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.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
STRATEGY INSTITUTE - Round Table
JUNE 26, 1998
Index
Question 1 - Trust Returns
Question 2 - Instalment Payments
Question 3 - Stop-loss Provisions
Question 4 - RRSP Designations by Executor
Question 5 - Division of RRSP on Marriage Breakdown
Question 6 - Beneficiary of Registered Pension Plan
Question 7 - Charitable Gifts
Question 8 - Designations of Taxable Capital Gains
Question 9 - 56(2) - Implications of Neuman v. The Queen
Question 10 - Estate Freeze - Non-resident
Question 11 - Power of Attorney
Question 12 - Buy-out of Spouse’s Interest in Spousal Trust
STRATEGY INSTITUTE - 1998 Round Table
Question 1
Trust Returns
Why is it that a Trust Return having a December 31 year-end has to be filed within 90 days from the end of the year, whereas a T5 Return of Investment Income and a T1 Income Tax Return must be filed by February 28 and April 30, respectively?
Response
A T1 Income Tax Return is a return prescribed within section 150 of the Income Tax Act and a T5 Return of Investment Income is an information return prescribed within Part II of the Income Tax Regulations. Paragraph 150(1)(d) requires a T1 return for a taxation year to be filed by April 30 of the following year and subsection 205(1) of the Regulations requires a T5 Return to be filed by the last day of February each year in respect of the preceding calendar year. The Trust Income Tax and Information Return (“T3 Return”) is, uniquely, both an income tax return and an information return that is required by paragraph 150(1)(c) of the Act and subsection 204(2) of the Regulations to be filed within 90 days from the end of the trust’s taxation year. An example best explains why the filing dates for a T3 Return and a T5 Information Return differ. Consider a trust with a December 31 year-end which holds a substantial investment portfolio and has beneficiaries who are individuals. Before the trust’s T3 Return can be prepared, the trustee must first determine the income of the trust. Since the trust itself will be the recipient of information slips (e.g., T5 slips for interest or dividends), the trustee may not be in a position to determine the income of the trust before the end of February. As a result, the trustee has only 30 days in which to complete the calculation of the income of the trust, determine the final dollar amount of income to allocate or flow through to the beneficiaries and file the T3 Return. On the other hand, the filing date for a T3 Return cannot be the same as that for a T1 Return because the individual beneficiaries of the trust need to receive their T3 slips from the trust in time for them to complete and file their T1 Returns.
STRATEGY INSTITUTE - 1998 Round Table
Question 2
Instalment Payments
In certain circumstances an individual may be required to pay his or her taxes by instalments. Why is it that trusts are not required to make instalment payments?
Response
Subsection 156 of the Act requires an individual to make instalment payments if certain conditions are met. Since trusts are taxed as individuals, generally, they are subject to these instalment payment provisions. For example, an inter vivos trust, including a mutual fund trust, may be required to make quarterly instalments during the year on account of its Part I tax payable for the year. However, a testamentary trust, instead of making instalment payments, is allowed to pay its tax payable for the year within 90 days from the end of the taxation year by virtue of paragraph 104(23)(e).
STRATEGY INSTITUTE - 1998 Round Table
Question 3
Stop-loss Provisions
What assistance will the Department provide to help taxpayers determine whether the stop-loss provisions apply to them?
In addition, can you provide examples of the types of "subsequent actions" in respect of any insurance policy which might be seen as proof that the main purpose test was not met?
Response
In Technical News No. 12 dated February 11, 1998 the Department set out general comments which it hopes will be helpful to taxpayers in determining whether the grandfathering provisions would apply in their particular situation. As noted therein taxpayers may obtain an advance income ruling as to whether the grandfathering provisions will apply in circumstances where there is a proposed disposition of shares. Generally in this regard the proposed disposition should occur with 12 months of the date on which the ruling is requested. Since the determination of whether the grandfathering provisions will apply in any particular situation is essentially a question of fact the main task that taxpayers should face is the provision of documentation.
