The upcoming parliamentary review of charitable donation incentives is a time to educate not just our parliamentarians about our tax system, but ourselves and our donors as well. Canada has an extremely generous system that should be appreciated by the sector. But first it must be understood (even by those who are not mathematically inclined).

Deductions vs. credits

The first thing to realize is that donations by corporations are treated differently than donations by individuals. Donations by corporations, whether or not a receipt is issued, result in a deduction from the corporation's income, whereas donations by individuals are treated as credits.

From a tax policy perspective the major impact of the difference is that the value of the deduction varies with the tax rate (and the income) of the particular corporate donor, while the amount of the credit is determined by a formula which makes the value of the credit the same regardless of the income of the individual donor.

For example, a corporate donor with a high income will typically pay tax at a high rate, so deducting from that income a $1 donation will have a correspondingly high reduction in tax. But the value of a credit on an individual's donation of the same amount will be the same whether the donor earns $10,000 or $10,000,000.

This difference between a deduction and credit has a significant impact on the tax revenues. I imagine it will be a subject of some discussion by the Parliamentary committee.

Impact of progressive tax rates

The Canadian tax system is referred to as a "progressive" system. This is not a political judgement, but rather refers to the increase in the rate at which tax is paid as the taxpayer's income increases. The increase in tax rates occurs only at certain levels. Here is a simplified version of the 2012 federal income tax levels and their rates.

Level of Income (Tax Brackets)	Tax Rate
$ 0 - $ 42,707	15 %
$ 42,708 - $ 85,414	22 %
$ 85,415 - $ 132,406	26 %
$ 132,407 and above	29 %

 

The provinces levy their own taxes at varying rates on different levels of income. Those rates are unrelated to the federal design, so the federal percentages are only part of the total amount of tax paid by people with the given level of income.

However, the rates at which the tax credits are applied are co-ordinated in all of the provinces except Quebec. In these jurisdictions, donations under $200 reduce the total tax payable by the amount of the donation multiplied by the lowest tax rate. For example, at the federal level any donor who donated $200 would reduce his or her tax payable by $200 x 15% or $30. A similar calculation at the provincial lowest rate would be conducted to reduce provincial tax payable. This reduction would be the same whether the donor was in the lowest or highest tax bracket.

Donations which exceed $200 in a year are credited at the lowest rate on the first $200 and at the highest rate after that. So, assuming that $350 is donated, the first $200 will result in a $30 credit as above but the remaining $150 would result in a credit of $43.50 (i.e. $150 x 29%) for a total tax credit of $73.50 on a $350 donation. Importantly, the treatment is again the same regardless of the donor's income tax bracket.

Credits favour middle brackets

The use of tax credits to standardize the tax impact of the donation across the tax brackets is most generous to people who a) donate more than $200 and b) are not in the highest tax bracket. These people not only do not pay tax on the dollar they have donated to charity but in fact receive a slight bonus in that their tax on other income is also reduced. This results because the credit on donations more than $200 is calculated using the highest rate but the actual tax is calculated at a lower rate.

Put another way, when a donor in the middle brackets donates over $200 to a charity, the government not only foregoes the tax on the amount over $200 but gives the donor a little extra refund as well. The effect is the same across all the provinces with the exception of Alberta, which actually goes out of its way to provide a much larger refund to the individual.

Potential changes

There is a lesson to be learned here by the sector. The government's look at the tax incentives for charitable giving is not occurring in a vacuum. The federal government intends to reduce its budget deficit. One obvious way to do so is to link the amount given to charity with the donor's highest tax rate so as to align the amount of the gift with the tax impact of the gift. (Some might also argue that it is unfair for the donor to direct not only his or her tax monies to a charity of their choosing but also for that individual to direct other people's tax money to that charity.)

This would likely mean converting the donation tax credit for individuals to a deduction, as is standard for corporations. I am unsure of the effect this would have on giving, although I suppose it would be minimal given the general level of ignorance about the tax system. But I suspect that the potential savings from converting the donation tax credit to a deduction are being seriously considered by Parliamentarians, and so should be considered by the sector and donors as well.

Adam Aptowitzer of Drache Aptowitzer LLP is a charity law lawyer with a national practice based in Ottawa. He has been published in Canadian Taxpayer, Canadian Fundraising & Philanthropy and the Not-for-Profit News. He has also published a widely distributed study on the regulation of Canadian charities with the C.D. Howe Institute.

As a speaker, he has presented to the National Symposium of Charity Law, the C.D. Howe Institute, the Association of Fundraising Professionals, the Canadian Association of Gift Planners, the Ottawa Estate Planning Council and various large and small Canadian charities. He has also given expert advice on Parliament Hill. Adam is an executive member of the Canadian Bar Association's Charity and Not-for-Profit Law section.

For speaking engagements and consultations, contact him at 613-237-3300 or visit http://www.drache.ca.