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Donation tax schemes can come back to bite you in three years

This week, my investment club met at our place. My wife Carolyn made things festive by heating up some concoction on the stove, not for consumption (unbeknownst to me), but to make the house smell like hot apple cider. Definitely a woman's thing. No guy would think of doing this.

So, when several friends at the meeting complimented me on the smell of the apple cider brewing, I quickly pulled out the ladle. The rest is history. Six guys and a dog ended up spending the next day in, well, let's say -- discomfort. Fortunately, in my generosity, I left none for myself that night. Okay, it was a dumb December thing to do that came back to haunt a few guys.

Want another example of a December thing to do that could come back to haunt you? I'm talking about donation tax shelters.

The shelters

Typically, donation tax shelters come in two flavours. The first is the buy-low, donate-high type of scheme in which you buy something for an amount below its "appraised" value, then donate it to a charity and receive a donation receipt for the full "fair market value."

The second type of shelter involves receiving a non-recourse loan where you donate some or all of the borrowed money to a charity. You then invest some money with the promoter, and the investment is supposed to grow to be sufficient to pay off the loan in the future.

On Dec. 5, 2003, the Finance Department announced changes to Canadian tax law to effectively shut down these tax shelters. This year, the schemes have been structured a little differently to attempt to get around the tax law.

A few of the new schemes work like this: The donor makes a cash donation to a charitable foundation and receives a donation receipt. As a result of this donation, the donor is eligible to become the beneficiary of a trust, which owns some products -- pharmaceuticals, for example. The donor then receives a tax-free distribution of these products from the trust, which the donor then has the option to keep, or donate to a registered charity.

Not surprisingly, donors tend to donate the products, and receive a donation receipt for the appraised value of the items.

In one tax shelter, a $10,350 investment will produce donation receipts of $34,950, which will result in tax savings in Ontario of $16,220 -- a 56.7-per-cent return on your cash outlay.

The problems

The promoters of these tax shelters are attempting to fly under the Canada Revenue Agency's (CRA) radar this year. But who's kidding? The CRA knows about these things and, on Nov. 25, issued a fact sheet dealing with the new donation tax shelters. It's the CRA's position that the Dec. 5, 2003, amendments apply to these arrangements and will reduce their associated tax benefits.

As for the buy-low, donate-high schemes, the CRA counts the items received from the trust as an "advantage," which will reduce the amount of your donation. Each tax shelter is different, however, and whether a particular scheme gets around the tax law is something that a court may have to ultimately decide.

Now, many people will think they're safe in buying these tax shelters because: (1) the shelter has a CRA identification number, and (2) they actually receive a refund in April. But neither is an endorsement of the tax shelter. The identification number will allow the CRA to track the users of the tax shelter later, and the CRA has three years from the date on your notice of assessment to reassess you.

Tim Cestnick, FCA, CPA, CFP, TEP, is author of Winning the Tax Game 2004, and The Tax Freedom Zone. He is managing director, Tax and Estate Planning, at AIC Ltd.

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