7 June 2019 STEP Roundtable
This provides the written questions that were posed, and abbreviated summaries of the CRA oral responses, at the Annual STEP Canada CRA Roundtable held in Toronto on 7 June 2019. The presenters from the Income Tax Rulings Directorate were:
Steve Fron, CPA, CA, TEP: Manager, Trust Section II, Financial Industries and Trusts Division
Marina Panourgias, CPA, CA, TEP: Acting Manager, Trust Section I, Financial Industries and Trusts Division
The questions were orally presented by Michael Cadesky (Cadesky Tax) and Kim G.C. Moody (Moodys Gartner). Steve Fron cautioned that their oral responses adopted a more conversational tone than the written answers to be subsequently released, and should not be fully relied upon until published.
Q.1: S. 94 trust becoming non-resident through share sale
In an article in the 2016 Canadian Tax Journal titled, “Non-Resident Trusts: Selected Interpretive and Planning Issues—Part 1” by Elie S. Roth and Kim Brown, the authors indicated that some of the statements made by the CRA in technical interpretation 2013-0509111E5, dated February 24, 2014 were unclear.
The hypothetical fact situation described in the 2014 technical interpretation was as follows:
- In 2010, Trust A, a factual non-resident trust was deemed a resident by reason of subsection 94(3) of the Act because Corp X, a Canadian resident corporation, issued 100 common shares to Trust A thereby triggering paragraph 94(2)(g) and making Corp X a resident contributor of Trust A. Trust A is not an exempt foreign trust.
- In calendar 2011, none of the trust circumstances changed except that Trust A ceased to have a resident contributor when the trust sold its 100 common shares of Corp X at fair market value to an unrelated third party on August 15th, 2011 in a transaction, the terms of which satisfied the requirements of paragraph 94(2)(t) of the Act.
Can the CRA please confirm their position and if necessary, correct any inaccurate statements made in the 2014 technical interpretation?
The conclusion in 2013-0509111E5 – that s. 94(2)(t) applied, but not in respect of the original transfer of shares by Corp X to Trust A – still stands.
One point requires clarification. 2013-0509111E5 quoted the Department of Finance explanatory notes for paragraph 94(2)(t) and the following passage is relevant:
Paragraph 94(2)(t) generally expunges a contribution of shares or indebtedness of a Canadian corporation from the corporation to a trust if the corporation issued (in circumstances described in subparagraph 94(2)(g)(i) or (iv)) the shares or the debt to the trust and the trust later sells the shares or indebtedness in circumstances in which the parties to the sale deal with each other on an arm's length basis. However, the application of paragraph 94(2)(t) will not affect the application of paragraph 94(2)(g) in respect of the original transfer by the corporation to the trust or the other person or partnership: such transfers will continue to be treated as transfers under section 94.
S. 94(2)(t) applies to expunge the contribution after the time of sale, so that thereafter, the contribution is considered to have never occurred. Thus, at the end of the 31 December 2011 taxation year of Trust A, s. 94(3)(a) would not apply because there is no longer a resident contributor - and, conversely, pursuant to s. 94(5), Trust A is deemed to have ceased to be resident as it it ceased to have a resident contributor.
Accordingly, s. 128.1(4) applies to create a deemed year end, and Trust A would be deemed resident under s. 94(3) for the taxation year ending on 15 August 2011 because, at the end of that taxation year, there is still a resident contributor. However, Trust A would not be deemed resident for its taxation year beginning on 16 August and ending on 31 December because, at the end of that particular taxation year, there is no resident contributor. The combined effect of these provisions is that, there is still a deemed resident trust in the period up to the time of sale, and thereafter there is not.
Note that there is a passage in 2013-0509111E5 that considers what would happen hypothetically “in the absence of s. 94(5).” The conclusions in that paragraph are, of course, not applicable to the actual state of the law.
Q.2: Directed or discretionary donations by alter ego trust
An alter ego trust owns a portfolio of publicly traded securities which have appreciated in value. The Settlor (Contributor) to the alter ego trust dies and the alter ego trust has a deemed year-end at the end of the day on which the individual dies pursuant to subsection 104(13.4). The trust realizes a capital gain at that time pursuant to subsection 104(4).
a) Assume that the residual beneficiary, after the death of the Contributor, is a registered charity, and a distribution is made to that registered charity. In these circumstances, can the alter ego trust claim the amount as a charitable gift that is eligible for the donation tax credit?
b) Assume that the residual beneficiaries are a class of registered charities as determined by the trustees, and that the trustees may make payments over a period of time, say the next 3 years, to those various registered charities. At the end of 3 years, the capital remaining is to be distributed to registered charities. In these circumstances, can a charitable donation be claimed by the alter ego trust?
c) If the donation by the alter ego trust is made by donating the publicly traded securities, is the taxable capital gain nil as would be the case for an individual?
Preliminary response (a)
After noting that s. (c)(ii)(C) of the “total charitable gifts” in s. 118.1(1) was added to allow for the inclusion, in a trust’s total charitable gifts of the eligible amount of a gift made by the it in a s. 104(13.4)(a)-shortened taxation year, CRA quoted Friedberg (“a gift is a voluntary transfer of property owned by a donor to a donee, in return for which no benefit or consideration flows to the donor,”), and indicated that at common law there is a gift if the taxpayer has donative intent and:
- there was a voluntary transfer of property to a qualified donee;
- the transferred property was owned by the donor; and
- no benefit or consideration flowed to the donor.
and that whether a payment by an alter ego trust to a registered charity is a charitable gift by it or a distribution of income or capital to a beneficiary turns on the trust-deed wording and the intentions of the trustee in making the payment.
