CRA Panelists:
Steve Fron, CPA, CA, TEP, Oshawa: Manager, Trust Section Il, Income Tax Rulings Directorate, Canada Revenue Agency;
Phil Kohnen, CPA, CMA, TEP, Ottawa: Technical Advisor, Financial Industries and Trusts Division, Income Tax Rulings Directorate, Canada Revenue Agency

Unless otherwise stated, all legislative references hereafter are to the Income Tax Act R.S.C 1985 (5th Supp.), c.1 (the “Act”).

Q.1 Application of the Executor’s Year to a Graduated Rate Estate

Paragraph 6 of IT-286R2 notes that under common law rules, the initial 12 month period for a testamentary trust, commencing with the date of the settlor’s death, is referred to as the “executor’s year” and the right to income of the trust is, during the executor’s year, unenforceable by a beneficiary of the trust. In spite of such common law rules, where the initial taxation year of a testamentary trust coincides with the executor’s year and where the sole reason for the rights of a beneficiary being unenforceable is the existence of an executor’s year, the CRA appears to consider the income of the trust for that year to be payable to the beneficiary or beneficiaries of the trust pursuant to subsection 104(24). However, if even one beneficiary of the trust objects to this treatment with respect to the executor’s year, the income of the trust for that year, to the extent that it was not actually disbursed during that year, will be taxed in the hands of the trust.

In any case where the trust has been wound-up and the final T3 return is filed for a period which terminates before the end of the executor’s year, the income of the trust (including taxable capital gains) earned for that period is considered to have been paid to the beneficiaries of the trust in the calendar year in which that period ends, except for any part of the trust’s income that was disbursed by the trustee to persons other than beneficiaries pursuant to the deceased’s will or the operation of law (e.g., the will stipulated that debts are to be paid out of income).

Assume an estate qualifies as a graduated rate estate (“GRE”). Could the CRA clarify whether, in the final year of the estate, income should be taxed in the estate or in the beneficiaries’ hands, where the final year: a) ends after the executor’s year; b) ends during the executor’s year and c) coincides with the end of the executor’s year?

CRA Response

Background

Firstly, we note that paragraph 6 of archived Interpretation Bulletin IT-286R2 Trusts - Amounts Payable, (“the Bulletin”, issued April 1988), is substantively reproduced in the first two paragraphs of the question. Since that time, several technical interpretations [1] have discussed paragraph 6, including document 2005-0116041E5, which provided further context in respect of the executor’s year:

On the death of an individual, the individual’s property comes under the control of an executor or other personal representative and thus the property is held in an estate, which is treated as a type of trust for purposes of the Income Tax Act. It is the executor’s role to administer the estate, which involves determining and paying creditors and distributing the remaining assets of the estate to the beneficiaries as soon as possible. Generally, the law provides the executor with a year (often referred to as the executor’s year) to administer an estate, during which time the beneficiaries cannot demand the distribution of property held by the executor. After this time, it is a question of fact as to whether the executor is able to distribute property and whether the income of the estate is payable to the beneficiaries.

Paragraph 6 of Interpretation Bulletin IT-286R2, Trusts - Amounts Payable, states that the income earned in the first 12 months of the estate will be considered payable to the beneficiaries, even though the estate is still under administration and the beneficiaries are not able to enforce payment of such income, provided that none of the beneficiaries object to such treatment. Note that this position only applies to the executor’s year. That is to say, where the only reason that an amount of income is not payable to the beneficiaries is that it was earned in the initial 12 months of the estate, the income can be considered payable to the beneficiaries provided that all beneficiaries agree to such treatment. This would not apply to any other situation in which the amount was not payable to the beneficiaries because the terms of the will did not provide for such a distribution or in which the income was not allocated to the beneficiaries in proportion to their respective shares of the estate.

As stated in a paper, Post Mortem Tax Planning, presented by Mary Louise Dickenson at the 1984 Canadian Tax Foundation:

“Generally, beneficiaries are entitled to the income of the estate according to the terms of the will. If under the will income is payable to beneficiaries, the income must also be allocated by the personal representatives. If, on the other hand, income is not payable to beneficiaries, it must be included in computing the estate’s income for tax purposes. If the personal representatives have discretion regarding the payment of income and can pay or accumulate it, the personal representatives have considerable flexibility, subject to the even-hand principle and other fiduciary considerations.”

Thus, if the terms of the will provide that the income is payable to beneficiaries, the income is allocated to them by the executor unless a designation is made under subsection 104(13.1) or (13.2). If, on the other hand, income is not payable to beneficiaries, it must be included in computing the estate’s income for tax purposes.

Before it can be concluded that an amount is payable within the meaning of subsection 104(13), subsection 104(24) must be considered. Subsection 104(24) applies for the purposes of inter alia subsections 104(6) and 104(13), and deems an amount that has otherwise become payable to a beneficiary, not to have become payable to a beneficiary in a taxation year unless the amount is paid in the taxation year to the beneficiary or the beneficiary was entitled in the taxation year to enforce payment of the amount.

The above principles are reflected in the T3 Trust Guide which states, “generally, you allocate income to the trust’s beneficiaries according to the terms of the will or trust document”. The T3 Trust Guide further points out that an amount can only be allocated to a beneficiary if one of the following applies:

the beneficiary is entitled to the income in the year that it is earned by the trust, under the trust document;
the trust makes a preferred beneficiary election to include the trust income in the beneficiary’s income; or
the beneficiary is paid income in the year that is earned by the trust, at the discretion of the trustee.

The entire context of paragraph 6 of the Bulletin contemplates a situation in which the income of the estate is otherwise payable to the beneficiaries. However, this may not always be the case; therefore, one must look to the terms of the Will to determine whether paragraph 6 is relevant in a particular situation. For example, the terms of the Will may:

require the payment of income to the beneficiaries;
provide the executor with discretion to pay income to the beneficiaries (in that case, whether the discretion is exercised is relevant), or to accumulate the income in the estate;
direct the executor to use the income for some other purpose (or to not pay the income to the beneficiaries); or
provide very little indication as to whether the income or capital of the estate should be used to make distributions to residual beneficiaries. [2]

Accordingly, there are situations where the guidance in paragraph 6 does not apply, for example, where the Will provides the executor with the discretion to distribute the income to the beneficiaries or accumulate the income in the estate and the executor chooses the latter.

In our view, paragraph 6 of IT-286R2 considers the treatment of income in the executor’s year where: a) the initial taxation year of an estate coincides with the executor’s year such that the administration of the estate is not completed until after the executor’s year, or b) the estate is administered and wound up in its first year.

Response for a) - where the estate is wound up after the executor’s year

Our understanding is that the greater need for clarification is in respect of the final year of the estate, and the discussion in the latter part of paragraph 6. Nonetheless, it is important to note that the treatment discussed in the first part of paragraph 6 which allows income in the executor’s year to be considered as payable to the beneficiaries (if all of the beneficiaries agree to the treatment) relates only to situations where the estate has not been wound up in the executor’s year such that the estate administration continues beyond the first year. Also the income must otherwise be payable to the beneficiaries.

Whether the income earned in the estate’s final year which falls beyond the executor’s year should be taxed in the estate or in the beneficiaries’ hands also depends on the terms of the trust as discussed above. Where the income is distributed or made payable to the beneficiaries pursuant to the terms of the Will, the amount must be included in the beneficiaries’ income, unless a valid subsection 104(13.1) or (13.2) designation is made (see below).

Response for b) and c) - where the estate is wound up before or at the end of the executor’s year

The latter part of paragraph 6 is framed under the assumption that where the estate is wound up prior to the end of the executor’s year, amounts will have been distributed to, or will have become payable to the beneficiaries. As noted above, this may not always be the case; as the determination of whether the distributed or payable amounts are income or capital of the estate depends on whether the terms of the Will and any other laws that impact the administration of the estate allow for the distribution of income to beneficiaries.

For example, document 2016-0669871C6 considers a situation in which a simple will provided minimal direction to an executor. The question was, where all of the debts and specific bequests have been paid, whether an executor can pay or make payable taxable income of an estate to the residual beneficiaries of the estate and thus satisfy subsection 104(24) such that a deduction under subsection 104(6) could be claimed. The CRA response noted in part:

While the issue of whether a deduction pursuant to subsection 104(6) of the Act will ultimately depend on the terms of the Will and any other laws that impact the administration of the estate, in our view, the following key concepts will be useful in determining how to treat testamentary gifts for tax purposes:

1. Where there is no indication in the Will from which assets the gift is to be paid, generally the Executor can make the payment as they wish as long as they act impartially (the even-hand rule), they follow the classification of gifts (and, as is noted in the question posed, they have paid the liabilities of the testator and the estate). The residue of the Estate can include income and the residue of an estate is not necessarily comprised only of after tax amounts. Accordingly, in such instances, the income of the estate may be paid or made payable to a residual beneficiary, and a deduction pursuant to subsection 104(6) may be taken by the estate (if no other provision of the Act prohibits such a deduction).

2. However, depending on the wording of the Will, after the debts and specific bequests of the estate have been paid, the Executor may be required to pay the taxes owing on the income generated by the Estate and distribute the after tax “residue” to the residual beneficiaries. In such cases distributions to residual beneficiaries could not be considered to be income payable to a beneficiary for purposes of subsections 104(6) and 104(13). Accordingly, the estate would be precluded from claiming a deduction under subsection 104(6) in respect of the distribution. Instead, the income would be taxed in the estate, and the residual beneficiaries would receive capital distributions, comprised of after tax paid capital of the estate.

