2001 Ruling 1999-0013123 - Distribution of Property From Trust

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

1. Where the terms of the testator's Last Will name a specific charity as a residual beneficiary of the testator's estate, can the executor of the estate cause a corporation that is wholly owned by the estate to make a donation to the charity and claim a tax credit under 110.1(1)(a)?

2. Will GAAR apply to the proposed transactions?

3. Will the payments pursuant to the settlement agreement by the estate to the child of the deceased be considered benefits as described in subsection 105(1)?

4. Since a payment made by the charity pursuant to the terms of the settlement agreement to a potential beneficiary of the estate would not constitute a proper use of the charity's resources, is it appropriate to amend the settlement agreement?

Position:

1. Yes.

2. No.

3. No.

4. Yes.

Reasons:

1. The executor was given broad powers by the Last Will, including the power to take any action in relation to the corporation that he considered to be in the best interests of the estate.

2. This issue was considered by the GAAR Committee.

3. The recipient of payments from the estate had launched legal suits in challenge of the Last Will. The claims were viewed by the charity, the named beneficiary of the estate, as having merit and accordingly an out-of-court settlement was concluded. As the child will receive payments as compensation for settlement of the legal action she had commenced against the estate, the payments are not benefits pursuant to subsection 105(1).

4. Although the settlement agreement committed the charity to making a certain payment, the charity would not be misusing its resources until an actual payment was made. It is appropriate to permit an alternative arrangement that does not offend the rules governing charities.

XXXXXXXXXX 								1999-001312
							(992493)
XXXXXXXXXX, 2001

Dear XXXXXXXXXX:

Re: XXXXXXXXXX (the "Estate")

This is in reply to your letter of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the Estate. We acknowledge the numerous written submissions which we received and the related telephone conversations.

To the best of your knowledge and that of your clients, none of the issues involved in this ruling is:

(i) in an earlier return of the Estate or a related person,

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the Estate or a related person,

(iii) under objection by the Estate or a related person,

(iv) before the courts, or

(v) the subject of a ruling previously issued by the Directorate to the Estate or a related person.

Income Tax Act Definitions

The following terms have the meanings specified:

"Act" means the Income Tax Act, R.S.C. 1985, c.1 (5th Supp.), as amended, and unless otherwise stated, every reference herein to a section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

"adjusted cost base", as defined in section 54;

"allowable capital loss", as defined in paragraph 38(b);

"capital dividend account", as defined in subsection 89(1);

"capital dividend", as described in section 83;

"capital gain", as defined in paragraph 39(1)(a);

"capital loss", as defined in paragraph 39(1)(b);

"capital property", as defined in section 54;

"charitable organization", as defined in subsection 149.1(1);

"disposition", as defined in section 54;

"official receipt", as defined in section 3500 of the Income Tax Regulations;

"paid-up capital", as defined in subsection 89(1);

"proceeds of disposition", as defined in section 54;

"registered charity", as defined in subsection 248(1);

"spouse trust" means a trust described in paragraphs 70(6)(b) and 104(4)(a);

"taxable Canadian corporation", as defined in subsection 89(1);

"taxable capital gain", as defined in paragraph 38(a);

"taxable dividend", as defined in subsection 89(1);

"undepreciated capital cost", as defined in subsection 13(21);

"valuation day", as defined in section 24 of the Income Tax Application Rules;

Other Terms

"Amalco" means the corporation formed as a result of the amalgamation of Newco and the Corporation;

"Apartment" means the apartment building and land owned by the Corporation;

"Charity" means XXXXXXXXXX;

"Child A" means XXXXXXXXXX;

"Child B" means XXXXXXXXXX;

"Class A Shares" refers to the class A common shares of the Corporation, as defined in 10 below;

"Class B Shares" refers to the class B common shares of the Corporation, as defined in 10 below;

"Corporation" means XXXXXXXXXX;

"Estate" means the trust created by the Will;

"Family Trust" means the XXXXXXXXXX;

"Final Payment" is described in 46 below;

"Initial Donation" is described in 39 below;

"Interim Payment" is described in 42 below;

"Late Husband" means XXXXXXXXXX, the settlor of the Estate;

"Late Wife" means XXXXXXXXXX;

"Newco" means XXXXXXXXXX;

"No Par Value Shares" means common shares of Newco having no par value, as described in 28 below;

"Par Value Shares" means common shares of Newco having a par value, as described in 29 below;

"Purchaser" means XXXXXXXXXX;

"Remaining Donation" is described in 43 below;

"Sale Agreement" means the contract of purchase and sale referred to in 36 below;

"Settlement Agreement" means the Deed of Compromise and Settlement entered into on or about XXXXXXXXXX by Child A, Child B, the executors of the Will of the Late Husband, the Late Wife and the Charity;

"Supplemental Agreement" means the agreement among Child A, the Trustee and the Charity amending the rights under the Settlement Agreement;

"Trustco" means XXXXXXXXXX;

"Trustee" means the trustee of the Estate, XXXXXXXXXX, a nephew of the Late Husband; and

"Will" means the Last Will and Testament of the Late Husband.

Facts

1. The account number of the Estate is XXXXXXXXXX. Its address is XXXXXXXXXX. It files its income tax returns with the XXXXXXXXXX.

2. The account number of the Charity is XXXXXXXXXX. Its address is XXXXXXXXXX. It files its information returns with the XXXXXXXXXX Tax Services Office.

3. The social insurance number of Child A is XXXXXXXXXX. Her address is XXXXXXXXXX. She files her income tax returns with the XXXXXXXXXX Tax Services Office.

4. The business number of the Corporation was XXXXXXXXXX. It filed its income tax returns with the XXXXXXXXXX Taxation Centre.

5. The Charity is a registered charity and a charitable organization.

6. The Late Husband died XXXXXXXXXX. He was a resident of Canada at that time.

7. The Late Wife died XXXXXXXXXX. She was the wife of the Late Husband at the time of his death.

8. Child A and Child B are the daughters of the Late Husband XXXXXXXXXX.

9. The Corporation was incorporated on XXXXXXXXXX under the laws of XXXXXXXXXX. The Corporation's normal taxation year-end was XXXXXXXXXX. The Corporation was, at all relevant times, resident in Canada and a taxable Canadian corporation.

10. The authorized share capital of the Corporation consisted of XXXXXXXXXX class A common shares without nominal or par value ("Class A Shares"), XXXXXXXXXX class B non-voting common shares without nominal or par value ("Class B Shares") and XXXXXXXXXX non-cumulative, non-participating redeemable preferred shares with a nominal or par value of $XXXXXXXXXX each.

11. All of the authorized Class A Shares and Class B Shares were issued. They were issued at $XXXXXXXXXX per share. Accordingly, the aggregate paid-up capital of the Class A Shares was $XXXXXXXXXX and the aggregate paid-up capital of the Class B Shares was $XXXXXXXXXX.

12. The Late Husband was the sole shareholder of the Corporation at the time of his death, holding XXXXXXXXXX Class A Shares and XXXXXXXXXX Class B Shares. He held the Class A Shares from the time of incorporation of the Corporation. He acquired the Class B Shares on XXXXXXXXXX from Trustco, trustee of the Family Trust, for the price of $XXXXXXXXXX which represented their fair market value. The Class B Shares had been acquired on XXXXXXXXXX and held by Trustco for the benefit of Child A and Child B. The Class A Shares and the Class B Shares were capital property to the Late Husband.

13. The XXXXXXXXXX Class A Shares and XXXXXXXXXX Class B Shares which were owned by the Late Husband at the time of his death were placed in the Estate by virtue of his Will. They were then held by the Estate until the time of the amalgamation described below. The shares constituted capital property to the Estate.

14. The only dividends that have been paid on the shares of the Corporation since the death of the Late Wife on XXXXXXXXXX were taxable dividends amounting to $XXXXXXXXXX which were paid to the Estate.

15. The initial executors and trustees of the Estate were the Late Wife and XXXXXXXXXX. Each was a resident of Canada throughout the time they were trustees.

16. The Trustee was appointed trustee of the Estate following the death of XXXXXXXXXX. The Late Wife was a trustee until the time of her death.

17. The Trustee is the sole surviving executor and trustee of the Estate. He is a resident of Canada and has been at all relevant times.

18. Under the terms of the Will of the Late Husband, the residue of his estate, after the payment of specific bequests, was to be held upon a trust providing that the net income therefrom was to be paid to the Late Wife during her lifetime with powers to encroach on capital in her favour.

19. The Will provides that, upon the death of the Late Wife, the balance of the Estate is to be donated to the Charity. A copy of the Will was enclosed with your letter.

20. Child A and Child B were not beneficiaries of the Estate under the Will. Following the death of the Late Husband, each of Child A and Child B formally challenged the validity of the Will. However, the XXXXXXXXXX Supreme Court held that it was valid. That Court's decision was appealed by Child A to the XXXXXXXXXX Court of Appeal.

21. Child A and Child B also threatened action under the XXXXXXXXXX if their challenge to the validity of the Will was not successful. Ultimately, prior to the appeal being heard and prior to an action being commenced under the XXXXXXXXXX a settlement was reached as documented in the Settlement Agreement. Under the terms of the Settlement Agreement agreed to by the initial executors and trustees of the Estate, the Late Wife, Child A, Child B and the Charity:

(a) cash payments of $XXXXXXXXXX and $XXXXXXXXXX were to be made by the Estate to Child A and Child B, respectively; and

(b) the Charity agreed to pay to Child A XXXXXXXXXX % of the value of the assets it receives from the Estate.

The cash payments referred to in (a) were subsequently made. No payments referred to in (b) have been made by the Charity to Child A. A copy of the Settlement Agreement was enclosed with your letter.

22. The principal asset of the Estate was the shares of the Corporation. The principal asset of the Corporation was the Apartment situated in XXXXXXXXXX. The Apartment had been owned by the Corporation continuously since XXXXXXXXXX and it constituted capital property to the Corporation.

23. With respect to the Apartment, the cost and capital cost, respectively, to the Corporation of the land and building was $XXXXXXXXXX and $XXXXXXXXXX. The undepreciated capital cost of the building as at XXXXXXXXXX was $XXXXXXXXXX.

24. In a report dated XXXXXXXXXX expressed the opinion that the valuation-day value of the Apartment was $XXXXXXXXXX and the fair market value at XXXXXXXXXX.

25. In a report dated XXXXXXXXXX expressed the opinion that as at XXXXXXXXXX, the date of the Late Husband's death, the fair market value of the Apartment was $XXXXXXXXXX. On the presumption that it is appropriate to allocate fair market values for the XXXXXXXXXX appraisal using the ratios that are relevant to the XXXXXXXXXX allocation, XXXXXXXXXX.

26. XXXXXXXXXX, who act for the Estate, have estimated that prior to the death of the Late Wife, the shares of the Corporation owned by the Estate had an adjusted cost base of $XXXXXXXXXX (i.e., $XXXXXXXXXX purchase price in respect of the Class B Shares plus $XXXXXXXXXX valuation-day value in respect of the Class A Shares) and a fair market value as at XXXXXXXXXX, the date of the Late Wife's death, of $XXXXXXXXXX (comprised of $XXXXXXXXXX in respect of the Class A Shares and $XXXXXXXXXX in respect of the Class B Shares).

27. Based on the terms on which the residue of the Estate is held, it is the Trustee's view that the Estate constitutes a spouse trust. As a consequence, upon the death of the Late Wife, the Estate was deemed pursuant to paragraph 104(4)(a) to have disposed of its property and accordingly it realized a significant capital gain in respect of the shares of the Corporation in its taxation year which ended XXXXXXXXXX.

Until the death of the Late Wife, the Estate held the shares of the Corporation with an adjusted cost base equal to the adjusted cost base to the Late Husband at the time of death. Due to the application of subsection 104(4), the adjusted cost base of those shares became equal to their fair market value at the time of the Late Wife's death.

Recently Completed Transactions

28. Newco was incorporated on XXXXXXXXXX, its shares consisting of 1 issued and outstanding common share without par value ("No Par Value Share"), having nominal value and nominal stated capital. The No Par Value Share was transferred to the Estate on XXXXXXXXXX. Newco was resident in Canada and was a taxable Canadian corporation.

29. On XXXXXXXXXX, the authorized capital of Newco was amended to create an additional class of common shares (the "Par Value Shares") identical in all material respects to the No Par Value Share except the new class had a par value of $XXXXXXXXXX per share. A total of XXXXXXXXXX Par Value Shares were authorized.

30. On XXXXXXXXXX, the Estate transferred to Newco, concurrently:

(a) XXXXXXXXXX Class A Shares of the Corporation, for XXXXXXXXXX Par Value Shares of Newco; and

(b) XXXXXXXXXX Class B Shares of the Corporation, for XXXXXXXXXX Par Value Shares of Newco.

The XXXXXXXXXX Par Value Shares issued by Newco on this transfer had an aggregate paid-up capital of $XXXXXXXXXX, which was equal to the aggregate paid-up capital of the shares of the Corporation.

31. Pursuant to the provisions of subsection 85(1), the Estate and Newco jointly elected to transfer all of the shares of the Corporation to Newco at agreed amounts equal to the adjusted cost base to the Estate of the shares (i.e., their fair market value at the date of death of the Late Wife). The elections were made in prescribed form and within the time constraints of subsection 85(6). The elections were made on XXXXXXXXXX. At the time of the transfer, the fair market value of the shares transferred by the Estate exceeded the agreed amounts.

32. On XXXXXXXXXX, Newco and the Corporation were amalgamated as described in subsection 87(1) to form Amalco. The authorized capital of Amalco consists of XXXXXXXXXX common shares with a par value of $XXXXXXXXXX per share ("Amalco Shares").

On the amalgamation, the 1 issued and outstanding No Par Value Share of Newco was exchanged for 1 Amalco Share, and the XXXXXXXXXX Par Value Shares of Newco were exchanged for XXXXXXXXXX Amalco Shares. The shares of the Corporation, which were owned by Newco, were cancelled. The sole director of Amalco is the Trustee.

33. Pursuant to the provisions of subsection 87(11) and paragraphs 88(1)(c) and (d), the adjusted cost base of the land which was held by the Corporation was increased to the amount that was its fair market value at the time of the Late Husband's death which occurred in XXXXXXXXXX.

34. Since the amalgamation referred to in 32 above, Amalco has paid a total of $XXXXXXXXXX in dividends to the Estate, all of which were capital dividends.

35. A T-2 income tax return was filed in or about XXXXXXXXXX for the Corporation in respect of its taxation year ended XXXXXXXXXX.

36. Pursuant to a contract of purchase and sale dated XXXXXXXXXX (the "Sale Agreement"), Newco agreed to sell and the Purchaser agreed to purchase the Apartment for $XXXXXXXXXX payable in cash on closing on or about XXXXXXXXXX. Neither the Estate nor the Corporation was a party to this agreement. At all relevant times, the Purchaser dealt at arm's length with the Estate, the Corporation, Newco and Amalco. Pursuant to the Sale Agreement, Amalco (being the successor of Newco) sold and the Purchaser purchased the Apartment on XXXXXXXXXX for $XXXXXXXXXX cash.

37. At the present time, the principal asset of Amalco is cash in the approximate amount of $XXXXXXXXXX. Thus, XXXXXXXXXX, estimates that the current fair market value of the shares of Amalco is between $XXXXXXXXXX and $XXXXXXXXXX.

Proposed Transactions

38. Rights under the Settlement Agreement will be amended by the Supplemental Agreement among Child A, the Trustee and the Charity to provide that the amount to which Child A is entitled to under the Settlement Agreement, which amount is equal to XXXXXXXXXX% of the fair market value of the property of the Estate, will be paid by the Estate directly to Child A. The Charity will not be required to make the payment referred to in 21(b) above. A draft copy of the Supplemental Agreement was provided to us.

39. In its taxation year which includes the sale of the Apartment to the Purchaser, Amalco will make a cash donation (the "Initial Donation") to the Charity of approximately $XXXXXXXXXX, for which the Charity will issue an official receipt.

40. Amalco will file a T-2 income tax return for its year ending XXXXXXXXXX, reporting a capital gain and recapture of capital cost allowance on the disposition of the Apartment as described in 36 above and a deduction in respect of the Initial Donation.

41. At or about the time of payment of the Initial Donation, Amalco will pay to the Estate a separate dividend of $XXXXXXXXXX, which is the amount of its capital dividend account and which will be a capital dividend. Amalco will also pay to the Estate a separate dividend of $XXXXXXXXXX as a taxable dividend.

42. Forthwith after receipt of the dividends from Amalco, the Estate will make an interim payment (the "Interim Payment") of $XXXXXXXXXX to Child A in respect of her entitlement under the Supplemental Agreement.

43. Amalco will then make another cash donation of approximately $XXXXXXXXXX (the "Remaining Donation") to the Charity.

44. Amalco will settle its liabilities and then wind up with a distribution of its remaining assets to the Estate.

45. Amalco will make application for a clearance certificate pursuant to subsection 159(2). This step will be carried out subsequent to receipt of a Notice of Assessment of the final T-2 income tax return of Amalco.

46. The Estate will settle its liabilities and pay the Trustee's fees. The Estate will make a final payment (the "Final Payment") to Child A equal to her remaining interest pursuant to the Supplemental Agreement.

47. The Estate will wind up and will file a T-3 income tax return for the period ending on its wind-up. The Estate will report on this return the deemed dividends arising on the wind-up of Amalco. The Estate will also report on this return the capital loss realized on the disposition of Amalco shares on the wind-up of Amalco. No amount will be deducted from the Estate's income in respect of the Interim Payment or the Final Payment, and no amount will be designated for purposes of subsection 104(19) in respect of taxable dividends received by the Estate.

48. The Estate's consequential net capital loss arising from the disposition of the Amalco shares will be carried back to the Estate's taxation year ended XXXXXXXXXX to offset to the extent possible the taxable capital gain realized by the Estate on the deemed disposition referred to in 27 above.

49. The legal representative of the Estate will make application for a clearance certificate pursuant to subsection 159(2). This step will be carried out subsequent to receipt of a Notice of Assessment of the final T-3 income tax return of the Estate.

50. The Charity and Child A will provide the Trustee with releases in respect of future claims brought against him by the Charity and Child A. A draft copy of the releases was provided to us.

51. Notwithstanding the effective date of the transactions referred to in paragraphs 43, 44, 46 and 47 above, the actual transfers of property pursuant to those paragraphs will not be fully effected until after receipt of the clearance certificates referred to in paragraphs 45 and 49 above.

Purpose of the Proposed Transactions

52. The purpose of the proposed transactions is to obtain a greater tax advantage in making a gift pursuant to the Late Husband's Will and to avoid unintended inappropriate tax consequences for the Charity.

Rulings

53. Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions, and purpose of the proposed transactions and provided further that the proposed transactions are carried out as described above, we confirm the following:

A. The amount of the Initial Donation given by Amalco to the Charity will qualify as a gift described in paragraph 110.1(1)(a), provided that an official receipt containing prescribed information is filed as required by subsection 110.1(2);

B. The payment of the Interim Payment and the Final Payment by the Estate to Child A will not constitute a benefit to Child A within the meaning of subsection 105(1); and

C. Subsection 245(2) will not be applied as a result of the proposed transactions, in and by themselves, to redetermine the tax consequences of the other rulings provided herein.

The above rulings are given subject to the limitations and qualifications set forth in Information Circular 70-6R4 dated January 29, 2001 and are binding on the Canada Customs and Revenue Agency provided that the proposed transactions are completed by XXXXXXXXXX.

Comments

You had requested us to confirm that the XXXXXXXXXX Par Value Shares issued by Newco in exchange for the Class A Shares and Class B Shares of the Corporation as noted in 30 above constituted capital property to the Estate. Since the shares of Newco have already been issued, we are not able to provide a binding advance income tax ruling as requested. However, it is our view that, provided that the Class A Shares and Class B Shares of the Corporation constituted capital property to the Estate, the XXXXXXXXXX Par Value Shares issued by Newco in exchange for the Class A Shares and Class B Shares of the Corporation would constitute capital property to the Estate. It follows that the shares of Amalco that were issued to the Estate upon the amalgamation of Newco and the Corporation in exchange for the Estate's shares of Newco would constitute capital property to the Estate.

Caveat

Nothing in this ruling should be construed as implying that the Canada Customs and Revenue Agency has agreed to or reviewed:

(a) the determination of the cost, adjusted cost base, undepreciated capital cost or value of any particular asset;

(b) the determination of the paid-up capital of any shares of any corporation;

(b) the balance of the capital dividend account of any corporation; or

(d) any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above.

Yours truly,

for Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch