29 May 2018 STEP Roundtable
This provides the written questions that were posed, and summarizes the oral responses provided by CRA, at the Annual STEP Canada CRA Roundtable held in Toronto on 29 May 2018. The presenters from the Income Tax Rulings Directorate were:
Steve Fron, CPA, CA, TEP: Manager, Trusts Section, Income Tax Rulings Directorate, Canada Revenue Agency
Phil Kohnen, CPA, CA, TEP: Manager, Trusts Section, Income Tax Rulings Directorate, Canada Revenue Agency
The questions were orally presented by Michael Cadesky and Kim G.C. Moody. Steve Fron cautioned that the oral responses adopt a more conversational tone than the written answers, which should be released around August.
Q.1 — Update on the Dedicated Telephone Service
The Income Tax Rulings Directorate formally launched a new dedicated telephone service (DTS) for income tax service providers in July of 2017. The DTS is a three-year pilot project which was initially offered to eligible Chartered Professional Accountants (CPAs) in Ontario and Quebec. The goal of the DTS is to assist professionals in the business of preparing income tax returns by providing them with access to experienced CRA staff who can help with more complex technical issues.
Can the CRA provide an update on this pilot project?
Steve Fron: The dedicated telephone started last year in July. When first opened up it was offered to CPAs in Ontario and Quebec and it was shortly expanded to be offered to eligible CPAs in Manitoba and New Brunswick as well. In August of last year, we reached out to some of the CPAs in Ontario and Quebec who had not yet registered for the service. To be eligible for the service, you have to be a sole practitioner or to be in a firm with up to three partners or shareholders. The idea of the service was to try to help income tax service providers with their complex questions. The feedback so far on the program has been positive. We are very encouraged by it.
We have introduced a voluntary phone service that the registrants or users of the service are asked to use, and it is obviously optional, and the feedback from that survey, plus other unsolicited comments, have been encouraging. As we are approaching our one-year anniversary, we are looking forward to evaluating the first year and seeing how we can improve the service. If it is successful, the DTS may expand nationwide and to more income tax service providers on a permanent basis.
If you are interested in this service, there is information on the CRA website. The page sets out eligibility, how to register, and contact information if you have questions.
Q.2 — Creation of a Trust
Assume that the will of a deceased person creates a graduated rate estate, and several testamentary trusts for the testator‘s children or grandchildren. For various reasons, no property is transferred to these testamentary trusts, and all property remains in the graduated rate estate for a period of time. When does CRA consider that the testamentary trusts came into existence for purposes of the 21-year deemed disposition rule?
Steve Fron: We touched on this issue previous Roundtables, which our written answer will reference two or three previous responses.
CRA generally does not attribute tax consequences to the transition from estate administration to trust administration, and we generally view trusts being created from the residue of an estate as arising on death, where the will requires or directs the executor or the trustee to hold the residue of the estate in the trust for the testator’s children during their lifetime.
These principles apply to the present scenario. They also would apply, for example, where the will provided for the residue of the estate to go to the testator’s child and also provided that, on that child’s death, the property would remain in a trust for the testator’s grandchildren. We would consider that to be just one trust, so that the same initial date would apply in that situation as well.
In those situations, the 21 year date would be based on the testator’s date of death (the date of the creation of the estate). We have also stated that the CRA’s T3 assessing area will generally assign the same commencement date to each trust that is created out of the estate residue.
However, in some scenarios (and whether this is the case is ultimately a question of fact) the creation date of the testamentary trust might not be concurrent with the testator’s date of death. For example, there might be a situation where the will provides that, on the date of the death of the first-generation beneficiaries, such as the spouse or common-law partner, the trustee is to divide the remaining property into equal parts and hold that property in new trusts for each of the testator’s children. In that situation, the latter trust may be viewed as being created some time after the testator’s date of death. However, the deemed disposition date of those new trusts would still be based on the testator’s date of death because of the rule in s. 104(5.8), which is there to prevent any restarting of the clock on trust-to-trust transfers. Thus, the subsequent creation date has no impact.
Q.3 — Trust return due date in the year of wind up
Where a trust winds up, by distributing all of its property to its beneficiaries, does the T3 Trust Income Tax and Information Return (T3 Return) need to be filed within 90 days of the date of wind up, or does the normal (calendar) year-end govern when the tax return must be filed?
Steve Fron: We will assume that this is a personal trust, and that there is no other event that has a tax consequence that impacts the taxation year in the year in which the trust is being wound up. The trust might depart from Canada, or something else might cause a deemed year-end, but let us assume that is not the case.