Accordingly, the guidance provided in the latter part of paragraph 6 does not apply to every situation. Further, we note that although the discussion in the latter part of paragraph 6 refers to “a period which terminates before the end of the executor’s year”, in our view, the guidance would also apply where the end of the estate’s tax year coincides with end of the executor’s year and only one T3 return is being filed which covers the time from the establishment of the estate to the final distribution of the property of the estate and its wind-up.

Designations under subsection 104(13.1) and (13.2)

We have noted in the past (for example in the 2005 document above) that a designation under subsection 104(13.1) or (13.2) may be utilized to have income that is otherwise paid or payable to beneficiaries taxed in the estate. It is important to note that since 2016, the application of these two subsections has been limited by subsection 104(13.3).

The Department of Finance’s Explanatory Notes indicate that subsection 104(13.3) ensures that subsection 104(13.1) or (13.2) designations “are made only to the extent that the trust’s tax balances (e.g., loss carry-forwards) are applied, under the rules that apply in Division C, against all of the trust’s income for the year determined after the trust claims the maximum amount deductible by it under subsection 104(6).” Therefore, where an estate’s taxable income would be greater than nil after a subsection 104(13.1) or (13.2) designation is made, subsection 104(13.3) will render the designation invalid. Subsection 104(13.3) may impact the ability to make a subsection 104(13.1) or (13.2) designation in any year of the estate.

Official Response

26 November 2020 STEP Roundtable Q. 1, 2020-0839931C6 - Executor's Year of a GRE

Q.2 Subsection 104(13.4) and Alter Ego Trusts and Joint Spousal Trusts

Pursuant to paragraph 104(13.4)(a), life interest trusts, such as Alter Ego Trusts and Joint Spousal Trusts, have a deemed year end on the date of the death of the last life interest beneficiary (the settlor in the case of the Alter Ego Trust, and the last to die of the spouses in the case of a Joint Spousal Trust). Paragraph 104(4)(a) deems the trust to have disposed of certain property of the trust at the date of death. As a result, tax on the resulting capital gains is payable by the trust on the trust’s “balance-due day” as defined in subsection 248(1).

The next taxation year of the trust will then be from the day after the date of death to December 31 of the year in which the death occurred. For example, if the death occurred on July 31, there will be a taxation year for January 1 to July 31, and a subsequent taxation year for August 1 to December 31. Both tax returns are due 90 days after the calendar year in which the death occurred.

Where a capital loss is realized by the trust in the 3 taxation years following death, the loss can be carried back under paragraph 111(1)(b) to be claimed against the capital gains in the trust’s taxation year which includes the date of death. This is claimed by filing form T3A — Request for Loss Carryback by a Trust.

However, if the loss occurs in the first taxation year after death, this loss will be known at the time of filing both tax returns for the calendar year in which the death occurred.

Can a loss which occurs in the taxation year immediately after the death be reported on the tax return filed for the date of death, rather than requiring the filing of a T3A loss carryback request? The loss will be known at the time of filing both tax returns, and both tax returns would be available for assessment at the same time, so the loss can be verified at the time of filing the date of death trust return.

CRA Response

For the 2016 and subsequent taxation years, subsection 104(13.4) applies to certain life interest trusts when an individual’s day of death, or later death, as the case may be, is referred to in paragraph 104(4)(a), (a.1) or (a.4). [3]

As noted in the question, paragraph 104(13.4)(a) results in two separate taxation years within the same calendar year. Section 3 and the description of “capital gain” and “capital loss” in subsection 39(1) refer to a “taxation year”; accordingly, these provisions will apply to each of the trust’s taxation years in the year of death. As a result, capital gains and capital losses which are realized or incurred in a particular taxation year must be reported in that taxation year.

Despite the fact that the capital loss incurred in the taxation year ending December 31 is known at the time of filing the T3 return for the taxation year ending July 31, the application of such loss cannot be “reported” on the T3 return filed for the taxation year ending July 31. This can only be done by filing a T3A form, Request for Loss Carryback by a Trust. However, the application of paragraph 104(13.4)(c) is worth noting.

Consider a situation in which the T3 return for each of the trust’s taxation years and the form T3A are all filed together, on March 31. [4] Also assume that the net capital loss for the taxation year ending December 31 is equal to the taxable capital gain realized in the taxation year ending July 31.

The loss carryback requested on the form T3A will not be processed concurrently with the T3 return for the taxation year ending July 31, as the loss must first be recognized by the CRA before it can be applied to any earlier taxation years in accordance with paragraph 111(1)(b). Therefore, the initial notice of assessment for the taxation year ending July 31 would not reflect the application of the loss carryback. Where the balance of tax is not paid on or before March 31, the assessment would include interest. When the loss carryback request is processed, the loss is applied using the request date of March 31.

For the taxation year ending July 31, the application of paragraph 104(13.4)(c) to subparagraph (a)(ii) of the definition “balance-due day” in subsection 248(1) postpones that day until 90 days after the end of the calendar year in which the taxation year ends, or March 31.

Therefore, in the example, the loss carryback is applied on the balance-due day for the taxation year ending July 31, and the net effect will be that there is no tax payable under Part I on the balance-due day of March 31. Accordingly, the interest which appeared on the notice of assessment will be reversed on the notice of reassessment for the taxation year ending July 31.

Official Response

26 November 2020 STEP Roundtable Q. 2, 2020-0840001C6 - Subsection 104(13.4) and LCBs

Q.3 Distribution of Taxable Capital Gain by Trust

A trust realizes a capital gain for a particular taxation year and would like to designate this to be a taxable capital gain of a beneficiary for that year. Is it sufficient for the amount of the taxable capital gain so designated to be paid or made payable pursuant to the provisions of subsections 104(21) and (24)?

CRA Response

The question implies that the trust will pay or make payable to the beneficiary only the taxable portion of the trust’s capital gain realized in the particular taxation year of the trust, and that the trust will not pay or make payable to the beneficiary any amount referable to the non-taxable portion of the trust’s capital gain for that taxation year.

For purposes of simplifying our response, we have assumed that neither the preferred beneficiary election nor section 105 is applicable and that the trust in question is a personal trust. Further, we have assumed that the trust has realized a net taxable capital gain for the year.

If the designation of the amount distributed is made by the trust in its T3 return for the year as required, and if all of the requirements set out in subsection 104(21) are met (including the requirements that the trust and, unless the trust is a mutual fund trust, the beneficiary, are resident in Canada), then for purposes of the provisions of the Act set out in the preamble to subsection 104(21), the beneficiary will be considered to have realized a taxable capital gain from the disposition by the beneficiary of capital property.

It is our view that the provisions of subsection 104(21) do not require that any additional amount, other than the net taxable capital gain so designated, be paid or made payable by the trust to the beneficiary such as an amount reflecting the non-taxable portion of any capital gain realized by the trust. We note that any amounts that the trust pays or makes payable to beneficiaries must be authorized or permitted by the trust instrument and the applicable law. We further note that we have assumed that the amounts that are paid or payable to the beneficiary, and designated under subsection 104(21), are for the beneficiary’s own account and benefit, and that the beneficiary is under no obligation to pay any part of such amounts to or for the benefit of another person.

Notwithstanding the above comments, it should be noted that CRA has applied the general anti-avoidance rule (“GAAR”) to certain abusive transactions involving the allocation of capital gains. The determination of whether the GAAR would apply to any particular situation would require a full consideration of all the facts and circumstances.

Official Response

26 November 2020 STEP Roundtable Q. 3, 2020-0839881C6 - Distribution of taxable capital gain

Q.4 Foreign Tax Credit

Under the Act, the Canadian tax base extends to tax a non-resident on the capital gain realized on a disposition of taxable Canadian property (“TCP”). For this purpose, TCP includes shares of a foreign corporation where the shares derive their value primarily from Canadian real estate (or certain other Canadian property as noted in the definition of TCP).

Other countries have similar rules, for example Australia and India.

Assume that an individual resident in Canada (the “Taxpayer”) owns all the shares of a corporation resident in the UK, and the UK corporation owns all the shares of a corporation resident in Australia. The value of the UK corporation’s shares is wholly derived from real property in Australia. The Canadian resident individual sells the shares of the UK corporation and realizes a capital gain under both Australian and Canadian income tax laws. The capital gain is subject to income tax in Australia which the Taxpayer pays. The capital gain is not subject to income tax in the UK.

In these circumstances, in computing its Canadian taxes payable can the Taxpayer obtain a foreign tax credit for the income tax paid to Australia on the capital gain? In particular, is the gain considered to be from a source in Australia for purposes of computing the foreign tax credit?

CRA Response

Generally, subsection 126(1) of the Act permits a Canadian resident taxpayer to deduct from the tax otherwise payable fora taxation year, a foreign tax credit in respect of “non-business income tax” (as defined in subsection 126(7) of the Act) paid by the taxpayer for the taxation year. Where a taxpayer has income for a taxation year that is sourced to more than one country, pursuant to paragraph 126(6)(b) of the Act and as stated in paragraph 1.91 of Income Tax Folio S5-F2-C1, Foreign Tax Credit (referred to herein as the “Folio”), separate foreign tax credit calculations under subsection 126(1) must be made for each country. In the example above and pursuant to paragraph 126(1)(b) of the Act, the tax paid to Australia may only be credited against Canadian taxes otherwise payable in respect of non-business income from sources in Australia.

Generally, when determining the source of a capital gain from the disposition of shares for foreign tax credit purposes under section 126 of the Act, certain factors as outlined in paragraph 1.65 of the Folio would be taken into consideration. However, where Canada has entered into a tax treaty with the country to whom taxes are paid, consideration must be given as to whether the provisions of the treaty may affect and modify the general sourcing rules. Paragraph 4 of Article 13 (Capital Gains) in the Canada-Australia Treaty (the “Treaty”) provides that gains from the disposition of shares of a company, where the value of the assets of such company is derived principally (whether directly or indirectly) from real property situated in a Contracting State, may be taxed in that Contracting State.

As the facts provide that the value of the UK corporation’s shares is wholly derived from real property in Australia, pursuant to paragraph 4 of Article 13 of the Treaty, the gain realized by the Taxpayer on the disposition of the shares of the UK corporation may be taxed in Australia.

Paragraph 2 of Article 22 (Source of Income) of the Treaty provides that for the purposes of Article 23 (Elimination of Double Taxation) and the law of Canada, profits, income or gains of a resident of Canada which are taxed in Australia in accordance with Article 13 of the Treaty shall be deemed to be income from sources in Australia. This paragraph would therefore apply to deem the capital gain realized by the Taxpayer on the disposition of the shares of the UK corporation to be income from sources in Australia for purposes of Article 23 and the Act.

In general terms, pursuant to subparagraph 2(a) of Article 23 of the Treaty, Canada shall provide a foreign tax credit for taxes payable in Australia on profits, income or gains from sources in Australia, subject to the existing provisions of the law of Canada. Therefore, in our view, in this particular hypothetical situation the Taxpayer would be eligible to claim a foreign tax credit for the income tax paid to Australia in accordance with subsection 126(1) of the Act and subparagraph 2(a) of Article 23 of the Treaty. The actual amount of the foreign tax credit would be determined based on the computational rules of section 126 of the Act.

Official Response

26 November 2020 STEP Roundtable Q. 4, 2020-0838001C6 - Foreign Tax Credit

Q.5 Subsections 40(3.61) and 164(6)

Question 5 of the 2012 STEP CRA Roundtable (document 2012-0449801C6) [5] discussed a situation in which an estate elects under subsection 164(6) to apply a capital loss resulting from the disposition of shares of the capital stock of a corporation to the terminal T1 return of the deceased individual. The CRA noted that based on a technical reading of the provisions it is possible for a circularity issue to arise:

“If the estate realizes capital gains during its first taxation year, those gains must be applied against the loss on the share disposition, in accordance with the requirements of subsection 164(6), in order to determine the amount that can be carried back. Where this occurs, the application of subsection 40(3.61) will result in an amount of loss stopped pursuant to subsection 40(3.6), which in turn will reduce the amount available for the subsection 164(6) election, and the circular nature of these provisions becomes an issue.”

CRA also noted that they had not seen an actual situation and that they would review the issue further on a case-by-case basis.

Consider the following example:

Mr. X (the “taxpayer) owned all of the common shares of the capital stock of a private corporation (“PrivateCo”) at his death.
The capital gain on the deemed disposition of the common shares of PrivateCo. pursuant to subsection 70(5) and reported on the taxpayer’s terminal T1 return was $4.9 million.
The taxpayer also owned an investment portfolio.
Capital gains were realized in the portfolio both prior to the date of death and between the date of death and December 31.
Capital gains of $30,000 were attributable to the period after the taxpayer’s death. Accordingly, these gains were reported in the estate’s T3 return for its first taxation year.
As part of the post mortem tax planning, a portion of the common shares of PrivateCo would be redeemed. The redemption of the common shares would create a capital loss of $1 million in the estate which would be applied to the taxpayer’s terminal T1 return by virtue of the legal representative electing pursuant to subsection 164(6).

In applying the CRA’s 2012 position to this situation, the $30,000 of capital gains realized by the estate in its first taxation year would grind the capital loss available for purposes of the subsection 164(6) election. The grind effected by the interaction of subsections 40(3.61) and 40(3.6) and the netting of the estate’s capital gains and capital losses in paragraph 164(6)(a) would be iterative, such that the estate’s $1 million capital loss would ultimately be reduced to nil.

Can the CRA comment on the appropriateness of the result?

CRA Response

Subsection 164(6) of the Act allows the estate of a deceased taxpayer to elect to have all or part of its capital losses (to the extent they exceed its capital gains) that are realized in its first taxation year to be deemed to be capital losses of the deceased. The election, which results in the carry back of the elected amount to the final T1 return of the deceased, can be useful in addressing potential double taxation which may arise where the deceased held shares of the capital stock of a corporation with accrued gains at the time of death.

Subsection 40(3.6) of the Act is a stop-loss rule that applies if a taxpayer disposes of a share of the capital stock of a corporation to the corporation, and the taxpayer is affiliated with the corporation immediately after the disposition. When subsection 40(3.6) applies, the taxpayer’s loss from the disposition is deemed to be nil. Prior to the introduction of subsection 40(3.61), if the estate and the corporation were affiliated immediately after the disposition (typically, on the redemption of shares by the corporation), the capital loss would be stopped, and could not be carried back to be applied on the terminal T1 return.

In general, subsection 40(3.61) was introduced to override the effect of the stop-loss rules in subsections 40(3.4) and (3.6) where an estate’s capital loss is being carried back pursuant to subsection 164(6). Subsection 40(3.61), which applies if the estate elects pursuant to subsection 164(6) in respect of a capital loss on the disposition of a share of a corporation, provides that subsections 40(3.4) and (3.6) apply “in respect of the loss only to the extent that the amount of the loss exceeds the portion of the loss to which the election applies.”

The CRA has reconsidered its earlier view and notes that an iterative grind of the estate’s capital loss would yield a result which is contrary to the purpose of the relief provided by subsection 40(3.61). Accordingly, the CRA will not apply subsection 40(3.61) as described in documents 2012-0449801C6 and 2012-0462941C6. The CRA is of the view that pursuant to subsection 40(3.61):

the subsection 164(6) election applies first, and the capital loss available for the election is determined without reference to subsection 40(3.4) or 40(3.6), and
the stop loss rules in subsections 40(3.4) or 40(3.6) apply to any capital loss of the estate that is not the subject of the subsection 164(6) election.

Applying this to the example above, the estate’s capital loss for the purpose of the subsection 164(6) election is $1 million. Paragraph 164(6)(a) limits the amount of the election to the net amount of the estate’s capital losses and capital gains, or $970,000. Assuming the legal representative elects on this amount, the $970,000 amount will be deemed to be a capital loss of the deceased taxpayer for the deceased taxpayer’s last taxation year (terminal T1 return) and $30,000 of the estate’s capital loss will remain in the estate. Accordingly, the relieving measure in subsection 40(3.61) preserves the estate’s capital loss that can be applied to the deceased taxpayer’s terminal T1 return. Subsection 40(3.6) would apply to any capital loss of the estate that remains after the election is made - in this case, the remaining capital loss of $30,000 would be deemed to be nil.

In summary, the estate would be taxed on its $30,000 of capital gains because the capital loss that remains in the estate after the election is nil and, in accordance with paragraph 40(3.6)(b), would be added to the adjusted cost base of the common shares of PrivateCo held by the estate after the disposition. A similar result would occur where the estate makes the subsection 164(6) election for an amount that is less than the result of the paragraph 164(6)(a) calculation (for example, if the estate elected for less than $970,000).

It is important to note that the relief provided by subsection 40(3.61) is only in respect of a disposition of a share of the capital stock of a corporation. For example, where the estate has a capital loss from the disposition of property other than shares to an affiliated person such that subsection 40(3.4) applies, for the purposes of computing the amount of the capital loss that is available for the election under subsection 164(6), the exemption in subsection 40(3.61) would not apply. Subsection 40(3.4) would apply and the amount of the capital loss available for the paragraph 164(6)(a) calculation would be deemed to be nil and would be suspended until the earliest of certain events described in paragraph 40(3.4)(b) occurs.

Official Response

26 November 2020 STEP Roundtable Q. 5, 2020-0847181C6 - Subsections 40(3.61) and 164(6)

Q.6 Impact of an Eligible Offset on a Disposition of a Capital Interest in a Personal Trust

Where a personal trust distributes property to a Canadian resident beneficiary in satisfaction of the beneficiary’s capital interest in the trust, the capital beneficiary is considered to have disposed of their capital interest and subsections 107(1) and 107(2) will generally apply. Consider a situation in which, as a condition of the distribution, the beneficiary assumes a debt of the trust which is applicable to the property being distributed. If the debt assumed by the beneficiary meets the definition of “eligible offset” [6] in subsection 108(1), will it create either a capital gain or capital loss for the beneficiary in respect of the disposition of their capital interest in the trust?

CRA Response

Although the question focuses on the disposition of the beneficiary’s capital interest, it is useful to consider the treatment of the distributed property as it provides context for the disposition of the beneficiary’s capital interest.

