19 June 2015 STEP Roundtable

This page provides all the questions that were posed to CRA at the 19 June 2015 STEP Roundtable together with a mildly edited version of a transcript of the CRA responses (and with some of the very preliminary remarks made before launching into the real responses being eliminated). Links also are provided to the official responses.

Q1. Graduated Rate Estate-Taxation Year

A graduated rate estate (GRE) obtains graduated tax rates for a period of 36 months. Can CRA confirm in the example below that a graduated rate estate can obtain graduated tax rates for up to four taxation years?

Suppose an individual dies on March 31, 2016. The executors adopt a first year-end of September 30, 2016. The second year-end is September 30, 2017. The third year-end is September 30, 2018. Lastly, a year-end is deemed to arise on March 31, 2019 (36 months after death), which is the last taxation year during which the testamentary trust is a graduated rate estate. Thereafter, it is required to adopt a December 31 year-end and for that taxation year and all following taxation years will not obtain graduated tax rates.

The result of selecting a short year-end for the first taxation year is that in four taxation years during the 36 month period graduated tax rates should be available. Does CRA agree?

Oral Response Summary

The rules are changing in 2016. Under s. 122(1), the general rule will be that trust income will be subject to the flat top marginal tax rate – with two exceptions for the graduated rate estate and the qualified disability trust. The requirements (as specified in the s. 248(1) definition) for a graduated rate estate include that

  • it be the estate that arose on and as a consequence of the death of the particular individual, and
  • the time is not later than 36 months after that death

As part of the wholesale 2016 changes, many of the tax rules that, up to now, have applied to testamentary trusts and grandfathered inter vivos trusts, will only apply to graduated rate estates after 2015. In this regard, changes (for 2016 and subsequent years) to the definition of taxation year and to fiscal year will allow an off-calendar taxation year for a graduated rate estate – but all other testamentary trusts will be required to use the calendar tax year.

In the fact scenario, the first taxation year of the estate (if the estate validly designated itself as a graduated rate estate of the deceased) begins on the day after the death of the individual and will end at any time the executors select within the following 12-month period so that, if the estate continues to meet all the conditions throughout the 36 months following death, it can, in fact, have four taxation years, but obviously those taxation years will still only total 36 months.

Official Response

18 June 2015 STEP Roundtable Q. 1, 2015-0572131C6

Q2. Meaning of Graduated Rate Estate

Under the new rules for testamentary trusts, a fundamental starting point is the definition of graduated rate estate, added to subsection 248(1).

It would seem extremely important for a testamentary trust to be a graduated rate estate for various reasons which include:

  1. The obtaining of graduated tax rates for the first 36 months;
  2. A $40,000 exemption from AMT;
  3. The making of an election under subsection 164(6);
  4. The reduction of the denial of capital losses to 50% of what would otherwise result, as provided for under subparagraph 112(3.2)(a)(iii);
  5. Determining whether a donation made by will can be claimed by the deceased pursuant to clause 118.1(1)(c)(i)(C), which is a component of the definition of total charitable gifts; and
  6. Determining whether on a donation by will of a publicly traded security, a taxable capital gain is included in the income of the deceased at death (by virtue of a deemed disposition under section 70), or the amount is deemed nil.

There may be other provisions which are also affected by whether or not a testamentary trust is a graduated rate estate.

As a result, we are keenly interested to understand more fully the definition of graduated rate estate.

It can be inferred, from the definition of graduated rate estate, that the government contemplates situations where an individual may have more than one estate (notwithstanding the fact that the Department of Finance’s Technical Notes state that generally there is only one estate for a deceased individual). Specifically, paragraph (e) of the definition of graduated rate estate states “no other estate designates itself as the graduated rate estate of the individual”. It is also clear that more than one testamentary trust can be created by will.

Our specific questions are:

Q2. (a) [one estate]

As a general matter, while an estate is under administration during its first 36 months, will it be considered a graduated rate estate in its entirety? In other words, is the estate an over arching entity which encompasses all the property of the deceased, or is it necessary to identity one specific testamentary trust which will be the graduated rate estate? At what point in time does an estate transition into testamentary trusts, or is this a question of fact to be determined on a case-by-case basis?

Oral Response Summary

It is CRA’s view that an individual on death has only one estate which encompasses the total property of any kind (regardless of where it may be situated) that is owned at the time of death by the decedent. Several people have pointed out that para. (e) of the definition of graduated rate estate might be seen to indicate that that would not be true. However, in CRA’s view, paragraph (e) is only used as a “for greater certainty” provision – really there to ensure that if you do indeed have competing parties (executors, for example) who each might attempt to make the graduated rate estate designation, that will not be a possibility. CRA would not want to get mired in the middle of a battle between executors who otherwise would have the ability to make the designation, so that the para. (e) rule precludes that possibility. Nothing more than this should be read into para. (e).

Official Response

18 June 2015 STEP Roundtable Q. 2, 2015-0572091C6

Q2. (b) [two wills]

Where an individual has two wills, does this preclude the possibility that the property of both wills can form one graduated rate estate?

Oral Response Summary

CRA recognizes that individuals may have multiple wills for various reasons: reduction of probate taxes; and several other estate planning purposes. Often those separate wills are separately administered. However, returning to the comment above, CRA still views an estate as encompassing all the decedent’s world-wide property regardless of the fact there may be multiple wills, so that there still is one estate.