The T3 return is both an income tax and an information return. The relevant provisions are s. 150(1)(c) and Reg. 204(2). Both of those provisions require that the trust return be filed within 90 days of the taxation year-end of the trust.
There are two situations. Where the trust is a graduated rate estate, s. 249(1)(b) provides that its taxation year is the period for which the accounts of the estate are made up for purposes of assessment under the Act. Ss. 249(1)(b) and 249(5) essentially provide that the taxation year-ends, is when the period of the accounts end, which essentially means the final distribution date. Thus, the due date for a GRE is 90 days after the final distribution.
For a non-GRE trust, paragraph 249(1)(c) defines the taxation year to be the calendar year except as otherwise expressly provided. In this case, the cessation of the period for making up the accounts, based on there being the final distribution, does not impact this calendar year result.
Thus, for a GRE the due date is 90 days after the final distribution of assets, and for a non-GRE it is 90 days after the calendar year. This leads to the apparently odd situation where a non-GRE trust could be wound up in mid-February and it would seem that the return should not be filed until the following year. That is not the case, according to the T3 Guide. I think the reason for that is to allow for a faster process to getting a clearance certificate.
Kim Moody: In that February wind-up example, what end-date should appear on the return, the February winding-up date or the December year-end?
Steve Fron: I know that the T3 assessing folks can handle such an early return, but I am not sure what date is to be put on that return.
Q.4 — Safe Income and an Estate
At the 2017 STEP Roundtable, CRA made the point that safe income of a corporation owned by a person that died did not flow through to the estate of that person. The reason was not clearly stated but appears to be that the safe income became encompassed in the adjusted cost base of the shares to the estate. Can CRA clarify its reasoning? Also, if the shares of the corporation were deemed to be disposed of at adjusted cost base (ACB) because of the rollover under subsection 70(6), would the safe income then flow through to the testamentary spousal trust or spouse, or common-law partner, as the case may be?
Phil Kohnen: This is a follow-up to question 7 of the 2017 STEP Rondtable, and we have consulted with our corporate reorganization staff in order to return to the question this year.
Last year’s question had a scenario where an individual died, and his estate acquired shares that had been held at death for an adjusted cost base equal to the fair market value of the shares. In our response, we stated there was no carry-over of safe income that had previously been attributable to the shares when they were transferred to the estate. The basis for that position is that the safe income was simply crystalized in the ACB of the shares that were held by the estate, and does not flow through from there.
That is still CRA’s view. However, in the scenario where the shares are disposed of as a consequence of death at ACB because there is a s. 70(6) rollover, CRA holds the view that the safe income that can reasonably be considered to contribute to the accrued gain on those shares would in fact flow through to the acquiror of shares.
Q.5 — Split Income Proposals - Definitions
In the definition of excluded shares, subparagraph (a)(i) refers to 90% of the "business income," of a corporation while in paragraph (c), the wording uses "all or substantially all of the income". We would like to understand what these terms mean within these definitions. It would seem reasonable that business income is the income of the corporation from a business, and refers to net income. Since subparagraph (a)(i) requires a determination of whether less than 90% of the corporation's business income is derived from the provision of services, does this mean that a segmented computation of business income needs to be done, allocating the business income between income from services and income from other sources, such as the sale of goods? In addition, there is uncertainty with respect to paragraph (c) of the definition of excluded shares and the words, all or substantially all of the income. Does this refer to net income or something else such as revenue?
Phil Kohnen: The definition of excluded shares (now in Bill C-74, currently before Parliament) has separate references to “business income” and “income” in paras. (a) and (c) respectively. CRA considers that both references generally mean gross income. As noted in the introduction, subpara. (a)(i) of that definition requires that less than 90% of business income of the corporation was from the provision of services.
In a scenario where the corporation has income from the provision of services and from income from non-services, the two should generally be computed separately, and the non-service income considered in determining if the requirement of the definition is met. This would not always be the case. There will be scenarios where the non-service income was necessary for or incidental to the provision of the services themselves – for example, an office cleaning service that bills separately for the actual service and for any cleaning supplies that are used in providing those services, would be such an exception.
We recognize that the need to track service and non-service income can potentially create significant compliance requirements. It would probably be wise, in many cases, to at least determine if an amount is excluded from the TOSI rules because it is a reasonable return for the individual, and therefore not need to look to the “excluded shares” definition.
Q.6 — Split Income Proposals - Holding company qualifying as "excluded share"
In general terms, is it possible for shares of a holding company to qualify as "excluded shares"? Does the answer depend on whether the holding company has income or not, such as dividend income from a subsidiary which might be a related business?
