Category: Insurance Journal

Tax effect if a charity returns a donated life insurance policy to a policyholder

At issue

Most people donate to charity by cash or its equivalent, whether on a one-off basis or as a periodic routine. This allows the donor to take an immediate tax benefit from the donation and for the charity to use funds for current needs. However, when longer term projects are contemplated, it may be desirable to establish a ‘planned giving’ arrangement, and that’s often when life insurance comes into consideration.

One way to do this is to name the charity as beneficiary on a policy owned by the donor. That person pays the annual premiums, with the tax benefit coming to the estate when the proceeds are paid at death. While the charity expects to eventually receive the money, the policyholder usually retains the ability to change the beneficiary, in which case the charity may ultimately get nothing.

For the charity’s greater certainty, the policy itself could be donated so the charity controls it. The donor receives tax credit for the value of the policy (if any) in the year of donation, plus year-to-year credit for any further premiums paid on the charity-owned policy. Of course, the donor may still have a change of heart, and though the charity could technically continue to carry the policy, that may be politically unpalatable. But is it even legally possible to return a policy, and if so then what are the tax implications for charity and donor?

CRA Guidance CG-016, Qualified donees – Consequences of returning donated property

The CRA’s guidance on this issue warns off the top that it is a legal issue whether a gift has been made and whether circumstances allow for a return by the charity. The guide focuses on the tax result on those “rare and unique circumstances” when there is a legal requirement for a charity to return a gift.

Assuming that the return of the property fits this test (or is believed to fit), an information return outlining the particulars must be filed with the CRA within 90 days. If the test is not met, this would likely be construed as a gift to a non-qualified donee, or the provision of an undue benefit. The penalty for such action is 105% of the value, or 110% on a repeat infraction, all the way up to revocation of registered status in egregious situations.

For a donor, there will be a reassessment of any year’s tax return related to the returned property, with any claimed charitable tax credits disallowed. This may be mitigated by the fact that the taxpayer is deemed not to have disposed of the property in the first place if the original property is returned. No mention is made of interest on related reduced/unpaid taxes, so presumably the normal rules apply.

CRA 2016-0630351E5 – Return of a gift

A taxpayer had gifted a whole life insurance policy to a charitable foundation in 1981, and now sought the return of that policy on the basis that a condition of the gift had not been fulfilled.

The foundation raises money to support a particular college, and the gift was made conditional on the proceeds being used to create a scholarship in a specific program. When the program was terminated, the taxpayer sought the return of the policy. The foundation was willing to comply, but on condition that the taxpayer obtain assurance from CRA that this would not negatively affect the foundation’s charitable status. This technical interpretation is the response to the taxpayer’s inquiry.

The writer on behalf of CRA repeats the relevant provisions of CG-016 (summarized above) with respect to the charity’s reporting obligations and the taxpayer’s exposure to reassessment.

However, it could not assist on the two key issues: whether the gift was subject to a condition, and whether the foundation could legally return the policy. The former requires a determination of the facts, and the latter a review of applicable legislation, both of which are outside the scope of a technical interpretation.

Practice points

  1. Donations to charity are almost invariably one-way transactions. Even if a donor and charity expect that the gift could be returned, governing legislation seldom allows that to occur.
  2. If a gift is to be conditional, that should be clearly documented between the donor and charity, including objective criteria regarding fulfilment of the condition. And if the condition is not fulfilled, it should be agreed what is (expected) to happen with the gift.
  3. Per CG-016, a taxpayer is subject to reassessment and disallowed tax credits claimed in preceding years. It is that much more uncertain in a situation like that outlined in letter 2016-0630351E5 with a timeline going back over 35 years, how statute-barred years would be treated. Whether or not those are included, with interest charges this could be quite costly.

Being an investment professional can influence tax treatment of your own investments

At issue

There is a fundamental concept in tax that determines how your investments are treated, being whether you are trading on ‘income account’ or on ‘capital account’.

It’s a concept that can cut both ways. On capital account, only half of gains are taxable, and only once realized; correspondingly, when losses are realized they can only be applied to reduce capital gains. On the other hand, income account treatment means full taxation on a year-to-year basis, while expenses in this arena are fully deductible in the year.

The ideal case for an investor would be to have all gains treated under capital account, and all expenses treated on a current/income account basis. As you might expect though, it’s not a matter of an investor simply choosing, though intention is part of the legal test.

What may surprise many people though, is that who you are – at least in terms of your professional/business profile – can influence how you are treated.

Income Tax Act (ITA) section 248 – Definitions

“business includes a profession, calling, trade, manufacture or undertaking of any kind whatever and … an adventure or concern in the nature of trade …”

Rajchgot v. the Queen, 2004 TCC 548

This is an oft-referenced authority on the legal test for income and capital treatment. The starting point is whether securities giving rise to a loss or gain are part of business activity (trading property) or investment activity (holding property). And the entrée into that analysis begins with ascertaining the taxpayer’s intention at the time of acquiring the securities.

Determining intention is understandably difficult, and is not helped much by a taxpayer’s statements, as those would be almost entirely self-serving. Intention then is derived by inquiring into and observing the taxpayer’s whole course of conduct. The framework for this analysis is arranged under the following headings:

  • Frequency of transactions
  • Duration of holdings
  • Nature and quantity of securities held
  • Time spent on the activity
  • Financing
  • Particular knowledge possessed by the individual

Foote v. the Queen, 2017 TCC 61 (released April 21, 2017)

According to the case fact summary, Mr. Foote had a sense that the markets had bottomed out in March 2009. Over the course of that year, he carried out 38 purchase transactions with an aggregate value of about $2.5 million, and generated about $3.0 million from 50 sale transactions. His total gain was about 23%. Mr. Foote reported the net result as capital gains in his 2009 income tax return. The Canada Revenue Agency (CRA) reassessed the amount as income, and Mr. Foote appealed to the Tax Court of Canada.

