29 April 2004 External T.I. 2003-0049291E5 - Revocable gift from non-resident

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 a resident of Canada who receives a revocable gift of marketable securities from a non-resident is required to report the income earned on the gifted securities and whether it should report such securities in accordance with section 233.3 of the Act.

Position: In the hypothetical situation outlined in the request, the income would have to be reported by the Canadian resident, who would also have to report the gifted securities in accordance with section 233.3 of the Act (assuming their cost amount to him exceeds $100,000).

Reasons: Case law and CRA publications

XXXXXXXXXX 						Éric Allard-Pouliot
							2003-004929
April 29, 2004

Dear Sir:

Re: Technical Interpretation Request: Revocable Gift from Non-Resident

This is in reply to your letter of November 10, 2003, regarding the above-noted subject. More particularly, you have requested our opinion as to whether a resident of Canada who receives a revocable gift of marketable securities from a non-resident is required to report the income earned on the gifted securities and whether it should report such securities in accordance with the rules found in section 233.3 of the Income Tax Act (the "Act").

Facts

In your request, you provide the following hypothetical situation:

a) Mr. M is a citizen of the Netherlands. Mr. M has not resided in the Netherlands within the past 10 years and currently resides in another European country.

b) Mr. M has marketable securities (stocks, bonds, etc.) held on deposit with a bank account in the Netherlands (the "Securities").

c) Mr. M's daughter, Miss M, is a citizen of the Netherlands and resides in Canada. For income tax purposes, Miss M is a resident of Canada.

d) Mr. M is proposing to make a revocable gift of the Securities to Miss M. The owner of the Securities will be changed from Mr. M to Miss M and, as a condition precedent to the gift, Miss M will agree to the following terms:

(i) The entire gift, including any income earned thereon and added to the principal, may be revoked at any time by Mr. M for any reason.

(ii) Mr. M will administer the management of the Securities as long as he is living and has complete freedom to make all of the investment decisions. On Mr. M's death, the administration of the Securities will revert to his spouse, Mrs. M, if she is alive.

(iii) Mr. M is able to distribute the income or capital to Miss M at his discretion at any time.

(iv) If Miss M dies, the gift must be paid to her children (to the exclusion of their spouse). If her children are not living at the time of her death, the gift will be paid to Miss M's brothers.

(v) Miss M will have complete control of the gift on the death of both Mr. and Mrs. M.

(vi) Mr. M is responsible to pay Dutch taxes on income earned on the gift while the gifted capital is under his administration.

(vii) Miss M is not able to enforce payment of the gift or any income thereon.

e) The gift will be made under Dutch law. Since Mr. M has been out of the Netherlands for more than 10 years, the gift will not be subject to Dutch gift tax.

f) The gift will be made solely to reduce Mr. M's Dutch estate taxes that would otherwise occur on his death and to protect family capital from matrimonial claims in the event his daughter divorces.

For the purposes of the present letter, we assumed that the transfer of the Securities would constitute a legally valid and binding transfer under Dutch law. The fact that the gift would enable Mr. M to avoid Dutch estate taxes with respect to the Securities upon his death does support such an assumption.

Questions

Having regards to this hypothetical situation, you ask our opinion as to whether the income earned on the Securities would have to be reported by Miss M while Mr. and Mrs. M are alive and whether Miss M would be required to report on her income tax return that she owns foreign property and complete prescribed form T1135, "Foreign Income Verification Statement".

Comments

The particular situation outlined in your letter appears to relate to a factual one, involving a specific taxpayer. As explained in Information Circular 70-6R5, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an Advance Income Tax Ruling. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate Tax Services Office for their views. However, we are prepared to offer the following general comments which may be of assistance.

In our view, in the hypothetical situation described in your request changing the owner of the Securities from Mr. M to Miss M would result in a disposition of the Securities by Mr. M and a corresponding acquisition of these properties by Miss M for the purposes of the Act (in this regard, it is to be noted, as previously mentioned, that for the purposes of the present letter we assumed that the transfer of the Securities would amount to a legally valid and binding transfer under Dutch law). As was clearly stated in Olympia and York Developments Ltd. V. The Queen, 80 DTC 6184 (F.C.T.D.), and M.N.R. v. Wardean Drilling Limited, 69 DTC 5194 (Ex. Ct.), property is disposed of and acquired when either title to the property or the normal incidents of ownership, such as possession, use and risk, have passed (see also Interpretation Bulletin IT-437R, at paragraphs 1 and 17).

Notwithstanding the foregoing conclusion, regards must be had to paragraph (e) of the definition of "disposition" found in subsection 248(1) of the Act. Pursuant to this provision, a transfer of property that does not result in a change in the beneficial ownership of the property does not constitute a "disposition" for the purposes of the Act. It would appear that there would be a change in the beneficial ownership of the Securities as a consequence of their transfer to Miss M since Mr. M would have to do something positive, i.e. revoke the gift, to put himself into the same beneficial position that he was in before he made the transfer to Miss M. For example, unless the gift is revoked, Mr. M will not be entitled to any of the income earned on the Securities, which, in our view, clearly entails that there has been a change in the beneficial ownership of the Securities following their transfer to Miss M. This result is in line with the position adopted by the Canada Revenue Agency (the "CRA") and the Department of Finance in similar situations involving transfers of property to a revocable living trust (see, among other things, the Explanatory Notes of March 2001 regarding subsection 107.4(1) of the Act and Issue No. 7 of the Income Tax Technical News).