With regard to the second question, in most cases we would expect that documentation such as buy-sell agreements or corporate documents would indicate whether a main purpose of the life insurance policy at April 26, 1995 was to fund a redemption, acquisition or cancellation of shares by the corporation that issued the shares. Where, for some reason, there is no clear evidence of the main purpose of a life insurance policy at April 25, 1995 the actual use of the proceeds, or if the policy is subsequently canceled or allowed to lapse, the circumstances surrounding such a decision, may be indicative of whether the purpose of the life insurance policy on April 26, 1995 was to fund the redemption of shares.
Clearly subsequent events cannot substitute or overrule documentary evidence existing at April 26, 1995 but where such evidence is lacking the Department may be prepared to consider subsequent actions as collaborative evidence.
STRATEGY INSTITUTE - 1998 Round Table
Question 4
RRSP Designations by Executor
A refund of premiums is defined in subsection 146(1) of the Income Tax Act (the “Act”) to be any amount paid out of or under an RRSP to the spouse of the annuitant or, if the annuitant had no spouse at the time of death, to a child or grandchild of the annuitant who was at that time financially dependent on the deceased for support. Where the estate is the beneficiary of the RRSP, subsection 146(8.1) of the Act permits an executor to designate an amount received in a year from the RRSP as a refund of premiums if the amount would have qualified as a refund of premiums had it been paid directly to the beneficiary of the estate.
Where an executor of a deceased annuitant’s estate elects under subsection 146(8.1) of the Act in respect of a financially dependent child or grandchild, can the executor purchase a qualifying annuity for the child or grandchild or does the amount have to be distributed to the child or grandchild’s guardian to purchase the qualifying annuity in order to qualify for the deduction provided under paragraph 60(l) of the Act? If the executor can acquire the qualifying annuity, can the estate receive the annuity payments under the annuity contract as part of a discretionary trust for the child or grandchild’s benefit and would the income received by the discretionary trust still be taxable in the hands of the child or grandchild?
Response
The Department’s views as to whether a payment out of an RRSP would qualify as a refund of premiums and whether the payment could be transferred to an RRSP under paragraph 60(l) of the Act can be found in paragraphs 17 and 27, respectively, of Interpretation Bulletin IT-500R titled “Registered Retirement Savings Plans - Death of an Annuitant”.
Paragraph 27 of IT-500R states that an individual may obtain a deduction under paragraph 60(l) in respect of all or part of any amount included in the recipient’s income under subsection 146(8) in the year to the extent the amount is paid in the particular year or within 60 days after the end of the particular year to accomplish one of the alternatives described in subparagraphs 27(c) to (g). We refer you to subparagraph 27(f) wherein we state that a deduction under paragraph 60(l) of the Act will be allowed when a refund of premiums is used to acquire an annuity under which a beneficiary child or grandchild, or a trust under which the child or grandchild is the sole person beneficially interested in all amounts payable under the annuity, is the annuitant for a term of years not exceeding 18 minus the age of the beneficiary at the time of its acquisition. Paragraph 28 of IT-500R states that the deduction under
STRATEGY INSTITUTE - 1998 Round Table
Response (continued)
RRSP Designations by Executor
paragraph 60(l) of the Act is available when amounts are received by the estate, provided the amount is designated in accordance with subsection 146(8.1) and the legal representative receives the amount from the RRSP under which the deceased was the annuitant immediately prior to death. We are of the view that paragraph 60(l) will apply where the legal representative acquires an annuity that meets the requirements described in subparagraph 27(f) of IT-500R.
The determination of whether a discretionary trust for the benefit of a child or grandchild would be a trust under which the child or grandchild is the sole person beneficially interested in all amounts payable under the annuity is a question of fact that could only be determined after a review of all of the terms of the particular trust. Generally, any deduction under paragraph 60(l) would be contingent on the child or grandchild being the sole beneficiary of the discretionary trust.
A trust for the benefit of a child or grandchild will have to include the annuity payments received in any year in its income. However, the trust will be entitled to a deduction in respect of the income that is paid to or payable to the beneficiary in the particular year, including amounts deemed payable under subsection 104(18) of the Act. In this regard, we would refer you to IT-342R titled “Trusts - Income Payable to Beneficiaries” wherein you will find the Department’s views on the amounts that may be included in a beneficiary’s income and the meaning of the term “payable” for determining the amount to be included in the beneficiary’s income.
