10 June 2016 STEP Roundtable - Official Response
STEP CANADA / CRA ROUNDTABLE: ADVISING FAMILIES ACROSS GENERATIONS June 9 -10, 2016
Unless otherwise stated, all statutory references in this document are to the Income Tax Act, R.S.C. 1985, c. 1 (5th Suppl.) (the "Act"), as amended to the date hereof.
Q1: Graduated Rate Estates and Transfers to Testamentary Trusts Created by Will
The definition of "graduated rate estate" in subsection 248(1) 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 form 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 (d) 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)?
CRA Response (a)
In our response to Question 8 at the 2012 STEP Roundtable, CRA noted that generally, we view trusts that arise out of the estate residue as arising on death. This view was reiterated in our response to Question 2 at the 2015 Roundtable. That said, it should be noted that ultimately it will be a question of legal fact as to when such trusts are established, and this will determine the filing requirements for tax returns under the Act.
CRA Response (b)
Pursuant to the definition of a graduated rate estate ("GRE") in subsection 248(1), only an estate can be a GRE. Once property is transferred from the estate to a testamentary trust, that trust cannot be a GRE. In the example provided where the deceased died in 2014, and in 2015 all of the assets were held in either a spousal trust or a trust for children of the decedent, there would be no GRE in 2016.
CRA Response (c)
Paragraph (b) of the GRE definition requires that the estate must be a testamentary trust as defined in subsection 108(1). Paragraph (b) of the testamentary trust definition provides that where property has been 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. Assets transferred to a GRE from the other testamentary trusts would cause the estate to lose its testamentary trust status and therefore it would no longer be a GRE.
CRA Response (d)
A GRE in respect of a decedent can remain as such for a maximum of 36 months following the death of the individual. For deaths occurring after 2015, the Department of Finance legislative proposals of January 15, 2016 in respect of subsection 118.1(5.1) would, if enacted into law, allow an estate that ceases to be a GRE only because 36 months has passed since the death, to make a donation within 60 months of the death.
Under the proposed change, the requirements other than in paragraphs (a) of the GRE definition must be met, including that it be the estate that arose on and as a consequence of the individual's death.
Q2: Graduated Rate Estates and Multiple Wills
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?
In our response to Question 2 of the 2015 STEP CRA Roundtable pertaining to graduated rate estates and multiple wills, we noted that where an individual has multiple wills for the purpose of reducing probate taxes, or for other estate planning purposes, there is nothing to preclude these from being separately administered. We also noted that it is our view that an individual's estate encompasses all of the worldwide property owned by the individual at death.
Pursuant to the definition of a "graduated rate estate" in subsection 248(1), an estate that arose on and as a consequence of the death of an individual can only be the graduated rate estate in respect of that individual if all of the requirements in paragraphs (a) through (e) of the definition are met. While not an exhaustive list of possible concerns, we would suggest that in a multiple will situation, the requirements in paragraphs (d) and (e) could be of particular concern, from a practical perspective.
Paragraph (d) requires that the estate designate itself as the graduated rate estate of the individual. Obviously, it will be necessary to ensure that the domestic executors have been given the ability to make the GRE designation. Furthermore, paragraph (e) requires that no other GRE designation has been made in respect of the individual. Accordingly, the domestic executors would be well advised to assure themselves that a designation has not been made by the foreign executors in respect of the individual.
Given our view that an individual's estate encompasses all worldwide property, we would also question how, in the absence of unfettered and complete communication amongst the executors, can complete tax reporting in regards to the estate be assured?
Q3: Distribution from Inter vivos Trust to Graduated Rate Estate
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 definition of a "graduated rate estate" in subsection 248(1) specifies that the estate must be "at that time a testamentary trust". The definition of testamentary trust in subsection 108(1) requires that (for trusts created after 1981) 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."
At the 2008 STEP Conference, in our response to Question 2 we said:
"a trust created pursuant to the individual's will or other testamentary instrument will not lose its testamentary trust status solely by reason of the receipt of the proceeds of an insurance policy on the life of that individual (who was the policyholder), where the trust is the designated beneficiary under the policy and the trust was not created or settled before the death of the individual."
In the case presented above the individual whose life is insured is not the policyholder, but rather it is the inter vivos trust that is the policyholder. Any property contributed to the estate as a beneficiary of the inter vivos trust would not meet the requirement that the property be contributed to the estate "by an individual on or after the individual's death and as a consequence thereof." Hence in such a scenario the estate would not meet the definition of a graduated rate estate.
