15 June 2021 STEP Roundtable
This sets out the questions that were posed, and provides summaries of the responses given, at the 2021 STEP CRA Roundtable, which was held as a webinar on June 15, 2021. Various of the titles shown are our own. The webinar was hosted by: Michael Cadesky, FCPA, FCA, FTIHK, CTA, TEP, Toronto: Cadesky Tax; and Kim G.C. Moody, FCPA, FCA, TEP, Calgary: Moodys Tax Law LLP.
Steve Fron, CPA, CA, TEP, Oshawa: Manager, Trust Section Il, Income Tax Rulings Directorate, Canada Revenue Agency;
Marina Panourgias, CPA, CA, TEP, Toronto: Manager, Trust Section I, Income Tax Rulings Directorate, Canada Revenue Agency
CRA released its written responses on July 7, 2021 and, in due course, will be issuing those responses with its own summaries under its severed letter program.
Q.1 - Security for trust departure tax
If a Canadian resident inter vivos personal trust becomes a non-resident of Canada (because its central management and control has shifted to somewhere outside of Canada), this would cause the provisions of subsection 128.1(4) of the Act to apply. If the trust does not have liquidity to pay its “departure tax”, its trustee(s) would likely seek to defer the amount owing by providing security pursuant to the provisions of subsections 220(4.5) – (4.54) (noting that the relief provided for in subsection 220(4.51) does not apply to a trust).
a) From an administrative perspective, could the CRA provide its general comments on how it deals with security issues with a trust vs an individual?
b) Because a Letter of Credit or a Letter of Guarantee carries a high continuing maintenance cost which results in these being impractical for most taxpayers, would the CRA consider a secured line of credit that it can draw on as adequate security?
Fron: This response was prepared by the Collections and Verification Branch.
(a) - How does CRA deal with security issues with a trust vs. an individual?
Fron: In general, there is no practical difference in the CRA’s handling of departure tax security for an individual taxpayer or a trust, because the adequacy of security is primarily determined based on the merits of the security itself and not on the party providing it. The required terms for security agreements are also based on the nature of the security provided and do not typically differ for trusts and individual taxpayers.
(b) - Would CRA consider a secured line of credit that it can draw on as adequate security?
Fron: Generally not.
There are several key differences between letters of credit or guarantee, and lines of credit, whether secured or otherwise, which affect their respective acceptability as security.
Several fundamental features of credit or letters or guarantee make then particularly suitable as security for departure tax. For example, they are irrevocable and they unconditionally guarantee payment to a single beneficiary, the CRA, for the entire time that they are in effect. While the lender retains the right to cancel the letter, the prescribed manner in which this can be done allows the CRA a reasonable opportunity to realize payment from the letter should the taxpayer be unable to provide replacement security or payment by alternate means.
Unlike letters of credit or guarantee, lines of credit are typically subject to numerous conditions that diminish their suitability as security. For example, lines of credit can generally be reduced, cancelled or limited at the lender’s discretion, without advance notice to the borrower, even when the lines are secured. Lines of credit do not typically allow third parties, i.e. the CRA, to draw upon the credit while at the same time denying the borrower, the taxpayer or the third party guarantor, the ability to do the same. Such provisions qualify the reliability of a line of credit to guarantee future payment.
Because of these differences, the CRA would not normally consider a line of credit to be adequate security given that the purpose of security is to guarantee future payment within an acceptable margin of certainty.
Letters of credit or guarantee are not the only forms of security that the CRA generally considers to be acceptable, but it is recommended that taxpayers contact the CRA as soon as possible before the security due date to discuss the various security options available. There are two telephone numbers: one if you are within North America (and the migration election team needs to be contacted), and one for calls originating outside of North America. The North America number is 1-877-301-3131.
Q.2 - None-of-the-reasons test for an “arm’s length transfer”
Section 94 of the Act is a provision designed to prevent the avoidance of tax on income which would otherwise be taxable in Canada, through the use of non-resident trusts. In general, if a Canadian resident contributes property to a non-resident trust (other than an “exempt foreign trust” as defined in subsection 94(1)), the trust is deemed under paragraph 94(3)(a) to be resident in Canada for a number of purposes. In addition, the contributor (other than an “electing contributor”) to the trust and certain Canadian-resident beneficiaries of the trust may all become jointly and severally, or solidarily, liable to pay Canadian tax on the income of the trust.
Consider a situation in which a resident of Canada (“Father”) makes a loan to a factually non-resident trust (“the Trust”) six months after the settlement of the Trust. The terms of the loan, including the interest rate, are consistent with the terms of a demand loan between arm’s length parties.
We note that the October 2012 Department of Finance Explanatory Notes state:
Thus, for example, if any person receives a beneficial interest in a non-resident trust as a result of a particular transfer or loan of property or if it is reasonable to conclude that one of the reasons for the transfer was to facilitate the acquisition of such an interest, the transfer will not be an arm's length transfer.
Would CRA consider Father’s loan to the Trust to be an “arm’s length transfer” as defined by subsection 94(1), particularly when no trust beneficiary acquires an interest under the Trust as a result of this loan?
