Tax considerations for gifts of art in Canada

We are in the midst of the largest wealth transfer in the history of the world. This transfer of wealth is largely a result of individuals described as the baby boomer generation dying and passing their accrued assets onto their heirs and other parties. These baby boomers' assets are held in many forms including art (which is usually in the form of personal property).

It has been the authors' recent experience that an increasing number of Canadian taxpayers are interested in giving pieces of art to charities or other qualified donees as part of their estate plans.^[1] Some of these Canadian taxpayers are choosing to make decisions to give such art during their lifetimes, while others are setting down a plan for their gifts of art to occur at death.

This article briefly addresses the benefits, requirements and risks of donating art for Canadian taxpayers to consider as part of their estate planning needs.

Benefits of gifts of art

Corporate donors may deduct the amount of the gift of art directly from their taxable income, and individual donors will receive a non-refundable tax credit. These benefits are subject to meeting requirements under the Income Tax Act ("ITA"). Subsection 118.1(1) of the ITA governs gifts for individuals, while subsection 110.1(1) governs gifts for corporations. Typically, the eligible amount that qualifies for the tax credit applies for the year that the donor gives the gift. However, the donor can choose part of the eligible amount of the gift that they want to claim in that tax year and carry forward any unused part of the donation tax credit for up to five years from the date of the gift.

Process of donation

Gifts of art can be a useful tax reduction tool when made by a living donor (an inter vivos gift) or as a testamentary disposition. The timing of the gift – whether during one's lifetime or upon their death – has its own unique considerations.

The Canada Revenue Agency ("CRA") requires gifts of art to be a gift at law. This means that the donor must voluntarily transfer the property comprising the gift to a donee. In the case of a gift of art pursuant to the ITA, this must be a "qualified donee," which is defined in the ITA and discussed further below. Importantly, the donor cannot retain any residual rights to the property forming the gift nor receive any consideration (i.e., oftentimes a benefit) in order to meet the criteria of a gift at law.^[2] For inter vivos gifts, this means that if a donor chooses to proceed with a gift of art to a qualified donee who accepts the gift and issues an official donation tax receipt, the donor will not be able to personally enjoy that artwork as their own once the gift is made.

We strongly encourage donors – and qualified donees – of inter vivos gifts of art to execute carefully drafted gift agreements that detail the agreed upon terms as between the parties and specifically addresses the future permitted use(s) of the donated property. This exercise can limit misunderstandings between the parties and often leads to less potential for conflict or even legal proceedings to address disputes at future dates.

Testamentary gifts of art provide the donor with lifelong use of this property and create opportunities for donors to offset terminal taxes. Uniquely, a taxpayer may claim donation tax credits on their annual income tax return for total gifts in a year up to 75 per cent of their net income. However, in that taxpayer's year of death the limit for using the charitable tax credit increases to 100 per cent of the taxpayer's net income. As such, charitable tax credits obtained from donating testamentary gifts of art provides an opportunity for Canadian taxpayers to reduce or even eliminate any income tax owed upon death.

Gifts of art are complex and can be time consuming when made by a taxpayer's estate. As such, if a taxpayer wants to include such gifts in their estate plan then they should consider speaking with their estate trustee(s) in advance of death. This is particularly true if a valuation of the art requires unique personnel as this can extend the timeline in which the gift is distributed to the ultimate beneficiary and the donation tax receipt is consequentially issued to the estate. This is an important consideration, because an estate's donation can only be carried back to the deceased taxpayer's final terminal tax return (i.e., usually the largest tax bill) if the estate meets the following criteria: (a) it qualifies as a graduated rate estate pursuant to the ITA (except for the 36-month time limit); (b) the art was acquired as a consequence of the deceased taxpayer's death; and (c) the gift is made within 60 months of the deceased taxpayer's date of death.

Additionally, as a precautionary measure, donors should consider speaking with their family members in advance of death if it is possible that these family members expect to receive the art as a gift from their estate. A well-planned discussion with the right parties can preempt any potential disputes or litigation—especially in instances where the gift of art could become a point of contention among a donor's heirs.

