10 June 2016 STEP Roundtable
This shows the written versions of the questions which were posed on June 10, 2016 at the 2016 STEP Canada Conference by the two panelists (Michael Cadesky and Kim G.C. Moody) to Phil Kohnen, Manager, Trusts Section, Income Tax Rulings Directorate and Marina Panougias, Senior Rulings Officer, Trust Section II, Income Tax Rulings Directoratate, together with an edited transcript of their responses to these and some oral supplementary questions of the panelists (provided below in abbreviated form).
The definition of “graduated rate estate” in subsection 248(1) of the Act requires such an estate to be a testamentary trust and that no other estate is designated as the graduated rate estate of the deceased individual. At the 2015 STEP – CRA Roundtable, CRA stated that an individual can only have one estate. This view is consistent with the Department of Finance’s Technical Notes. Accordingly, even if a person has multiple wills, different executors, assets in Canada and in foreign countries and so forth, all of these assets would be grouped together such that they collectively formed one estate (assuming of course that these assets are not held in joint tenancy with right of survivorship).
Suppose that a deceased taxpayer’s will provides that the assets are to be divided into a spousal trust and a trust for children. Does this mean, as a practical matter, that three testamentary trusts would in fact be formed, the spousal trust, the trust for children, and a third trust which would be called, for want of another description, the general estate?
a) If assets were held in the general estate, and not transferred to the spousal or children trusts, say for a period of two or three years while the estate is under administration, would tax returns be required for all three testamentary trusts (presumably nil tax returns except for the general estate as the other trusts would hold no assets)?
b) Taking this further, suppose that the deceased died in 2014, and in 2015 all of the assets were held in either the spousal trust or the children trust. Does this mean that in 2016, there is no graduated rate estate?
c) Can assets be transferred from the other testamentary trusts back to the graduated rate estate? Or would this offend the anti-stuffing rule under paragraph (b) of the “testamentary trust” definition in subsection 108(1)?
d) To obtain access to the new rules on donations, these donations need to be made by the general estate and not the other testamentary trusts. If so, does this mean in practice that the general estate must remain as such until the donations are fully made (which might now extend to 60 months)?
Phil Kohnen: Let’s address this one piece at a time.
a) Transfer to spousal/children trust
Looking back to the 2012 Roundtable, we had noted that CRA generally views trusts arising from estate residues as arising at the time of death. We reiterated that general position in question 2 at last year’s Roundtable.
The key question of fact is as to when the trusts are created. That question of fact will ultimately determine the filing requirements under the Income Tax Act. The long and short of it is that if the spousal trust, or the trust for the children, or both, are created and holding assets, then the Act would require filing in respect of each of them, subject of course to the exceptions that may be found in the T3 Guide.
b) All assets in spousal/children trust
In this scenario, it is important to note that the definition of graduated rate estate in s. 248(1) of the Act is clear that only an estate can be a graduated rate estate. Once property is transferred from the estate to a testamentary trust, that particular trust is not a graduated rate estate because it is not an estate. In example (b), if all the assets are held in either the spousal trust or the trust for children in 2016, there would be no graduated rate estate.
c) Anti-stuffing rule
Paragraph (b) of the graduated rate estate definition requires that the estate be a testamentary trust as defined in s. 108(1) of the Act. Paragraph (b) of that s. 108(1) definition is such that where property is contributed to a trust otherwise than by an individual on or after the individual’s death, and as a consequence thereof, it will not be a testamentary trust. Thus, the asset transfer back to what would have been the graduated rate estate would cause it to no longer be a graduated rate estate, because it would not be a testamentary trust.
d) Donations after 36 mo.
As you probably well know, a graduated rate estate by definition can exist for a maximum of 36 months after the death of the individual. The Department of Finance legislative proposals of January 15th of this year, in respect of s. 118.1(5.1), have introduced some interesting changes. If enacted, estates that cease to be graduated rate estates solely for the reason that 36 months have passed since death, can make a donation within 60 months of death. The key point to remember here is that all of the other requirements, other than paragraph (a) of the graduated rate estate definition, must be met. They include the important requirement that the estate arose on or as a consequence of the individual’s death.
Supp. Q: Anti-stuffing
Kim Moody: I am going to quickly comment on your answer to question (c) on the anti-stuffing rule. In the Joint Committee submission on the January proposals, we submitted that we do not even need the anti-stuffing rule anymore under s. 108(1) - (b). It was intended to prevent mischief with respect to multiplying access to graduated rates. However, there is now a bright line test of 36 months. If the person died, all the assets were distributed and then were distributed back to the GRE, where is the mischief?
