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: Kiddie Tax
Position: Various questions
Reasons: General comments provided
2013 STEP CANADA ROUNDTABLE, June 10 & 11, 2013
QUESTION 1. "Kiddie Tax" - Section 120.4
This series of questions concerns certain aspects of the Kiddie Tax under section 120.4 of the Income Tax Act (the "Act").
Under the income attribution rules in general, income attribution ceases when the person who contributed the property dies or becomes a non-resident. For example, if a parent makes a gift to a minor child, income earned from the proceeds of the gift will be attributed back to the parent but only while the parent is alive and resident in Canada. However, if the parent is deceased or a non-resident, income attribution ceases.
It seems that the Kiddie Tax does not operate exactly in this fashion. The tax applies to certain income if the child has one parent resident in Canada even if that parent was not the contributor of the property.
Do you agree with this analysis?
The attribution rules and "split income" rules do not apply in the same way. One difference is that, under the attribution rules, the amount is taxed in the hands of the "individual" who contributed the amount, in most cases the parent of the minor. Under the split income rules, the amount is taxed in the hands of the minor "specified individual," not the parent. Subsection 74.5(13) is a specific provision that provides an exception to the attribution rules in respect of split income under section 120.4. Therefore, the two sets of rules are mutually exclusive.
Section 120.4 of the Act provides for a tax on split income of a specified individual. A specified individual for a tax year is an individual who:
(i) has not attained the age of 17 years before the year;
(ii) at no time in the year was non-resident; and
(iii) has a parent who is resident in Canada at any time in the year.
Split income includes certain passive income which does not include an "excluded amount." An excluded amount for a tax year means an amount that is the income from, or the taxable capital gain from the disposition of, a property acquired by or for the benefit of the individual as a consequence of death of:
1) a parent of the individual; or
2) any person, if the individual is
(i) enrolled as a full-time post-secondary student as defined in subsection 146.1(1) during the year, or
(ii) an individual in respect of whom an amount may be deducted under section 118.3 for mental or physical impairment for the year.
Thus, split income for a tax year does not include income from property inherited by a specified individual from a parent or any person if certain conditions apply.
If the amount of income in question is not an excluded amount and is "split income," as defined, section 120.4 can apply to the split income of a child who has one parent resident in Canada at any time in the year, even if that parent was not the contributor of the property.
The Kiddie Tax has recently been extended to apply to capital gains from the disposition of private company shares by a person under the age of 18 to a non-arm's-length person - see subsection 120.4(4). Another rule extends the application to a capital gain derived by a trust and allocated to the minor. As such, the capital gain is reclassified as a taxable dividend that is not an eligible dividend. Our question concerns certain aspects of this rule:
(i) First, would CRA take the position that a gain created in a crystallization-type transaction would be subject to the Kiddie Tax?
(ii) Secondly, where a Canadian-controlled private corporation that is a small business corporation becomes a public corporation, an election is available to deem the subject shares to be sold at any amount between cost and fair market value - see section 48.1 of the Act.
Presumably, this is a relieving rule for persons to claim the capital gains deduction, where applicable, before the corporation becomes public and the shares thereby cease to qualify. In such a circumstance, if this election were made, would the capital gain be subject to the Kiddie Tax? It seems that it may not be caught by section 120.4 since the disposition is not to a non-arms-length party and also because section 48.1 appears to explicitly carve out the disposition for purposes of subsection 120.4(4). May we please have your views on this?
(i) A "crystallization" transaction can take many different forms. If the form of the crystallization involves the disposition by the specified individual to a non-arm's-length person, then subsection 120.4(4) can apply.
For example, if a parent controls Opco, and a child of the parent crystallizes an accrued gain on shares of Opco that he or she owns by transferring those shares to Opco in exchange for newly issued shares of Opco, the child would have disposed of the shares to a non-arm's-length person, such that subsection 120.4(4) could apply.
Where subsection 120.4(4) does apply, the specified individual would be deemed to have received a taxable dividend equal to twice the amount of the taxable capital gain. The taxable dividend is not an eligible dividend. More importantly, since the taxable capital gain is treated as a dividend, the specified individual would not be entitled to the capital gains deduction under subsection 110.6(2.1).
(ii) The deemed disposition under subsection 48.1(1) is expressly provided not to apply for the purposes of subsections 120.4(4) and (5). Therefore, a capital gain realized by a specified individual as a result of a deemed disposition under subsection 48.1(1) is not subject to the tax on split income under section 120.4.
Where a capital gain is subject to the Kiddie Tax, and accordingly deemed to be a taxable dividend, is it considered to be a taxable dividend paid by the corporation for purposes of a dividend refund under section 129 of the Act?
Where a dividend is deemed to result as described above, can one elect for the dividend to be a capital dividend pursuant to subsection 83(2) of the Act?
With respect to both questions (c) and (d) above, subsections 120.4(4) and (5) are deeming provisions, under which a taxable capital gain is deemed not to be a taxable capital gain and twice the amount is deemed to be received as a taxable dividend. The provision does not deem any amount to be paid by the corporation. As a result, a dividend refund is not available under subsection 129(1) and no election is available under subsection 83(2) in respect of a capital dividend. The September 2011 Department of Finance Explanatory Notes confirm that subsections 120.4(4) and (5) are intended to apply in this manner.
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