Official Response

18 June 2015 STEP Roundtable Q. 2, 2015-0572091C6

Q2. (c) [different executors, jurisdictions]

Assuming that it is possible that two wills can be taken together to constitute the estate, does it make a difference if the executors are different, the beneficiaries are different, or the jurisdictions are different (for example, a will constituted under the laws of a province of Canada, and a will constituted under foreign law which governs only foreign assets)?

Oral Response Summary

Using multiple wills potentially could create practical difficulties. This certainly would be the case respecting making the graduated rate estate designation. There can be issues such as different executors and different jurisdictions, so that it will be essential in going forward to consider issues such as information sharing, communication and other issues as the estate planning is done, as the graduated rate estate is a very important entity from 2016 and onwards.

Official Response

18 June 2015 STEP Roundtable Q. 2, 2015-0572091C6

Q2. (d) [other]

Are there any other helpful comments you can give concerning the meaning of graduated rate estate, which can be used as guidance for estate planning and tax planning purposes? It is noted that depending on the answers to the questions above, many persons may wish to consider major revisions to their estate planning in order to benefit from the traditional post-mortem estate planning methods used in the past.

Oral Response Summary

CRA cannot provide any further direction. We are CRA, you can only expect so much [laughter].

Official Response

18 June 2015 STEP Roundtable Q. 2, 2015-0572091C6

Supplementary Question [timing of transition]

What happens if you pour the assets of the main estate into testamentary trusts before all the post-mortem planning, such as making donations, is finished?

Oral Response Summary

You will have to be thoughtful of that but CRA cannot provide a one-size-fits-all answer. You have the 36-month period, which you will need to look at closely in terms of your estate planning.

Q3. Redeemable Preferred Shares

The CRA has previously commented that it is the legal form of the particular financial instrument, not its economic substance, that will usually determine its income tax treatment. As a result, redeemable preferred shares would be treated as equity irrespective of their accounting classification when applying the “thin-capitalization” rules under subsection 18(4). (Technical Interpretation 9619120).

Can the CRA please comment on whether this position continues to apply?

Oral Response Summary

It is still CRA’s view that the classification of a financial instrument, for example, a redeemable preferred share, as debt or equity for purposes of s. 18(4) will be based on its legal form regardless of its accounting classification. We understand that the context of the question is the Exposure Draft of the Accounting Standards Committee dated October 2014 entitled “Redeemable Preferred Shares Issued in a Tax Planning Arrangement.”

In speaking to the International Division of the Rulings Directorate, they pointed out that they were not trying to indicate that they were fine with everything in the Exposure Draft as well as anything that has happened in the accounting world since 1996. If there is a particular redeemable preferred share where there is a term of the share – or there is a statement in the Exposure Draft – that causes a concern that it might cause CRA’s longstanding position to be invalid, the taxpayer should write into the Rulings Directorate providing the example, and the Directorate would consider providing a more specific answer.

Official Response

18 June 2015 STEP Roundtable Q. 3, 2015-0572201C6

Q4. Canadian Resident Shareholder of US S Corporation

Paragraph 5 of Article XXIX of the Canada-US Tax Convention reads as follows:

Where a person who is a resident of Canada and a shareholder of a United States S corporation requests the competent authority of Canada to do so, the competent authority may agree, subject to terms and conditions satisfactory to such competent authority, to apply the following rules for the purposes of taxation in Canada with respect to the period during which the agreement is effective:

(a) the corporation shall be deemed to be a controlled foreign affiliate of the person;

(b) all the income of the corporation shall be deemed to be foreign accrual property income;

(c) for the purposes of subsection 20(11) of the Income Tax Act, the amount of the corporation's income that is included in the person's income shall be deemed not to be income from a property; and

(d) each dividend paid to the person on a share of the capital stock of the corporation shall be excluded from the person's income and shall be deducted in computing the adjusted cost base to the person of the share. [our emphasis]

We recognize that the CRA provides its guidance on how to request assistance from the Canadian Competent Authority in Information Circular IC 71 -17R5. However, can the CRA provide specific guidance with respect to paragraph 5 of Article XXIX of the Canada – US treaty? Are there any circumstances where such a request would be denied? When filing tax returns, should the returns be filed contemporaneously with the competent authority request assuming that such a request will be granted?

Oral Response Summary

An S Corporation is a small business corporation that has elected for US federal income tax purposes to be a flow-through entity. The effect of the election is that shareholders of the S Corporation are taxed for US federal tax purposes on their proportionate share of the corporation’s income in the year concerned. For Canadian purposes, the S Corporation is not a flow-through entity, such that a Canadian shareholder of an S Corporation is not subject to Canadian income tax on the active business earnings of the S Corporation until they are distributed. Therefore, in the absence of an S Corporation agreement under the Treaty, the shareholder may not qualify for foreign tax credit relief, or may only qualify for limited foreign tax credit relief, for US taxes paid.

Under Art. XIX, para. 5 of the Canada-US Treaty, the competent authority may agree to allow the shareholder of an S Corporation to treat the shareholder’s share of the income of the S Corporation as FAPI. The election synchronizes the recognition of the income in Canada and in the US, and allows the shareholder to claim a foreign tax credit in respect of the full amount of the US tax paid on his or her share of the S Corporation’s income.