Where the trust has no discretion as to whether to make the payment to the charity, the payment does not qualify as a gift and thus, is ineligible for the donation tax credit. However, CRA has accepted that where the trustee is clearly given the discretion to decide if the payment is to be made to a charity or to use the funds in some other manner, the payment is considered voluntary. Accordingly, payment by the trust to the charity would be considered a charitable gift that is eligible for the donation tax credit, provided that the other conditions of the subsection were satisfied.
Preliminary response (b)
The fact that the trustee may make payments over the three years suggests that the trustee may have discretion and the payments may be voluntary – so that the payments to the charity over the three years may be eligible for the donation tax credit provided the other conditions of the subsection are satisfied.
Once the three years have passed, it appears that the remaining capital is to be distributed to the charities. This wording suggests that the trustee may not have discretion with regard to this payment, and the payment by the trust would not be eligible for the donation tax credit.
Preliminary response (c)
Under s. 38(a.1)(i), the taxable capital gain for a taxation year from the disposition of a property is equal to zero if the disposition is the making of a gift to a qualified donee of certain publicly traded securities as described therein. If, as discussed above, the factual determination were made that the disposition of the property to the qualified donee was a gift, then it so qualify under s. 38(a.1)(i) so that the capital gain would be equal to zero.
Q.3: TOSI and under 5 hrs. worked
A safe harbour for purposes of the Excluded Business definition applies where a person works on average at least 20 hours a week during the part of the year that the business is carried on. If this test is satisfied, then the business is considered an Excluded Business and the TOSI rules do not apply by virtue of the amount being an Excluded Amount.
It is noted that the 20 hour week rule is a safe harbour. Working less than 20 hours per week might still meet the requirement for an Excluded Business, since the wording is general in nature, using the phrase “actively engaged on a regular, continuous and substantial basis in the activities of the business”.
Suppose a business is carried on through a corporation owned by husband and wife. Both husband and wife contribute an equal amount of effort but the business only requires 10 hours of work per week on average, with each spouse contributing 5 hours. In these circumstances, can the business be an Excluded Business?
Whether an individual has been “actively engaged on a regular, continuous and substantial basis in the activities of the business” (hereinafter, “actively engaged”) will depend on the circumstances, including the nature of the individual’s involvement in the business, i.e., the work and energy that the individual devotes to the business and the nature of the business itself. The more an individual is involved in the management and/or current activities of the business, the more likely it is that the individual will be considered to be actively engaged.
Here, the facts are similar to Example 9 of CRA’s split-income guidelines. There, Spouses A and B, who were the only shareholders of Opco (with a business of developing mobile apps) both had other jobs or were attending university, and they only worked on the Opco business (evenings and weekends) for less than an average of 20 hours per week, without any need for involvement of other employees or more involvement from them. CRA concluded that the specified individuals could be considered to be actively engaged.
Therefore, in the current scenario, both the husband and wife could be considered to be actively engaged in the business, even though neither of them reaches the 20-hour threshold.
It is a question of fact as to whether the husband and wife could be considered to satisfy the excluded business test for a particular year or continue to meet such test thereafter, as consideration must be given to the ongoing nature and labour requirements of the corporation’s business.
Q.4: Large dividend excluded amount to spouse
A resident of Canada (“Individual”) carries on a professional practice through a professional corporation (“XCo”). Individual owns all the voting common shares of XCo and the spouse of Individual (“Spouse”), who is also an adult resident of Canada, owns non-voting preferred shares of XCo. Spouse acts as a part-time receptionist for XCo and on average, works at least 20 hours per week. Typically, a part-time receptionist working similar hours would be paid a salary of $18,000 per annum, however, Spouse, by virtue of being a shareholder of XCo, receives a dividend of $150,000 each year.
Can the CRA provide confirmation that the dividend income received by Spouse from XCo on the non-voting preferred shares will not be subject to tax on split income (“TOSI”)? Specifically, can the CRA confirm that the dividend income received by Spouse will be considered an “excluded amount” pursuant to subparagraph (e)(ii) of that definition found in subsection 120.4(1) of the Income Tax Act (Canada) (the “Act”) by virtue of the fact that paragraph (a) of the “excluded business” exception will apply because Spouse works at least 20 hours a week as a part-time receptionist for XCo?
Any dividends received by Spouse would be considered split income unless they were an excluded amount, which could be the case if they were derived directly or indirectly from an excluded business of Spouse for the year.
It is a question of fact as to whether an individual is actively engaged in the activities of the business, and s. 120.4(1.1)(a) provides a 20-hour-per-week deeming rule.
If Spouse works for XCo at least 20 hours per week throughout the portion of the year that the business operates, that would satisfy s. 120.4(1.1)(a), and the dividend income received by Spouse would be considered to be an excluded amount because it is derived from an excluded business – so that it would not be subject to the tax on split income.
Q.5: TOSI and surviving spouse/65+ exclusion
A specified individual’s income or taxable capital gain for a taxation year will be an excluded amount if the amount would have been an excluded amount in respect of an individual who was, immediately before their death, the specified individual’s spouse or common-law partner, assuming such amount were included in the spouse or common-law partner’s income for that year.
