15 June 2021 STEP Roundtable - Official Response
Christine Van Cauwenberghe, LLB, CFP, RRC, TEP, Winnipeg: IG Wealth Management
Michael Cadesky, FCPA, FCA, FTIHK, CTA, TEP, Toronto: Cadesky Tax;
Kim G.C. Moody, FCPA, FCA, TEP, Calgary: Moodys Tax Law LLP
Steve Fron, Manager, Trust Section II, Income Tax Rulings Directorate, CRA; Marina Panourgias,
Manager, Trust Section I, Income Tax Rulings Directorate, CRA
Unless otherwise staterd, all legislative references hereafter are to the Income Tax Act, R.S.C. 1985 (5h Supp.), c.1 ("the Act").
Q.1 - Trust Residency and 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?
a) In general, there is no practical difference in the CRA’s handling of departure tax security when dealing with a trust taxpayer compared to an individual taxpayer. This is because the adequacy of security is primarily determined 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 trust and individual taxpayers. Additionally, suitability of any necessary intermediaries is determined based on qualities and certifications which do not limit the intermediaries’ ability to provide service to either individuals or trusts.
b) 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 Letters of Credit or Guarantee make them particularly suitable as security for departure tax. For example, they are irrevocable and they unconditionally guarantee payment to a single beneficiary (CRA) for the entire time 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 secured. Additionally, lines of credit do not commonly allow third parties (i.e. CRA) to draw upon the credit while simultaneously denying the borrower (i.e. the taxpayer or their third party guarantor) the ability to do the same.
Such provisions effectively nullify the reliability of a line of credit to guarantee future payment. Because of this, 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.
It should be noted that Letters of Credit or Guarantee are not the only forms of security that the CRA generally considers to be acceptable. We recommend taxpayers contact the CRA as soon as possible before the security due date to discuss the various security options available. If you do not yet have an assigned Migration Specialist, the Migration Collections team can be reached from within North America at 1-877-301-3131. Collect calls from outside North America can be made to General Enquiries at 613-940-8495, where a call back from a Migration Specialist can be requested.
Q.2 - Interpretation of the Definition of “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 anumber 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 ademand 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.
Paragraph 94(3)(a) deems a trust to be resident in Canada for the specific purposes mentioned therein, if the following conditions are met:
- The trust is a factually non-resident trust;
- The trust is not an “exempt foreign trust” as defined in subsection 94(1); and
- The trust has either a “resident contributor” or a “resident beneficiary”: both of which are defined in subsection 94(1).
For purposes of our response, we accept the assumptions that the Trust is a factually non-resident trust and that it is not an exempt foreign trust. Thus, if the Trust has either a “resident contributor” or a “resident beneficiary” paragraph 94(3)(a) will apply.
Before it can be determined if Father is a “contributor” to the Trust, and therefore a “resident contributor” to the Trust, the definition of “contribution” in subsection 94(1) must first be satisfied. This definition contains three paragraphs - only one of which must be satisfied. Given that Father has made a loan directly to the Trust, paragraph (a) of the definition applies.
However, if Father’s loan to the Trust is determined to be an “arm’s length transfer” as defined in subsection 94(1), Father will not be considered to have made a “contribution” to the Trust.
The definition of “arm’s length transfer” contains two paragraphs, both of which must be satisfied in order for the transfer in question to be an “arm’s length transfer”. The question at hand deals specifically with paragraph (a) of the definition which reads as follows:
“arm's length transfer”, at any time by a person or partnership (referred to in this definition as the "transferor") means a transfer or loan (which transfer or loan is referred to in this definition as the "transfer") of property (other than restricted property) that is made at that time (referred to in this definition as the "transfer time") by the transferor to a particular person or partnership (referred to in this definition as the "recipient") if
(a) it is reasonable to conclude that none of the reasons (determined by reference to all the circumstances including the terms of a trust, an intention, the laws of a country or the existence of an agreement, a memorandum, a letter of wishes or any other arrangement) 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; and ...
