15 June 2022 STEP Roundtable - Official Response
Moderator: Christine Van Cauwenberghe, LLB, CFP, RRC, TEP, Winnipeg: IG Wealth Management
Panelists: Michael Cadesky, FCPA, FCA, FTIHK, CTA, TEP, Toronto: Cadesky Tax; Kim. G.C. Moody, FCPA, FCA, TEP, Calgary: Moodys Tax Law LLP
CRA Panelists: Steve Fron, Manager, Trust Section II, Income Tax Rulings Directorate, CRA; Marina Panourgias, Manager, Trust Section I, Income Tax Rulings Directorate, CRA
Unless otherwise stated, all legislative references hereafter are to the Income Tax Act R.S.C 1985 (5th Supp.), c.1 (the “Act”).
Q.1 - Interaction Between Subsections 104(21) and 104(21.2)
Subsection 104(21) permits a trust to designate, in respect of a beneficiary under the trust, a portion of its net taxable capital gains (“NTCG”). Where the designation is made, the amount designated is deemed, for the purposes of sections 3 and 111 (except as they apply for the purposes of determining whether a beneficiary is entitled to claim a capital gains exemption under section 110.6 ), to be a taxable capital gain (“TCG”) for the year of the beneficiary from the disposition of capital property.
Given that a designation made pursuant to subsection 104(21) is not for the purposes of section 110.6, in order for a beneficiary under the trust to claim the lifetime capital gains exemption (“LCGE”) in respect of the TCG designated to them under subsection 104(21), aseparate designation pursuant to subsection 104(21.2) must be made.
Consider the following facts:
1) A trust (“the Trust”) is an inter vivos, discretionary personal trust, resident in Canada;
2) There are 2 adult beneficiaries under the Trust (“Beneficiary A”; “Beneficiary B”), each of whom are resident in Canada;
3) Only Beneficiary B has access to their LCGE;
4) The Trust realizes two capital gains during the year, resulting in total NTCG to the Trust in the amount of $1,000,000, broken down as follows: >a) a$300,000 “regular” TCG, from the disposition of the shares of a publicly traded >corporation; and > >b) a$700,000 TCG resulting from the sale of qualified small business corporation >shares (“QSBCS”); and 5) The trust indenture permits the trustees to allocate and designate the NTCGs as follows: >a) The $300,000 TCG to Beneficiary A; and > >b) The $700,000 QSBCS TCG to Beneficiary B (so that Beneficiary B may use their >LCGE to offset as much of the gain as possible ).
Does the formula in subsection 104(21.2) permit the trustees to allocate the NTCGs in the desired manner, or does the interaction of subsections 104(21) and 104(21.2) require a proration, such that the entire $700,000 QSBCS TCG cannot be designated to Beneficiary B?
Generally speaking, subsection 104(21) permits a trust resident in Canada to designate an amount in respect of the trust’s NTCG, for a particular taxation year of the trust if:
- the amount is designated by the trust in respect of a beneficiary under the trust who is resident in Canada;
- the designation is made in the trust’s return of income for the particular taxation year;
- the amount was included in computing the income for that taxation year of the beneficiary under paragraph 104(13)(a), subsection 104(14) or section 105; and
- the total of all amounts designated by the trust in respect of each beneficiary under the trust for the particular taxation year is not greater than the trust’s NTCG for the particular taxation year.
When a designation is made under subsection 104(21) in respect of a beneficiary under the trust, the amount so designated is deemed to be a TCG for the taxation year of the beneficiary in which the particular taxation year ends, from the disposition of capital property.
For purposes of our response, we assume that all of the conditions in subsection 104(21) are satisfied, such that the Trust is able to designate for a particular taxation year:
- NTCG of $300,000 in respect of Beneficiary A; and
- NTCG of $700,000 in respect of Beneficiary B.
Where, for the purposes of subsection 104(21), a personal trust designates an amount in respect of a beneficiary in respect of its NTCG for a taxation year (the “designation year”) a separate designation under subsection 104(21.2) must be made in the trust’s T3 Trust Income Tax and Information Return.
Subsection 104(21.2) sets out rules for determining the NTCG of a personal trust that, for the purposes of section 110.6, can be designated to the beneficiaries of the trust. This permits the beneficiary to claim the LCGE under section 110.6 in respect of a disposition by the trust of QSBCS or qualified farm or fishing property (“QFFP”).
Under subsection 104(21.2), the trust shall designate an amount in respect of its eligible taxable capital gains, if any, for the designation year in respect of the beneficiary determined by the applicable formulas in clauses 104(21.2)(b)(ii)(A) for QFFP and (B) for QSBCS.
Very generally, the effect of each of these formulas is that the amount designated to a particular beneficiary is equal to the beneficiary’s proportionate share of all the trust’s subsection 104(21) designations for the year to its beneficiaries in respect of its NTCG for the year, to the extent that the amount so calculated represents eligible taxable capital gains of the trust for the year from the disposition of QFFP or QSBCS (depending on which formula is being applied).
As the above example deals with QSBCS, the formula in clause 104(21.2)(b)(ii)(B) applies: (AxBxF)/(DxE)
For illustration purposes however, the formula can be re-written as follows:
Element A establishes a cap on TCGs that must be designated among the beneficiaries under subsection 104(21.2) as the lesser of:
(i) the trust’s subsection 104(21) designations minus any subsection 104(13.2) designations, and
(ii) the trust’s eligible taxable capital gains for the designation year.
The fraction B/D produces the proportion of the QSBCS TCG to be designated to each beneficiary, whereby:
B is the amount, if any, of the trust’s subsection 104(21) designation in respect of the beneficiary that exceeds the trust’s subsection 104(13.2) designation for the beneficiary.
D is the sum of the amounts determined for B, for all beneficiaries.
The fraction F/E is relevant where the trust has both QSBCS and QFFP gains. The F/E calculation ensures that the amount determined for element A is split on a proportionate basis between the two formulas:
F is the amount that would be determined for the trust under paragraph 3(b) for the designation year if the only properties referred to in that paragraph were QSBCS.
E is the total of the amounts determined for C and F in respect of the beneficiary.
Where the trust only has QSBCS gains and no QFFP gains, the fraction F/E will produce a result of 1.
In applying the numbers from the example, note that only element B is different for Beneficiary A and B.
AxBxF D E =$700,000 x 300,000 x 700,000 1,000,000 700,000 =$700,000 x 0.3 x 1 =$210,000
AxBxE D E =$700,000 x 700,000 x 700,000 1,000,000 700,000 =$700,000 x 0.7 x 1 =$490,000
Therefore, the subsection 104(21.2) designation in respect of Beneficiary B is limited to 70% of the Trust’s QSBCS TCG, or $490,000.
Q.2 - Subparagraph 104(4)(a)(ii.1) Election
In the 2021 STEP CRA Roundtable , it was noted that an alter ego trust can effectively elect to have the 21 year deemed disposition rule apply, rather than having the deemed disposition occur upon the death of the taxpayer who created the trust. To do so, the alter ego trust must make an election in its tax return for its first taxation year, pursuant to subparagraph 104(4)(a)(ii.1).
One consequence of the election is that the property transferred to the alter ego trust will be deemed to be disposed of by the taxpayer at fair market value and not the adjusted cost base pursuant to subparagraph 73(1)(a)(ii), because the condition in paragraph 73(1.02)(c) will not be satisfied.
Given the above, we have two questions:
A. Will CRA accept a late election under subparagraph 104(4)(a)(ii.1)?
B. Can this election be made by other trusts to which a subsection 73(1) rollover would otherwise apply, such as a spouse or common-law partner trust, or a joint spouse or common-law partner trust?
In making a determination on whether to accept an election provided for in a particular provision of the Act, the CRA would look to the specific language used in that provision. The Act contains a number of provisions that require certain elections to be filed with the return of income, while other provisions require certain elections to be filed by the “filing-due date” as that term is defined in subsection 248(1).
