A recently released letter from the Department of Finance to the Joint Committee on Taxation recommends changes to enacted tax rules that would provide relief from Canadian withholding tax on estate distributions to non-resident beneficiaries of a graduated rate estate.
Budget 2018 included a widened surplus stripping rule applicable to non-residents to ensure the existing rules in section 212.1 of the Income Tax Act could not be frustrated by transactions involving partnerships and Canadian resident trusts, including graduated rate estates. Concerns were expressed regarding the application of the widened look-through rule to a Canadian resident graduated rate estate with one or more non-resident beneficiaries. Specifically, there was a concern that this look-through rule will reduce the ability of such an estate to implement post-mortem tax planning transactions that are commonly undertaken.
Certain post-mortem tax planning is generally implemented by a graduated rate estate selling the shares of a Canadian resident corporation (Canco) held at death to a new Canadian corporation (NewCanco) in exchange for a promissory note equal to the graduated rate estate’s adjusted cost base (ACB) in the Canco shares (which ACB is generally equal to the fair market value of the Canco shares at the deceased’s date of death). Under this post-mortem tax planning, tax is generally payable in respect of the deemed disposition of the Canco shares on the deceased’s death, and not payable in respect of the corporate surplus that is eventually extracted by the graduated rate estate through the repayment of the promissory note.
Where the conditions of section 212.1 are satisfied, each non-resident beneficiary is deemed to have received a dividend from the NewCanco to the extent that the non-resident beneficiary’s proportionate share of the promissory note from the NewCanco exceeds the PUC of the non-resident beneficiary’s proportionate interest in the Canco shares transferred to the NewCanco. As a result, tax is payable in respect of this deemed dividend to the non-resident beneficiary
The Department of Finance has agreed that the widened application of section 212.1 can give rise to results in the context of graduated rate estates that are not consistent with current tax policy and have indicated in their letter they are prepared to recommend to the Minister of Finance that section 212.1 be amended to exclude dispositions after February 26, 2018 of shares by a Canadian resident graduated rate estate of an individual who was resident in Canada immediately before the individual’s death, provided that those shares were acquired by the estate on and as a consequence of the individual’s death.
This change should be welcome news to non-resident beneficiaries of a graduated rate estate that would otherwise bear a Canadian tax cost that may not be recoverable as a foreign tax credit in their home jurisdiction..