All About Estates

GAAR and 21-year rule planning

The Canada Revenue Agency (CRA) was asked to comment on the implications of a transfer of property from a discretionary trust (Old Trust) to a Canadian corporation wholly owned by a new discretionary trust (New Trust).

The 21-year deemed disposition rule provides that every 21 years in a family trust’s life, the CRA looks at the property in a trust as if it were the property of someone who had just died.  When the 21 years are up, if the trust holds property on that date, it is deemed to have sold the property at its current worth and has to pay taxes on the gain, if any.  A common method of avoiding the 21-year deemed disposition involves the distribution of property with an unrealized gain to a Canadian resident beneficiary on a tax-deferred basis.  Where the beneficiary is a natural person, the realization of any capital gains inherent in the property distributed will be deferred and (absent a spousal rollover) realized at the earlier of the date that the individual actually disposes of the property, or the date that the individual dies.   Where the tax-deferred distribution is instead made to a beneficiary that is another Canadian resident discretionary trust, a specific anti-avoidance rule would apply to prevent a deferral of the 21-year deemed disposition date and really not accomplishing anything.

The hypothetical situation considered was where a Canadian resident discretionary trust (Old Trust) that is approaching its 21st anniversary distributes property with an unrealized gain on a tax-deferred basis to a Canadian resident corporate beneficiary, a beneficiary of Old Trust, that is wholly owned by a newly established discretionary trust resident in Canada (New Trust).

In their view, such planning would be considered by the CRA as circumventing the anti- avoidance rule in a manner that frustrates the object, spirit and purpose of that provision, the deemed disposition rule and the scheme of the Act as a whole as it relates to the taxation of capital gains – in other words the planner would step right into the general anti-avoidance rule (GAAR) unless substantial evidence supporting its non-application is provided.

Trustees and executors are encouraged to tread carefully as they approach the 21-year anniversary of a trust.

About Derek de Gannes
Derek A. de Gannes: Director, Domestic & International Tax of RSM Canada. RSM Canada is committed to the highest level of integrity, quality and professionalism and provides clients with solutions in the area of Audit, Tax and Transaction Services. Email: derek.degannes@rsmcanada.com

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