SUBJECT: INCOME TAX ACT Property Transfers After Separation, Divorce and Annulment

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1 IT INTERPRETATION BULLETIN SUBJECT: INCOME TAX ACT Property Transfers After Separation, Divorce and Annulment NO.: IT-325R2 DATE: January 7, 1994 REFERENCE: Subsection 73(1) (also sections 13, 20, 74.1 and 74.2, subsections 70(5) and (6), 73(1.1) and (2), 75(2), 104(4), 248(22) and (23) and 252(3) and (4), paragraphs 40(2)(g), 54(b), 54(i), 56(1)(b), (c) and (c.1), 60(b), (c) and (c.1) and section 6500 of the Regulations) Application This bulletin replaces and cancels Interpretation Bulletin IT-325R dated December 28, Summary This bulletin discusses transfers of property under subsection 73(1), which provides for a tax-deferred rollover when capital property is transferred to a spouse, to a former spouse in settlement of rights arising out of marriage, to a spousal trust or, in more limited circumstances, to a former common-law spouse. It also comments on the extended meaning of "spouse" that extends this rollover to certain common-law spouses for 1993 and later years. The bulletin explains the availability and the mechanics of the rollover, as well as the option of electing not to have this rollover apply. It also discusses certain rules relating to partitions of property in which both spouses have an interest under a matrimonial property regime in the Province of Quebec. Discussion and Interpretation Subsection 73(1) Rollover 1. Subsection 73(1) allows capital property to be transferred between living persons on a tax-deferred rollover basis to: (a) the spouse of a taxpayer (see 7 below); (b) the former spouse of a taxpayer, in settlement of rights arising out of their marriage; (c) a spousal trust (see 8 below); or PAGE 2 (d) in certain cases, to a former "common-law" spouse (see 11 and 12 below). Unless the taxpayer (the transferor) elects not to have the rollover apply (see 5 below), the realization of accrued gains and losses, including any terminal losses or the recapture of capital cost allowance, is postponed until the recipient (the spouse, former spouse or trust) disposes or is deemed to dispose of the property. The values or amounts that apply to subsection 73(1) rollovers are discussed in 3

2 and 4 below. Some examples of how subsection 73(1) operates are contained in the current version of IT-209, Inter-Vivos Gifts of Capital Property to Individuals Directly or Through Trusts. 2. The property transferred must be a capital property as defined by paragraph 54(b), meaning: (a) any depreciable property of the transferor, and (b) any other property that when disposed of would result in a capital gain or capital loss to the transferor. For subsection 73(1) to apply, both the transferor and the recipient must be resident in Canada at the time of the transfer. This rollover applies to transfers to a spouse or a spousal trust at any time after Transfers to a former spouse in settlement of rights arising out of marriage, as well as certain transfers to a former common-law spouse (as discussed in 8 and 9 below), are only eligible if the transfer takes place after Depreciable Property 3. Paragraph 73(1)(e) provides that, in the case of depreciable property, the transferor is deemed to have received proceeds equal to the undepreciated capital cost of the property. The recipient is deemed to have acquired the property for the same amount. If the transferor has more than one property in a prescribed class of depreciable property, but is transferring only part of the property in that class, the undepreciated capital cost of that property is transferred in proportion to its fair market value as determined immediately before the time of transfer, as follows: Fair Market Value of the Transferred Property x Undepreciated Capital Cost of that Class Fair Market Value of All the Property of that Class Subsection 73(2) applies to transfers of depreciable property where the transferor s capital cost is more than the recipient s cost determined under paragraph 73(1)(e). In such cases, for the purposes of sections 13 and 20 and any regulations made under paragraph 20(1)(a), subsection 73(2) deems the capital cost to the recipient of the depreciable property to be the same amount that was the capital cost of the property to the transferor. Any capital cost allowance already claimed for that property by the transferor is deemed to have been allowed to the recipient in years prior to the transfer. Non-depreciable Property 4. Paragraph 73(1)(f) provides that where non-depreciable property, such as land or personal-use property, is transferred, the transferor is deemed to have received proceeds equal to the adjusted cost base of the particular property. The recipient is deemed to have acquired the property for the same amount.

