This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: [TaxInterpretations translation] 1) At a time when the estate of a taxpayer and the surviving spouse of the deceased hold shares in undivided co-ownership, can the partition of those shares be effected between the surviving spouse and a spousal trust for that spouse’s exclusive benefit without jeopardizing a rollover to the trust under subsection 70(6)?
2) In the event that the estate of the deceased first transfers the interests in the shares held in undivided co-ownership to the spousal trust, could the partition of the shares be carried out without any tax burden pursuant to subsection 248(20) or (21)?
Position: 1) No.
(2) The partition of shares could be made tax-free pursuant to subsection 248(20) or (21), subject to compliance with the conditions for the application of those provisions.
Reasons: 1) Wording of the Act.
2) Wording of the Act and previous position adopted.
January 30, 2009
Subject: Death - shares held in co-ownership
This is in response to your letter of July 16, 2008 requesting our opinion on the application of subsections 70(6), 248(20) and (21) of the Income Tax Act in the following hypothetical situation. We apologize for the delay in responding to this request.
Please note that unless otherwise indicated, the legislative references below are to the provisions of the Income Tax Act, R.S.C. 1985 c. 1 (5th Supp,), as amended, in force as of the date hereof.
Shares with an unrealized capital gain are held in undivided ownership by two individuals, X and Y, through a non-registered investment account (the "Account"). They are spouses are residents of Québec. Y dies and his estate must be settled. Under the terms of Y's will, a universal residual legacy is provided for in favour of a spousal trust for the benefit of X. This legacy includes the undivided interest in the shares held through the Account by Y prior to his death.
1. At a time when the undivided co-owners are X and the estate of Y (the "Estate"), can a partition of the shares held through the Account be effected between X and the spousal trust without jeopardizing a rollover to the trust under subsection 70(6)?
2. In the event that the transfer by the Estate of the undivided interest in the shares held through the Account to the spousal trust for the benefit of X is first made, can the partition of the shares held through the Account be effected pursuant to subsection 248(20) or (21) free of tax?
It appears to us that the situation described in your letter could constitute an actual situation involving taxpayers. As explained in Information Circular 70-6R5 issued on May 17, 2002, it is the practice of the Income Tax Rulings Directorate of the Canada Revenue Agency ("CRA") not to issue written opinions regarding proposed transactions otherwise than by way of advance income tax rulings. If your situation involves a specific taxpayer and a completed transaction, you should forward all relevant facts and documents to the appropriate CRA Tax Services Office for its views. However, we are prepared to provide the following general comments, which we hope you will find helpful. These comments are technical interpretations that are not binding on the CRA and may, in certain circumstances, not apply to your particular situation.
Application of subsection 70(6)
A transfer of property to a spousal trust can only be effected on a rollover basis if all the conditions set out in subsection 70(6) are satisfied. In particular, the deceased's property must have vested irrevocably in the spousal trust within 36 months following the taxpayer's death.
We are of the view that the conditions for the application of subsection 70(6) would not be satisfied if the partition of the shares held by the X and Estate co-owners, through the Account, were to be effected between X and the spousal trust. In fact, in these circumstances, the property held by Y prior to his death, i.e. the undivided interest in shares, would not be the same property as the property received by the spousal trust in connection with the partition effected by the Estate, i.e. shares.
An undivided interest in a property constitutes a separate property from the property held in co-ownership. In this regard, the second paragraph of article 1015 of the Civil Code of Québec ("CCQ") seems to support this position in a Quebec civil law context.
In these circumstances, subsection 70(6) is therefore only likely to apply where the undivided interest in the shares is transferred by the Estate to the spousal trust. To this end, the necessary legal acts will be required be concluded between the parties in order to produce legal effects. It should be noted, however, that the non-completion of administrative formalities by the financial institution custodian of the Account, such as the registration of the Account in the name of the spousal trust, does not affect the legal reality of the transactions.