In order for donors to receive the tax benefits from such donations of art, there are three main requirements which must be met. The art must:

1. be given to a qualified donee;
2. obtain a fair market value valuation; and
3. be voluntarily transferred from the donor to the qualified donee.

A discussion of these requirements follows.

1. Donation to qualified donee

Subsection 149.1(1) of the ITA explicitly defines the term "qualified donee." It encompasses a wide range of entities, including but not limited to, registered Canadian charities, Canadian amateur athletic associations, municipalities, and registered journalism organizations, among others. Relevant to this article, many museums and art galleries in Canada are qualified donees and more specifically registered Canadian charities.

It is crucial for any donors considering donating art – who also want a donation tax receipt for such donation – to conduct thorough research to confirm that the intended recipient is indeed a qualified donee at law. CRA maintains a list of registered qualified donees in Canada that can be accessed and searched here.

2. Valuation of the gift of art

Determining the FMV

Once a potential donor has confirmed that a potential qualified donee is interested in receiving the specific gift of art, the artwork must be valued to determine its fair market value ("FMV"). The official donation tax receipt that the qualified donee will issue to the donor, if the gift is perfected at law, should reflect this FMV (or a lesser amount as is detailed in the sections below).

In many cases, it is the most prudent course of action for both parties to have a third-party valuator determine the FMV of the gift and issue a corresponding valuation report. This valuation report can justify the value of the official donation receipt if CRA audits either the potential qualified donee, potential donor, or both.

That all said, CRA notes that if the FMV of the artwork is presumed to be less than $1,000 (in Canadian legal tender) and a formal valuation may be cost prohibitive for the parties, then a member of the qualified donee or another individual with sufficient knowledge of the property may determine the artwork's value. Nevertheless, the potential donor and qualified donee should retain all documentation substantiating the FMV determination in the event that the CRA requests verification upon audit. It is essential to adhere to best practices in maintaining and updating books and records to mitigate potential hurdles in the future for all parties involved.

If a valuator is engaged, then CRA notes that the valuator should:

• be accredited in the field of valuation for the specific art (i.e., have the appropriate credentials, etc.);
• be knowledgeable about the principles, theories, and procedures of the applicable valuation discipline, and follow the Uniform Standards of Professional Appraisal Practice or the standards of the profession;
• be knowledgeable about and active in the marketplace for the specific property;
• be independent from both the donor and qualified donee; and
• be knowledgeable about the elements of a properly prepared and credible valuation report.

Qualified donees should ensure that internal corporate or trust requirements regarding such valuations are followed. It is prudent for such qualified donees to undertake an internal review of all their policies, procedures, or other governing documents (like letters patent, articles of incorporations, or deeds of trust, for instance) so that the organization's leadership is satisfied that it can, in fact, receive the gift and has handled the process appropriately. This due diligence – paired with the qualified donee meeting its books and records requirements pursuant to the ITA – is critical for qualified donees to develop standardized procedures within their organizations to help the organizations meet their tax compliance and other legal obligations.

Split receipting and the de minimus rule of advantage

Qualified donees giving a benefit (i.e., an example of consideration) in exchange for the donation need to familiarize themselves with the CRA's guidelines for split receipting to ascertain whether the benefit received can be deducted from the FMV of the donated item. Particularly, under the de minimus rule of advantage, advantages that have a combined FMV that is not more than $75 or 10 per cent of the FMV of the gift, whichever is less, are considered too minimal to affect the amount of the gift. Consequently, a charity is not required to deduct such minor benefits from the donated item's FMV when preparing donation receipts.

For illustration, suppose someone donates artwork valued at $100 to a charity. In appreciation, the charity gives the donor a pen and notebook worth $2 and $5, respectively, bringing the total benefit value to $7. This amount falls below the minor benefits threshold of $10, allowing the charity to issue a receipt for the full value of the donated artwork without deducting the value of the returned gifts. However, it's important that the donation, after accounting for the benefit, still represents a voluntary contribution of property and demonstrates the donor's intent to give the gift at law.