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 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 — it is that a beneficiary’s existing or future interest in the trust motivates the transferor to make the transfer.
In our view, this definition aims to ensure there is no nexus between the transfer and person or partnership that already has an interest in the non-resident trust or could have such an interest in the future. When this is the case, it is our view that paragraph (a) fails and the loan or transfer is not an “arms length transfer”.
In respect of the situation described above, despite the fact that 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 has to 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.
Although the determination of the reasons for the loan or transfer depends on “all the circumstances including the terms of a trust, an intention, the laws of a country or the existence of an agreement, a memorandum, a letter of wishes or any other arrangement”, we are of the view that a conclusion that Father has made an “arm’s length transfer” is highly unlikely given the relationship between Father and his children. As such paragraph (a) will most likely fail, and the loan will not be an “arm’s length transfer”. Therefore, Father will be considered to have made a “contribution” to the Trust and will bea “contributor” and a “resident contributor” to the Trust. As such, pursuant to paragraph 94(3)(a), the Trust will be deemed to be resident in Canada for the purposes outlined therein.
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) ifthe interest rate is equivalent to an interest rate that would have been charged between parties dealing at arm’s length with each other?
As noted in our response to Q13 and 14 of the 2019 STEP Roundtable, in respect of a specified individual who is a beneficiary of a trust, where such an individual receives an amount of income from the trust that is included in the beneficiary’s income pursuant to subsection 104(13), paragraph (c), or in the case of taxable dividends designated by the trust under subsection 104(19), subparagraph (a)(i) of the definition of “split income” must be considered. While the issuance of a promissory note by a trust to a beneficiary may be an acceptable method of providing evidence of an amount made payable to a beneficiary for the purposes of subsection 104(13), such evidence does not have any impact on the determination of whether such income would otherwise be considered split income of that individual.
Based on the above, the amount of income received by the beneficiary from the trust and evidenced by the promissory note will be “split income” to the beneficiary and subject to tax on split income (“TOSI”) unless it is an “excluded amount” as each of these terms are defined in subsection 120.4(1).
Paragraph (d) of the definition of split income provides, inter alia, that split income is an amount included in computing the individual’s income for the year to the extent that the amount is in respect of a debt obligation that is of a trust and is not described in paragraph (a) of the definition of “fully exempt interest” in subsection 212(3), listed or traded on a public market, or a deposit standing to the credit of the individual. It is assumed that such interest receipts, in respect of the promissory note issued to the beneficiary, would be funded by the operations of a “related business” in respect of the beneficiary, as defined in subsection 120.4(1).
Based on the above, the interest income paid to the particular beneficiary by the trust will be “split income” to the beneficiary and subject to TOSI unless it is an “excluded amount” as each of these terms are defined in subsection 120.4(1). In that regard, it does not appear to qualify as an “excluded amount” pursuant to subparagraph (f)(ii) (assuming the beneficiary is between the age of 17 and 24) since the note does not appear to be “arm’s length capital” as defined in subsection 120.4(1). If the beneficiary has attained the age of 24 years before the particular year, the “reasonable return” exception provided in subparagraph (g)(ii) must be considered for such interest income.
Whether the arm’s length rate of interest charged is a reasonable return in the case where the individual has not assumed any risk, is a mixed question of fact and law that can only be determined after a review of all the facts and circumstances applicable to a particular situation. Notwithstanding the above, in determining whether something constitutes a reasonable return, the CRA does not intend to generally substitute its judgement of what would be considered a reasonable amount where taxpayers have made a good faith attempt to do so based on the reasonableness factors set out in the definition of “reasonable return” as provided in subsection 120.4(1).
Additional guidance on the TOSI rules can be found on the CRA website at: https: //www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/federal-government-budgets/income-sprinkling/guidance-split-income-rules-adults.html.