Consider the following facts:
- The settlor is, and has always been a non-resident;
- To date, the settlor is the only contributor to the Trust;
- The trustee (who is not the settlor, Father or a beneficiary) is a non-resident;
- The central management and control of the trust rests with, and is exercised by the trustee;
- The only beneficiaries of the Trust are the two children of Father. Both children are resident in Canada, and both were named beneficiaries in the trust deed when the Trust was settled;
- Father has always been resident in Canada; and
- Father and the trustee entered into an enforceable contract regarding the terms and conditions of the loan.
Fron: To determine whether a father is a resident contributor, we must determine whether he made a contribution. An arm’s length transfer is not a contribution, so the question turns on whether we have an arm’s length transfer as defined in s. 94(1).
The definition of “arm’s length transfer” contains two paragraphs, and para. (b) is not relevant to these facts. Para. (a) states that “it is reasonable to conclude that none of the reasons (...) for the transfer is the acquisition at any time by any person or partnership of an interest as a beneficiary under a non-resident trust”. (I will address the parenthetical portion of para. (a) later.)
In our view, the wording of paragraph (a) does not support the interpretation that the test is that the beneficiary’s interest must be acquired as a result of the particular transfer being considered.
The use of the term “reason” over “purpose” or “result” in this paragraph creates a broader, more restrictive test. The word “reason” as used here implies a motive or justification for the transfer. Put differently, the issue is not whether the transfer causes a person or partnership to receive an interest in the trust, but rather that the beneficiary’s existing or future interest motivates the transfer, or its making. In our view, this definition aims to ensure there is no connection between the transfer, and the person or partnership that already has an interest in the non-resident trust, or would have such an interest in the future. Where this is the case, para. (a) fails and the loan or transfer is not an arm’s length transfer.
Regarding Father’s situation described in the question, although the terms of the loan are commensurate to what an arm’s length lender and borrower would agree on, for paragraph (a) to be satisfied, it must be reasonable to conclude that none of the reasons why Father made the loan to the trust is the fact that his children are beneficiaries under the trust.
Returning to the parenthetical part of para. (a), this particular question of fact is not likely to satisfy para. (a).
A conclusion that Father has made an arm’s length transfer is highly unlikely given the relationship between Father and his children. Therefore, Father will be considered to have made a contribution to the trust, he will be a contributor, and therefore a resident contributor and, pursuant to s. 94(3)(a), the trust will be deemed to be resident in Canada for the purposes outlined in that provision.
Q.3 - Reasonable return on promissory note issued by family trust
A family trust can distribute its income to a beneficiary by making an amount payable in the year to the beneficiary, provided the beneficiary is entitled in the year to enforce payment of it (as per the requirements of subsection 104(24) of the Act). If the amount payable to the beneficiary is in the form of an interest bearing promissory note owing to the beneficiary, the beneficiary will report interest income for each year the promissory note remains outstanding. Assuming the beneficiary is not a minor and has not performed any work, has not contributed any property or assumed any risk with respect to any related business owned directly or indirectly by the trust, would the beneficiary be able to rely on the “reasonable return” exception in either subparagraph (f)(ii) or (g)(ii) of the definition of “excluded amount” in subsection 120.4(1) if the interest rate is equivalent to an interest rate that would have been charged between parties dealing at arm’s length with each other?
Panourgias: In this answer, all terms, including “split income”, have the meaning assigned by s. 120.4(1).
For income that is being distributed from the trust to the beneficiary of the trust, the fact that the income is distributed by way of a promissory note does not have any impact on whether the distributed amount would be considered to be split income of the individual. Where the beneficiary is a specified individual, it must be determined whether the amount distributed is split income. In this situation, the amount distributed would presumably be split income, and would be subject to the tax on split income unless it is an excluded amount.
Regarding the interest income earned on the promissory note, paragraph (d) of the definition of “split income” includes an amount that is included in computing the individual’s income for the year to the extent that the amounts is in respect of a debt obligation of a trust, with certain exceptions.
We have assumed that the interest on the promissory note will be funded by operations of a related business in respect of the beneficiary. In this situation, the interest income paid to the beneficiary by the trust will be split income of the beneficiary and will be subject to TOSI unless it is an excluded amount.
The question asks whether the beneficiary would be able to rely on subparagraphs (f)(ii) or (g)(ii) of the definition of “excluded amount.” The interest income does not appear to qualify as an excluded amount under subparagraph (f)(ii) since the note does not appear to be arm’s length capital as that term is defined, but consideration should be given to the reasonable return exceptions in subparagraph (g)(ii) if the beneficiary is 24 years old before the particular year.
In a situation where the individual has not assumed any risk, whether an arm’s length rate of interest charged is a reasonable return is a mixed question of fact and law that can only be determined after a review of all of the facts and circumstances applicable in a particular situation.
In determining whether something constitutes a reasonable return, the CRA does not intend to generally substitute its judgment about what would be considered a reasonable amount where the taxpayer has made a good faith attempt to do so based on the reasonableness factors set out in the definition of “reasonable return."