Q4: Qualified Disability Trust and Preferred Beneficiary Election
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 the 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?
The introduction of the QDT provisions has not restricted the availability of the preferred beneficiary election under subsection 104(14), nor have there been any changes to the method in which a preferred beneficiary election is made. Many of the requisite conditions for making a preferred beneficiary election differ from those required for a trust to be a QDT. Accordingly, where the respective conditions of each election are met, the trust has the ability to choose whether to make a preferred beneficiary election or a QDT election. It is also possible for a trust which elects to be a QDT to also make a preferred beneficiary election (jointly with the beneficiary) in a given tax year.
Q5: Capital Loss Carryback and Late Filed Subsection 104(13.2) Designation
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?
The trust can make a late subsection 104(13.1) or (13.2) designation as long as the application of the loss results in nil taxable income for the trust. Filings to amend the tax position of the trust and the beneficiary are as follows:
• The trust would file Form T3A "Request for a Loss Carryback by a Trust" in connection with the loss year to request the loss be carried back to the prior year.
• The trust would file Form T3-ADJ "T3 Adjustment Request" for the prior year to reflect a late subsection 104(13.1) or (13.2) designation so as to amend the trust's T3 Return.
• The trust would issue amended T3 slips to the beneficiary for that prior year, reducing the income allocated.
• The beneficiaries would file a Form T1-ADJ "T1 Adjustment Request" to reflect the revised T3 slip and to amend the T1 Return.
The CRA will only reassess beneficiaries' returns if the tax years to which they relate and the tax year of the trust to which the loss will be applied are not statute-barred.
The trust must file Form T3A and T3-ADJ together as they must be processed concurrently.
Q6: Trust Instalment Requirements and Interest
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?
Prior to 2016 only inter vivos trusts (other than grandfathered inter vivos trusts) were legislatively required to make instalment payments under section 156. For the 2016 and subsequent taxation years, all inter vivos trusts and testamentary trusts (other than a graduated rate estate) are required to make instalment payments. However, consistent with the current administrative practice, the CRA will continue to not assess interest and penalties where a trust does not make sufficient instalment payments.
If there is any change to this administrative practice in the future, sufficient information will be made available to trustees and estate administrators to assist in meeting the instalment filing requirements.
Q7: Deemed Resident Trust and CCPC Status
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?
We have assumed for the purpose of our response that you are asking us to confirm whether a Canadian corporation ("Opco") controlled by a deemed resident trust (the "Trust") would be considered a Canadian-controlled private corporation ("CCPC") as defined in subsection 125(7).
In order to be deemed resident by virtue of section 94, a trust must be a factually non-resident trust. In order for a trust to be factually non-resident the central management and control of the trust must be exercised outside of Canada. It is our view that where a factually non-resident trust holds the majority of the voting shares of a corporation, non-resident persons generally exert de jure control of that corporation.
In order for Opco to be a CCPC, Opco must not be controlled directly or indirectly in any manner whatever by one or more non-resident persons, one or more public corporations, or any combination of non-resident persons and public corporations. Therefore, Opco will not be a CCPC if any non-resident persons or public corporations or a combination thereof have de jure or de facto control of Opco.
The question then becomes whether Opco can be considered to be a CCPC if Trust is deemed to be resident in Canada by virtue of section 94 even though non-resident persons exert de jure or de facto control over Opco. Where, in a particular year, subsection 94(3) applies to a factually non-resident trust, the trust is deemed resident in Canada throughout the particular year for certain specified purposes described in paragraph 94(3)(a). Subsection 94(3) does not deem Trust to be resident in Canada for the purpose of applying the definition of CCPC found in subsection 125(7).
Therefore, we can confirm that Opco will not be considered a CCPC as a result of the fact that Trust is deemed resident in Canada by virtue of section 94.
Q8: Characterization of LLPs and LLLPs
What is the status of the CRA's review of the characterization for Canadian tax purposes of U.S. LLLPs?
We recently announced our final position in respect of the proper classification of limited liability partnerships ("LLPs") and limited liability limited partnerships ("LLLPs") governed by the laws of the state of Florida or Delaware at the 2016 International Fiscal Association Conference, CRA Roundtable, held on May 26, 2016.
