In a recent letter, the CRA was asked whether a testamentary spousal trust could qualify as the graduated rate estate where the spousal trust is comprised of the deceased’s entire estate.
As discussed in previous blog posts, qualification as a graduated rate estate brings with it several advantages. Although the application of graduated tax rates to testamentary trusts will cease in the new year (resulting in such trusts being taxed at the highest marginal rate applicable to individuals), exceptions exist for graduated rate estates and qualified disability trusts. These trusts will continue to be taxed at graduated rates. Qualification as a graduated rate estate also has important implications for testamentary charitable giving, as discussed in earlier blog posts.
The definition of “graduated rate estate” is found in proposed amendments to s. 248(1) of the Income Tax Act. A graduated rate estate is defined there as “… the estate that arose on and as a consequence of the individual’s death…” provided that conditions set out in subsection 248(1) are met.
In response to the author’s query, the CRA confirmed that a testamentary spousal trust cannot qualify as a graduated rate estate. As indicated by the excerpt of the definition of graduated rate estate above, a graduated rate estate must be an estate. Therefore, a testamentary trust created by the Will of the deceased taxpayer cannot qualify as a graduated rate estate, irrespective of whether part or all of the property of the deceased is transferred to it.
Because of the advantages associated with graduated rate estates, clients and their advisors may wish to consider drafting in order to delay the transfer of assets to trusts created under the Will. The CRA’s recent technical interpretation suggests that care must be taken to ensure that the Will provisions authorizing and governing this waiting period do not inadvertently create a testamentary trust, thereby losing graduated rate estate status. In some cases, it may be difficult to distinguish between a deceased taxpayer’s estate and a testamentary trust of all of the deceased taxpayer’s property.