Q.4 - TOSI re dividends from rental company
Tom, Dick and Harry are brothers and Canadian residents. Many years ago they pooled their savings and incorporated TDH Co, a Canadian private corporation. Each owns 1/3 of the issued shares of the corporation. TDH Co owns three rental properties known as T, D and H. Each have equal value. The brothers live primarily on the dividend income of TDH Co and receive around $100,000 per year each. The brothers have never been active in managing TDH Co, which engages an outside arm’s length property management company to manage the properties. The initial capital was repaid many years ago.
a) Does the CRA agree that dividends received by Tom, Dick and Harry are subject to TOSI?
b) If a butterfly reorganization was done to split the corporation into 3 equal parts where Tom, via a corporation owned T, Dick via a corporation owned D, and Harry via a corporation owned H, would dividends received by Tom, Dick and Harry, as the case may be, thereafter be subject to TOSI?
Panourgias: As with Q.3, terms in this response have the meaning assigned by s. 120.4(1).
We assume that each of Tom, Dick and Harry are at least 25 years old and own shares of TDH that give each of them 10% or more of the votes and fair market value of all of the issued and outstanding shares of the corporation.
(a) - Subject to TOSI?
Panourgias: If the shares of TDH are excluded shares, any dividends paid on those shares would be an excluded amount and would not be subject to TOSI. The CRA has previously commented on whether shares of a corporation that derives its income from the rental of real property would constitute “excluded shares” in a situation where the rental operations do not constitute a business. For example, in our response to 2018 CTF Q.10, we indicated that, where the level of activity in a corporation was enough to constitute a business, and the other conditions in the excluded share definition were met, those shares would be excluded shares. Conversely, if there were an insufficient level of activity to constitute a business, the shares of the corporation would not be excluded shares.
In this scenario, assuming the level of activity in TDH is sufficient to constitute a business carried on by TDH, which is a question of fact, the shares of TDH would appear to qualify as excluded shares. However, if it is determined that TDH does not carry on a business, the excluded share exception would not apply, and any taxable dividends received from TDH would be subject to TOSI unless another exception applied. In this case, subparagraph (e)(i) of the definition of excluded amount would apply to prevent the taxable dividend from being subject to TOSI, provided the dividends are not derived directly or indirectly from a related business in respect of the individual for the year.
(b) - Butterfly reorganization
Panourgias: In this scenario, Tom, Dick and Harry undertake a split-up butterfly reorganization, so that each of them through a holding company will indirectly own a particular rental property that was formerly owned by TDH.
Our analysis in this scenario is similar to scenario (a), notwithstanding the change in ownership structure.
Q.5 - Income attribution from alter ego trust
A taxpayer settles an alter ego trust and contributes property to the trust. In general, the income of an alter ego trust attributes to the settlor because subsection 75(2) of the Act applies to the trust.
Are there any exceptions to this (i.e. types of income that would not attribute)? For example, consider the following independent scenarios:
a) The property transferred is an interest in a limited partnership and the trust is allocated business income.
b) The trust realizes a capital gain, reinvests the proceeds and realizes another capital gain.
c) The trust earns income, reinvests the income and earns income on the reinvestment (second generation income).
For each scenario above, could the CRA comment on the possible application of subsection 75(2) to that type of income.
Fron: First, some background: generally s. 75(2) will apply to a trust that holds property on condition (a) that the property or property substituted for it will either revert to the person from whom the property or property for which it was substituted was directly or indirectly received, pass to persons to be determined by the contributor at a time subsequent to the creation of the trust; or (b) that, during the existence of the contributor, the property not be disposed of except with that person’s consent or in accordance with that person’s direction.
If any of these conditions are met, any income or loss from the property or from property substituted for the property, and any taxable capital gain or allowable capital loss from the disposition of the property or from property substituted for the property, is attributed to the contributor or to the settlor while they are alive and are resident in Canada.
(a) - Property is LP interest generating business income
Fron: Pursuant to ss. 96(1)(f) and (g), the amount of any income or loss of a partnership for a taxation year from any source or sources in a particular place is generally considered to be the member’s income or loss from that source or sources in the particular place for the taxation year in which the partnership taxation year ends to the extent of the member’s share thereof. Whether the income or loss of a partnership is from a source that is business or from a source that is property or from another source is a question of fact. Where the partnerships allocates its income and losses to the partners, the income or losses keep their source identity.
The business income or loss that is allocated to the trust from the limited partnership will not be attributed to the settlor on the basis that s. 75(2) does not attribute business income. However, it is important to take note that, in respect of an alter ego trust, the settlor must be entitled to receive all of the income of the trust that arises before their death, and no other person may, before the settlor’s death, receive or otherwise obtain the use of any income or capital of the trust.
Therefore, the business income that is not attributed, but is earned by the trust, will be generally included in the settlor’s income under s. 104(13). S. 108(5) provides that, except as otherwise provided in Part 1, an amount included in the income of a beneficiary under s. 104(13) shall be deemed to be income of the beneficiary from a property that is an interest in a trust and not from any other source. Therefore, the business income allocated by the partnership will be treated as property income in the settlor’s hands.
If the partnership earned income from property and, in accordance with the partnership agreement, the trust has allocated such property income, s. 75(2) will apply such that the income will be attributed to the settlor.
If the attributed property income is a dividend, then s. 82(2) should apply such that the dividend shall be deemed to have been received by the settlor. Therefore, when the partnership allocates dividend income to the trust and s. 75(2) applies, the dividend will retain its character.
(b) - Trust realizes further gain with reinvested capital gain
Fron: This question deals with the disposition and then a reinvestment of the proceeds of disposition.