Q.4 - TOSI on Dividends
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 viaa corporation owned H, would dividends received by Tom, Dick and Harry, as the case may be, thereafter be subject to TOSI?
a) In order to properly respond to this question, we have made the assumption that each of Tom, Dick and Harry (“Siblings”) are at least 25 years of age and own shares of TDH Co giving each such holder 10% or more of the votes and fair market value (“FMV”) of all the issued and outstanding shares of the corporation.
We have previously discussed whether shares of a corporation which derives its income from the rental of real property, inter alia, would constitute “excluded shares”, as that term is defined in subsection 120.4(1) of the Act, if the rental operations do not constitute a business.
For instance, in our response to Question 10 of the 2018 CTF Conference, which also referred to our response to Question 7 of the 2018 STEP conference, 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, such shares would be excluded shares. However, if there was not a sufficient level of activity to constitute a business, the shares of the corporation would not be excluded shares for the purposes of determining whether tax is payable on such dividends as split income under 120.4(2) of the Act (“TOSI”).
In this scenario, assuming the level of activity in TDH Co is sufficient to constitute a business that is carried on by TDH Co, which is a question of fact, the shares of TDH Co would appear to qualify as excluded shares. However, if it is determined that TDH Co does not carry on a business the excluded share exception would not apply and any taxable dividends received from TDH Co by the Siblings (each being a “specified individual”) would be subject to TOSI unless another exception applies. In this case, subparagraph (e)(i) of the definition “excluded amount” (applicable to individuals who have attained the age of 17 years before the year) would apply to prevent such taxable dividends from being subject to TOSI provided that such dividends are not derived directly or indirectly from a related business in respect of the individual for the year.
The expression “related business” in respect of a specified individual for a taxation year is also defined in subsection 120.4(1) and means, in the case of a corporation either: 1) a business carried on by the corporation if a source individual in respect of the specified individual at any time in the year is actively engaged on a regular basis in the activities of the corporation related to earning income from the business; or 2) a business of a corporation if a source individual in respect of the specified individual owns shares of the capital stock of the corporation or property that derives, directly or indirectly, all or part of its FMV from shares of the capital stock of the corporation and the total FMV of the shares and property equals at least 10% or more of the total FMV of all of the issued and outstanding shares of the capital stock of the corporation.
b) In this scenario, each of Tom, Dick and Harry, will undertake a “split-up” butterfly reorganization under paragraph 55(3)(b) of the Act such that each of the Siblings will ultimately indirectly own, through a holding corporation, a particular rental property formerly owned by TDH Co. In this scenario, although the ownership structure has changed, and the tax consequences of a butterfly transaction are beyond the scope of this response, the analysis with respect to the application of the TOSI rules in this scenario essentially remains the same as discussed in our response in the first scenario.
Q.5 - Income Attribution from Alter Ego Trust
A taxpayer settles an alter ago 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?
Generally, subsection 75(2) will apply to a trust that holds property on condition:
a) that the property or property substituted for it may:
(i) revert to the person from whom the property or property for which it was substituted was directly or indirectly received, (the “contributor”) or
(ii) pass to persons to be determined by the contributor at a time subsequent to the creation of the trust, or
b) during the existence of the contributor, the property shall 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 while the contributor exists and is resident in Canada.
a) Pursuant to paragraphs 96(1)(f) and (g) of the Act, the amount of the income or loss of a partnership for a taxation year “from any source or from sources in a particular place” is generally considered to be the members’ income or loss “from that source or from 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. Also, paragraph 12(1)(I) of the Act provides that income from a business or property includes “any amount that is, by virtue of subdivision j, income of the taxpayer for the year from a business or property.” Whether the income or loss of a partnership is from a source that is business, froma source that is property, or from any other source for that matter, is a question of fact. When the partnership allocates 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 subsection 75(2) does not attribute business income.
However, we 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 earned by the trust will generally be included in the settlor’s income under subsection 104(13) of the Act. Subsection 108(5) of the Act provides that except as otherwise provided in Part I, an amount included in the income of a beneficiary under inter alia subsection 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.