The main factors we considered in our analysis of these entities are the existence of a separate legal personality that is recognized under the law of the relevant foreign jurisdiction - meaning the full legal capacity to acquire and own property, to sue and be sued, to carry on their own activities and to incur liabilities of their own - and the extensive limitation of liability afforded to all of their members. It is the combination of these two general factors, in this particular context, that sets these entities apart from general partnerships ("GPs") and limited partnerships ("LPs") that exist under Canadian provincial law. While we have come to accept that legal personality alone is not sufficient to distinguish certain U.S. partnerships from their Canadian counterparts, we have great difficulty with the limited liability factor. We find it difficult to accept that an entity that is solely and entirely responsible for its own obligations can be considered not to be the relevant unit for the purposes of assessing tax under the Act.
Furthermore, we believe it has become widely accepted that U.S. limited liability companies ("LLCs") are properly viewed as corporations for the purposes of the Act, notwithstanding the recent excitement created by the Anson' case in the United Kingdom. We see little substantive difference between LLPs, LLLPs and LLCs governed by the laws of the states of Florida and Delaware. As such, we have reached the general conclusion that Florida and Delaware LLPs and LLLPs should be treated as corporations for the purposes of Canadian income tax law.
We acknowledge the difficulties that may be created by these positions. Thus, in order to promote fairness and predictability, we are prepared to make certain administrative concessions in this regard. Specifically, in the absence of abusive tax avoidance, we are prepared to accept that any such LLP or LLLP be treated as a partnership for the purposes of the Act, from its time of formation, where
• the entity is formed and begins to carry on business before July 2016;
• it is clear from the surrounding facts and circumstances that the members
o are carrying on business in common with a view to profit; and
o intended to establish an entity that would be treated for Canadian income tax purposes as a partnership and not a corporation;
• neither the entity itself nor any member of the entity has ever taken the position that the entity is anything other than a partnership for Canadian income tax purposes; and
• the entity converts, before 2018, to a form of entity that is generally recognized as a partnership for Canadian income tax purposes.
Any such entities in respect of which some but not all of these conditions are met will be dealt with on a "facts and circumstances" basis. However, we will not generally accept partnership treatment for a Florida or Delaware entity that starts out as an LLC and then converts, under corporate continuance-like statutory provisions, to an LLP or LLLP where there is no significant substantive change to their legal context.
We suspect that much of this reasoning may be applicable in respect of entities of other states of the U.S. and perhaps other foreign jurisdictions as well, but we would need to analyze each specific statute and other relevant documents in order to make a determination as to their status.
We would also point out that these are general views only. The classification of a particular entity is a question of fact. Taxpayers may wish to request an advance income tax ruling where they are contemplating transactions involving foreign entities whose Canadian income tax status may be unclear.
Q9: Support for U.S. Foreign Tx Credit Claims
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?
Since the Canadian tax system functions on the basis of self-assessment, the Canada Revenue Agency (CRA) conducts reviews every year as a means of ensuring that income is properly reported and that expenses, deductions, and credits are correctly claimed in accordance with the provisions of the Act.
The CRA neither targets nor excludes any specific category of people when reviewing returns. It uses a sophisticated scoring system to select returns for review. This system is designed to
incorporate multiple factors to identify those returns that carry the highest potential for inaccuracy of certain claims. In addition, some returns are chosen for review at random. One of the claims identified as having a high potential for inaccuracy is the foreign tax credit.
In 2015, a decision was made to change the requirements for acceptable supporting documents related to claims for the foreign tax credit made by individuals with U.S. source income. This decision was made in response to an observed increase in the trend of incorrect reporting and incomplete submission of documents relating to this type of income. It should be noted that for all other countries, the CRA has always required a copy of the taxpayer's foreign income tax return and assessment notice or equivalent document from the foreign tax authority. To be equitable in our treatment of all taxpayers, it was determined that the best course of action was to require the same level of proof from individuals reporting U.S. source income that we require from individuals reporting foreign source income from other countries.
The documents necessary to support a claim for taxes paid in the U.S. are noted on Form T2209, Federal Foreign Tax Credits. These documents include but are not limited to federal, state, and municipal tax returns and all associated schedules and forms, a copy of the federal account transcript, and an account statement or similar document from the state and/or municipal tax authority. A breakdown by income type (for example, interest, dividends, capital gains), country and recipient is also required if the taxpayer filed a joint return with their spouse or common-law partner.
In response to feedback received, the CRA has decided to offer the following option to support a claim for the federal foreign tax credit:
• If you are unable to provide a copy of a notice of assessment, transcript, statement, or other document from the applicable foreign tax authority indicating your client's foreign income and final tax liability, we will accept proof of payment made to or refund received from them.