Pursuant to s. 248(5), where a trust has disposed of a particular property and reacquired another property in substitution therefor and subsequently by one or more further transactions has effected one or more further substitutions, the property acquired by any such transaction is deemed to have been substituted for the particular property.
The proceeds received in respect of the disposition of a property of a trust would be considered substituted property. Similarly, if the proceeds were then reinvested in securities, the securities would also be considered substituted property, such that any income or loss from the securities, and any taxable capital gain or allowable capital loss resulting from the disposition of the securities, would also be attributed to the settlor or to the contributor of the original property.
The attribution will continue to apply if the securities are then repeatedly sold and reinvested in other securities. The corresponding proceeds of disposition and other securities would continue to be substituted property pursuant to s. 248(5).
(c) - Trust earns income, reinvests, and earns further income
Fron: Where a trust earns income from a property contributed by a person or a property substituted therefor, and reinvests that income, any income or loss derived from the reinvestment of the earnings (the "second generation income") would not be attributed to that person. S. 75(2) does not apply to second generation income as this income is not earned on property contributed to the trust.
For example, to continue on with the situation in part (b), the income earned on the securities, which are substituted property, is attributed pursuant to s. 75(2) as it is first-generation income.
However, any income earned on that income will not be attributed. Second-generation income will be taxed in the trust, to the extent that it is not paid or payable to the beneficiaries of the trust in the trust’s taxation year.
However, again, in the context of an alter ego trust, as we saw in the first example with the business income, we would expect the second generation income earned in the trust to be payable to the beneficiary under s. 104(13). We then go through the same mechanics, under which s. 108(5) will generally apply to the income included in the beneficiary’s hands unless the income is of a particular nature for which the trust can make a designation, for example under 104(19) in respect of a dividend, or under s. 104(21).
Q.6 - Vested indefeasibly
A trust in which all interests have vested indefeasibly is excluded from the scope of the 21-year deemed disposition rule in paragraph 104(4)(b) of the Act. This result arises from the definition of “trust” in subsection 108(1) of the Act. It is noted that other conditions apply under paragraph (g) of that definition, such that in order for a trust to qualify for the exclusion, the trust cannot be described in subparagraphs (g)(i) to (vi) of the definition of “trust” - for example, subparagraph (iv) stipulates that not more that 20% of the total value of all interests of a trust that is resident in Canada may be held by non-resident beneficiaries.
a) Can the CRA provide clarity as to what is required to meet the condition that all interests in the trust have vested indefeasibly?
b) How is this disclosed on the trust return for the trust?
c) What are the tax implications when a beneficiary resident in Canada holds an interest which has vested indefeasibly, and the beneficiary dies?
(a) - When are trust's interests vested indefeasibly?
Fron: Paragraph (g) of the definition of “trust” in s. 108(1) provides for a potential exception to the deemed disposition rules in s. 104(4) where all the interests of the trust at that time had vested indefeasibly. The Act does not define the term “vested indefeasibly”. Our response to 2018 STEP Q.9 (2018-0744111C6) provides useful guidance as to what is required in order for an interest in a trust to vest indefeasibly. The comments in our 2018 response continue to apply.
Ultimately, whether a trust would fall under the exclusion in paragraph (g) is a question of fact and law that requires reference to the applicable law, jurisprudence, the will or the trust agreement, and all other relevant documents and circumstances in respect of those interests. It is also a question of fact and law as to whether a trustee has the power within the terms of a trust to vest all interests indefeasibly.
Cancelled Interpretation Bulletin IT 449R (“Meaning of ‘Vested Indefeasibly’”) states that “vested indefeasibly” refers to the unassailable right to ownership of a particular property, and that such right cannot be defeated by any future event, even though that person may not be entitled to an immediate enjoyment of all the benefits arising from that right. Although the Bulletin dealt with provisions of the Act other than the definition of trust found in s. 108(1), we believe the same views apply.
For an interest in a trust to vest indefeasibly in a beneficiary of the trust, the situation must be one where the beneficiary can be ascertained and there is no condition precedent to the beneficiary holding such trust interest. Further, there must be no condition subsequent or possible future event or limitation that could revoke, limit or defeat the beneficiary’s interest in the trust. Where none of the exceptions in subparagraphs (g)(i) through (vi) apply, and it is clear in law that the interests have vested indefeasibly since inception, or where a trust gives the trustees the power to indefeasibly vest the interest in the trust and they lawfully do so before the 21st anniversary date specified in s. 104(4), the 21-year deemed disposition rule will not apply.
(b) - How is vesting reported on a T3?
Fron: The second question was, how do we disclose this on a return? The quick answer is that there is no place on the return to disclose it. The T3 return does not request information on whether all of a trust’s interests have vested indefeasibly and that, therefore, the trust qualifies for the exclusion.
We spoke to the people who handle CRA’s intake and assessment of the T3 returns, and they have seen a number of approaches from taxpayers. Sometimes, the taxpayer will provide a covering letter or a note on the top of the return explaining why there is no T1055 form being filed; the note might even just say that all interests have vested indefeasibly. Others file a blank T1055 along with such a note.
We will continue to confer with our colleagues in T3 Assessing and see whether there is any additional information they would want from taxpayers, or additional guidance to be provided in the T3 Guide, for situations like this.