Where the partnership earns property income, and in accordance with the partnership agreement the trust is allocated such property income, subsection 75(2) will apply, such that the income will be attributable to the person from whom the partnership interest was received (the settlor).
b) Pursuant to subsection 248(5) of the Act, where a trust has disposed of a particular property and acquired 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 contributor of the original property.
c) Where a trust earns income from a property contributed (or property substituted therefor) by a person and reinvests that income, any income or loss derived from the reinvestment of these earnings (second generation income) from the property (or substituted property) will not be attributed to that person.
Subsection 75(2) does not apply to second generation income, as this income is not earned on property contributed to the trust. For example, if the property received from a person is money which is deposited by the trust into a bank account, the interest on the initial deposit will attribute to that person but interest earned on the interest left to accumulate in the bank account will not attribute.
Second generation income will be taxable 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, in the context of an alter ego trust, we would expect the second generation income earned in the trust to be payable to the beneficiary under subsection 104(13), as discussed above. Where the second generation income is payable to a beneficiary in the year, subsection 108(5) will generally apply to the income included in the beneficiary’s hands. For certain types of income such as dividends and taxable capital gains, the trust may make a designation pursuant to subsections 104(19) or 104(21) of the Act respectively, which will result in the income retaining its character in the beneficiary’s hands.
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) Howis 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) Paragraph (g) of the definition of “trust” in subsection 108(1) provides for a potential exception to the 21-year deemed disposition rule in paragraph 104(4)(b) where all interests of the trust at that time have vested indefeasibly. The Act does not define the term vested indefeasibly; however, our response to Question 9 at the 2018 STEP Roundtable (document 2018-07441 11C6) provides useful guidance as to what is required in order for an interest in a trust to be vested 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 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.
b) The T3 Trust Income Tax and Information Return does not request information on whether all of the trust’s interests have vested indefeasibly and as such, that the trust qualifies for the exclusion from the deemed disposition rule in paragraph 104(4)(b).
c) Abeneficiary 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 subsection 70(5). Subsection 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 - Subsection 107(2) and Trust to Trust Transfers
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 “NewtTrust”) 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?
Where property is distributed by a personal trust to a beneficiary in satisfaction of all or part of their capital interest in that trust, subsection 107(2) should apply provided that none of subsections 107(2.001), (2.002), and (4) to (5) apply. Under subsection 107(2), the trust is deemed to dispose of the distributed property for its cost amount and the beneficiary is generally deemed to have acquired the property at the same cost amount.
As defined in subsection 108(1), for the purposes of subdivision k of the Act, a beneficiary under a trust includes a person beneficially interested in the trust. Therefore, for the purposes of applying subsection 107(2), a beneficiary includes a person beneficially interested in the trust.
Paragraph 248(25)(a) describes a person or partnership beneficially interested in a particular trust as “any person or partnership that has any right ... as a beneficiary under the 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.”
Based on the wording of paragraph 248(25)(a), the person having any right as a beneficiary under a trust to receive any income or capital of the trust, either directly or indirectly, must have that right as a beneficiary under a trust. The Act does not define the term beneficiary for the purposes of paragraph 248(25)(a). It is our view that the definition of beneficiary for the purposes of paragraph 248(25)(a) will be based on its ordinary meaning. Whether a person isa beneficiary of a trust in its ordinary sense is determined based on the relevant facts and circumstances (in particular, the terms of the trust agreement) and the relevant trust law.
In this case, the Trust Agreement does not include a trust for the benefit of the children of Mr. X as a beneficiary nor does it contemplate the creation of such a trust to be a future beneficiary. Therefore, it is our view that subsection 107(2) will not apply on the transfer of property from Trust to NewTrust since NewTrust is not a beneficiary of Trust for the purposes of subsection 107(2).