However, there is a question of whether this exemption will apply where the deceased spouse qualified under the “excluded shares” exception based on direct ownership of the shares, and the surviving spouse holds the shares through a holding company or trust. The issue is whether the surviving spouse’s indirect ownership arrangement needs to be imputed to the deceased in determining whether he or she would have qualified for an exemption from the TOSI rules.
As well, split income received by a specified individual in a year will be deemed to be an excluded amount if that person’s spouse or common-law partner has attained the age of 65 in the year, and the split income would be an excluded amount if that amount had been received by the spouse or common-law partner in the year.
Again, there may be a question as to whether this exemption will apply where the spouse qualifies for the excluded shares exemption, but the specified individual does not directly own the shares in the corporation. In effect, does the specified individual’s ownership arrangement impact the application of this deeming rule for purposes of the excluded shares exemption?
Para. (g) of “excluded amount” includes income from (or a taxable capital gain from the disposition of) excluded shares where the individual is at least 25 years old in the year.
S. 120.4(1.1)(c) deems any income (or taxable capital gain) that would otherwise be split income of a specified individual to be an excluded amount for a taxation year if either of two situations applies. In the first situation (outlined in s. (i)), the amount that would otherwise be split income of the specified individual is an excluded amount of that individual if it would have been an excluded amount of the specified individual’s spouse or common-law partner for the year if the amount were included in that spouse or common-law partner’s income instead, and that spouse or common-law partner was 65 years or older in the year.
The other situation (outlined in s. (ii)) is where the amount that would otherwise be split income of a specified individual is deemed to be an excluded amount of the individual if the amount would have been an excluded amount in respect of an individual who was, immediately before their death, the specified individual’s spouse or common-law partner, and that amount was included in that person’s income for their last taxation year before death.
The question deals with whether this deeming rule applies where the exclusion for excluded shares is relied on.
Assume that individual A, the deceased spouse of a specified individual, owned shares of Canco (a taxable Canadian private corporation) whose shares were excluded shares of A throughout A’s last taxation year before death. The specified individual is a beneficiary of a Canadian-resident trust, which acquired Canco shares during A’s lifetime, and such shares were not acquired for the benefit of the spouse as a consequence of his death. Canco carries on a related business with respect to A and the specified individual.
Canco pays a dividend to the trust, which is then distributed by the trust to the specified individual. It is assumed that the dividend would not otherwise be an excluded amount but for s. 120.4(1.1)(c)(ii).
The exclusion in s. 120.4(1.1)(c)(ii) will apply if the dividend would have been an excluded amount of A had it been included in computing A’s income for A’s last taxation year before death.
In general, for the purposes of determining whether an amount would have been an excluded amount in respect of a deceased spouse or common-law partner of a specified individual had it instead been included in their income, consideration needs to be given to all their facts and circumstances in the applicable taxation year, including any shares of the corporation owned by them.
In CRA’s view, the ownership requirement in para. (b) of “excluded shares,” for this purpose, is based on the actual ownership of the shares by the deceased spouse or common law partner in the relevant year.
Returning to the example, given that A owned shares of Canco throughout A’s last taxation year before death, those shares satisfied the requirements for being excluded shares during that period, and CRA considers the amount of the dividend that was notionally included in A’s income to have been income from those shares, so that such dividend would have been an excluded amount in respect of A had it been included in A’s income in A’s last taxation year, because it would have been income from excluded shares.
The dividend in that case should be deemed to be an excluded amount in respect of the specified individual under s. 120.4(1.1)(c)(ii), and a similar analysis would also apply in respect of the situation in s. 120.4(1.1)(c)(i), which is where the spouse or common-law partner was 65 years or older in the year.
This example illustrates a general approach to the s. 120.4(1.1)(c) deeming rule in the context of a basic share ownership structure. For more complex structures, it is not clear whether the same approach would be applicable. Furthermore, where artificial transactions are undertaken to achieve a similar but inappropriate result, the GAAR could be applicable.
Q.6(a): Double application of s. 120.4(1.1)(b)(ii)
It is unclear how the rules in subsection 120.4(1.1) will work where there have been multiple deaths. For example, assume Mr. and Mrs. A own all the shares of Opco, which operates a services business. Mrs. A has been actively engaged in the business for at least five years, whereas Mr. A has not been actively engaged in the business. Mrs. A passes away and all her shares are gifted through her will to Mr. A. Subsequent distributions from Opco to Mr. A would not be split income as Opco would be deemed to be an excluded business in respect of Mr. A, even if he is not actively engaged in the business. But how will the deeming rules apply if Mr. A subsequently dies and those shares are gifted to the children. Will they be deemed to have made the same contributions as Mrs. A? Or do the deeming rules only reference Mr. A’s contributions? If the latter, then the children could become subject to the TOSI rules unless they can rely on another exemption.
S. 120.4(1.1)(b)(ii) essentially provides that, for the purposes of that subparagraph and the “excluded business" definition, where property was acquired for the benefit of a specified individual as the consequence of the death of another person and that other person was actively engaged in the activities of the business throughout the five previous taxation years, then the individual is deemed to have been actively engaged in the business throughout those five years. If this rule applies, then the specified individual’s income from that inherited property would qualify as an excluded amount, and would not be subject to the tax on split income.
Whether a particular individual acquired property as a consequence of the death of another person, or whether that other person was actively engaged in the activities of a business for five prior taxation years, is a question of fact.