Generally speaking, when subsection 107(2) of the Act applies to a distribution of property by a trust [7] :

The trust is deemed under paragraph 107(2)(a) to have disposed of the property for proceeds of disposition (POD) equal to the property’s “cost amount” [8] immediately before the disposition.
Pursuant to paragraph 107(2)(b), the beneficiary is deemed to have acquired the property for an amount equal to the total of the amount described in paragraph 107(2)(a) plus, in certain circumstances, an adjustment. [9]

In respect of the disposition of the beneficiary’s capital interest, in general, the proceeds of disposition are deemed by paragraph 107(2)(c) to be the amount determined in paragraph 107(2)(b) [10] less any “eligible offset” in respect of the capital interest.

To determine the beneficiary’s adjusted cost base (ACB) of their capital interest we must consider subsection 107(1) of the Act. Pursuant to paragraph 107(1)(a), the ACB to the taxpayer of their capital interest, for the purpose of computing a capital gain (if any) in paragraph 40(1)(a), is generally equal to the greater of:

the ACB otherwise determined immediately before the disposition and
the “cost amount” of the interest immediately before the disposition.

[11]

Example 1

Consider an example in which a personal trust resident in Canada [12] (“Trust”) owns all of the issued and outstanding common shares of the capital stock of a corporation (“the Shares”) which have an ACB of $100,000. The Trust also has a $20,000 liability in respect of the Shares, which satisfies the definition of “eligible offset” in subsection 108(1). The Trust beneficiary (“the Beneficiary”) is an individual resident in Canada who did not pay for their capital interest under the Trust and holds the interest as capital property. The Trust has not previously distributed any of its property to the Beneficiary. The Trust distributes all of the Shares to the Beneficiary in satisfaction of the Beneficiary’s capital interest in the Trust. The Shares are capital property [13] and subsection 107(2.1) does not apply to the distribution.

The rules in paragraphs 107(2)(a) to (c) respectively will result in the following:

The Trust will be deemed to dispose of the Shares for POD equal to their “cost amount” immediately before the disposition. The deemed POD of the Shares are therefore $100,000;
The Beneficiary will be deemed to acquire the Shares at a cost equal to the total of their “cost amount” to the Trust immediately before the distribution ($100,000) and the amount, if any, by which the ACB to the Beneficiary of the capital interest (nil) exceeds the “cost amount” ($100,000) to the Beneficiary of the capital interest. The Beneficiary is therefore deemed to have acquired the Shares at a cost equal to $100,000;
The Beneficiary’s POD of their capital interest are deemed to be equal to the amount, if any, by which the cost at which the Beneficiary is deemed to have acquired the Shares ($100,000) exceeds the total of all eligible offsets ($20,000) of the Beneficiary in respect of the capital interest or part of it. Thus, the Beneficiary’s POD of their capital interest in the Trust are deemed to be $80,000.

For the purpose of computing the Beneficiary’s capital gain, if any, paragraph 107(1)(a) determines the ACB of the Beneficiary’s capital interest to be the greater of its ACB otherwise determined (nil) and the Beneficiary’s cost amount ($100,000). Therefore, the ACB of the Beneficiary’s capital interest would be $100,000 for the purpose of calculating a capital gain on the disposition thereof. The application of paragraph 107(1)(a) to the computation of the capital gain in paragraph 40(1)(a) results in a negative amount (deemed POD of $80,000 pursuant to 107(2) less the deemed ACB of $100,000); accordingly, the capital gain is nil.

It is important to note that the deemed ACB resulting from paragraph 107(1)(a) is only relevant for determining a capital gain -it is not used to determine whether or not a capital loss [14] results.

The capital loss will be calculated pursuant to paragraph 40(1)(b). Thus, the loss will be the amount, if any, by which the ACB of the Beneficiary’s capital interest immediately before the disposition (nil) plus any outlays and expenses relating to the disposition (nil) exceeds the Beneficiary’s POD as determined by paragraph 107(2)(c) ($80,000). Since the result is negative, the capital loss is nil.

Example 2

If we change our facts such that the Beneficiary paid $100,000 for their capital interest in the Trust, certain of the above outcomes are impacted. Notably though, the results with respect to subsection 107(2) and paragraph 107(1)(a) remain unchanged:

The Trust will be deemed to dispose of the Shares for POD equal to $100,000;
The Beneficiary will be deemed to acquire the Shares at a cost equal to $100,000 [15] ;
The Beneficiary’s POD of their capital interest are still deemed to be equal to $80,000;
For the purpose of determining the Beneficiary’s capital gain on the disposition of their capital interest, paragraph 107(1)(a) will deem the beneficiary’s ACB to be $100,000 [16] ; and
The computation of the capital gain under paragraph 40(1)(a) results in a negative amount (deemed POD of $80,000 pursuant to 107(2) less the deemed ACB of $100,000); accordingly, the capital gain, if any, is still nil.

However, the computation of the capital loss pursuant to paragraph 40(1)(b) yields a different outcome. The capital loss is the amount, if any, by which the ACB of the Beneficiary’s capital interest immediately before the disposition plus any outlays and expenses relating to the disposition (now $100,000 plus nil) exceeds the Beneficiary’s proceeds of disposition as determined by paragraph 107(2)(c) ($80,000). Since the result is positive $20,000, the capital loss, if any, is $20,000.

It is important to note the determination of the ACB of the beneficiary’s capital interest in paragraph 107(1)(a) as described above, does not apply if any part of the interest was acquired for consideration and the trust is non-resident at the time of the disposition.

Finally, we note that where, as in Example 2, a loss results on the disposition of a capital interest in a personal trust, paragraph 107(1)(c) must be considered. Paragraph 107(1)(c) is a "stop-loss" rule which reduces a beneficiary’s loss from the disposition of an interest in a trust in certain situations. The loss restriction provisions in paragraph 107(1)(c) are dependent on whether the beneficiary is a corporation, another trust, or a natural person. If the beneficiary is a partnership, the stop loss rules contained in paragraph 107(1)(d) may have application.

Official Response

26 November 2020 STEP Roundtable Q. 6, 2020-0839991C6 - Eligible offset

Q.7 TOSI and Rental Income

A number of related people hold a co-tenancy interest in a rental property. Assume that the rental activities do not amount to a partnership. Can CRA confirm that in these circumstances the rental income will not be split income for purposes of the TOSI rules?

Similarly, when the property is sold, can CRA confirm that any resulting taxable capital gain will not be split income?

For the purposes of this question it is assumed that the people who hold the co-tenancy in the rental property are individuals (other than trusts).

CRA Response

The tax on split income in section 120.4 of the Act only applies to “split income” of a “specified individual” for a taxation year pursuant to subsection 120.4(2) of the Act. “Split income” and “specified individual” are defined for this purpose in subsection 120.4(1) of the Act.

A “specified individual” is generally defined as an individual, other than a trust, who is resident in Canada at the end of the year, and if the individual is under 18 years of age at the end of the year, the individual has a parent that is resident in Canada at any time in the year.

Split income of a specified individual for a taxation year is defined as the total of all amounts listed under paragraphs (a) to (e) of the definition of “split income” in subsection 120.4(1), other than excluded amounts. Generally split income is defined to include amounts that are included in a specified individual’s income in respect of a corporation, partnership or a trust. The definition “split income”, however, does not include amounts that are included in the income of a specified individual as a result of the direct ownership of real property.

Therefore, assuming the people holding the co-tenancy in the real property are individuals (other than trusts), and that the rental activities do not amount to a partnership, the rental income earned and the taxable capital gain realized on the real property will not be subject to the tax on split income.

Official Response

26 November 2020 STEP Roundtable Q. 7, 2020-0837611C6 - TOSI and Rental Property

Q.8 TOSI and Donations

An individual has a large taxable capital gain which will be considered split income. The individual intends to make a substantial donation with the proceeds from the sale. Assume that the individual does not otherwise have any income other than this taxable capital gain.

Does CRA agree that in these circumstances the amount of the donation cannot be taken as a tax credit to reduce the amount of tax calculated under TOSI?

CRA Response

Subsection 120.4(3) of the Act ensures that the Part I tax payable by a specified individual is not less than the individual's split income for the year multiplied by the highest individual tax rate for the year reduced only by the dividend tax credit (section 121 of the Act) and the foreign tax credit (section 126 of the Act) available in respect of amounts included in that split income and the disability tax credit (section 118.3 of the Act). Therefore, the charitable donation tax credit (section 118.1 of the Act) cannot be applied to reduce a specified individual’s Part I tax payable that arises as a result of the application of the tax on split income.

Official Response

26 November 2020 STEP Roundtable Q. 8, 2020-0837621C6 - TOSI and Donations

Q.9 TOSI and Excluded Business

Suppose that a husband and wife own shares of a number of corporations each of which has its own business. Both spouses work on a full-time basis for each of the various companies, but no particular company’s business requires more than 4 hours a week of work by either spouse on average. Assume that each spouse works at least 20 hours a week collectively in respect of all the corporations. In this circumstance, can the hours worked by each spouse in the businesses of these various corporations be added together for the purpose of applying the deeming rule in paragraph 120.4(1.1)(a) to the definition of excluded businesses?