Phil Kohnen: I am not going to speak for Finance, but I think you could probably conjure up some scenarios, other than the one you just presented, that might make that anti-stuffing rule relevant going forward.
If someone has a second will pertaining to foreign assets, and the domestic executors either do not know about this second will, or cannot deal with the foreign executors on a timely basis, would the status of the estate as a graduated rate estate (“GRE”) be invalidated if only the domestic executors elected for the estate to be a GRE?
Phil Kohnen: You might recall that last year we had a question on multiple wills in relation to graduated rate estates. We commented that we recognize that multiple wills are used for probate tax planning and other quite valid estate planning purposes. Nothing prevents these multiple wills from being administered separately, but it is our view that there is one estate, and only one estate, which encompasses all of the world-wide property of the deceased.
With that in mind, looking to the graduated rate estate definition in s. 248(1), an estate can only be a graduated rate estate if all the requirements in paragraphs (a) through (e) are met. In a multiple will situation, there might be issues with paragraphs (d) and (e) of that definition. This is not an exhaustive list of paragraphs that may be worthy of attention, but those are the two that jump out as potentially being problematic.
Looking at paragraph (d), the estate must designate itself as the graduated rate estate (there is a formal designation process involved). Right off the bat in the planning process, one would have to ask whether the domestic executors have the ability to make the designation?
Paragraph (e) might be more problematic yet. It requires that no other graduated rate designation be made in respect of the deceased individual. The domestic executors would be well advised to ensure that the foreign executors do not make a separate attempt to designate what they view as their portion of the estate. This hearkens back to my comments last year that in our view that if there is an absence of complete communication and information sharing, there will probably be potential problems. I would also question as well, where there is not complete communication and information sharing, how would complete tax reporting in respect of the world-wide property of that deceased individual be assured in any event?
Inter vivos trusts may be created with one of the beneficiaries being an individual’s estate. A life insurance policy, for example, might be held by such a trust with the trust being the beneficiary of the policy at death and the estate being the beneficiary of the trust.
Does such an arrangement, once a payment is made, disqualify the estate from being a testamentary trust and thus a graduated rate estate?
The graduated rate estate definition requires that an estate must be at that time a testamentary trust, which is defined in s. 108(1) of the Act. That definition requires, for any trust that is created after 1981, that no property has been contributed to the trust otherwise than by an individual on or after the individual’s death and as a consequence thereof.
In the scenario presented here, the property contributed to the estate, as the beneficiary of the inter vivos trust, in our view fails that requirement that the property is contributed by an individual on or after the individual’s death and as a consequence thereof - so the short answer is that the estate would not be a graduated rate estate.
Marina Panougias: There are a number of conditions that must be met in order for a trust to be eligible to be a Qualified Disability Trust (“QDT”) for a particular tax year. One of the conditions in subsection 122(3) is that the electing beneficiary cannot make a joint election with any other trust for that other trust to be a QDT in the same year. Consider the situation where each of the four grandparents of an individual with a disability establishes a trust for the individual under his/her will. Since the individual with a disability is a beneficiary of each of the four trusts, it would only be possible for one of the trusts to be a QDT for 2016 and subsequent tax years. As a result, only the QDT will be taxed at graduated income tax rates while the remaining three trusts would be subject to tax at the highest marginal tax rate.
Where the preferred beneficiary election in subsection 104(14) is available, it is possible for a trustee and preferred beneficiary to jointly elect to have all or a portion of the taxable income earned by trust included in the income of the preferred beneficiary. Thus, the income of the trust will be taxed based on the individual’s graduated income tax rates.
Can the CRA confirm whether the introduction of the QDT provisions restricts the ability to make a preferred beneficiary election? In particular, is it possible for a preferred beneficiary election to be made for each of the four testamentary trusts created for the benefit of the same disabled individual?
We can confirm that in a situation where the four grandparents of the same disabled beneficiary each created a separate trust for that one beneficiary, that one beneficiary can only make a joint election with one of the trusts in a given tax year. Accordingly, in that scenario, only one of those trusts would be a QDT.
