Flashing orange for aggressive charities

I recently received an e-mail inquiry that asked for my advice about a new charity that the writer heard being promoted. Here’s part of his question:

“The scheme involves the donor buying comic books at a low price and donating them to a charity which issues a tax receipt at over five times the value of the donation. The program is run by an organization called Canadian Literacy Initiatives (CLI). More information is available on their web site at www.canadianliteracy.ca

“It appears to me that this falls into the “too good to be true” category. However, the speaker was a well-known personality and assured the audience that the CLI has done its due diligence. He also cited a couple of court rulings and legal and accounting opinions.

“One thing that was not mentioned is that how much of the “donated” money was actually used to buy comic books and trading cards for use in literacy programs. Aside from that, can you comment on this program as a tax saving tool?”

I hadn’t heard about CLI prior to this, so I undertook some research. It appears that the idea is that you buy comic booksr trading cards from a private company at a wholesale price. You then donate them to a literacy charity through a Toronto church. They are appraised at “fair market value” (retail price). This is the value for which your charitable donation receipt will be issued, and the suggestion is the amount will be several times more than your contribution.

Refund could be greater than contribution
This could result in a tax refund that’s more than the amount you actually contributed! For example, if you contributed $100 and received a receipt for $500, you would get a federal tax reduction of $119 (16% on the first $200; 29% on the rest). When the provincial tax deduction is added, your total saving will be in the area of $150. You’ve made a 50% profit on a charitable donation!

There is nothing wrong in principle with donating a gift to charity and getting a receipt for more than the price you originally paid. I do it myself with wine donations for charitable auctions. However, the wines were purchased several years ago and have appreciated in value while resting in my cellar. That’s a lot different from the quick flip this represents.

Donor beware
CLI has tax opinions from three well-known law firms that should be read carefully (they’re available on the Web site). All the opinions are lengthy and contain warnings that prospective participants of the plan should heed.

For example, the nine-page opinion from BDO Dunwoody states that the basic concept of the plan is legally sound, but it warns that the appraisal of the donation must be at fair market value. The opinion contains the following statements:

“CCRA [Canadian Customs and Revenue Agency] is in the process of issuing notices of reassessment on many taxpayers that purchased works of art and donated them to charities. CCRA is taking the position that the fair market value of the works of art which were donated was substantially less than the amount for which the donation receipts were issued. In many cases they have charged a gross negligence penalty as part of the reassessment, claiming that the valuation was negligent and that the taxpayer should have known that it was wrong.”

The legal firm notes that some of the reassessments are being contested in the courts and that there is no way of knowing what the outcome will be. The firm’s advice: “Although not required under the law, we suggest that as a matter of prudence you should obtain two independent appraisals.”

Next page: No ruling yet

Two other legal opinions are even lengthier but reach generally the same conclusions. One from Fraser Milner Casgrain runs to 10 pages. It reviews the BDO Dunwoody opinion and in general concurs with its views. An opinion from Stikeman Elliott covers all of 34 pages, complete with footnotes and legal precedents. It’s a chore to wade through, but contains all the detail you could ever want to know on this subject.

No green light from CCRA
CLI does not have a ruling from Canada Customs and Revenue on whether the program will pass their tests. That makes me a bit nervous. The CCRA has a history of going after aggressive tax claims. I have seen several situations in which assessments were held up for years (literally) and then the claims were disallowed.

That is not to say that anything similar might happen in this case. But you need to be aware of potential problems if you’re considering this plan.

My recommendation is that you consider this option only if you take an aggressive approach to tax-cutting and are willing to accept the possibility of a CCRA challenge. I strongly suggest that you read all the legal opinions thoroughly and discuss them with your own tax advisor before taking any action. Based on what he or she has to say, you can then make an informed decision.

Adapted from an article that originally appeared in the Internet Wealth Builder, a weekly e-mail newsletter that offers conservative investment advice from some of Canada’s top financial experts. Get a three-month no-risk trial membership at a special rate of just $19.97 plus tax!