CRA Response

One of the safe harbour exclusions from TOSI is for income received by a “specified individual” from an “excluded business”. The definitions of specified individual and excluded business are set out in subsection 120.4(1). In general, a business is an excluded business of a specified individual for a taxation year if the specified individual is actively engaged on a regular, continuous and substantial basis in the activities of the business in either: (a) the relevant taxation year; or (b) any five prior taxation years of the specified individual.

Paragraph 120.4(1.1)(a) also sets out a bright line test whereby a specified individual will be deemed to be actively engaged on a regular, continuous and substantial basis in the activities of a particular business in a taxation year of the individual if that individual works in the business at least an average of 20 hours per week during the portion of the year in which the business operates. This test requires that it be applied on a business by business basis. Since neither spouse works more than 4 hours in any business carried on by any of the particular corporations they own, the requirements of the bright line test in paragraph 120.4(1.1)(a) would not be met and, as such, it remains a question of fact as to whether either spouse would otherwise be considered to be actively engaged on a regular, continuous and substantial basis in the activities of each such business on the basis of the limited number of hours worked.

The above scenario provides no rationale for why multiple corporations are being used by the spouses to carry on the various business activities or whether any other factors exist (such as additional labour) that may be necessary to operate each corporation’s business for a particular year. As such, it is not possible to conclusively determine whether, on the basis of an evaluation of such relevant factors, each spouse could otherwise be considered as being actively engaged on a regular, continuous and substantial basis in the activities of each of the businesses carried on by their various corporations for a particular taxation year.

However, the comments in our response to Question 3 at the 2019 STEP Conference (2019-0799901C6) and in Example 9 of our Guidance on the Application of the Split Income Rules for Adults provide useful general guidance on this issue. In particular, in the fact situation set out in Question 3 of the 2019 STEP Conference, we indicated that a husband and wife could both be considered to be actively engaged in the activities of a particular business carried on by their corporation on a regular, continuous and substantial basis for a particular year where the particular business did not require any other workers and only required them to spend on average 5 hours each per week in that business.

Official Response

26 November 2020 STEP Roundtable Q. 9, 2020-0837631C6 - TOSI - Excluded Business

Q.10 TOSI and Change in Business

Suppose that husband and wife both worked in the business of a corporation for at least 20 hours a week for 5 years. At some future time, the assets of the business are sold, and the business ceases to be carried on in a particular year. The funds are invested producing investment income, and dividends are paid from this investment income in the following years. Assume the exception for “excluded shares” does not apply. In these circumstances, would the dividends be split income, because the definition of “excluded business” can no longer be met if the business has ceased?

CRA Response

Under the TOSI rules in section 120.4 of the Act, TOSI will apply to tax the “split income” of a “specified individual” at the highest marginal rate unless the amount is an “excluded amount” as these terms are defined in subsection 120.4(1).

In the above scenario, the corporation has sold the assets used in its previous business operations, which have completely ceased, and the proceeds from that sale have been reinvested (presumably along with the historical retained earnings) in various investments. However, while we have been asked to assume that the dividends paid by the corporation to the husband and wife would not be an excluded amount under the “excluded shares” definition as that term is also defined in subsection 120.4(1), no information has been provided on the following:

whether the corporation’s investment activities constitute a business;
if the corporation’s investment activities do constitute a new business, whether that business is a related business in respect of husband and wife (each being a specified individual); and/or
whether the husband and/or wife for a particular taxation year is actively engaged on a regular, continuous and substantial basis in the activities of that investment business.

The determination of whether any dividends paid by the corporation will be subject to TOSI can only be made following a complete review of all the relevant facts and circumstances. However, for some guidance on some of the above-noted informational issues please refer to our response to question 8 of the 2019 Canadian Tax Foundation Round Table (2019-0824411C6) and question 10 of the 2018 Canadian Tax Foundation Round Table (2018-0780081C6).

However, assuming the corporation is considered to be carrying on an investment business that is a related business then the excluded business exception would not apply to husband and/or wife if such individual is not considered to be actively engaged in that investment business on a regular, continuous and substantial basis either during the particular taxation year or in any five prior taxation years. Consequently, the taxable dividends will be split income subject to TOSI unless another excluded amount exception applies.

Official Response

26 November 2020 STEP Roundtable Q. 10, 2020-0837641C6 - TOSI - Excluded Business

Q.11 Taxable Dividends from a Trust

Where a Canadian resident inter vivos trust receives a taxable dividend from a Canadian corporation, it may designate such dividend to be a taxable dividend received by a Canadian resident beneficiary pursuant to the provisions of subsection 104(19). CRA has said that the designation cannot be made until the end of the year.

Consider the following situation. A Canadian resident personal trust receives a dividend from a taxable Canadian corporation (ACo.) Suppose another taxable Canadian corporation (B Co.) is a beneficiary of the trust. At the time the dividend is paid to the trust by A Co., and then distributed to the beneficiary, B Co., the two corporations are connected for Part IV tax purposes.

However they are not connected at December 31 (the year-end of the trust). Would Part IV tax apply?

If a beneficiary receives an amount to be designated as a taxable dividend, but does not exist at the year-end of the trust (for example, an individual dies), what is the nature of the income?

CRA Response

A trust that is resident in Canada throughout a particular taxation year in which it receives a taxable dividend on a share of the capital stock of a taxable Canadian corporation may, pursuant to the requirements of subsection 104(19), designate in respect of a taxpayer (who is a beneficiary), a portion of the taxable dividend. The amount equal to that portion of the dividend designated is:

for the purposes of paragraphs 82(1)(b), 107(1)(c), and 107(1)(d) and section 112, deemed not to have been received by the trust, and
for the purposes of the Act other than Part XIII, deemed to be a taxable dividend on the share received by the beneficiary in the beneficiary’s taxation year in which the particular taxation year of the trust ends.

However, the deeming rules described above do not apply unless a number of conditions are met, including that:

The amount is designated by the trust, in respect of the beneficiary, in the trust’s return of income under Part I for the particular taxation year;
The amount may reasonably be considered (having regard to all the circumstances including the terms and conditions of the trust) to be part of the amount that was included in computing the income for that taxation year of the beneficiary because of:
- an amount payable under paragraph 104(13)(a),
- an amount upon which the trust and the beneficiary have made a preferred beneficiary election under subsection 104(14), or
- a benefit under section 105 conferred upon a beneficiary by the trust;
The taxpayer is in the particular taxation year a beneficiary under the trust;
The trust is, throughout the particular taxation year, resident in Canada; and
The total of all amounts each of which is an amount designated, under subsection 104(19), by the trust in respect of a beneficiary under the trust in the trust’s return of income under Part I for the particular taxation year is not greater than the total of all amounts each of which is the amount of a taxable dividend, received by the trust in the particular taxation year, on a share of the capital stock of a taxable Canadian corporation.

It is CRA’s opinion that a taxable dividend designated in favour of a particular beneficiary pursuant to subsection 104(19) will be deemed to have been received by the beneficiary at the time that is the end of the particular taxation year of the trust in which the trust received the dividend. This position is based on the fact that the designation under subsection 104(19) could only occur at the end of the taxation year of a trust, since among others, paragraphs 104(19)(a) and (d) require that the designation is made in the income tax return of a trust. Also, it is only at the end of its taxation year that a trust will know its income for the year and that all the conditions set out in subsection 104(19) will be met.

Part IV tax

Paragraph 8 of Interpretation Bulletin IT-269R4, Part IV Tax on Taxable Dividends Received by a Private Corporation or a Subject Corporation [archived] provides that the determination of whether an assessable dividend was received from a “connected” corporation must be made at the time that the dividend was received by the recipient corporation. If the assessable dividend was received from the payer corporation at a time when that corporation was not connected to the recipient corporation, then the dividend is subject to Part IV tax, notwithstanding that the payer corporation may have been connected to, or might subsequently become connected to, the recipient corporation at some other time during the taxation year.

Accordingly, in the hypothetical situation provided, if the requirements of subsection 104(19) were met and a valid designation was made in respect of the taxable dividend received by the trust, B Co. would be deemed to have received the taxable dividend on the shares of A Co. on December 31st, the taxation year end of the trust. At that date, A Co. and BCo. are not connected. Therefore, B Co. would be subject to Part IV tax on the taxable dividend received from the trust for which a designation was made under subsection 104(19).

When an individual beneficiary dies before the trust’s year end

Pursuant to subsection 104(13), a beneficiary of a trust must include in income for a given taxation year, the portion of the income of the trust in respect of the trust’s taxation year that ends in that given year, as became payable to the beneficiary. The taxation year of an individual is defined in subsection 249(1) as being a calendar year. There is no provision in the Act that shortens a taxpayer’s taxation year in his or her year of death so as to cause it to end as at the taxpayer’s date of death.

As such, assuming all the conditions of subsection 104(19) are met, a trust would not be prohibited from designating an amount, in respect of an individual beneficiary, in the trust’s return of income under Part I for the particular taxation year. The designated amount would be deemed to be a taxable dividend on the share received by the beneficiary in the beneficiary’s taxation year in which the particular taxation year of the trust ends. Accordingly, the taxable dividend deemed to be received would need to be reported in the individual's final personal income tax and benefit return.

