Changes to the Taxation of Estate and Testamentary Trusts

Transcription

1 Changes to the Taxation of Estate and Testamentary Trusts Testamentary Trust Testamentary Trust 2013 Federal Budget The Government is also concerned with potential growth in the tax motivated use of testamentary trusts and the associated impact on the tax base. Current tax planning opportunities associated with the availability of trust-level graduated rates include the use of multiple testamentary trusts, tax motivated delays in completing the administration of estates, and avoidance of the OAS Recovery Tax. 2

2 Testamentary Trust Testamentary Trust A Brief History of Events March 21, 2013 Federal Budget 2013 Federal government announces intention to eliminate tax benefits arising from graduated rate taxation of testamentary trusts and estates June 3, 2013 Department of Finance releases consultation paper Proposed measures to eliminate graduated rate taxation February 11, 2014 Federal Budget 2014 Federal government confirms proposals are to proceed, with a limited exception for disabled beneficiaries August 29, 2014 Department of Finance releases draft legislation 3 Testamentary Trust Testamentary Trust Measures Proposed in Consultation Paper and Budget 2014 Flat top-rate taxation will apply to grandfathered inter vivos trusts and trusts created by will except for qualified disability trusts Flat rate equal to the top rate of combined federal and provincial tax for individuals Will apply to estates after 36-month administration period following death of individual Retain access to graduated rates for first 3 years of estate s administration 4

3 Testamentary Trust Testamentary Trust Measures Proposed in Consultation Paper and Budget 2014 No changes to: Preferred beneficiary rules Rules applying to trusts for minor children Spousal rollover rules Asset rollover rules on death of a spouse or common-law partner 5 Testamentary Trust Testamentary Trust August 29, 2014 Draft Legislation Main concepts unchanged S. 248 amended to add definition of graduated rate estate New S.104(13.3) introduced to limit the application of S.104(13.1) and (13.2) New S.104(13.4) introduced to provide rules applicable to spousal/alter-ego trusts on death of beneficiary S. 122 updated for newly conceived qualified disability trust and associated recovery tax Measures to apply to all existing and new arrangements for 2016 and subsequent tax years 6

4 Testamentary Trust Testamentary Trust New definition provided for in 248(1) graduated rate estate, of an individual at any time, means the estate that arose on and as a consequence of the individual s death if a) that time is no more than 36 months after the death, b) the estate is at that time a testamentary trust, c) the individual s Social Insurance Number (or if the individual had not, before the death, been assigned a Social Insurance Number, such other information as is acceptable to the Minister) is provided in the estate s return of income under Part I for the taxation year that includes that time and for each of its earlier taxation years that ended after 2015, d) the estate designates itself as the graduated rate estate of the individual in its return of income under Part I for its first taxation year that ends after 2015, and e) no other estate designates itself as the graduated rate estate of that individual in a return of income under Part I for a taxation year that ends after 2015; 7 Testamentary Trust Testamentary Trust Graduated Rate Estate (GRE) Graduated rates limited to up to 36 months after date of death Estate must designate itself as a graduated rate estate in first T3 return for year ending after 2015 Marginal tax rates will be of no use to an estate during first 36 months if the income is payable to a beneficiary (which will be a question of fact) due to S.104(13.3) 8

5 Testamentary Trust Testamentary Trust Graduated Rate Estate (GRE) GRE will have deemed year end on earlier of December 31, 2015 and 36 months after death of individual This will be last tax return on which graduated tax rates will apply Only GRE can have non-calendar year end; once graduated rates no longer apply, year end must be calendar year end 9 Testamentary Trust Testamentary Trust Graduated Rate Estate (GRE) Why status of GRE is important: Calendar year reporting [S.249(1)] Stop loss rules capital loss limitation [S.112(3.2)] Capital loss carry back [S.164(6)] Donations by will and gifts of publically traded securities [S.38(a.1)(ii)/S.118.1(1)] 10

6 Testamentary Trust Testamentary Trust Graduated Rate Estate (GRE) Use of multiple wills (in certain provinces) to limit probate Example: Taxpayer s main assets consist of private company shares and marketable securities. Taxpayer has two wills, each with different executors. The beneficiaries of private company shares are taxpayer s children and beneficiary of marketable securities portfolio is a charity. Only one estate can be designated as a taxpayer s GRE If designate estate with private company shares as GRE, lost ability to use 38(a.1)(ii)/118.1(1) for the other estate If designate estate with marketable securities as GRE, lost ability to use 164(6) and 112(3.2) for the other estate 11 Testamentary Trust Testamentary Trust Graduated Rate Estate (GRE) In most cases, GRE status will likely cease after one year (i.e. executor s year ) assuming will does not specifically create ongoing trust 104(13.3) limits designations under 104(13.1) and (13.2) If income is paid or payable to beneficiaries (question of fact), no further access to marginal rates Key question if beneficiary chose to, could they demand payment of estate assets due to them? When executor in position to windup estate administration but chooses not to, CRA takes position that ceases to be estate Carrying on estate that is otherwise administered for 36 months was one of reasons cited by Finance for S.104(13.3) 12

