5 October 2018 APFF Financial Strategies and Instruments Roundtable Q. 4, 2018-0765811C6 F - Tax on Split Income

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120.4(1), 120.4(1.1)

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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: Mr. X personally owned commercial rental property. On Mr. X’s death, the commercial rental property were transferred to a spousal trust ("Spousal Trust") for the benefit of his spouse, Mrs. X. Every year, Spousal Trust distributes all its net rental income to Mrs. X. Whether Mrs. X is subject to TOSI on the income distribution received from Spousal Trust under three assumptions: 1) Mrs. X’s son ("Son") is a trustee of Spousal Trust and manages the trust’s rental activities (repairs, collection of rents, etc.); 2) Son is not a trustee of Spousal Trust, is self-employed and manages the trust’s rental activities as in 1) above; and 3) Son is not a trustee of Spousal Trust and is an employee of the trust.

Position: No. If it is established that Spousal Trust does not carry on a business, the trust distribution would be an excluded amount in respect of Mrs. X under subparagraph (e)(i) of the definition “excluded amount” in subsection 120.4(1). If it is established that Spousal Trust does carry on a business, the trust distribution would be deemed to be an excluded amount under subparagraph 120.4(1.1)(c)(ii).

Reasons: According to the law.

FINANCIAL STRATEGIES AND INSTRUMENTS ROUNDTABLE 5 OCTOBER 2018
2018 APFF CONFERENCE

Question 4

Trust, rental income and tax on split income

SITUATION

Jocelyne, a resident of Canada at all material times, has been the beneficiary of a spousal trust ("Trust") since the death of her husband Joseph.

During his lifetime, Joseph owned commercial rental properties, which were managed solely by him.

Trust's assets consist of only five commercial rental properties, in the order of $3,500,000, generating annual rental income of $250,000, which is distributed to Jocelyne.

All commercial rental properties came from Joseph.

Jocelyne has a son, Julien, from her marriage with Joseph. Julien is a resident of Canada at all relevant times.

In this regard, the following three hypothetical situations apply:

1. Julien is trustee of Trust and is engaged in the property management: repairs, rent collection, lease preparation and other matters.

2. Julien is not a trustee of Trust, is self-employed and, in that capacity, is engaged in the property management in the same way as described in the first situation.

3. Julien is not a trustee of Trust, is an employee of Trust and, in that capacity, performs the tasks described in the first situation.

Question to the CRA

Taking into account each of these three situations, can the rental income earned by Trust and distributed to Jocelyne be subject to the new rules for tax on split income?

CRA Response

The definition of "split income" in subsection 120.4(1) describes the types of income that are subject to the split income tax under subsection 120.4(2).

Regarding Jocelyne, the distribution received from Trust (the "Distribution"), unless it qualifies as an excluded amount, could constitute split income under clause (c)(ii)(D) of the definition of "split income" in subsection 120.4(1).

Indeed, Jocelyne is a specified individual (footnote 1) and the amount of the Distribution should be included in computing her income by virtue of subsection 104(13).

For purposes of clause (c)(ii)(C) of the definition of "split income" in subsection 120.4(1), it must be reasonable to consider that the Distribution is income derived directly or indirectly from one or more related businesses with respect to Jocelyne.

As appears from the question as stated, the Distribution is derived solely from the assets held by Trust and not from any other related business with respect to Jocelyne. Thus, it is necessary to determine whether Trust carries on a related business with respect to Jocelyne.

The term "related business" in respect of a specified individual is defined in subsection 120.4(1) and includes, with respect to a trust (footnote 2), a business carried on by a trust if a source individual in respect of the specified individual is actively engaged on a regular basis in the activities of the trust related to earning income from the business.

The expression "source individual" in respect of a specified individual for a taxation year is defined in subsection 120.4(1) and means an individual (other than a trust) who, at any time in the year, is resident in Canada and related to the specified individual. As Julien is the son of Jocelyne, those individuals are connected by blood relationship by virtue of section 251(6) and are therefore related persons by virtue of subsection 251(2). Consequently, Julien is a source individual in respect of Jocelyne.

For the purposes of the definition of "related business", it must therefore be determined, inter alia, that: (1) Trust is carrying on a business; and 2) a source individual is actively engaged on a regular basis in the activities of Trust related to earning income from the business. These are essentially two questions of fact that can only be resolved after a comprehensive analysis of all the facts and circumstances with respect to a particular situation.

For purposes of clause (c)(ii)(D) of the definition of "split income" in subsection 120.4(1), it must be reasonable to consider that the Distribution is income from the leasing of property by Trust in the case where a person who is related to Jocelyne is actively engaged on a regular basis in the activities of Trust related to the leasing of property.

