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: How is a trust and its beneficiary treated for income tax purposes after the trust ceases to be a TFSA because it borrowed money?
Position: Taxed according to the general rules applicable to inter vivos trusts and subsection 75(2).
Reasons: The trust loses its tax-exempt status under paragraph 149(1)(u.2).
July 17, 2019
Offshore and Aggressive Tax HEADQUARTERS
Planning Directorate Income Tax Rulings
Att: Janet Hope Wayne Doiron
Taxation of trust and beneficiary after deregistration of TFSA
This is in reply to Pamela MacInnis’ email of August 14, 2017 regarding the income tax treatment of a trust and its beneficiary where the trust lost its status as a tax-free savings account (“TFSA”) because it contravened the registration restriction on borrowing money. The trust continued to exist for several years after the borrowing occurred and was administered during that time by the TFSA issuer as though it were a TFSA. While we had previously conveyed the information in this memo at a meeting in 2017 with Ms. MacInnis, it was agreed that we would follow-up in writing. We apologize for the delay.
To qualify as a TFSA, paragraph 146.2(2)(f) (footnote 1) requires that the terms of a TFSA trust prohibit the trust from borrowing money or other property. If a TFSA is not administered in accordance with this condition, paragraph 146.2(5)(c) provides that the arrangement automatically ceases to be a TFSA, and thus loses its tax-exempt status effective at the particular time the borrowing occurs. Subsection 146.2(8) then deems the trust:
- to have disposed of, immediately before the particular time, each property held by the trust for proceeds equal to the property's fair market value immediately before the particular time; and
- to have acquired, at the particular time, each such property at a cost equal to that fair market value.
Subsection 146.2(8) also deems the trust's current taxation year to have ended immediately before the particular time and a new taxation year to have begun at the particular time.
Tax treatment after deregistration
As a result of ceasing to be a TFSA, the trust will no longer be exempt from taxation by paragraph 149(1)(u.2) and the general rules concerning the taxation of trusts and beneficiaries will apply. Further, the exemption for TFSA trusts contained in paragraph 75(3)(a) from the application of subsection 75(2) will no longer apply. Subsection 75(2) generally provides that where property is held by a trust, the terms of which provide that the property (or substituted property) may revert to the person from whom the property was directly or indirectly received, or where a certain degree of control of the property remains with that person, the trust's income or loss, or taxable capital gain or allowable capital loss, derived from the property (or substituted property) is attributed to that person provided that the person is alive and resident in Canada.
The requirements of the Act are such that the terms of a TFSA trust would provide that the holder of the TFSA is the only person permitted to make contributions to the trust, and that those contributions can revert back to the holder as the beneficiary of the trust. Consequently, subsection 75(2) may apply to attribute any income, losses, taxable capital gains or allowable capital losses of a trust that has lost its status as a TFSA to the individual who was formerly the holder of the arrangement.
Subsection 75(2) does not apply to income earned by a trust from the re-investment of income that was previously subject to attribution (i.e., second generation income), as this income is not earned on property contributed to the trust by a person (or substituted property). Thus, any second generation income earned by the former TFSA trust after deregistration will generally be taxable to the trust to the extent that it is not paid or payable to the beneficiary of the trust. Where an amount is paid or payable in the year to the beneficiary, the trust may claim a deduction under subsection 104(6) in computing its income for that year. Such income would be included in the beneficiary’s income under subsection 104(13).
See the current version of the T3 Trust Guide (T4013) for details on T3 reporting requirements applicable to the trust.
TFSA contribution room
If any contributions, distributions or transfers had been made to or from the trust after the date it ceased to be a TFSA, those amounts should not be treated as having been made to or from a TFSA of the individual. The CRA should make corresponding adjustments to the individual’s TFSA contribution room to undo any incorrect reporting of amounts in the past.
The loss of TFSA status and resulting deemed disposition and re-acquisition of property as described above is not considered to be a distribution from the TFSA. Accordingly, no amount would be added back to the individual’s TFSA contribution room for the following year.
We trust our comments will be of assistance.
Dave Wurtele, Section Manager
for Division Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
c.c. Nadine Huneault, Registered Plans Directorate
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 Unless otherwise stated, all statutory references in this memorandum are references to the provisions of the Income Tax Act (the “Act”).
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