Even though subsection 107(2) will not apply to the transfer, paragraph (f) of the definition of disposition in subsection 248(1) and subsection 107.4(3) may apply to allow the transfer to be completed on a tax deferred basis. The determination of whether these provisions could apply on the transfer of property from Trust to NewTrust would require consideration of all the relevant facts and circumstances, including the terms and conditions that apply in respect of Trust and NewTrust.
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?
The objective of the Income Tax Rulings Directorate (the “Directorate”) is to issue a Ruling or complete a Pre-ruling Consultation within a specified, agreed-upon time period.
The service standard for a Ruling is 90 business days commencing with the receipt of all information required from the client as outlined in Appendix A - Ruling Request Checklist of Information Circular IC 70-6R11, Advance Income Tax Rulings and Technical Interpretations (IC 70-6). The service standard for a Pre-ruling Consultation is to complete a teleconference within 15 business days from the date the Directorate confirms to the client that the request complies with IC 70-6 and has been accepted.
In some cases, achieving these service targets may not be possible. Where the service target date needs to be adjusted, the Directorate will inform the client in advance and establish an alternate, mutually agreed upon service target date.
Remission of the service fee will be granted when the Ruling is issued, or the Pre-ruling Consultation is completed, subsequent to its service target date, as set out in Appendix H -Remissions of IC 70-6.
The remission will be calculated on an incremental basis as a percentage discount on the hourly rate applicable to the hours worked subsequent to the service target date and will be processed as a reduction to the client invoice.
Remission of the service fee, where appropriate, will apply to Rulings or Pre-ruling Consultations received by the Directorate after April 1, 2021. Additional information regarding remissions can be found in Appendix H - Remissions of IC 70-6.
Q.9 - Safe Income Computation
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?
In this response “safe income” will be used to describe the income earned or realized after 1971 and before the applicable safe income determination time (as determined under paragraphs 55(5)(b) and (c) of the Act) and “safe income on hand” will be used to describe safe income that can reasonably be considered to contribute to the capital gain ona share.
In John R. Robertson’s paper “Capital Gains Strips: A Revenue Canada Perspective on the Provisions of Section 55”, Report of Proceedings of the Thirty-Third Tax Conference, 1981 Conference Report (Toronto: Canadian Tax Foundation, 1982) (the “Robertson Rules”) non-deductible expenses were generally described as any expense incurred or disbursement made that was not allowed or not claimed as a deduction in computing income (other than an expense or disbursement made in respect of the acquisition of property or a repayment on account of the principal amount of a loan). In Income Tax Technical News 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 positions set out in the Robertson Rules and Income Tax Technical News No. 37 continue to reflect the CRA’s administrative position regarding the non-deductible expenses that will reduce safe income in order to determine safe income on hand. Specifically, non-deductible expenses can generally be 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 in respect of the acquisition of property or a repayment on account 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.
Examples of non-deductible expenses would include:
- dividends 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
- non-deductible (portion of) expenses or expenditures, such as the non-deductible potion of meal and entertainment expenses.
It should also be noted that in addition to the non-deductible expenses described above, as confirmed in CRA Document 2016-0672321C6, contingent liabilities and accounting reserves also need to be taken into account in determining safe income on hand.
Q.10 - 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.
Ata 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.
It is our view that, if an election is made under subsection 256(9), CCo would acquire control of ACo at the time when ACo acquires, and BCo disposes of, the ACo shares on November 1, 2020 and, therefore, paragraph 249(4)(a) would deem ACo’s taxation year to end immediately before that time.
However, if subsection 256(9) applies to deem CCo to have acquired control of ACo at the commencement of the day on November 1, 2020, paragraph 249(4)(a) would deem ACo’s taxation year to end immediately before that time, being the last moment of time on October 31, 2020.
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 the New Taxation Year and, therefore, the dividend refund to ACo, with respect to the Deemed Dividend, computed under paragraph 129(1)(a), would be for its New Taxation Year.
