7 October 2021 APFF Roundtable Q. 18, 2021-0901091C6 - TOSI continuity rule for inherited property

Unedited CRA Tags

120.4(1.1)(b), 248(8), 248(23.1)

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This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.

Principal Issues: An individual (“Father”) is the only person actively engaged on a regular, continuous and substantial basis in the activities of the business of a corporation (“Opco”). The business of Opco is an excluded business for Father. Further to an estate freeze implemented in a previous year, a discretionary family trust (“Trust”) holds non-voting participating shares of Opco and Father holds preferred and voting shares of Opco. The beneficiaries of Trust are the wife of Father (“Mother”) and their only child (“Child”) aged 20. On December 30, 2021, Father dies. Situation A: Pursuant to the will of Father, a testamentary trust (“Trust C”) for the benefit of Child is set-up and 50% of the preferred shares owned by Father at the time of his death are transferred to Trust C for the benefit of Child. According to the will of Father, Trust C should pay $30,000 of income to Child annually and should be dissolved in the year Child reaches 36 years of age. If the amount of dividend paid by Opco to Trust C in a year is less than $30,000, Trust C may cause the redemption of a number of preferred shares sufficient to attain the amount of $30,000. On the redemption, Trust C will realize a deemed dividend under subsection 84(3) and the amount of deemed dividend will be allocated to Child. When Child attains the age of 36, the shares of Opco will be transferred to him and he will then ask for the redemption of the preferred shares and realize a deemed dividend in the amount of $100,000. Situation B: Pursuant to the trust indenture of Trust, Father has a power of appointment. Father exercised this power in his will and from the date of his death to the date of dissolution of Trust, Trust should pay $30,000 of income to Child annually and in the year Child reaches the age of 36, Trust will be dissolved and the capital of Trust will be transferred to Child. If Trust did not receive dividends of $30,000 from Opco in a year, Trust may cause the redemption of a number of preferred shares sufficient to attain the amount of $30,000. On the redemption, Trust will realize a deemed dividend under subsection 84(3) and the deemed dividend will be allocated to Child.

Position: Situation A: Yes. Situation B: No.

Reasons: Situation A: The rule is applicable, since Trust C acquired the Opco shares as a consequence of the death of Father for the benefit of Child. Situation: B The rule is not applicable for the years during which Trust owns the Opco shares, since Trust acquired the Opco shares before the death of Father. The rule will be applicable after the liquidation of Trust and the acquisition of the Opco shares by Child, since Child will acquire the shares as a consequence of the death of Father by virtue of the application of the power of appointment in the Father's will.

FEDERAL TAX ROUNDTABLE, OCTOBER 7, 2021
APFF CONFERENCE 2021

Question 18

Tax on Split Income and continuity rule

For several years now, following an estate freeze, a discretionary family trust (the "Trust") has held all of the Class C non-voting and participating shares of the capital stock of a private corporation ("Opco"). As part of the estate freeze, the common shares of the capital stock of Opco then held by Mr. X were exchanged for 1,000,000 Class E preferred shares of the capital stock of Opco. These Class E shares have a nominal ACB to Mr. X and paid-up capital ("PUC") and a redemption value of $1,000,000. They also entitle the holder to receive an annual non-cumulative dividend at a fixed rate ranging from 5% to 10% per annum, calculated on the redemption value. Mr. X also holds all of the voting shares of the capital stock of Opco.

Mr. X's spouse (Ms. X), and the 20 year old child of Mr. X and Ms. X (Child X), are beneficiaries of the Trust and none of them is involved in the business of Opco. Only Mr. X has been actively engaged on a regular, continuous and substantial basis in the business of Opco for more than five years, making the business of Opco an "excluded business" to him, within the meaning of the definition of that term in subsection 120.4(1). Opco is not a professional corporation and the FMV of the Class C shares of the capital stock of Opco held by the Trust has been determined to be $1,500,000 on December 30, 2021.

Opco's business is a "related business", as defined in subsection 120.4(1), in respect of Ms. X and Child X and any dividend amount distributed to them by the Trust will be subject to TOSI, provided that it qualifies as an "excluded amount" within the meaning of subsection 120.4(1).

