Private Foundations: Exceeding the 20 Percent Limit
A private foundation that owns more than 20 percent of a class of shares
of a corporation's stock faces a penalty of 5 percent of the FMV of
those excess shares (10 percent for a repeat offence), and the CRA may
revoke its charitable registration. This limit can be exceeded
unintentionally, perhaps by accepting a share donation or through the
actions of a corporation in which the foundation owns shares (for
example, selective redemptions). Corrective actions may be problematic
or ineffective (for example, exchanging shares for debt).
The excess corporate holdings percentage (ECHP) is the percentage of a
class of shares held by a private foundation at the end of its taxation
year that exceeds the 20 percent limit. A net increase in ECHP is
allocated to the private foundation's divestment obligation percentage
(DOP) between its current and fifth subsequent taxation year, depending
on how the shares were acquired. A penalty is assessed for any year in
which the private foundation has a positive DOP.
Gifting the shares to a public foundation or a charitable organization
might solve the problem, since those types of entities are not subject
to the excess corporate holdings regime. However, the entities would
have to consider the impact that the shares may have on their activities
and disbursement quotas, particularly where the shares are not liquid
or retractable. The problem could also be avoided by converting the
private foundation into a public foundation.
Another possibility is requesting a reallocation of the DOP to a
subsequent taxation year (up to 10 years) under subsection 149.2(6).
This reallocation is possible only if the minister believes that it
would be just and equitable.
A further potential solution is to sell the shares for cash. However,
selling the shares back to the issuing corporation may not be possible
if the corporation does not have sufficient liquidity. Finding a
third-party purchaser for the shares may not be possible or desirable,
and selling the shares for less than FMV to a non-qualified donee may
constitute a breach of trust under common law.
Where the issuing corporation does not have the liquidity to pay cash
for the shares, another idea that seems attractive at first glance is
for the corporation to redeem the shares, with the compensation being a
promissory note. However, subsection 188.1(3.2) states that if a private
foundation enters into a transaction to avoid a DOP by substituting
shares for "an interest (or for civil law, a right), in a corporation
other than shares," then for this purpose such interest is deemed to
have been converted back into shares at their FMV. Is debt considered an
"interest," or is that term restricted to a form of equity
participation, such as a stock option or warrant? In a technical
interpretation provided to the author (dated December 12, 2018), which
should at some point become public, the CRA takes the former
interpretation. Thus, this exchange would not reduce the DOP, and the
ECHP problem would still exist.
A side point: Suppose the ECHP problem arises because an individual
donates shares of his or her private company to a private foundation. In
that case, some planning might be required to ensure that the
foundation can issue a donation receipt, because a non-qualifying
security includes shares of a corporation not dealing at arm's length
with the donor (subsection 118.1(18)).
Gardiner Roberts LLP, Toronto
Canadian Tax Focus
Volume 9, Number 2, May 2019
©2019, Canadian Tax Foundation