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.

Principal Issues:

Calculation of the capital gain arising from the release of a remainder interest in farm land for no consideration. The remainder interest was acquired pursuant to the terms of a will.

Position:

The capital gain equals the deemed proceeds of disposition (pursuant to 69(1)(b)) less the adjusted cost base of the remainder interest determined in accordance with either 70(5) or 70(9). Factors to be taken into account in valuing a remainder interest are indicated in paragraph 5 of IT-226.

Reasons:

Calculation in accordance with the provisions of the Act.

								April 1, 1996

	London Tax Services Office		Trusts Section
	International Tax Programs		C.R. Bowen
	Tax Avoidance & International
	Bruce Reed, Team Leader

Attention: Earl Ducksworth
953076

XXXXXXXXXX
Disposition of a remainder interest in real property

We are writing in reply to your memorandum dated November 22, 1995, wherein you requested our comments on the calculation of a capital gain arising from the disposition of a remainder interest in farm land. Your primary concern is with the gain attributable to XXXXXXXXXX, a non-resident of Canada. We apologize for the delay in responding to your memorandum.

Background Information

XXXXXXXXXX

Issue

The issue is how to calculate the capital gain arising from the disposition of XXXXXXXXXX remainder interest in the Farm Land.

Position of Taxpayer's Representative

It is the position of the taxpayer's representative,

XXXXXXXXXX

In a letter dated October 24, 1995 from the representative, he conceded that, based on jurisprudence, in particular, S.E. Lewis Estate v. M.N.R., (T.C.C.), 1989 2 C.T.C. 2011, the Farm Land, has in all likelihood vested in XXXXXXXXXX as to their interest as remaindermen. It is his opinion that

XXXXXXXXXX

Your Position

It is your position that the Farm Land vested indefeasibly in XXXXXXXXXX at the time of their father's death. In the event that one of the children dies before their mother, it is your opinion, as supported by comments in Lewis Estate, that the deceased child's remainder interest would pass into his or her estate. Therefore, any capital gain that accrued from the date of XXXXXXXXXX death to the date of transfer of the remainder interest to their mother would have to be recognized by the children. It appears that XXXXXXXXXX is entitled to the capital gains deduction for qualified farm property (pursuant to subsection 110.6(2) of the Act).

Literature and Jurisprudence

A) Vesting and Vested Indefeasibly

Various relevant definitions contained in Black's Law Dictionary, by Henry Campbell Black, (sixth edition) are as follows:

Devise- Devises are contingent or vested; that is after the death of the testator. Contingent, when the vesting of any estate in the devisee is made to depend upon some future event, in which case, if the event never occurs, or until it does occur, no estate vests under the devise. But, when the future event is referred to merely to determine the time at which the devisee shall come into the use of the estate, this does not hinder the vesting of the estate at the death of the testator.

Remainder interest- The property that passes to a beneficiary after the expiration of an intervening income interest.

Life interest- A claim or interest in real or personal property, not amounting to ownership, and limited by a term of life, either that of the person in whom the right is vested or another.

Life Estate- An estate whose duration is limited to the life of the party holding it, or some other person. A legal arrangement whereby the beneficiary (i.e., the life tenant) is entitled to the income from the property for his or her life. Upon the death of the life tenant, the property will go to the holder of the remainder interest...

In the book Oosterhoff on Wills and Succession, fourth edition, by A.H. Oosterhoff, B.A., LL.B., LL.M., chapter 14 entitled "Vested and Contingent Gifts and Void Conditions" provides the following relevant comments on the subject of vesting.

The term "vested" can mean either "vested in possession" or "vested in interest". The former means that the interest is presently being enjoyed by its owner and if it is vested in that sense, it has also vested in interest. "Vested in interest" refers to an interest that stands ready to fall into possession as soon as all preceding interests have determined naturally. An interest is vested if,

(a)it is limited to a person who is

(i) in existence, and

(ii) ascertained, and

(b)it is not subject to a condition precedent. (page 572)

Although an interest may be vested, it is not necessarily vested absolutely. It may be subject to divestment in whole or in part by the operation of a condition subsequent or for another reason. One may therefore distinguish the following three types of vested interest:

Absolutely or Indefeasibly Vested Interests. These are interests that are vested at the testator's death and cannot be defeated. Thus, in a gift, "to A for life, remainder to B absolutely," B's remainder is vested indefeasibly. If he or she predeceases A, B's estate will take the interest. In contrast, in a gift, "to A for life, remainder to B for life, remainder to C absolutely," although C's interest is vested indefeasibly, B's is not, since it is a limited interest and B may not survive A to take it. It is, therefore, vested subject to complete divestment. (page 573)