STRATEGY INSTITUTE - 1998 Round Table
Question 5
Division of RRSP on Marriage Breakdown
Paragraph 146(16)(b) of the Income Tax Act (the “Act”) provides for the transfer of property from one person’s RRSP to that person’s former spouse’s RRSP or RRIF where they are living apart as a result of a marriage breakdown. There does not appear to be a similar provision allowing for the division of annuity payments from a matured RRSP as a result of a marriage breakdown. What is Revenue Canada’s position?
Response
Tax-free transfers of RRSP property and RRIF property on marriage breakdown are governed by, respectively, paragraphs 146(16)(b) and 146.3(14)(b) of the Act. We confirm that there is no provision that allows for a direct tax-free division of a matured RRSP as a result of a marriage breakdown. However, the Act does provide for the division of retirement income, on a tax-free basis, as a result of a marriage breakdown from a matured RRSP when two separate steps are undertaken.
The first step is described in paragraph 7 of Interpretation Bulletin IT-528 titled “Transfers of Funds Between Registered Plans”. An annuitant is allowed to commute, in whole or in part, the retirement income under an RRSP in accordance with subparagraph 146(2)(b)(ii) of the Act, bring the amount into income under subsection 146(8) and paragraph 56(1)(h) of the Act, and then transfer the commutation payment to a RRIF and obtain a deduction under paragraph 60(l) of the Act. Consequently, the annuitant’s matured RRSP can be divided into a matured RRSP and RRIF without the annuitant incurring any taxes as a result of the division. The second step which is described in paragraph 8 of IT-528 is to transfer the amount in the annuitant’s RRIF to the annuitant’s former spouse’s RRSP or RRIF in accordance with paragraph 146.3(14)(b) of the Act. Under such a transfer no amount is deemed to be received by the annuitant out of or under the RRIF. Accordingly, the combined effect is a tax-free transfer from a matured RRSP to a former spouse’s RRSP or RRIF.
STRATEGY INSTITUTE - 1998 Round Table
Question 6
Beneficiary of Registered Pension Plan
Can a spousal testamentary trust, created under a registered pension plan member’s “Last Will and Testament”, be named as the member’s beneficiary under the plan for purposes of receiving the survivor’s entitlements to a pension income? If yes, how can the beneficiary election be set up with the pension administrator?
Response
The provisions of paragraphs 8503(2)(d), (e) and (f), and 8506(1)(d) and (e) of the Income Tax Regulations provide for the survivor benefits that may be paid as a result of the death of a member of a registered pension plan. These provisions refer to the deceased member’s spouse or former spouse and not to a spousal trust. Consequently, a spousal testamentary trust cannot be named as a member’s beneficiary for the purpose of receiving survivor benefits.
STRATEGY INSTITUTE - 1998 Round Table
Question 7
Charitable Gifts
The charitable giving rules apply so long as the donor is dealing at arm’s length with the donee. Does Revenue Canada have guidelines which list or refer to the factors which they will consider when determining the “non-arm’s length” issue in the context of a charitable gift?
Response
Paragraph 251(1)(a) of the Income Tax Act (the “Act”) deems related persons as defined in subsection 251(2) not to deal at arm’s length and paragraph 251(1)(b) provides that it is a question of fact whether unrelated persons deal with each other at arm’s length. While the Department provides general criteria to determine whether there is an arm’s length relationship between unrelated persons for a given transaction (see IT-419R), it must be recognized that all encompassing guidelines to cover every situation cannot be supplied. Each particular transaction or series of transactions must be examined on its own merits.
This examination should take into account the general guidelines set forth in paragraphs 15 to 19 of IT-419R. These guidelines would apply in determining whether a donor and the recipient of the gift deal with each other at arm’s length. However, as stated in paragraph 17 of IT-419R, when a common purpose exists, a transaction is not necessarily a non-arm’s length one when different interests (or independent parties) are also present. In this context, different interests are considered to exist when each party has an independent interest from the other parties to a transaction, notwithstanding the fact that each party may have the same purpose, such as the same charitable objectives.
STRATEGY INSTITUTE - 1998 Round Table
Question 8
Designations of Taxable Capital Gains
In designating taxable capital gains under subsection 104(21) of the Act, can the entire taxable capital gain be designated to a beneficiary who received only 75% of the capital gain (i.e., the taxable portion only)?
Response
Subsection 104(21) permits a trust to designate a portion of its net taxable capital gains for a taxation year as a taxable capital gain of a beneficiary of the trust. In essence, the designated portion of the net taxable capital gains of the trust is deemed to be the taxable capital gain of a particular beneficiary. The amount of the net taxable capital gains that may be designated to a particular beneficiary is limited to the portion of the net taxable capital gains as may reasonably be considered having regard to all circumstances, including the terms and conditions of the trust arrangement, to be part of the amount included in computing the beneficiary’s income for the taxation year under subsection 104(13) or (14) or section 105.
Subsection 104(21) does not, however, deem the beneficiaries to have triggered the capital gains themselves. Thus, a beneficiary’s entitlement to only the taxable portion of the capital gain would not affect the amount available to be designated to that beneficiary under subsection 104(21).
STRATEGY INSTITUTE - 1998 Round Table
Question 9
56(2) - Implications of Neuman v. The Queen
Would the Department apply subsection 56(2) in the following estate freeze situation:
- freezor exchanges common shares of an investment holding company (“Holdco”), under subsection 86(1), for redeemable, retractable preference shares of Holdco having a fair market value and redemption price equal to the fair market value of the common shares of Holdco for which they were exchanged;
- a trust for the adult children of freezor subscribes for new common shares of Holdco;
- some of the “freeze” preference shares are redeemed each year in lieu of paying dividends on the “freeze” shares; and
- each year dividends, which do not impair the redemption value of the outstanding preference shares, are paid on the common shares to the trust.
Response
On May 21, 1998 the Supreme Court of Canada rendered its judgment in the case of Melville Neuman v. Her Majesty the Queen concerning the application of subsection 56(2) to dividends.
Iacobucci, J. speaking for the Court concluded that subsection 56(2) cannot operate to attribute dividend income to a taxpayer unless the taxpayer had a pre-existing entitlement to the dividend income paid to another shareholder. Effectively, the Court confirmed the conclusion reached in McClurg “that, as a general rule, subsection 56(2) does not apply to dividend income since, until a dividend is declared, the profits belong to the corporation as retained earnings. The declaration of a dividend cannot be said, therefore, to be a diversion of a benefit which the taxpayer would have otherwise received.”
The Court also addressed the obiter comments made by Dickson, C.J. in McClurg and clarified that subsection 56(2) will not apply to dividend income where the recipient of the dividend in a non-arm’s length transaction has not made any contribution to the corporation. In this regard, Iacobucci, J. stated that “dividends are paid to shareholders as a return on their investment in the corporation. Since the distribution of the dividend is not determined by the quantum of the shareholder’s contribution to the corporation, it would be illogical to use contribution as the criterion that determines when dividend income will be subject to s. 56(2). The same principles apply in the context of both non-arm’s length relationships such as often exist between small closely held corporations and their shareholders, and arm’s length relationships such as exist between publicly held corporations and their shareholders.”
STRATEGY INSTITUTE - 1998 Round Table
Response (continued)
56(2) - Implications of Neuman v. The Queen
Consequently, in the example described, provided that the dividends paid on the common shares do not impair the redemption value of the “freeze” preference shares or any other class of fixed-value preferred shares, subsection 56(2) will not apply to the dividends paid to the holders of the common shares. However, the possible application of the attribution rules, including those found in subsection 74.4(2), would have to be considered to any estate freeze situation.
STRATEGY INSTITUTE - 1998 Round Table
Question 10
Estate Freeze - Non-Resident
Does Revenue Canada’s administrative practice on estate freezes apply where one of the beneficiaries of the freeze, such as a child of the freezor, is a non-resident of Canada?