Turning to the given example, respecting the acquisition of Mrs. A’s Opco shares by Mr. A as a consequence of Mrs. A’s death, Mr. A. would be deemed to have been actively engaged in the activities of Opco’s business throughout the five previous taxation years for purposes of the excluded business definition, for all years starting with the year in which the Opco shares were inherited. Any dividends arising on the Opco shares owned by Mr. A, for a taxation year starting with that year, would not be subject to the tax on split income.
In CRA’s view, the effect of a previous application of s. 120.4(1.1)(b)(ii) could extend to a subsequent acquisition of property as a consequence of the death of another individual. For example, when the children inherit Mr. A’s Opco shares as a consequence of his subsequent death, the deeming rule would apply to deem each child to be actively engaged in the activities of the business for five prior taxation years, because Mr. A. was also deemed by that same provision to have satisfied that requirement. The result is that the income from Opco that would otherwise be subject to the tax on split income would be an excluded amount. Therefore, any dividends arising on any of the shares of Opco owned by the children, for any taxation year starting with the year in which they inherited the Opco shares, would not be subject to such tax.
Q.6(b): S. 120.4(1.1)(b)(ii) application to previous bequest
Consider the situation where Mr. A passed away in Year 1 and Mrs. A passed away in Year 2. In each of their wills, they each bequest 2 of their shares of Opco to each of their 2 inactive children. As a result, each child received 12 of his/her shares of Opco from Mr. A and the other 2 from Mrs. A. Is each child entitled to the excluded business exemption in respect of all future dividends received from Opco?
Since Mr. A was not actively engaged in the activities of the business before his death, and did not inherit any of Mrs. A’s shares before his death (his death preceded hers), when the children acquire the shares of Opco as a consequence of Mr. A’s death, the conditions in s. 120.4(1.1)(b)(ii) would not be satisfied, so that the excluded business exception would not apply. Thus, any dividends on the Opco shares inherited from Mr. A would initially be subject to the tax on split income (unless one of the other exceptions applies).
However, beginning in the taxation year in which the children inherit Mrs. A’s Opco shares as a consequence of her death, the deeming rule would apply, so that each child would be deemed to be actively engaged in the business of Opco throughout the five previous taxation years. The result is that any income from Opco that would otherwise be subject to the tax on split income would be an excluded amount. Once the children inherit the shares of Opco from Mrs. A, any dividends received on any of their Opco shares (from the taxation year in which they inherited Mrs. A’s shares onward) would not be subject to the tax on split income, including the shares that they previously acquired as a result of Mr. A’s death.
Q.7: Royalties of artist
A) The case of Roco Gagliese Productions Inc. v. The Queen, 2018 TCC 136 involved determining the nature of copyright royalties received by an author/musician. The question was whether the income was royalty income (which would be from a specified investment business) or income from services (which would be active business income). It was held that the income was income from services because the person who derived the income was earning the income in the normal course of his business. Does CRA agree with the decision in this case?
B) If so, how does the decision apply to a mortgage lending business that earns interest income on a business of renting real estate?
Preliminary response A
CRA agrees with the Gagliese Productions decision based on the factual findings made. The principal purpose of the taxpayer’s music composing business was to derive income from the provision of services. The residual income from the music tracks aired in reruns of television episodes was incident to, and pertained to, the taxpayer’s active business. CRA positions stated in this regard in 1997  and 2007 remain unchanged.
Although royalty income is generally considered to be income from property, such income will be considered to be income from an active business where it can be established that the income was related to an active business carried on by the recipient taxpayer in the year, or the recipient taxpayer is, in the year, in the business of originating property from which the royalties are received.
If a taxpayer is in the business of composing music, the income earned by the taxpayer respecting the copyrighted music will generally be considered to be active business income. The fact that such income is in the form of royalties does not, in itself, make it income from property. Its proper characterization will depend on the facts.
Preliminary response B
A strong connection between the Gagliese Productions case and a mortgage-lending business is not apparent. It is also unclear what the connection is between the mortgage-lending business and the rentals. Our comments below are derived from 2002-01685750.
The expression "income of the corporation for the year from an active business" in s. 125(7) generally refers to income from an active business carried on by it, including any income for the year pertaining to or incident to that business. As indicated in IT-73R6, para. 5, the expressions “pertains to” or “incident to” involve a financial relationship of dependence of some substance between the property in question and the active business before the property is considered to be incident to or to pertain to the active business carried on by the corporation. In addition, the operations of the business must have some reliance on the property such that the property is a back-up asset that could support the business operations either on a regular basis or from time to time.
The courts have held that, when a corporation derived income from an activity that was inseparable from its normal active business, such income was properly classified as active business income. If the income is part of the normal business activity of the corporation, and it is inextricably linked with an active business, it will be considered active business income.
Applying this to the question at hand, if the principal purpose of a corporation’s business is to derive income from property such as interest or rental income, and the business does not employ more than five full-time employees, and none of the other exceptions apply, then the income will be considered to be an income from a specified investment business. The question does not appear to suggest that the mortgage-lending or rental operation was an active business. Here, the interest and rental income does not pertain to, is not incident to, and is not inseparable from or inextricably linked to an active business carried on by the corporation.
