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 are the income tax implications associated with the distribution of property from a discretionary trust to a Canadian resident corporation the shares of which are held by a new discretionary trust in order to avoid the 21-year deemed disposition in paragraph 104(4)(b)?
Position: CRA will typically apply GAAR in this situation.
Reasons: The transaction described circumvents the anti-avoidance rule in subsection 104(5.8) in a manner that frustrates the object, spirit and purpose of that provision, paragraph 104(4)(b) and the scheme of the Act as a whole.
STEP CRA Roundtable – June 13, 2017
QUESTION 2. GAAR and Capital Distribution to Canco Beneficiary
At the 2016 CTF Annual Tax Conference Roundtable, the CRA indicated that it was considering whether the general anti-avoidance rule (“GAAR”) in subsection 245(2) should apply to a situation involving a distribution from a discretionary family trust to a Canco the shares of which are held by a newly established discretionary family trust, thereby avoiding the 21-year deemed disposition that would have otherwise applied if the property had not been distributed by the first trust. Has the CRA made a determination in respect of this matter, and, if so, what are the factors relevant to this determination?
At the 2016 CTF Annual Tax Conference, the CRA provided its view on the application of the GAAR to a situation involving the distribution of property by a discretionary family trust (Old Trust) to a Canadian resident corporate beneficiary (Canco) the shares of which are held by a newly established discretionary trust resident in Canada (New Trust) on a tax deferred basis pursuant to subsection 107(2) in order to avoid the 21-year deemed disposition pursuant to paragraph 104(4)(b). In particular, the CRA provided the following:
The transactions described effectively result in Old Trust indirectly transferring property to New Trust on a tax deferred basis, thereby avoiding the application of the anti-avoidance provision in subsection 104(5.8) of the Act and restarting the 21-year clock. Thus, the capital gains that would otherwise be realized by Old Trust would be deferred beyond its 21st anniversary while the property continues to be held in a discretionary trust arrangement. Furthermore, the New Trust is provided with another 21 years to decide who from the potential beneficiaries will receive the property which could result in deferring the unrealized gain beyond the lifetime of the individual beneficiaries alive on the date of the Old Trust’s 21st anniversary.
Generally, it is the CRA’s view that such planning circumvents the anti-avoidance rule in subsection 104(5.8) of the Act in a manner that frustrates the object, spirit and purpose of that provision, the deemed disposition rule in paragraph 104(4)(b) and the scheme of the Act as a whole as it relates to the taxation of capital gains. It is also the CRA’s view that if a distribution is made by an existing discretionary trust to a Canadian resident corporation wholly owned by a new discretionary trust resident in Canada, it will generally be inferred that the primary purpose of such distribution is to defer the income tax otherwise applicable in respect of the 21-year deemed disposition pursuant to subsection 104(4) of the Act. The CRA has significant concerns regarding these transactions and will apply GAAR when faced with a similar set of transactions unless substantial evidence supporting its non-application is provided.
The CRA is also concerned that the proposed transactions may be repeated where the terms of New Trust are similar to those of Old Trust. Thus the realization of the capital gains inherent in the property could be deferred for several generations or indefinitely. This contravenes one of the underlying principles in the taxation of capital gains regime, which is to prevent the indefinite deferral of tax on capital gains.
The CRA also indicated that it was considering the application of GAAR to another situation, whereby the realization of the capital gains inherent in the distributed property would not be deferred beyond the lifetime of the existing beneficiaries of Old Trust. This other arrangement effectively proposed to avoid having the 21-year deemed disposition in paragraph 104(4)(b) apply to the Old Trust on the basis that the deferral of the realization event would be consistent with that achieved by a tax deferred rollover of property to a Canadian resident individual beneficiary pursuant to subsection 107(2); however, the trust property would continue to be indirectly held in a discretionary trust.
The CRA has concluded its review of this situation. It is the CRA’s view that the planning outlined would effectively permit taxpayers to circumvent the anti-avoidance rule in subsection 104(5.8) in a manner that frustrates the object, spirit and purpose of that provision, the deemed disposition rule in paragraph 104(4)(b) and the scheme of the Act as a whole. It is the CRA’s view that the object, spirit and purpose of these provisions is that realization of gains on property in a discretionary family trust should occur at least every 21 years. There are specific situations provided for in the Act to which the 21-year deemed disposition rule does not apply. In the CRA’s view, the Act does not contemplate any deferral beyond a 21-year period while property is directly or indirectly held in a discretionary trust and therefore, the situation described above raises the same policy concerns as the situation described at 2016 CTF Annual Tax Conference.
As a result, the CRA will not provide any Advance Income Tax Ruling where such a structure is proposed to be put in place unless substantial evidence supporting the non-application of GAAR is provided.
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