In respect of your second question, the introduction of the QDT provisions does not restrict the availability of the preferred beneficiary election. We do want to point out, though, that many of the conditions required for a trust to make a preferred beneficiary election are different from those required for a trust to be a QDT. Depending on the situation, both elections might not be available to the trust - but assuming that the respective conditions are met for both, then the trust has the ability to choose whether to be a QDT or to make a preferred beneficiary election. It is also possible for a trust that elects to be a QDT to also make the preferred beneficiary election in a given tax year because the two elections are not mutually exclusive.
For 2016 and subsequent years, where income and capital gains of a trust are actually paid out or made payable, a designation under subsection 104(13.1) or subsection 104(13.2) is not permitted pursuant to subsection 104(13.3), unless the taxable income of the trust is nil.
At the 2015 STEP CRA Roundtable, we queried whether a carry back of a capital loss realized in a subsequent year would allow a late subsection 104(13.2) designation to be filed. CRA noted that a late-filed subsection 104(13.2) designation would generally be acceptable provided that taxable income for the year was not greater than nil.
The 104(13.2) designation will include in the income of the trust a capital gain realized for that previous year that was allocated out to the beneficiary. The beneficiary’s tax return would then be amended to remove the capital gain. Is this permissible?
Marina Panougias: We confirm that a trust can make a late s. 104(13.1) or (13.2) designation as long as the application of the loss results in nil taxable income for trust for the year. We also confirm that the CRA will reassess the beneficiary’s tax return to remove that gain provided that the tax return for the trust for the year in which the loss is applied, as well as the tax return for the beneficiary for that year, are not statute-barred.
In order to ensure that those returns are all processed appropriately, there are quite a few mechanics to work through. The trust would need to file a form T3A loss carry-back request with its tax return for the year in which the loss is realized in order to request that that loss be carried back to that prior year. The trust would also need to file a T3 adjustment request for that prior year in order to make the late-filed s. 104(13.1) or (13.2) designation. It is important to make sure that the T3A loss carry-back request, and the T3 adjustment request for the prior year, are filed together so that those returns can be processed concurrently. The trust would also of course need to issue amended T3 slips to the beneficiaries to reflect that reduction in the gain allocated and of course the beneficiary would need to file a T1 adjustment request to ensure that their tax return is reassessed to reflect that revised T3 slip.
In response to question 9 at the 2014 STEP Canada National Conference, the CRA noted that under its then current administrative practices, penalties and interest would not be assessed where an inter vivos trust failed to make sufficient instalment payments. The CRA stated that all administrative practices related to the new trust rules announced in Budget 2014 would be reviewed and that any changes to these practices would be introduced in conjunction with these new rules. Can the CRA provide an update to its administrative practice of not assessing instalment interest and penalties?
Marina Panougias: The CRA has not changed its administrative practice. The CRA will continue not to assess interest and penalties for insufficient instalments paid by trusts. If there is any change to this administrative practice in the future, sufficient information will be made available to assist trustees to ensure that they do meet their obligations.
This is also a good time to mention that there is a Q & A on the CRA website relating to graduated rate estates and other related rules. This administrative practice is included there as well as some other information on graduated rate estates and qualified disability trusts. Anyone wanting to access that Q & A, can go to the CRA website and use the search tool to enter in “graduated rate estate” - and the Q & A will be the first hit for the search.
A trust which meets the conditions of section 94 is considered resident for certain purposes of the Act. It is generally referred to as a deemed resident trust, but it is in fact not considered resident for all purposes of the Act and certain rules are quite different from those applicable to a resident trust (for example, withholding tax and the deduction for distributions to beneficiaries who are non-resident).
Our question concerns a situation where a deemed resident trust controls a Canadian corporation. Since subsection 94(3) does not state that a deemed resident trust is considered resident for purposes of determining control, we would imagine that the corporation would not be considered Canadian controlled. Can CRA confirm this?
Phil Kohnen: Factual residence of a trust is determined based on the central management and control concept under the St. Michael Trust Corporation case. On top of that, the CRA has a view that when a factually non-resident trust holds the majority of voting shares that means that non-resident persons generally exert de jure control over the corporation. We look to Consolidated Holdings, for example, as support for that view.
Looking at the CCPC requirements in the Act, they require that Canco must not be controlled, directly or indirectly, in any manner by non-resident persons, public corporations or any combination thereof. Thus, Canco would not be a CCPC if any non-resident persons or public corporations had de jure or de facto control of it.
