A client recently approached us to ask about donating shares to charity through their will. They wanted to know if they could take advantage of the “zero inclusion rate” for donated shares. This is the rule that provides that none of the capital gain realized on the donation of publicly traded securities is subject to income tax, but at the same time provides a donation credit for the value of the donated securities.
I wanted to tell them that, yes, this is possible, and the legislation specifically provides for this treatment when shares are donated pursuant to the terms of the will.
However, the client did not want to simply donate the shares to charity when he dies. If his wife survives him, he wants to ensure she is taken care of for the rest of her life (with the dividends from the shares providing some of that support), and then on her death, the shares can be given to the charity.
I thought, this should not be a problem – it is consistent with public policy, and the 2016 Federal budget took care of a problem that existed in the Graduated Rate Estate (“GRE”) provisions that had been previously introduced. These changes ensure that a donation made by a GRE, or an estate after it ceases to be a GRE, but within 5 years of the date of death, qualify for the donation credit in the tax return of the deceased, and also qualify for the zero inclusion rate.
Unfortunately, the rules do not work the way I had expected.
The typical planning in this scenario would be to create a trust under the terms of the will, whereby the surviving spouse is entitled to all of the income generated by the target property (the shares for example) during her lifetime. Upon her death, the trustees would be instructed to make the appropriate donations to the selected charities. There are some technical issues to be respected, such as ensuring this is truly a donation by the trust, and not a distribution of capital to the residual beneficiary charities, but the concept is straightforward.
The 2016 budget changes provided for the donation made by the trust, after the death of the surviving spouse, to be eligible for credit in the tax return of the trust for the year ending with the spouse’s death – to avoid the donation credit being “stranded” in a subsequent tax year, while the capital gain was subject to tax at the date of death. However, there is no parallel provision in the capital gains inclusion rules – the capital gain arising as a result of the spouse’s death is subject to full capital gains tax, even though the shares are donated to charity shortly after.
I believe this should be corrected with a technical amendment to paragraph 38(a.1), ideally retroactive to January 1, 2016. I cannot think of a policy reason to deny the Spousal Trust the benefit of the zero inclusion rate, which would have been available if the donation were made at the death of the first spouse, or even moments before the death of the surviving spouse.