It is important to note that Art. XIX, para. 5 does not apply automatically (application to the competent authority for the S Corporation agreement is necessary) and if the shareholder has an interest in more than one S Corporation, a separate agreement is required for each S Corporation. A Canadian shareholder of an S Corporation seeking to enter into an agreement with the competent authority should be aware of a number of factors affecting the calculation of the Canadian shareholder’s Canadian taxation position. These include:

  • the income of the S Corporation is computed under US tax rules. What that means, for example, is that the full amount of a capital gain would be included in the shareholder’s FAPI
  • dividends paid to the shareholder by the S Corporation are excluded from the shareholder’s income, but only to the extent of the accumulated amount of FAPI that has been included in their income already
  • S Corporation losses cannot be deducted from income, including income from other S Corporations, in the year
  • losses from an S Corporation can be carried forward and deducted [under Reg. 5903] against the income from the S Corporation if it realizes income in later years
  • the income of an S Corporation attributed to a shareholder is not earned income for purposes of the RRSP contribution limit
  • the agreement does not relieve the shareholder from the obligation to file a T1134
  • the agreement imposes an obligation on the shareholder to retain various worksheets to provide support in the event of an audit. Things that are required to be retained include information in respect of the FAPI which is included in the shareholder’s income since the time of the agreement, the amount of dividends which have been excluded from the shareholder’s income and adjustments to the cost base of the shares of the S Corporation.

The competent authority may refuse to provide an S Corporation agreement if the shareholder does not submit the information requested by a competent authority or the Canadian shareholder is seeking to revise his Canadian tax reporting for past years.

Ideally, a request for an S Corporation agreement would be made well in advance of the due date for the first year in which the agreement is to come into effect. However, it is not uncommon for a shareholder to request an S Corporation agreement and, while the request is under consideration, file the Canadian returns in the expectation that an S Corporation agreement will be provided.

Official Response

18 June 2015 STEP Roundtable Q. 4, 2015-0581931C6

Q5. Designations to Include Income in a Trust

Q5. (a) [s. 104(13.3) designation only where nil TI?]

New subsection 104(13.3) prohibits a designation under subsections 104(13.1) or 104(13.2) (to include income and taxable capital gains in the income of a trust, where that income is paid or made payable to a beneficiary of the trust) unless the taxable income of the trust for the year is nil. It would appear from this that the designations can only be made in circumstances where losses of other years (capital or non-capital) can be applied such that taxable income is nil.

Do you agree with our interpretation, and can you add any additional comments?

Oral Response Summary

Department of Finance Explanatory Notes indicate the subsection 104(13.3) ensures that a (13.1) or (13.2) designation is made only to the extent that he trust’s tax balances, for example, loss carryforwards, are applied under the rules that apply under Division C against all of the trust’s income for the year determined after the trust claims the maximum amount deductible by it under subsection 104(6). Therefore, any situation in which the trust’s taxable income is greater than nil will render the s. 104(13.1) and (13.2) designations invalid. Such would be the case where the trust chooses to have taxable income in order to utilize certain credits, for example, the dividend tax credit, the donation tax credit or the investment tax credit, to reduce or eliminate the trust’s tax payable. Accordingly, CRA agrees with Q.5(a).

Official Response

18 June 2015 STEP Roundtable Q. 5, 2015-0572101C6

Q5. (b) [carry-back to amended trust return]

If a trust realizes a loss (capital or non-capital) in one of its subsequent three taxation years, is it permissible to amend the trust’s tax return for a particular year to include the amount of income otherwise paid or payable to the beneficiaries in the income of the trust, offset the resulting net income of the trust by the loss carried back (so that taxable income is nil), and request an adjustment to the beneficiaries’ tax returns?

Oral Response Summary

The Act does not specifically provide for the late-filing of (13.1) or (13.2) designations. However, at the 2009 APFF Conference, CRA noted that it would accept a late-filed s. 104(13.1) designation where the trustee can demonstrate that an honest mistake has been made or where a designation is made in respect of a carryback of a non-capital loss. The CRA would only reassess beneficiaries’ income and make a corresponding adjustment to the trust’s income tax return if the tax years to which they relate are not statute-barred where it is not a case of retroactive tax planning.

CRA would expect that it would generally accept a late-filed (13.2) designation where the trust has a capital loss carryback to apply against capital gains, subject to the caveats mentioned above in respect of the s. 104(13.1) designation.

This capital loss situation can be approached with cautious optimism subject to a review of each particular situation in light of any retroactive tax planning issues.

Official Response

18 June 2015 STEP Roundtable Q. 5, 2015-0572101C6

Q6. Spousal, Alter Ego, Joint Partner Trusts on Death

This question concerns new subsection 104(13.4).

A spousal trust, alter ego trust or joint partner trust are subject respectively to a deemed disposition on the date of death of the spouse, the contributor to the alter ego trust, or the death of the later of the contributor and that person’s spouse or common law partner. The deemed disposition arises at the end of the day on which death occurred. Income attribution would not apply because at the time the gain was realized, the person to whom the gain may attribute would be deceased. The consequence of this is that the gain is subject to tax in the trust. Tax planning may be carried out at a later date to potentially create, for example, a capital loss which can be carried back three taxation years to offset the capital gain. Post-mortem planning of this nature was and indeed is regularly carried out.

New subsection 104(13.4) provides for a different result. The trust is deemed to have a year-end at the end of that day, as before, but the income of trust is deemed to have become payable in the year to the individual (whose death caused the deemed disposition).