3 Election Not to Have Subsection 73(1) Rollover Apply 5. If the conditions in subsection 73(1) are met, the rollover applies automatically. However, for transfers of property after 1979, the transferor may elect, on a property by property basis, not to have the rollover apply to the property transferred. In such a case, the general rules in section 69 apply to any non-arm s length transfers or gifts and the transferor is generally considered to have disposed of the property for proceeds equal to the fair market value of the property at the time of transfer. As a result, the transferor will realize any capital gain or recapture of capital cost allowance or sustain any capital loss or terminal loss at the time of the transfer. The recipient of the property will be considered to have acquired the property for an amount equal to the transferor s proceeds of disposition. 6. There is no official form for the election not to have the subsection 73(1) rollover apply. This election is normally made by the transferor simply reporting the full tax consequences of the disposition on his or her Income Tax Return for the year of the transfer. This election may result in the transferor realizing a capital gain against which any existing capital losses or unused capital gains deduction may be applied. (However, if the transferor and the recipient remain spouses, a capital loss realized on such a disposition of property may be disallowed as a "superficial loss" pursuant to paragraph 54(i) and subparagraph 40(2)(g)(i).) Meaning of Spouse or Former Spouse 7. For transfers of property before 1993, the term "spouse" in this bulletin refers to persons who are legally married to each other. However, after 1992, the term "spouse" has an extended meaning for all purposes of the Act including property transfers under subsection 73(1). Under subsection 252(4), two individuals of the opposite sex will be considered to be spouses of each other when they are cohabiting in a conjugal relationship and either (a) they have so cohabited throughout the preceding 12 months, or (b) they are the natural or adoptive parents of the same child. Generally, in cases of the annulment of either void or voidable marriages, provisions in the Act relating to spouses will apply to the parties of annulled marriages between the time of the supposed marriage and the declaration of annulment. Subsection 252(3) provides that, for purposes of subsection 73(1), "spouse" and "former spouse" includes a party to a void or voidable marriage, as the case may be, with the result that a former spouse includes both a divorced person and a party to a marriage which has been annulled. Transfers to a Former Common-Law Spouse 8. Certain transfers of capital property made after July 13, 1990 and before 1993 to a former common-law spouse are subject to the subsection 73(1) rollover. To qualify, the transfer must be:

4 (a) made to an individual of the opposite sex with whom the taxpayer cohabited in a conjugal relationship before the date of the order; and (b) made pursuant to an order for support or maintenance of the individual, where that order is made by a competent tribunal in accordance with the applicable provincial laws. As indicated in 7 above, the definition of "spouse" after 1992 includes many "common-law" relationships. 9. Transfers of capital property made by a taxpayer before July 14, 1990 pursuant to a decree, order or judgment of a competent tribunal in accordance with prescribed provisions of the law of a province, and made to an individual who was the taxpayer s partner in a common-law relationship, are treated in the same way as transfers to a former spouse, if the individual: (a) had entered into a written agreement with the taxpayer in accordance with such provisions, or (b) had been a partner with the taxpayer in a common-law relationship of some permanence as described in prescribed provisions of the law of a province. The relevant provisions of the provincial laws are prescribed by subsection 6500(1) of the Regulations. Although only provisions of the Ontario Family Law Reform Act, 1978, dealing with transfers of property to satisfy support obligations are actually prescribed, this is considered to include similar provisions under the Ontario Family Law Act. Transfer to a Spousal Trust 10. Paragraph 73(1)(c) allows rollover treatment when capital property is transferred to what is known as a spousal trust. This is a trust created by the taxpayer (the transferor) under which: (a) the taxpayer s spouse is entitled to receive all of the income of the trust that arises before his or her death; and (b) no person except the spouse may, before the spouse s death, receive or otherwise obtain the use of any of the income or capital of the trust. 11. A spousal trust continues to be a spousal trust even after a divorce or an annulment. Subsection 104(4) will apply so that the spousal trust is normally deemed to dispose of its capital property, other than depreciable property, at fair market value on the death of the spouse. (Special rules apply to pre-1972 spousal trusts.) Trust Created to Make Alimony or Maintenance Payments 12. When a taxpayer creates a trust to make alimony or maintenance payments to a spouse or former spouse and subsection 75(2) applies to the trust, the trustee is considered to be acting as an agent for the taxpayer. The income and taxable capital gains of the trust