(c) - What happens when a Canadian-resident with an indefeasibly vested interest dies?
Fron: A beneficiary holding an indefeasibly vested capital interest in a trust is deemed to have disposed of their capital interest for proceeds equal to the fair market value of the interest immediately before their death, pursuant to s. 70(5). S. 107.4(4) provides that the fair market value of the capital interest is deemed to be not less than the beneficiary’s pro rata share of the fair market value of the total net assets of the trust.
Q.7 - S. 107(2) re transfer to trust not named as beneficiary
A discretionary family trust, a personal trust resident in Canada, (the “Trust”) is settled by Mr. X. The beneficiaries of Trust are the children of Mr. X (the “Beneficiaries”). The trust agreement (the “Trust Agreement”) gives the trustees the power to distribute income or capital of the Trust to or for the benefit of the Beneficiaries. The Trust Agreement does not contemplate that a trust created for the benefit of the Beneficiaries could be added as a beneficiary nor does it provide that a trust for the benefit of the Beneficiaries is a beneficiary of Trust.
The trustees of Trust intend to distribute the property of Trust to a newly created trust (the “NewTrust”) which has been settled for the benefit of the Beneficiaries, on a tax deferred basis pursuant to subsection 107(2) of the Act. None of subsections 107(2.001), and (4) to (5) are applicable to deny the application of subsection 107(2) to any distributions from Trust.
Can the CRA confirm that subsection 107(2) will apply to the transfer of the property from Trust to NewTrust?
Panourgias: S. 107(2) generally applies where property is distributed by a personal trust to a beneficiary of the trust in satisfaction of all or part of that beneficiary’s capital interest in the trust – provided that certain exceptions are inapplicable, as is the case here.
Where s. 107(2) does apply, the trust is deemed to have disposed of the distributed property for its cost amount, and the beneficiary is generally deemed to have acquired the property for a cost equal to the same amount.
For the purposes of 107(2), the term “beneficiary” includes a person beneficially interested in the trust, and the term “beneficially interested” is defined in s. 248(25). Para. (a) of that definition provides: “a person or partnership beneficially interested in a particular trust includes any person or partnership that has any right ... as a beneficiary under a trust to receive any of the income or capital of the particular trust either directly from the particular trust or indirectly through one or more trusts or partnerships.” This means that the person having any right “as a beneficiary under the trust to receive any income or capital of the particular trust” must have that right as a beneficiary.
The term “beneficiary” is not defined in s. 248(25)(a), but CRA’s view is that it holds its ordinary meaning. That determination is dependent on the relevant facts and circumstances, which include the terms of the trust, as well as the relevant trust law.
In this situation, the trust agreement does not include a trust for the benefit of the children of Mr. X as a beneficiary, and does not contemplate any trust to be a future beneficiary. Therefore, it is our view that s. 107(2) would not apply on the transfer of property from Trust to New Trust, because New Trust is not the beneficiary of Trust for the purposes of s. 107(2).
Although s. 107(2) is not applicable to this situation, consideration could be given to whether s. 248(1) – “disposition” – (f) or s. 107.4(3) could apply to allow the property to be transferred on a tax-deferred basis. We have not considered the application of these provisions in this situation, but note that the determination of whether they could be applicable would require consideration of all the relevant facts and circumstances, including the terms and conditions that apply in respect of both Trust and New Trust.
Q.8 - Income Tax Rulings Directorate – Remissions
The fees charged by the CRA for providing an advance income tax ruling or a supplemental ruling (a Ruling), and a consultation in advance of a Ruling (a Pre-ruling Consultation), are governed by the Service Fees Act.
In accordance with section 7 of the Service Fees Act, a reduction of a fee (a remission) is required where the CRA considers that a service standard has not been met. Can the CRA describe how a remission will be determined with respect to the fees charged for Rulings and Pre-ruling Consultations?
Our connection was interrupted for part of this answer, which expanded slightly on CRA’s answer to IFA 2021 Q.9. Refer to the most recent version of IC 70-6 (currently IC 70-6R11) for up-to-date information on CRA’s service standard policies for technical interpretations and advance tax rulings.
Q.9 - Non-deductible expenses and safe income
CRA’s Income Tax Technical News No. 37 released in 2008 sets out the CRA’s position that non-deductible expenses must be deducted in computing safe income on hand. However, non-deductible expenses for purposes of the safe income on hand calculation are not explicitly defined. In addition, the phrase ‘non-deductible expenses’ is not defined within subsection 55(5) of the Act. Accordingly, can the CRA provide a definition of non-deductible expenses for the purposes of section 55?
Fron: For the response, “safe income” means the income earned or realized after 1971 and before the applicable safe income determination time, as determined under ss. 55(5)(b) and (c), and “safe income on hand” described safe income that can reasonably be considered to contribute to the capital gain on a share.
In their response, our colleagues in the Reorganizations Division, who crafted this answer, refer to a paper presented at the 1981 CTF Conference, containing the “Robertson rules,” which note that the non-deductible expenses are generally described as “any expense incurred, or disbursement made, that was not allowed or not claimed as a deduction in computing income.” They do not refer to an expense or disbursement made in respect of the acquisition of a property, or a repayment on account of the principal of a loan.