Q.8: Contingency fees and WIP
As a result of recent changes to the taxation of WIP for certain professionals, the CRA has published the following statement as it relates to contingency fee arrangements made by certain professionals under FAQ #5 at https://www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/federal-government-budgets/budget-2017-building-a-strong-middle-class/billed-basis-accounting.html :
Under the terms of a contingency fee arrangement, all or a portion of a designated professional’s fees may only become known and billable at some time after the taxation year in which the professional provided services under the arrangement (e.g., where, under the terms of a written contingency fee agreement between a personal injury lawyer and a client, legal fees are only billable by the lawyer on a periodic basis as amounts are received by the client under a negotiated settlement or a court judgment). Until such time, there is often no liability on the professional’s client to pay any fee; consequently, no amount is receivable by the professional until the right to collect the amount is established. Under these circumstances, for purposes of determining the value of the professional’s work in progress at the end of the year, no amount would normally be recognized. As a result, the proposed change to eliminate the ability of designated professionals to elect to use billed-basis accounting is not expected to have any impact on these types of contingency fee arrangements where the terms and conditions of such arrangements are bona fide.
While this position is very generous for the professional that has entered into a contingent fee arrangement, we question whether this position is correct. Specifically paragraph 10(4)(a) of the Act states:
work in progress at the end of a taxation year of a business that is a profession means the amount that can reasonably be expected to become receivable in respect thereof after the end of the year;
Accordingly, the amount of WIP that a professional is required to value is the amount that can reasonably be expected to become receivable after the end of the year. It would not seem unreasonable that a professional should be able to value its contingent fee files to determine what amounts could reasonably be expected to become receivable after the end of the year. Can the CRA reconcile its administrative position to the law?
When a designated professional, as part of an agreement, undertakes to provide services in exchange for contingency fees, sometimes a portion or all of these fees cannot be known or determined until an event occurring after the taxation year in which the professional provided the services. In that situation, at the end of the year, the fair market value of the WIP would be nil.
However, in certain circumstances, it is possible at the end of the year to establish an amount that can reasonably be expected to become receivable in respect of the WIP after the end of the taxation year. In that case, it is our view that the fair market value of this WIP should correspond to this amount.
Q.9: Subsequently resident estate as GRE
A non-resident individual passed away in June 2016. The Estate which arose on the death (“Estate”) was non-resident at that time and section 94 does not apply to it.
On January 1, 2018, the non-resident trustee of the Estate resigned and a new trustee was appointed. The new trustee was a resident of Canada and, from that time onward, the management and control of the Estate took place in Canada. As such, the Estate became factually resident in Canada and pursuant to subparagraph 128.1(1)(a)(i) of the Act, a new taxation year of the Estate commenced at the time of the Estate’s immigration to Canada, and the taxation year which would have otherwise included that time, ceased.
The Estate will file its first tax return in Canada for the period January 1, 2018 to December 31, 2018. The taxation year is no more than 36 months after the death.
a) Can the Estate designate itself as the graduated rate estate (“GRE”) of the individual when filing its first tax return under Part | of the Act?
b) If the individual had not, before the death, been assigned a Social Insurance Number (“SIN”), what other information is acceptable to the Minister for purposes of paragraph (c) of the definition of GRE in subsection 248(1) of the Act?
In order for an estate to be a graduated rate estate (“GRE”), it must satisfy all the requirements in the s. 248(1) GRE definition including para. (d), which requires that the estate designates itself as the GRE of the deceased individual in its Part I return for its first taxation year ending after 2015.
This requirement would be satisfied where the designation is made in the tax return for the estate in the estate’s first taxation year ending after 2015 in which it is required to file a Canadian tax return under Part I.
For example, where a non-resident individual died in 2016, and the estate (a trust) becomes resident in Canada on January 1, 2018, there are no facts to suggest that the trust should file a Canadian tax return before 2018, and all the requirements can be satisfied for the estate to be a GRE. Accordingly, the estate could designate itself to be a GRE of the individual when it files its 2018 Canadian tax return.
As for (b) of the question, para. (c) of the GRE definition requires an individual’s SIN to be provided on the estate’s income tax return each year or, if the individual had not been assigned a SIN before death, such other information as is acceptable to the Minister.
If the individual did not have a SIN, the Minister would accept a temporary tax number, or an individual tax number, which can be obtained by filing a T1261.
Q.10: Non-resident estate as GRE
An individual who was a U.S. citizen and resident in the U.S. throughout their life owned real estate in Canada at the time of their death. The individual had never worked in Canada and as such did not have a Social Insurance Number (“SIN”). Assume that the executor of the estate is resident in the U.S. and all decisions related to the estate are made in the U.S. such that the estate is factually resident in the U.S. The executor filed a T1 return for the deceased, reporting a capital gain in respect of the deemed disposition of the real property at death. The executor anticipates that the estate will also realize a gain on the disposition of the property.
Does the requirement for a SIN or “such other information as is acceptable” in paragraph (c) of the definition of a Graduated Rate Estate (“GRE”) in subsection 248(1) preclude an estate from meeting the definition of a GRE in its first taxation year where the deceased person is a non- resident? Can a non-resident estate be a GRE, and if yes, what would the CRA consider as “such other information as is acceptable” to meet the requirement in paragraph (c) of the definition of a GRE?
The definition of “graduated rate estate” in s. 248(1) does not require an estate to be resident in Canada, nor does it require the deceased individual to have been a resident in Canada before death. Instead, the requirement in para. (c) is to provide the SIN of the deceased, or other acceptable information, allowing CRA to ensure that only one graduated rate estate designation is made for each deceased individual.
In this situation, if a deceased individual did not have a SIN, the estate could provide a temporary tax number or an individual tax number.
