3 June 2011 STEPs Roundtable Q. 2, 2011-0401831C6 - 2011 STEP Conference-Q2-Trusts & Principal Res.

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.

Principal Issues: What legislative provisions must be considered with regards to a plan to rollout a cottage to a capital beneficiary in order to avoid the deemed disposition rules in 104(4) but also ensuring that it is a tax deferred roll-out under 107(2), which may not apply if 75(2) applies in respect of any property of the trust.

Position: See response

Reasons: Based on legislation and existing CRA position

QUESTION #2 - TRUSTS AND PRINCIPAL RESIDENCE EXEMPTION

Assume the following facts:

1. A personal trust has been settled inter vivos. The trust is not an alter ego or joint partner trust.

2. A cottage is contributed to the personal trust by "B", a Canadian resident individual who is one of the income and capital beneficiaries of the trust.

3. B triggers a capital gain as a result of contributing the cottage to the personal trust. As B occupied the cottage as his principal residence prior to contributing it to the trust, B uses his available principal residence exemption ("PRE") to reduce his tax exposure on the capital gain.

4. Subsection 75(2) applies to the trust, as B is both a contributor and is also a capital beneficiary of the trust.

5. The twenty one year deemed realization rule under subsection 104(4) of the Act continues to loom over the trust. This rule presumably still applies even though any income is to be attributed under subsection 75(2) to B as contributor.

Given the above facts, it would often be a "normal" plan to consider a rollout of the cottage to a capital beneficiary as an option to avoid the deemed disposition rules under subsection 104(4) and one would normally expect to achieve that as a tax deferred roll-out to a capital beneficiary (using the provisions of subsection 107(2)) but the normal rules will not apply if subsection 75(2) also applies in respect of any property of the trust.

Accordingly, our questions are as follows:

1. Do the provisions of subsection 104(4) of the Act apply notwithstanding that income (or loss) and taxable capital gains (or allowable capital losses) will be attributed to the contributor pursuant to subsection 75(2)?

2. If the cottage is distributed to B prior to subsection 104(4) applying to the trust, will the provisions of paragraph 107(4.1)(c) apply so as to preclude the application of subsection 107(2) to the distribution such that subsection 107(2.1) will apply to the distribution?

3. If the cottage is distributed to "D", who is one of the other capital beneficiaries of the trust, and D has never contributed property to the trust, will the provisions of subsection 107(4.1) be applicable to such distribution?

4. Assuming our understanding under assumption 4 above is correct, will the amount of the capital gain realized on the distribution of the cottage to a capital beneficiary attribute to B pursuant to the provisions of subsection 75(2)?

5. If the answer to question 4 above is that the capital gain attributes to B pursuant to subsection 75(2), will B be able to utilize his PRE even though he will not be in receipt of the distributed property, namely the cottage?

CRA Response

1. Yes, the 21-year rule in subsection 104(4) of the Act will apply regardless of the fact that income or loss or capital gains or losses may have been attributed pursuant to subsection 75(2). (footnote 1)

2. Given that B is the person from whom the property was acquired by the trust, the condition in paragraph 107(4.1)(c) would not be met, and thus a subsection 107(2) rollover of the property would not be precluded pursuant to subsection 107(4.1). (footnote 2)

3. On the assumption that B is still living at the time of the distribution to D and that subparagraph 107(4.1)(c)(ii) is not applicable, yes, the provisions of subsection 107(4.1) will apply. It should be noted that the fact that D has never contributed any property to the trust is not relevant in this case, as the property referred to in subparagraph 107(4.1)(c)(i) is the property referred to in paragraph 107(4.1)(b), which is the cottage that was contributed to the trust by B. (footnote 3) This also assumes that the trust itself has not claimed the principal residence exemption and reduced the amount to be attributed to nil.

4. If B is alive and resident in Canada at the time of the gain, then subsection 75(2) will apply to deem the amount of the taxable capital gain, if any, to be a taxable capital gain of B.

5. The fact that the capital gain will be attributed to B will not mean that B will have a principal residence exemption in respect of the property. As is noted in paragraph 4 of IT-120R6, for a property to be a taxpayer's principal residence for a particular year, the taxpayer must own the property in the year. Thus, B could not have a principal residence exemption.

Roger Filion
June 2-3, 2011
2011-040183

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 Ref 2000-0000217 (severed internal technical)
2 Ref 1999-0013085 (severed external technical interpretation)
3 Ref 1999-0013085 (severed external technical interpretation) and 2002-0118255 (severed external technical interpretation)