Steve Fron: Generally, no.
The safe harbour exclusions are generally there to provide a bright-line test, and are intended to act as a proxy for situations where amounts received by individuals would have otherwise been considered to be a reasonable return, and do not raise any policy concerns.
Looking at the excluded shares test, there is that 90% provision of services test, there is the 10% of votes and value test, and the test in para. (c), which requires that all or substantially all of the income of the corporation for the relevant year is not derived directly or indirectly from one or more related businesses in respect of the specified individual.
In the Explanatory Notes regarding para. (c) of the definition of “excluded share," Finance has said that this limitation is intended to prevent the circumvention of the TOSI rules by splitting a services business into a services and a non-services business. For example, this would apply to the use of holding companies and so-called “side car” structures, for example where property used in a service business is leased to a corporation carrying on that services business and it is leased to that services business by another corporation in which the specified individual has an interest.
The definition of excluded shares therefore should generally not include the shares of a Holdco, because all or substantially all of its income would be derived from a related business with respect to the individual. The shares will not be excluded shares and any income or taxable capital gains from the disposition of such shares will not be an excluded amount. It will be split income of the individual subject to TOSI unless another exclusion applies. For example, if the related business is itself an excluded business, that would be one exclusion that would work.
To reiterate, the safe harbour exclusions, including the ones for excluded shares, are not intended to apply in all circumstances. Where the safe harbours do not apply in a particular case, the general underlying rationale is that, in such circumstances, the most appropriate test for determining whether the income of a specified individual from a related business should be excluded from split income treatment should be based on a general test of whether the amount received is a reasonable return according to the specific factors applicable in the circumstances, which include the work performed, properly contributed in support of the business, the risks assumed by the specified individual or related individual, prior amounts received by or in respect of the business, and any other relevant factor.
Q.7 — Split Income Proposals - Excluded shares and business income
Assume that a corporation has no business income because it derives income from property (possibly rental income from real property where the activities are not sufficient to constitute business income). In this case, can the shares of the corporation be excluded shares?
Steve Fron: No. If a corporation has no business income, its shares cannot qualify as excluded shares.
The test in proposed s. 120.4(1) – “excluded shares” – (a)(i) is that business income be less than 90% from the provision of services. In the scenario presented, the rental income is property income, so that the business has neither services income nor business income. Where both the business and service income are nil, that will not satisfy the 90% requirement, 0 is being compared to 0, because 0÷0 is mathematically undefined.
Q.8 — Subsection 70(5)
In a recent case, McKenzie v The Queen (2017 TCC 56), the Court stated that subsection 70(5) of the Act does not apply to a non-resident person. Could the CRA comment on how it views this case?
Phil Kohnen: In McKenzie, the taxpayer received a payment from her mother’s US individual retirement account (“IRA”) after her mother had passed away, and did not include it in her Canadian income. Unsurprisingly, the Tax Court upheld CRA’s reassessment to so include it under 56(1)(a)(i)(C.1).
One of the taxpayer’s alternative arguments was that the IRA income was precluded from taxation under s. 248(28), which is how the Court came to consider the application of s. 70(5).
The Court made the striking statement (at para. 39) that “the appellant’s mother ... was not a resident of Canada; therefore there was no deemed disposition for Canadian income tax purposes under the Act upon her death.”
CRA respectfully disagrees. We agree with the brief analysis in paras. 46-47, but not the statement above. We have long-standing views on the application of s. 70(5) to non-residents (there are a few documents mentioned in our pending written response), but our position has not changed.
We would caution anyone from relying on para. 39 of McKenzie. There are deemed dispositions for non-residents, because there are scenarios where they are holding taxable Canadian property or other properties that are picked up under the Canadian tax rules.
Kim Moody: I think that is obviously correct. If para. 39 were taken literally, then all you would have to do to for planning purposes is have a non-resident acquire and hold taxable Canadian property, and never be subject to a deemed disposition, even on death. That has to be wrong.
Phil Kohnen: I think that is right. I didn’t bring any scenarios to the conference, but we gave it a quick look. It just wouldn’t make sense – the “tax net” wouldn’t work properly if that were the case.
Q.9 — Requirements for a trust to have all interests in the trust vest indefeasibly
For purposes of the so-called 21-year deemed disposition rule, a trust does not include a trust where "all interests in which, at that time, have vested indefeasibly". Can CRA comment on what is required for all interests in the trust to have vested indefeasibly?