To the extent that it was established that Julien actively engages on a regular basis in the activities of Trust, the Distribution could constitute split income for Jocelyne by virtue of clause (c)(ii)(D) of the definition of split income in subsection 120.4(1), except in the case of an excluded amount.

However, by virtue of subparagraph (e)(i) of the definition of "excluded amount" in subsection 120.4(1), the Distribution could be an excluded amount for Jocelyne if was not derived directly or indirectly from a related business in respect of Jocelyne.

In light of the foregoing, if it could be determined that the Distribution was not derived directly or indirectly from a related business in respect of Jocelyne, the Distribution would be an excluded amount with respect to Jocelyne and, therefore, would not be not included in the computation of her split income.

However, for the purpose of applying clauses (c)(ii)(C) or (D) of the definition of "split income" in subsection 120.4(1) with respect to the situation described in this question, if it was determined that the Distribution was derived directly or indirectly from a related business in respect of Jocelyne, the interpretive rule under subparagraph 120.4(1.1)(c)(ii) could apply in respect of Jocelyne so that the Distribution is deemed to be an excluded amount.

By virtue of subparagraph 120.4(1.1)(c)(ii), the amount that is Jocelyne's income from property is deemed to be an excluded amount to the extent that the amount would have been an excluded amount in respect of an individual - Joseph – who was, immediately before his death, Jocelyne's spouse or common-law partner, if the amount were included in computing Joseph's income for his last taxation year.

The Distribution would have been an excluded amount in respect of Joseph since it was not derived directly or indirectly from a related business in respect of Joseph by virtue of subparagraph (e)(i) of the definition of "excluded amount" in subsection 120.4(1).

Since Joseph owned the commercial rental properties directly, and even under the assumption that Joseph derived income from a business, that business could not be classified as a related business.

Indeed, by virtue of subparagraph (a)(i) of the definition of "related business" in subsection 120.4(1), the business carried on by an individual must be carried on by a source individual in respect of the specified individual. Since Joseph could not be a source individual in respect of himself, the hypothetical business could not be a related business in respect of Joseph.

Jean Lafrenière
(613) 670-9013
5 October 2018
2018-076581

FOOTNOTES

Due to our system requirements, footnotes contained in the original document are reproduced below:

1 Since the question as stated indicates that Jocelyne is resident in Canada at all relevant times.

2 In subparagraph (a)(ii) of the definition of "related business" in subsection 120.4(1)).

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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.

Principales Questions: Mr. X personally owned commercial rental property. On Mr. X’s death, the commercial rental property were transferred to a spousal trust ("Spousal Trust") for the benefit of his spouse, Mrs. X. Every year, Spousal Trust distributes all its net rental income to Mrs. X. Whether Mrs. X is subject to TOSI on the income distribution received from Spousal Trust under three assumptions: 1) Mrs. X’s son ("Son") is a trustee of Spousal Trust and manages the trust’s rental activities (repairs, collection of rents, etc.); 2) Son is not a trustee of Spousal Trust, is self-employed and manages the trust’s rental activities as in 1) above; and 3) Son is not a trustee of Spousal Trust and is an employee of the trust.

Position Adoptée: No. If it is established that Spousal Trust does not carry on a business, the trust distribution would be an excluded amount in respect of Mrs. X under subparagraph (e)(i) of the definition “excluded amount” in subsection 120.4(1). If it is established that Spousal Trust does carry on a business, the trust distribution would be deemed to be an excluded amount under subparagraph 120.4(1.1)(c)(ii).

Raisons: According to the law.

TABLE RONDE SUR LA FISCALITÉ DES STRATÉGIES FINANCIÈRES ET DES INSTRUMENTS FINANCIERS DU 5 OCTOBRE 2018
APFF - CONGRÈS 2018

Question 4

Fiducie, revenu de location et impôt sur le revenu fractionné

MISE EN SITUATION

Jocelyne, une résidente du Canada à tout moment pertinent, est bénéficiaire d’une fiducie exclusive au conjoint (« Fiducie »), depuis la mort de son mari Joseph.

De son vivant, Joseph détenait des immeubles locatifs commerciaux, lesquels étaient gérés uniquement par lui.

L’actif de Fiducie est composé uniquement de cinq immeubles locatifs commerciaux, de l’ordre de 3 500 000 $, générant des revenus locatifs annuels de 250 000 $ qui sont distribués à Jocelyne.

Tous les immeubles locatifs commerciaux proviennent de Joseph.

Jocelyne a un fils, Julien, issu de son mariage avec Joseph. Julien est un résident du Canada à tout moment pertinent.

À cet égard, les trois hypothèses suivantes sont émises :

1. Julien est fiduciaire de Fiducie et s’occupe de la gestion des immeubles : réparations, collection des loyers, préparation des baux et autres.

2. Julien n’est pas fiduciaire de Fiducie, est à son compte et, à ce titre, s’occupe de la gestion des immeubles de façon identique à la première hypothèse.

