Excess Corporate Holdings of Private Foundations under Alter-Ego Trusts
Aug 2018 Charity & NFP Law Update
On May 8, 2018, the Canada Revenue Agency (“CRA”) responded to a question at a Roundtable regarding the application of excess corporate holdings rules (no. 2018-0745861C6). Specifically, the question addressed whether subsections 188.1(3.3) and (3.5) of the ITA would apply where a private foundation receives the residue of an alter-ego trust after the death of the life interest beneficiary.
By way of background, the excess corporate holdings regime was introduced for private foundations to limit potential opportunities for persons connected with a foundation to use their own and the foundation’s shareholdings for their own benefit. The rules limit a private foundation’s share ownership that also takes into account the holdings of any relevant person (defined in subsection 149.1(1) to generally mean a person not dealing at arm’s length with the foundation). The rules in section 149.2 of the ITA provide that a private foundation must divest itself of excess shares if the private foundation and any non-arm’s length persons (“relevant persons”) collectively own more than 20% of any class of a corporation’s shares. Failure to do so can result in loss of charitable status for the private foundation. Subsection 188.1(3.3) of the ITA sets out conditions in which the subsection 188.1(3.5) provisions for avoidance of divestiture would apply to a private foundation.
Further, paragraph 149.2(5)(b) allows a private foundation five years to meet the divestment obligation if the excess is the result of a donation by way of a bequest. The term, “bequest”, is not defined in the ITA but is defined in Black’s Law Dictionary as “the act of giving property by will or property disposed of in a will.” The CRA acknowledges that paragraph 149.2(5)(b) will apply in a situation where the private foundation acquires the shares as a beneficiary under an individual’s will. For tax and other estate planning reasons, an individual will transfer shares to a so-called life interest trust as a will substitute and such trusts generally include an alter-ego trust and a joint spousal and common-law partner trust as well as spousal trusts.
As such, given that the alter-ego trust may be considered a will substitute for an individual and results in the acquisition of shares by the private foundation in circumstances substantially similar to that which would occur under a will (in that the individual has all of the use of the freeze shares while he is alive and the shares are distributed to the private foundation after his death), the CRA was asked to comment on whether the private foundation will be subject to subsection 188.1(3.5) such that it will be treated as owning a portion of the freeze shares.
The CRA was of the view that whether subsections 188.1(3.3) to (3.5) apply to a particular situation is a mixed question of fact and law that can only be determined following a review of the circumstances and all underlying documentation with respect to the situation. However, given the broad nature of these provisions, where a private foundation is a beneficiary under an alter-ego trust, consideration must be given to subsections 188.1(3.3) to (3.5) for the purposes of determining the private foundation’s excess corporate holdings percentage and divestment obligation percentage for a taxation year.