All About Estates

Estate planning and TOSI – Part II

In my previous blog, Estate planning and TOSI Part I, I introduced the concept of the tax on split income (TOSI) continuity rules which are extremely important when estate planning.  The objective of the continuity rules is to afford the beneficiary, who would not have an excluded amount of their own, with an excluded amount exception TOSI.

The continuity rules accommodate many estate situations, but the rules do not accommodate all possible scenarios.  Here are three specific scenarios where the continuity rules just don’t cut it.

1. Sub-paragraph 120.4(1.1)(b)(ii) – 5 year window

The continuity rule under subparagraph 120.4(1.1)(b)(ii) allows the beneficiary to step into the shoes of the deceased and inherit the excluded business excluded amount, but be careful with this continuity rule as it only applies to paragraph (b) of the definition excluded business in subsection 120.4(1) of the Income Tax Act (ITA).  As a result, the beneficiary only inherits the excluded business excluded amount if the deceased was actively engaged on a regular, continuous, and substantial basis in the activities of the business for any five prior taxation years. Therefore, if the deceased was actively engaged in the business for only four years, then the beneficiary would not inherit the excluded business excluded amount and would need to rely on a different excluded amount to avoid TOSI.

2. As a consequence of death

Two of the three continuity rules discussed in my last blog require that the property was acquired by or for the benefit of the individual as a consequence of the death.  This criteria is not a problem if the inherited property was held directly by the deceased individual, but what happens if the property was indirectly held by a trust. Unless the trust’s indenture provides for an unconditional distribution of the property as a consequence of death of an individual then any voluntary distribution of the property would not be considered as a consequence of death[1]. If the property is not considered received as a consequence of death then two of the three continuity rules do not apply.

3. Post-mortem tax planning

A potential issue that can arise in an estate plan with a privately held company is the possibility of double taxation. This can happen when there is a taxable capital gain on the deemed disposition of the private company’s shares under subsection 70(5) followed by an extraction of the corporate value via a taxable dividend to the beneficiaries. The same corporate value was effectively taxed both as a capital gain and as a taxable dividend.  There are two specific strategies to avoid this double taxation:

  1. 164(6) loss carry-back strategy, and
  2. Pipeline strategy.

The main concern when carrying out either of the two post-mortem tax planning strategies is the elimination of shares that have been received as a consequence of death.  Two of the three continuity rules require that the property was received as a consequence of death, and CRA has concluded that only dividends declared on the shares received as a consequence of death would be afforded the continuity rule protection[2]. Therefore, if 100 per cent of the shares that were received as a consequence of death were either redeemed or exchanged for new shares, then the continuity rule being relied upon may no longer be effective.

When estate planning it is not sufficient enough to assume that the continuity rules will apply. As they say, devil is in the details and not all details were contemplated by Department of Finance when drafting the continuity rules.

[1] CRA document no. 2019-0824401C6, December 3, 2019

[2] CRA document no. 2019-0824401C6, December 3, 2019

About John Oakey
National Tax Director for Baker Tilly Canada. John has extensive experience with Canadian corporate and personal income taxes with specialization in the areas of corporate reorganizations, estate planning, succession planning and tax compliance. He also has significant experience dealing with GST/HST issues and U.S. citizen cross-border tax reporting issues.

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