The courts have established that the meaning of the words “in the taxpayer’s return of income” are clear and unambiguous and therefore require that the election must be made in the return of income. For instance, in Rezek et al v. The Queen et al (2005 FCA 227), the Federal Court of Appeal opined (in paragraphs 113-115) that where an election is required to be filed in the taxpayer’s return of income for the year, such an election would not be considered late-filed if the election was filed with a return of income for that year that was late-filed. As well, the courts have held that where an election that is required to be filed with the return of income for the year is not filed with the return of income, the election would be late.
Therefore, the CRA will accept an election filed under subparagraph 104(4)(a)(ii. 1) only if it is made in the trust’s return of income filed for its first taxation year, regardless of whether the return is filed by the required filing deadline specified in paragraph 150(1)(c).
Where the election is not filed with the trust’s return of income for its first taxation year, but rather is filed later, that election would be late and could not be accepted. As subparagraph 104(4)(a)(ii.1) is not a prescribed provision listed in section 600 of the Income Tax Regulations, the Minister has no discretion under subsection 220(3.2) to accept a late-filed election made under that provision.
Subsection 248(1) defines an “alter ego trust” 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 alter ego trust is described in clause 104(4)(a)(iv)(A) in conjunction with subparagraph 104(4)(a)(ii.1).
The election provided for in subparagraph 104(4)(a)(ii.1) is to have that subparagraph not apply. The election can only be made by a trust, the terms of which are described in clause 104(4)(a)(iv)(A). In other words, the election only applies to an alter ego trust and cannot be made by a spouse or common-law partner trust, a joint spouse trust, and a joint common-law partner trust which are described in subparagraph 104(4)(a)(iii), clause 104(4)(a)(iv)(B) and clause 104(4)(a)(iv)(C) respectively. The first deemed disposition for these trusts would occur on the death or the later death referred to in the respective provisions.
Q.3 - Electing Contributor and Electing Trust
a) Electing Contributor
The definition of “electing contributor” in subsection 94(1) is relevant in applying the rules in subsections 94(16) and 94(17). Subsection 94(16) provides rules for attributing the income of a trust that is deemed to be resident in Canada under subsection 94(3) to its electing contributors. The provision applies on an electing contributor-by-electing contributor basis. Subsection 94(17) provides rules regarding certain liabilities in respect of joint contributions where there is an electing contributor who is a joint contributor in respect of a contribution to the trust.
Can the election described in the definition of electing contributor in subsection 94(1) be late-filed?
b) Electing Trust
The definition of “electing trust” in subsection 94(1) is relevant in determining whether property held in the “non-resident portion”, as defined in subsection 94(1), of a deemed resident trust is considered to be held in a separate trust.
Paragraph 94(3)(f) provides rules that generally have the effect, on an elective basis, of excluding from the taxable base of a deemed resident trust for Canadian tax purposes any income relating to property that has been contributed to the trust otherwise than by a “resident contributor” to the trust or, if there is a current “resident beneficiary” under the trust, a “connected contributor” to the trust (i.e., property that is part of the non-resident portion of the trust). Resident contributor, resident beneficiary, and connected contributor are all defined in subsection 94(1). In effect, this is accomplished by deeming there to be a second trust in addition to the electing trust. The additional trust is deemed to hold the property that forms the trust’s non-resident portion. This has the effect of removing from the taxable base of the trust any income derived from that property.
Can the election described in the definition of electing trust in subsection 94(1) be late-filed?
a) Electing Contributor
The term electing contributor is defined in subsection 94(1) and is applicable for section 94. An electing contributor at any time in respect of a trust means a resident contributor to the trust, who has elected to have subsection 94(16) apply in respect of the “contributor”, as defined in subsection 94(1), and the trust for a taxation year of the contributor that includes that time or that ends before that time and for all subsequent taxation years, if
- the election was filed in writing, on or before the contributor’s filing-due date for the first taxation year of the contributor for which the election was to take effect (referred to as the “initial year”); and
- the election included both the trust’s account number and evidence that the contributor notified, no later than 30 days after the end of the trust’s taxation year that ends in the initial year, the trust that the election would be made.
Based on this definition, it is clear that the election must be filed on or before the contributor’s filing-due date for the initial year. The filing-due date for a taxation year of a taxpayer is defined in subsection 248(1) as the day on or before which the taxpayer’s return of income under Part | for the year is required to be filed or would be required to be filed if tax under that Part were payable by the taxpayer for the year.
For example, consider a situation involving a contributor that is an individual with a filing-due date for a taxation year (a calendar year) which is April 30" of the following year. If the individual contributor to the trust would like to be an electing contributor in respect of the trust for their 2022 and subsequent taxation years, the election would need to be filed on or before May 1, 2023 (since April 30, 2023 is a Sunday). Even if the contributor files their tax return after May 1, 2023, the election must be filed on or before May 1, 2023.
Subsection 220(3.2) provides the Minister the discretion to allow a taxpayer to late-file, amend, or revoke an election that was otherwise required to be made under a provision that is prescribed by section 600 of the Income Tax Regulations (“Regulations”). The definition of electing contributor in subsection 94(1) is not a prescribed provision listed in section 600 of the Regulations.
Accordingly, there is no provision which would permit a contributor to be an electing contributor for an initial year, and all subsequent years, if the election is filed after the contributor’s filing-due date for that chosen initial year. However, this does not preclude a contributor from filing this election for a subsequent taxation year, assuming all conditions are met.
b) Electing Trust
The term electing trust is defined in subsection 94(1) and is applicable for section 94. In order for a trust to be an electing trust, it must meet the conditions outlined in the definition. In general, the conditions described in the definition include that the trust files the election described therein in writing with the Minister with the trust’s return of income for its first taxation year throughout which it is deemed by subsection 94(3) to be resident in Canada and in which it holds property that is at a time in the year part of its non-resident portion.
The courts have established that the meaning of the words “in the taxpayer’s return of income” are clear and unambiguous and therefore require that the election must be made in the original return of income. For instance, in Rezek et al v. The Queen et al, 2005 FCA 227, the Federal Court of Appeal opined (in paragraphs 113 - 115) that where an election is required to be filed in the taxpayer’s return of income for the year, such an election would not be considered late-filed if the election was filed with a return of income for that year that was late-filed. As well, the courts have held that where an election that is required to be filed with the return of income for the year is not filed with the return of income, the election would be late.
Therefore, it is our view that where the Act specifies that an election is required to be filed with the taxpayer’s return of income for the year, no other filing requirement or specified deadline should be read into the Act that does not appear.
As such, the election must be filed with the trust’s return of income for its first taxation year throughout which the trust is deemed by subsection 94(3) to be resident in Canada for the purpose of computing its income and in which it holds property that is at a time in the year part of its non-resident portion. Where the particular return of income is late-filed, as long as the election is filed with the return of income, the election would not be considered late. Where the election is not included with the return of income filed, the election would be considered late.
Subsection 220(3.2) provides the Minister the discretion to allow a taxpayer to late-file, amend, or revoke an election that was otherwise required to be made under a provision that is prescribed by section 600 of the Regulations. The definition of electing trust in subsection 94(1) is not a prescribed provision listed in section 600 of the Regulations.
Accordingly, unless an electing trust election is filed with the trust’s return of income for its first taxation year throughout which the trust is deemed by subsection 94(3) to be resident in Canada for the purpose of computing its income and in which it holds property that is at a time in the year part of its non-resident portion, there is no provision which would permit the election to be made.
Q.4 - Death and Tax Payment over 10 Years
The tax payable by a deceased individual related to certain income and gains (rights and things per subsection 70(2), and deemed dispositions per subsections 70(5) and 70(5.2)) may be, pursuant to subsection 159(5), paid in 10 annual installments provided the taxpayer’s legal representative so elects and furnishes the Minister with security acceptable to the Minister.
Can the CRA comment on what is acceptable security and what the recommended process should be to provide for such an arrangement?
The process for providing acceptable security in the situation described is initiated as outlined at the top of election form T2075 Election to Defer Payment of Income Tax, Under Subsection 159(5) of the Income Tax Act by a Deceased Taxpayer's Legal Representative or Trustee, which states:
This election is to be filed at the Tax Services Office in the area in which the taxpayer resided prior to death on or before the day on which payment for the first of the equal consecutive annual instalments is required to be made. Include a copy of this form with the return that contains the income subject to this election.