This may be in the form of bank statements, cancelled cheques, or official receipts. The following information has to be clearly indicated:
o that the payment was made to or received from the applicable foreign tax
o the amount of the payment or refund;
o the tax year to which the payment or refund applies;
o the date that the amount was paid or received.
Note: If you are submitting photocopies of a cancelled cheque, you will need to copy both sides of the cheque unless the front has been micro-encoded by the banking institution.
The CRA realizes that the changes made to its requirements in respect of supporting documents for the foreign tax credit related to U.S. source income were new in 2015, and acknowledges that there was an understandable transition period for taxpayers and their representatives in this regard. Since we are now almost one year later, there is a certain level of expectation that a more pro-active approach will be adopted to ensure that the required documents are requested or obtained in anticipation of a possible review by the CRA.
It is recommended that taxpayers and their representatives not wait until CRA asks for supporting documents before requesting them. According to the IRS website "Most requests will be processed within 10 business days". If a request for the account transcript is made promptly, there would be a reduction or elimination of issues related to the timeframe for submitting a copy if the CRA asks for documentation.
Based on our findings, the IRS has a very structured process for requesting tax account transcripts online or through the mail using Form 4506-T. Information about requesting transcripts from the IRS is available on their website at https://www.irs.gov/Individuals/Get-Transcript-FAOs. In addition, the majority of the U.S. states have an online system which allows the taxpayer to print his/her "account statement" which would confirm the taxpayer's final tax liability.
It should also be noted that if additional time is needed to respond to a request for supporting documents, an extension may be requested.
Q10: U.S. Revocable Living Trusts
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) 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), 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, 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?
CRA Response (a)
The CRA announced its opinion in respect of the Canadian income tax consequences of a transfer to a revocable living trust at the 1995 Canadian Tax Foundation annual conference. It was the CRA's opinion that a revocable living trust should be recognized for income tax purposes at the time that legal title to property is transferred to it and that the transfer of the property is at its full fair market value (and not the value of the remainder interest only). This continues to be the CRA's opinion in respect of U.S. revocable living trusts.
Although the Court concluded that the trusts in question in De Mond were bare trusts in its decision rendered on July 7, 1999, the decision has not altered the CRA's opinion as it relates to revocable living trusts. It is the CRA's view that a key distinguishing factor between a revocable living trust and a bare trust is that a revocable living trust generally includes beneficiaries that are contingent on the death of the settlor/grantor. As such, there is a change of beneficial ownership in respect of a transfer to a revocable living trust.
Further, it is the CRA's view that the 2001 amendments to subsection 104(1) further support this view. In particular, subsection 104(1) provides that, "except for the purposes of this subsection, subsection (1.1), subparagraph (b)(v) of the definition "disposition" in subsection 248(1) and subsection (1.1), subparagraph (b)(v) of the definition "disposition" in subsection 248(1) and paragraph (k) of that definition, a trust is deemed not to include an arrangement under which the trust can reasonably be considered to act as agent for all the beneficiaries under the trust with respect to all dealings with all of the trust's property unless the trust is described in any of trust can reasonably be considered to act as agent for all the beneficiaries under the trust with respect to all dealings with all of the trust's property unless the trust is described in any of respect to all dealings with all of the trust's property unless the trust is described in any of paragraphs (a) to (e.1) of the definition "trust" in subsection 108(1)."
CRA Response (b)
Under paragraph 70(5)(a), a deceased taxpayer is deemed to have disposed of any capital property owned by the taxpayer immediately before his or her death at fair market value. Under paragraph 70(5)(b), any person who acquires such property as a consequence of the taxpayer's death is deemed to have acquired the property at the time of death at a cost equal to fair market value.
The expanded definition of "as a consequence of death" in subsection 248(8) generally provides that an acquisition of property under or as a consequence of the will or other testamentary instrument of a taxpayer or as a consequence of the law governing the intestacy of a taxpayer is considered to be an acquisition of the property as a consequence of the death of the taxpayer.
In the circumstance described, the remainder beneficiary acquired his or her interest in the revocable living trust pursuant to the terms of that trust and not as a consequence of the decedent's death. Accordingly, it is the CRA's view that paragraph 70(5)(b) is not applicable to determine the adjusted cost base of the capital interest in the trust to the remainder beneficiary.
Q11: Tainting of a Spousal 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?