Q.11 - TFSA Over-contribution
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. Duetoa misunderstanding of the TFSA rules, the taxpayer contributes $18,000 to his TFSA and invests it allin 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?
Section 207.02 provides that an individual who makes a contribution to a TFSA that exceeds their contribution room is subject to a 1% tax on the excess TFSA amount. The tax is
calculated monthly based on the individual’s highest excess TFSA amount for that month. The 1% tax continues to apply for each month that the excess TFSA amount remains. Generally, an individual may take action to correct an over-contribution and minimize the tax by making one or more withdrawals from their TFSA to reduce or eliminate the excess TFSA amount. However, in this case, the individual is unable to withdraw any amounts from their TFSA and therefore the individual would be unable to mitigate the tax in this manner. Only new TFSA contribution room that becomes available to the individual in future years will serve to reduce the excess TFSA amount.
One of the conditions that must be met for the Minister to waive or cancel the 1% tax pursuant to subsection 207.06(1) is that the individual withdraw from their TFSA an amount sufficient to eliminate the excess TFSA amount, together with any associated income and capital gains. Again, in this case, the individual is unable to withdraw any amounts from their TFSA and therefore the Minister would have no authority to waive or cancel the tax.
Assuming that the individual makes no additional TFSA contributions in 2021, 2022 and 2023 and that TFSA dollar limit for each of 2022 and 2023 remains at $6,000, the excess TFSA amount would be reduced to $6,000 as at January 1, 2022 and fully eliminated as at January 1, 2023. Asa result, the individual would be liable for the 1% tax in 2021 and 2022 and would need to complete Form RC243 Tax-Free Savings Account (TFSA) Return and remit the tax for each year. The individual could begin making TFSA contributions in 2024.
Q.12 - Joint Spousal or Common-law Partner Trust - Contribution of Jointly-held Property
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?
Pursuant to subsection 73(1) of the Act, an individual (other than a trust) can transfer capital property on a tax-deferred basis, where certain conditions are met. In order for subsection 73(1) to apply, the following conditions must be met:
- t the time of the transfer of property, both the transferor of the property and the transferee must be resident in Canada;
- hetransferor must not elect out of the rollover rule; and
- ubsection 73(1.01) must apply in respect of the transfer (a “qualifying transfer”).
Subsection 73(1.01) provides that, subject to the requirements of subsection 73(1.02), qualifying transfers include, inter alia, transfers to a trust created by the individual transferring the property that meet the requirements of subparagraph 73(1.01)(c)(iii), such that the individual and his or her spouse or common-law partner are entitled to receive all the income of the trust arising before their deaths and under which no one other than the individual or the individual’s spouse or common-law partner is permitted to receive or otherwise obtain the use of any of the income or capital of the trust before the death of both the individual and the individual’s spouse or common-law partner.
Subsection 73(1.02) imposes additional conditions that must be met in order for a trust to meet the requirements of subparagraph 73(1.01)(c)(iii). In this particular case:
- the trust must be created after 1999; and
- the individual must be at least 65 years of age at the time the trust is created.
A trust described in subparagraph 73(1.01)(c)(iii) that meets all of the relevant conditions outlined above will generally be a “joint spousal or common-law partner trust” as defined in subsection 248(1).
If a trust was created by the contribution of jointly-owned property by an individual and the individual’s spouse or common-law partner and no other person, the trust would be considered to be created by both individuals for purposes of subsection 73(1.01). Thus, as long as a trust was Created by both individuals and no one else, and the other conditions in subsections 73(1), (1.01) and (1.02) were met, a transfer of property by either spouse or common-law partner or
both spouses or common-law partners to the trust after its creation would be eligible for the rollover provided in subsection 73(1).