The CRA requires that Form T2075 be submitted twice - once on its own with the Tax Services Office in the area where the deceased taxpayer resided prior to death, and also attached to the tax return, which should be filed as directed in CRA publication T4011 Preparing Returns for Deceased Persons. Once filed, the election will be forwarded to a Collections Officer who will contact the legal representative of the deceased taxpayer’s estate in order to provide direction on, and facilitate the requirement to provide adequate security in fulfillment of the election.
The Collections Directorate, within the Collections and Verifications Branch of the CRA, recently revised its Information Circular IC98-IR8, Tax Collections Policies, which includes additional information on what constitutes acceptable security, and the hallmarks of acceptable security. The information and guidelines provided in the Information Circular are not meant to be exhaustive. Taxpayers or their representatives will discuss arrangements for security as part of the process for the election. For your convenience, we reproduce the relevant section of the Information Circular, which states:
Acceptable forms of security
Some types of security we may accept include bank letters of guarantee, standby letters of credit, or mortgages. Bank letters of guarantee or standby letters of credit should be provided by a Schedule | or Schedule II Canadian financial institution as defined in the Bank Act. Other forms of security can be accepted in certain circumstances. Acceptability of other forms of security is determined on a case by case basis, subject to the Minister’s discretion to accept security under subsection 220(4) of the Income Tax Act.
Acceptable security must be liquid (easily convertible to cash), equivalent or near equivalent to cash, and realizable on demand without defense or claim from third parties. Provisions under the Income Tax Act , the Excise Tax Act, the Excise Act, 2001, the Greenhouse Gas Pollution Pricing Act, the Softwood Lumber Products Export Charge Act, 2006, and the Air Travellers Security Charge Act determine when the CRA may, or must, accept security depending on your circumstances. For more information about the process to provide security for your debt, contact your collections officer. If you do not have a collections officer or cannot reach the collections officer, call us to discuss your options.
Q.5 - Trust and Debt Forgiveness
A Canadian resident trust makes a loan (the “Loan”) to a beneficiary. The beneficiary uses the Loan proceeds for investment. Later the trust distributes the Loan as an in specie capital or income distribution to the beneficiary.
Is the distribution of the Loan to the beneficiary a settlement of debt? If so, do the debt forgiveness rules under section 80 apply to the beneficiary for the “forgiven amount”?
If the beneficiary used the loan proceeds for personal purposes (e.g. to buy a principal residence), is the answer different?
For the purposes of our response, we have assumed that the trust qualifies as a “personal trust” within the meaning of that term in subsection 248(1) and that the trust’s taxation year ends on December 31, which coincides with the taxation year-end of the beneficiary. We have further assumed that the beneficiary of the trust is resident in Canada for the purposes of the Act.
We understand that the in specie capital or income distribution, as the case may be, is legally effective and is made to a capital or income beneficiary of the trust, as the case may be, in accordance with the terms of the trust indenture.
We also understand that the Loan is a bona fide loan made by the trust to the beneficiary and is capital in nature at the time of the distribution. We understand that the amount of principal and fair market value of the Loan is equal to the capital or income distribution, as the case may be.
The meaning of a settlement or extinguishment of an obligation is not defined in the Act. The determination of whether an obligation is settled or extinguished, whether there is payment and whether there is a forgiven amount resulting from its settlement or the extinguishment is a mixed question of fact and law and can only be determined on a case-by-case basis. Generally, where the qualities of creditor and debtor are united in the same person, the obligation would be extinguished under the doctrine of “merger” under the Common Law (or “confusion” under article 1683 of the Civil Code of Quebec), and thus would generally constitute a settlement of the obligation for the purposes of section 80.
For the purposes of our response, we understand that the Loan is extinguished in accordance with the applicable law as a result of the distribution of the Loan to the beneficiary under the doctrine of “merger” (or “confusion”, as applicable) and that the settlement of the Loan in such a manner does not constitute a “payment” by the beneficiary in satisfaction of the principal of the Loan within the meaning of the applicable law.
The “forgiven amount” defined in subsection 80(1) applies to a “commercial obligation” issued by a debtor. À “commercial obligation” issued by a debtor means (a) a commercial debt obligation issued by the debtor or (b) a distress preferred share issued by the debtor. A “commercial debt obligation” is a debt obligation for which an amount relating to interest paid or payable on the debt obligation, if any, is or would be deductible in computing the debtor’s income, taxable income or taxable income earned in Canada. In the present question, if the proceeds from the Loan are used by the beneficiary for investment purposes that meet the criteria for interest deductibility, the Loan would qualify as a “commercial debt obligation”. If the proceeds of the Loan are used by the beneficiary for personal use such as to buy a personal residence, the Loan would not be considered as a “commercial debt obligation”, so that the definition of the “forgiven amount” would not apply to the settlement of the Loan.
When a “commercial obligation” is settled, it must be determined whether it gives rise to a “forgiven amount”. A “forgiven amount” at any time is determined by the formula “A-B” under that definition in subsection 80(1). The element “A” of the formula is the lesser of the amount for which the obligation was issued and the principal amount of the obligation. The element “B” of the formula is the total of the amounts described in paragraphs (a) to (I) of that element “B”. Paragraph (a) of the element “B” includes any amount paid at the time the obligation is settled in satisfaction of its principal amount. In the fact situation described in your question, as we understand it, a settlement of the Loan does not constitute a payment in satisfaction of the principal amount of the obligation and would not constitute an amount described in paragraph (a), nor in any other paragraphs (b) to (1) of the element “B”. Therefore, a settlement of the obligation without any payment could give rise to a forgiven amount equal to element “A” in the said formula “A-B”.
In some specific situations, when a “commercial obligation” is extinguished under the doctrine of “merger” (or “confusion” as applicable) and it does not constitute a payment under the applicable law, the CRA adopts a long-standing position to consider that those situations will not give rise to a “forgiven amount” for the purposes of section 80. Based on the facts and assumptions as we understand them, we are of the view that the CRA’s long standing position would apply to the extinguishment of the Loan described in the present question.
Finally, we would like to point out that the taxpayer could structure the transactions in such a way that the legal documentation clearly demonstrates the payment of the Loan, so that the transactions do not raise uncertainty as to the application of section 80 in similar situations.
Q.6 - Acquisition of Control
Assume a Canadian corporation is wholly owned by a trust. Assume also that the trust document provides that the trustees of the trust can exercise discretionary power in the distribution of income and capital from the trust such that paragraph 256(7)(i) will not apply to deem there not to have been an acquisition of control if there is a change to the trustees of the trust. Is there an acquisition of control (giving rise to a loss restriction event for the Canadian corporation) in the following circumstances?
(a) The trust has one trustee, A, who resigns. B, who is related to A, takes over as trustee.
(b) The same circumstances as (a) except that A and Bare not related.
(c) The trust has two trustees, D and E. The trust document requires unanimous decision making. E resigns and is replaced by F. E and F are related.
(d) The trust has two trustees, D and E. The trust document requires unanimous decision making. E resigns and is replaced by G. E is not related to G.
(e) The trust has three trustees, H, | and J. The trust requires majority decision making. J resigns and is replaced by K. Each of H, I, J and K are not related.
Paragraph 256(7)(i) applies in circumstances in which a trust, at a particular time after September 12, 2013, controls a particular corporation and the trustee or other legal representative (the trustee) having ownership or control of the trust property (i.e., including shares of the capital stock of the particular corporation held by the trust) changes. Paragraph 256(7)(i) deems control of the particular corporation not to be acquired solely because of the change, provided that two additional conditions are met. The first additional condition requires that the change in trustees not be part of a series of transactions or events under which beneficial ownership of the trust property changes. The second additional condition requires that no amount of the income or capital of the trust to be distributed at or after the change in trustees be subject to a discretionary power.