Official Response

26 November 2020 STEP Roundtable Q. 11, 2020-0839891C6 - Subsection 104(19)

Q.12 Distribution of Property by a Canadian Resident Trust to a Canadian Corporation that is Wholly Owned by One or More Non-Residents

At the 2017 CTF Annual Conference the CRA addressed a situation involving the distribution of property by a Canadian resident discretionary trust to a Canadian corporation whose shares would be wholly owned by a non-resident beneficiary. It was noted that it is the CRA’s view that the situation addressed circumvented the application of subsection 107(5) and 107(2.1) in a manner that frustrates or defeats the object, spirit or purpose of those provisions, subsections 70(5), 104(4) and 107(2) and the Act as a whole. Would your view be different where the property distributed from a Canadian resident discretionary trust to a Canadian corporation, the shares of which are held by one or more non-resident beneficiaries, constituted taxable Canadian property?

Consider a situation where the trustees of a Canadian resident discretionary family trust (the “Trust”) are planning to distribute all or a portion of the Trust’s property (the “Property”) to one or more of its beneficiaries in advance of the Trust’s 21st anniversary. The Property is taxable Canadian property, as defined in subsection 248(1), but is not property described in subparagraphs 128.1(4)(b)(i) to (iii) nor a share of the capital stock of a non-resident-owned investment corporation. The beneficiaries of the Trust that are intended to receive the Property are natural persons who are non-residents of Canada at the relevant time (“NR beneficiaries”).

Instead of distributing the Property to the NR beneficiaries directly, the trustees propose to distribute the Property, on a tax-deferred basis pursuant to subsection 107(2), to one or more Canadian corporations (“Canco”) that are wholly owned by one or more of the NR beneficiaries, and that are beneficiaries of the Trust. The result is that the Property will no longer be held by the Trust and as such will not be subject to the 21-year deemed disposition rule. In addition, since the Property will be distributed to one or more Canadian resident corporations, subsection 107(5) should not be applicable. Therefore, the Property will be transferred out of the Trust on a tax-deferred basis pursuant to subsection 107(2).

Does the CRA agree with this conclusion?

CRA Response

Consistent with our response at the 2019 CTF Conference, it is the CRA’s view that if the Property distributed to Canco constitutes taxable Canadian property, other than a property described in subparagraphs 128. 1(4)(b)(i) to (iii) or a share of the capital stock of a non-resident-owned investment corporation, such transactions would result in a misuse or abuse of subsections 107(2), (2.1) and (5). Subsections 107(2.1) and (5) effectively result in the immediate realization of capital gains on property distributed to non-residents over which Canada does not retain the absolute right to tax without restriction. It is the CRA’s view that the intention of subsection 107(5) is to ensure that Canada maintains the ability to tax capital gains that accrue during the period that property is held by a Canadian resident trust and that the transactions described herein are not consistent with this intention.

The CRA has significant concerns regarding these transactions and will consider the application of the General Anti-Avoidance Rule (GAAR) when faced with a similar set of transactions unless substantial evidence supporting its non-application is provided. In addition to the specific transactions described herein, it is the CRA’s view that the GAAR may be applicable in respect of other situations involving the distribution of property from a family trust to a Canadian corporation with one or more non-resident shareholders. For instance, it is the CRA’s view that it would be appropriate to consider that the same conclusion would apply regardless of whether or not the transactions are being undertaken to avoid the 21-year deemed disposition rule in subsection 104(4).

Accordingly, unless substantial evidence supporting the non-application of GAAR is provided, the CRA will not provide any Advance Income Tax Ruling where such structure is proposed to be put in place.

Official Response

26 November 2020 STEP Roundtable Q. 12, 2020-0839981C6 - 21 year planning, 107(5) and TCP

Q.13 Rental Property Owned by Non-Resident Estate

In general terms, section 216 sets out rules that allow a non-resident of Canada to elect to file an optional return to be taxed under Part I on the net rental income from real or immovable property or the net income from timber royalties in Canada in lieu of paying Part XIII withholding tax at a rate of 25% (or such reduced rate pursuant to an applicable tax treaty) on the gross amount of such income.

Consider a situation in which a non-resident individual (“Ms. X”) owned a Canadian rental property for several years prior to her death. Ms. X had filed a personal T1 income tax return each year pursuant to the rules in section 216 of the Act. Ms. X’s Will provides that the residue of her estate (“Estate”) is divided equally between her children, Y and Z, both of whom are non-residents. The Estate assets may be distributed in specie. Y and Z are the only capital beneficiaries of the Estate. Ms. X’s Will does not provide for the distribution of income to Y and Z while the rental property is held in the Estate.

The rental property would be considered real or immovable property situated in Canada and depreciable capital property for purposes of the Act. Asa result, on Ms. X’s death, she will be deemed to have disposed of the rental property at its then fair market value (“FMV”) and recognize the appropriate capital gains and recaptured depreciation on her terminal T1 income tax return and the return required under section 216, respectively.

The rental property will be transferred to the Estate at the above noted FMV. The executors of the Estate, who are also non-resident wish to designate the Estate as a graduated rate estate (“GRE”) pursuant to the definition in subsection 248(1) of the Act. [17]

After the executors have administered the Estate and determined the residue, the executors will distribute a 50% interest in the rental property to each of Y and Z.

1. Will the Estate be a GRE?

2. Can the Estate file a T3 trust return under section 216 of the Act?

3. When the Estate distributes the rental property to Y and Z, will the Estate be deemed to dispose of the rental property at its tax cost to the Estate pursuant to subsection 107(2) of the Act?

4. After the Estate distribution, can Y and Z each file a section 216 return on 50% of the income derived from the rental property?

CRA Response

For the purpose of our response, we assume that the Estate and the beneficiaries are not resident in Canada for Canadian income tax purposes, and that section 94 of the Act does not apply to the Estate. [18] We have further assumed that 1) the Estate does not carry on business in Canada, 2) paragraphs (a) to (d) of the definition of “testamentary trust” under subsection 108(1) do not apply to the Estate, and 3) that the Estate will not use the optional method of payment provided under subsection 216(4).

Prior to the time when the estate administration is complete, the executors are generally considered to hold legal and beneficial ownership of the estate property and the estate is still considered to be in existence. It is a question of mixed fact and law as to when beneficial ownership of the estate property is considered to pass to the beneficiaries. The answer would depend on the wording of the Will, all of the facts and circumstances and the applicable law. Accordingly, we are unable to confirm whether the beneficiaries (Y and Z) would hold beneficial ownership prior to the time when the distribution is made by the executors to Y and Z. For the purposes of our response, we have assumed that the Estate would still be considered to be in existence prior to the distribution and that the transfer of beneficial ownership would coincide with the completion of the estate administration and distribution of the rental property from the Estate.

Subsection 216(3) provides that where a section 216 election is made, Part I applies with such modifications as the circumstances require to the payment of tax under section 216. Subsection 122(1) of Part I provides that all trusts, other than a GRE or “qualified disability trust”, pay a flat rate of tax at the top marginal rate.

Questions 1 and 2

A non-resident estate could be a GRE. Neither section 216 nor the definition of a GRE includes any language distinguishing a non-resident estate filing under Part I (T3 Return) on an elective basis pursuant to section 216 in respect of a Part XIII tax liability from a taxpayer who is required to file under Part I in respect of a Part I filing obligation. There is no provision in the Act prohibiting an estate filing under section 216 from qualifying as a GRE.

A non-resident estate could file its return of income under Part I pursuant to a section 216 election by the filing due date set out under section 216 and make the GRE designation in the return. While the Estate is a GRE, the Estate will be taxed at the graduated rates in respect of the net rental income.

Questions 3 and 4

In the taxation year that a non-resident estate disposes of rental property considered “taxable Canadian property”, it must file a separate T3 Return in respect of the disposition as required under section 150. The Estate would have compliance obligations under section 116, which are outside the scope of this question. We refer you to IC72-17R6 Procedures Concerning the Disposition of Taxable Canadian Property by Non-Residents of Canada - Section 116.

Assuming the distribution of the rental property to Y and Z is made out of the residue of the Estate and transferred to Y and Z in accordance with the provisions of the Will in satisfaction of all or any part of their interests in the capital of the Estate, then subsection 107(2) could apply to allow a tax-deferred rollover on the distribution of the rental properties to Y and Z.

Real or immovable property situated in Canada is a property described in subparagraph 128.1(4)(b)(i). Therefore, subsection 107(5) [19] should not apply to deny the tax-deferred rollover of the rental property to Y and Z and the rental property may be distributed under subsection 107(2) provided the requirements of subsection 107(2) are otherwise satisfied.

It is possible for the assets of an estate to be considered to have vested indefeasibly in and be beneficially owned by the beneficiary of the estate once the estate administration is complete (or sooner in the case of a specific bequest) depending on the particular facts. Ultimately, it is a question of mixed fact and law as to whether the Estate or Y and Z would be considered the beneficial owner of the rental property at a particular time for purposes of making the section 216 election.

Provided that the section 216 requirements are satisfied, from the time they acquire beneficial ownership of the property, Y and Z could elect to file under Part I pursuant to section 216 in respect of their share of income derived from the rental property. Y and Z would each be required to file a Part I return pursuant to section 150 when they dispose of their interest in the rental property. In addition, Y and Z would also be required to file a Part I return pursuant to subsection 216(5) and (6), if the conditions requiring filing pursuant to those provisions are met (e.g., recapture of depreciation).

