Earlier this week I had the pleasure of attending STEP Canada’s 19th National Conference, where I, along with over 700 other trust and estates professionals from across Canada, had the opportunity to hear from engaging and thought-provoking speakers on a diverse range of trust and estates topics.

One of the plenary sessions every year at the Conference, which attendees particularly anticipate, is the STEP Canada/CRA Round Table, where senior representatives from the CRA answer questions prepared by trust and estate practitioners about cases and issues of concern to practitioners and their clients. The 2017 STEP Canada Round Table addressed two questions which were of particular interest to me and my practice.  GAAR and a capital distribution to a Canco beneficiary:

GAAR and a capital distribution to a Canco beneficiary:

As a number of Canadian resident discretionary family trusts approach their 21st anniversary, trustees are considering planning alternatives to avoid the 21-year deemed disposition pursuant to subsection 104(4) of the Income Tax Act (Canada) (the “Act”). 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 pursuant to subsection 107(2) of the Act. [1]   However, a distribution to a beneficiary in advance of the 21st anniversary of the trust may not always be the desired course of action.  Where the tax-deferred distribution is instead made to a beneficiary that is another Canadian resident discretionary trust, subsection 104(5.8) of the Act would apply to prevent a deferral of the 21-year deemed disposition date.  The trustees of the recipient trust would then be faced with the transferor trust’s approaching 21-year deemed disposition.

At the 2017 STEP Canada Round Table, the CRA explained that where a Canadian resident discretionary trust (“Old Trust”) that is approaching its 21st anniversary distributes property with an unrealized gain to a Canadian resident corporate beneficiary (“Canco”), which is a beneficiary of Old Trust, that is wholly owned by a newly established discretionary trust resident in Canada (“New Trust”) on a tax-deferred basis pursuant to subsection 107(2) of the Act, the general anti-avoidance rule (“GAAR”) in subsection 245(2) may apply. The CRA views such a planning strategy as circumventing the specific anti-avoidance rule in subsection 104(5.8) of the Act in a manner that frustrates the object, spirit and purpose of the Act. The CRA is particularly concerned that this type of transaction may be repeated where the terms of New Trust are similar to those of Old Trust, thereby deferring the realization of the capital gains inherent in the property for several generations or indefinitely. This contravenes one of the underlying principles in the taxation of capital gains regime, which is to prevent the indefinite deferral of tax on capital gains. Even if under the structure the realization of the accrued gains on the trust property would not be deferred beyond the lifetime of those who were beneficiaries at the time of the 21st anniversary of Old Trust, the CRA has confirmed this more limited type of deferral would also represent an abuse of subsection 104(5.8) of the Act. Unless substantial evidence supporting the non-application of GAAR is provided, the CRA will not provide any Advance Income Tax Ruling where such a planning structure is proposed to be put in place.

Spousal rollover and substituted property:

As a consequence of the death of a taxpayer, and where certain conditions are met, subsection 70(6) of the Act allows property held by the deceased immediately before death to be transferred to a trust described in paragraph 70(6)(b) on a tax-deferred “rollover” basis. This provision requires, inter alia, that the property has vested indefeasibly with the spousal trust within 36 months of the taxpayer’s death.

Where the will of a deceased taxpayer provides that certain assets are to be transferred to a spousal trust, the executor must ensure that there has been no change in the property prior to it being transferred and vesting indefeasibly in the spousal trust. There is no reference in the provision to allow for substituted property to take advantage of the “rollover”.  Accordingly, if shares of the deceased taxpayer are converted from one class to another prior to vesting indefeasibly in the spousal trust, subsection 70(5), rather than subsection 70(6), would apply and therefore no “rollover” in respect of such property would be available.  The determination of whether property is eligible for the “rollover” is on a property-by-property basis

These questions raise important points to be aware of both at the planning stage and after death.

To learn more about the Conference and STEP Canada, please visit www.step.ca.

[1]  I previously blogged about the 21-year deemed disposition rule, which can be found at: https://www.allaboutestates.ca/the-21-year-deemed-disposition-rule/.