5 are deemed to be the income and taxable capital gains of the taxpayer and are taxable in the taxpayer s hands. However, the taxpayer is allowed a deduction under paragraph 60(b), (c) or (c.1) if the payments otherwise qualify and the amount is taxable to the spouse under paragraph 56(1)(b), (c) or (c.1). Meaning of Transfer 13. The term "transfer" has a broad meaning that encompasses virtually any means by which ownership or title to property is conveyed from one person to another, or to a trust. It therefore includes a sale of property, whether or not it was made at fair market value. However, it does not include a genuine loan. 14. In addition, some provinces have enacted legislation declaring that a spouse has a specified interest in certain property owned by the other spouse or providing for such a determination by a court. Property that passes under these provisions may not constitute a "transfer" under the general legal meaning. For greater certainty, subsection 73(1.1) deems a transfer to have occurred in many of these cases. Subsection 73(1.1) applies if, by the operation of the provisions of a provincial law prescribed by subsection 6500(2) of the Regulations, or by virtue of a decree, order or judgment of a competent tribunal made in accordance with such provisions, a recipient referred to in 1 above (a) acquires or is deemed to have acquired, (b) is deemed or declared to have or is awarded, or (c) has vested in him or her, property that was a capital property of the transferor (or would have been but for such provisions). In these cases, that property is, for the purposes of subsection 73(1), deemed to be a capital property that has been transferred to the recipient. (The references to provincial laws in subsection 6500(2) of the Regulations are considered to include similar provisions under the current family laws of those provinces.) Note: If a measure contained in the draft Amendments to the Income Tax Act and Regulations issued by the Minister of Finance on August 30, 1993, is enacted as proposed, subsection 73(1.1) will not be limited to transfers made pursuant to provincial laws that are prescribed by Regulation. As amended, subsection 73(1.1) will apply to a transfer of the type described in 14 above that is made after July 13, 1990, provided the transfer is made under the laws of a province or because of a decree, order or judgment of a competent tribunal made in accordance with such provincial laws. Transfer to Satisfy Obligation for Equalization Payment 15. In some cases, an obligation to make an "equalization payment" arising under the Ontario Family Law Act, or a similar provision under the law of another province, may be satisfied or settled by a transfer of a capital property between the spouses or former spouses. Such a transfer would be considered to be in settlement of rights arising out of the marriage for the purposes of

6 paragraph 73(1)(b), and is eligible for the rollover provided it otherwise qualifies. Attribution Rules 16. Even if a subsection 73(1) rollover applies to a transfer, capital property transferred between spouses may still be subject to the rules in sections 74.1 and 74.2 concerning the attribution of income and capital gains to the transferor. The attribution rules are discussed in greater detail in the current version of IT-511, Interspousal and Certain Other Transfers and Loans of Property Made After May 22, 1985, and the following points are noteworthy: (a) The attribution rules cease to apply after divorce. (b) The rules concerning the attribution of income do not apply for the period that the parties are living separate and apart by reason of a marriage breakdown. (c) The rules concerning the attribution of capital gains and losses do not apply to dispositions of property while the parties are living separate and apart by reason of a marriage breakdown, if the parties jointly elect not to have section 74.2 apply. (d) The attribution rules do not apply if fair market consideration is paid for the property transferred and an election is made to not have the subsection 73(1) rollover apply. Property Subject to an Interest of a Spouse Under a Matrimonial Regime in the Province of Quebec 17. Subsections 248(22) and (23) set out rules that apply after July 13, 1990 to govern property in which both spouses have an interest under a matrimonial regime and which therefore could be subject to partition on dissolution of that matrimonial regime. These rules only apply to matrimonial property regimes created under the civil law in Quebec (or in another civil law jurisdiction) that involve some common interest between the spouses, such as a community of property. These rules clarify the tax treatment of the income and capital gains attributable to the property during the matrimonial regime and upon its dissolution. 18. Property that has been continuously owned by one spouse since before the property became subject to the matrimonial regime is deemed by paragraph 248(22)(a) to be owned exclusively by that spouse, even though the other spouse has an interest in the property. Accordingly, all income and capital gains from that property while it is subject to the matrimonial regime are attributable to the owner spouse. 19. Property not meeting the conditions in 18 above is deemed by paragraph 248(22)(b) to be owned exclusively by the spouse who has the administration of it, with the same tax consequences as outlined in 18 above. This rule would apply to common property that is subject to the particular matrimonial regime from the moment it is acquired. It would also apply to property that was disposed of or gifted by one spouse in favour of the other during the existence

7 of the matrimonial regime. 20. Subsection 248(23) deems a transfer to have occurred as a result of certain property allocations on the dissolution of the matrimonial regime. A matrimonial regime may be dissolved (a) by the death of a spouse, (b) upon separation or divorce, or (c) by a change from one type of matrimonial regime to another, e.g., from a community of property regime to a partnership of acquests or, if the parties move from Quebec, to a system in place in another jurisdiction. 21. Upon dissolution of the matrimonial regime, the property in which the spouses have a common interest may be allocated between the spouses (or between a spouse and the estate of a deceased spouse, as the case may be). This allocation is referred to as a partition in civil law and operates as a judicial division of property. Subsection 248(23) provides that the allocated property is deemed to have been transferred from one spouse to the other if, immediately after a dissolution of a matrimonial regime, the spouse to whom a property is allocated is not the same spouse (or that spouse s estate) who was the deemed owner of the property immediately before the dissolution. (As discussed in 18 and 19 above, subsection 248(22) sets out the rules to determine who was the deemed owner before the dissolution.) This deemed transfer takes place immediately before the dissolution of the matrimonial regime. Accordingly, the realization of accrued gains may be postponed by virtue of the subsection 73(1) rollover. Where the conjugal relationship continues and the dissolution of the matrimonial property regime arises as a result of a simple change from one form of matrimonial regime to another (e.g. from community of property to separation of property), the attribution rules discussed in 16 above will also apply to such a transfer. 22. In the case of a dissolution of a matrimonial regime following the death of one spouse, a deemed transfer under subsection 248(23) resulting from an allocation of property to a spouse would occur immediately before the deemed disposition on death set out in subsections 70(5) and (6). As a result, any property so allocated to the deceased spouse or to that spouse s estate, would also be subject to the deemed disposition on death rules in the hands of the deceased spouse. Similarly, property deemed to be owned by the deceased spouse and that was allocated upon the dissolution of the matrimonial regime to the surviving spouse will be deemed to have been transferred to the surviving spouse immediately before the deemed disposition on the death of the deceased spouse. As a result, the deemed disposition on death set out in subsections 70(5) and 70(6) will not apply at this time to this property in the hands of the surviving spouse. Note: The preceding comments may be affected by the draft Amendments to the Income Tax Act and Regulations issued by the Minister of Finance on August 30, If enacted as proposed, the draft legislation amends subsection 248(23) and adds subsection 248(23.1). Consequently, in

8 cases of dissolution or death occurring after December 21, 1992, property transferred between spouses as a result of the dissolution of a matrimonial regime occurring as a consequence of the death of a spouse will not be governed by subsection 248(23) as explained in 22 above, but rather by new subsection 248(23.1), as explained in 23 below. Transfers After Death 23. Subsection 248(23.1) will apply to certain transfers of property occurring after the death of a taxpayer who dies after December 21, 1992, if the transfer is made as a consequence of the laws of a province relating to spouses interests in property that result from marriage. This subsection applies not just to transfers resulting from rights under matrimonial regimes under the civil law of Quebec, but also to transfers made as a consequence of the laws of other provinces that provide for the sharing of property used by spouses during marriage. Where these conditions are met, subsection 248(23.1) applies as described below to the following two situations. (a) If property is transferred to the person who was the taxpayer s spouse at the time of the taxpayer s death, that property shall be deemed to have been disposed of as a consequence of the taxpayer s death. As a result, such transfers may benefit from the tax-deferred rollover of property between spouses on death, which is provided for in subsection 70(6). (b) If property is transferred from the person who was the taxpayer s spouse at the time of the taxpayer s death and the transfer is made to that deceased taxpayer s estate, that property shall be deemed to have been transferred immediately before the time that is immediately before the death of the taxpayer. As a result, such transfers may benefit from the tax-deferred rollover between living spouses, which is provided for in subsection 73(1). If you have any comments regarding the matters discussed in this bulletin, please send them to: Director, Technical Publications Division Legislative and Intergovernmental Affairs Branch Revenue Canada - Customs, Excise and Taxation 875 Heron Road Ottawa, Ontario K1A 0L8 Explanation of Changes for Interpretation Bulletin IT-325R Property Transfers After Separation, Divorce or Annulment Introduction The purpose of the Explanation of Changes is to give the reasons for the revisions to an interpretation bulletin. It outlines revisions that we have made as a result of changes to the law, as well as changes reflecting new or revised departmental interpretations.

9 Overview This bulletin updates existing IT-325R, which deals with property transfers on separation and divorce, primarily in relation to the rollover available under subsection 73(1) of the Act. The current revision was undertaken to incorporate a number of changes to sections 73 and 248 enacted in S.C. 1991, c.49 (formerly Bill C-18) and to discuss the extended meaning of "spouse" that was introduced in S.C. 1993, c.24 (formerly Bill C-92). The bulletin is affected by measures contained in the draft Amendments to the Income Tax Act and Regulations issued by the Minister of Finance on August 30, 1993 and are reflected in the notes at the end of Ps 14 and 22. Legislative and Other Changes New Ps 1 and 2 provide a general overview of the rollover under subsection 73(1). They outline the types of property that qualify and indicate the eligible recipients for such a rollover. New Ps 3 and 4 explain the deemed proceeds and cost bases that result under subsection 73(1) for both depreciable and non-depreciable property. New Ps 5 and 6 discuss the election which is available so that the rollover under subsection 73(1) will not automatically apply. In addition they discuss why a taxpayer might use it and how the election is made. New P 7 updates and clarifies the comments in former P 8 concerning the meaning of "spouse" or "former spouse". It also discusses the introduction of subsection 252(4) in Bill C-92, which extends, after 1992, the definition of "spouse" to include certain "common-law spouses." New P 8 explains the amendment to paragraph 73(1)(d) in Bill C-18 concerning court-ordered transfers to former common-law spouses. For transfers after July 13, 1990, this general provision replaces the requirement that such transfers be made under prescribed provincial laws to prescribed persons, as is explained in new P 9. New P 13 discusses the meaning of "transfer", while new P 14 explains the deemed transfers provided (for greater certainty) by subsection 73(1.1) to deal with judicial vesting orders that might not otherwise satisfy the legal conception of a "transfer." A note has been added at the end of new P 14 to explain the effect of a proposed amendment to subsection 73(1.1) in the draft amendments issued on August 30, This amendment will eliminate the need for qualifying "transfers" to be made under provincial laws that have been prescribed by Regulation.

10 New P 15 explains that capital property transferred to satisfy an obligation to make an equalization payment under the Family Law Act of Ontario can qualify for the rollover under subsection 73(1). New P 16 has been added to give an indication of the possible impact of the attribution rules and refers the reader to the main bulletin on that subject. New Ps 17 to 22 discuss the rules in new subsections 248(22) and (23) which were added by Bill C-18. These provisions deal with property subject to petition on the dissolution of a matrimonial property regime under the civil law of Quebec. These rules clarify the tax treatment of the income and capital gains attributable to the property during the matrimonial regime and upon its dissolution. They are also intended to harmonize the tax treatment at the provincial and federal levels. A note and a new P 23 has been added at the end of the bulletin to explain the effect of new subsection 248(23.1) and the change to subsection 248(23), as proposed in the draft amendments issued on August 30, These set out new rules for certain transfers of property after death made as a consequence of provincial laws relating to the sharing of property as a result of marriage. In addition, we have changed some of the wording and the order of some sentences and paragraphs to clarify the bulletin and improve its cohesiveness without changing the substance of what was said in the old bulletin.