Official Response

26 November 2020 STEP Roundtable Q. 13, 2020-0847201C6 - GRE & section 216 election

Q.14 Adjusted Aggregate Investment Income

Subsection 125(5.2) is an anti-avoidance rule which may apply if a particular corporation transfers “property” at any time, either directly or indirectly to another corporation which is related to but not associated with the particular corporation, in circumstances where one of the reasons the loan or transfer was made was to reduce the “adjusted aggregate investment income” (“AAII”) of the particular corporation.

Would subsection 125(5.2) apply to deem a transferee corporation to be associated with a related transferor corporation when the transferor corporation transferred property which were “active assets”, the income from which did not reduce Variable E of the definition of “adjusted aggregate investment income” in subsection 125(5.1) for the transferee corporation?

CRA Response

Subsection 125(5.2) is an anti-avoidance rule intended to prevent the avoidance of the application of the “passive income reduction” rule in paragraph 125(5.1)(b) through the transfer of property to a related company.

Subsection 125(5.2) operates to deem two corporations associated with each other when they are otherwise not associated. It applies where the corporations are related to each other, one corporation (directly or indirectly) transfers assets to the other corporation and one of the reasons for the transfer can reasonably be considered to be to reduce the amount of the adjusted aggregate investment income of the associated group for the purposes of the passive income reduction rule in paragraph 125(5.1)(b).

Whether subsection 125(5.2) would apply in any given situation remains a question of fact that can only be made once all the relevant facts of a particular situation are known and have been fully considered. Should all the relevant facts and documentation be submitted, the Income Tax Rulings Directorate may be able to provide additional comments applicable to the fact scenario in the context of a technical interpretation or in the context of an advanced income tax ruling request submitted in the manner set out in Information Circular IC 70-6R10, Advance Income Tax Rulings and Technical Interpretations.

Official Response

26 November 2020 STEP Roundtable Q. 14, 2020-0839961C6 - Adjusted Aggregate Investment Income

Q.15 Subsection 164(6) Limitations

The conditions to be eligible to utilize the double tax relieving provisions of subsection 164(6) are very restrictive. For example, there must be a disposition that occurs within the first taxation year of the graduated rate estate. Because of these strict requirements, practitioners have for years been concerned — and experienced the results of such concerns — that many estates may not be eligible for such planning because of the tight timelines and requirements for an actual disposition.

Would the CRA be prepared to recommend and work with the Department of Finance to offer affected taxpayers more relieving conditions to utilize subsection 164(6)? For example, perhaps an expanded 3 year limitation could be introduced along with an elective disposition rather than an actual disposition?

CRA Response

Subsection 164(6) of the Act allows the legal representative that is administering the graduated rate estate (“GRE”) of a deceased taxpayer to elect to have certain capital losses and terminal losses deemed to be losses of the deceased for the taxpayer’s year of death (and not of the GRE). The election, which results in the carry back of the elected amount to the final return of the deceased, can be useful in addressing potential double taxation concerns which may arise on death.

The election must be made in prescribed manner and within a prescribed time, as set out in section 1000 of the Income Tax Regulations (the “Regulations”). However, pursuant to paragraph 600(b) of the Regulations, subsection 164(6) is a prescribed provision for purposes of paragraphs 220(3.2)(a) and (b) of the Act. Accordingly, CRA has the authority to accept a late filed subsection 164(6) election, should it agree to do so. It should be noted that this does not change the requirement that the losses to which this election applies must have been incurred in the first taxation year of the estate.

We note that concerns regarding subsection 164(6) were raised with the Department of Finance (“Finance”) in the October 2, 2017 submission of the Joint Committee on Taxation of the Canadian Bar Association and Chartered Professional Accountants of Canada. The submission raised several reasons in support of its belief that post-mortem planning using the provision may not be practical.

The submission noted the requirement that the election be made within the first taxation year of the estate following death, and suggested that this did not provide sufficient time to decide and implement the necessary steps to realize the capital loss, so that the election can be made, citing reasons such as matters as family grieving, complicated estate administration, or pending or potential litigation.

It also raised a concern that the estate may not be able to require the shares to be fully redeemed within one taxation year, citing as potential reasons the terms of the shares, related shareholder agreements, or cooperation from other shareholders.

The submission suggested that subsection 164(6) be modified to (i) extend the time limit for making the election to the end of the third taxation year of the estate and (ii) allow the election to be made in respect of an “elective disposition” as well as actual dispositions.

In regard to your question posed, we would like to remind you that the CRA is responsible for administering and enforcing the Act and the Regulations as enacted by Parliament. Any proposed changes to tax policy or amendments to legislation, such as that suggested in the Joint Committee submission, are the purview of the Tax Policy Branch at Finance.

Accordingly, CRA is prepared to work with Finance should they seek our views on this issue.

Official Response

26 November 2020 STEP Roundtable Q. 15, 2020-0839951C6 - Subsection 164(6) limitations

Q.16 Offshore Tax Informant Update

While the CRA provided updated statistics on this program in 2019, can the CRA provide any further updated statistics in respect of how effective this program is?

CRA Response

Since the OTIP launch, there has been sustained interest in the program by potential informants. As of December 31, 2019, the OTIP has received nearly 5,500 calls of which of over 1,600 have been from potential informants, received over 750 written submissions and has entered into nearly 50 contracts with informants.

In addition to what was provided previously, over 150 audits of taxpayers have been completed, nearly $60 million has been assessed of which approximately $20 million has been collected and over 300 audits of taxpayers are in progress.

Official Response

26 November 2020 STEP Roundtable Q. 16, 2020-0839921C6 - Offshore Tax Informant Update

Q.17 Trust Pass-Through of Capital Gains Exemption

Assume that a Graduated Rate Estate (Trust 1) holds shares that qualify as qualified small business corporation (QSBC) shares, as defined in subsection 110.6(1). Trust 1 has two beneficiaries - Trust 2 and Trust 3, which are both testamentary trusts and personal trusts. Trust 2 and Trust 3 each have various individuals (other than trusts) as beneficiaries.

Trust 1 sells its QSBC shares and allocates the taxable capital gain realized to each of Trust 2 and Trust 3 in the year. Then, Trust 2 and Trust 3 each allocate their respective taxable capital gains to their respective various individual beneficiaries in the year. Trust 1, Trust 2 and Trust 3 do not dispose of any other properties in the year. Cash payments are made in accordance with the allocations in the year. Designations are also made under subsections 104(21) and 104(21.2). All relevant designations, allocations and payments are made in accordance with the will of the deceased taxpayer. The payments made by Trust 2 and Trust 3 are received by the respective beneficiaries for their own account and benefit. The amounts received are retained by each respective beneficiary.

Under these circumstances, can the individual beneficiaries of Trust 2 and Trust 3 claim the capital gains exemption assuming that all other conditions are met?

CRA Response

When all of the conditions set out in subsection 104(21) are met, this subsection provides that for the purposes of sections 3 and 111, except as they apply for the purposes of section 110.6, an amount in respect of a trust’s net taxable capital gains, as defined in subsection 104(21.3), for a particular taxation year of the trust is deemed to be a taxable capital gain of the recipient beneficiary from the disposition of a capital property, for the taxation year of the beneficiary in which the particular taxation year of the trust ends.

Subsection 104(21) does not apply for the purposes of section 110.6. Accordingly, a designation under subsection 104(21.2) is also required in respect of the trust’s eligible taxable capital gains, in order for the beneficiaries to be able to claim the capital gains deduction under subsection 110.6(2.1).

When a personal trust designates an amount to a beneficiary under subsection 104(21) in respect of its net taxable capital gains for a particular taxation year, paragraph 104(21.2)(a) provides that the trust must also designate an amount in its income tax return for the year, in respect of its eligible taxable capital gains, if any, in respect of the beneficiary equal to the amount calculated under subparagraphs 104(21.2)(b)(i) and (ii).

Subsection 108(1) defines “eligible taxable capital gains” of a trust as the lesser of: (i) its “annual gains limit” for the year, as defined in subsection 110.6(1); and (ii) the amount of its “cumulative gains limit” at the end of the year, as defined in subsection 110.6(1), less the total of all amounts designated under subsection 104(21.2) by the trust in respect of beneficiaries for taxation years before that year.

When an amount is designated under subsection 104(21.2), paragraph 104(21.2)(b) provides that, for the purposes of section 120.4 and for the purposes of sections 3, 74.3 and 111 as they apply for the purposes of section 110.6, the beneficiary is deemed to have disposed of a capital property that is either a qualified farm or fishing property or a QSBC share, as the case may be, as defined in subsection 110.6(1). Paragraph 104(21.2)(b) also provides that the beneficiary is deemed to have a taxable capital gain equal to the amount determined by the formula set out in each of clause 104(21.2)(b)(ii)(A) or (B), as the case may be, for the taxation year of the beneficiary in which the taxation year of the trust ends.

The result is that for the purposes of calculating the “annual gains limit” of the beneficiary, the amount calculated in element A takes into consideration the taxable capital gain designated by the trust under subsection 104(21.2) in respect of the beneficiary, in order to permit the beneficiary (if they are an individual other than a trust) to claim the capital gains deduction under subsection 110.6(2.1).