In s. 108(1) – “trust” – (g), there is an exception to, among other things, the 21-year deemed disposition rule in s. 104(4). It is an important exception, because, generally speaking, when all interests in the trust vest indefeasibly before the 21-year anniversary, the deemed disposition rule does not apply, and the trust is not subject to s. 104(4).
I say “generally” because there are exclusions to the exclusions – subparas. (i) to(vi) of para. (g). A prominent example is that, where non-residents’ interests in the trust exceed 20% of the fair market value of the trust, para. (g) cannot be used to avoid the 21-year rule.
Coming back to the question on what constitutes vesting indefeasibly, the Act does not define this term.
There is direction available when looking at the issue. Archived Interpretation Bulletin IT-449R dealt with the specific subject of “vested indefeasibly.” It was looking at that issue in the context of some of the rollover provisions in the Act, such as 70(9). Rollover treatment is a different subject than the vesting indefeasibly of the interests in a trust, but the comments in that Bulletin are equally applicable.
There is case law as well. Boger Estate, 91 DTC 5506 (FCTD) is probably the best known one. It dealt with whether property had indefeasibly vested in the context of a s. 70(9) rollover. The Appeal Court (93 DTC 5276) approved the decision, and laid out what they felt were determinative legal principles as to when vesting occurs.
The Court’s view was that vesting occurs when there is no condition precedent to be fulfilled before the gift can take effect, and the persons that are entitled are ascertained and ready to take possession – there can be no prior interest in existence. Furthermore, a vested interest becomes indefeasible where there is no condition subsequent, or determinable limitation set out in the grant. That lays out the parameters.
In 2006, Catherine Brown wrote an article in the Canadian Tax Journal entitled “Vesting Indefeasibly: Its Importance for Tax Purposes.” I think it is well worth checking out. She lays out a good checklist of the questions to ask in making that determination.
Q.10 — Pipeline Rulings
In light of the proposed and subsequent abandonment of proposed section 246.1, how will these developments impact the ability of a taxpayer to request an advance tax ruling on inter vivos or post-mortem pipeline plans?
Phil Kohnen: There has been no change – things are still “business as usual.” CRA will continue to consider issuing favourable rulings on pipeline transactions on a case-by-case basis. That consideration will always be predicated on a review of all the facts and circumstances.
I should reiterate our answer to a similar question at STEP 2011 (2011-0401861C6). That response was cautionary, in that it pointed out that there are certain facts and circumstances in proposed pipelines that, in CRA’s view, could lead to the application of s. 84(2) deemed dividend treatment.
If the funds or property of the original corporation were to be distributed to the estate in a short timeframe following the death of the testator, that would raise concerns. We also discussed cash corporations and scenarios where the nature of the underlying assets of the original corporation were cash, and the original corporation had no active business. Those would raise concerns.
We have issued, and will continue to issue, favourable rulings where the facts of the proposed transaction did not involve a cash corporation, and contemplated the continuation of the particular business for a period of at least one year, to be followed by a progressive distribution of the corporate assets over a period of time.
In summary, our position has not changed as a result of s. 246.1 being proposed, nor of it being dropped.
Q.11 — Trusts subject to subsection 104(13.4) in year of death of the trust's primary beneficiary
For taxation years ending after 2015, where the lifetime beneficiary of an alter ego trust (AET) dies, the trust will be subject to subsection 104(13.4). As a result, the trust will have a deemed year end on the beneficiary's day of death. Where the AET receives income, such as dividends, in the year and before the beneficiary's death, does subsection 104(13.4) cause that income to be taxed in the trust? Where the trust realizes a capital gain arising from the deemed disposition of capital property pursuant to subsection 104(4) on the death of the beneficiary, can the capital gain be reported on the beneficiary's final T1 Income Tax and Benefit Return (T1 Return)?
Would the results be different, if the trust was a post-1971 spousal or common-law partner trust?
Let us assume that we are in fact dealing with an alter ego trust. This question is a good reminder of the s. 104(13.4) rules, and how they work.