In ITTN No. 37, non-deductible expenses are generally described as cash outflows which are not deducted in the computation of a corporation’s net income for tax purposes, but still have the effect of reducing the amount of disposable after-tax income by an equivalent amount.
The position set out in the Robertson rules and ITTN No. 37 continue to reflect the CRA’s administrative position regarding non-deductible expenses that will reduce safe income in determining safe income on hand. Specifically, non-deductible expenses can be generally described as cash outflows which are not deducted in the computation of a corporation’s net income for tax purposes, other than an expense or disbursement made for the acquisition of property or for the repayment of the principal amount of a loan - and safe income should be reduced by such non-deductible expenses in order to determine the safe income on hand.
Some examples of non-deductible expenses include:
- dividend paid or payable;
- taxes, including refundable taxes;
- non-deductible interest and penalties;
- charitable donations, gifts and political donations that are not already deducted in net income for tax purposes; and
- the non-deductible portion of expenses or expenditures such as the non-deductible portion of meal and entertainment expenses.
In addition to the non-deductible expenses listed above, 2016-0672321C6 states that contingent liabilities and accounting reserves also need to be taken into account.
Q.10 - Timing of dividend refund where acquisition of control
The hypothetical fact situation is described as follows:
ACo, BCo and CCo are Canadian-controlled private corporations. All of the issued and outstanding shares of ACo are owned equally by BCo and CCo. BCo and CCo are not related under paragraph 251(2)(c), and deal at arm’s length with each other. Neither BCo nor CCo controls ACo. ACo’s taxation year ends on December 31 of each year.
At a particular time on November 1, 2020, ACo purchases for cancellation all of its shares owned by BCo for consideration that exceeds the aggregate paid-up capital of those shares, resulting in ACo being deemed to pay a dividend, as computed under subsection 84(3) (“Deemed Dividend”) at that time, to BCo.
ACo’s acquisition of its own shares owned by BCo results in CCo acquiring control of ACo (“the AOC”).
CCo’s AOC of ACo is a “loss restriction event” (as defined in subsection 251.2(2)). Unless ACo elects for it not to apply, subsection 256(9) will deem CCo to have acquired control of ACo at the beginning of November 1, 2020, and not at the particular time of CCo’s AOC of ACo on November 1, 2020, such that paragraph 249(4)(a) will deem ACo to have: (i) a deemed taxation year end immediately before the beginning of November 1, 2020, (i.e., the last moment of time on October 31, 2020), and (ii) a new taxation year commence at the beginning of November 1, 2020.
If an election is made for subsection 256(9) not to apply, paragraph 249(4)(a) will deem ACo to have: (i) a deemed taxation year end immediately before the particular time of the AOC on November 1, 2020; and (ii) a new taxation year commence at the particular time of the AOC on November 1, 2020.
ACo selects December 31, 2020 as the last day of its new taxation year (“New Taxation Year”) to coincide with its previous practice.
Assuming that ACo was entitled to receive a dividend refund as computed under paragraph 129(1)(a), with respect to the Deemed Dividend, can the CRA please confirm its position as to whether the dividend refund to ACo is for the taxation year deemed to end by paragraph 249(4)(a), or the New Taxation Year, in the situation both where ACo elects for subsection 256(9) to apply to the AOC and where it does not.
|Election Under Subsection 256(9)||No||Yes|
|Aco's deemed year end is||31 October 2020 (last moment||1 November 2020 (time of day immediately before redemption)|
|Dividend refund arises for ACo||?||?|
Fron: In each case, the deemed dividend that arises on ACo’s acquisition of its own shares would be considered to be paid by ACo in its new taxation year. The dividend refund to ACo with respect to the deemed dividend computed under s. 129(1)(a) would be for its new taxation year.
In other words, whether or not a s. 256(9) election is made, the "?" in the table above is “new taxation year.”
Q.11 - TFSA over-contribution where investment craters
A taxpayer moves to Canada in 2021 and opens a TFSA soon afterwards. Because he was previously non-resident, the taxpayer’s TFSA contribution room for 2021 is only $6,000. Due to a misunderstanding of the TFSA rules, the taxpayer contributes $18,000 to his TFSA and invests it all in shares of one company. Before he has a chance to withdraw the $12,000 over-contribution, the company goes bankrupt and the value of the TFSA goes to zero. How can the taxpayer stop the TFSA over-contribution tax or request a waiver of the tax under subsection 207.06(1) if he can no longer withdraw the over-contribution? Does he need to wait two years for new TFSA contribution room to open up?
Panourgias: Where an individual makes a contribution to a TFSA that exceeds their contribution limit, the individual would be subject to a 1% tax on the excess amount. The tax is calculated monthly based on the individual’s highest TFSA amount for that month, and the 1% tax continues to apply for each month that the excess amount remains.
Generally, an individual can correct an over-contribution and minimize the tax by making a withdrawal from their TFSA to reduce or eliminate the excess amount. In this situation, however, the individual is unable to withdraw any amount to reduce or eliminate the excess amount. Instead, the excess TFSA amount will only be reduced by new contribution limits as they become available in future years.