Our questions concern how this new provision will operate from the perspective of post-mortem tax planning:

Q6. (a) [capital loss carry-back]

Does this now preclude a strategy whereby a subsequent capital loss of the trust can be carried back to offset the capital gain, as might have been done in the past?

Oral Response Summary

In addition to the submissions of others, CRA has had some discussions with Finance. It cannot be predicted what will come out of that. It can be stated that there are practical issues surrounding 104(13.4).

This part of the question is very similar to Q.5. If a capital loss arises in a subsequent year after the death, there would be a desire to carry it back and apply it and one would need to make use of a 104(13.2) designation. A late-filed s. 104(13.2) designation is possible and CRA generally will accept it unless there is retroactive tax planning. CRA cannot draw lines as to what that means at this point, but taxpayers are encouraged to follow up with CRA for its views on that issue.

Official Response

18 June 2015 STEP Roundtable Q. 6, 2015-0572121C6

Q6. (b) [income to deceased individual]

Subparagraph 104(13.4)(b)(i) states that the trust’s income is deemed to have become payable in the year to the individual. However, at the time at which this rule becomes operative, the individual is deceased. So how does the income actually become that of the individual, or does it become that of his or her estate? What is the actual mechanism by which the amount becomes income (is it paragraph 12(1)(m)?), and does the income preserve its nature (if so, how?)

Oral Response Summary

The key point to consider is that s. 104(13.4)(b)(i) is a deeming provision. The Supreme Court stated in Verette [1978] 2 S.C.R. 838, at 845 (a decision quoted in the Federal Court of Appeal [see Placements Serco and OSFC Holdings]) that a deeming provision is a statutory fiction. It implicitly admits that something is not what it is deemed to be – but it decrees that it shall be taken as though it were, in terms of applying a tax provision. In applying s. 104(13.4)(b)(i), it functions as if the deceased individual were, in fact, alive so that the income which is deemed to have been made payable in the year is (on a fictional basis) treated as if it had been made payable while the individual was still alive. On that basis, the normal income inclusion under s. 104(13)(a) would apply.

The second part of this question relates to income preservation. The Department of Finance Technical Notes for s. 104(13.4)(b) point out, for example, that in that year of death no designation under s. 104(13.1), (13.2) or 104(19) to (22) can be made for any beneficiary except for the deceased. That is instructive. It is those designations normally made under s. 104(19) to (22) that allow for character preservation, as spelled out therein.

Official Response

18 June 2015 STEP Roundtable Q. 6, 2015-0572121C6

Q7. Deemed Resident Trust

Q7. (a) [January 1 effective date]

Under the rules concerning deemed resident trusts, an individual who becomes resident in Canada for the first time, and who has previously contributed property to a non-resident trust, will be considered a resident contributor. As such, the trust would come within the provisions of section 94 with the result that the trust would be deemed resident. Paragraph 94(3)(a) seems to deem the trust resident from January 1 of that taxation year. This pre-dates the time at which the person became Canadian resident. Does CRA agree with this interpretation?

Oral Response Summary

94(3)(a) deems it to be resident throughout the tax year despite the fact that one is looking at conditions at a specified time, which is essentially the end of the year. Even though the individual becomes resident part way through the calendar year, the entire year is treated as a year of a deemed resident trust.

Official Response

18 June 2015 STEP Roundtable Q. 7, 2015-0572141C6

Q7. (b) [retroactivity on Canadian residence resumption]

Suppose that the person was previously a long-term Canadian resident, left more than 5 years ago, and then made a contribution to the non-resident trust but within five years becomes Canadian resident again. Assume also that the trust has Canadian resident beneficiaries who are not successor beneficiaries (within the meaning of subsection 94(1)).

Our analysis of this situation is that upon the individual becoming Canadian resident, the nonresident trust is deemed to become Canadian resident, with retroactive application of potentially up to six taxation years, including the current year. We reach this conclusion because a contribution would have been made at a time which is not a non-resident time, and the trust throughout the taxation years in question had Canadian resident beneficiaries.

In such a situation, it would seem that the trust would be responsible for filing tax returns for up to five previous taxation years, furnishing foreign reporting forms in respect of its holdings (T1134 and T1135), and paying income tax on any income of the trust, computed in accordance with Canadian rules, subject to foreign tax credit relief. No relief would be provided under an international tax treaty, by virtue of the overriding provision of section 4.3 of the Income Tax Conventions Interpretation Act. In addition late filing penalties and interest may apply.

Does CRA agree with our interpretation in these circumstances? If so, can CRA offer any strategy whereby the adverse tax consequences described above can be mitigated (for example winding up the trust before becoming Canadian resident)?

Oral Response Summary

CRA agrees with the conclusion. The scenario deals with a person that was a non-resident for more than 60 months before contributing. It is s. 94(10) that really results in the retroactive application of s. 94(3) right back to the tax year of the contribution. If the person was non-resident for less than 60 months before the contribution was made, the trust obviously would be deemed resident under s. 94(3). But if the person was non-resident for more than 60 months before the contribution - but returned to Canada within 60 months after the contribution - then s. 94(10) does kick in and pick up all those years – so that if the contribution was originally made in 2010, for example, and the person comes back to Canada in early 2015, less than 60 months later, all those six years (2010 through 2015) are picked up and deemed resident under s. 94(3). Accordingly, all the indicated filing requirements would apply.