Where paragraph 256(7)(i) does not apply, the Canada Revenue Agency’s position provided in response to a similar question at the 2011 STEP CRA Roundtable would continue to apply. Specifically, based on the decision in M.N.R v. Consolidated Holding Company Limited, where the majority of the voting shares of a corporation are held by a trust, it is the trustees of the trust who have the legal ownership of the shares, who have the right to vote those shares, and who, therefore, control the corporation. Where a trust has multiple trustees, the determination as to which trustee or group of trustees controls the corporation can only be made after a review of all the pertinent facts, including the terms of the trust document. However, in the absence of evidence to the contrary, we would consider there to be a presumption that all of the trustees would constitute a group that controls the corporation.
Given our position as summarized above, we would generally take the position that there would be an acquisition of control in each of the situations described in paragraphs (b), (d) and (e) of the question. With respect to paragraphs (a) and (c) of the question, paragraph 256(7)(a) may apply, where shares are acquired by a person related to the former trustee, to deem that there be no acquisition of control provided that the replacement trustee is appointed concurrently with the resignation of the former trustee.
Q.7 - Paragraph 88(1)(d.3) “as a consequence of the death of an individual”
Paragraph 88(1)(d.3) states that “for the purposes of paragraphs 88(1)(c), (d) and (d.2), where at any time control of a corporation is last acquired by an acquirer because of an acquisition of shares of the capital stock of the corporation as a consequence of the death of an individual, the acquirer is deemed to have last acquired control of the corporation immediately after the death from a person who dealt at arm's length with the acquirer”.
In 2010, the CRA issued an advance tax ruling described in document 2009-0350491R3 dealing with the availability of a section 88 bump to a series of transactions involving property owned by a subsidiary of an alter ego trust immediately after the death of the settlor. It was stated that among the reasons for granting the ruling was that the parent corporation seeking the bump, another subsidiary of the alter ego trust, acquired control of the subsidiary as a consequence of the death of the settlor of the alter ego trust because the shares of the subsidiary were acquired by the parent corporation pursuant to the terms governing the alter ego trust which imposed an equitable obligation on the trustees to transfer the shares of the subsidiary to the parent on the death of the settlor.
1. Does this continue to be CRA’s position and as a consequence the provisions of paragraph 88(1)(d.3) would apply to the parent in these circumstances?
2. Does the deemed reacquisition, pursuant to subsection 104(4), of the shares of a corporation wholly-owned by an alter ego trust on the death of the settlor of the alter ego trust result in an acquisition of control of the corporation by the alter ego trust as “a consequence of the death of an individual” for purposes of paragraph 88(1)(d.3)?
1. The CRA has not modified its views on the application of paragraph 88(1)(d.3) in the circumstances described in document 2009-0350491R3.
2. Where subsection 104(4) applies to deem a trust to have disposed of and reacquired shares of the capital stock of a wholly-owned corporation, the deemed reacquisition of the shares pursuant to this subsection would not, in itself, result in an acquisition of control of the corporation. While such shares are deemed, for tax purposes, to be reacquired by the trust at their fair market value, the shares continue to be legally owned by the trust. Thus, there is no transfer of the legal ownership of those shares in circumstances that would result in an acquisition of control.
Q.8 - TOSI and Multiple Businesses
Suppose that husband and wife reside in Canada and own a number of corporations each of which has its own business and full-time staff. They work on a full-time basis for the various companies, but do not work for any particular company at least 20 hours a week. In this circumstance, would dividends above a reasonable amount be subject to tax on split income (“TOSI”)? Assume the shares of the corporations do not qualify as excluded shares.
For the purposes of our response, it is assumed that each of the businesses described above is a “related business” - as that term is defined in subsection 120.4(1) — in respect of both spouses.
Under the TOSI rules in section 120.4, TOSI will apply to tax the “split income” of a “specified individual” at the highest marginal rate unless the amount is an “excluded amount” as these terms are defined in subsection 120.4(1).
Subparagraph (e)(ii) of the definition of “excluded amount” in subsection 120.4(1) provides that, in respect of an individual for a taxation year (if the individual has attained the age of 17 before the year), an amount that is derived directly or indirectly from an excluded business of the individual for the year is an excluded amount.
The definition of “excluded business” is set out in subsection 120.4(1). In general, a business is an excluded business of a specified individual for a taxation year if the specified individual is actively engaged on a regular, continuous and substantial basis in the activities of the business in either: (a) the taxation year ; or (b) any five prior taxation years of the specified individual.
Without limiting the generality of the “regular, continuous and substantial” test described above, paragraph 120.4(1.1)(a) also sets out a bright line test whereby a specified individual will be deemed to be actively engaged on a regular, continuous and substantial basis in the activities of a particular business in a taxation year of the individual if that individual works in the business at least an average of 20 hours per week during the portion of the year in which the business operates. This test requires that it be applied on a business by business basis.
With respect to the scenario provided in the question, since neither spouse works more than 20 hours in any business carried on by any of the particular corporations they own, the requirements of the bright line test in paragraph 120.4(1.1)(a) would not be met and, as such, it remains a question of fact as to whether either spouse would be considered to be actively engaged on a regular, continuous and substantial basis in the activities of each such business on the basis of the limited number of hours worked in each business.
Whether an individual has been actively engaged in the activities of a business on a “regular, continuous and substantial basis” in a particular year will depend on the circumstances, including the nature of the individual’s involvement in the business (i.e., the work and energy that the individual devotes to the business) and the nature of the business itself. The more an individual is involved in the management and/or current activities of the business, the more likely it is that the individual will be considered to participate in the business on a regular, continuous and substantial basis. Likewise, the more an individual’s contributions are integral to the success of the business, the more substantial they would be. Therefore, such a determination will depend on the facts and circumstances specific to each particular situation.
We have not been provided with sufficient facts to determine whether each business would be considered an excluded business of each spouse for the year.
Finally, where none of the safe harbour exclusions apply, whether the TOSI should apply is generally determined on the basis of whether the amount received is a “reasonable return” according to the specific factors applicable in the circumstances, including the work performed, the property contributed in support of the business, the risks assumed by the specified individual or a related individual, prior amounts received by them in respect of the business, and any other factor as may be relevant.
Q.9 - Section 43.1 - Life Estate
If a taxpayer transfers a remainder interest in real property to another person and retains a life estate in the property, subsection 43.1(1) will apply to the disposition as long as all conditions therein are satisfied. If, upon the death of an individual, the life estate to which subsection 43.1(1) applied is terminated:
- the holder of the life estate immediately before the death is, generally speaking, deemed pursuant to paragraph 43. 1(2)(a) to have disposed of the life estate for proceeds of disposition (“POD”) equal to the holder’s adjusted cost base (“ACB”); and
- the ACB of the property to the holder of the remainder interest is increased pursuant to paragraph 43. 1(2)(b), if the individual who held the life estate was not dealing at arm’s length with the holder of the remainder interest in the real property.
a) What provisions of the Act apply if, rather than transferring a remainder interest in a principal residence (the “Residence”) directly to an adult child (the “Child”), a parent (“Parent”) transfers the remainder interest to a personal trust under which the Child is a beneficiary?
b) If Parent later moves out of the Residence to live in an assisted-living residence and the Residence is sold prior to the death of Parent what provisions of the Act then apply? Does the ACB of the life estate stay with Parent, with no adjustment available to the trust? Alternatively, is the life estate considered to be a gift from Parent to the trust at the time of Parent’s relocation, thereby resulting in an increase in the ACB of the remainder interest to the trust?
Consider the following example:
- Parent transfers a remainder interest in the Residence to a personal, inter vivos trust (the “Trust”) and retains a life estate in the property;
- The Child is the only beneficiary under the Trust;
- At the time of the transfer of the remainder interest:
- the Residence has a fair market value (“FMV”) of $250,000;
- the life estate has a FMV of $50,000; and
- the remainder interest has a FMV of $200,000;
- Assume all conditions in the definition of “principal residence” contained in subsection 54(1) are satisfied and that Parent has never claimed the principal residence exemption on any other property;
- Parent later moves out of the Residence and willingly disposes of the life estate to the Trust to enable the sale of the Residence to a third party;
- The Residence is immediately sold to an arm’s length third party; and
- Atthe time of the sale, the Residence has a FMV of $400,000.
c) Does the answer change if Parent continues to live in the Residence while the remainder interest is held by the Trust and the Residence is not sold until after Parent’s death? Is the trust considered not to deal at arm’s length with Parent such that paragraph 43. 1(2)(b) will apply?
