Charitable Debentures
There has been a growing interest among both donors
and charities in alternative and more flexible approaches to
gift giving. One of the more creative tax planning ideas in the
recent past involves the use of charitable debentures.
There are three required elements before a charitable debenture
is feasible. First there must be a donor willing to make a significant
gift to a registered charity. Second, the donor must be a shareholder
of a corporation which is indebted to the donor. This is very
common among private corporations where the principle shareholders
routinely reinvest profits back into the business. Third, the
donor's life must be insurable.
Charitable debentures are best explained by way of example. Assume
that Susan Black, a 50 year old businesswoman, is the majority
shareholder of Black Corporation. Over the years, Susan has loaned
a great deal of her personal wealth to that Corporation, and
the financial statements now indicate that the corporation owes
Susan $500,000.
The first step in arranging a charitable debenture is to formally
acknowledge that the corporation owes Susan $500,000. This can
be achieved by the corporation executing a debenture made payable
to Susan but fully assignable. The terms of the debenture should
provide that the corporation shall pay the debenture holder interest
at prevailing commercial rates, say, 8% per annum.
The second step is for the corporation to take out a $500,000
life insurance policy on the life of Susan. An agreement between
Susan and the corporation should provide that the corporation
shall make full payment of the amount owing under the debenture
within, say, 60 days of Susan's death.
Susan, then, donates the debenture to her favourite charity and
for that donation, she will receive a charitable receipt for
$500,000 which she can use to reduce her income taxes in the
usual way. Although interest payments made by the corporation
may be deducted as a business expense, the life insurance premiums
paid by the corporation are likely not deductible.
Consider the result. Susan will get the immediate tax benefit
associated with a charitable donation, but Black Corporation
continues to have the use of the $500,000 until Susan dies. Since
the debenture now held by the charity is backed up by life insurance,
the charity has assurance that it will receive $500,000 on Susan's
death. Until then, the charity will receive interest from the
corporation.
The arrangement also provides potential benefit to Susan's heirs.
The life insurance proceeds received by the corporation on Susan's
death will be added to the corporation's so-called capital dividend
account. This will enable the corporation to distribute $500,000
to Susan's heirs on a tax-free basis which otherwise would have
been subject to tax.
There are clear advantages to using charitable debentures as
a form of gift giving. The donor and the charity each receive
an immediate benefit. The donor's heirs may also benefit from
a tax-free distribution from the corporation.
Although the use of charitable debentures does require a very
specific set of circumstances, such circumstances are not uncommon
among owner-managed businesses. Needless to say, the advice of
a tax professional should be sought before engaging in this type
of arrangement.
John W. McClure is a lawyer with the firm of Parlee
McLaws in Edmonton, Alberta.