Response
An estate freeze will not generally fail to satisfy the Department’s guidelines solely because of the fact that one of the beneficiaries of the estate freeze is not a resident of Canada.
STRATEGY INSTITUTE - 1998 Round Table
Question 11
Power of Attorney
Will the Department reconsider its position that the granting of an enduring power of attorney (“EPA”) which is unrestricted and can be exercised at any time creates a controlling interest under subparagraph 251(5)(b)(i) and paragraph 256(1.4)(a) of the Income Tax Act (hereafter the “Act”) even when no voting powers are exercised? Many if not most shareholders have granted such powers of attorney, in accordance with estate planning practice in the past without the Department’s current position being contemplated. Will existing powers of attorney granted before this policy be grandfathered in any way, or will a substantial number of corporations be subject to the consequences such as loss of the small business deduction. What is the mischief the Department seeks to arrest by this interpretation? Is this not a serious infringement on the ability of individuals to select the best person to manage their affairs if they lose capacity short of permanent disability? It would seem that such a decision should not be affected by income tax considerations.
Response
We assume that the policy or position referred to in the question above is our interpretation of subparagraph 251(5)(b)(i) and paragraph 256(1.4)(a) of the Act as provided in two letters of opinion issued in 1996 and 1997. The issue in those letters was related to certain EPAs executed pursuant to the Power of Attorney Act of Alberta. We stated in those letters that where the powers of the attorney under an EPA include the right to control the voting rights of the shares of a corporation owned by the donor and where the powers under the EPA can be exercised at any time by the attorney, the attorney under the EPA is deemed, pursuant to subparagraph 251(5)(b)(i) and paragraph 256(1.4)(a) of the Act, to have the same position in relation to the control of the corporation as if he owned the shares or to own the shares of the donor (for the purposes mentioned in the preamble of subsections 251(5) and 256(1.4) of the Act), from the time the EPA is executed by the donor.
In Ontario, such a power of attorney for property of a person is rather called a “continuing power of attorney for property” (“CPA”) and is subject to the Substitute Decisions Act. It is our view that the position above applies as well to a CPA that includes the right to control the voting rights of the shares owned by the grantor where the powers under the CPA can be exercised at any time by the attorney, even when no voting powers are actually exercised.
The scope of subparagraph 251(5)(b)(i) and paragraph 256(1.4)(a) of the Act is very broad. Those provisions apply where a person has a right under a contract, a right in equity or a right arising otherwise than under a contract or in equity, either immediately or in the future and either absolutely or contingently, to control the voting rights on shares of the capital stock of a corporation (except where the right is not execisable at the time because the exercise thereof is contingent on the death, bankruptcy or permanent disability of an individual).
STRATEGY INSTITUTE - 1998 Round Table
Response (continued)
Power of Attorney
We believe that our position, as stated above, is a reasonable interpretation of subparagraph 251(5)(b)(i) and paragraph 256(1.4)(a) of the Act. Moreover, it is not subject to a grandfathering rule.
Any specific concern that you may have with respect to the tax policy behind subparagraph 251(5)(b)(i) and paragraph 256(1.4)(a) of the Act should be submitted to the Department of Finance for consideration.
STRATEGY INSTITUTE - 1998 Round Table
Question 12
Buy-out of Spouse’s Interest in Spousal Trust
After a few years of existence, a testamentary spousal trust (as defined in paragraph 70(6)(b)) distributes assets in satisfaction of the surviving spouse’s whole income interest in that trust, an amount equivalent to the fair market value of that interest. After the distribution, the spouse will no longer be “entitled to receive” any income from that trust and therefore the trust will cease to be a spousal trust pursuant to paragraph 70(6)(b).
1) Is there a disposition of the trust’s assets due to the change of the trust’s status? If so,
a) pursuant to which provision of the Income Tax Act, and
b) when will this disposition be deemed to have occurred?