Pursuant to paragraph (c) of the definition of “disposition” in subsection 248(1), a disposition includes any transfer of property to a trust, other than a transfer described in paragraph (f) or (k). Therefore, when Parent transfers the remainder interest in the Residence to the Trust a disposition of property occurs.
Notwithstanding any other provision of the Act, subsection 43.1(1) applies any time a taxpayer disposes of a remainder interest in real property (except as a result of a transaction to which subsection 73(3) would otherwise apply or by way of a gift to a qualified donee) to another person and the taxpayer retains a life estate in the property. When subsection 43.1(1) applies, the taxpayer who disposes of the remainder interest in the real property is deemed:
- under paragraph 43.1(1)(a): to have disposed of the life estate in the property for POD equal to its FMV at that time; and
- under paragraph 43.1(1)(b): to have reacquired the life estate immediately after that time for a cost equal to the above POD.
Therefore, when Parent disposes of the remainder interest in the Residence to the Trust and retains a life estate, Parent will be deemed to have disposed of the life estate for POD equal to $50,000 and to have reacquired the life estate at a cost of $50,000.
Pursuant to paragraph 251(1)(a), Parent is deemed not to deal with the Child at arm’s length. Accordingly, Parent and the Trust are deemed pursuant to paragraph 251(1)(b) not to deal with each other at arm’s length because the Child is beneficially interested in the Trust.
Where a taxpayer has disposed of anything to a person with whom the taxpayer was not dealing at arm’s length for no proceeds or for proceeds less than FMV, or to any person by way of gift, paragraph 69(1)(b) will apply to the disposition. Whether a property is disposed of for no proceeds or by way of gift is a question of fact and law.
If, based on all the facts and surrounding circumstances, it is concluded that Parent has disposed of the remainder interest to the Trust for no proceeds or for proceeds less than FMV, subparagraph 69(1)(b)(i) will apply to the disposition. Parent will be deemed to have received POD equal to the FMV of the remainder interest at the time of its disposition to the Trust, which in the above example is $200,000.
Alternatively, if it is concluded that Parent has disposed of the remainder interest to the Trust by way of gift, subparagraph 69(1)(b)(ii) will apply and will yield the same result as subparagraph 69(1)(b)(i) for Parent as they will be deemed to have received POD equal to $200,000. Additionally, since the Trust has received the remainder interest by way of gift, the Trust will be deemed under paragraph 69(1)(c) to have acquired the remainder interest at a cost equal to its FMV, which is $200,000.
In the case of a principal residence as defined by section 54, provided the conditions therein are satisfied, any capital gain realized by Parent on the deemed disposition of the life estate and on the disposition of the remainder interest to the Trust would be sheltered by the principal residence exemption.
Subsection 43.1(2) will only apply to the termination of a life estate if subsection 43.1(1) applied to the life estate and said termination is caused by the death of an individual. In this case, Parent moves out of the Residence and the Residence is immediately sold by the Trust.
If Parent has disposed of the life estate to the Trust for no proceeds or for proceeds less than FMV, subparagraph 69(1)(b)(i) will apply to the disposition and will deem Parent to have received POD equal to the FMV of the life estate at the time of its disposition to the Trust. If the life estate was disposed of to the Trust by way of an inter vivos gift, subparagraph 69(1)(b)(ii) would apply to deem Parent to have received POD equal to the FMV of the life estate and paragraph 69(1)(c) would deem the Trust to have acquired the life estate at a cost equal to that FMV.
Where the FMV of the life estate has increased from the time of the deemed disposition to which subsection 43.1(1) applied, Parent may realize a further gain on the disposition thereof. Alternatively, where the FMV of the life estate has decreased and Parent incurs a loss on the subsequent disposition of their life estate, the loss would be denied by subparagraph
40(2)(g)(iii) since the loss is from the disposition of personal-use property as defined in section 54.
When a life estate to which subsection 43.1(1) applied is terminated by the death of an individual, paragraph 43.1(2)(a) will apply. Pursuant to paragraph 43.1(2)(a), Parent will be deemed to have disposed of the life estate immediately before their death for POD equal to their ACB of the life estate immediately before the death.
As explained above, Parent and the Trust are deemed under paragraph 251(1)(b) not to deal with each other at arm’s length. Therefore, paragraph 43. 1(2)(b) will also apply to the termination of the life estate. As such, an amount will be added to the ACB of the Residence equal to the lesser of:
- the ACB of the life estate in the property immediately before the death; and
- the amount, if any, by which the FMV of the property immediately after the death exceeds the ACB to the Trust of the remainder interest immediately before the death.
To determine whether a trust can claim the personal residence exemption, refer to paragraphs 2.65 to 2.68 of Income Tax Folio S1-F3-C2, Principal Residence.
Q.10 - Taxation Year-End of a Trust
When a trust winds up and ceases to exist, does the taxation year of the trust end at that time or does its taxation year continue until the time of its normal year-end? For an inter vivos trust the normal taxation year-end would be December 31 and for a graduated rate estate (GRE) (in its first 36 months) that year-end would be the end of the fiscal period adopted.
The Act is specific in certain provisions in deeming a year-end to arise (e.g. for alter ego, spousal and joint spousal trusts, a testamentary trust that ceases to be a GRE, and when a trust becomes or ceases to be resident in Canada). The Act is silent on this point in the general case.
The T3 Guide states that when a GRE winds up, a taxation year-end occurs on the date of the final distribution of its assets.
Can CRA explain the rationale for this?
Subsection 249(1) defines a taxation year for purposes of the Act and applies except as otherwise provided.
As was noted in our response to Question 3 of the 2018 STEP CRA Roundtable , paragraph 249(1)(b) defines a taxation year of a GRE to be the period for which the accounts of the estate are made up for purposes of assessment under the Act. Paragraph 249(1)(b), when combined with subsection 249(5), causes the taxation year to cease when the period of accounts ends. In the year of wind up, the last period for which the accounts of the trust would have been made up would presumably end on the final distribution of the trust assets.
Paragraph 249(1)(c) defines, for purposes the Act, a taxation year of a trust, other than a GRE, to be a calendar year. In the year that such a trust is wound up and the final distribution of assets occurs, there is no provision that would cause the taxation year to be a period other than a calendar year, regardless of when the period of accounts cease.
Q.11 - Joint Spousal or Common-law Partner Trust
At the 2021 STEP CRA Roundtable, the CRA confirmed that a joint spousal or common-law partner trust may be created with a contribution of jointly-owned property by an individual and the individual’s spouse or common-law partner.
We have two questions.
a) Once the joint spousal or common-law partner trust is created, can further contributions be made by the spouses or common-law partners at any time, in any form? For example, we assume the contributions are not limited to the initial settlement or to only jointly-owned property.
b) How is income computed in respect of the contributed property where subsection 75(2) is applicable? For example, assume that subsequent to the initial contribution by Spouse A and Spouse B, they contribute portfolios X and Y, respectively, to a joint spousal trust. Assume both Spouse A and Spouse B are discretionary capital beneficiaries such that subsection 75(2) applies to both of them.
In our response to Question 12 of the 2021 STEP CRA Roundtable, we stated that 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). Further, we indicated that 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).
As such, where a joint spousal or common-law partner trust is created by the contribution of jointly-owned property by spouses or common-law partners, contributions are not limited only to the initial settlement of the trust or to only jointly-owned property. With respect to contributions made subsequent to the initial contribution, a transfer of property held solely by either spouse or common-law partner, or a transfer of property jointly held by both spouses or common-law partners, to the joint spousal or common-law partner trust would be eligible for the rollover provided in subsection 73(1).