Q.11: Continuation of GRE as QDT
Consider a situation in which an individual’s will provides that the residue of their estate is bequeathed to a single beneficiary. Assume that for the first 36 months of the estate it qualifies as a graduated rate estate (GRE) and the appropriate GRE designations are made in the estate’s T3 returns. The nature of some of the property of the estate is such that it is not converted into cash until late in the third year after the individual’s death.
During the 36 month GRE period, the beneficiary becomes disabled such that they are eligible to claim the disability tax credit for the foreseeable future. Can the estate continue indefinitely and elect to be treated as a qualified disability trust each year such that the graduated tax rates will continue to apply?
It would be difficult to make that argument.
Where an estate and a particular beneficiary meet the requirements of the definition of “qualified disability trust” in s. 122(3), the estate can be a QDT. The fact that the estate made a GRE designation in the earlier years does not impact this whatsoever.
However, the administration of an estate includes collecting the deceased’s assets, paying the deceased’s debts including taxes, and distributing the residue of the estate to the beneficiaries specified under the will (or pursuant to provincial intestacy laws). Although it may depend on the particular laws or the will instrument, the estate administration typically does not include the ongoing management of assets that have been bequeathed to a particular individual.
In this scenario, there is nothing to indicate that there is anything preventing the executor from paying the residue of the estate to the beneficiaries. As a result, it is difficult to argue that the administration of the estate could be extended indefinitely. Thus, if the particular facts and law suggest that the estate administration is complete, and beneficial ownership has passed to the residuary beneficiaries who are entitled to the property, there would be no income earned in the estate.
Alternatively, to the extent that the beneficiary was able to enforce payment of the income earned within the estate, there would be no income taxable in the estate, as it would all be considered to be payable to the beneficiary under s. 104(13), consistently with s. 104(24).
Q.12: Attribution under s. 75(2)
Income attribution rules, generally speaking, operate so that income of one person (the actual recipient of the income) is attributed to and becomes income of another person (the transferor). Section 74.1 (and other provisions) use this type of language. However, subsection 75(2) does not employ this language. Under subsection 75(2), income is considered to be the income of another taxpayer (the contributor of property to the trust) without explicitly stating that the income is removed from the trust itself.
Whether or not income which is subject to subsection 75(2) is first and foremost income of the trust itself can be significant for the following reasons:
i. How the trust return is prepared; or
ii. Whether or not a liability for alternative minimum tax could arise (if the income is removed from the trust by way of deduction at line 471 of the T3 Return)
The treatment of income where subsection 75(2) applies was considered in the case of Fiducie Financiere Satoma v Canada (“Satoma”; 2018 DTC 5052, Federal Court of Appeal “FCA”). There it was concluded that the dividend income attributed under subsection 75(2) was not income of the trust.
In light of the comments made in the judgment concerning how subsection 75(2) operates, does CRA now accept that income (and capital gains) subject to subsection 75(2) is never income of the trust in the first place? If so, would it be appropriate to simply omit from the trust return the income which is subject to subsection 75(2)? Further, does the CRA now agree that there would be no need to prepare a T3 slip for the attributed income as the CRA’s administrative position currently requires?
The trust in Satoma was reassessed under GAAR, which was confirmed by the Tax Court and Federal Court of Appeal. A series of transactions was undertaken to ensure that s. 75(2) applied to the Trust, such that dividend income received by the trust would be attributed to the corporation – which was then able to claim a deduction under s. 112(1), so that the income was taxed to neither the trust nor the corporation.
The question appears to reference some comments in the Satoma case in and around paras. 33-37, and para. 53 of the FCA decision. In particular, Noël CJ. (at para. 35) referred to the Tax Court decision, which considered whether the wording of s. 75(2) supported the exclusion of the dividends from Satoma Trust’s income. In comparison to other attribution provisions, e.g. s. 74.1, which specifically provide that, where income is also deemed to be income of the taxpayer, it is deemed not to be income of another person, Noël CJ. noted that s. 75(2) is silent in this regard, and also regarding the exclusion provided in other attribution provisions.
However, Noël CJ. also noted express exclusions of this type are inserted for greater certainty. He also noted that, in respect of dividend income, s. 82(2) further provides that, where a dividend is attributed to another person, pursuant to s. 75(2), that person is also deemed to receive it. He concluded by noting that the same dividend cannot be received by two persons at once.
While these comments in Satoma are acknowledged, they are not specifically directed at trust return reporting. The T3 return is an information return in addition to being a return of income. It serves to report information about the trust itself, but also information that affects the taxation of persons who happen to have some connection to the trust – beneficiaries, settlors, and contributors.
CRA’s longstanding position for a trust holding property subject to s. 75(2) is that s. 204 of the Regulations imposes a requirement to file a T3 return where the trustee has control of, or receives, income, gains, or profits in the trustee’s fiduciary capacity – even if the Trust computes nil income. This includes circumstances where the trust has no income because of the application of s. 75(2), and that income is recognized as income of someone else.
This is noted in several CRA documents, including previous STEP Roundtable answers in 2006, 2016, and 2017.
The requirement to report income in this manner ensures the proper administration of the tax system, including the assessment of tax payable of the settlor or contributor of the property. Also, p. 45 of last year’s T3 guide notes:
Certain related amounts, including taxable capital gains and allowable capital losses from that property or the substituted property, are considered to belong to the contributor during the contributor's life or existence while a resident of Canada. The trust must still report the amount on the trust's T3 return and issue a T3 slip reporting the amount as that of the contributor of the property.