Winding-up the trust pre-arrival does not necessarily fix the problem. For example, if the trust were wound up two years before the individual came to Canada, there are still implications for those years 2010 to the point of wind-up so that the counting of the time periods, pre-contribution and post-contribution, if that trust has any beneficiaries who are resident in Canada, will really be important.

Official Response

18 June 2015 STEP Roundtable Q. 7, 2015-0572141C6

Q8. Foreign Entity Classification

The case of Sommerer highlighted the need for practitioners to carefully consider the issue of foreign entity classification when dealing with foreign legal entities / relationships. While we are certainly aware of the CRA’s approach to foreign entity classification that is outlined in Technical News No. 38 (now Archived), does the CRA keep a list of foreign entities that it generally (we appreciate that each case is a question of fact) considers to be foreign trusts that it would be willing to share with our members?

Oral Response Summary

There currently is no list. CRA still thinks the two-step approach is the correct one. In determining the status of an entity for Canadian tax purposes, the characteristics of the foreign business association are reviewed under the commercial law of that jurisdiction and the relevant documentation. Those characteristics are compared to the characteristics that are recognized in Canada under Canadian commercial law in order to classify the entity under one of the categories.

There is support for this approach in the Sommerer case. Miller J in the Tax Court looked not so much to whether the foundation in that case was a trust but rather whether there was a trust relationship and whether the foundation could be seen as a trustee and, in fact, could it be a corporate trustee. He looked to the Backman case respecting the classification of a foreign entity.

Official Response

18 June 2015 STEP Roundtable Q. 8, 2015-0581961C6

Q9. Non-Qualifying Country

For the purposes of section 95 of the Income Tax Act, income earned by a foreign affiliate from a business carried on through a permanent establishment in a non-qualifying country is considered to be income earned from a business other than an active business and will thus be included in computing the foreign accrual property income (FAPI) of the foreign affiliate.

A “non-qualifying country” is a country or other jurisdiction with which Canada does not have a tax treaty (including one that has been signed but is not yet in effect), one for which the Convention on Mutual Administrative Assistance in Tax Matters?(the MAC) is not in force and effect, or one with which Canada does not have a comprehensive tax information exchange agreement (TIEA), unless Canada has not, more than 60 months before that time, begun or sought by written invitation to enter into negotiations for a TIEA. In effect, a country with which Canada has neither a treaty nor a TIEA and has not ratified the MAC will only be a non-qualifying country if it has failed to enter into a TIEA with Canada within 60 months of being asked to do so or beginning negotiations towards one.

Are there any non-qualifying countries, and if so is CRA able to provide a list of them?

Oral Response Summary

There is only one non-qualifying country as at May 6, 2015, and that is Liberia, which has been a non-qualifying country since February 24, 2015. Finance Canada’s website lists Canada’s current treaties and jurisdictions for which Treaty negotiations have started as well as those which have been invited to start negotiations along with the dates. The status of the jurisdictions participating in the MAC is on the OECD website.

Official Response

18 June 2015 STEP Roundtable Q. 9, 2015-0581921C6

Q10. Interest in a Trust as Taxable Canadian Property

The definition of “taxable Canadian property” (TCP) in subsection 248(1) provides that an interest in a trust (other than a unit of a mutual fund trust or an income interest in a trust resident in Canada) will be TCP if, at any particular time during the 60 month period that ends at that time, more than 50% of the fair market value (FMV) of the interest was derived directly or indirectly from one or any combination of real or immovable property situated in Canada, Canadian resource properties, timber resource properties, and options or interests in such properties. The CRA has previously indicated that where such a trust makes a distribution of capital to a non-resident beneficiary, the notification and withholding requirements of section 116 will apply.

It is common for a will to direct that the executors shall administer the deceased’s estate, and on completion of the administration, transfer the residue to one or more trusts for the benefit of various beneficiaries. At common law, the estate and a trust constituted out of a portion of the residue are separate trusts.

In the following situation, would an interest in the “Son’s Trust” be TCP at the time of the distribution?

A testator dies leaving an estate, more than 50% of which is comprised of real property situated in Canada, for example, the testator’s house (a principal residence). The testator’s will directs his executor to administer the estate by converting the assets, paying the testator’s debts and testamentary expenses, and upon the completion of the administration, to divide the residue into two shares. One of the shares is transferred to a resident trust (the “Son’s Trust”) for the benefit of the testator’s son, who is a non-resident. Assume the executor and the trustee of the Son’s Trust are different people.

The estate is administered within the first year after the testator’s death. At the conclusion of the administration, the estate is comprised entirely of cash. The executor transfers half of the estate to the Son’s Trust.

One year later, the trustee of the Son’s Trust makes a capital distribution to the non-resident son.

Oral Response Summary

CRA assumes that in this situation the estate must transfer the son’s share of the cash to the Son’s Trust with no direction or agreement required from him. The most likely situation is that the transfer of cash from the estate to Son’s Trust would satisfy para. (f) of the definition of “disposition” in s. 248(1), such that there would be no change in beneficial ownership of the property. As para. (f) applies, s. 248(25.1) provides that Son’s Trust is deemed to be a continuation of the estate. As a result, in considering whether the Son’s interest in Son’s Trust is taxable Canadian property at the time the cash is distributed by Son’s Trust to Son, one would have to consider the 60-month look-back rule in para. (d) of the definition of tcp. As the residue of the estate results entirely from the sale of the principal residence, being real property situated in Canada, CRA would consider Son’s interest in Son’s Trust to be derived directly or indirectly from that real property. Since the distribution of cash by Son’s Trust occurs within the 60 months, the Son’s interest in the Son’s Trust would be tcp.