In order to understand the relevance of the commentary in paragraph 8 of archived IT-305R4, one must first consider section 70. Where a taxpayer dies, as a general rule subsection 70(5) provides that, immediately before the death, the taxpayer is deemed to have disposed of each capital property that was owned at that moment for proceeds equal to the property's fair market value. However, where certain conditions are met, subsection 70(6) allows such property to be transferred to a trust described in paragraph 70(6)(b) on a tax-deferred "rollover" basis. This provision requires, inter alia, that the surviving spouse or common-law partner (the "survivor") be entitled to receive all of the income of the trust that arises before the survivor's death, and that no person except the survivor may, before his or her death, receive or otherwise obtain the use of any of the income or capital of the trust.
Subsection 104(4) provides for the deemed dispositions of capital properties held by certain trusts. For a testamentary trust created as a consequence of the death of a taxpayer under which the surviving spouse was exclusively entitled to the income of the trust before his or her death and no other person was entitled before that time to the capital of the trust, the first deemed disposition is determined pursuant to paragraph 104(4)(a). This first deemed disposition occurs on the day on which the beneficiary spouse or common-law partner dies. This ensures that any accrued gains on properties which could have been deferred at the time of the death of the taxpayer that gave rise to such trusts, are appropriately triggered on the death of the spouse or common-law partner beneficiary.
The wording of subparagraph 104(4)(a)(i) clearly provides for a deemed disposition date that is based on the terms of the trust "at the time it was created", accordingly, even if the terms of the trust are varied by agreement, legal action, or breach - it is the terms of the trust upon creation that would determine the application of subsection 104(4). In the case of a post-1971 spousal or common-law partner trust, as defined in subsection 248(1), these would be the terms described in subparagraph 104(4)(a)(iii).
The main purpose of paragraph 8 in IT-305R4 (and of the similar comments in the earlier versions of this Bulletin dating back to IT-305), is to clarify that in applying paragraph 104(4)(a), one must look to the terms of the trust at time of creation, such that any subsequent change in the terms of the trust would not invalidate the application of paragraph 104(4)(a). It is worth noting that the wording of subsection 104(4), before its revised wording was introduced by subsection 40(1) of Bill C-22 in 1976, was not as clear in this regard as it is now. Paragraph 5 of IT-305, which was published on April 8, 1976, provided clarity as to our view as to how subsection 104(4) applies; and that has been brought forward, as most recently expressed in paragraph 8 of archived IT-305R4.
CRA has recently begun a project to draft a new income tax folio that will cover much of the information that was contained in archived IT-305R4. We anticipate that the wording in the new folio that will deal with the subject matter previously discussed in paragraph 8 of IT-305R4 will provide clarity, by more closely reflecting the actual wording of subsection 104(4).
Q12: Amounts Payable and Phantom Income
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?
It is our understanding that a deemed capital gain for purposes of the Act is not recognized as income or capital for trust law purposes. A deemed capital gain is a "nothing" for trust law purposes. Where a trust elects under section 48.1, the taxable capital gain resulting from the deemed disposition would be taxed in the trust, unless the deemed taxable capital gain is paid or payable to the trust beneficiaries within the meaning of subsection 104(24) and the requirements of subsection 104(6) are met.
Subsection 104(24) provides that an amount is deemed 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 the amount. The word "entitled" refers to a legal entitlement as would be dictated by the terms of the trust indenture. A power to encroach on capital is not in and of itself sufficient to make a deemed capital gain payable for purposes of subsection 104(24). Instead, the terms of the trust must specifically permit an amount equivalent to the deemed taxable capital gain to be paid or payable, or the trustee must have the discretionary power to pay out amounts that are defined as income under the Act.
For a discretionary trust, an amount equivalent to the deemed taxable capital gain would be payable for income tax purposes only where the trustees have exercised their power to make it payable. The trustees must exercise their discretion before the end of the trust's taxation year and the exercise must be irrevocable with no conditions attached to the beneficiaries' entitlements to enforce payment of the amount in the year. Furthermore, the beneficiaries must be advised before the end of the trust's taxation year. The trustees' exercise of discretion and notification to the beneficiaries should be in writing (e.g. in a resolution signed by the trustees, minutes of a trustees' meeting). Where a trust is non-discretionary, the trust indenture must provide that the amount equivalent to the deemed taxable capital gain is to be paid or payable to the beneficiaries by the end of the trust's taxation year.
