Form T2140: Non-Qualified Investments and Part V Tax

A private foundation lends money to the founder's company at a friendly rate, or takes shares in it instead of cash. The Income Tax Act does not automatically prohibit the investment, although fiduciary, corporate and charity-law considerations may still apply to it. What the Act does is make sure the foundation is not being used as a cheap source of capital for its insiders, and it does so with a tax that lands on the borrower rather than the foundation, reported on Form T2140, the Part V Tax Return for Non-Qualified Investments of a Registered Charity.

What Part V Tax Covers

Part V of the Income Tax Act deals with registered charities and other qualified donees. It contains the revocation tax a charity pays when its registration ends, the penalties the CRA can impose for specific breaches, and, in section 189, the tax on non-qualified investments. Our post on charity revocation covers the revocation tax. This page is about section 189 only, which applies to one designation of charity, the private foundation, and to one kind of asset.

What Makes an Investment Non-Qualified

The definition in subsection 149.1(1) turns on who issued the investment rather than what it is.

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Three things are carved out. Shares listed on a designated stock exchange and shares prescribed by regulation are never non-qualified, whoever holds them. Debts and shares of an excluded corporation are outside the rule; an excluded corporation is a limited-dividend housing company, a corporation whose shares are all owned by the foundation, or one whose entire property is used by a registered charity. A debt already taxed as a benefit under subsection 80.4(1) is not counted twice.

Our broader guide to CRA compliance for private foundations sets this rule beside the others that attach to the designation.

Who Pays the Tax and How It Is Calculated

The tax is payable by the issuer or debtor, not the foundation. Section 189(1) charges the person who owes the debt, in the amount by which interest at the prescribed rate exceeds the interest actually paid to the foundation within 30 days after the end of the year. A borrower who paid a market rate owes nothing; a borrower who paid nothing owes the full prescribed-rate interest for the period the debt was outstanding.

Shares are folded into the same mechanism. A non-qualified share, or a right to acquire one, is deemed to be a debt owed by the corporation to the foundation in an amount equal to the share's cost to the foundation. Dividends paid on the share are treated as interest on that deemed debt.

For a genuine debt the interest is computed at the lesser of the prescribed rate and an arm's-length rate, so a commercial loan documented at a commercial rate is generally safe.

Filing Form T2140

The return is filed by the person liable, which means the borrowing corporation or individual files it, not the foundation, and it is filed with that person's own tax centre rather than the Charities Directorate. It is due on the day that person's Part I income tax return is due, or would be due, and any tax owing goes with it. The CRA's guidance on the topic is CG-006, Non-qualified investment: tax liability.

The foundation files nothing under section 189, but the same facts that create a Part V liability for the borrower usually create questions for the foundation: whether an insider received an undue benefit, and whether the share holdings trigger the separate excess corporate holdings rules reported on Form T2081. Our post on whether a charity can provide benefits to its directors covers the benefit side.

Avoiding the Problem

The cleanest answer is for a private foundation not to lend to, or invest in, its own insiders. Where there is a real reason to do so, the investment should be documented at a rate that meets or exceeds the prescribed rate, interest or dividends should be paid within 30 days of year end without exception, and the board minutes should record why the investment was in the foundation's interest with the interested director out of the room. A loan set up informally years ago can be regularized going forward by repricing it and paying interest on time from that point. It cannot be fixed retroactively: section 189 gives credit only for interest paid no later than 30 days after the end of the year it relates to, so a catch-up payment made now does not erase tax that arose in earlier years. Historical exposure has to be quantified separately.

If your foundation holds a loan to or shares in a company connected to its directors or major donor, we can determine whether the investment is non-qualified, quantify any Part V exposure and restructure it if needed. Call us at 416-488-5888, email us at ask@charitylawgroup.ca, or schedule a free meeting with our legal team. Form T2140 is on our forms and statutes page.

Frequently Asked Questions

Here are answers to the questions we hear most often about non-qualified investments.

Does this rule apply to charitable organizations and public foundations?

No. Section 189 applies only to non-qualified investments of private foundations. The other designations have their own restrictions on dealings with insiders, but not this tax.

Is a private foundation prohibited from holding a non-qualified investment?

No. The Act does not prohibit the investment; it taxes the issuer if the foundation is not receiving a prescribed-rate return. The foundation may still face separate issues around undue benefit and excess corporate holdings.

Who actually files Form T2140?

The person who owes the debt or issued the shares. A corporation files it with its tax centre by its own return deadline. The foundation does not file it.

Can a foundation buy publicly traded shares of a company its director controls?

Shares listed on a designated stock exchange are excluded from the definition of non-qualified investment, so section 189 does not apply. The excess corporate holdings rules and the undue benefit rules may still apply.

This article provides general information about the Income Tax Act rules for private foundations and is not legal advice. Speak with a charity lawyer about your organization's specific circumstances.

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