There is an alternative. In the situation where the transfer of the Son’s share of the estate cash to Son's Trust does not meet all the conditions of para. (f) of the definition of disposition, s. 248(25.1) would not apply, and CRA would look to determine whether Son’s interest in the estate was tcp. Here, the analysis would be the same: the residue of the estate results from the sale of the principal residence, being real property situate in Canada. As it occurs within 60 months, that interest also would be tcp.

Official Response

18 June 2015 STEP Roundtable Q. 10, 2015-0578541C6

Q11. New Charitable Donation Rules – Part 1

The new rules regarding charitable donations from a graduated rate estate, contained in amended subsection 118.1(5.1), require that the donation be a gift of “property that was acquired by the estate on and as a consequence of the death” or “property that was substituted for that property”. This is not a requirement under the current law. Consider an individual who dies, after 2015, owning shares of an investment holding company (“Holdco”) that owns marketable securities with fair market value greater than their adjusted cost base. The individual’s will provides for a charitable donation to be made on death. The graduated rate estate (“Estate”) requires Holdco’s marketable securities or cash from sale of such marketable securities to make the donation.

Scenario 1 [dividends as substituted property?]

Holdco sells securities and pays a dividend to Estate. Estate then makes the donation. Would the cash from the dividend be considered substituted property?

Oral Response Summary

S. 118.1(5.1) provides the new rules for charitable donations from a graduated rate estate and in essence provides that the donation must be a gift of (i) property that was acquired by the estate on and as a consequence of the death or (ii) property that is substituted for that property. In Scenario 1, where Holdco pays a cash dividend to the estate, the estate has not replaced the Holdco shares received on death. The cash dividend is not property substituted for those shares for that very reason, and the requirement in s. 118.1(5.1)(b) is not met. Accordingly, only the estate could claim a donation in the year or in the five subsequent taxation years.

Official Response

18 June 2015 STEP Roundtable Q. 11, 2015-0578551C6

Scenario 2 [share redemption proceeds from Newco]

Estate transfers the shares of Holdco, on a tax deferred basis, to Newco and takes back high PUC shares of Newco. Holdco is wound up and Newco gets a paragraph 88(1)(d) bump to increase the adjusted cost base of the marketable securities. Newco sells securities and uses the proceeds to purchase for cancellation some of Estate’s shares. Estate then uses the cash to make the charitable donation. Can the CRA confirm the donation is made with substituted property?

Oral Response Summary

The result in Scenario 2 is more favourable. The key difference is that the shares are being redeemed. The shares of Holdco are received on death and they are disposed of in exchange for the Newco shares, so that the Newco shares are substituted property. The Newco shares then are purchased for cancellation, and the cash received on that purchase would be substituted property for the cancelled shares. Under the extended meaning of “substituted property” in s. 248(5)(a), the cash would be considered to be substituted property for the Holdco shares of the estate and the s. 118.1(5.1)(b) condition would be met.

The key concept is that the gift which arises on death is meant to be paid out of the property owned at death. That is the key difference in Scenario 1: the cash dividend was not a substituted property for the original property.

Official Response

18 June 2015 STEP Roundtable Q. 11, 2015-0578551C6

Q12. New Charitable Donation Rules – Part 2

Under the new tax legislation dealing with testamentary gifts, the “taxpayer” making the gift will be the deceased’s estate (paragraph 118.1(5)(a) provides that the gift is deemed to be made by the estate and not by any other taxpayer). An estate is a “trust”, and generally is both a “testamentary trust” and a “personal trust” for tax purposes. Under paragraph 251(1)(b), a personal trust is generally deemed not to deal at arm’s length with any person that is beneficially interested in the trust. Therefore, as a beneficiary of the deceased’s estate, the Public Foundation will be beneficially interested in the deceased’s estate and will thus be deemed not to deal at arm’s length with the deceased’s estate. Since the Public Foundation and the estate will be deemed not to deal with one another at arm’s length, the gift will not be an “excepted gift” under subsection 118.1(19). This seems like a bizarre result, in that it essentially prevents all gifts from an estate from being “excepted gifts”. If the deceased had made the gift to an arm’s length public foundation during his lifetime, the “excepted gift” rules would apply differently. Can the CRA provide its comment on the above interpretation of the new legislation?

Oral Response Summary

Under the gifting rules for gifts after 2015, s. 118.1(5)(a) provides that a gift by will is deemed to be made by the estate. An estate typically will be a “personal trust” under the s. 248(1) definition and, under s. 251(1)(b), a personal trust generally will be deemed not to deal at arm’s length with a person which is beneficially interested in it.

Here, assuming that the public foundation is a beneficiary of the estate, the estate will be deemed not to deal at arm’s length with the foundation. Accordingly, the gift of the shares, which are non-qualifying securities as defined in s. 118.1(18), will not qualify as an “excepted gift” under s. 118.1(19).

Note that a share listed on a designated stock exchange will not be a non-qualifying security.