Mr. Foote had been in the investment industry for over 25 years, at the time working as head of institutional trading at a major investment dealer. In his role, he did not directly trade securities, but did oversee others who traded. On a personal level, he testified that his investment strategy had always been to invest in diversified securities he felt had the potential for 30% returns over a reasonable time frame.

The judge reviewed the facts under the Rajchgot heads of analysis. Trade frequency had tripled in 2009 relative to prior years, and hold periods averaged just 50 days, with some securities bought and sold within the same week. Despite not technically being a trader, his position “in common parlance and as generally described in the markets” nonetheless fell into that category. While acknowledging that the activities did not amount to “carrying on a business of trading securities”, the judge found that they handily met the requirements of “an adventure or concern in the nature of trade” under the ITA s.248 definition of business. Accordingly, the appropriate treatment of the gains was held to be income.

Practice points

  1. Tax treatment of securities trading can vary based on the subject matter traded, the manner of trading, and the individual carrying out the trades. Frequent trades and short holding periods tend toward full income inclusion, as opposed to capital gains treatment.
  2. Working within the investment industry does not invariably result in income treatment. For example, being the vice-president of human resources or information technology for a securities dealer would not in itself suffice. However, where a person’s job is integral to the business function of trading securities, that fact is far more influential in arriving at a determination of income treatment. And it is not a sufficient reply to merely show that the individual was not trading on insider-type information.
  3. Still, it remains possible for even a full-time professional trader to be trading on capital account in his or her personal affairs, if the facts can support that conclusion.

Uber-taxation arrives; GST/HST catching up with ride-sharing services

At issue

Millennials may believe that the sharing economy is the economy, but our tax system needs time to adapt. In the breach, both purveyors and consumers may be unclear as to the true ultimate economic cost and value of these novel offerings.

Arguably, the poster-child for the new economy is Uber, the ride-sharing technology company that has disrupted the taxi industry across the globe. This and other new technologies can also be disruptive to tax authorities: What jurisdiction can levy tax? Who do you collect it from? And as a starting point, is it even something that is taxable?

In this last respect, the 2017 Federal Budget has brought some clarity to the intersection of ride-sharing and taxis for GST/HST purposes.

CRA and the sharing economy

For a few years now, the Canada Revenue Agency has used news releases and its own website to make taxpayers aware that tax obligations arise out of the sharing economy. It enumerates five sectors that have emerged: accommodation sharing, ride sharing, music and video streaming, online staffing and peer/crowd funding.

Income from sharing-economy activities must be reported for income tax purposes, whether earned by an individual or a registered business. As well, these activities are often caught by GST/HST, imposing collection, remittance and reporting obligations.

Excise Tax Act (R.S.C., 1985, c. E-15) – GST/HST small supplier rules

Suppliers of goods and services covered by the GST/HST must register and comply with the rules under the Excise Tax Act (ETA). However, s.148(1) relieves certain small suppliers who supply less than $30,000 annually in goods or services from having to collect the tax. As it doesn’t collect and remit the tax, a small supplier is also not entitled to claim input tax credits (which are available to registrants).

This general rule is then modified in s.240. Section 240(1) sets out the requirement for suppliers to be registered under the ETA, excepting small suppliers and a few others from registration. There is then an exception to the exception:

Taxi business – s. 240(1.1) Notwithstanding subsection (1), every small supplier who carries on a taxi business is required to be registered for the purposes of this Part in respect of that business.

Uber Canada inc. c. Agence du revenu du Québec, 2016 QCCA 130

Uber appealed a motions judge’s ruling that denied its attempt to obtain a return of property seized from its premises under warrant by Revenu Quebec. Among the issues raised in the appeal was whether certain Uber drivers were carrying on a taxi business. Section 407.1 of the Quebec legislation has similar wording and effect as ETA s.240(1.1).

Uber lost its appeal and subsequently negotiated an agreement with Quebec regulators (September 2016) requiring its drivers in that province to register for GST and QST. This appears on the Uber website, but there is no mention of other provinces (at time of writing).

Federal Budget 2017 – Amend ITA s.123 definition of “taxi business”

In the Budget, the government noted the similarity between commercial ride-sharing services facilitated by web applications and traditional taxi services. However, for a variety of regulatory reasons, under current tax rules ride-sharing may not be subject to the same GST/HST rules applicable to taxis.

The existing definition in the ETA is one brief sentence referring specifically to transport by “taxi”. To place matters on a level footing, the definition will be expanded to include “taxi or other similar vehicle”, including transportation “arranged or coordinated through an electronic platform or system”.

Practice points

  1. While new technologies like ride-sharing may quickly change commercial dynamics, rest assured – unfortunately for individual wallets – that the tax system will eventually follow.
  2. For drivers, it seems likely that the central ride-sharing service will take care of GST/HST collection and compliance (as is the case in Quebec now). It remains to be seen how demand may be affected by this narrowing of cost differential vis-à-vis traditional taxis.
  3. For consumers, the ETA amendments to the definition of a taxi business come into effect as of Canada Day, 2017. Enjoy the ride while you can..”