FSCO, Advocis, the Canadian Life and Health Insurance Association (CLHIA) and the Ontario Securities Commission (OSC). None of the organizations said they were aware of such strategies, though Advocis said it would now be on high alert.
Mr. Jindal says that questions broker should ask first and foremost are: is this basically a regulated product?
Does it seem morally and ethically reasonable as a proposition to your client? And if you propose it to your clients, would your lawyers, accountants and the CCRA agree with the proposition?
He adds that it is important to also question the appraisers determining the FMV, since they may also be part of the illegitimate deal.
For the children
Canadian Gift Initiatives (CGI) is another organization with a donation program. It is currently recruiting life brokers to find Canadian donors interested in purchasing pharmaceuticals for children in Iraq and Africa. It is working in conjunction with a number of Canadian-based charities including, Children’s Emergency Foundation, Escarpment Biosphere Foundation and Canadian Physicians for Aid and Relief. Feed the Children International, specifically its U.S. and U.K. offices, are helping to distribute the pharmaceuticals.
CGI works as an intermediary or transfer agent between the donor and the charity. It obtains pharmaceuticals at cost which donors are asked to purchase. In return, the donor receives a credit for the FMV of the gift, which is higher than what they paid, and the brokers make a commission from the transaction.
The promoters stress that they are a legitimate deal and refuse to be grouped with shady tax shelter programs.
No license is required to make the sale since it does not fall under securities regulations, says Leonard Bellan, Chairman of CGI. As well, if a broker sells a million dollars worth of pharmaceuticals, they will be awarded a free trip to Africa.
David Franklin, legal advisor with CGI, gives an example of an individual who wants to donate 1,000 pens to a charity. If the individual manages to get 1,000 pens at fifty cents each, he just has to prove the real FMV of one pen to the charity. If he goes to Wal-Mart and finds the same pen at one dollar, he buys one to prove the FMV is one dollar, and in turn will receive a tax receipt for $1,000 for the pens he donated.
The same principle is at play with CGI, where the donor is buying pharmaceuticals at a lower cost than the FMV.
Mr. Bellan stresses, “the culture of CGI is not a culture of tax shelter, but a culture of international development, fund raising and management using tax shelters.” He adds, “We feel we are very unique in that we produce a program that a charity really uses in their programming…. In my view there was no better product than pharmaceuticals and there is a terrific demand in the world for fresh pharmaceuticals…. We are really concerned with the integrity of the supply chain of the product and that it actually ends up for development purposes.”
He adds that CGI is aware of CCRA’s concerns of total abuse of these programs and says that CGI meets the requirements of dealing with registered charities and following the regulations. He stresses that lawyers and accountants have reviewed the CGI program.
Another organization targeting brokers is Thornhill-based Global Learning Systems (GLS). The organization was a hot topic on the For Advisors Only chat list, where brokers questioned its validity. GLS’ goal is to provide course material (software, computers etc.) for Canadian registered charities. It operates the same way as CGI in that it solely acts as the facilitator between the charity and the donor.
Instead of pharmaceuticals, the organization proposes donors purchase packages consisting of learning software. If someone purchases the $5,000 package the tax receipt will show a FMV of $30,000. There is also a $10,000 package with a FMV of $60,000. The donor declares a capital gain and receives a charitable donation receipt.
“In principle these ideas can work. You can buy something at a discount and donate it for a higher value. The problem with programs like CGI is that no one is really sure what the FMV is of these supplies,” states Mr. Cestnick.
It is clear the donors are taking part in the initiative solely to get a tax break, Mr. Cestnick remarks. He adds that the intent is not to help somebody since the donors never take possession of these medical supplies. “That is one problem that will cause Revenue Canada to take offence,” he stresses.
The CCRA will then attempt to shut down that tax shelter and the easiest way to do that is for it to argue the FMV is really less than what the donation receipt says. “Whether that is true is open to debate,” he adds.
Mr. Cestnick reveals that though Canada’s tax law will not deny a donation receipt solely because the intent was to save tax, it will still cause CCRA to raise an eyebrow and investigate.
He explains that if he were a broker giving advice to a client, he would be upfront and clear. “If somebody gives advice that it is a good idea and it turns out a bad idea because Revenue Canada disallows the donation, brokers can end up with upset clients and risk losing them altogether.”
“If I were to sit down with a client, I would say, ‘technically speaking it works, but there is a risk Revenue Canada will disagree with the value and your donation receipt will be reduced.’ … I would then leave it up to the client to decide.” He adds, however, if advisors do not fully understand the risks, they should avoid mentioning the initiative to clients altogether.
Prepare...just in case
Mr. Cestnick also suggests brokers advise clients taking part in the deal to take the tax savings and invest it, in case the CCRA disallows the donation and says the client owes money back. “Set it aside for three years. After three years the tax return is statute barred (the government cannot come back and review it again).”
He says the CCRA could do an audit of each organization but that is a very lengthy process. Instead, Mr. Cestnick predicts that, come the next federal budget, the government will revise its charitable giving process. “It may introduce provisions that deal specifically with charitable donations where a donor does not take possession of the goods or it is clear that the FMV is too high and will in turn restrict particular shelters or shut them down altogether.”
Check it out online
Colette Gentes-Hawn, a spokesperson for CCRA, says, “I would like them [donors] to make sure that what they are buying is real and that it is being given to a charity that is registered and indeed it has a fair market value.” Ms. Gentes-Hawn also says that all registered charities in Canada are listed on the CCRA website, www.ccra-adrc.gc.ca/tax/charities/, and brokers should check if it is there.
Ms. Gentes-Hawn adds that upon studying the tax return, CCRA may audit the gift and/or charity if things seem suspicious. If the donation is found not to be a true gift or that the value was inflated, the donation in turn would be disallowed, giving the broker a bad name. There are also penalties for third parties, such as the promoters or appraisers of the gift or even the charity itself. Third-party penalties are based on the amount of tax the third party allowed others to evade. As well, the charity may face loss of its registered status.
Noted Canadian expert, Arthur Drache, a lawyer with the Ottawa-based firm Drache, Burke-Robertson & Buchmayer is in favour of gifts-in-kind initiatives. He says that the CCRA rules are clear and that there is nothing wrong with receiving a tax receipt for the FMV of the gift. However, he emphasizes that it is vital to distinguish between genuine charitable donations, which have tax benefits, and fraud.
“There is no doubt, and particularly in Quebec, there has been a whole bunch of cases with clearly fraudulent appraisals. But fraud is fraud. You cannot take the position that all tax incentives should be abandoned because some people cheat, because people cheat all the time on everything,” he says. He adds that a number of charities in Quebec were deregistered because they were working hand-in-glove to cheat the system.
What is the Fair Market Value?
According to the Canada Customs and Revenue Agency (CCRA), the fair market value (FMV) is the, “highest price, expressed in a dollar amount, that the property would bring in an open and unrestricted market, between a willing buyer and a willing seller who are both knowledgeable, informed, and prudent, and who are acting independently of each other.”
Donors are allowed to deduct charitable gifts up to the applicable net income limit in calculating their taxable income. Results will vary from province to province based on the individual’s residence and marginal tax rates. The total amount of charitable gifts eligible for a tax credit in a particular taxation year is 75% of the individual’s net income for the year and added to that 75% limit, a 25% preferential rate for taxable capital gain resulting from the gain.