Subsection 75(2) is an attribution rule applicable in respect of trusts factually resident in Canada and created since 1934. The rule generally applies where property is held by such a trust on condition that:
- the property, or property substituted for it, may revert to the person from whom it was directly or indirectly received, or pass to persons determined by that person subsequent to the creation of the trust, or
- during the existence of the person, the property may be disposed of only with the person’s consent or in accordance with the person’s direction.
When either of these conditions is met, any income or loss from or taxable capital gain or allowable capital loss in respect of the property, or property substituted for it, is attributable to that person while resident in Canada. Accordingly, any amounts attributable are determined in respect of a particular property, or property substituted for that property.
As such, in the situation described in the example whereby Spouse A transfers the investments in portfolio X to a joint spousal trust, any income or loss from the investments in portfolio X or from property substituted for the investments in portfolio X, and any taxable capital gain or allowable capital loss from the disposition of the investments in portfolio X or of property substituted for the investments in portfolio X, will be deemed to be income or a loss, as the case may be, ora taxable capital gain or allowable capital loss, as the case may be, of Spouse A. Such amounts will continue to be attributable to Spouse A as long as the investments in portfolio X transferred by Spouse A, or property substituted for any of those investments, continue to be held by the trust and while Spouse A is resident in Canada.
Similarly, any income or loss from the investments in portfolio Y or from property substituted for the investments in portfolio Y, and any taxable capital gain or allowable capital loss from the disposition of the investments in portfolio Y or of property substituted for the investments in portfolio Y, will be deemed to be income or a loss, as the case may be, or a taxable capital gain or allowable capital loss, as the case may be, of Spouse B. Similar to above, as long as the investments in portfolio Y transferred by Spouse B, or property substituted for any of those investments, continue to be held by the trust and while Spouse B is resident in Canada, such amounts will continue to be attributable to Spouse B.
Additionally, 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.
Q.12 - Sale to Alter Ego Trust
A transfer of capital property to an alter ego trust by the settlor occurs at cost absent an election for the transfer to occur at fair market value.
Given such, consider the following short fact pattern. A settlor settled an alter ego trust (the “Trust”) a few years ago. The trust agreement provides that the settlor is not entitled to receive or otherwise obtain the use of any of the capital of the Trust during their lifetime. The Trust has cash. The settlor later transfers appreciated non-depreciable capital property (the “Transferred Property”) to the Trust in exchange for cash. The acquisition of property by the Trust is consistent with the terms of the Trust. Does CRA agree that the Transferred Property will be deemed to have been disposed of by the settlor for proceeds equal to their adjusted cost base to the settlor (absent an election to the contrary) even though the settlor received payment?
If the settlor later gifts the cash, say to an adult child, does this alter the answer?
Pursuant to subsection 73(1), 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:
1. at the time of the transfer of property, both the transferor of the property and the transferee must be resident in Canada;
2. the transferor must not elect out of the rollover rule; and
3. subsection 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)(ii), such that the individual is entitled to receive all the income of the trust arising before the individual’s death and no person except that individual may receive or otherwise obtain the use of any of the income or capital of the trust before that individual’s death.
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)(ii). Generally:
- the trust must be created after 1999;
- the individual must be at least 65 years of age at the time the trust is created, or, the transfer of property by the individual must involve no change in beneficial ownership of the property and no person (other than the individual) or partnership has any absolute or contingent right as a beneficiary under the trust (determined with reference to subsection 104(1.1)); and
- the trust does not make an election under subparagraph 104(4)(a)(ii.1).
A trust described in subparagraph 73(1.01)(c)(ii) that meets all of the relevant conditions outlined above will generally be an “alter ego trust” as defined in subsection 248(1).
The term “transfer” has a broad meaning that encompasses virtually any means by which ownership or title to property is conveyed from one person to another, or to a trust. It therefore includes a sale of property, whether or not it was made at fair market value.
Further to the above, subsection 73(1) sets out the rules for determining a taxpayer’s proceeds of disposition and the transferee’s cost of acquisition when capital property is transferred from a taxpayer to an alter ego trust. Thus, assuming that the requirements of subsection 73(1) are otherwise met, and that the trust agreement allows for such a sale, the proceeds of disposition of the Transferred Property would be deemed to be equal to the adjusted cost base of the capital property to the taxpayer immediately before the transfer. Further, the Trust would be deemed to have acquired the Transferred Property at that time for an amount equal to such proceeds of disposition.
Provided that the sale of the Transferred Property is complete, our response would not differ if the settlor subsequently gifts the cash to an adult child.
Q.13 - Subsection 164(6) - Amending Deceased’s Final T1 Return
Subsection 164(6) allows capital losses of a graduated rate estate in its first taxation year to be considered capital losses of the deceased, where all required conditions are met. Such conditions include that the estate is a graduated rate estate (“GRE”), an election is filed, and the legal representative amends the deceased’s final T1 return of income.
a) In amending the deceased’s final T1 return of income, is the filing of a T1 Adjustment Request sufficient?
b) Assume a refund results from the application of the election under subsection 164(6). When does interest begin to accrue on the refund?
a) Subsection 164(6) allows the legal representative that is administering the GRE of a deceased taxpayer to elect to have all or part of the GRE’s capital losses (to the extent they exceed its capital gains) that are realized in its first taxation year to be deemed to be capital losses of the deceased. The election, which results in the carry back of the elected amount to the final T1 return of the deceased, can be useful in addressing potential double taxation which may arise on death.
To make the election, paragraph 164(6)(e) requires the legal representative to file an amended final T1 return of income for the deceased taxpayer to give effect to the election made under paragraph 164(6)(c). As such, filing aT 1-ADJ, T1 Adjustment Request, is not sufficient. When filing the amended final T1 return, the legal representative must clearly identify the amended return of the deceased person as a “ 164(6) election”. For more information, see pages 32 and 33 of T4013, T3 Trust Guide 2021.
b) Any refund arising from the subsection 164(6) election will be paid out to the deceased’s legal representative (estate executor) in respect of the final T1 return of the deceased taxpayer. Given that such an election shifts the losses available to be deducted from the GRE to the final T1 return, it would not give rise to a refund in respect of the GRE.
The portion of any overpayment of the tax payable by a deceased taxpayer for a taxation year that arose as a consequence of the deduction for losses relating to an election under paragraph 164(6)(c) or 164(6)(d) by the taxpayer’s legal representative, is deemed to have arisen (and as a result, refund interest would start) on the day that is 30 days after the latest of:
- the first day immediately following the subsequent taxation year,
- the day on which the return of income for that subsequent taxation year was filed, and
- the day on which the amended return was filed under paragraph 164(6)(e).
Q.14 - Information on new T3 EFILE process
Can the Canada Revenue Agency (CRA) provide us with additional information about their new service which allows users to file a T3 return via EFILE?
The 2018 Federal Budget proposed that certain trusts will be required to file a T3 return annually and to provide beneficial ownership information. Based on the draft legislative proposals released for public comment on February 4, 2022, by the Department of Finance, these proposed new reporting requirements will be applicable for tax years that end on or after December 31, 2022. As a result, some trusts will be required to file a T3 return where previously they did not. Therefore, the volume of T3 returns is expected to increase significantly. In preparation, the CRA is in the process of modernizing how T3 returns are electronically filed shifting from XML Internet File Transfer to EFILE. The recently published RC4657, T3 Electronic Filers Manual, available on the Government of Canada website, provides supplementary information to tax preparers for the completion and submission of the electronic T3 return using the T3 EFILE service.
The Canada Revenue Agency's EFILE web service is now accepting transmissions of T3 returns (currently limited to only 2021 and subsequent tax years T3RET, T3S, T3M, T3RCA & T3ATH-IND return types) and T1135 Foreign Income Verification Statements. Refer to the T3 EFILE Information web page for the current list of certified software products. The CRA will continue to update this page as additional software is certified.
Refer to the How to file a T3 return web page on the Government of Canada website, which includes information regarding the Trust Account Registration online service. Filers are required to have a trust account number before they are eligible to EFILE. This page also includes a list of the different types of T3 returns that can be filed via EFILE, and contains a link to more information on EFILE for electronic filers.