In the situation described, in order to compute the “annual gains limit” of each of Trust 2 and Trust 3, it is necessary to take into account the amount designated by Trust 1 under subsection 104(21.2) in respect of each of Trust 2 and Trust 3. Paragraph 104(21.2)(b) provides that for the purposes of sections 3, 74.3 and 111 as they apply for the purposes of section 110.6, Trust 2 and Trust 3 shall be deemed to have disposed of capital property that is a QSBC share, and to have a taxable capital gain equal to the amount determined by the formula in clause 104(21.2)(b)(ii)(B).

Consequently, where Trust 1 has made designations under subsections 104(21) and (21.2) in respect of amounts distributed to Trust 2 and Trust 3, Trust 2 and Trust 3 can also make designations under subsections 104(21) and 104(21.2) in respect of the amounts distributed to their respective beneficiaries, provided all of the conditions are met. The designations made under subsection 104(21.2) by Trust 1 in respect of each of Trust 2 and Trust 3 must be taken into consideration in order to determine the eligible taxable capital gains of Trust 2 and Trust 3, respectively. Furthermore, where designations are made by Trust 2 and Trust 3 under subsections 104(21) and (21.2) in respect of amounts distributed to the individual beneficiaries of Trust 2 and Trust 3, the respective individual beneficiaries of each of Trust 2 and Trust 3 will be deemed to have disposed of capital property that is a QSBC share, and to have a taxable capital gain equal to the amount determined by the formula in clause 104(21.2)(b)(ii)(B), to allow them to claim the capital gains deduction under subsection 110.6(2.1) provided all the other conditions are met.

As a result of the above, the position set out in Technical Interpretation 2016-0667361E5 no longer represents the position of the CRA.

Official Response

26 November 2020 STEP Roundtable Q. 17, 2020-0837001C6 - Trust Pass-Through of CGE

1 Several documents are discussed in the response. See also documents 2007-0259841E5 and 2016-0630781E5.

2 See document 2016-0669871C6 - Question 14 from the 2016 CTF Annual Conference Roundtable which provides further discussion in respect of the last two bullets above.

3 Subsection 104(13.4) generally applies to alter ego trusts, joint spousal and common-law partner trusts, spousal and common-law partner trusts, and trusts to which property has been transferred by the beneficiary for the beneficiary’s exclusive benefit in circumstances described in subparagraph 73(1.02Xb)(ii) or subsection 107.4(1).

4 As noted in the question, both returns are to be filed with the Minister within 90 days of the end of the calendar year in which the taxation year ends. For this example, we assume the year in which the returns must be filed is not a leap year. For the taxation year ending December 31, the filing-due date is determined by virtue of paragraph 150(1)(c) and subsection 204(2) of the Income Tax Regulations. The application of paragraph 104(13.4)(c) to these two provisions yields the same filing due date of March 31 for the taxation year ended July 31.

5 See also document 2012-0462941C6

6 Subsection 108(1) defines an “eligible offset” of a taxpayer at any time in respect of all or part of the taxpayer’s capital interest in a trust to be the portion of any debt or obligation that is assumed by the taxpayer and that can reasonably be considered to be applicable to the property distributed at that time in satisfaction of the interest or part of the interest, as the case may be, if the distribution is conditional upon the assumption by the taxpayer of the portion of the debt or obligation.

7 Subsection 107(2) is subject to subsections 107(2.001), (2.002), and (4) to (5).

8 Unless expressly otherwise provided in the Act, paragraph 248(1)(b) defines “cost amount” to a taxpayer of any property at that time which is a capital property (other than depreciable property) of the taxpayer to be its adjusted cost base to the taxpayer at that time. The “cost amount” in subsection 248(1) is distinguishable from the “cost amount” of a beneficiary’s capital interest in a trust, which is defined in subsection 108(1) and is described further below.

9 The adjustment is a bump equal to the “specified percentage” of any excess of the adjusted cost base (ACB) to the beneficiary of the capital interest over the beneficiary’s “cost amount” as defined in subsection 108(1). For the purposes of this discussion, we do not consider a situation in which a “bump” results.

10 Subparagraph 107(2)(c)(i) considers what the result in paragraph 107(2)(b) would be if the specified percentage were 100%. In the Example below, the specified percentage is 100%, accordingly, no other adjustment is necessary to the paragraph 107(2)(b) amount.

11 "The “cost amount” to a taxpayer at any time of a capital interest in a trust (or part of it) is defined in subsection 108(1) as, generally speaking, where any money or other property of the trust has been distributed by the trust to the taxpayer in satisfaction of all or part of the taxpayer’s capital interest as the total of: the money so distributed and all amounts, each of which is the cost amount (generally the ACB) to the trust, immediately before the distribution, of each such property.

The amount in the second bullet, in subparagraph 107(1)(a)(ii), is: the amount, if any, by which the cost amount to the beneficiary immediately before the disposition exceeds the total of all amounts deducted under paragraph 53(2)(g.1) in computing the ACB of the interest to the beneficiary.

12 The analysis for Example 1 would also apply if the trust was factually non-resident.

13 The specified percentage determined in paragraph 107(2)(b.1) is 100%

14 Note that the Act formerly contained a “greater certainty” provision in 107(1)(b) to be used for computing a possible capital loss. This paragraph was repealed in 2001 and the Department of Finance’s March 2001 Technical Notes state “Paragraph 107(1)(b) is repealed because it is unnecessary. Since paragraph 107(1)(a) applies only for the purposes of computing a taxpayer’s capital gain, it is clear without paragraph 107(1)(b) that the ACB calculation in paragraph 107(1)(a) is not relevant for the purposes of computing a taxpayer’s allowable capital loss”.

15 This amount is determined as above, as the total of the “cost amount” of the Shares to the Trust immediately before the distribution ($100,000) and the amount, if any, by which the ACB to the Beneficiary of their capital interest (now $100,000) exceeds the “cost amount” ($100,000) to the beneficiary of the capital interest. The beneficiary is deemed to have acquired the Shares at a cost equal to ($100,000).

16 Determined as follows: the greater of the ACB otherwise determined to the beneficiary immediately before the disposition (now $100,000) and the amount, if any, by which the cost amount to the beneficiary immediately before the disposition ($100,000) exceeds the total of all amounts deducted under paragraph 53(2)(g.1) in computing its ACB to the beneficiary immediately before the disposition (nil). Therefore, the ACB of the beneficiary’s capital interest is $100,000.

17 Ms. X has a Social Insurance Number (or if she had not been assigned a Social Insurance Number before her death, she has available such other information as is acceptable to the Minister, i.e., a Temporary Tax Number (TTN) or an Individual Tax Number (ITN)).

18 The residence of a trust or estate and the beneficiaries of the estate is a question of fact. For the Estate, we refer you to Income Tax Folio S6-F1-C1, Residence of a Trust or Estate. For the beneficiaries, we refer you to Income Tax Folio S5-F1-C1, Determining an Individual’s Residence Status. Consideration should be given to whether any particular estate could be deemed to be resident in Canada pursuant to section 94.

19 Subsection 107(5) provides that subsection 107(2.1) applies (giving rise to a taxable distribution) and subsection 107(2) does not apply “in respect of a distribution of a property (other than a share of the capital stock of a non-resident-owned investment corporation or property described in any of subparagraphs 128.1(4)(b)(i) to (iii)) by a trust to a non-resident taxpayer (including a partnership other than a Canadian partnership)) in satisfaction of all or part of the taxpayer's capital interest in the trust.”

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26 November 2020 STEP Roundtable

Q.1 Application of the Executor’s Year to a Graduated Rate Estate

CRA Response

Background

Response for a) - where the estate is wound up after the executor’s year

Response for b) and c) - where the estate is wound up before or at the end of the executor’s year

Designations under subsection 104(13.1) and (13.2)

Official Response

Q.2 Subsection 104(13.4) and Alter Ego Trusts and Joint Spousal Trusts

CRA Response

Official Response

Q.3 Distribution of Taxable Capital Gain by Trust

CRA Response

Official Response

Q.4 Foreign Tax Credit

CRA Response

Official Response

Q.5 Subsections 40(3.61) and 164(6)

CRA Response

Official Response

Q.6 Impact of an Eligible Offset on a Disposition of a Capital Interest in a Personal Trust

CRA Response

Example 1

Example 2

Official Response

Q.7 TOSI and Rental Income

CRA Response

Official Response

Q.8 TOSI and Donations

CRA Response

Official Response

Q.9 TOSI and Excluded Business

CRA Response

Official Response

Q.10 TOSI and Change in Business

CRA Response

Official Response

Q.11 Taxable Dividends from a Trust

CRA Response

Part IV tax

When an individual beneficiary dies before the trust’s year end

Official Response

Q.12 Distribution of Property by a Canadian Resident Trust to a Canadian Corporation that is Wholly Owned by One or More Non-Residents

CRA Response

Official Response

Q.13 Rental Property Owned by Non-Resident Estate

CRA Response

Questions 1 and 2

Questions 3 and 4

Official Response

Q.14 Adjusted Aggregate Investment Income

CRA Response

Official Response

Q.15 Subsection 164(6) Limitations

CRA Response

Official Response

Q.16 Offshore Tax Informant Update

CRA Response

Official Response

Q.17 Trust Pass-Through of Capital Gains Exemption

CRA Response

Official Response