For a joint spousal or common-law partner trust, paragraph 104(4)(a) provides that the trust will be deemed to have disposed of certain properties at the later of the day on which the individual dies and the day on which the individual’s spouse or common-law partner dies for proceeds equal to the fair market value of the property at that time and the trust will be deemed to have acquired the property immediately thereafter at a cost equal to that same amount. This will generally result in the trust reporting taxable capital gains in the year in which the relevant death occurs. For the 2016 and subsequent taxation years, paragraph 104(13.4)(a) provides, inter alia, that the taxation year of a joint spousal or common-law partner trust is deemed to end at the end of the day of death referred to in paragraph 104(4)(a), and that a new taxation year is deemed to begin immediately after that day.
Q.13 - Paragraph 104(13.4)(a) Deemed Taxation 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 paragraph 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?
The preamble to subsection 104(13.4) considers the death of an individual that is “the death or later death, as the case may be, referred to in paragraph 104(4)(a), (a.1) or (a.4) in respect of the trust”.
Subsection 248(1) of the Act defines an “alter ego trust” (AET) for purposes of the Act as “a trust to which paragraph 104(4)(a) would apply if that paragraph were read without reference to subparagraph 104(4)(a)(iii) and clauses 104(4)(a)(iv)(B) and (C)”. In other words, an AET is described in clause 104(4)(a)(iv)(A) in conjunction with subparagraph 104(4)(a)(ii.1).
Subparagraph 104(4)(a)(ii.1) reads as follows:
(ii.1) is a trust (other than a trust the terms of which are described in clause (iv)(A) that elects in its return of income under this Part for its first taxation year that this subparagraph not apply) that was created after 1999 by a taxpayer during the taxpayer’s lifetime and that, at any time after 1999, was a trust... [Emphasis added]
Accordingly, where the trust elects in its T3 return for its first taxation year to have subparagraph 104(4)(a)(ii. 1) not apply to the trust, the trust would not fall within the scope of that subparagraph and therefore, paragraph 104(4)(a) also would not apply to the trust. Therefore, we would not consider the settlor’s death to be relevant for purposes of the preamble to subsection 104(13.4) and as a result, paragraph 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. Instead, the trust will generally have a deemed disposition on the day that is 21 years after the day on which the trust was created, pursuant to paragraph 104(4)(b).
We note that although a deemed year end does not occur, the terms of the AET include the requirement that the settlor is entitled to receive all of the income of the trust that arose before their death. As such, any income earned by the trust prior to the settlor’s death would be taxed in the settlor’s terminal T1 tax return.
We also note that by electing to have subparagraph 104(4)(a)(ii.1) not apply to the trust, the trust would not satisfy all of the required conditions in subparagraph 73(1.01)(c)(ii) and subsection 73(1.02) of the Act for a trust to qualify for a tax-deferred rollover on the transfer of capital property to the trust by the settlor. In that case, the proceeds of disposition for the settlor on the transfer of the capital property to the trust would be deemed by subsection 69(1) of the Act to be the fair market value of the property so transferred.
As noted in the question, subsection 104(13.4) applies to the other trusts described in paragraphs 104(4)(a), (a.1) and (a.4). The above comments do not apply to these other trusts because none of these provisions have the “electing out” language as found in subparagraph 104(4)(a)(ii.1). For the other trusts described in paragraphs 104(4)(a), (a.1) and (a.4), paragraph 104(13.4)(a) will deem a taxation year to end at the end of 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 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?
The GRE definition establishes that at any time, an individual’s estate may be a GRE where that time is not more than 36 months after the individual’s death. The GRE definition does not provide the Minister with the ability to extend the 36-month GRE period, nor can the authority for an extension be found elsewhere in the Act.