Q.15 - Meaning of Habitual Abode in Canadian Tax Treaties
As you know, Canada’s extensive treaty network contains residency “tie-breaker” provisions -usually in Article IV:2 of most of the treaties. For example, in the Canada-US treaty, the residency “tie-breaker” rule is indeed in Article IV:2. Paragraph (b) of the provision states:
“...if the Contracting State in which he has his centre of vital interests cannot be determined, he shall be deemed to be a resident of the Contracting State in which he has an habitual abode;”
Can the CRA comment on its views of what an habitual abode is of an individual and what factors the CRA reviews to make a determination?
Under Canadian domestic law, an individual may be a factual resident or deemed resident of Canada, both of which are liable to tax in Canada on worldwide income. Although the term “resident” is not defined in the Act, its meaning has been determined by the Courts. The leading decision on the meaning of resident is Thomson v. Minister of National Revenue,  S.C.R. 209, 2 DTC 812. In this decision, Rand J. of the Supreme Court of Canada held residence to be“a matter of the degree to which a person in mind and fact settles into or maintains or centralizes his ordinary mode of living with its accessories in social relations, interests and conveniences at or in the place in question.” To determine factual residence of an individual, all of the relevant facts in each case must be considered, including residential ties with Canada and length of time, object, intention and continuity with respect to stays in Canada and abroad. For greater clarity, the CRA has split residential ties into three main categories: significant residential ties, secondary residential ties, and other residential ties. Significant residential ties include an individual’s dwelling place(s), spouse or common law partner, and dependents. Secondary residential ties include personal property, social ties, and economic ties. Other residential ties include a Canadian mailing address, post office box, or safety deposit box, but are generally of limited importance except when considered together with other factors. If an individual is not considered a factual resident of Canada based on residential ties, they may still be considered a deemed resident under subsection 250(1).
If it is determined that an individual is a resident of Canada as well as a resident of another country, then the “residency tie-breaker” provision under Article IV:2 of the treaty between the two countries, if any, may apply. Under the Canada-US treaty, the term “resident” includes an individual who is liable to tax by reason of that individual’s domicile, residence, or citizenship. When applying the “residency tie-breaker” tests in Article IV:2, they are applied in order, starting with paragraph (a), which considers where the individual has a permanent home. If that test is not determinative because the individual does not have a permanent home in either country, or the individual has a permanent home in both countries, then the second test, relating to the individual’s centre of vital interests, under paragraph (b), is considered. This test looks at personal and economic ties the individual has in each country and will usually determine an individual’s residence, if it has not yet been determined through a previous step. If the individual’s centre of vital interests cannot be determined, only then is the individual’s habitual abode, under paragraph (c), considered.
The same progression of “tie-breaker” tests is found in most of Canada’s treaties as they mirror the tests found in the Organization for Economic Co-operation and Development (“OECD”) Model Tax Convention on Income and on Capital (“Model Treaty”).
The objective of the “habitual abode” test can generally be described as identifying where the individual usually lives. For individuals who have a permanent home in both countries, or in neither, and where the centre of vital interests is not determinative, stays in all countries must be considered to identify where the individual usually or habitually abides. In gauging the stays in a country, the nature of the individual’s activities at the location(s) in a country may also aid in establishing where the individual’s usual or habitual abode is. The stays in a country must be gauged over a sufficient period of time to identify where the individual usually lives. This period of time should be one that is reasonable and appropriate in the circumstances and is not necessarily limited to a specific period, such as a calendar year. For additional information regarding determining an individual’s residence status, see Income Tax Folio S5-F1-C1, Determining an Individual’s Residence Status. Additional information on the habitual abode test can also be found in the official commentary to Article 4 of the OECD Model Treaty (paragraphs 19-20).
Q.16 - Foreign Entity Classification of a Foundation
In civil law countries a foundation is often used where the trust concept is not recognized. The foundation typically will have a founder who created the foundation (similar to a settlor), a foundation council with a role similar to that of trustees, and beneficiaries who may have a discretionary entitlement.
Does CRA have a view on how a foundation created under the laws of a country where civil law applies would be considered under the Act?
The CRA’s approach to the classification of a foreign entity or arrangement in respect of a property, venture or other object (collectively referred to in this response as the “foreign entity or arrangement”) remains the same as indicated in prior years. That is, to determine the status of an entity or arrangement for Canadian tax purposes, the CRA generally follows the two-step approach described below:
1) Determine the characteristics of the foreign entity or arrangement under applicable foreign law, relevant constating documents, indentures, partnership agreement, contracts and other relevant terms or documentation (the “applicable law and documentation”).
2) Compare these characteristics with those of recognized categories of entity or arrangement under relevant Canadian law in order to classify the foreign entity or arrangement under one of the categories around which the provisions of the Act and the Income Tax Regulations are drafted.
As part of this two-step approach, the CRA examines the nature of the relationship between the various parties that are involved and their rights and obligations in respect of the foreign entity or arrangement under the applicable law and documentation.
The two-step approach was applied in prior interpretations on the classification of a foundation created under the laws of a foreign country where civil law applies. These interpretations were issued after a careful examination of the applicable law and documentation. Consistent with the round table response (Question 8) presented by the CRA on May 17, 2022 at the International Fiscal Association Conference, the CRA would consider the classification of a foreign foundation in the context of an advance income tax ruling supported by the information described in that response.
Q.17 - Deceased Taxpayer and Stock Options
On death, an individual holding stock option rights is deemed to have disposed of those rights immediately before death - pursuant to paragraph 7(1)(e) - at the value of those rights immediately after death.
CRA has stated in views 2009-032722117 and 2011-0423441E5 that the 50% deduction allowed under paragraph 110(1)(d) is not permitted to a deceased taxpayer.
Since providing the views above, paragraph 110(1)(d) has been amended to make specific reference to paragraph 7(1)(e) (see subparagraph 110(1)(d)(i)).
Does CRA agree that the 50% deduction is now allowed by a deceased pursuant to the amendment?
The CRA agrees that as a result of the 2017 amendments to paragraph 110(1)(d) the deduction is now available to a deceased taxpayer in circumstances where paragraph 7(1)(e) applies, provided that all of the conditions of paragraph 110(1)(d) are met.
The 2017 amendments also included consequential amendments to subsection 110(1.1) (employer election to forego deduction) to ensure its proper application in circumstances where paragraph 7(1)(e) applies.
Q.18 - McNeeley et al v. The Queen
The Federal Court of Appeal recently confirmed the decision of the Tax Court of Canada in McNeeley et al v. The Queen (2021 FCA 218 affirming 2020 TCC 90) and the Supreme Court of Canada dismissed the taxpayer’s application for leave to appeal (2022 CanLII 42894). A key issue before the Courts was whether a trust established for the benefit of employees was an employee benefit plan (“EBP”), as defined in subsection 248(1) or a prescribed trust pursuant to paragraph (a) of Regulation 4800.1.
The Federal Court of Appeal’s decision seems to demonstrate the need for employers and their tax advisors to exercise care in structuring employee trust arrangements as the tax outcome for the employees who are beneficiaries of such a trust can be very significantly impacted, depending on how the arrangement is structured. Could the CRA provide comments?
The decisions rendered by the Federal Court of Appeal and Tax Court in this case were in respect of the appeals by three appellants, which were heard on common evidence. Each of the three individuals appealed reassessments by CRA of their 2012 personal returns, in which amounts were included in their income in respect of the shares that they received from a trust that held shares of their employer. The assessments were made on the basis that CRA had concluded that the Stock Trust was an EBP under the Act.
In general terms, an EBP, as defined in subsection 248(1), is an arrangement in which contributions are made by an employer, or by a person not dealing at arm’s length with the employer, to a custodian and under which payments are to be made to or for the benefit of employees or former employees of the employer, or for persons not at arm’s length with the employees/former employees. Under paragraph 6(1)(g), amounts received by an employee from an EBP are included in income as a benefit from employment.
