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: Whether cash received by the Estate constitutes substituted property for the purpose of paragraph 118.1(5.1)(b).
Position: A cash dividend does not constitute substituted property for the shares received by the Estate. Cash received on the purchase for cancellation of shares received by the Estate does constitute substituted property.
Reasons: See below.
STEP CRA Roundtable June 18, 2015
Question #11
New Charitable Donation Rules Part 1
The new rules regarding charitable donations from a graduated rate estate, contained in amended subsection 118.1(5.1), require that the donation be a gift of "property that was acquired by the estate on and as a consequence of the death" or "property that was substituted for that property". This is not a requirement under the current law.
Consider an individual who dies, after 2015, owning shares of an investment holding company ("Holdco") that owns marketable securities with fair market value greater than their adjusted cost base. The individual's will provides for a charitable donation to be made on death. The graduated rate estate (the "Estate") requires Holdco's marketable securities or cash from sale of such marketable securities to make the donation.
Scenario 1
Holdco sells securities and pays a dividend to Estate. Estate then makes the donation. Would the cash from the dividend be considered substituted property?
Scenario 2
Estate transfers the shares of Holdco, on a tax deferred basis, to Newco and takes back high PUC shares of Newco. Holdco is wound up and Newco gets a paragraph 88(1)(d) bump to increase the adjusted cost base of the marketable securities. Newco sells securities and uses the proceeds to purchase for cancellation some of Estate's shares. Estate then uses the cash to make the charitable donation. Can the CRA confirm the donation is made with substituted property?
CRA Response
Scenario 1
When Holdco pays a dividend to the Estate, the Estate has not replaced the Holdco shares received as a consequence of the death of the individual. Therefore, the cash received by the Estate will not be property substituted for the Holdco shares. Consequently, the condition contained in paragraph 118.1(5.1)(b) would not be met.
Scenario 2
When the shares of Newco are received as consideration for the disposition of the Holdco shares, the Newco shares would be considered as substituted property for the Holdco shares. When Newco purchases its shares for cancellation, the cash received by the Estate would be substituted property for the Newco shares.
Based on the extended meaning for substituted property in paragraph 248(5)(a), the cash received by the Estate on the purchase for cancellation would be considered property substituted for the Holdco shares received by the Estate as a consequence of the death of the individual. Therefore, when the cash is used by Estate to make a donation, the condition in paragraph 118.1(5.1)(b) would be met.
Analysis
In determining whether the cash dividend on the Holdco shares or the cash received on the purchase for cancellation of the Newco shares is considered to be substituted property for the Holdco shares received by the Estate, we must consider the ordinary meaning of the term substituted property as well as the extended meaning of substituted property in paragraph 248(5)(a).
The Canadian Oxford Dictionary (2001) contains the following definitions of "substitute":
A thing that is or may be used in place of another, often to serve the same function but with a slightly different effect
.replace (a person or thing) with another
Similarly, Black's Law Dictionary (1999) defines "substitution" as "
the process by which one person or thing takes the place of another person or thing."
Paragraph 248(5)(a) states that where there are multiple substitutions the final property held will be considered to be substituted for the original property held.
The term substituted property was considered in McLaughlin v. MNR, [1952] CTC 104 (Exch. Ct.). The taxpayer, Mr. X, sold shares of XCo to his wife, Mrs. X for par value. Mrs. X subsequently acquired shares of YCo for consideration consisting of the XCo shares. The issue before the Court was whether a dividend received on the YCo shares was subject to attribution under former subsection 32(3) of the Act by virtue of these shares constituting property substituted for property transferred from Mr. X to Mrs. X. The Court was of the view that the YCo shares were property substituted for the XCo shares as substituted property was property which replaces, or takes the place of, the original property.
Scenario 1
When Holdco pays a dividend to the Estate, the Estate has not replaced the Holdco shares received as a consequence of the death of the individual. Therefore, the cash received by the Estate will not be property substituted for the Holdco shares. Consequently, the condition contained in paragraph 118.1(5.1)(b) would not be met.
When the donation is made by the Estate, subsections 118.1(4.1) and (5) would apply such that Estate, and no other taxpayer, would be eligible to claim the donation. By virtue of subsection 118.1(3), the Estate would be eligible to deduct the donation in the year the Estate makes the donation or any of the subsequent five taxation years.
Scenario 2
When the shares of Newco are received as consideration for the disposition of the Holdco shares, the Newco shares would be considered as substituted property for the Holdco shares. When Newco purchases its shares for cancellation, the cash received by the Estate would be substituted property for the Newco shares.
Based on the extended meaning for substituted property in paragraph 248(5)(a), the cash received by the Estate on the purchase for cancellation would be considered property substituted for the Holdco shares received by the Estate as a consequence of the death of the individual.
Therefore, when the cash is used by Estate to make a donation, the condition in paragraph 118.1(5.1)(b) would be met. By virtue of subsection 118.1(3), the donation could be claimed by the individual in the year of death or the preceding year or by the Estate in the year the donation is made or a preceding taxation year of the Estate.
Katie Campbell
2015-057855
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