Superannuation or pension benefits are included in the income of a taxpayer for a taxation year when they are received, pursuant to subparagraph 56(1)(a)(i) of the Act. Thus, although the lump-sum pension benefit may have become payable to the estate upon the death of the individual, it must be included in the taxation year of the estate in which it was received. If no amount of the estate’s income has been made payable to a beneficiary of the estate in the taxation year in which the pension 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, that amount will be included in the income of the beneficiary pursuant to subsection 104(13) of the Act. The estate may also take a corresponding deduction pursuant to subsection 104(6) of the Act. It is important to note that when an amount of income has become payable to a beneficiary, subsection 104(24) of the Act must be considered. Subsection 104(24) applies for the purposes of subsections 104(6) and 104(13), inter alia, and provides that an amount which is otherwise payable to a beneficiary is deemed not to have become payable to the beneficiary in a taxation year unless it was paid in the year to the beneficiary or the beneficiary was entitled in the year to enforce payment of the amount.
As noted in the question, no amount of the estate’s income has been paid to the beneficiary during the Estate’s taxation year in which it was received. Therefore, for the estate’s income for a taxation year to be payable to the beneficiary for the purposes of subsections 104(6) and 104(13), the beneficiary would have to be entitled to enforce payment of the income in the same year.
The determination of whether a beneficiary is entitled to enforce payment of an amount payable
must be made by the executor of the estate as this will, in the least, depend on the relevant law, the terms of the deceased’s will and the status of the executor’s administration of the estate.
If, based on all the facts and surrounding circumstances, the executor determines that the beneficiary was entitled to enforce payment of the gross amount of lump-sum benefit, the beneficiary must include the amount in their income pursuant to subsection 104(13). The executor must issue a 73 Statement of Trust Income Allocations and Designations to the beneficiary for the amount that became payable to the beneficiary.
Finally, it should be noted that when certain conditions are met, subsection 104(27) of the Act allows a GRE to flow through to a beneficiary of the estate, the character of certain pension benefits received by the estate and included in the beneficiary’s income. Given that the estate no longer qualifies as a GRE when the lump-sum pension benefit is received by the estate, this provision cannot be relied upon and pursuant to subsection 108(5) of the Act 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?
Since February 2021, trustees (which includes an executor, an administrator or a liquidator who owns or controls property for another person) and their representatives have been able to immediately obtain a trust account number using the online registration service through CRA My Account, My Business Account, and Represent a Client.
In order to apply for a trust account number using the online portals, trustees will need to know the trust type and have a signed copy of the trust document or the last will and testament.
Online registration is not available to a non-resident trust electing to file an income tax return under section 216 of the Income Tax Act.
1 We gratefully acknowledge the following CRA personnel who were instrumental in helping us prepare for the Roundtable: Stéphane Charette, Phil Kohnen, Dave Wurtele, Kim Duval, Wayne Doiron, Helen Ferrigan, Dawn Dannehl, Katie Campbell, Katie Robinson, Tara Mathanda, Laura Monteith, William King, Stéphane Prud’homme, David Palamar, Michael Cooke, Ryan McPherson, Allison Thomas, Daniel Wong, Tobias Witteveen, Ellen Ramsay, Nancy Degready and Chris Deutsch.
2 The definition of “resident beneficiary” requires that, in addition to a beneficiary who is resident in Canada, there must be a “connected contributor” to the trust. If Father is a contributor for purposes of determining whether he is a “resident contributor”, an analysis of the “resident beneficiary” definition is not needed.
3 Paragraph (a) provides that a contribution to a trust means a transfer or loan (other than an arm’s length transfer) of property to a trust by a particular person or partnership — in our case Father.
4 We will focus on paragraph (a) and assume paragraph (b) is otherwise satisfied.
5 Note that allocations of partnership income are subject to subsections 103(1) and (1.1) of the Act.
6 See clause 104(4)(a)(iv)(A).
8 Based on the information provided, we have assumed that paragraphs 248(25)(b) and (c) do not apply.
9 S.C. 2017, c. 20, s. 451.
10 IC 70-6R11 Advance Income Tax Rulings and Technical Interpretations was published April 1, 2021
11 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”
12 Paragraphs 73(1.02)(a) and (c) would be not be met.
13 “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)).
14 Pursuant to subsection 248(1), “trust” has the meaning assigned by subsection 104(1) and, unless the context otherwise requires, includes an estate.