In order for a deemed taxable capital gain to be distributed by way of a payment in-kind, the trust indenture must also permit the assets of the trust to be distributed to the beneficiaries as a payment in-kind. The resolution authorizing the distribution should indicate that the payment is in respect of the amount of the deemed taxable capital gain and not in satisfaction of a beneficiary's capital interest in the trust. Where the fair market value of the property distributed in-kind exceeds the amount of the deemed taxable capital gain, the difference would represent a distribution in satisfaction of the beneficiary's capital interest in the trust as contemplated under subsection 107(2) assuming the conditions in that provision are otherwise met and no other trust income is being distributed.
Q13: Filing obligation for 75(2) trust holding non-income producing property
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?
At the 2006 STEP National Conference, we noted that the T3 Trust Income Tax and Information Return is both a return of income and a general information return. A T3 return serves to report not only information about the reporting trust, but also additional information, such as that affecting the taxation of persons (for example, beneficiaries or settlors) having some connection to the trust.
The requirement for a trust to file a return is provided in paragraph 150(1)(c) and section 204 of the Regulations. Subsection 150(1.1), as it applies to a Canadian resident trust, provides that the trust is required to file an income tax return if tax is payable by the trust or the trust disposes of capital property or realizes a capital gain. 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 a return. Therefore, a T3 return is required for a reversionary trust where the trustee computes nil income for the trust for tax purposes because subsection 75(2) applies to attribute income to the person from whom the trust directly or indirectly received the property (or property for which it was substituted).
Conversely, where a person in a fiduciary capacity does not control or receive income, gains or profits during the tax year, they are not required to file a T3 return for that year.
Q14: Offshore Tax Informant Program
Can the CRA provide an update regarding statistical information for the Offshore Tax Informant Program since its launch on January 15, 2014?
Since the OTIP launch, there has been sustained interest in the program by potential informants. As of April 30, 2016, the OTIP has received 2,984 calls, 812 of which have been from potential informants, 333 written submissions, and has entered into over a dozen contracts with informants.
Q15: Trust and Estates Issues
Can the CRA provide an update on some of the recent issues that it has considered relating to trusts and estates?
The Income Tax Rulings Directorate addresses a wide variety of issues relating to trusts and estates in our internal and external technical interpretations. The following is a brief overview of some of our recently published views that may interest the STEP audience.
Form T1135 and jointly held property:
At the 2015 Canadian Tax Foundation Annual Conference, CRA was asked how to report specified foreign property on form T1135, if the property is jointly held by spouses. Our response, in document 2015-061064106, noted that in general, CRA would compare each spouse's share of the property with the $100,000 reporting threshold and that the respective shares would be based on the amounts contributed by each spouse toward the cost to purchase the property.
Form T1135 and normal reassessment period:
In internal interpretation 2015-057277117 we were asked whether the normal reassessment period for a T1135 return can be considered to be separate and apart from the normal reassessment period for the Part I return of the reporting entity. Our response noted that the filing deadline for the T1135 is the same as for the filing of the Part I return, and that any assessment for failure to file on time pursuant to subsection 162(7) must, subject to subsection 152(4), be made within the normal reassessment period for Part 1.
Subsection 159(6.1) election:
In external interpretation 2015-0594201E5 we were asked whether an election pursuant to subsection 159(6.1) of the Act can be made where a liability for tax arises from a deemed disposition of resource property. CRA noted that since subsection 159(6.1) specifically refers to tax liability arising on the occurrence of a time determined under paragraph 104(4)(a), (a.1), (a.2), (a.3), (a.4), (b) or (c) which is the time when a deemed disposition pursuant to subsection 104(5.2) occurs, an election under subsection 159(6.1) is possible.
Transfer pursuant to subsection 70(6):
At the 2015 APFF (l'Association de planification fiscale et financiere) Conference, we were asked to consider a scenario in which an estate executor disposed of some of the assets of the estate of the deceased, in order to transfer the proceeds of disposition (or property substituted for those proceeds) to a spousal trust created by the will of the deceased. We were asked whether subsection 70(6) of the Act could apply to the transfer.
Our response, in document 2015-059661106, noted that subsection 70(6) would not apply in the given scenario. It was noted that the rules in subsection 70(6) apply on a property-by-property basis, and that subsection 70(6) requires, inter alia, that the property transferred must be the same property that was deemed to have been disposed of by the deceased.
'Anson v. HMRC  UKSC 44, United Kingdom Supreme Court.