The dividend income received by the trust prior to the beneficiary’s death will be included in the beneficiary’s final T1 return. The capital gain on the deemed disposition on the beneficiary’s death will be taxed in the trust. Let us discuss why:
There is the deemed disposition, which applies to an alter ego trust, and to other types of trusts where the beneficiary’s death is described in s. 104(4)(a), (a.1), or (a.4). For the alter ego trust, two things could happen with the dividend income. Normally, the alter ego trust would be subject to s. 75(2) attribution. As long as the terms of the alter ego trust trigger s. 75(2), the income would be attributed to that beneficiary, as well as the income received by the trust prior to the beneficiary’s death. If the terms of the trust do not trigger s. 75(2), the terms of the trust must require, in order to still be an alter ego trust, that the beneficiary be entitled to the income of the trust. Thus, the income will be included in the beneficiary’s T1 return, either because of s. 75(2) or because of s. 104(13). (In the s. 104(13) case, the trust can get a s. 104(6) deduction for that amount.)
The taxable capital gain will be taxed in the alter ego trust. If s. 75(2) applies, it does not attribute the gain to the beneficiary because the wording in s. 75(2) refers to the existence of the person. The deemed disposition that occurs on the person’s death occurs at the end of the day. The deceased is no longer with us, so s. 75(2) does not apply and the taxable capital gain stays in the trust.
If, on the other hand, s. 75(2) does not apply, then there will still be the deemed disposition at the end of the of death, but s. 104(6) provides a deduction for the trust for the amount of income that is paid or made payable to the beneficiary. The formula is A-B, and the A part is the amount of the trust income for the year that became payable to, or was included under s. 105(2) in the income of, the beneficiary.
Term B essentially does two jobs. First, for the trust year in which the primary beneficiary dies, or a prior year, the trust cannot claim a deduction for any income that becomes payable to someone other than that primary beneficiary. Second, and more importantly for that deemed disposition on death, for the trust year in which the primary or lifetime beneficiary dies, no deduction is available in respect of any amount included in the trust income because of the application of ss. 104(4) to (5.2) or s. 12(10.2).
Essentially, the trust has a deemed disposition giving rise to a taxable capital gain, but s. 104(6) prevents a deduction to the trust for that taxable capital gain, so that it remains in the trust.
The last piece of the question was whether this would be different for a post-1971 spousal trust. Almost everything is the same, with the s. 104(13) income going into the beneficiary’s return, and the same thing in respect of the deemed disposition on the death of the beneficiary.
There is one other option that might be available. There is an election under s. 104(13.4)(b.1), which is the joint election between the beneficiary’s GRE and the trust, to take the income of the trust and put it into the beneficiary’s return. The conditions on that are that the beneficiary is resident in Canada immediately before death, the trust is a post-1971 spousal or common-law partner trust created by the will of a taxpayer who died before 2017, and the joint election itself was attached to both returns.
Q.12 — U.S. Transition Tax
Recently implemented U.S. tax reform has introduced a one-time so-called "transition tax" that applies to U.S. persons who own interests in certain non-US corporations. Consider the situation of a U.S. citizen resident in Canada who holds a controlling interest in a U.K. company. The U.S. imposes its one time transition tax on the "earnings and profits" of the U.K. company held at certain dates in 2017. Would Canada view such U.S. transition tax as an "income or profits tax" as referred to under subsection 126(7) of the Act when applying the foreign tax credit ("FTC") rules in the computation of the US citizen/Canadian resident individual?
Phil Kohnen: Our written response is technically oriented. I will just mention a couple of things.
The U.S. shareholder of a specified foreign corporation that is subject to the rule must then include in their U.S. income their share of the corporation’s U.S. Subpart F income. The U.S. shareholder may elect to pay the resulting net liability in eight annual instalments.
Suppose that the U.K. company has a calendar year-end. We understand that the rules as described would mean that the individual would have to include, in their 2017 U.S. income their pro-rata share of the company’s U.S. Subpart F income, and would likely pay that in eight annual instalments.
As we have indicated in Folio S5-F2-C1 on foreign tax credits, in order to determine whether a foreign tax is an income or profits tax, the basic scheme of application of the foreign tax is compared with the scheme of application of the income and profits under our Act. Generally, if the basis of taxation is substantially similar to the basis of taxation in Canada (in the sense that it is also levied on income, net income or profits, but not necessarily computed the same way that we do it), the foreign tax will be considered an income or profit tax for the purpose of Canadian foreign tax credit rules.
So far so good, but this is where problems arise.
We understand that the U.S. Subpart F income resembles our own FAPI rules, and that the U.S. tax paid by the individual on the individual’s share of the U.S. Subpart F income in this example is an income tax similar to ones levied under our Act. We would therefore view it as qualifying as an income tax for the purposes of the Canadian foreign tax credit rules.