Interests Vested Subject to Partial Divestment. (Comments not applicable) (page 573)

Interests Vested Subject to Complete Divestment. These are interests that are given in remainder and that are less than absolute interests...Thus, in a gift, "to A for life, remainder to B for life," B's interest is subject to complete divestment, since he or she may not survive A to take. (page 574)

If a gift is prima facie contingent because of words of futurity, but the postponement is solely to let in a prior interest, it will be construed as vested at the testator's death. A common situation is a gift, "to A for life, and after A's death to X." A's death is not really a contingency in this situation; it merely show that X's estate is postponed until A's life estate has ended. Hence, X's interests vests a morte testoris. (Two leading cases Browne v. Moody and Re Taylor are cited as support.) (page 589)

On the subject of conditional gifts, The Canadian Law of Wills, Volume 2 Construction (third edition) by Thomas G. Feeney, B.A., LL.B., B.C.L., Q.C., has the following relevant comment on page 227:

Most important of all, in a gift "to A for life and then to B" it is necessary to understand that B's interest is not contingent. Footnote 6 - Contrast, however, to "A for life and then to B if he survives A", where B's interest is contingent.

In the Lewis Estate, the will of the testator conveyed farm property to his two grandsons, Terry and Todd, when Todd reached the age of 20 years and there was no gift over clause in the event that either of the two grandsons died. On this matter, the court commented as follows on page 2019 "...if either of the grandsons died before Todd reached age 20 years of age had he lived, their respective interest would descend to their respective heirs-at-law." This statement is supported by quotes from several textbooks which also indicate the same result. On page 2021, the court indicated that the farm property had been disposed of by the will and hence did not vest three years after the death of the testator pursuant to subsection 9(2) of the Estates Administration Act (Ontario). "That disposition was as to an indefeasible vesting of an interest in fee simple to the grandsons, the disposition being one in civil law as a vested legacy debitum in presenti, solvendum in futuro, subject only to a fixed-term tenancy in favour of the widow." The findings of this case as to when property is vested indefeasibly were used as support for the decision reached on page 1037 of the Leonhardt Estate et al. v. M.N.R., 90 D.T.C. 1034, (T.C.C.). Comments on the meaning of "vested indefeasibly" are also found in The Queen v. Boger Estate, 93 D.T.C. 5276, (F.C.A.) and Hillis et al. v. The Queen, 83 D.T.C. 5365, (F.C.A.).

Paragraph 1 of IT-449R states: "In the Department's view a property vests indefeasibly in a spouse or child of the deceased when such a person obtains a right to absolute ownership of that property in a manner that such right cannot be defeated by any future event, even though that person may not be entitled to the immediate enjoyment of all benefits arising from that right." Paragraph 2 of that bulletin indicates that: "Property is considered to vest indefeasibly in the person to whom it is bequeathed when that person has an enforceable right or claim to the ownership thereof. This will be so even when the formal legal conveyance and registration of ownership of the property has not been completed. Accordingly, the ownership of property described in a specific bequest in a will will vest in the beneficiary immediately after the death of the testator." Where property is conveyed in accordance with paragraph 8(a)(i) of IT-449R, the post amble to that paragraph indicates that the farm land vests indefeasibly in the child who has the remainder interest on the death of the testator.

B)Lapsed Gifts

Chapter 12 of Oosterhoff on Wills and Succession entitled "Lapse and Survivorship" has the following applicable comments on the subject of lapsed gifts.

The doctrine of lapse is a rule of law. It states that a gift to a beneficiary who predeceases the testator fails or lapses. It will not pass to the beneficiary's estate. The doctrine of lapse is subject to certain exceptions at common law...At common law a lapsed devise of real property devolved upon the heir, whereas a gift of personal property which lapsed fell into the residue. (page 497) (Section 23 of the Succession Law Reform Act R.S.O. 1990, c.S.26 deals with lapsed gifts and provides, in summary, that except where a contrary intention appears in the will, lapsed gifts are included in the residuary devise, if any contained in the will. As an exception to that rule, section 31 of that act provides anti-lapse legislation for gifts to immediate family members of the testator).

Similar comments on lapsed gifts are also found on pages 133 and 134 of The Canadian Law of Wills. Per Black's Law Dictionary, the definition of lapse is "failure to vest a bequest or devise by reason of death of devisee of legatee prior to death of testator."

