29 May 2018 STEP Roundtable Q. 11, 2018-0748241C6 - Subsection 104(13.4)

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: 1. For taxation years ending in 2016 and subsequent years, on the death of the primary beneficiary of an alter ego trust (AET) paragraph 104(13.4)(a) provides for a deemed year end of the trust. How is the trust income which became payable to the beneficiary prior to their death treated?

2. For an alter ego trust, are the taxable capital gains arising from a deemed disposition under subsection 104(4) taxed in the AET?

3. Does the result in 1 and 2 also occur where the AET is subject to subsection 75(2)?

4 Would the result for 1 and 2 also occur if the trust was a post-1971 spousal or common-law partner trust?

Position: 1. Income of the trust which became payable to the beneficiary prior to their death is included in the beneficiary’s income in their final T1 return. 2. Yes 3. The results in 1. and 2. are the same. 4. The results in 1, where subsections 104(13) and 104(6) apply, also apply to a post 1971 spousal or common law partner trust. The results in respect of capital gains or income arising from subsections 104(4) to 104(5.2) or subsection 12(10.2) also apply to a spousal or common law partner trust; however one additional result is available. Where certain conditions are met, a joint election may be made to have the income or gains caused by the deemed dispositions to be taxed in the beneficiary’s final T1 return.

Reasons: 1. The deduction available to the trust under subsection 104(6) may be claimed by the trust to the extent the income became payable to the primary beneficiary before death. 2. Clause (i)(B) of element B in paragraph 104(6)(b) denies the trust a deduction that arises from the application of any of subsections 12(10.2) or 104(4) to (5.2). 3. Where subsection 75(2) applies to the AET, income received by the trust prior to the primary beneficiary’s death is attributed to the beneficiary. Where subsection 75(2) otherwise applied to the trust, at the end of the day of the settlor’s death the settlor (person referenced in subsection 75(2)) no longer exists and, as a result, subsection 75(2) would no longer apply. Any taxable capital gains arising from the subsection 104(4) deemed dispositions would be taxed in the AET. 4. The conditions for the joint election are provided in paragraph 104(13.4)(b.1).

2018 STEP CRA Roundtable – May 29, 2018

QUESTION 11. Trusts subject to subsection 104(13.4) in year of death of the trust’s primary beneficiary

For taxation years ending after 2015, where the lifetime beneficiary of an alter ego trust (AET) dies, the trust will be subject to subsection 104(13.4). As a result, the trust will have a deemed year end on the beneficiary’s day of death. Where the AET receives income, such as dividends, in the year and before the beneficiary’s death, does subsection 104(13.4) cause that income to be taxed in the trust? Where the trust realizes a capital gain arising from the deemed disposition of capital property pursuant to subsection 104(4) on the death of the beneficiary, can the capital gain be reported on the beneficiary’s final T1 Income Tax and Benefit Return (T1 Return)?

Would the results be different, if the trust was a post-1971 spousal or common-law partner trust?

CRA Response

Although it is a question of fact as to whether a trust meets the criteria to be considered an “alter ego trust” as described in the Act, for purposes of our response, we assume such is the case.

For the 2016 and subsequent taxation years, paragraph 104(13.4)(a) provides that the taxation year of an AET, and certain other trusts is deemed to end at the end of the day of death of an individual whose day of death is a day referred to in paragraphs 104(4)(a), (a.1) or (a.4) of the Act (“primary beneficiary”, in the case of an AET, this is the settlor).

Depending on the terms of the alter ego trust, the dividend income earned by the trust prior to the primary beneficiary’s death will generally be included in the beneficiary’s income by virtue of subsection 75(2) or subsection 104(13).

Where property is held by a trust under any of the conditions described in paragraph 75(2)(a) or (b), any income or loss from the trust property (or substituted property) and any taxable capital gain or allowable capital loss realized on the disposition of the trust property (or substituted property) prior to the primary beneficiary’s death in the year will be attributed to the person referred to in subsection 75(2) (in the case of an AET, the “person” is the settlor). Accordingly, the dividend income received by the AET prior to the settlor’s death will be included in the settlor’s final T1 Return.

The preamble to subsection 104(4) provides that an AET (and certain other trusts) is deemed to have disposed of its properties described therein at the end of the day on which the trust’s primary beneficiary dies. As subsection 75(2) refers to the existence of the person, any taxable capital gain arising from the deemed disposition under subsection 104(4) will be taxed in the trust and not attributed to the deceased beneficiary.

Where subsection 75(2) does not apply to a trust, we note that for the trust to be considered an AET for purposes of the Act, the terms of the trust must ensure that the primary beneficiary is entitled to receive all the income of the trust arising before his or her death and no person except that individual may receive or otherwise obtain the use of any of the income or capital of the trust before that individual's death. Accordingly, any portion of the income of an AET that is not attributed to the settlor under subsection 75(2) would generally be included in that individual’s income under subsection 104(13) as being payable to the primary beneficiary.

Paragraph 104(6)(b) will also apply, and the trust may claim a deduction. Paragraph 104(6)(b) calculates the maximum deductible amount available to the trust as A – B. Element A is the part of the trust’s income for the year that became payable to, or was included under subsection 105(2) of the Act in the income of, a beneficiary. Element B restricts the deduction available to the trust as follows:

• for the trust’s year in which the primary beneficiary dies and prior years, clause (i)(A) of element B ensures that no deduction may be made for income which became payable to a beneficiary other than the primary beneficiary, and
• for the trust’s year in which the primary beneficiary dies, subclause (i)(B)(I) of element B ensures that no deduction is available in respect of any amount included in the trust’s income because of the application of subsections 104(4) to (5.2) or subsection 12(10.2) of the Act.

Therefore, in the current AET situation, if either subsection 75(2) or subsection 104(13) applies to the dividend income earned by the trust prior to the primary beneficiary’s death, it will be included in the beneficiary’s income on their final T1 Return. The taxable capital gain realized by the trust upon the deemed disposition of trust property pursuant to subsection 104(4) will be reported by the AET.

Testamentary spousal or common law partner trusts

The above discussion in respect of subsections 104(6) and (13) and income which becomes payable to the beneficiary prior to their death also applies to a post-1971 spousal or common-law partner trust and the primary beneficiary under such trusts.

The above discussion in respect of the taxable capital gain realized by the AET upon the death of the primary beneficiary also applies to a testamentary post-1971 spousal or common-law partner trust; however, one additional result may be available. Where the following conditions are met, a joint election described in paragraph 104(13.4)(b.1), between the trust and the deceased beneficiary’s graduated rate estate, may be filed to report the income of the trust arising from the application of subsections 104(4) to (5.2) or subsection 12(10.2) on the deceased beneficiary’s final T1 Return:

• Immediately before death, the beneficiary was a resident of Canada.
• The trust is a testamentary trust that is a post-1971 spousal or common-law partner trust and was created by the will of a taxpayer who died before 2017.
• A copy of the joint election is filed with both the final T1 Return of the beneficiary and the T3 Trust Income Tax and Information Return for the deemed year end of the trust.

Where the election is made, the trust may deduct the corresponding amount from its income.

William King
2018-074824