Saturday, May 28, 2011

When is a scholarship a "forgiveable loan" (or vice versa)?

A very interesting class action lawsuit has been launched here in The Hammer.   It involves students of Redeemer University College and their parents who claim they were ripped off by an enticing "forgiveable loan" scheme to offset the costs of the tuition at the private university.   The "found class" of 500 or so people is demanding $6 million in damages.

This is a case I have been reading about the last few years and it makes me wonder who's regulating private institutions.   Of course it's no one.

The concept behind the program was basically was that students would solicit donations to the university's fund raising arm.   In turn the foundation would hand out loans and as long as the student who received such loan finished out the year and wasn't cited for academic dishonesty, the loans would be "forgiven."  At the same time, the donor would get a tax break for charitable donations over and above the student tax credit.

So say tuition was $10,000.   The student would "pay" the tuition knowing it would be paid off at the back end.   At the same time the parent would make an equal donation of $10,000.   The combined federal and provincial credit was 40% dropping the tuition to $6000.  Then on top of this the student would also get a tuition tax receipt for $10,000 of which $5,000 could be transferred to a parent and the tax credit there was 21% or $1,050.   Net tuition:  $4,950, only a few hundred bucks more than one would pay at a public university.

The problem was that the Canada Revenue Agency (CRA) investigated and found the only reason the foundation existed was to pay for tuition.  That's potentially illegal under the law.   The feds backed off slightly, but did demand the "foundation" prove it could trace donations from the donor directly to the intended recipient.   After several attempts over a few years to get the records, the school still couldn't provide them and the CRA shut the scheme down.

So it was the parents who were hit with audits, often in the thousands of dollars.   The case went all the way to the Supreme Court of Canada in 2008 which ruled in favour of the feds and told the parents if they had a problem with getting reassessed, even if they made the donation in good faith, they had to sue the CRA in Tax Court.   (This could be either by the "informal" process if the amount is under $12,000, a form of small claims court; or through the "general" process if the disputed amount is over, which appears to be the case for quite a few parents, which means a full blown civil trial.)

I'll admit Redeemer was scrupulous in one respect:  As I understand the situation, they didn't exactly treat these as scholarships, where a few thousand more each year could have been written off and the potential tax bill could have been even higher if caught.   But wasn't this what it really was?   A way to hand out scholarships for a lot of students even if they weren't really called that?

I'll leave it to the courts to decide whether the plaintiffs have a case.   But keep in mind this is an accredited university.   There are quite a few "diploma mills" now operating in Ontario, all claiming to be "Christian" as well and I would not be surprised if they are playing fancy with tax avoidance rules as well.   As for those running the operation, if the feds said there was a problem they should have fixed it.  If they didn't as alleged they should not only be responsible for the tax bills of the unwitting donors, they should go to prison as well.

UPDATE (9:18 am EDT 05-30-2011, 1318 GMT):   In my calculations I neglected to include the "education" amount of $400 per month, or $3200 per year, which results in an imputed tax credit of $704 and thus reduced the tuition at Redeemer to just under $4150.   It still doesn't explain however how the so-called foundation thought they could get away with it without an explanation.

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