2) If this trust is governed by the rules of the Quebec Civil Code and the sole income beneficiary stated in the trust document is no longer a beneficiary ( having received cash in satisfaction of his whole income interest), section 1286 stipulates that the income beneficiary’s right:
“passes (...) to the co-beneficiaries of the fruits and revenue (...) in proportion of the share of each. If he is the sole beneficiary of the fruits and the revenues of his rank, his right passes in proportion to the share of each, to the beneficiaries of the fruits and revenues of the second rank, or where there are no such beneficiaries to the beneficiaries of the capital.”
Since the trust agreement does not provide to whom the income right will pass to, the right of the income beneficiary will automatically pass to the capital beneficiary pursuant to the section 1286 of the Quebec Civil Code.
In such a case, for tax purposes,
a) Is there a “deemed” disposition of the trust’s assets?
b) Is there a “deemed” disposition of the capital interest held by the capital beneficiary (who is entitled under the trust agreement to receive solely the capital after the death of the surviving spouse) since he acquires a new right (due to section 1286 Quebec civil code)?
c) Does the answer remain the same if no income can be paid to him ( a non-spouse capital beneficiary): the trust agreement stating that the annual income can only be paid to the spouse during his or her lifetime?
STRATEGY INSTITUTE - 1998 Round Table
Question 12 (continued)
Buy-out of Spouse’s Interest in Spousal Trust
d) Does Revenue Canada agree that the capital beneficiary should rather be considered having acquired a separate interest in the trust (an income interest)? Therefore the capital interest should not be deemed to have been disposed of.
e) Is the answer the same even if the trust has never been a spousal trust under paragraph 70(6)(b) and the annual income can be paid to any of the income beneficiaries?
3) If an application to the Court to vary the terms of a trust agreement to enable the trustees to distribute 2/3 of the trust property to the capital beneficiary and to “redeem” 2/3 of the income interest is approved, would Revenue Canada consider that the variance is so significant that it will cause a deemed disposition of the trust’s assets and/or the beneficiary’s interest in the trust?
Response
Part 1)
Pursuant to subsection 106(3), where property of a trust is distributed to a beneficiary in satisfaction of that beneficiary’s income interest in the trust, the trust is deemed to have disposed of the property for proceeds of disposition equal to the fair market value of the property at that time. The fact that the spouse is no longer an income beneficiary of the trust would not, in and by itself, result in the trust being considered to have disposed of its remaining assets. Further, the fact that the spouse is no longer an income beneficiary of the trust would not result in the trust ceasing to be a spousal trust. For purposes of the Act, the trust will always be a spousal trust. If, in accordance with the testator’s will, the remaining capital beneficiaries are not entitled to the capital until the death of that spouse the testamentary trust will remain intact.
Part 2)
Subsection 1286 of the Quebec Civil Code is not applicable to the scenario laid out in this part. This subsection applies only where a beneficiary “renounces his right, or if his right lapses” which is not the case here. Rather, in the scenario presented, the income beneficiary has in fact disposed of his or her interest for consideration, in which case, as described above, unless the terms of the trust are varied, the remaining beneficiaries would only be entitled to the capital upon the death of the beneficiary spouse. As there is no beneficiary otherwise entitled to income, any income earned on the capital remaining in the trust during the lifetime of that spouse would be taxed in the trust.
STRATEGY INSTITUTE - 1998 Round Table
Response (continued)
Buy-out of Spouse’s Interest in Spousal Trust
Part 3)
Where a variation of a trust amounts to an acceleration of otherwise vested interests in that trust, generally the Department would not consider such a variation in and by itself to be so significant so as to cause a resettlement of the trust or a disposition of property either by the trust or by the beneficiaries.
Finally, the application of subsection 107(4) must be considered. This provision applies where a post-1971 spousal trust distributes capital property, resource property or land inventory during the beneficiary spouse’s lifetime to a beneficiary other than the spouse. Where it applies, the trust is deemed to have disposed of the property and to have received fair market value proceeds and the beneficiary is deemed to have disposed of all or part of the beneficiary’s capital interest for an amount equal to those same proceeds minus any debt assumed.
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