Official Response

18 June 2015 STEP Roundtable Q. 12, 2015-0578561C6

Q13. Question on the T3 guide

Q 10 on the T3 Return asks:

Did the trust receive any additional property by way of a contribution of property (as defined in the "Definitions" of the guide) since June 22, 2000? If yes, enter the year, and, if during this taxyear, attach a statement giving details.

The definition “contribution of property” in the Guide reads as follows:

Contribution of property – generally refers to a transfer or loan of property, other than an arm’s length transfer, to a non-resident trust including:

  • a series of transfers or loans that results in a transfer or loan to the non-resident trust; and
  • a transfer or loan made as a result of a transfer or loan involving the non-resident trust.

Accordingly, can it be concluded that for the purpose of Q10 a contribution can only be made to a non-resident trust, and therefore that it will never be appropriate to answer “yes” to this question in a T3 prepared for a trust that is a factual resident of Canada?

Oral Response Summary

The answer is “no.”

As a preliminary observation, the definition of contribution of property in the Guide changed last year in 2014 to more accurately reflect the definition of “contribution” in s. 94(1). The revised definition is similar to that quoted in the question, although there are some nuances.

Q.10 in the Guide relates to whether the trust qualifies as a grandfathered inter vivos trust. A grandfathered inter vivos trust is a trust which was created before June 18, 1971 and satisfies certain conditions. Up to and including 2015, the grandfathered inter vivos trusts typically qualified for graduated rates of taxation. Those conditions are set out in s. 122(2). In particular, s. 122(2)(d.1) requires that the trust is not a trust to which a contribution as defined by s. 94 (as it reads for taxation years that end after 2006) was made after June 22, 2000.

Accordingly, the reference in Q.10 of the Guide to June 22, 2000 relates to legislative proposals that Finance released back in the day in respect of the NRT (non-resident trust) rules. Therefore, respecting whether Q.10 is relevant to a trust which is factually resident in Canada, given that the Q.10 refers to a transfer or loan of property to a non-resident trust, it is CRA’s view that the fact that Finance chose to use the definition of contribution in s. 94(1) for the purpose of s. 122(2)(d.1) does not support the conclusion that that paragraph will never apply to a factually resident trust. In fact, s. 122(2)(b) requires that the trust was resident in Canada on June 18, 1971 and without interruption thereafter until the end of the year.

In light of the 2016/GRE changes, this question may now have less relevance after 2015.

Official Response

18 June 2015 STEP Roundtable Q. 13, 2015-0581941C6

Q14. Requirements for Question #6 on Page 2 of the T3 Return

Question 6 of the T3 return reads as follows:

Did the trust borrow money, or incur a debt, in a non-arm's length transaction since June 18, 1971? If yes, state the year, and, if during this tax year, attach a statement showing the amount of the loan, the lender's name, and the lender's relationship to the beneficiaries.

In many cases, amounts of trust income are allocated to the beneficiaries of the trust but the corresponding amounts are not actually paid. Instead, the trustees ensure that the amounts are due to the beneficiaries and such amounts are legally enforceable against the trust property (in order to ensure that the conditions of subsection 104(24) are met). Given such, are amounts that are due to the beneficiary for reasons described above required to be disclosed pursuant to question #6 of the T3 return? The T3 Guide does not seem to address this specific question.

Oral Response Summary

Under s. 104(24), an amount is deemed, for purposes of the deduction to the trust under s. 104(6), the inclusion to the beneficiary under s. 104(13) and for several other purposes of the Act, not to have become payable to a beneficiary in a taxation year unless it was paid in the year to the beneficiary or the beneficiary was entitled in the year to enforce payment of it.

As noted by Rip J (as he then was) in Fingold, "a debt is a sum of money owed in respect of which a plaintiff has a right to bring and maintain an action." Accordingly, where a trust allocates income to a beneficiary in a particular year but, rather than paying out the income, it provides the beneficiary with a right to enforce payment, that establishes a debt to that beneficiary. The instructions in Q.6 in the Guide refer the reader to IT-406R2 “Tax payable by an inter vivos trust.” As noted in para. 2, it is the graduated rate taxation rather than flat rate taxation which is available to certain grandfathered inter vivos trusts that meet the conditions under s. 122(2). S. 122(2)(e) requires that the trust has not, after June 18, 1971, incurred any debt, or any other obligation to pay an amount, to, or guaranteed by, any person with whom any beneficiary of the trust was not dealing at arm’s length. Background on “arm’s length” is provided in S1-F5-C1. Para. 12 of IT-406R2 states that:

Paragraph 122(2)(e) is not contravened by a debt or other obligation of the trust to pay to a beneficiary an amount required by the terms of the trust, provided that it is paid out to the beneficiary during the reasonable time needed to discharge the debt or obligation. A reasonable time will usually not be considered to extend beyond the end of the taxation year following the year in which the debt or obligation became payable by the trust. However, where subsection 104(8) applies with respect to the income of a trust in which a minor beneficiary has a vested interest, a reasonable time will usually not be considered to extend beyond the end of the taxation year following the year in which the child reaches the age of majority.

Accordingly, if there is a beneficiary, who is not at arm’s length with a trust, who has been provided with rights to enforce payment, that information should be included on filing the return.