Our Comments

A)Remainder Interest

We agree that clause XXXXXXXXXX of the Will did not create a trust in respect of the Farm Land, but instead bequeathed a life interest or life estate in the Farm Land to XXXXXXXXXX and a remainder interest therein to XXXXXXXXXX.

B)Vested Indefeasibly and Lapsed Gift

It is our opinion that the remainder interest in the Farm Land vested indefeasibly in XXXXXXXXXX immediately after the death of their father. In addition, it is our view that should XXXXXXXXXX have predeceased their mother prior to the disposition of their remainder interest, his or her remainder interest would have passed to his or her respective estate. The doctrine of lapsed gifts has no application in this situation since the children did not predecease their father. Our comments are supported by the information provided above XXXXXXXXXX.

C)Acquisition and Disposition of the Remainder Interest

If the conditions in subsection 70(9) of the Act were met at the time of XXXXXXXXXX death, he would have been deemed to have disposed of the remainder interest in the Farm Land immediately before his death and to have received proceeds of disposition equal to the adjusted cost base (the "ACB") of that interest. In such case, XXXXXXXXXX would have acquired their remainder interest in the Farm Land for an amount equal to those proceeds of disposition. If the conditions in subsection 70(9) of the Act were not met, XXXXXXXXXX would, pursuant to paragraph 70(5)(a) of the Act, have been deemed to have disposed of the remainder interest in the Farm Land for proceeds equal to its fair market value ("FMV") at the time of his death and his children, pursuant to paragraph 70(5)(c) of the Act (as it read in 1973), would have been deemed to have acquired their remainder interest at its FMV. In the interest of responding to your enquiry as soon as possible, we have not reviewed the Income Tax Application Rules ("ITAR") rules in order to determine whether they would affect the amount of the adjusted cost base of the remainder interest determined under either subsection 70(5) or 70(9) of the Act. In this regard, IT-132R may be of assistance to you in making such a determination.

It is our opinion that the FMV of a remainder interest in a real property at a particular time is equal to the FMV of that real property minus the FMV of the life interest therein. The calculation of the FMV of the life interest would usually be based on the following elements: FMV of the real property, a reasonable rate of interest, life expectancy of the beneficiary of the life interest at the date of transaction, and any other factors relevant to the specific case (as indicated in paragraph 5 of IT-226R). The value of the remainder interest in real property is generally determined by what a typical purchaser would pay for fee simple ownership in the real property subject to the life interest held by another.

Pursuant to paragraph 115(1)(b) and subsection 115(3) of the Act, "taxable Canadian property" includes any interest in real property situated in Canada. Paragraph 2 of IT-176R2 indicates that an interest in real property includes a remainder interest in real property for which present enjoyment has been postponed until the death of the life tenant. Former paragraph 48(1)(a) of the Act would have exempted XXXXXXXXXX remainder interest from being subject to the deemed disposition rules when he emigrated to United States in XXXXXXXXXX and the election to realize capital gains under that provision in accordance with section 1302 of the Income Tax Regulations was not available in that year. Therefore, the adjusted cost base of the remainder interest after XXXXXXXXXX ceased to be a resident of Canada would have continue to be the amount determined under either subsection 70(5) or 70(9) of the Act (subject to the possible application of the ITAR rules).

The release and transfer by XXXXXXXXXX of their remainder interests to their mother for no consideration will result in a disposition of their interests for deemed proceeds of disposition equal to the FMV of those interests at the time they are disposed of (pursuant to paragraph 69(1)(b) of the Act). The resulting capital gain to each of them will equal the deemed proceeds of disposition less: a) the adjusted cost base of that interest (determined in the manner indicated above) and b) any outlays or expenses incurred for the purpose of making that disposition. XXXXXXXXXX will be required to report the capital gain from the disposition of his remainder interest pursuant to paragraph 115(1)(b) and subsection 2(3) of the Act, subject to Article XIII of the Canada-U.S. Income Tax Convention.

As XXXXXXXXXX has not disposed of any capital property (i.e., her existing life interest in the Farm Land) as a result of her children transferring their remainder interests to her, no capital gain should be reported by her. The cost of the remainder interests acquired by her will be equal to the FMV at that time of acquisition pursuant to paragraph 69(1)(c) of the Act, subject to any implications under the ITAR rules.

We trust that our comments will be of assistance.

for Director
Resources, Partnerships and
Trusts Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch