3 June 2003 External T.I. 2002-016643A - General Comments on 70(7)

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 CCRA.

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

Principal Issues: (1) Would subsection 70(6) of the Act apply to a property where the property is used to secure a loan and only the proceeds of the loan, not the mortgaged property, is transferred to a spouse trust. (2) Would 70(6) of the Act apply where mechanisms are put in place to either have the estate or the surviving spouse assume the "non-qualifying debts" in order to circumvent the application of subsection 70(7) of the Act. (3) Can the executors use property that entered the estate after the individual passed away to make the election under subsection 70(7) of the Act.

Position: (1) and (2) Question of facts - maybe no transfer of property or income being paid out to a third party. The submitted scenarios might result in the replacement of a testamentary debt by a non-testamentary debt, thereby making subsection 70(7) of the Act inapplicable. (3) Taxpayer has submitted this question to the Department of Finance.

Reasons: Wording of the Act.

XXXXXXXXXX 2002-016643

September 4, 2003

Dear Sir:

Re: Spouse Trust

This is in reply to your letter of September 30, 2002. In that letter, you describe numerous scenarios which are aimed to ascertain the timing and scope of subsections 70(6) and 70(7) of the Income Tax Act (the "Act"). You also ask whether those scenarios would be subject to the application of section 245 of the Act. Incidentally, you ask what would be the impact of some of those scenarios on the existence of a "testamentary trust" as defined in subsection 108(1) of the Act.

Subsection 70(5) of the Act provides that immediately before an individual's death, he is deemed to have disposed of each capital property that he owned at that moment for proceeds equal to their fair market value. Subsection 70(6) of the Act provides an exception where, among other conditions, a property is transferred or distributed to a trust under which the individual's spouse is entitled to receive all of the income of the trust that arises before the spouse's death and no person other than the spouse may receive or obtain the use of any of the income or capital of the trust before the spouse's death (in this letter, the word spouse includes the common-law partner and a trust that is created for the benefit of the surviving spouse is referred to as a "Spouse Trust"). Finally, subsection 70(7) of the Act provides an election that can be filed in order to have subsection 70(6) of the Act apply to the assets transferred to a trust that would otherwise be a Spouse Trust if it were not for the payment (or provision for payment) of certain debts.

As stated in paragraph 26 of IT-305R4:

It is arguable that a trust in favor of a spouse created under a taxpayer's will out of the residue of his or her estate is tainted by the distributions and payments necessary to establish the trust corpus. Under this interpretation it is necessary to follow the procedures set out in subsection 70(7) when it is intended that the trust qualify as a spouse trust under subsection 70(6). Another view is that subsection 70(6) applies to such of the original properties of the estate as are retained to form a part of the trust corpus without the necessity of following the procedures set out in subsection 70(7). Either interpretation is acceptable....

We have grouped scenarios (a) to (f) described in your letter in the three following questions:

Question 1 - Would subsection 70(6) of the Act apply to a property where the property is used to secure a loan and only the proceeds of the loan, not the mortgaged property, is transferred to a Spouse Trust (scenario (a)).

For subsection 70(6) of the Act to be applicable, one of the conditions is that the property must vest indefeasibly in a Spouse Trust within the period ending 36 months after the death of the taxpayer (or the period determined by the Minister) and be transferred or distributed to the Spouse Trust as a consequence of the death. The subsection makes no reference to substituted property.

Whether the property is transferred and vests indefeasibly in the Spouse Trust within the relevant period is a question of fact to be determined in light of the will, the applicable case law, provincial legislation and relevant circumstances. If such analysis leads to the conclusion, as indicated in scenario (a), that a particular property was never transferred or distributed to the Spouse Trust as a consequence of death, subsection 70(6) of the Act will not apply with respect to that property.

Question 2 - Would 70(6) of the Act apply where mechanisms are put in place to have either the estate or the surviving spouse assume the "non-qualifying debts" in order to circumvent the application of subsection 70(7) of the Act (scenarios (b), (c) and (d)).

Scenario (b) involves a Spouse Trust wherein the trustees are instructed to mortgage the property and to distribute the borrowed money to the surviving spouse provided the latter assumes any debt that would be a "non-qualifying debt" as defined in subsection 70(8) of the Act. Scenario (c) is along the same lines as scenario (b), but the property is mortgaged by the executors before the trust is created, the proceeds of that loan are used to repay the "non-qualifying debts" and the property is then transferred to the Spouse Trust. Finally, in scenario (d), the trust instrument provides that should the spouse refuse to assume the "non-qualifying debt", the trust's income would be computed differently.

The tax consequences of subsection 70(6) of the Act only apply to property transferred to a trust which provides, among other things, that no other person may receive any of the income or capital of the trust while the surviving spouse is alive. Considering the object and spirit of subsection 70(6) of the Act and the fungible nature of money, the facts in scenarios (b) and (c) might indicate that either the property was not transferred to the Spouse Trust or the spouse is not entitled to the income of the Spouse Trust such that the provisions of subsection 70(6) would not be applicable.

Furthermore, the Spouse Trust might be irrevocably tainted in scenarios (b) and (c) because a testamentary debt would be replaced by a non-testamentary debt, thereby making subsection 70(7) of the Act inapplicable.

Scenario (d) contemplates a situation where the terms of the Spouse Trust would not provide that the surviving spouse be entitled to receive all the income of the Spouse Trust. In such a scenario, the trust would not meet the requirements of subsection 70(6).

Question 3- Can the executors use property that was acquired by the estate after the individual passed away to make the election under subsection 70(7) of the Act (scenarios (e) and (f)).

Subsection 70(7) of the Act contains many indications that the property listed in the election must be owned by the taxpayer on death. The effect of subsection 70(7) of the Act is to untaint the Spouse Trust by denying the benefit of subsection 70(6) of the Act only with respect to the assets listed in the election made under that provision. If the assets were not owned immediately before the individual passed away, subsection 70(5) of the Act would not apply to those assets. Subsection 70(7) of the Act would have to be interpreted in light of its underlying policy and in this regard, we understand that you have submitted this question to the Department of Finance.

Incidentally, you also ask whether the Spouse Trust would be a testamentary trust as defined in subsection 108(1) of the Act, where the assets acquired by the estate after the individual passed away are transferred to the Spouse Trust. Paragraph (b) of the definition of testamentary trust excludes a trust created after November 12, 1981 from the definition of testamentary trust if any property is contributed to it otherwise than by an individual on or after the individual's death and as a consequence thereof. Property held in the estate of a deceased individual which is transferred to a Spouse Trust under or as a consequence of the terms of the will or other testamentary instrument of the deceased or of the law governing the intestacy of the deceased will generally not taint the status of the Spouse Trust as a testamentary trust.

With regard to the general anti-avoidance rule, our general practice is to comment on the application of subsection 245(2) of the Act only after reviewing all the facts and circumstances of a transaction and after receiving a request for an advance ruling, made according to the terms and conditions in Information Circular 70-6R5, by a taxpayer or his or her duly authorized representative.

This opinion is provided in accordance with the comments in paragraph 22 of Information Circular 70-6R5. If you have any questions concerning our comments please call Yves Moreno at 613-957-1764.

T. Murphy
for Director
International and Trusts Division
Income Tax Rulings Directorate