26 November 2021 CTF Roundtable Q. 5, 2021-0911821C6 - Corporate Attribution

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: In the scenario described whereby an individual indirectly transfers property to a corporation through a trust and a holding corporation, does corporate attribution apply?

Position: Inconclusive, but likely yes.

Reasons: A complete review of the facts and circumstances, including the trust documents, is required; however, the conditions for the application of subsection 74.4(2) seem likely to have been met, based on the limited facts provided. Subsection 74.4(4) does not apply.

2021 CTF Annual CRA Round Table – November 25, 2021

Question 5: Corporate Attribution in a Tiered - Corporate Structure

An individual transfers $100 to a trust. The trust uses the $100 to subscribe for shares of Holdco. Holdco is a holding company. Holdco then uses the $100 to subscribe for shares of Subco. Subco is an investment company. Subco uses the $100 to acquire investments. The beneficiaries of the trust include minor children who are “designated persons” in respect of the individual, as defined in subsection 74.5(5) of the Income Tax Act. The trust agreement prohibits any distribution (income or capital) from the trust to minors. The individual is not a beneficiary of the trust nor a shareholder of either Holdco or Subco. Subco is not a small business corporation.

Assuming that subsection 74.4(2) does not apply to the transfer of the $100 to Holdco in light of subsection 74.4(4), will subsection 74.4(2) or subsection 74.5(6) apply to the transfer of the $100 to Subco?

CRA Response

Unless otherwise stated, all references to a statutory section, subsection or paragraph in this response are references to the relevant provision of the Income Tax Act, R.S.C. 1985 (5th Suppl.) c.1, as amended.

Subsection 74.4(2) - Overview

Subsection 74.4(2) is a corporate attribution rule with broad application. It applies to a direct or indirect transfer or loan of property by an individual to a corporation, by means of a trust or by any other means whatever, where it can reasonably be considered that one of the main purposes of the transfer or loan is to reduce the income of the individual and to benefit, either directly or indirectly, though a trust or by any other means whatever, a designated person in respect of that individual.

Subsection 74.5(5) defines a “designated person” to include, inter alia, a child (under the age of 18 years old) of the individual that makes the transfer or the loan to the corporation.

In the scenario above, an individual has indirectly transferred property ($100 cash) to Subco, through a trust and Holdco.

The question of whether it is reasonable to consider that one of the main purposes of this transfer of property is to reduce the income of the individual and to benefit, either directly or indirectly, his or her minor children (the “Purpose Test”) is a question of fact which must be resolved in light of all the circumstances and particulars of each case. We do not have any facts relating to the purposes of the transfer and we are therefore unable to conclude on the Purpose Test in this scenario.

Subsection 74.4(4) – Exception to the Purpose Test

Subsection 74.4(4), which provides an exception to the Purpose Test in subsection 74.4(2), does not apply in this situation for the reasons set out below.

Subsection 74.4(4) was introduced to ensure that, in certain estate planning circumstances, subsection 74.4(2) will not apply with respect to a designated person in respect of an individual where the individual loans or transfers property to a corporation, and:

(a) the only interest that the designated person has in the corporation is a beneficial interest in the shares of the corporation which are held through a trust,

(b) the terms of the trust provide that the person may not receive or otherwise obtain the use of any income or capital of the trust while the person is a designated person in respect of the individual, and

(c) the designated person has not received or otherwise obtained the use of any of the income or capital of the trust, and no deduction has been made by the trust in computing its income under subsection 104(6) or (12) in respect of amounts paid or payable to, or included in the income of, that person while being a designated person in respect of the individual.

When interpreting the condition in paragraph 74.4(4)(a) above, for purposes of answering this question, “the corporation” refers to Subco. The minor children in respect of the individual have a beneficial interest in the trust that only owns the shares of Holdco. The trust does not own any shares of Subco. Therefore, this condition is not met, and subsection 74.4(4) does not apply to prevent the application of subsection 74.4(2) to the indirect transfer of property by the individual to Subco.

Subsection 74.4(2) – Requirements for Application in a Particular Taxation Year

Accordingly, to the extent that the Purpose Test is met, subsection 74.4(2) will apply to the individual in a taxation year that includes a period after the transfer throughout which all of the following three conditions are met:

• the individual was a resident in Canada;
• the corporation was not a small business corporation (defined in subsection 248(1)); and
• the person is a designated person in respect of the individual and would have been a specified shareholder of the corporation if the definition “specified shareholder” in subsection 248(1) were read without reference to paragraphs (a) and (d) of that definition and if the reference therein to “any other corporation that is related to the corporation” were read as a reference to “any other corporation (other than a small business corporation) that is related to the corporation”.

The scenario states that Subco is not a small business corporation.

For purposes of our response, we have assumed that Holdco is not a small business corporation and that the individual is a Canadian resident.

With respect to whether the minor children of the individual (i.e., the designated persons) are specified shareholders of Subco, the relevant portion of the modified definition of “specified shareholder” states:

specified shareholder of a corporation in a taxation year means a taxpayer who owns, directly or indirectly, at any time in the year, not less than 10% of the issued shares of any class of the capital stock of the corporation or of any other corporation (other than a small business corporation) that is related to the corporation and, for the purposes of this definition,

(b) each beneficiary of a trust shall be deemed to own that proportion of all such shares owned by the trust at that time that the fair market value at that time of the beneficial interest of the beneficiary in the trust is of the fair market value at that time of all beneficial interests in the trust, […]

and

(e) notwithstanding paragraph (b), where a beneficiary’s share of the income or capital of the trust depends on the exercise by any person of, or the failure by any person to exercise, any discretionary power, the beneficiary shall be deemed to own each share of the capital stock of a corporation owned at that time by the trust.

We would have to review the relevant trust documents to conclude on whether paragraph (e) of the definition of “specified shareholder” is met in this case because there is no mention of the trust being discretionary in the scenario. Assuming the children’s shares of the income or capital of the trust depend on the trustee’s exercise, or failure to exercise, any discretionary power, paragraph (e) of the definition of “specified shareholder” would be met, even if the children are not entitled to any income or capital of the trust while they are minors. In such a case, paragraph (e) of the definition of “specified shareholder” would deem the minor children to own the shares of Holdco, a corporation related to Subco. Therefore, the minor children who are designated persons in respect of the individual, would also be specified shareholders of Subco.

Subsection 74.5(6)

In light of the comments made above, it is not necessary for us to consider the application of the anti-avoidance provision to subsection 74.4(2) in subsection 74.5(6), dealing with back-to-back loans and transfers.

N. Verlinden
2021-091182
November 25, 2021