However, this does not necessarily resolve the issue of whether the foreign tax credit should be available in this case. As indicated in the Folio, a separate foreign tax credit calculation is required for each foreign country, and the maximum amount of the foreign tax credit that the taxpayer may claim in respect of foreign non-business income tax is essentially equal to the lesser of two amounts:
- the applicable foreign tax that is paid to a government of a country for the year; and
- the amount of Canadian tax otherwise payable for the year that pertains to the applicable foreign income from sources in that country.
In the example, the foreign tax credit would be calculated based on the formula, which takes into account the amount of U.S.-sourced income. It is not clear, in this case, if any income is sourced to the U.S. U.S. Subpart F income is not deemed to be income under Canadian domestic law, and thus would not be considered to be U.S.-sourced income for the purposes of the foreign tax credit calculations. In other words, the second component of the above formula is zero.
It is thus our view that a foreign tax credit would not be available in this example. As indicated in the Folio, before a foreign tax credit can be claimed under s. 126 of the Act, it must be paid for the year (2017 in this case), whether it is paid before, after, or during the year in question. We understand that the transition tax would be paid for 2017, and that a foreign tax credit would not be available in any other year, even if the tax burden were to be repaid in annual instalments.
Q.13 — Alter ego trust subject to foreign withholding tax
Assume that an individual (the "Settlor") creates an alter ego trust, and transfers various securities to the trust. Included with the securities are US stocks on which dividends are paid. These US stocks are subject to a 15% withholding tax.
Subsection 75(2) of the Act applies so that the income of the alter ego trust is considered to be the income of the Settlor, who created the trust and who is, under the trust, a lifetime beneficiary. Is it correct that in this circumstance, the foreign tax (being the withholding tax on the dividend) would not be attributed to the Settlor, and remains in the trust?
Phil Kohnen: In the interests of time, I will give a short response.
Without getting into the definition of an alter ego trust, subsection 75(2) does not attribute a foreign non-business income tax payment back to the settlor. Under s. 126(1), to claim a foreign tax credit, the amount must have been paid by the taxpayer who is making the claim. The settlor would not be eligible to claim a foreign tax credit in respect to the U.S. tax paid in the alter ego trust and, for the same reason, the settlor would not be able to claim a s. 20(11) or (12) deduction because, again, the settlor did not make the payment.
There is some mitigation possible, though, in the sense that the trust itself may be able to look to a deduction under ss. 20(11) or (12) in calculating the ultimate amount of income attributed back to the settlor.
Q.14 — Non-resident trust filing obligations
In certain circumstances, a non-resident trust will be deemed to be resident in Canada by virtue of section 94. The main circumstances will be situations where a resident of Canada has contributed property to a non-resident trust such that the non-resident trust has a resident contributor, as defined in subsection 94(1). Assume that a person immigrating to Canada has contributed property to a non-resident trust. Upon becoming resident, does the CRA agree that the non-resident trust will be deemed resident in Canada by virtue of paragraph 94(3)(a) as of January 1 of the taxation year in which the contributor immigrated to Canada?
The short answer is yes.
Under s. 94(3)(a), if there is a resident contributor to a non-resident trust that is not an exempt trust at a specified time in a taxation year, the trust is deemed to be resident in Canada throughout the year for tax purposes. The “resident contributor” is defined in s. 94(1), as “a person that is, at that time, resident in Canada and a contributor to the trust”.
A contributor itself is defined as “a person (other than an exempt person but including a person that has ceased to exist) that, at or before that time, has made a contribution to the trust.” When that particular individual has previously contributed property to that trust, he will be a contributor and, as that contributor has now immigrated, he will be a resident contributor. Thus, the non-resident trust will be deemed to be resident in Canada throughout the tax year.
Assume that the non-resident trust has beneficiaries resident in Canada who are not successor beneficiaries (within the meaning of subsection 94(1)) when the contributor immigrates to Canada, and the contributor has made a contribution to the trust less than 60 months before becoming resident. Does the CRA agree that the non-resident trust may be deemed resident for up to five taxation years before the taxation year in which the individual became resident in Canada?
If so, would the CRA expect T3 income tax returns to be filed for these previous years? Would the CRA expect foreign reporting forms, such as the T1 135 and the T1 134, to be filed as well? Would the CRA apply interest and late-filing penalties to any tax owing by the non-resident trust for these prior years?
Phil Kohnen: The short answer is that it is bad news on all fronts. The written response will go into more detail, but the most relevant provision is s. 94(10), which has a lookback effect. Where s. 94(10) applies, the outcome is, among other things, that the trust is subject to Canadian tax for each of the taxation years.