The question here is, given that the trust in the example is deemed to be resident in Canada, can this result in Canco being a CCPC? When you look at section 94, in particular subsection 94(3) when it applies to a factually non-resident trust, that trust is deemed to be resident in Canada throughout that year for certain specified purposes, but only those specified. In general, those purposes include computing income tax liability, the tax treatment of its beneficiaries, reporting and filing obligations, and liability for Part XIII tax to name some of the major purposes. You can look to paragraph 94(3)(a) in this regard which pretty much lists the things that that the deeming of residence does.
But one thing it does not do is to deem that trust to be resident in Canada for purposes of applying the CCPC definition in subsection 125(7). So the short answer is that the fact that the trust is deemed resident in Canada under section 94 will not result in Canco being a CCPC.
What is the status of the CRA’s review of the characterization for Canadian tax purposes of U.S. LLLPs?
Phil Kohnen: I will tell you what was discussed at the recent IFA Roundtable. Our International Division at Income Tax Rulings, in looking at these two types of entities (LLPs and LLLPs), focused on two main determining factors. The first one was the existence of a separate legal personality, and the second was the limitation of liability that applies to all the members of these entities: these were the two attributes which they thought were the most relevant in making their determination.
Their conclusion after a hard look at both types of entities was that it was these two factors which differentiate these entities from general and limited partnerships under Canadian and provincial law – but, to be clear, they wanted to make the point that it is really that limited liability factor that they view as most problematic. They were not able to accept the concept that these entities’ sole and entire responsibility for their own obligations can be ignored when assessing tax under our Income Tax Act.
So the long and short of it is that CRA believes that there is little substantive difference, between LLPs and LLLPs, and LLCs, under Florida and Delaware law.
Respecting your comment about Anson, I do not know the case intimately, but I do know that our folks at International looked at it and Anson has not changed their views on LLCs. At the end of the day, our general conclusion is that Florida and Delaware LLPs and LLLPs should be treated as corporations.
That being said, we recognize that that causes difficulty for some out there, and CRA stated at IFA that we are willing to make certain concessions as follows. Where there are scenarios where there is clearly an absence of abusive tax avoidance, we will allow an LLP or a LLLP to be treated as a partnership for purposes of our Act where all of the following four requirements are met.
- The entity has to have been formed and commenced carrying on business before July of this year.
- The facts and circumstances must make it clear that the members were carrying on a business in common with a view to making profit and intended that the entity would be treated as a partnership, not a corporation, for Canadian tax purposes.
- Thirdly, neither the entity, nor any member of it, has ever taken a position that it is anything other than a partnership for Canadian tax purposes.
- And lastly, the entity has to convert, before 2018, to a form that is generally recognized as a partnership for Canadian tax purposes.
That being said, where some but not all of those conditions are met, those cases may be dealt with on a facts and circumstance basis. There is a caveat, which is that generally CRA will not accept partnership treatment for Florida or Delaware entities that started as LLCs and then converted to an LLP or LLLP with no substantive change to their legal context.
Kim Moody: I see some very practical problems with this. I am quite confident that there will be a [Joint Committee] submission made on this once we see the material in writing, which I understand will be released.
Phil Kohnen: Yes, it should be fairly soon.
Recently, many practitioners and/or Canadian taxpayers have been receiving requests from the CRA to obtain a transcript from the United States Internal Revenue Service to the extent that foreign tax credits were claimed in respect of US tax paid that corresponds to the filing of a US tax return. However, getting a transcript from the IRS for taxpayers living outside the US isn’t as straightforward as logging onto CRA My Account. Can the CRA comment on why this seems to be an administrative change and whether it would consider not requiring transcripts from the IRS to support a foreign tax credit claim?
Marina Panougias: I will start with some background. Since the Canadian tax system is based on a system of self-assessment, the CRA conducts tax reviews every year in order to make sure that income is properly reported and expenses, deductions and credits are correctly claimed in accordance with the Act. The CRA does not target or exclude any specific category of taxpayer when selecting returns for review. Some of those returns are selected randomly, and some are selected using a sophisticated scoring system which incorporates multiple factors to identify returns which show the highest potential for inaccuracies for certain types of claims. And as you would expect, one of the claims that has a high potential for inaccuracy is the foreign tax credit.
