7 June 2019 STEP Roundtable Q. 6, 2019-0799941C6 - TOSI tracing of attributes

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. Whether the deeming rules provided in subsection 120.4(1.1) apply if Mr. A ("inactive" parent) subsequently dies and those shares he inherited from Mrs. A ("active" parent) are inherited from him, by his children. 2. Whether the children who inherit shares from an "active" parent and an "inactive" parent are entitled to the excluded business exemption in respect of all future dividends received from Opco.

Position: 1. Yes 2. No for the taxation year in which the children inherit the "inactive" parent's shares and, Yes, beginning in the taxation year in which the children inherit the "active" parent's shares.

Reasons: Based on technical requirements.

2019 STEP CRA Roundtable – June 7, 2019

QUESTION 6(a). Tracing of Owner or Property Attributes

It is unclear how the rules in subsection 120.4(1.1) will work where there have been multiple deaths. For example, assume Mr. and Mrs. A own all the shares of Opco, which operates a services business. Mrs. A has been actively engaged in the business for at least five years, whereas Mr. A has not been actively engaged in the business. Mrs. A passes away and all her shares are gifted through her will to Mr. A. Subsequent distributions from Opco to Mr. A would not be split income as Opco would be deemed to be an excluded business in respect of Mr. A, even if he is not actively engaged in the business. But how will the deeming rules apply if Mr. A subsequently dies and those shares are gifted to the children. Will they be deemed to have made the same contributions as Mrs. A? Or do the deeming rules only reference Mr. A’s contributions? If the latter, then the children could become subject to the TOSI rules unless they can rely on another exemption.

Question 6(b) – Tracing of Attributes (Cont-d)

Consider the situation where Mr. A passed away in Year 1 and Mrs. A passed away in Year 2. In each of their will, they each bequest ½ of their shares of Opco to each of their 2 inactive children. As a result, each child received ½ of his/her shares of Opco from Mr. A and the other ½ from Mrs. A. Is each child entitled to the excluded business exemption in respect of all future dividends received from Opco?

CRA Response

Question 6(a)

Subparagraph 120.4(1.1)(b)(ii) provides a continuity rule that may apply for the purposes of this subparagraph and the definition of “excluded business” in subsection 120.4(1). This rule can apply where the property (in this case the inherited shares) was acquired by, or for the benefit of, the specified individual as a consequence of the death of another person. If this rule applies, the specified individual’s income on the inherited property will qualify as an “excluded amount” under subparagraph 120.4(1)(e)(ii) to the extent that the deceased individual was otherwise actively engaged on a regular, continuous and substantial basis in the activities of the particular business throughout five previous taxation years, and will not be subject to the tax on split income (TOSI). It remains a question of fact as to whether a particular individual acquired property as a consequence of the death of another individual and whether that other individual was otherwise actively engaged on a regular, continuous and substantial basis in the activities of such business throughout five previous taxation years.

With respect to the acquisition of Mrs. A’s Opco shares by Mr. A as a consequence of her death, Mr. A will be deemed to have been actively engaged on a regular, continuous and substantial basis in the activities of Opco’s business throughout five previous taxation years for the purposes of the “excluded business” definition for all taxation years commencing with the year in which such Opco shares were so acquired. Therefore, any dividends arising on any Opco shares owned by Mr. A for a taxation year commencing with the year in which such shares were acquired as a consequence of Mrs. A’s death will not be subject to the TOSI.

Similarly, in our view, the effect of the previous application of the deeming rule in subparagraph 120.4(1.1)(b)(ii) could extend to a subsequent acquisition of property as a consequence of death of another individual. This would be the case where in respect of a particular property the particular deceased individual was previously deemed by subparagraph 120.4(1.1)(b)(ii) to have been actively engaged on a regular, continuous and substantial basis in the activities of that particular business throughout five previous taxation years.

For instance, for the purposes of subparagraph 120.4(1.1)(b)(ii) and the definition of “excluded business” in subsection 120.4(1), Mr. A was deemed by this subparagraph to have been actively engaged on a regular, continuous and substantial basis in the activities of Opco’s business throughout five previous taxation years when he acquired shares of Opco as a consequence of Mrs. A’s death. Similarly, when the children inherit Mr. A’s Opco shares as a consequence of his death, subparagraph 120.4(1.1)(b)(ii) will apply to deem each of the children to have been actively engaged on a regular, substantial and continuous basis in the business of Opco throughout five prior taxation years since Mr. A was also deemed by subparagraph 120.4(1.1)(b)(ii) to have met that requirement. As a result, the income from Opco, which would otherwise be subject to TOSI, would be an excluded amount under the excluded business definition, as discussed above. Therefore, any dividends arising on any of the shares of Opco owned by the children, for any taxation year commencing with the taxation year in which they inherited Mr. A’s Opco shares, will not be subject to the TOSI.

Question 6(b)

As noted above, Mr. A was not actively engaged on a regular, continuous and substantial basis in the activities of Opco’s business throughout five previous taxation years before his death and he did not inherit any of Mrs. A’s Opco shares before his death. As such, when his children acquire his shares of Opco, as a consequence of his death, the conditions in subparagraph 120.4(1.1)(b)(ii) would not be met. Therefore, the “excluded business” exemption will not apply at that time, and any dividends arising on the shares of Opco they inherited from Mr. A will initially be subject to the TOSI (unless another exception applies).

However, beginning with the taxation year in which the children inherit Mrs. A’s Opco shares as a consequence of her death, subparagraph 120.4(1.1)(b)(ii) will apply such that each of the children will be deemed to have been actively engaged on a regular, substantial and continuous basis in the business of Opco throughout five prior taxation years. Based on the foregoing, income from Opco that would otherwise be subject to TOSI would be an excluded amount under the “excluded business” definition as discussed above. Therefore, once the children inherit shares of Opco from Mrs. A, any dividends received on any of the Opco shares (including those previously acquired on Mr. A’s death) will not be subject to TOSI from that taxation year onward.

Additional guidance on the TOSI rules can be found on the Canada Revenue Agency (CRA) website at: https://www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/federal-government-budgets/income-sprinkling/guidance-split-income-rules-adults.html.

Allison Thomas
2019-079994