The trust will also be subject to interest and penalties for each year for which a return was not filed, and it will be required to complete foreign reporting forms, T1135 and T1134, if applicable, for each of those years. Interest and penalties will also apply to the reporting for the relevant taxation years.
Also note that s. 152(4)(b)(vii) allows for assessment or reassessment of tax, interest or penalties within an additional three years beyond the normal reassessment period to give effect to the application of section 94.
I recommend looking at the three examples in the written response, when it is released.
Q.15 — Subsection 164(6) and the application of 112(3.2)(b)
This question deals with capital loss of an estate on a redemption of shares and the carryback election under subsection 164(6).
In particular, the question relates to the stop-loss rule in subsection 112(3.2) which may be applicable to reduce the capital loss otherwise realized by the estate upon the disposition of a share of the capital stock of a corporation. There are two components to subsection 112(3.2). The first component, outlined in paragraph 112(3.2)(a), generally provides for a reduction of the capital loss where non-taxable capital dividends were received by the estate on the share, subject to certain limitations. The second component, in paragraph (b), provides for a further reduction of the loss where taxable dividends or life insurance capital dividends are received on the share and designated by the trust under subsection 104(19) or 104(20) in respect of a beneficiary that was a corporation, partnership or trust.
Assume that the estate provides that the beneficiary is a spousal trust. The will of the deceased creates an estate, and under that estate, amounts are to be paid to the spousal trust. That trust may, in turn, pay amounts to beneficiaries. In this circumstance, suppose that a taxable dividend is created on a redemption of shares. The graduated rate estate ("GRE") receives the taxable dividend. If this taxable dividend is designated to an individual, then paragraph 112(3.2)(b) would not apply. However, if the GRE designates the amount to the spousal trust, which then designates the amount to a beneficiary who is an individual, it seems that paragraph (b) could apply to reduce the capital loss. How does CRA administer this as a question of practice?
Steve Fron: Our written answer is fairly lengthy. I will try to just give you the highlights.
First of all, the answer is actually favourable, in that there is a provision that provides an exception to the application of s. 112(3.2)(b). See ss. 112(3.32) and 112(6.1). Subsection 112(3.32) is the exception to the stop-loss rule in s. 112(3.2)(b) and s. 112(6.1) is the definition of qualified dividend.
In this particular scenario, the exclusion should work where an estate has received an s. 84(3) deemed dividend on a redemption, it designates that dividend, distributes it to the spousal trust, and the spousal trust in turn designates and pays it to the individual beneficiary. S. 112(3.32) should ensure that the taxable dividend does not factor into the loss reduction.
There are basically two parts to this. S. 112(3.32) essentially says that an exception applies in respect of a taxable dividend that is a qualified divided received on the share by the trust, and that is designated by the trust under subsection 104(19) in respect of a beneficiary that was a corporation, a partnership or a trust, where the trust establishes two different conditions. The first condition is the relevant one for our purposes, which is that the trust establishes that the dividend was received by a beneficiary that was an individual other than a trust.
The next step is to check whether the dividend fits the definition of a qualified dividend. The provision is lengthy, so that I will review just the highlights.
The qualified dividend can be one of two things. One is a dividend other than a s. 84(3) dividend, which does not fit here. The other is certain dividends that are deemed to be 84(3) dividends. (There is more to the provision, so you will have to see whether it fits under the second part.)
Certain deemed dividends on redemption would fit. It is necessary to look to what happens to that dividend when the estate has received the dividend, and to whom the estates pays or designates the dividend. It would be a qualified dividend if the estate or trust retained the dividend and it was taxed in the trust, or if it was paid to another individual that was not a trust – in this case, that does not work.
I am going to cut this short just because of time. At the end of the day, where the estate has the dividend, designates it under s. 104(19) to the spousal trust, and the spousal trust designates it to an individual beneficiary, s. 112(3.32) should work.
The only proviso that I mention is that, in order for a dividend to be designated under s. 104(19) in the first place in respect of a beneficiary, s. 104(19) requires that, among other things, the amount may reasonably be considered to be included in the beneficiary’s income because of the application of s. 104(13)(a), 104(14) or 105. For s. 104(13)(a) to apply, both the executor and the trustee have to ensure that they were able to make the amounts payable to the beneficiary in the particular year.
Q.16 — Canadian tax implications of a US LLC making a check-the-box election
Given recent changes to the tax system in the US, Canadian resident persons who carried on business in the US through US LLCs may now prefer to alter this choice of entity for US tax purposes. An election is permitted in this case, the check-the-box election, whereby the US LLC may be designated to be a corporation for US tax purposes. In such a circumstance, where a check-the-box election is made, does CRA agree, generally speaking, that the making of the check-the-box election has no implications for Canadian tax purposes? It is noted that the Canadian tax treatment of the US LLC would be that it is a foreign corporation, and the check-the-box election would not alter this treatment for Canadian tax purposes.