Last year there was a change to what supporting documents are acceptable for foreign tax credit claims in respect of U.S.-sourced income. This decision was made in response to a trend for an increase in incorrect reporting and incomplete submissions in respect of U.S.-source income. For all other countries, the CRA requires a copy of the foreign tax return as well as a copy of the foreign notice of assessment (or other equivalent document) from the foreign tax authority. To be equitable in the treatment of all taxpayers, the CRA now requires the same level of proof from taxpayers with U.S.-source income.
That being said, in response to feedback in respect of this change, if a taxpayer is not able to provide a copy of the notice of assessment, the transcript or equivalent document from the foreign tax authority, the CRA will accept proof of payment to the foreign tax authority or proof of the refund received. That proof can come in the form of bank statements, cancelled cheques, or official receipts so long as there is certain information clearly indicated on that document. That information includes that the payment was made to that foreign tax authority or the refund was received from that foreign tax authority, the amount of the payment, the date the payment was made or the refund received and the tax year in respect of the payment or refund.
It is common in U.S. estate planning for a U.S. person (non-resident of Canada) to create a “revocable living trust”, in which the settlor (or ‘grantor’) is the sole trustee and for as long as the settlor / grantor is living, he/she is also the sole beneficiary who can request, from time to time, that herself/himself, as trustee, pays or applies for her/his own use and benefit any portion or all of the trust’s net income and principal. Further, the settlor / grantor can exercise his / her power to revoke the trust at any time. The settled property often includes all personal, tangible, intangible and real property of the settlor / grantor. Finally, such trust provisions often provide for a distribution of the trust property to certain named beneficiaries upon the death of the settlor / grantor, for example to a child or a surviving spouse.
Even if both the trust and the settlor / grantor are non-residents of Canada, there could be situations where the arrangement is relevant from a Canadian tax perspective, such as where the trust invests in taxable Canadian property or where a remainder beneficiary is a Canadian resident.
a) Given the above, can the CRA please comment on its previously published general policy - and the continued relevance thereof - that such an arrangement constitutes a trust pursuant to subsection 104(1) of the Act in light of the findings of the court in De Mond v. R.  4 CTC 2007? In De Mond, the court found that such a trust was a ‘bare’ trust and hence not a trust for the purpose of subsection 104(1), given the fact that the settlor could cause the trust property to revert to himself at any time. Further, the settlor could exercise his power to revoke the trust at any time and the trustee has no choice but to convey the property. For these reasons, the court found that it was difficult to say that the trustee has significant powers or responsibilities or can take action without instructions from the settlor, or that the trustee is not subject to the control of his beneficiary, since the appellant in fact plays the role of all three of the constituent parties. Therefore, the individual settlor was at all times the true beneficial owner of the trust property.
b) In such instances that a Canadian resident is a remainder beneficiary of a U.S. revocable living trust as described above, and assuming that such an arrangement is a trust in accordance with subsection 104(1) of the Act, the beneficiary will be required to ascertain the adjusted cost base of her/his capital interest in the trust, as well as the trust’s cost amount in the trust property, in order to accurately apply the provisions of section 107 of the Act, and certain elections available therein on a future distribution of property from the trust to the remainder beneficiary.
Paragraph 70(5)(b) applies to any person who “acquires any property” that is deemed by paragraph 70(5)(a) to have been disposed of by the decedent. Given such, would the remainder beneficiary of the revocable living trust be considered to have “acquired” the capital interest from the decedent such that the capital interest in the revocable living trust will be acquired by the remainder beneficiary at a cost equal to the fair market value immediately prior to the death of the settlor/life interest beneficiary?
Marina Panougias: The CRA announced its position in respect of the Canadian income tax consequences of transfers to revocable living trusts back in 1995 at the CTF Conference. At that time, we said that it was the CRA’s view that a revocable living trust is recognized at the time that legal title to property is transferred to it, and the transfer of that property is considered to have occurred at fair market value. This continues to be the CRA’s opinion with respect to U.S. revocable living trusts.
The De Mond decision has not altered the CRA’s opinion. The key distinguishing factor between a revocable living trust, and a bare trust, is that a revocable living trust generally includes remainder beneficiaries - and so, in that case, there is a change in beneficial ownership when property is transferred to the revocable living trust.
To respond to your second question in respect of the adjusted cost base of the beneficiary’s capital interest in the trust, paragraph 70(5)(a) of the Act provides that when a taxpayer dies, they are deemed to have disposed of all of their capital property at fair market value immediately before death. Paragraph 70(5)(b) provides that a taxpayer who acquires property as a consequence of death is deemed to have acquired that property at a cost equal to its fair market value at the time of death.