SITUATION A

Mr. X died on December 30, 2021 and his will provided for a bequest of all of the voting shares and 500,000 Class E shares of the capital stock of Opco to Ms. X. The will also provided for a bequest to a testamentary trust for the benefit of Child X ("Trust X") of 500,000 Class E shares of the capital stock of Opco.

The will provided that Trust X was to provide an annual income of $30,000 to Child X until he reached the age of 35. If, in any year, the dividends paid by Opco on the 500,000 Class E shares of Opco's capital stock were insufficient to pay $30,000 to Child X, Trust X was required to redeem some of those shares to make up the difference.

The will provided that the capital of Trust X would be distributed to Child X in the calendar year in which he attained the age of 36. The sole trustee of Trust X was Ms. X.

On December 31, 2037, when Child X was 36 years old, Trust X is wound up and the remaining 100,000 Class E shares of Opco's capital stock are distributed to Child X without tax consequences. Child X requests the redemption of the Class E shares of the capital stock of Opco that he holds. By virtue of subsection 84(3), Opco is deemed to have paid and Child is deemed to have received a dividend in the amount of $100,000. The dividend is a taxable dividend to Child X.

Ms. X still personally holds all of the voting shares and a number of Class E shares in the capital stock of Opco having an FMV of at least 10% of the FMV of the capital stock of Opco. The Trust has not yet been wound up.

Questions to the CRA

(a) Is the amount of dividends totalling $30,000 received by Child X in a year an excluded amount pursuant to subparagraph 120.4(1.1)(b)(ii)?

(b) Is the $100,000 dividend amount deemed to be received by Child X as a result of the redemption of the Class E shares an excluded amount pursuant to subparagraph 120.4(1.1)(b)(ii)?

SITUATION B

The Trust Deed contains a designation clause. Under this clause, on the death of Mr. X, the beneficiaries of the Trust will be the persons expressly designated as such by Mr. X in his will. The right to elect will become effective upon the death of Mr. X. The Trust Deed specifies that the persons to whom Mr. X may exercise his power of election will be Ms. X and Child X.

Mr. X died on December 30, 2021. Mr. X's will provided for a bequest of all of the voting shares and 1,000,000 Class E shares in the capital stock of Opco to Ms. X.

The will provides that the trustee of the Trust will provide an annual income of $30,000 to Child X until he attains the age of 35. If, in any year, the dividends paid by Opco to the Trust on the Class C shares of the capital stock of Opco are insufficient to provide $30,000 to Child X, the Trust will be required to redeem a portion of the shares to make up the difference.

The will provides that the entire trust capital will be distributed to Child X in the calendar year in which he attains 36.

From the time of Mr X's death, the sole trustee of the Trust is a third party.

Ms. X still personally holds the voting shares and a number of Class E shares in the capital stock of Opco having an FMV of at least 10% of the FMV of Opco's capital stock.

Question to the CRA

Is the amount of dividends totalling $30,000 received by Child X in a year an excluded amount under subparagraph 120.4(1.1)(b)(ii)k?

CRA Response

General comments

Paragraph 120.4(1.1)(b) introduces a continuity rule in respect of, inter alia, inherited property. It applies to amounts that would, but for the application of that rule, be split income of a specified individual who attained 17 years of age before the year, in respect of property that was acquired by or on behalf of the specified individual as a consequence of the death of another person.

Subparagraph 120.4(1)(b)(ii) provides that, for the purposes of that subparagraph and the definition "excluded business" in subsection 120.4(1), if the other person was actively engaged on a regular, continuous and substantial basis in the activities of the related business in five preceding taxation years, the specified individual is deemed to have been actively engaged on a regular, continuous and substantial basis in the business throughout those five years.

Where subparagraph 120.4(1.1)(b)(ii) applies, the individual's income determined on the property acquired by or on behalf of the individual as a consequence of the death of a person will be an excluded amount to the extent that the amount, if received by the deceased person, would have been derived from an excluded business because the deceased person was actively engaged on a regular, continuous and substantial basis in the business throughout the preceding five taxation years, or was deemed by that subparagraph to be actively engaged in the business.

Paragraph 120.4(1.1)(b) provides, inter alia, that a property must be acquired by or on behalf of the specified individual as a consequence of the death of another person. Whether property is acquired by or on behalf of the specified individual because of the death of another person is a question of fact and law that can only be resolved after considering all of the relevant facts and circumstances of a particular situation.

Paragraph 248(8)(a) provides, inter alia, that a transfer, distribution or acquisition of property made under a taxpayer's will is considered to be a transfer, distribution or acquisition of property made as a consequence of the death of the taxpayer.

CRA answers to questions (a) and (b) of Situation A

First, for the purposes of this Situation, we have assumed that Child X is the sole beneficiary of the income and capital of Trust X.

Given that the Class E shares of the capital stock of Opco were acquired by Trust X pursuant to the terms of Mr. X's will, that acquisition is considered to be an acquisition made as a consequence of Mr. X's death by virtue of paragraph 248(8)(a). Since Child X is Trust X's sole beneficiary, Trust X's acquisition of the Class E shares of the capital stock of Opco was therefore made on behalf of Child X. Furthermore, upon the delivery of the capital by Trust X to Child X in the calendar year in which he turns 36 years old - as provided for in Mr. X's will - Child X will acquire, inter alia, the Class E shares of the capital stock of Opco. That acquisition will also be considered an acquisition of property made as a consequence of Mr. X's death. Consequently, the deeming rule in subparagraph 120.4(1.1)(b)(ii) will apply in respect of Child X. Child X will therefore be deemed to have been actively, regularly, continuously and substantially engaged in the business of Opco and Opco's business will be an excluded business for Child X. All dividends paid (or deemed to be paid) by Opco on the Class E shares of its capital stock and received (or deemed to be received) by Child X directly or indirectly through Trust X, will then be excluded amounts for Child X by virtue of subparagraph (e)(ii) of the definition of "excluded amount" in subsection 120.4(1).

CRA response to the question from Situation B

The Class C shares of the capital stock of Opco held by the Trust were not acquired by the Trust on behalf of Child X as a consequence of the death of another person, as the Trust already held such shares at the time of Mr. X's death. Consequently, the deeming rule in subparagraph 120.4(1.1)(b)(ii) cannot apply and the business of Opco will not be an excluded business for Child X. All dividends paid (or deemed to be paid) by Opco on the Class C shares of its capital stock and indirectly received (or deemed to be received) by Child X, through the Trust, will not be excluded amounts for Child X by virtue of subparagraph (e)(ii) of the definition of "excluded amount" in subsection 120.4(1).

Furthermore, upon the delivery of capital by the Trust to Child X in the calendar year in which he or she turns 36 years of age - as provided for in Mr. X's will - Child X will acquire, inter alia, Class C shares of the capital stock of Opco. That acquisition will be considered to be an acquisition of property made as a consequence of Mr. X's death and from that time on, the conditions for the application of the deeming rule in subparagraph 120.4(1.1)(b)(ii) will be satisfied and Child X will be deemed to have been actively involved on a regular, continuous and substantial basis in the business of Opco. Opco's business will therefore be an excluded business for Child X. Thus, as of the time Child X holds Class C shares of the capital stock of Opco, the income from those shares will be an excluded amount for Child X within the meaning of subparagraph (e)(ii) of the definition of "excluded amount" in subsection 120.4(1).

Yvon Beaudoin
(514) 496-6688
October 7, 2021
2021-090109

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Text of Severed Letter

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.

Position: Situation A: Yes. Situation B: No.

TABLE RONDE SUR LA FISCALITÉ FÉDÉRALE DU 7 OCTOBRE 2021

APFF - CONGRÈS 2021

18. Impôt sur le revenu fractionné et règle de continuité

Depuis quelques années déjà, suite à un gel successoral, une fiducie familiale discrétionnaire (« Fiducie ») détient la totalité des actions sans droit de vote et participantes de catégorie « C » du capital-actions d’une société privée (« Opco »). Dans le cadre du gel successoral, les actions ordinaires du capital-actions d’Opco alors détenues par M. X ont été échangées pour 1 000 000 d’actions privilégiées de catégorie « E » du capital-actions d’Opco. Ces actions de catégorie « E » ont un prix de base rajusté (« PBR »), pour M. X, et un capital versé (« CV ») nominaux tandis que leur valeur de rachat a été fixée à 1 000 000 $. Elles confèrent également à leur détenteur le droit de recevoir un dividende annuel non cumulatif au taux fixe variant de 5 % à 10 % l'an, calculé sur la valeur de rachat. M. X détient également la totalité des actions avec droit de vote du capital-actions d’Opco.

La conjointe de M. X, Mme X, et l’enfant de M. X et Mme X, Enfant X, âgé de 20 ans, sont bénéficiaires de Fiducie et aucun d’entre eux ne participe aux activités de l’entreprise d’Opco. Uniquement M. X participe activement, de façon régulière, continue et importante aux activités de l’entreprise d’Opco depuis plus de cinq ans, ce qui fait de l’entreprise d’Opco une « entreprise exclue » pour lui, au sens de la définition de cette expression au paragraphe 120.4(1) L.I.R. Opco n’est pas une société professionnelle et la juste valeur marchande (« JVM ») des actions de catégorie « C » du capital-actions d’Opco détenues par Fiducie a été établie à 1 500 000 $ au 30 décembre 2021.

L’entreprise d’Opco est une « entreprise liée », au sens de la définition de cette expression au paragraphe 120.4(1) L.I.R., relativement à Mme X et à Enfant X et tout montant de dividende qui leur sera attribué par Fiducie sera assujetti à l’impôt sur le revenu fractionné, sous réserve qu’il se qualifie de « montant exclu » au sens du paragraphe 120.4(1) L.I.R.

SITUATION A

M. X décède le 30 décembre 2021 et son testament prévoit un legs à titre particulier de la totalité des actions avec droit de vote et de 500 000 actions de catégorie « E » du capital-actions d’Opco en faveur de Mme X. Le testament prévoit également le legs à une fiducie testamentaire au bénéfice d’Enfant X (« Fiducie X ») de 500 000 actions de catégorie « E » du capital-actions d’Opco.

Le testament prévoit que Fiducie X devra assurer un revenu annuel d’un montant de 30 000 $ à Enfant X jusqu’à ce qu’il atteigne l’âge de 35 ans. Si, au cours d’une année, les dividendes versés par Opco sur les 500 000 actions de catégorie « E » du capital-actions d’Opco sont insuffisants pour payer un montant de 30 000 $ à Enfant X, Fiducie X devra demander le rachat d’une partie de ces actions pour combler la différence.

Le testament prévoit que le capital de Fiducie X sera remis à Enfant X durant l’année civile au cours de laquelle il atteindra l’âge de 36 ans. L’unique fiduciaire de Fiducie X est Mme X.

Le 31 décembre 2037, alors qu’Enfant X a 36 ans, Fiducie X est liquidée et le solde des actions de catégorie « E » du capital-actions d’Opco lui est remis, soit 100 000 actions, sans conséquence fiscale. Enfant X demande le rachat des actions de catégorie « E » du capital-actions d’Opco qu’il détient. En vertu du paragraphe 84(3) L.I.R., Opco sera réputée avoir versé et Enfant sera réputé avoir reçu un dividende d’un montant de 100 000 $. Le dividende est un dividende imposable pour Enfant X.

Mme X détient toujours personnellement la totalité des actions votantes et un nombre d’actions de catégorie « E » du capital-actions d’Opco ayant une JVM au moins égale à 10 % de la JVM du capital-actions d’Opco. Fiducie n’est toujours pas liquidée.

Questions à l’ARC

a) Est-ce que le montant de dividendes totalisant 30 000 $ reçu par Enfant X au cours d’une année est un montant exclu en vertu du sous-alinéa 120.4(1.1)b)(ii) L.I.R.?

b) Est-ce que le montant de dividende de 100 000 $ réputé reçu par Enfant X à la suite du rachat des actions de catégorie « E » est un montant exclu en vertu du sous-alinéa 120.4(1.1)b)(ii) L.I.R.?

SITUATION B

L’acte constitutif de Fiducie contient une clause de faculté d’élire. En vertu de cette clause, à compter du décès de M. X, les bénéficiaires de Fiducie seront les personnes désignées expressément à ce titre par M. X dans son testament. La faculté d’élire deviendra effective à compter du décès de M. X. L’acte constitutif de Fiducie spécifie que les personnes en faveur desquelles M. X pourra exercer sa faculté d’élire seront Mme X et Enfant X.

M. X décède le 30 décembre 2021. Le testament de M. X prévoit le legs de la totalité des actions votantes et des 1 000 000 actions de catégorie « E » du capital-actions d’Opco en faveur de Mme X.

Le testament prévoit que le fiduciaire de Fiducie devra assurer un revenu annuel d’un montant de 30 000 $ à Enfant X jusqu’à ce qu’il atteigne l’âge de 35 ans. Si, au cours d’une année, les dividendes versés par Opco à Fiducie sur les actions de catégorie « C » du capital-actions d’Opco sont insuffisants pour qu’un montant de 30 000 $ soit attribué à Enfant X, Fiducie devra demander le rachat d’une partie des actions pour combler la différence.

Le testament prévoit que le capital de Fiducie sera entièrement remis à Enfant X durant l’année civile au cours de laquelle il atteindra l’âge de 36 ans.

À compter du décès de M. X, l’unique fiduciaire de Fiducie est un tiers.

Mme X détient toujours personnellement les actions votantes et un nombre d’actions de catégorie « E » du capital-actions d’Opco ayant une JVM au moins égale à 10 % de la JVM du capital-actions d’Opco.

Question à l’ARC

Est-ce que le montant des dividendes totalisant 30 000 $ reçus par Enfant X au cours d’une année est un montant exclu en vertu du sous-alinéa 120.4(1.1)b)(ii) L.I.R.?

Réponse de l’ARC

Commentaires généraux

L’alinéa 120.4(1.1)b) L.I.R. instaure une règle de continuité à l’égard, notamment, des biens hérités. Il s’applique aux montants qui seraient, en l’absence de l’application de cette règle, un revenu fractionné d’un particulier déterminé, qui a atteint l’âge de 17 ans avant l’année, à l’égard du bien qui a été acquis par le particulier déterminé, ou pour son compte, par suite du décès d’une autre personne.

Le sous-alinéa 120.4(1)b)(ii) L.I.R. prévoit que, pour l’application de ce sous-alinéa et de la définition de l’expression « entreprise exclue » au paragraphe 120.4(1) L.I.R., si l’autre personne participait activement, de façon régulière, continue et importante, aux activités de l’entreprise liée dans cinq années d’imposition précédentes, le particulier déterminé est réputé avoir participé activement, de façon régulière, continue et importante à l’entreprise tout au long de ces cinq années.

Lorsque le sous-alinéa 120.4(1.1)b)(ii) L.I.R. s’applique, le revenu du particulier déterminé sur le bien acquis par lui ou pour son compte en raison du décès d’une personne sera un montant exclu dans la mesure où le montant, s’il avait été reçu par la personne décédée, aurait été tiré d’une entreprise exclue parce que la personne décédée participait activement, de façon régulière, continue et importante, aux activités de l’entreprise dans les cinq années d’imposition précédentes, ou était réputée y participer activement en vertu de ce sous-alinéa.

L’alinéa 120.4(1.1)b) L.I.R. édicte, entre autres, qu’un bien doit être acquis par le particulier déterminé, ou pour son compte, en raison du décès d’une autre personne. La question de savoir si un bien est acquis par le particulier déterminé, ou pour son compte, en raison du décès d’une autre personne est une question de fait et de droit qui ne peut être résolue qu’après avoir considéré l’ensemble des circonstances et des faits pertinents propres à une situation donnée.

L’alinéa 248(8)a) L.I.R. édicte, entre autres, qu’un transfert, une distribution ou une acquisition de biens effectué en vertu du testament d’un contribuable est considéré comme un transfert, une distribution ou une acquisition de biens effectué par suite du décès du contribuable.

Réponses de l’ARC aux questions a) et b) de la Situation A

Tout d’abord, pour les fins de la présente Situation, nous posons comme hypothèse qu’Enfant X est l’unique bénéficiaire du revenu et du capital de Fiducie X.

Compte tenu du fait que les actions de catégorie « E » du capital-actions d’Opco ont été acquises par Fiducie X conformément aux termes du testament de M. X, cette acquisition est considérée comme une acquisition effectuée par suite du décès de M. X en vertu de l’alinéa 248(8)a) L.I.R. Puisqu’Enfant X est l’unique bénéficiaire de Fiducie X, l’acquisition par cette dernière des actions de catégorie « E » du capital d’Opco a donc été effectuée pour le compte d’Enfant X. De plus, lors de la remise du capital par Fiducie à Enfant X dans l’année civile au cours de laquelle il atteindra 36 ans, – tel qu’il est prévu dans le testament de M. X – Enfant X acquerra, entre autres, les actions de catégorie « E » du capital-actions d’Opco. Cette acquisition sera également considérée comme une acquisition de biens effectuée par suite du décès de M. X. Par conséquent la règle déterminative prévue au sous-alinéa 120.4(1.1)b)(ii) L.I.R s’appliquera à l’égard d’Enfant X. Enfant X sera donc réputé avoir participé activement, de façon régulière, continue et importante à l’entreprise d’Opco et l’entreprise d’Opco sera une entreprise exclue pour celui-ci. Tous les dividendes versés (ou réputés versés) par Opco sur les actions de catégorie « E » de son capital-actions et reçus (ou réputés reçus) par Enfant X directement ou indirectement par le biais de Fiducie X, seront alors des montants exclus pour Enfant X en vertu du sous-alinéa e)(ii) de la définition de l’expression « montant exclu » au paragraphe 120.4(1) L.I.R.

Réponse de l’ARC à la question de la Situation B

Les actions de catégorie « C » du capital-actions d’Opco détenues par Fiducie n’ont pas été acquises par cette dernière pour le compte d’Enfant X en raison du décès d’une autre personne, car Fiducie détenait déjà lesdites actions au moment du décès de M. X. En conséquence, la règle déterminative prévue au sous-alinéa 120.4(1.1)b)(ii) L.I.R. ne peut s’appliquer et l’entreprise d’Opco ne sera pas une entreprise exclue pour Enfant X. Tous les dividendes versés (ou réputés versés) par Opco sur les actions de catégorie « C » de son capital-actions et indirectement reçus (ou réputés reçus) par Enfant X, par le biais de Fiducie, ne seront pas des montants exclus pour Enfant X en vertu du sous-alinéa e)(ii) de la définition de l’expression « montant exclu » au paragraphe 120.4(1) L.I.R.

Par ailleurs, lors de la remise du capital par Fiducie à Enfant X dans l’année civile au cours de laquelle il atteindra 36 ans, – tel qu’il est prévu dans le testament de M. X – Enfant X acquerra, entre autres, des actions de catégorie « C » du capital-actions d’Opco. Cette acquisition sera considérée comme une acquisition de biens effectuée par suite du décès de M. X et à partir de ce moment, les conditions d’application de la règle déterminative prévue au sous-alinéa 120.4(1.1)b)(ii) L.I.R. seront réunies et Enfant X sera réputé avoir participé activement, de façon régulière, continue et importante à l’entreprise d’Opco. L’entreprise d’Opco sera donc une entreprise exclue pour Enfant X. Ainsi, à compter du moment où Enfant X détiendra des actions de catégorie « C » du capital-actions d’Opco, les revenus tirés de ces actions constitueront des montants exclus pour Enfant X au sens du sous-alinéa e)(ii) de la définition de l’expression « montant exclu » au paragraphe 120.4(1) L.I.R.

Yvon Beaudoin
(514) 496-6688
Le 7 octobre 2021
2021-090109

Summaries

Summary Under

Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1.1) - Paragraph 120.4(1.1)(b) - Subparagraph 120.4(1.1)(b)(ii)

a dividend on shares that were distributed by an inter vivos trust, as directed in a will 15 years previously, can be excluded by s. 120.4(1.1)(b)(ii)

A discretionary family trust (the "Trust") held all the Class C non-voting common shares of Opco having an FMV of $1,500,000, and Mr. X held all the voting shares, and Class E preferred shares with a nominal ACB and paid-up capital and a redemption value of $1,000,000.

Mr. X had been actively involved etc. in the Opco business for over five years, whereas his spouse (Ms. X), and their 20 year old child (Child X), who were beneficiaries of the Trust, had no such involvement.

Situation A

The will of Mr. X, who died on December 30, 2021, provided for a bequest of half the Class E shares to a testamentary trust for the benefit of Child X ("Trust X"), as well as bequest of the remaining shares to Ms. X. The will provided that: Trust X was to provide an annual income of $30,000 to Child X until age 35 and to distribute the Trust capital to Child X on turning 36.

Accordingly, Child X receives the Class E shares (that had not previously been encroached on) on turning 36 – whereupon Child X requests their redemption, thereby resulting in the receipt of a deemed dividend of $100,000.
Are the following amounts received by Child X "excluded amounts" under s. 120.4(1.1)(b)(ii): (a) the dividends of $30,000; and (b) the $100,000 deemed dividend?

In responding affirmatively, CRA noted that the Class E shares were acquired by Trust X (on behalf of Child X, its sole beneficiary) pursuant to the terms of Mr. X's will and thus were deemed by s. 248(8)(a) to be acquired as a consequence of Mr. X's death. Furthermore, the distribution of Class E shares on Child X turning 36 - as provided in Mr. X's will – would also be considered an acquisition of property made as a consequence of Mr. X's death. CRA stated that pursuant to s. 120.4(1.1)(b)(ii):

Child X will therefore be deemed to have been actively, regularly, continuously and substantially engaged in the business of Opco and Opco's business will be an excluded business for Child X. All dividends paid (or deemed to be paid) by Opco on the Class E shares of its capital stock and received (or deemed to be received) by Child X directly or indirectly through Trust X, will then be excluded amounts for Child X pursuant to subparagraph (e)(ii) of the definition of "excluded amount" … .

Situation B

The Trust deed provides that, upon the death of Mr. X, the beneficiaries of the Trust would be whichever of Ms. X and Child X was expressly designated by Mr. X in his will. Mr. X died on December 30, 2021, and his will provided for all his Opco shares to go to Ms. X.

However, the will provided that: Trust X was to provide an annual income of $30,000 to Child X until age 35; and to distribute the Trust capital to Child X on turning 36.
Would the dividends of $30,000 received by Child X be excluded amounts under s. 120.4(1.1)(b)(ii)?

CRA indicated that the Class C shares held by the Trust were not acquired by the Trust on behalf of Child X as a consequence of the death of another person, as the Trust already held such shares at the time of Mr. X's death, so that the s. 120.4(1.1)(b)(ii) deeming rule did not apply, and the dividends indirectly received by Child X, through the Trust would not be excluded amounts under s. (e)(ii) of the definition.
However, the acquisition by Child X of the Class C shares distributed to that child upon turning 36 would occur as provided for in Mr. X's will and, thus, as a consequence of Mr. X's death – so that from that time on, the conditions in s. 120.4(1.1)(b)(ii) will be satisfied and the income from those shares (including the deemed dividend) will be an excluded amount to Child X.

Summary Under

Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Amount - Paragraph (e) - Subparagraph (e)(ii)

s. 120.4(1.1)(b)(ii) can apply to shares distributed by inter vivos trust but as directed in will, so that (e)(ii) exclusion can apply

The will of an individual (Mr. X), who had for many years been actively involved in the business of an Opco, provided for a portion of his Opco shares to go to a testamentary trust for his 20-year old child. CRA indicated that the child would be deemed by s. 120.4(1.1)(b)(ii) to have been also actively engaged in the Opco business, so that the Opco dividends received by the child through the trust were deemed to be “excluded amounts.” Also, a deemed dividend received by the child over 15 years later when a distribution of the Opco shares occurs on the distribution date established in the testamentary trust was to be followed by a redemption in the child’s hands of those shares.

An alternate scenario involved an inter vivos trust holding Opco shares at the time of Mr. X’s death which were directed under the trust deed to be applied as directed in Mr. X’s will – which provided the same terms as described above. Here, since the shares held in the trust were not acquired by it as a consequence of Mr. X’s death (they had been settled on it before his death), the s. 120.4(1.1)(b)(ii) rule could not be applied to render the dividends distributed by the trust to the child as excluded amounts. However, this issue was cured once the shares were distributed by the inter vivos trust to the child on the distribution-date 15 years later, since such distribution occurred as directed in Mr. X’s will and, therefore, as a consequence of his death. Consequently, the deemed dividend received on the ensuing redemption of those shares would be deemed to be an excluded amount.

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7 October 2021 APFF Roundtable Q. 18, 2021-0901091C6 - TOSI continuity rule for inherited property

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Situation A

Situation B