In contrast, a prescribed trust under paragraph (a) of Regulation 4800.1 is a trust maintained primarily for the benefit of employees of a corporation, where one of the main purposes of the trust is to hold interests in the shares of the corporation. Such trusts are prescribed for the purposes of specific provisions of the Act, namely paragraph 107(1)(a) and subsections 107(1.1), (2) and (4.1).
The relevant facts
The facts in this case are relatively straightforward and not uncommon, and can be briefly summarized as follows:
One of the appellants was the founder (“Founder”) and president of a Canadian company (“Employer”), as well as its sole shareholder until 2006. The other two appellants were employees.
In 2005 the Founder’s mother contributed cash to settle a trust established to acquire and hold securities of the Employer for the benefit of certain full-time employees of the Employer and its affiliates (the “Stock Trust”).
The trustees of Stock Trust were required to allocate and distribute shares to the beneficiaries in any manner and proportion as they, in their absolute and sole discretion, might determine.
In 2006 the Stock Trust subscribed for common shares of Employer for a nominal cash amount. Between that time and 2012, the shares held by Stock Trust were exchanged for different shares as a result of certain reorganization and freeze transactions.
In 2012, the Stock Trust distributed the shares it held, which by that time had significant accrued gains, to various beneficiaries including Founder, in two tranches. An election was made pursuant to subsection 107(2.001) to apply subsection 107(2.1) in respect of the share distributions to beneficiaries other than the first share distribution to Founder, and tax filings were made on the basis that a subsection 107(2) rollover applied to the first share distribution made to him. The resulting taxable capital gains realized by the Stock Trust in respect of the distributions were allocated to the other beneficiaries on a pro-rata basis.
Founder transferred the shares he received on the first distribution, which was by far the larger of the two distributions he received, to a numbered corporation owned by him on a subsection 85(1) rollover basis, but reported a taxable capital gain in respect of the second smaller distribution to him. The other two appellants claimed the capital gains deduction in respect of the taxable capital gains that were allocated to them and also sold the shares they received to the numbered corporation owned by Founder.
The issues considered in the case
The issues which the Tax Court had to consider included the following:
1. Was the Stock Trust an EBP or a prescribed trust pursuant to paragraph (a) of Regulation 4800.1?
2. If the Stock Trust was both an EBP and a prescribed trust, did the prescribed trust rules take precedence over the EBP rules?
The appellants asserted that the amounts they received from Stock Trust were trust capital distributions from a prescribed trust, and that a rollover pursuant to subsection 107(2) applied to the first distribution to the Founder. In addition, based on that assertion that the Stock Trust had realized taxable capital gains in respect of the other share distributions, it flowed those gains out to the beneficiaries, who in turn claimed capital gains deductions pursuant to subsection 110.6(2.1), if they were eligible to.
The Crown argued on behalf of the CRA that the appellants had received the shares as EBP distributions and not from a prescribed trust, so the fair market value of what was received had to be included as income from an office or employment pursuant to paragraph 6(1)(g). Furthermore, pursuant to subparagraph 107.1(b)(i), the Stock Trust would be deemed to have disposed of the shares at cost amount, thus realizing no capital gains at the trust level. This would preclude capital gains treatment in regard to the shares distributed, and by extension, claims for the capital gains deduction by the employees.
Federal Court of Appeal
The Federal Court of Appeal agreed with the Tax Court that the arrangement was an EBP but noted that it also satisfied the requirements for a prescribed trust. On behalf of a unanimous Court, Mr. Justice Wyman Webb noted that while the definitions of EBP and prescribed trust overlapped in this case, they do not always overlap and that it is possible to create an EBP which is not a prescribed trust and vice versa.
Since the Stock Trust was an EBP and also met the requirements to be a prescribed trust, it was necessary to determine which set of rules governed the tax treatment of shares distributed to the employees. The employees reported their income on the basis that the Stock Trust was a trust for purposes of section 107. Under the “trust” definition in subsection 108(1), however, a trust for purposes of various sections of the Act, including section 107, does not include an EBP. Since the Stock Trust was an EBP, it could not be a trust for purposes of section 107 and therefore the capital gains treatment reported by the employees was unavailable.
The Court acknowledged that there was a clear conflict between the provisions of the Act governing EBPs and the prescribed trust rules which could not be reconciled as the tax consequences were significantly different depending on how the arrangement was characterized. However, since the EBP definition was set out in the Act and the prescribed trust definition is set out in the Regulations, the paramountcy doctrine required that the EBP rules governed.
Some key considerations from the decision
When contemplating the establishment of a trust which will acquire securities of an employer to be held for the benefit of employees, consideration of the EBP rules is advised. If the intent is that the trust be governed by section 7, so as not to be treated as an EBP, then care must be taken to ensure that the requirements to be a section 7 trust are met. As noted in CRA technical interpretation 2016-064184117, a trust arrangement that provides for allocations and distributions of employer shares on a fully discretionary basis would not be governed by section 7.
If the arrangement is found to be an EBP, any distributions of shares to the employee beneficiaries will be included in their income at their fair market value as income from an office or employment pursuant to paragraph 6(1)(g), with no rollover available, and the employee beneficiaries will not be able to claim a capital gains deduction in respect of the growth in the value of the shares up to the time they are received.
1 We gratefully acknowledge the following CRA personnel who were instrumental in helping us prepare for the Roundtable: Stéphane Charette, Mélanie Beaulieu, Phil Kohnen, Kim Duval, Irina Schnitzer, Aleksandra Bogdan, Dawn Dannehl, Katie Campbell, Katie Robinson, Laura Monteith, William King, Stephane Prud’homme, David Palamar, Urszula Chalupa, Jean Lafreniére, Tobias Witteveen, Nathalie Aubin, Linda Do, Daryl Boychuk, Yves Moreno, Lori Carruthers, Yves Grondin, Alison Spiers, Cindy Yan, Chris Deutsch, Roger Dhillon, Justin Lawson, Marco Cadorette, and Tera Capps.
2 Determined in subsection 104(21.3).
3 The designation is also subject to paragraph 132(5.1)(b).
4 Defined in subsection 110.6(1).
5 Although amounts designated by a personal trust under subsection 104(21.2) are for the purpose of section 3 as >it applies for the purposes of section 110.6; the LCGE available to an individual in a particular taxation year is >determined pursuant to subsections 110.6(2), (2.1) and (2.2).
6 Or a trust referred to in subsection 7(2).
7 Defined in subsection 108(1).
8 Or C/E, if computing the designation for QFFP TCGs.
9 and C/E.
10 In clause 104(21.2)(b)(ii)(A) Element C is the amount that would be determined for the trust under paragraph 3(b) for the designation year if the only properties referred to in that paragraph were QFFP.
11 Similarly, where the trust only has QFFP gains and no QSBCS gains, the fraction C/E will produce a result of 1.
13 For purposes of the transfer under subsection 73(1), these trusts are described in subparagraph 73(1.01)(c)(i), and clauses (c)(iii)(A) and (c)(iii)(B).
15 Except in respect of an amount described in paragraph (e) of the definition “split income”.
16 Pursuant to paragraph (a) of the definition of “property” in subsection 248(1), property includes a right of any kind whatever, a share or a chose in action.
17 According to the definition contained in section 54, personal-use property includes property owned by the taxpayer that is used primarily for the personal use or enjoyment of the taxpayer or for the personal use or enjoyment of one or more individuals each of whom is: the taxpayer, a person related to the taxpayer or where the taxpayer is a trust, a beneficiary under the trust or any person related to the beneficiary.
18 For example subsections 149(10), 249(4), 104(13.4), 128.1(1) and 128.1(4) all provide for a deemed year-end in respect of a trust. This is not an exhaustive list however.
21 An election can also be made in respect of a terminal loss of the GRE pursuant to paragraph 164(6)(d).
23 See paragraph 164(3)(d) and paragraphs 164(5)(d), (i), (j) and (k).
24 The EFILE for electronic filers web page on the Government of Canada website includes information regarding T3 EFILE including links to T3 EFILE exclusions and the T3 EFILE certified software web page.