Steve Fron: Checking the box has implications for U.S. tax purposes, but our understanding is that it does not impact the US legal attributes or the laws regarding the governance or operation of the LLC. From a US legal perspective, the LLC remains the same legal entity after checking the box as it was before it made the election. Therefore, for Canadian tax purposes, checking the box would not result in a disposition of either the units held in the LLC by its members or of the LLC’s assets for Canadian purposes.
The question was worded fairly broadly, but we think that was the key point. The question does also note that checking the box could have implications for the Canadian resident and their taxation. We discuss this a bit in our answer, because in previous Roundtables we discussed the impact on the Canadian. Now that the tax has shifted to the LLC, that could change those answers.
Q.17 — Section 84.1 and Capital Gains Reserve
Generally speaking, section 84.1 of the Act applies to prevent the tax-free extraction of surplus of a corporation through a non-arm's length transfer of share(s) by an individual resident in Canada to a corporation where the individual's adjusted cost base (ACB) of the particular share(s) so transferred has been increased by the capital gains exemption (CGE) or V-Day value. However, we are aware that section 84.1 could apply in a situation where the individual's ACB of the particular share(s) has not been increased by the CGE or V-Day value. More specifically, subsection 84.1(2.1) provides that, for purposes of determining ACB of the individual's share for the purposes of section 84.1 (and in particular the ACB reduction under subparagraph 84.1(2)(a.1)(ii)), where a capital gains reserve is claimed under subparagraph 40(1)(a)(iii) by the individual or a non-arm's length individual (herein referred to as the "transferor") and it is possible for the transferor to claim the CGE, the CGE is deemed to be claimed by the transferor in the maximum amount irrespective of whether it is in fact claimed.
Can the CRA provide any comments with respect to this interpretation of subsection 84.1(2.1)? Specifically, can the CRA comment on whether the application of subsection 84.1(2.1) could result in a transferor being deemed to have claimed CGE in the maximum amount where the transferor claims a capital gains reserve under subparagraph 40(1)(a)(iii) but has not, and has no intentions of, claiming CGE even though there is unused CGE room available?
For example, Father transfers shares of Opco (a small business corporation whose shares are eligible for the CGE) to his children in consideration for a note that is payable over 10 years, claims the capital gains reserve, but does not claim the CGE. The children transfer the Opco shares to a new Holdco in consideration for a note of Holdco, with a view to opco dividends funding note repayments . Are the children deemed to receive a dividend under s. 84.1 on their receipt of the note?
Phil Kohnen: There is no interpretive leeway in s. 84.1(2.1). S. 84.1 is itself an anti-avoidance provision. S. 84.1(2.1) was specifically put in place to deem any unused capital gains exemption room for the year of the disposition to be fully used even though it may not have been.
In particular, a transferor, a father in this case, may have room that he wants to retain for future use. That does not matter. S. 84.1(2.1) does not look to what your plans for using that capital gains exemption are, it deems you to have used all of the room that you have available. There is no flexibility or Ministerial discretion built in.
Q.18 — Reliance on archived Interpretation Bulletins and Income Tax Technical News releases
In recent years, CRA has been working on its folio project to organize information by subject. As part of this, many interpretation bulletins have been archived. In general terms, to what extent can persons rely on interpretation bulletins which have been archived, and also to what extent can one rely on comments made in Income Tax Technical News releases?
Phil Kohnen: There is a lot of confusion about archived Bulletins and what that means. It is not the same as cancelled. Bulletins are cancelled when their technical content is outdated or patently wrong, or the law has changed, or so forth, so that the value of a cancelled IT Bulletin has eroded over time.
A lot of ITs were archived a few years ago, and that is because they did not meet the Government of Canada’s requirements for publishing online. It was going to cost too much and take too much effort to bring them up to date, particularly when we were moving into the new Folio format.
Can you rely on an archived IT bulletin? Yes, but bear in mind that they only ever were current up to their stated effective date when they were published and they are not a substitute for the law.
When you look at an archived Bulletin, consider the following points. Are there any relevant provisions of the law that have been changed since the publication of that document? And are there any court decisions that would vary the ideas expressed?
Where a Bulletin overlaps with a Folio, you should not rely on the Bulletin.