Have you heard the definition of a business consultant? It's an individual who is smart enough to advise on how to run your business and far too intelligent to start one on his or her own.
If you've ever owned a business you can likely relate. Most business owners have war stories to share about those times when cash flow was tight, the risks were high and the business nearly failed. Yet the most successful entrepreneurs have come through those times and many have created great value for themselves and others.
As the value of your company grows, so does your ultimate tax liability in most cases. Is it possible to combine the desire to save tax with the desire to be charitable? Sure it is. Today, I want to talk about donating private company shares to charity.
Why is it done?
The key reason that the owner of a private company might consider donating shares of that company to charity is simple: to help others. There needs to be a charitable intention here. But let's face it: Shares with large accrued capital gains are going to become taxable at some point – typically when you sell or transfer the shares, die, or leave Canada. Given that a tax bill is imminent, donating some of those shares to offset the tax bill can make sense when you're charitably minded.
When is it done?
This may be stating the obvious, but there are really two times you can donate private company shares to charity: during your lifetime, or at the time of your death. If you donate shares during your lifetime, it should generally be after there has been a "freeze" undertaken. A freeze is an exercise where you exchange your common shares that have grown in value for special shares that are frozen in value (the future growth after a freeze will generally accrue to new common shares that are issued to the next generation or a trust for their benefit).
A freeze makes sense since this will establish a clear value for the frozen shares, which is helpful when donating those shares since the charity is going to be required to issue a donation receipt at some dollar amount. By the way, your family doesn't give up control over or use of the corporation or its assets when you donate some frozen shares to charity because the common shares held by the family can provide growth and control.
If the value of your company today is higher than what you're going to need to support yourself for the rest of your days, a freeze can make sense. And if you're going to complete a freeze, I like the idea of donating some of those frozen shares during your lifetime if you intend to be charitable. Many people who make these types of gifts also donate some shares upon death as well.
How is it done?
Unlike donating publicly traded securities, there's no elimination of the capital gain on private company shares when donating them. Still, the donation tax credit should more than offset the tax on any capital gain realized when donating the shares to charity.
You can donate your private company shares to a public foundation or registered charity, but most of these donations are made to private foundations in order to maintain privacy around the holdings of company and its activities, and to avoid dealing with valuation concerns. So, consider setting up a private foundation if you're going to donate private shares.
Now, if you donate private shares to a private foundation, our tax law will defer the donation tax credit until the foundation receives cash for the shares or you somehow become arm's-length to the foundation. One of these two things must happen within five years of the donation of the shares, otherwise you'll forgo the opportunity to claim any tax relief for the gift.
Normally your company would redeem the shares held by the foundation in exchange for cash or liquid assets. So, the foundation ends up with cash or assets that it can in turn distribute to other charities, and you've eliminated some of the shares in your hands that would eventually have been taxed.
To the extent you'll be donating private company shares upon death, life insurance can be a great tool to provide the cash to immediately redeem those shares donated. Your company should generally buy the insurance. The charity will appreciate having the cash quickly, and there are other tax benefits available to the remaining shareholders when life insurance is used.