About 35 years ago, I studied gifts in my first semester in my first year at law school. To make a “gift”, I learned that you must have the intention to make a gift, that you must actually complete the transfer to the giftee and that you cannot receive any benefit or consideration for doing so. A gift is a fully unilateral and voluntary action. In retrospect, the quiet backwater of gift law was on the curriculum to illustrate some of the most basic legal concepts underlying the concept of “property” in the common law.
On May 16, 2014, Kathryn Kossow lost in the Supreme Court of Canada. She had claimed big charitable gifts on her tax returns.
I suspect that it was attractive to Ms. Kossow to borrow some money interest-free, and with the loan proceeds and some cash of her own, make a large donation to a charity, claim a nice sized charitable credit against her taxes on her other income, and pay some small amount (in relation to the taxes saved) into an account that, with the miracle of compound interest, would sufficiently grow to pay off the loan over 25 years.
It was a complicated scheme, developed by promoters with reputable accounting and law firms, but at its core, the plan depended on the provisions of the Income Tax Act that a taxpayer is entitled by law to a charitable tax credit for gifts made to registered charities. Ms Kossow pledged a large charitable donation. She was given a 25 year interest-free loan equal to 80% of the pledge. She made up the remaining 20% with her own money and also paid an amount into an escrow account which, it was calculated, would sufficiently grow over 25 years to pay off the interest-free loan. And she paid the promoters for their ingenuity and to cover the fees of the many well-known and reputable accountants and lawyers who did all of the financial and legal engineering.
Too bad for Kathryn Kossow. She, her advisers, the promoters, and their lawyers and accountants were so immersed, it appears, in the beauty of generating tax credits by intricately weaving disparate bits and pieces together that they overlooked that basic, simple principle from my first year law school class that a gift must be voluntary, without any benefit or consideration.
Ms. Kossow would never have received the loan if she had not pledged the gift to the charity. The 25-year, interest-free loan was clearly a benefit to her for making the payment to the charity, with the result that the payment was not a gift at all, and therefore, she was not entitled to the charitable gift tax credit.
As a result of the Kossow decision and several others like it, the leveraged gift schemes which were actively promoted a few years ago are now dead in the water.
The real point is that in complex business transactions including tax-driven deals like the one Ms Kossow signed up to, it is easy to get lost in the intricate detail, or to envisage an end-result that is so desirable that seductive tic-tac-toe logic is created to justify it.
In to-day’s complex business world, be careful if it is too easy; be wary if it is too neat and cute; be afraid of Rembrandt’s created by fitting puzzle pieces together.
And the more so when everyone else gets paid early in the game.
© Morrison Brown Sosnovitch LLP, 2014. All rights reserved.