The potential waiver of tax in s. 207.06(1) requires, inter alia, that the individual withdraw an amount from their TFSA that is sufficient to eliminate both the excess TFSA amount and any associated income and capital gains. Again, in this situation, the individual cannot meet the conditions in this provision, and the Minister lacks the authority to waive or cancel any of the tax.
Assuming the individual makes no additional TFSA contributions, and the TFSA dollar limits are $6000 for each year, the excess TFSA amount will be reduced to $6000 on 1 January 2022, and fully eliminated on 1 January 2023. The individual is liable on that basis for the 1% tax in 2021 and 2022, and would need to complete form RC-243 and remit the tax for each of those years.
Q.12 - Contribution of co-owned property to joint spousal trust
Is it possible for spouses or common-law partners to jointly create a trust which meets the conditions set out in subparagraph 73(1.01)(c)(iii) of the Act with a contribution of property jointly-owned by the spouses or common-law partners? Further, is it possible for one or both spouses or common-law partners to make subsequent contributions to the trust on a tax-deferred basis with property that is owned jointly by the spouses or common law partners, and other property that is owned individually? Assume that both spouses or common-law partners have attained 65 years of age and are resident in Canada at all relevant times. Additionally, would paragraph 104(4)(a) apply in this particular situation?
Panourgias: If a trust is created by the contribution of jointly owned property by an individual and that individual’s spouse or common-law partner, and no other person, the trust would be considered to be created by both individuals for the purpose of s. 73(1.01).
As long as the trust was created by both individuals and nobody else, and the other conditions in ss. 73(1), (1.01), and (1.02) are met, a transfer of property to the trust after its creation by either spouse or common-law partner (or both spouses or partners) would be eligible for the rollover provided for in s. 73(1).
Regarding the application of s. 104(4)(a), for a joint spouse or common-law partner trust, this provision generally provides that the trust will be deemed to have disposed of certain properties on the death of the surviving spouse or common-law partner for proceeds equal to the fair market value of the property at that time, and the trust will be deemed to have re-acquired the property immediately after that time for the same amount.
This will generally result in the trust reporting any taxable capital gains in the year which the death of the surviving spouse or common-law partner occurs. Paragraph 104(13.4)(a) would also be applicable, and generally provides that the taxation year of the joint spousal or common-law partner trust is deemed to end at the end of the day of the death of the surviving spouse or common-law partner, which is the day of the deemed disposition, and a new taxation year is deemed to begin immediately after that day.
Q.13 - S. 104(13.4)(a) year end for an alter ego trust
Generally speaking, where the settlor of an alter ego trust dies, the trust is deemed to dispose of its capital property  at the end of the day of death, and to reacquire the property immediately after that day, pursuant to paragraph 104(4)(a) of the Act. Paragraph 104(13.4)(a) of the Act provides that on a death referred to in paragraph 104(4)(a), (a.1) or (a.4), the taxation year of the trust is deemed to end at the end of the day of death.
Does a deemed year end occur pursuant to 104(13.4)(a) where a trust that would otherwise be an alter ego trust makes an election under subparagraph 104(4)(a)(ii.1) to not have that subparagraph apply?
Fron: As noted in the question, the preamble to s. 104(13.4) considers the death of an individual that is the death or the later death, as the case may be, referred to in ss. 104(4)(a.1) or (a.4) - that is, you need a relevant death.
Subsection 248(1) defines an “alter ego trust” for the purposes of the Act, and the definition tells us to read s. 104(4)(a) without reference to certain other provisions. To paraphrase, a trust is an alter ego trust if it meets the conditions in ss. 104(4)(a)(ii.1) and 104(4)(a)(iv)(A). In summary, those conditions are: at the time of the trust’s creation, the taxpayer creating the trust is alive and has attained 65 years of age; the trust is created after 1999; the taxpayer is entitled to receive all of the income of the trust that arose before their death; no person except for the taxpayer could, before the taxpayer’s death, receive or otherwise obtain the use of any of the income or the capital of the trust; and the trust did not make an election referred to in s. 104(4)(a)(ii.1).
Thus, if the trust files a T3 return, and elects out in its first taxation year, then it will no longer fall within the scope of this subparagraph, and therefore s. 104(4)(a) would also not apply to the trust. Because it does not apply, we would consider that the settlor’s death would not be relevant for the purposes of the preamble to s. 104(13.4). Consequently, s. 104(13.4)(a) will not apply to deem a taxation year to occur at the end of the day on which the settlor dies.
We do note, however, that, although a deemed year-end does not occur, the terms of the alter ego trust require that the settlor be entitled to receive all of the income of the trust that arose before their death. Thus, any income earned by the trust prior to the settlor’s death will be taxed in the settlor’s terminal T1 return.
If you were to elect out, the trust would not satisfy certain other required conditions in ss. 73(1.01) and (1.02) to qualify for the tax-deferred rollover on the transfer of capital property to the trust. In that case, the proceeds of disposition to the settlor on the transfer of the capital property to the trust would be deemed by s. 69(1) to be the fair market value of the property so transferred.
There is a trade-off. If you are settling an alter ego trust, and want a tax-deferred transfer out of the trust, you cannot use the election in s. 104(4)(a)(ii.1), and the trust will be subject to a deemed disposition under s. 104(4)(a), and a deemed year-end under s. 104(13.4)(a). Alternatively, if you do elect out, you will not get a roll-in on the transfer in – it will be at fair market value, and the trust will not have a deemed disposition or year-end on the death of the settlor. Instead, a deemed disposition would typically occur on the trust’s 21st anniversary.
