With the introduction of the 2007 Federal Budget, there are significant changes ahead for high net-worth individuals who plan to use private foundations as part of their personal tax planning. Charitable donations have always been a great tax minimization tool, the donor receives a tax credit in the amount of the donation to be used against his or her tax liability. Donating to a private foundation, however, has the added benefit of control. In a private foundation, the donors are usually also directors, trustees, or officers of the foundation, and thus the donors will usually have direct control over the use of their donations. They can control which charitable uses their donations are put to, and what other charities will later receive their donations.

Donors may wish to contribute gifts of property (including shares, real property, etc.) to charity, including to private foundations. When a gift of property is made, the donor will receive a tax receipt which will credit the amount of the donation against his or her tax liability for that year. A gift of appreciated property does, however, trigger a disposition for tax purposes. On any disposition, only 50% of the gain is generally taxable. However, in 2006, the federal government completely eliminated the capital gains tax on gifts of ‘qualified property’ (including publicly listed securities and ecologically sensitive land) to charitable organizations and public foundations. Until now, the federal government had not extended this favorable tax treatment to private foundations. However, the 2007 Budget has made good on the government’s promise to remove the capital gains tax on publicly listed securities donated to private foundations, effective as of March 19, 2007. Thus, preferential tax treatment has been extended to donations to private foundations, but, there is a catch (or two).

Along with the tax break on capital gains, a new excess holdings regime has been imposed on private foundations to monitor and protect against self-dealing. Under the new rules, limits are placed on private foundation shareholdings that take into account the holdings of persons dealing at non-arm’s length with the foundation. Non-arm’s length parties will include any person, or member of a related group of persons, who controls the foundation, and any person not dealing at arm’s length with such a controlling person or group member. One of the limits imposed by the new excess holdings regime is the 2% safe harbour threshold. If a private foundation holds 2% or less of any class of shares in any one corporation, the foundation can carry on as usual and nothing will be required. However, if the 2% safe harbour threshold is exceeded, the foundation will be required to publicly report its holdings together with the holdings of non-arm’s length persons in that corporation. Furthermore, the private foundation will also have to report any ‘material transactions’ engaged in by the foundation or non-arm’s length parties during the period when the foundation was outside of the safe harbour threshold. Thus, the foundation and related parties must keep in mind that, if they exceed the 2% safe harbour threshold, they will be subject to enhanced reporting requirements.

The 2007 budget also imposes a monitoring and divestiture regime on private foundations. It specifies that, if the combined shareholdings of the foundation and non-arm’s length persons exceeds 20% of the shares of any class in a given corporation, the foundation and the non-arm’s length persons will be required to reduce their combined holdings to the 2% or less safe threshold. The foundation and non-arm’s length party will be given up to 5 years to divest themselves of the excess holdings, depending upon the circumstances that resulted in the 20% threshold being exceeded. Financial penalties and deregistration may result should the parties fail to divest the shares and fully comply with the new excess holdings regime. Therefore, the foundation and related parties must also ensure that their combined holdings of a particular class of shares in a given corporation remain under the 20% threshold in order not to be subject to divestiture or stringent penalties.

Certain exemptions to the divestiture regime do, however, exist. That is, private foundations will not be required to divest of shares which were donated before March 19, 2007, if the terms of the gift specify that the foundation must retain the shares and prevent the foundation from disposing of them. Also, no divestiture will be required on donations made on or after March 19, 2007 and before March 19, 2012, pursuant to the terms of a will signed or an inter-vivos (lifetime) trust settled before March 19, 2007 and not amended thereafter.

Though the legislative details, including exact implementation date of the changes initiated by the 2007 Federal Budget, are currently indefinite, it seems that the plan will be retroactive to March 19, 2007. As a result of the 2007 Budget, there are new opportunities for tax planning using private foundations, however, not without limits. Consequently, tax planners and charity lawyers will have to quickly apprise themselves of these changes, and keep them in mind when engaging in tax planning involving donations to private foundations.