In order to respond to this question, we also considered the expanded definition of “as a consequence of death” in subsection 248(8) of the Act, which generally provides that the acquisition of property as a consequence of death includes the acquisition of property under or as a consequence of the will or other testamentary instrument of a taxpayer, or the acquisition of property as a consequence of the law governing the intestacy of a taxpayer. In the circumstances which you described, where a Canadian resident individual is a remainder beneficiary of a U.S. revocable living trust, it is our view that the remainder beneficiary would have acquired his or her interest in that trust as a consequence of the terms of the trust and not as a consequence of the death of the settlor. Thus it is our view that paragraph 70(5)(b) of the Act does not apply in order to determine the adjusted cost base of the remainder beneficiary’s capital interest in the trust.
Paragraph 8 of archived IT-305R4 – Testamentary Spouse Trusts reads as follows:
8. Once a trust qualifies as a spouse trust under the terms of subsection 70(6), it remains a spouse trust and is subject to the provisions affecting such trusts (for example, paragraph 104(4)(a)) even if its terms are varied by agreement, legal action or breach of trust. However, these events may cause other provisions of the Act to apply, such as paragraph 104(6)(b) and subsections 106(2) and 107(4).
At the 2016 Conference for Advanced Life Underwriting (CALU), the CRA was asked to provide its views on paragraph 8 of IT-305R4. Would the CRA share those comments?
This was presented at the recent Calgary conference, and we were asked about paragraph 8 of archived Bulletin IT-305R4 and whether the comments in it are still valid. I think that this is a very much misunderstood paragraph that is read, perhaps in isolation and without the full context. Let me take you through what it is the point of that paragraph. Bear in mind that the Bulletin (now archived) was issued in 1996, so it has got a few years on it, and it obviously dealt with testamentary spousal trusts.
Let us start back with the basics and work forward from there. As most of you know, subsection. 70(5) provides as a general rule for the disposition on death of one’s capital property at fair market value. Where its requirements are met, subsection 70(6) allows for a transfer to a trust described in paragraph 70(6)(b) on a roll-over basis. The requirements for that to occur include that the surviving or common-law spouse is entitled to receive all income of the trust until that person’s death, and that no person, other than that survivor, can receive or use any of the trust income or capital while that survivor is alive.
In general, subsection 104(4) provides for the deemed disposition of capital property of certain trusts. And for a testamentary spousal or common-law partner trust, the first deemed disposition occurs when that spouse or common-law partner, as the case may be, dies. The wording in subparagraph 104(4)(a)(i) is, in my view, very clear. It provides for a deemed disposition date that is based on the trust terms at the time it was created - so that even if the trust terms are subsequently varied, it is the terms at creation of that trust that determine how subsection 104(4) applies, in respect of deemed dispositions.
That really is the point that paragraph 8 in the Bulletin was trying to make. It was simply trying to clarify that a change in trust terms would not invalidate how paragraph 104(4)(a) applied. That is notable if you look back at how subsection 104(4) has changed over the years and how that particular Bulletin has been revised over the years. Before subsection 104(4) was revised in 1976, its wording was certainly not as clear as it is now. Paragraph 5 of what was then IT-305, which was published that year, provided our views as to how subsection 104(4) applied, because clarity was required at that time due to the perhaps less concise wording of subsection 104(4). That view has been almost word-for-word brought forward in each and every revised version of that Bulletin. And now its latest iteration is in paragraph 8, which you see before you.
That is all paragraph 8 is trying to do: to make it crystal clear that you look at the terms at initiation of that trust, and if they are changed subsequently, that does impact how subsection 104(4) applies to that trust. That is all it is trying to do, there is no other deeper message in there.
We have just started a new draft Folio to replace the archived Bulletin, and I would expect the wording of that Folio would provide greater clarity yet.
Supp. Q: Meaning of archiving
Michael Cadesky: Could you please also comment on what it means when a Bulletin is archived?
Phil Kohnen: That is a good question and there is a fair bit of confusion in that regard. It was at the end of 2013 (I believe) that the Treasury Board came up with a new standard for published documents on government websites as a whole (not just on the CRA website) relating to accessibility, readability, and various issues like that - so a large number of our Bulletins and other documents on the CRA website were archived at that time.