Application of subsections 248(20) and (21)
The partition at a particular time of property held in undivided co-ownership constitutes a disposition for tax purposes. It appears that the third paragraph of article 1037 CCQ supports this assertion in a Quebec civil law context. It is also necessary to analyze the application of subsections 248(20) and (21) in order to determine the tax consequences arising from this event.
Subsections 248(20) and (21) are general provisions applicable in the case of the division of property owned by more than one person. The application of these provisions with respect to the partition of intangible property, such as shares, implies a priori an analysis of the legal feasibility of proceeding with the partition of property held in co-ownership in accordance with the conditions set out in each of those provisions. With respect to shares held in undivided co-ownership, we believe that it is necessary to consider the legal terms of partition separately for each of these shares. This is so because each share constitutes separate property.
First, subsection 248(21) applies where a property held in undivided co-ownership by several persons is partitioned among them and each co-owner receives a new interest in the property as part of that process. A proportionality test as to the fair market value ("FMV") of the original share and the new interest must be satisfied in respect of all co-owners. The application of this provision has the effect of rendering subsection 248(20) inapplicable. The new interest in the property of each co-owner is deemed to be a continuation of the co-owner’s undivided interest in the property prior to the partition.
In order for subsection 248(21) to apply with respect to the partition of a share held in undivided co-ownership, it is required, inter alia, that the share originally held in undivided co-ownership not be cancelled as part of the partition process. Thus, the same share initially held in undivided co-ownership must be held in divided ownership following the partition. In addition, it should be noted, by way of example, that subsection 248(21) would not apply where the partition involves the payment of consideration other than in shares.
Second, should subsection 248(21) not apply, subsection 248(20) should be considered. This provision applies where a property held in co-ownership by several persons is divided among them. A proportionality test as to the FMV of the interest in the property prior to the partition and the FMV of the interest in the property after the partition must be applied in respect of each of the co-owners. This test makes it possible to determine how the presumptions of no disposition and no acquisition provided for in subsection 248(20) are to be applied for each of the co-owners.
As in the case of the application of subsection 248(21), for subsection 248(20) to apply in respect of the partition of a share held in undivided co-ownership, it is required, inter alia, that the share originally held in undivided co-ownership not be cancelled as part of the partition process. It should also be noted that the application of subsection 248(20) would generally result in tax consequences.
It should be noted that, to date, the opinions issued by this Directorate with respect to the application of subsections 248(20) and (21) to the partition of shares have always dealt with situations where each of the shares held in undivided co-ownership that are subject to a partition gave rise to the issuance of fractional shares. In this context, the corporation must legally be able to issue fractional shares to its shareholders. The partition of a share must therefore give rise to the issuance of fractions of the same share issued prior to the partition to each of the co-owners in order to represent their respective rights in that share. The totality of the fractions of shares issued upon partition must represent the same property as the share previously held in undivided co-ownership. Following the partition, each co-owner then holds a divided part of each share.
Subsequently, a consolidation of divided shares of a corporation held by a shareholder could be effected without tax consequences. However, this would be the case provided that the consolidation does not involve a change in the rights of the shareholders.
You stated in your letter that this methodology, involving the issuance of fractional shares to each holder, raises significant practical difficulties. In your opinion, it would be appropriate if it were possible to divide an Account by dividing the shares into two lots of equal value. This approach does not permit the application of subsections 248(20) or (21). In particular, a block of shares cannot be considered as a single property for the purposes of subsections 248(20) and (21).
Furthermore, it is possible that the partition of shares held in undivided co-ownership may be carried out other than through the issuance of fractional shares. We have already stated that the Income Tax Rulings Directorate remains prepared to analyze this issue in the context of an advance ruling request. However, it seems to us that steps to obtain a legislative solution to the practical situation you have submitted to us may be more appropriate. As you know, however, such measures should be addressed to the Department of Finance, Canada.
We hope you find the above comments of assistance.
for the Director
International Operations and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.
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