Recently the Canada Revenue Agency (the “CRA”) issued a technical interpretation on the application of the income attribution rules under the Income Tax Act (“ITA”) which serves as a good primer particularly when a personal representative is looking at the deceased’s prior year returns with joint accounts and the potential for additional taxes.
Mrs. Entrepreneur owned and sold shares of a Canadian-controlled private corporation that were “qualified small business corporation shares,” as defined in the ITA. The capital gain arising on the disposition of shares qualified for the capital gains exemption. The proceeds from the sale of the shares were placed in a non-registered joint investment account with Mrs. Entrepreneur’s spouse for the purpose of acquiring and holding financial instruments such as bonds and mutual funds.
Mrs. Entrepreneur asked the CRA to confirm that the capital gains and other income earned in the joint account and reported by the spouse would be attributed back to Mrs. Entrepreneur unless a prescribed loan is made from Mrs. Entrepreneur to her spouse.
The CRA confirmed that, except where fair market value consideration is paid by the spouse or the parties are living separate and apart by reason of a breakdown of their marriage, income earned and capital gains and losses realized on property transferred or loaned from an individual to the individual’s spouse (and on property substituted for that property) are generally deemed to be the income, gains or losses of the taxpayer and not of the individual’s spouse.
There are provisions in the Act to allow for the transfer of assets between spouses at cost; however the attribution rules in the ITA still apply. Any income realized from the assets after the transfer to the spouse, will be deemed to be the transferor’s income, and any capital gains or losses realized on the subsequent disposition of the property will be deemed to be the transferor’s capital gains or losses.
In circumstances where one spouse purchases property using funds which are provided solely from the assets or earnings of the other spouse (the “Contributing Spouse”), the Contributing Spouse is considered to have transferred property to the other spouse. However, the CRA believes the attribution rules would apply to property transferred by the Contributing Spouse to the other spouse.
Generally, if a Contributing Spouse loaned funds to his or her spouse and charged interest on the loan at a rate equal to or greater than the lesser of the prescribed rate that was in effect at the time the loan was made, and the rate, that would, having regard to all the circumstances, have been agreed on, at the time the loan was made, between parties dealing with each other at arm’s length, the attribution rules would not apply.
The CRA also confirmed that the anti-avoidance rules contained in the ITA may have application where it can be shown that the primary purpose, or one of the main purposes, of the transactions was to reduce the tax liability of the taxpayer or the spouse.