That was not a condemnation of their content from a technical perspective. Instead, it was the fact that many of these were written in the 80’s or 90’s and did not meet those new requirements for government documents published on government websites - so we had to do a wholesale archiving of a lot of those. Again it was not a particular commentary as to whether they were technically up to date or not. It was just the formatting if you will of those IT Bulletins.
The technical content of any IT is fine at the time it is published.
In certain circumstances, a trust may realize income for income tax purposes without receiving a payment, or even having a transaction. Such income is sometimes called “phantom income”. One example might be where a trust owns shares of a Canadian controlled private corporation which is a small business corporation, which then becomes publically listed. An election can be made under section 48.1 to realize a capital gain. The trust itself has no transaction and no economic realization, yet income is deemed to arise for tax purposes.
Our question is whether phantom income of this kind can be taxed in the hands of a beneficiary and, if so, how does the trust meet the requirement that the income is paid or made payable to the beneficiary by the end of the year? Assuming the trust meets this requirement, can the payment be made ‘in kind’ by distributing the shares that were the subject of the section 48.1 election?
Marina Panougias: Although a section 48.1 election would result in a deemed capital gain for purposes of the Income Tax Act, we understand that the deemed capital gain is not recognized as income or capital for trust law purposes - so the deemed capital gain is basically a nothing for trust law purposes. In order for the amount to be paid or payable, first the trust indenture must acknowledge the amount. In order to acknowledge the amount, the terms of the trust must specifically permit or require an amount equal to the deemed capital gain to be paid or payable, or the trustees must have the discretionary power to pay out amounts that are defined under the Income Tax Act.
We also note that a power to encroach on the capital of a trust is not in and of itself sufficient to make a deemed capital gain payable. If the trust was a discretionary trust, once it is determined that the trustees have that discretion to make the deemed capital gain payable, the trustees of course must exercise their discretion to pay out an amount equal to the deemed taxable capital gain in the year to the beneficiary, or to make that amount payable, such that the beneficiary is entitled to enforce payment of that amount in the year.
You might have had a second part to that question at one point in the written paper. The question was: would a payment in kind be a sufficient distribution to pay out the deemed capital gain? Assuming everything else which we discussed has been met, it is possible to make the distribution by way of a payment in kind provided the trust indenture provides the trustee with the power to make a payment of assets in kind to the beneficiary.
The “Who Should File” section of the T3 Guide states:
A T3 return must be filed if the trust is subject to tax, and any one of the following conditions applies. The trust: … holds property that is subject to subsection 75(2) of the Act
This seems to suggest that a reversionary trust is required to file a T3 Trust Income Tax and Information Return for a year regardless of whether the trust has tax payable, or whether property subject to subsection 75(2) earns any income or profits, or generates a capital gain.
Can the CRA comment?
Marina Panougias: To first give some background, at the 2006 STEP National Conference, we outlined the legislative authority for the CRA’s requirement for trusts, with property subject to subsection 75(2), to file a T3 return. In that response, we noted that a T3 return is both an income tax return and an information return. Although subsection 150(1.1) of the Act provides that a trust is not required to file an income tax return unless it has tax payable for the year, or unless it disposes of capital property or realizes a capital gain in the year, subsection 204(1) of the Regulations provides that every person having control of or receiving income, gains or profits in a fiduciary capacity must file an information return.
As a result, a T3 return is required for a trust with property subject to subsection 75(2), even though the trust would actually have nil taxable income because of the application of 75(2) where that trustee is in control of or receives income, gains or profits in a fiduciary capacity in respect of that trust. On the other hand, if the trust only held property that is subject to subsection 75(2), but that property does not generate any income, profits or gains and, of course, the trustee is not in control of any income, profits or gains in respect of that property, a T3 return would not be required to be filed for the trust.
Can the CRA provide an update regarding statistical information for the Offshore Tax Informant Program since its launch on January 15, 2014?
Phil Kohnen: You will recall last year, we had a similar question and I provided some of the statistics at that point. We can compare last year with where we are at now. The stats last year ran from the program’s launch in 2014 up to a March 31st 2015 cut-off: that was the initial 14 ½ month period of the program. Again, this year our colleagues in the International Large Business and Investigations Branch (ILBIB) - which is a spin-off from our former Compliance Programs Branch at CRA - provided stats to us, so I am thankful for their help on that.
To recall how the program works, it allows CRA to pay for specific and credible details as to major international tax non-compliance. The details provided under the program must lead to assessment and collection of federal tax. If the tax assessed and collected exceeds $100,000, rewards range between 5% and 15% of tax collected.