As noted in the question, s. 104(13.4) applies to the other trusts described in ss. 104(4)(a), (a.1) and (a.4), so the above analysis does not apply to any of these other trusts, because none of these others provisions have the electing-out language in s. 104(4)(a)(ii.1). Therefore, all of these other trusts would have a deemed taxation year-end on the day of death referred to in those paragraphs.
Q.14 - Extending the “Graduated Rate Estate” Period
Generally speaking, pursuant to subsection 248(1) of the Act, a “graduated rate estate” (GRE) of an individual at any time means the estate that arose on and as a consequence of the individual’s death if:
(i) that time is not more than 36 months after the death of the individual;
(ii) the estate is a “testamentary trust”; 
(iii) the individual’s social insurance number is provided in estate’s T3 Trust Income Tax and Information Return; and
(iv) the estate designates itself as a GRE of the individual; and no other estate makes this designation in respect of the same individual.
Therefore, an estate may be a GRE for a maximum period of 36 months beginning from the date of the death of the individual.
Consider a situation where an individual is a member of a pension plan which, upon the death of the individual, provides that a lump-sum pension benefit is payable to the estate of the deceased individual. Unfortunately, on occasion, these payments are received after the GRE status of the estate has expired. Consider a further complication whereby the lump-sum amount is received by the estate at the end of its taxation year and the executor is unable to distribute the income to the sole beneficiary before the end of the year. When this is the case, it would appear that the estate is not be able to calculate its tax payable using the graduated tax rates and the estate’s income would be subject to the highest marginal tax rate for individuals.
Can the Minister, under circumstances where the late payment of the pension benefits is of no fault of the executor, extend the GRE status of the estate beyond the 36-month period? If not, is there any way the pension income could be taxed in the estate’s 36-month GRE period?
Fron: The GRE definition establishes that, at any time, the individual’s estate may be a GRE where that time is not more than 36 months after the end of the individual’s death. The GRE definition does not provide the Minister with the ability to extend the 36 month GRE period, nor does that authority exist anywhere else in the Act.
In respect of the superannuation or pension benefit (in this case, a benefit that occurs upon the death of the individual), pension benefits are included in the income of a taxpayer for the taxation year in which they are received, pursuant to s. 56(1)(a)(i). Thus, although the estate became eligible for the lump-sum pension benefit upon the death of the individual, it still must be included in the taxation year of the estate in which it was received. If no amount of the estate’s income was made payable to a beneficiary in the taxation year in which the benefit was received, the full amount of the benefit will be taxed in the estate. Where the pension benefit is received after the 36-month GRE period, the graduated rates cannot be used to determine the estate’s tax payable.
However, where, in the taxation year of the estate, an amount of the estate’s income has become payable to a beneficiary of the estate, the amount will be included in the income of the beneficiary, pursuant to s. 104(13), and the estate can make a corresponding deduction under s. 104(6).
When determining “amounts payable to a beneficiary” under ss. 104(13) and (6), s. 104(24) must be considered, which provides that an amount which is otherwise payable to a beneficiary is deemed not to have become payable to the beneficiary in the taxation year, unless it was paid in the year to the beneficiary, or the beneficiary was entitled in the year to enforce payment of the amount.
Under the present facts, nothing has been paid to the beneficiary, so that the question becomes whether the beneficiary was entitled to enforce payment of the income in the year it was received by the estate. The executor of the estate will have to make that determination, which will depend on the relevant terms of the will of the deceased, and the status of the executor’s administration of the estate.
If, based on all the facts and circumstances, the executor determines that the beneficiary was entitled to enforce payment of the lump-sum benefit, the beneficiary must include that amount in their income, pursuant to s. 104(13). The executor must issue a T3 slip to the beneficiary for the amount that became payable to the beneficiary.
Where certain conditions are met, s. 104(27) allows a GRE to flow through, to the beneficiary, the character of certain pension benefits received by the estate, and included in the beneficiary’s income. However, given that the estate no longer qualifies as a GRE when the lump-sum pension benefit is received by the estate, s. 104(27) cannot be relied upon and, pursuant to s. 108(5), the pension benefit will be deemed to be income of the beneficiary for the year from a property that is an interest in the estate, and not from any other source.
Q.15 - Information on Trust Registration New Online Process
Can the CRA provide us with additional information about their new service which allows users to apply for a trust account number online?
Panourgias: As of February 2021, trustees and their representatives have been able to immediately obtain a trust account number using the online registration service. You can access this through the CRA My Account, My Business Account, or Represent a Client portals.
To apply for a trust account number, you will need to know the trust type, and have a signed copy of the trust document or will.
The registration is not available for a non-resident trust electing to file a return under s. 216.
1 1 S.C. 2017, c. 20, s. 451.
2 The preamble of subsection 104(4) refers to “each property of the trust (other than exempt property) that was capital property (other than depreciable property) or land included in the inventory of a business of the trust”
3 “testamentary trust” is defined in subsection 108(1) to mean, subject to certain exceptions, a trust that arose on and as a consequence of the death of an individual (including a trust referred to in subsection 248(9.1)).