The definition in law of a "gift" is crucial in determining the tax and legal treatment of transfers in families and other situations. Lawyers at Baker & McKenzie examine a recent case in Canada.

Editor’s note: As part of a continuing monitoring of tax and regulatory developments around the world, legal experts at Baker & McKenzie, Salvador Borraccia and Kristy Balkwill, both in Toronto, examine an important ruling in a Canada court as to the meaning of “gift” in the context of family transfers and tax.

A recent decision of the Ontario Court of Appeal in McNamee v McNamee, 2011 ONCA 533, has clarified the meaning of the term “gift.” While the case addressed the term in a family law context, the case should also be important coming from an income tax perspective.

The term “gift” is not defined in the Income Tax Act (Canada). The Act is an accessory system to the common law and, as such, relies on the normal definition in the local case law to determine the meaning of particular terms not otherwise defined in the Act.

The Canada Revenue Agency has attacked a number of arrangements, including those constituting tax shelters that involve gifts to charitable organisations by taking the position that the arrangement did not constitute a valid gift by the taxpayer. So, the taxpayer was not entitled to a charitable tax credit that would otherwise have been available for the amount of the gift.

For example, in the recent case of Maréchaux v R, 2010 FCA 287, the Federal Court of Appeal found that the taxpayer did not make a “gift” within the meaning of section 118.1 of the Act because he made the particular payment to a charitable foundation expecting to receive (and in fact did receive) a significant benefit, namely an interest-free loan of C$80,000 (about $76,500) from a lender (not the foundation) repayable in 20 years. Other benefits that the court found to exist in Maréchaux consisted of a put-option and a life insurance policy. The FCA noted, in deciding against the taxpayer, that the taxpayer’s counsel did not cite any authority for the proposition that only a benefit provided by the donee to an alleged donor can prevent a payment to a charity from being a gift for the purpose of section 118.1 of the Act. The FCA also stated that it did not see any principled reason for disregarding a benefit (i.e., consideration) simply because it was provided by a third party (and not the donee). Particularly, as the court found in that case, the “donation” was conditional on the provision of the benefit.

McNamee was decided in the context of the divorce between a husband and wife and a claim by the wife for a part of the interest in the company’s shares owned by her husband. The husband received the shares as part of an estate freeze, whereby his father froze the value of an operating business by transferring the shares of the business to a holding company and taking back preferred and common shares in the holding company. The father then transferred the common shares (in equal parts) to his two sons who participated in the operation of the business. The father transferred the common shares to his sons by way of a declaration of a gift and the sons did not pay for the shares.

Marital breakdowns

Under Ontario law, if the husband receives the shares by way of a gift, his wife cannot make a claim for them as part of the family property upon marital breakdown. The Ontario Court of Appeal analysed the situation by looking at the elements of the term “gift.” Acknowledging that the word was not defined specifically, the court regarded the general definition of “gift” as a “voluntary transfer of property to another without consideration” per the definition in Black’s Law Dictionary and other sources. The trial judge found two qualifications on the meaning of the term to be significant. First, the trial judge concluded that in order to create a valid gift, the donor must divest himself of all power or control over the property and transfer such control to the donee.

Secondly, on the issue of this case, the trial judge concluded that the intention of the donor must be inspired by affection, respect, charity or like impulses, and not by commercial purposes.

Addressing the requirement of gift as precluding the existence of “consideration,” the OCA stated that: “Consideration in law is a contractual concept. It is the value that flows from a promisee to a promisor as a result of a bargain. There can be no consideration, however, when there has been no bargain or – to put it another way – consideration cannot flow from a promisee who does not know he or she is negotiating, much less passing value to a promisor in an exchange he or she doesn’t know exists.”

The Court found that the shared transaction was completely unilateral on the part of the father, and his sons had no meaningful input with respect to it. It went on to state that the issue was not whether the donor received some benefit from the estate freeze. Rather, it was about whether the donee had provided any consideration to the donor for the transfer of the shares. The Court emphasised that in order to vitiate the making of a valid gift, the consideration must come from the donee.

In this case, the husband or the son provided no consideration to his father for the shares. The Court found the fact that the father who had accomplished his corporate planning goals did not result in consideration flowing from his son to him. It concluded that the motive underlying a donor’s conduct is not the same thing as consideration flowing from the donee.

Intentions

Next, the Court dealt with the issue of “intention.” The trial judge found that the father did not intend to give the shares as a gift to his sons. Rather, he intended to complete the estate freeze in order to protect his company from creditors and the “gifting” of the common shares was just one step in the overall corporate reorganisational plan. This is typical of a very common argument that is being used by the CRA with respect to various tax shelters - that the purpose of the transaction is not to make a gift/donation, but rather to, for example, obtain a tax deduction. The Court dealt with this issue by opining that the trial judge had erroneously conflated “intention” with underlying “motivation” or “purpose.”

It pointed out that these are not the same concepts, and to treat them as such constitutes an error in law. The father’s primary purpose and motivation in transferring the shares to implement an estate freeze did not mean that he did not intend to give the shares as a gift in order to give effect to that purpose. It further stated that had the trial judge focused on the father’s intention of transferring the shares itself rather than delving into the purpose and motivation in putting the estate freeze in place, the trial judge would have realised the evidence that the father did intend to give the shares as gift (regardless of the overall plan).

The documentation to that effect, being the declaration of gift, was clear. The intention respecting the transfer of the shares was to do so gratuitously. The transfer of the common shares from the father to the sons was part of the corporate structure, which put the estate freeze in place. The estate freeze was the ultimate motivation or purpose. Because the trial judge had not given effect to this distinction, the Court determined that he reached a wrong conclusion with respect to the meaning of the term “gift.”

The OCA held that it was not persuaded “that a gift must be inspired by affection, respect, charity or other like impulses” in order to be a valid gift. The fact that the intention behind transferring the shares had a perfectly legitimate legal objective (mainly to underpin the corporate restructuring in the form of an estate freeze) did not compromise the validity of the father’s gift. That is, a transfer of property by way of gift, being equally motivated by commercial purposes, does not preclude the transfer from being gratuitous.

Now that the Ontario Court of Appeal has shed additional light on the meaning of the term “gift,” it will be interesting to see if the Tax Court of Canada and the Federal Court of Appeal apply the accessory rule and revisit the meaning of gift for income tax purposes.