Let me just take you through a quick comparison of the major stats - comparing the March 31st 2015 number with the cut-off at April 30th of this year.
- Last year the calls received under the program were 1,900, in total. It has jumped to 2,984, so there seems to be an ongoing influx of calls under the program.
- Of those calls, they had identified the number from potential informants as 522 at the cut-off last year, and that is now up to 812 in aggregate this year.
- In terms of written submissions received under the program, last year it was 201. It is now up to 333.
- Perhaps the most interesting stat of the four is at this time last year, there were no contracts which had been entered into with informants. As of the cut-off this year there are more than a dozen contracts that have been finalized. That would suggest that the program is progressing.
Can the CRA provide an update on some of the recent issues that it has considered relating to trusts and estates?
These are four relatively recent interpretations, all of them published. We thought they were probably interesting, in terms of what they dealt with, to the general STEP audience. Let me take you through them.
The first two are in relation to the T1135, which has been a hot topic for a few years now. At the 2015 CTF Conference, we were asked the question, “How would one report specified foreign property on the T1135 when spouses hold the property jointly?” That is a question that could arise frequently. The simple answer is that generally CRA would compare each spouse’s share of that property with the $100,000 reporting threshold, and the share of each of those spouses (or common-law partners, as the case may be) would be based on the amounts that were contributed towards the cost of purchasing the property. And so in a simple example, if you have a specified foreign property at a cost of a $150,000, and Mr and Mrs each contributed half, or $75,000 each, and if neither holds any other specified foreign property, the result would be that each would have a cost amount attributed to them of $75,000, which is below the threshold for reporting, and neither would have to file the T1135.
Another issue of interest, and this was raised internally in an internal interpretation, from our colleagues at International Large Business Directorate. They had a question on the normal reassessment period for the T1135, and whether or not that normal reassessment period is actually separate and distinct from the normal reassessment period for the Part I return. The relevance of that question would simply be: would the assessment of the particular taxpayer’s T1 return trigger the start of the normal reassessment period for purposes of applying penalties on late filed T1135s? The quick answer to that is that the filing deadline is the same as for the T1 return, so any potential assessment under subsection 162(7) must, subject to subsection.152(4), be made within the same normal reassessment period as that for the Part I return: they are not separate and apart and they are tied together.
The third question is one that came out relatively recently. It is an external interpretation on the subsection 159(6.1) election. You may recall back in the 2011 STEP Roundtable we had a discussion on subsections 159(5), (6) and (7). We were focusing at that time on the election. There is an election in the Act to pay, in installments, tax that arises on deemed realizations and dispositions of property held at death by the taxpayer. Typically these are the deemed dispositions under subsections 70(5) and (5.2) of the Act. In simple terms, under subsection 159(5), where the legal representative files an election, there is the ability to remit in up to 10 equal annual instalments plus interest provided that acceptable security is provided to CRA. But the more recent internal interpretation that we addressed was whether the election pursuant to subsection 159(6.1) is possible where such a tax liability arises from a deemed disposition of resource properties. That would be a scenario where essentially the property is held by a trust, and there is a deemed disposition pursuant to subsection 104(5.2) of the Act. And the simple answer is, yes, that subsection 159(6.1) election is available. Again, there is the ability to elect to pay any tax arising in up to 10 equal annual installments, as long as acceptable security is provided.
And the last one I wanted to point out, which is very relevant to many real life scenarios, is a question that was covered at the 2015 APFF Conference, having to do with subsection 70(6) transfers. The scenario was one whereby an estate executor disposed of certain estate assets, and then transferred the proceeds of disposition, or property that was substituted for those proceeds of disposition, to a spousal trust created by the will of the deceased. The question in that scenario was whether subsection 70(6) could apply to that transfer, so that it could occur on a roll-over basis. The answer to that is no - technically it fails the requirements. The rules in subsection 70(6), it is important to note, apply on a property by property basis, and the property that is transferred if the requirements of subsection 70(6) are to be met, must be the same property that was deemed to be disposed of on the death of the deceased. In essence, when you look at the rules in subsection 70(6), they do not contemplate the concept of substituted property. Substituted property in the rules of the Act do not tie in to that provision. That is an important piece of information for executors, who must know to be careful which property is being contemplated to be rolled to a spousal trust.