Case Study – Donating FTLP’s

Investors who buy units of a Limited Partnerships can further improve on their tax-efficiency by donating their return. Here is how it works in more detail. The Limited Partnership takes the investments to purchases shares of small cap resource companies. By virtue of a written agreement with the Limited Partnership, the companies agree to renounce their Canadian Exploration and Canadian Development Expenses (CEE) to the Limited Partnership, which in turn flows the CEE expenses to the individual unit holders. The unit holders use these expenses as a deduction in income to reduce the value of their original investment in the Limited Partnership to nil or zero – a process that may take up to two years.

The investor can write off the capital cost of the securities against income. After a couple of years, the Limited Partnership typically rolls all of its holdings into a mutual fund and a special election is filed to eliminate any tax on this roll over. Now the mutual funds are publicly traded securities with a fair market value and when sold or gifted, the difference between their ACB and the fair market value is a capital gain.

How it works

Investment generates deduction in year of investment
2 years later, Limited Partnership converted to mutual fund
Taxpayer donates units to charity and receives tax credit
Capital gain is non-taxable

Benefits to Your Clients

FTLP’s:
At the end of the day, the investor could have three tax wins.
1. The investor can write off the capital cost of the securities against income (some provinces also kick in credits that permit unit holders to realize tax savings in excess of their original investment).
2. By reducing the capital cost if the units to zero or nil, when the investor sells their units, they realize a capital gain, not regular income. Capital gains are taxed far more favorably than normal income.
3. If the securities are owned by a personal corporation;, the entire gain can be placed into the Capital Dividend Accounts (CDA) to be paid out to shareholders on a tax-free basis.

Example: Investing in FTLP and donating the resulting fund units to charity

Kathleen is a higher-risk investor in the 46% marginal tax bracket. She invests $10,000 in a flow through limited partnership. Over the next two years, she deducts the entire $10,000 (assume no provincial credit), which saves her $4,600 in taxes. When the limited partnership rolls her holdings (and everyone else’s) into a mutual fund, there is no tax consequence to her. Assume that the units of the mutual fund have a FMV of $10,000, and her cost base is nil. She decides to donate them to her church. Let’s assume Kathleen has sufficient income to use the donation credit. The church issues her a $10,000 tax receipt that reduces another $4,600 in taxes. Given that there is no taxable portion of her capital gain, her net tax win is $9,200.

The cost of making a $10,000 donation is only $800 ($10,000 – $9,200). In other words, it cost Kathleen just 8 cents ($800/$10,000) to donate one dollar! It is important to note that this tax win was made possible by Kathleen deducting the investment first, then donating the publicly traded security.

Now, what if Kathleen also owned a private corporation with abundant cash reserves. Once she has written off all of her eligible expenses, she may be able to use a common tax planning tool known as a Section 85 rollover of the flow through units into her private corporation. The mutual fund rolls over at ACB (nil) and the corporation donates them for FMV ($10,000). The corporation deducts the donation as per normal AND allocates the full capital gain to the corporation’s Capital Dividend Account for tax free payout to shareholders. In the above example, Kathleen’s ACB was ground down to nil, therefore the entire $10,000 capital gain could be paid out to her or other shareholders tax free!

A reminder that anyone thinking that this strategy will work for them should consult their tax planning professional to ensure everything will work as illustrated. For more information on this and other charitable gift concepts, I urge you to go to the following excellent website.