When an individual taxpayer transfers or loans directly or indirectly property to a corporation, certain provisions of the Income tax Act (“the Act’) may deem the transferor to have received annual interest income on the property at the prescribed rate as set out in the Regulations of the Act. The deemed income will fluctuate with the prescribed rate and the rate is not locked in at the time of transfer. These are commonly referred to as corporate attribution rules.
This “deemed income” benefit applies if one of the main purposes of the transfer or loan of property was to reduce the transferor’s income and to benefit a spouse or child under the age 18 (referred to as designated persons in the Act).
These corporate attributions rules do not apply while the corporation is a small business corporation (“SBC”) as defined by the Act. A future loss of SBC status may result in deemed income until and/or the SBC status is re-established.
In addition, the rules do not apply where the only interest that the designated person has in the corporation is an interest held through a trust in which the designated person may not receive, or otherwise obtain the use of any income or capital of the trust while a designated person.
In an estate freeze, when an individual freezes the value of a company into fixed value preferred shares and allows a designated person to acquire common shares, the exchange of common shares for preferred shares by the initial shareholder is considered a transfer of property. This can trigger corporate attribution if one of the exclusions do not apply.
However, if the company issued a stock dividend of preference shares with a total redemption value equivalent to the fair market value of the company to the existing holders of common shares and then a designated person subscribed to common shares, the CRA has confirmed that the corporate attribution rules do not apply as the recipient of the stock dividends has not technically transferred property to the corporation.
Nevertheless, the CRA would not comment on the applicability of the General Anti-Avoidance Rule in such a scenario.
Bottom line to this, be mindful of the corporate attribution rules when contemplating an estate freeze. Consult with your pros.
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