Q.13: Preferred beneficiary distributions as TOSI
The preferred beneficiary election is made jointly by a trust and a preferred beneficiary pursuant to subsection 104(14). The term “preferred beneficiary” is defined in subsection 108(1) to be an individual resident in Canada who is a beneficiary of a trust who has either a severe and prolonged impairment in physical or mental functions that qualifies for the disability amount, or, if at least age 18, is dependent on another individual because of mental or physical infirmity and whose income does not exceed an amount referenced to the basic personal tax credit for single status. In addition, the individual must be a settlor of the trust, a spouse, common law partner or former spouse or common law partner of the settlor, or a child, grandchild or great grandchild of the settlor, or the spouse or common law partner of such person.
The preferred beneficiary election allows the trust to “allocate” income of the trust to the preferred beneficiary, whereupon the trust can take a deduction and the amount is included in the income of the preferred beneficiary.
The question is whether an amount included in a beneficiary’s income under a preferred beneficiary election is split income or not under paragraph (c) of the definition of “split income” in the TOSI rules. Paragraph (c) refers to an amount included in a beneficiary’s income because of the application of subsection 104(13) or 105(2) and does not refer to the preferred beneficiary election where the designated amount is included in the beneficiary’s income pursuant to subsection 104(14).
Para. (c) of the definition of “split income” includes the portion of certain amounts that are included in the income of an individual because of the application of ss. 104(13) and 105(2).
Because the amount of income that is designated under the preferred beneficiary election is included in the individual’s income under s. 104(14) and not because of the application of s. 104(13) or 105(2), para. (c) of the “split income” definition is not applicable to this amount.
That being said, subpara. (a)(i) of the definition provides for the inclusion of taxable dividends received by the specified individual in respect of the shares of the corporation, other than shares of a class listed on a designated stock exchange or shares of a mutual fund corporation.
If the income allocated to a preferred beneficiary is also subject to a s. 104(19) designation, the amount designated is deemed to be a taxable dividend received by the preferred beneficiary on those shares for all purposes of the Act except for Part XIII. The result is that any amount that is designated under s. 104(19) would be included in the split income of the specified individual, unless one of the exceptions applies.
Q.14: TOSI treatment of s. 104(19) dividend to preferred beneficiary
In the Summary portion of Technical Interpretation 2018-0759521E5, the CRA indicated that if a designation under subsection 104(19) is made in respect of a preferred beneficiary income amount resulting from an election under subsection 104(14), the amount would be includable in the definition of “split income” by virtue of paragraph (a) of that definition. However, the CRA did not provide any explanation for this statement in the body of the External Interpretation document. By referring only to trust income under subsections 104(13) and 105(2) in paragraph (c) of the split income definition, it appears to us that the provision was deliberately drafted to exclude a preferred beneficiary elected income amount, and this has been the case since the introduction of the kiddie tax rules in 2000. We submit that it was always common practice to make the subsection 104(19) designation in respect of any dividend income allocation made under a preferred beneficiary election to allow the beneficiary to access the gross-up and dividend tax credit regime, and in fact, all major tax return preparation software automatically preserve dividend characterization (in effect making the subsection 104(19) designation) whenever a trust receives dividend income that is allocated to a preferred beneficiary. Can the CRA (i) elaborate on its reasoning behind its comment regarding subsection 104(19) in Technical Interpretation 2018- 075952 1E5, (ii) confirm its position on this matter for minor preferred beneficiaries for years prior to 2018, (iii) provide guidance on how a T3 return and slip should be prepared to avoid a subsection 104(19) designation when allocating a taxable dividend to a preferred beneficiary, and (iv) consider granting relief for all historical preferred beneficiary elections made?
The facts in 2018-0759521E5 did not involve dividend income received by the trust that made the preferred beneficiary election, so that it did not address the allocation of dividend income to a preferred beneficiary. Instead, the response noted that the amount included in the income of the preferred beneficiary was not split income, because of para. (c) of the definition of “split income.”
The exception to this rule, for a designation made under s. 104(19) in respect of taxable dividends was included in the summary header of the technical interpretation. The rationale for including it was for the same reasons given in Q.13 above.
There is no legislative exclusion for tax on split income for dividends designated under s. 104(19).
This is not a new interpretation – it is consistent with 2000-0056385 F. It has also been noted in the T3 guide every year since 2000 (page 44 of the 2018 guide).
In order to avoid making the s. 104(19) designation when preparing a T3 slip, the amount should simply be included in Box 26 (“other income”).
This issue has been discussed with the Department of Finance, and CRA’s interpretation on this matter is consistent with tax policy, so that CRA will not be granting relief for any historical preferred beneficiary elections made.
Q.15: CPP/EI Rulings
Many small businesses hire “contractors” to assist in the day-to-day business operations. It is a question of fact whether the CRA considers such “contractors” to be employees or self-employed workers. Accordingly, in order to reduce withholding risks, many small business owners request a ruling from CPP/El to ensure proper treatment. However, some STEP members have recently become aware that the CRA has an internal policy of conducting a trust account examination (for example payroll and GST HST remittance accounts), after a ruling determination. This trust examination can result in additional ruling requests along with additional payroll taxes, interest and penalties, and the possibility of additional professional fees associated with representations to the CRA. Can the CRA confirm that it is indeed their internal policy to review trust accounts of the payer after a CPP/EI ruling has been completed?