Although pursuant to subparagraph 69(1)(b)(i) of the Act, a taxpayer who has disposed of property to a person with whom he was not dealing at arm's length may be deemed to have disposed of it at fair market value (however, in the hypothetical situation submitted, the application of this provision would not result in any Canadian tax consequences for Mr. M given that he is not resident in Canada and that the Securities do not constitute taxable Canadian properties within the meaning of the Act), paragraph 69(1)(c) of the Act would not apply so as to deem Miss M to have acquired the Securities at fair market value. This result stems from the fact that although the transfer of the Securities would result in a change in the beneficial ownership of the Securities, it would not amount to a gift for the purposes of the Act. As mentioned by the Tax Appeal Board in the case of Sewell v. M.N.R., 68 DTC 328, at p. 331: "the word "gift", unquestionably, implies that the property in question is being given completely and with no strings attached, i.e. the donor must divest himself of his entire interest in the subject matter of the gift." (see also Income Tax Technical News Issue No. 26). In our view, the power of revocation that Mr. M would reserve unto himself in the hypothetical situation outlined in your request would prevent the transfer of the Securities from qualifying as a gift for the purposes of the Act (although, as hereinafter mentioned, this power of revocation may not prevent the transfer from constituting a disposition for the purposes of the Act). Therefore, since no consideration would be given by Miss M in return for the Securities and since the acquisition of these properties by Miss M would fall outside the ambit of paragraph 69(1)(c) of the Act, the cost of the Securities to Miss M following their transfer to her would be nil.

Given that the cost of the Securities to Miss M following their transfer would be nil, it follows that Miss M would not qualify as a "reporting entity" within the meaning of subsection 233.3(1) of the Act and, therefore, that no return would have to be filed in accordance with subsection 233.3(3) of the Act in respect of the Securities (although the Securities would, in our view, qualify as "specified foreign properties" of Miss M for the purposes of section 233.3 of the Act).

As for the income earned on the Securities, we are of the view that such income would have to be reported by Miss M given that she would be the legal owner of the said properties and that neither Mr. M nor any other entity or person would have any entitlement whatsoever to such income. The fact that Miss M will agree to have the income earned on the Securities being managed by Mr. M and subjected to his discretion as regards its payment to her does not alter the fact that, subject to Mr. M exercising his power of revocation, Miss M will be the only one legally entitled to the income earned on the Securities vis-à-vis the paying entity of such income and that no one but Miss M will be entitled to the Securities or the income earned thereon while she lives.

Generally, we would consider that the power of revocation that a transferor reserves unto himself would not affect the otherwise legal effect of a transfer of properties, nor would it prevent the accrual of income into the transferee's hands. In our view, such a power of revocation would be tantamount to a condition subsequent and, therefore, should be considered as being without effect up to and until it is exercised. In the case of Imperial General Properties Ltd. V. The Queen, 83 DTC 5059, the Federal Court, Trial Division, made the following comments regarding the meaning of the expression "condition subsequent" and its effects:

"The expression "condition subsequent" referred to a term in a contract by virtue of which the contract could be rendered invalid and non-binding ab initio, if a certain event or occurrence happened. That condition was also called "resolutive" because it acted to dissolve or render ineffective a contract that had already become operative. [...]

If the condition is a true condition precedent there is no contract until it is satisfied, whereas if the condition is a condition subsequent, then in event of its non-fulfilment there may still be a binding contract upon the parties."

As for the effect of a condition subsequent on the question of an accrual to income, the Federal Court of Appeal considered this issue in the case of The Queen v. Foothills Pipe Lines (Yukon) Ltd., 90 DTC 6607, where it cited with approval the following comments of the Exchequer Court of Canada in Commonwealth Construction Company Limited v. The Queen, [1984] C.T.C. 388:

"Once the conditions precedent imposed in the letter agreements between the parties, supra, had been fulfilled, as they were, the right to receive the moneys and to retain them had accrued and was absolute. True, it might be necessary to return the moneys in whole or in part if the appeal were successful. But, as I see it, that was a condition subsequent which did not affect the unrestricted right of the appellant to use them until such a requirement occurred. It did not, as I see it, affect their quality as income upon receipt.

As to the difference in effect of a condition precedent from a condition subsequent on the question of an accrual to income, the learned trial judge relied on a quotation from Meteor Homes Ltd. V. M.N.R., [1960] CTC 419; 61 DTC 1001 at 430-431; [1007-8] which substantiates the view which I expressed, supra:

...Mertens, Law of Federal Income Taxation, Vol 2, c 12, p 127, considers "the problem of when items are... deductible to the taxpayer on the accrual basis", and deals with it at

p. 132 in these terms:

Not every contingency prevents the accrual of income: the contingency must be real and substantial. A condition precedent to the creation of a legal right to demand payment effectively bars the accrual of income until the condition is fulfilled, but the possible occurrence of a condition subsequent to the creation of a liability is not grounds of postponing the accrual. (Emphasis mine)

[...] If an amount received is, as here, in the nature of income, the fact that in the future the recipient may be under an obligation to repay it does not change the character of the receipt from income to a liability whether deferred or otherwise."

It flows from the foregoing that the power of revocation that Mr. M would reserve unto himself would not affect the binding effect of the transfer of the Securities from Mr. M to Miss M, nor would it prevent the accrual of income into Miss M's hands.

Although the facts submitted in your request do not allow us to reach a conclusion in this regard, we wish to bring to your attention that the Foreign Investment Entities rules (either the actual or the proposed ones) could find application with respect to some of the Securities.

The above comments are an expression of opinion only and are not binding on the CRA, as explained in paragraph 22 of Information Circular 70-6R5. We trust that the foregoing will be of assistance to you.

Alain Godin
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Planning Branch