Determining the value of tangible items like pens and notebooks is typically straightforward. However, valuing intangible benefits can be more complex. For example, if the artwork is given to a qualified donee that is a museum or an art gallery that exhibits its art to the public, then the donor – as a member of the public – can also enjoy the artwork they gifted to the qualified donee. Valuing such intangible benefits may require professional appraisal. In such cases, following the CRA's advice to engage valuation experts is recommended.

Application of deemed FMV rules

The deemed FMV rule states that, under certain conditions, an official donation tax receipt issued for a non-cash gift must be issued for the lesser of the gift's FMV and its cost to the donor immediately before the gift is made.^[3] The conditions which determine if the deemed FMV rule applies are:

1. the gift was donated to the qualified donee after Dec. 5, 2003; and
2. additionally:
   1. the gift received by the qualified donee was initially acquired by the donor as part of a tax shelter arrangement; or
   2. the gift was acquired less than three years before the time of donation; or
   3. the gift was acquired less than 10 years before the time of donation, with one of the main purposes being to gift the property (i.e., art) to a qualified donee.

The qualified donee should take great care to determine if the deemed FMV rule may apply based on the date of the donation and the date when the donor acquired the piece of art (i.e., non-cash gift). The onus also lies with the donor to inform the qualified donee of any situations that may impact the application of the deemed FMV rule (including the donor's personal situation) as the CRA can reassess the official donation receipt to $0 and involve both parties in a time-consuming and costly process relating to the reassessment.

There are some exemptions for the application of the deemed FMV rule, but it is unlikely that any can be claimed if a piece of art cannot be certified as cultural property (which can only be undertaken by a separate legal process).

3. Voluntary transfer of property

Once the donor and qualified donee have: (1) agreed that the donor will give the qualified donee the gift of art which the qualified donee will accept; and (2) agreed on the amount of the official donation receipt based on the FMV of the piece of art; then the donor and qualified donee should make arrangements for the art to be transferred into the qualified donee's possession. The qualified donee should undertake at least minimal due diligence to confirm what legal documentation is required to transfer legal title of the art to the qualified donee. The parties should also consider the issue and timing of insurance coverage for the piece of art in relation to the date of transfer.

Once again, the parties should also consider the utility of entering into a gift agreement detailing agreed terms of the gift and specifically the future use of the gift.

Potential hurdles

Capital gains liabilities can materialize when art is donated to a qualified donee if the FMV of the gift is more than the donor paid for the artwork when it was acquired. This would give rise to a capital gain to be included in the donor's income, ultimately reducing the overall benefit of the donation tax receipt in the hands of the donor. While the donor can designate the proceeds of the disposition to be less than FMV, this limits the maximum value of the donation tax receipt, and such an outcome should only be considered in tandem with the donor obtaining professional advice relating to the donor's personal or corporate circumstances.

The donor's personal or corporate status may also affect their tax treatment relating to the gift of art. For instance, if the donor is an artist, an art dealer, collector, or individual carrying on a business related to the sale of art, and is donating a piece of art from their inventory, additional provisions in the ITA apply to tax benefits and tax consequence relating the donor's status. The impact of these provisions on a specific gift of art – and its related valuations – must be dealt with on a case-by-case basis.

Conclusion

In order to receive the tax benefits stemming from a qualifying gift of art, potential donors should undertake careful planning to consider whether the gift of art meets the ITA requirements. An important and sometimes time-consuming step is the valuation process of the artwork itself, and the agreement between the potential donor and qualified donee regarding the value of the official donation receipt. While these steps may seem onerous to complete, a successful donation can result in tax benefits for the donor and the satisfaction that such art will be used to benefit Canada's charitable sector and by extension the public.

Gowling WLG's Private Client Services and Charities & Not-for-profits lawyers would be pleased to advise donors and qualified donees navigating the complexities of this process.