A CPP/EI ruling is an official decision that confirms whether a worker is an employee or self-employed, and whether the work is pensionable or insurable for the purposes of the CPP/EI Act. A payor can ask the CPP for a ruling if it is unsure whether it should deduct contributions or premiums. A worker can also request a ruling.
When the CPP/EI Rulings Division receives a ruling request from a payor or a worker, it does not automatically send a referral to the Collections and Verification Branch. A referral is sent in specific situations for the purpose of ensuring employer compliance with CPP and EI contribution and premium requirements. Such a referral would be made where, for example:
- the ruling changed the employment status of the worker from self-employed to employed or vice-versa;
- after examining all the circumstances of a worker who is related to the employer, the CRA determines that they were dealing at arm’s length and the employment was insurable, but the employer did not remit premiums for the worker; or
- the ruling confirms that there was an employer/employee relationship but no source deductions were made, and the payor had not recorded the wages or issued T4 slips.
When the Collections and Verification Branch receives a referral from the CPP/EI Rulings Division for a completed ruling, the employer account is assigned for examination, and the examination officer will contact the employer and make an appointment in order to validate that the employer has deducted and remitted the required CPP or EI for the employee for the period stated in the ruling.
The officer will also review the GST/HST account on the CRA database to ensure that there are no outstanding items. If the GST account is non-compliant, the officer will examine the employer’s payroll and GST/HST files.
Q.16: Small Business Deduction and Passive Income
Effective for taxation years beginning in 2019, the amount that can be claimed under the small business deduction will be reduced if investment income (adjusted aggregate investment income) of the corporation and associated corporations for taxation years ending in the preceding calendar year exceeds $50,000.
An anti-avoidance rule (subsection 125(5.2)) deems corporations which are related but not associated to be associated for the purposes of this rule where it may reasonably be considered that one of the reasons for a loan or transfer was to reduce investment income and increase the amount which can be claimed under the small business deduction.
Assume that a corporation (Opco) is owned by five corporations (Holdco 1 through Holdco 5). All corporations are related to one another but not associated.
Opco has established a pattern in the past of paying dividends equal to substantially all of its annual income. The Holdco’s have built up large amounts of investment funds.
In these circumstances, would CRA generally accept that the anti-avoidance rule in subsection 125(5.2) would not apply if Opco continues its practice of paying annual dividends?
This anti-avoidance provision also specifies that these transfers include transfers via a trust. There are conceivably numerous situations in which a taxpayer may want to transfer property to a trust or entities controlled by a trust for estate planning reasons unrelated to the SBD.
Can the CRA please provide guidance on how CRA plans to enforce this rule for the large number of transfers to trusts which may result in a dissociation of assets previously held in a corporation and a reduction in AAII?
The anti-avoidance rule in 125(5.2) applies to a loan or transfer of property between corporations that are related but not associated, and deems the two corporations to be associated. It applies where the corporations are related to each other, one corporation directly or indirectly transfers assets to the other corporation, and one of the reasons for the transfer can reasonably be considered to be to reduce the amount of adjusted aggregate investment income of the associated group for the purposes of the passive income reduction rule in s. 125(5.1)(b).
Whether s. 125(5.2) applies in any given situation remains a question of fact.
It could also apply in the case of a transfer to a trust.
Q.17: FATCA stats
Can the CRA provide recent statistical data with respect to data that it is required to collect and transmit to the US IRS pursuant to Part XVIII of the Act and the Inter-Governmental Agreement between the US and Canada? For example, how many accounts’ information was transmitted during the last transmission period? Has the US requested any further information in respect of any of the transmitted data?
As of 1 April 2019, CRA has sent over 700,000 records to the IRS under the Canada-US IGA for the 2017 taxation year. However, other than standard automated notifications to identify file- and record-level errors, no further information has been requested by the US in respect of this data.
Q.18: Update re DTS
The Canada Revenue Agency (CRA) launched a new dedicated telephone service for income tax service providers in July of 2017. Service providers are accountants and other professionals (such as bookkeepers and lawyers) who provide general audit, accounting, tax, and other advisory services to individuals and businesses. In the previous 2018 STEP Roundtable update, the CRA indicated that if the pilot was successful, it would consider expanding the DTS nationwide and to more income tax service providers on a permanent basis.
Can the CRA provide an update on the status of the DTS pilot project?
When the dedicated telephone service pilot was initially launched, the service was offered to eligible CPAs in Ontario and Quebec, and then quickly expanded to include CPAs in Manitoba and New Brunswick. Last year, the service was further expanded to include all non-CPA service providers in Ontario, Quebec, Manitoba, and New Brunswick.
In January of this year, the dedicated telephone service was expanded to include all small- and medium-sized income tax service providers across Canada. More than 4000 service-providers were registered and had access to the service in time for this year’s personal tax busy-season.
The feedback has been very positive, with the overwhelming majority of the users strongly agreeing that they were satisfied with the information and service being provided. Based on the success of the pilot, and the reception of the service by the tax community, the government announced in the 2019 Budget that it would provide ongoing funding to make the dedicated telephone service a permanent program.
Currently, preparations are underway to transition the pilot into a permanent program. That includes establishing new performance objectives, as well as formulating strategies to enhance and build new relationships with industry partners and associations.
Any income tax service providers who are not already registered, and are interested in registering, should go to the DTS page on the CRA website for more information on revised eligibility criteria and on how to register.