Official Response

18 June 2015 STEP Roundtable Q. 14, 2015-0581951C6

Q15. Tax Audit and Net Worth Statements

Can CRA comment on the following:

Q15. (a) [personal financial information of shareholders]

It has come to our attention that CRA is increasingly requesting personal financial information of the shareholders of Canadian corporations which are selected for audit. In some cases, the information is requested for all members of a household (for example husband, wife and children) even though only one of those persons is the owner.

Oral Response Summary

There is not really a new approach.

When small businesses are selected for audit, the CRA seeks to gain assurance about the completeness of the income recorded in their filings. In some of these small businesses, internal controls are weak, and segregation of duties is either low or absent, so that the use of indirect tests in these situations is a means of gaining assurance about the completeness of income that has been reported. Indirect tests that are undertaken by the CRA include bank deposit analyses, rough net worth calculations or analyses of sources and applications of funds. In order to [not?] undertake these tests, at the outset, the business transactions are reported within the business and not in the personal bank accounts of the proprietor, the shareholder or related or household members.

Privacy and confidentiality of taxpayer information is protected and managed under the confidentiality provisions of s. 241 and the CRA is also obliged to protect personal information under the provisions of the Privacy Act. CRA respects these obligations when it obtains taxpayer information from taxpayers in the due course of CRA audits.

Part of the question relates to situations where there is a sole proprietorship, a sole shareholder or a closely-held corporation. There can be potential commingling of business and personal funds. When the CRA is performing the indirect tests referred to above, the auditors also request personal financial information of either the proprietor or the shareholder, spouse or common law partner or other contributing individuals living in the same household.

The authority to request personal banking statements of the shareholder, spouse or other individuals is provided in s. 231.1(1), which authorizes the CRA to inspect, audit or examine records of other persons, where those records relate to information which is or should be in the books and records of the taxpayer who is under inspection or examination.

Official Response

18 June 2015 STEP Roundtable Q. 15, 2015-0572151C6

Q15. (b) [net worth statements]

In addition, CRA auditors have requested individuals to furnish statements of net worth, even in circumstances where this would not have to be prepared, and is not readily available (most people do not routinely compile and maintain statements of net worth).

Oral Response Summary

When conducting an audit where indirect verification of income tax is necessary to verify the completeness of reported revenues, it would be a standard practice for an auditor to request the taxpayer to complete a questionnaire detailing his or her personal expenditures. The questionnaire is quite detailed. However, it does not constitute a statement of net worth. A statement of net worth would include an exhaustive list of all assets and liabilities of the taxpayer.

It is not a standard procedure to request that a statement of net worth be prepared by a taxpayer.

Official Response

Q16. Offshore Tax Informant Program

The Government of Canada introduced a number of measures in the 2013 Federal Budget to strengthen the CRA’s ability to address international tax evasion and aggressive tax avoidance, including a paid informant program. Can the CRA give a brief overview of the Offshore Tax Informant Program, as well as provide other information that may be of interest to our members regarding the new program?

Oral Response Summary

The OTIP program allows the CRA to seek specific and credible details as to major international tax non-compliance. The details have to lead to an assessment and collection of federal tax. If the federal tax assessed and collected exceeds $100,000, the reward would be between 5% and 15% of the federal tax collected excluding interest and penalties.

CRA will consider the eligibility of a written submission and, if the informant appears to qualify, the next step is that CRA enters into a contractual obligation with the informant.

The payment process, assuming the matter proceeds, applies where over $100,000 of federal tax is collected and the recourse rights of the taxpayer are exhausted – which can take several years. The award is taxable in the year of receipt, and applicable taxes will be withheld from the payment.

Most submissions received to date have been received from individual informants, and most of those submissions have been in respect of individual taxpayers. It is felt that the types of international non-compliance issues which have been identified so far are fairly diverse, and have involved various countries and financial institutions, so that there does not appear to be a particular pattern. CRA’s compliance program branch believes at this point that the submissions to date reflect the types of non-compliance that the program was designed to identify. Accordingly, the program appears to be proceeding successfully.

Since launch on January 15, 2014, to March 31, 2015, they received over 1900 calls (522 of which were from potential informants) and 201 written submissions. (These numbers since have increased.)

There currently are over 100 cases being reviewed to determine if they qualify, and those that do not are, where appropriate, referred to other CRA compliance areas. At this point, the program currently is in the contracting phase with several informants.

Official Response

18 June 2015 STEP Roundtable Q. 16, 2015-0572181C6

Q17. Update on FATCA Information Exchange

Articles 2 and 3 of the Agreement between the Government of Canada and the Government ofthe United States of America to Improve International Tax Compliance through Enhanced Exchange of Information under the Convention between Canada and the United States ofAmerica with Respect to Taxes on Income and on Capital (the “IGA”) sets out the timing of when information must be provided by a Canadian Financial Institution. Paragraph 12.29 of the CRA’s publication Guidance on enhanced financial accounts information reporting nicely lays out the information deadline days. Given that the deadline for 2014 information exchange has already passed, can the CRA provide any comments on how the information exchange procedures / obligations has been proceeding?

Oral Response Summary

Advisors [FIs?] are required to file information returns on certain accounts annually starting with the 2014 calendar year. The deadline for the 2014 year was May 1, 2015 and any FI which does not meet those obligations may be subject to penalties and interest, and may be considered non-compliant. If they have not filed at this point, they are urged to do so immediately.

Official Response

18 June 2015 STEP Roundtable Q. 17, 2015-0572191C6