3. Julien n’est pas fiduciaire de Fiducie, est l’employé de Fiducie et, à ce titre, exécute les tâches décrites à la première hypothèse.

Question à l’ARC

En tenant compte de chacune de ces trois hypothèses, le revenu de loyer gagné par Fiducie et distribué à Jocelyne peut-il être soumis aux nouvelles règles de l’impôt sur le revenu fractionné?

Réponse de l’ARC

La définition de « revenu fractionné » au paragraphe 120.4(1) L.I.R. décrit les types de revenus qui sont assujettis à l’impôt sur le revenu fractionné prévu au paragraphe 120.4(2) L.I.R.

À l’égard de Jocelyne, la distribution reçue de Fiducie (la « Distribution »), sauf si elle se qualifie à titre de montant exclu, pourrait constituer du revenu fractionné en vertu de la division c)(ii)(C) ou de la division c)(ii)(D) de la définition de l’expression « revenu fractionné » au paragraphe 120.4(1) L.I.R.

En effet, Jocelyne est un particulier déterminé (footnote 1) et le montant de la Distribution devrait être inclus dans le calcul de son revenu en vertu du paragraphe 104(13) L.I.R.

Aux fins de la division c)(ii)(C) de la définition de l’expression « revenu fractionné » au paragraphe 120.4(1) L.I.R., il doit être raisonnable de considérer que la Distribution est un revenu provenant, directement ou indirectement, d’une ou de plusieurs entreprises liées relativement à Jocelyne.

Tel qu’il appert de l’énoncé de la présente question, la Distribution provient uniquement des actifs détenus par Fiducie et non de quelconque autre entreprise liée relativement à Jocelyne. Ainsi, il s’agit de déterminer si Fiducie exploite une entreprise liée relativement à Jocelyne.

L’expression « entreprise liée », relativement à un particulier déterminé, est définie au paragraphe 120.4(1) L.I.R. et comprend, en ce qui concerne une fiducie (footnote 2), l’entreprise exploitée par une fiducie si un particulier source relativement au particulier déterminé participe activement, de façon régulière, aux activités de la fiducie qui se rapportent au fait de tirer un revenu de l’entreprise.

L’expression « particulier source » relativement à un particulier déterminé pour une année d’imposition est définie au paragraphe 120.4(1) L.I.R. et signifie un particulier (autre qu’une fiducie) qui, à un moment de l’année, d’une part, réside au Canada et, d’autre part, est lié au particulier déterminé. Julien étant le fils de Jocelyne, ces particuliers sont unis par les liens du sang en vertu du paragraphe 251(6) L.I.R. et sont donc des personnes liées entre elles en vertu du paragraphe 251(2) L.I.R. Par conséquent, Julien est un particulier source relativement à Jocelyne.

Aux fins de la définition de l’expression « entreprise liée », il doit donc être établi, entre autres, que : 1) Fiducie exploite une entreprise; et 2) un particulier source participe activement, de façon régulière, aux activités de Fiducie qui se rapportent au fait de tirer un revenu de l’entreprise. Il s’agit essentiellement de deux questions de fait ne pouvant être répondues qu’à la suite d’une analyse exhaustive de tous les faits et circonstances à l’égard d’une situation donnée.

Aux fins de la division c)(ii)(D) de la définition de « revenu fractionné » au paragraphe 120.4(1) L.I.R., il doit être raisonnable de considérer que la Distribution est un revenu provenant de la location de biens par Fiducie dans le cas où une personne qui est liée à Jocelyne prend une part active, de façon régulière, aux activités de la fiducie se rapportant à la location de biens.

Dans la mesure où il était établi que Julien prend une part active, de façon régulière aux activités de Fiducie, la Distribution pourrait constituer un revenu fractionné pour Jocelyne en vertu de la division c)(ii)(D) de la définition de revenu fractionné au paragraphe 120.4(1) L.I.R., sauf s’il s’agit d’un montant exclu.

Or, en vertu du sous-alinéa e)(i) de la définition de l’expression « montant exclu » au paragraphe 120.4(1) L.I.R., la Distribution pourrait constituer un montant exclu quant à Jocelyne si elle ne provenait pas, directement ou indirectement, d’une entreprise liée relativement à Jocelyne.

Compte tenu de ce qui précède, s’il pouvait être établi que la Distribution ne provenait pas, directement ou indirectement, d’une entreprise liée relativement à Jocelyne, la Distribution serait un montant exclu quant à Jocelyne et, de ce fait, ne serait pas incluse dans le calcul de son revenu fractionné.

Toutefois, pour les fins de l’application des divisions c)(ii)(C) ou (D) de la définition de l’expression « revenu fractionné » au paragraphe 120.4(1) L.I.R. à l’égard de la situation décrite dans la présente question, s’il était établi que la Distribution provenait, directement ou indirectement, d’une entreprise liée relativement à Jocelyne, la règle interprétative du sous-alinéa 120.4(1.1)(c)(ii) L.I.R. pourrait s’appliquer à l’égard de Jocelyne afin que la Distribution soit réputée être un montant exclu.

En vertu du sous-alinéa 120.4(1.1)c)(ii) L.I.R., le montant qui est un revenu de Jocelyne tiré d’un bien est réputé être un montant exclu dans la mesure où le montant aurait été un montant exclu relativement au particulier – Joseph – qui, immédiatement avant son décès, était l’époux ou le conjoint de fait de Jocelyne, si le montant avait été inclus dans le calcul du revenu de Joseph pour sa dernière année d’imposition.

Or la Distribution aurait été un montant exclu relativement à Joseph puisqu’elle ne provenait pas, directement ou indirectement, d’une entreprise liée relativement à Joseph en vertu du sous-alinéa e)(i) de la définition de l’expression « montant exclu » au paragraphe 120.4(1) L.I.R.

Puisque Joseph détenait directement les immeubles locatifs commerciaux, et même dans l’hypothèse où Joseph tirait de ces biens un revenu provenant d’une entreprise, cette entreprise ne pourrait être qualifiée d’entreprise liée.

En effet, en vertu du sous-alinéa a)(i) de la définition de l’expression « entreprise liée » au paragraphe 120.4(1) L.I.R., l’entreprise exploitée par un particulier doit être exploitée par un particulier source relativement au particulier déterminé. Puisque Joseph ne peut être un particulier source par rapport à lui-même, l’hypothétique entreprise ne pourrait être une entreprise liée relativement à Joseph.

Jean Lafrenière
(613) 670-9013
Le 5 octobre 2018
2018-076581

FOOTNOTES

En raison des exigences de nos systèmes, les notes de bas de page contenues dans le document original sont reproduites ci-dessous :

1 Puisque l’énoncé de la présente question précise que Jocelyne réside au Canada à tout moment pertinent.

2 Au sous-alinéa a)(ii) de la définition de l’expression « entreprise liée » au paragraphe 120.4(1) L.I.R.

Summaries

Summary Under

Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Split Income - Paragraph (c) - Subparagraph (c)(ii) - Clause (c)(ii)(D)

no TOSI on net rental income of spousal trust on properties managed by son if excluded amounts

A spousal trust for Jocelyne (“Trust”) holds five commercial rental properties (generating $250,000 in annual rents, which had been managed by her deceased husband). Is the income generated by Trust and distributed to Jeanne subject to the tax on split income where the Trust investments are managed by: Jocelyne’s son Julien who, as the sole trustee, manages the properties (e.g., repairs, rent collections, accounts); and Julien not as trustee but as Trust employee; and Julien, as neither.

CRA noted that the net rental income distributed to Jocelyne would come within s. (c)(ii)(D) of the definition of "split income" if “it was established that Julien actively engages on a regular basis in the activities of Trust” and that it also could be included under s. (c)(ii)(D ) – except that by virtue of s. (e)(i), the distribution would be an excluded amount if it was not derived directly or indirectly from a related business in respect of Jocelyne.

However, even if the distribution were not otherwise an excluded amount, it would likely be excluded under s. 120.4(1.1)(c)(ii).

Summary Under

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

exclusion where rental portfolio of spousal trust was a directly-conducted business of deceased husband

CRA noted that the net rental income distributed to Jocelyne might come within s. (c)(ii)(D) of the definition of "split income" depending on the level of involvement of Julien, but went on to indicate that even if this were the case, the exclusion in s. 120.4(1.1)(c)(ii) would appear to apply:

By virtue of subparagraph 120.4(1.1)(c)(ii), the amount that is Jocelyne's income from property is deemed to be an excluded amount to the extent that the amount would have been an excluded amount in respect of an individual - Joseph – who was, immediately before his death, Jocelyne's spouse or common-law partner, if the amount were included in computing Joseph's income for his last taxation year.

The Distribution would have been an excluded amount in respect of Joseph since it was not derived directly or indirectly from a related business in respect of Joseph by virtue of subparagraph (e)(i) of the definition of "excluded amount" in subsection 120.4(1).

Since Joseph owned the commercial rental properties directly, and even under the assumption that Joseph derived income from a business, that business could not be classified as a related business.

Indeed, by virtue of subparagraph (a)(i) of the definition of "related business" in subsection 120.4(1), the business carried on by an individual must be carried on by a source individual in respect of the specified individual. Since Joseph could not be a source individual in respect of himself, the hypothetical business could not be a related business in respect of Joseph.

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5 October 2018 APFF Financial Strategies and Instruments Roundtable Q. 4, 2018-0765811C6 F - Tax on Split Income

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