26 November 2020 STEP Roundtable Q. 2, 2020-0840001C6 - Subsection 104(13.4) and LCBs

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: Paragraph 104(13.4)(a) applies to alter ego, joint spousal and certain other trusts. Where the provision applies, the trust will have two taxation years in the same calendar year. Consider a situation where the trust realizes a capital gain in the first taxation year and realizes a capital loss in the second taxation year. 1. What is the proper method for ensuring the capital loss is applied in the first taxation year? 2. Where the net capital loss carried back (LCB) is at least equal to the taxable capital gain in the first taxation year, will arrears interest be charged in respect of tax payable in the first taxation year?

Position: 1. The capital loss realized in the second taxation year must be reported in the T3 return for that year and the LCB request must be made by filing a T3A form. The T3A form should be filed on or before the balance-due day for the first taxation year. 2. The LCB request will be processed after the notice of assessment for the first taxation year is issued. Where the tax payable reported on the return for first taxation year is not paid on the balance-due day, the notice of assessment will reflect arrears interest. However, where the LCB request is filed on or before the "balance-due day" of the first taxation year and the net capital loss is at least equal to the taxable capital gain in the first taxation year, arrears interest reported on the notice of reassessment should be reversed.

Reasons: 1. The date on which the T3 return is due, and the “balance-due day” for the first taxation year is extended by paragraph 104(13.4)(c) to be 90 days within the end of the calendar year in which the taxation year ends. 2. The application of the LCB as described will result in no tax payable at the balance-due day for the first taxation year. Accordingly, arrears interest should not apply.

2020 STEP CRA Roundtable – November 26, 2020

QUESTION 2. Subsection 104(13.4) and Alter Ego Trusts and Joint Spousal Trusts

Pursuant to paragraph 104(13.4)(a), life interest trusts, such as Alter Ego Trusts and Joint Spousal Trusts, have a deemed year end on the date of the death of the last life interest beneficiary (the settlor in the case of the Alter Ego Trust, and the last to die of the spouses in the case of a Joint Spousal Trust). Paragraph 104(4)(a) deems the trust to have disposed of certain property of the trust at the date of death. As a result, tax on the resulting capital gains is payable by the trust on the trust’s “balance-due day” as defined in subsection 248(1).

The next taxation year of the trust will then be from the day after the date of death to December 31 of the year in which the death occurred. For example, if the death occurred on July 31, there will be a taxation year for January 1 to July 31, and a subsequent taxation year for August 1 to December 31. Both tax returns are due 90 days after the calendar year in which the death occurred.

Where a capital loss is realized by the trust in the 3 taxation years following death, the loss can be carried back under paragraph 111(1)(b) to be claimed against the capital gains in the trust’s taxation year which includes the date of death. This is claimed by filing form T3A – Request for Loss Carryback by a Trust.

However, if the loss occurs in the first taxation year after death, this loss will be known at the time of filing both tax returns for the calendar year in which the death occurred.

Can a loss which occurs in the taxation year immediately after the death be reported on the tax return filed for the date of death, rather than requiring the filing of a T3A loss carryback request? The loss will be known at the time of filing both tax returns, and both tax returns would be available for assessment at the same time, so the loss can be verified at the time of filing the date of death trust return.

CRA Response

For the 2016 and subsequent taxation years, subsection 104(13.4) applies to certain life interest trusts when an individual’s day of death, or later death, as the case may be, is referred to in paragraph 104(4)(a), (a.1) or (a.4). (footnote 1)

As noted in the question, paragraph 104(13.4)(a) results in two separate taxation years within the same calendar year. Section 3 and the description of “capital gain” and “capital loss” in subsection 39(1) refer to a “taxation year”; accordingly, these provisions will apply to each of the trust’s taxation years in the year of death. As a result, capital gains and capital losses which are realized or incurred in a particular taxation year must be reported in that taxation year.

Despite the fact that the capital loss incurred in the taxation year ending December 31 is known at the time of filing the T3 return for the taxation year ending July 31, the application of such loss cannot be “reported” on the T3 return filed for the taxation year ending July 31. This can only be done by filing a T3A form, Request for Loss Carryback by a Trust. However, the application of paragraph 104(13.4)(c) is worth noting.

Consider a situation in which the T3 return for each of the trust’s taxation years and the form T3A are all filed together, on March 31. (footnote 2) Also assume that the net capital loss for the taxation year ending December 31 is equal to the taxable capital gain realized in the taxation year ending July 31.

The loss carryback requested on the form T3A will not be processed concurrently with the T3 return for the taxation year ending July 31, as the loss must first be recognized by the CRA before it can be applied to any earlier taxation years in accordance with paragraph 111(1)(b). Therefore, the initial notice of assessment for the taxation year ending July 31 would not reflect the application of the loss carryback. Where the balance of tax is not paid on or before March 31, the assessment would include interest. When the loss carryback request is processed, the loss is applied using the request date of March 31.

For the taxation year ending July 31, the application of paragraph 104(13.4)(c) to subparagraph (a)(ii) of the definition “balance-due day” in subsection 248(1) postpones that day until 90 days after the end of the calendar year in which the taxation year ends, or March 31.

Therefore, in the example, the loss carryback is applied on the balance-due day for the taxation year ending July 31, and the net effect will be that there is no tax payable under Part I on the balance-due day of March 31. Accordingly, the interest which appeared on the notice of assessment will be reversed on the notice of reassessment for the taxation year ending July 31.

William King
November 26, 2020
2020-084000

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 Subsection 104(13.4) generally applies to alter ego trusts, joint spousal and common-law partner trusts, spousal and common-law partner trusts, and trusts to which property has been transferred by the beneficiary for the beneficiary's exclusive benefit in circumstances described in subparagraph 73(1.02)(b)(ii) or subsection 107.4(1).

2 As noted in the question, both returns are to be filed with the Minister within 90 days of the end of the calendar year in which the taxation year ends. For this example, we assume the year in which the returns must be filed is not a leap year. For the taxation year ending December 31, the filing-due date is determined by virtue of paragraph 150(1)(c) and subsection 204(2) of the Income Tax Regulations. The application of paragraph 104(13.4)(c) to these two provisions yields the same filing due date of March 31 for the taxation year ended July 31.