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: Can CRA provide an update on common audit issues it finds/reviews regarding trusts?
Position: Various audit issues considered by ITRD in recent years discussed.
Reasons: See below.
STEP CRA Roundtable June 2014
QUESTION 6. Trust Audit Issues
Can the CRA provide an update on the most common audit issues that it finds / reviews regarding trusts?
The Income Tax Rulings Directorate is often asked to provide technical assistance in regard to compliance issues encountered in respect of trusts. The following is a brief discussion of some of the interesting trust compliance concerns that we have dealt with in recent years.
Benefits under trust (subsection 105(1)):
In one audit that we dealt with, the taxpayer had been the sole shareholder and director of OPCO. The taxpayer settled a trust, purportedly for employees of OPCO, and was the sole trustee. Both taxpayer and the trust subscribed for new common shares of OPCO for a nominal amount. When an offer was received from an arm's length party to buy OPCO several years later, the taxpayer and OPCO entered an agreement to allow OPCO to redeem the shares held by the trust (which now had a significant fair market value) for the nominal amount originally paid for them. This effectively inflated the value of the remaining OPCO shares held by the taxpayer, and thus the amount received by him on the sale of the company. CRA took the position that there was a benefit pursuant to subsection 105(1) in respect of the taxpayer. Furthermore, because the taxpayer, the trust and OPCO were all persons not dealing at arm's length, the trust could be assessed pursuant to subparagraph 69(1)(b)(i) in respect of the disposition of shares.
Gifts by will:
Compliance issues are often encountered in regard to claims in respect of gifts by will. For example, severed memorandum 2012-0472161I7 dealt with the issue of whether the executors of an estate were empowered to make a gift to charities, and thus claim a deduction pursuant to subsection 118.1(3) in computing the tax payable by the estate. Based on the terms of the will in the particular case, it was our view that the executors did not have the power to make such a gift.
Late or amended 104(21) designation:
In severed document 2014-0517191I7, we provided advice in respect of the audit of a discretionary family trust, which determined that subsequent to filing its T3 return for a taxation year, had overlooked a capital gain for that year. The taxpayer requested an adjustment to designate under both subsections 104(21) and (21.2) of the Act the net taxable capital gain associated with the said gain to the adult children who were both income and capital beneficiaries of the subject trust. It was noted that the amount of the gain was actually paid to their father, who was also both an income and capital beneficiary.
It was our view that a late or amended designation under subsection 104(21) of the Act was not available to the trust. It was noted that in respect of the adult children, one of the requirements under subsection 104(21) is that the amount designated can reasonably be considered to have been included in computing their respective incomes for the year pursuant to paragraph 104(13)(a) or section 105.
Attribution pursuant to subsection 75(2):
In document 2010-0366301I7 we considered an audit in which a taxpayer who was the sole trustee and was a capital beneficiary of a trust, had transferred property to the trust by accepting undervalued freeze shares as consideration when growth shares were issued to the trust. It was our view that because the growth shares could revert back to the taxpayer, subparagraph 75(2)(a)(i) applied, and furthermore, because he was the sole trustee, both 75(2)(a)(ii) and 75(2)(b) were also applicable.
The stop-loss rule in subsection 112(3.2):
Our Directorate has provided advice on a number of audits where the issue of the potential application of the "stop-loss" rule in subsection 112(3.2) that can reduce the loss of a trust on the disposition of a share is in question. Document 2009-0310601I7 is an interesting example. In that case, in the first year of an estate, common shares held by the estate were redeemed and the aggregate capital loss realized was carried back to the final return pursuant to subsection 164(6).
The share redemption was done in two steps so as to allow the corporation to make a subsection 83(2) election to the extent of its capital dividend account. The first redemption resulted in a deemed dividend on which the corporation made the 83(2) election, and a capital loss to the estate. The second share redemption, the following day, resulted in a deemed taxable dividend and another capital loss to the estate. It was later realized that the tax result would have been more favourable if all of the shares had been redeemed in a single transaction.
The result was that the two redemptions were viewed as separate transactions for the purpose of applying the stop-loss rule in subsection 112(3.2).
In document 2013-0477561I7 we provided advice on the deductibility of carrying charges (specifically legal and accounting expenses), with respect to an individual's T1 final return and an estate trust return. Given the specific facts dealt with in that case, it was appropriate to disallow certain expenses claimed. However, the document clearly notes that such conclusions cannot be generalized, as the deductibility of an expense is fact specific and can only be determined on a case-by-case basis. The letter cites relevant case law that can provide guidance in making such determinations.
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