7 Testamentary Trust Testamentary Trust Estates Administered Before 2016 Initially unclear whether the 36-month period to commence on January 1, 2016 or from date individual died. Based on August 29, 2014 legislation, the definition of graduated rate estate only applies at a time that is no more than 36 months after the death Definition is effective December 31, 2015 Consequently, estates will not get a full 36 months of graduated rates under the new rules beginning on January 1, Testamentary Trust Testamentary Trust Restriction on Ability to Retain Income S.104(13.3) Existing S.104(13.1) & (13.2) allow trust to choose to have distributed income and gains taxed at trust level rather than at beneficiary level New S.104(13.3) makes designation invalid if trust s taxable income for year is greater than nil Will only allow trust to retain income to offset other deductions (i.e. trust s tax balances) 14

8 Testamentary Trust Testamentary Trust Restriction on Ability to Retain Income S.104(13.3) Practical Implications on Current Trust Planning Loss carry back situations uncertain under new rules: Can designations under S.104(13.1) & (13.2) be made to utilize loss carry back from subsequent tax year? Will S.104(13.3) permit an adjustment to trust s taxable income for year to factor in future tax consequences (i.e. carry back of capital loss)? Will a late-file designation under S.104(13.1) & (13.2) be permitted to accommodate subsequent change in trust s taxable income? Finance acknowledged at Joint Committee meeting that technical changes may be necessary to address this issues, and S.104(13.4) concerns (discussed later) 15 Testamentary Trust Testamentary Trust Restriction on Ability to Retain Income S.104(13.3) Practical Implications on Current Trust Planning Frustrates other trust planning: Retaining income in spousal trust to avoid OAS clawback Avoiding distribution of income to disabled beneficiary so as to maintain access to income tested benefits 16

9 Trusts and Attribution in the Income Tax Act Jesse Brodlieb, Tax Lawyer Dentons Canada LLP Whose Income Is it Anyway? Some rules that we will review: 56(4.1) Below-market loans 74.1(1) Transfers and loans to spouse 74.1(2) Transfer and loans to minor child 74.3 Transfers to Trusts 74.4 Corporate attribution 75(2) Reversionary Trust Rule Kiddie tax 18 Jesse Brodlieb

10 Whose Income Is it Anyway? 56(4.1) Below-market loans Requirements: Individual or trust of which individual is a beneficiary becomes indebted to a related individual or a trust which received property from the related individual and one of the main reasons for the loan was reduction or avoidance of tax on income from the loaned property, or property acquired with the loaned property. 19 Jesse Brodlieb Whose Income Is it Anyway? 56(4.1) Below-market loans Results: Income from the property attributed back to the lender (while the lender is resident in Canada and was not at arm s length with the debtor) or the lender trust, as the case may be. A rule of somewhat narrow application, since a tax avoidance motivation is required. 20 Jesse Brodlieb

11 Whose Income Is it Anyway? 74.1(1) Transfers or loans to Spouse Requirements: Transfer or loan of property by an individual, by any means including a trust, to a person who is a spouse or common law partner of the transferor. Result: Income or loss from property or substituted property deemed to be that of the transferor while resident in Canada and married/common law 21 Jesse Brodlieb Whose Income Is it Anyway? 74.1(2) Transfers or loans to minor child Requirements: Transfer or loan of property by an individual, by any means including a trust, to a person who is under 18 and is non arm s length (or niece or nephew). Result: Income or loss from property or substituted property deemed to be that of the transferor while resident in Canada and person has not turned 17 before the year 22 Jesse Brodlieb

12 Whose Income Is it Anyway? Planning Tips and Opportunities: Prescribed rate loans: Can use a family trust to split income where the transferor instead makes a loan at the prescribed rate kiddie tax will apply to certain forms of income need to be careful! Limitations on who can benefit 23 Jesse Brodlieb Whose Income Is it Anyway? 74.4 Corporate Attribution Example: Mom is a successful entrepreneur. Time for an estate freeze. Exchanges common shares for prefs, new growth shares transferred to a trust, kids and Dad beneficiaries. This is ok assuming that Opco is a SBC. 24 Jesse Brodlieb

13 Whose Income Is it Anyway? 74.4 Corporate Attribution Example: But a few months later, Mom sells the business by way of asset sale. Opco becomes Investco and is no longer an SBC may now apply 25 Jesse Brodlieb Whose Income Is it Anyway? 74.4 Corporate Attribution How can you avoid it? No transfer of property to a corporation (for example, freeze by way of stock dividend) Use of trust with Anti-attribution language (74.4(4)). 26 Jesse Brodlieb

14 Whose Income Is it Anyway? 75(2) Reversionary trust rule The granddaddy of them all! Requirements: Trust resident in Canada (new!) Property held at any time since 1934 (not new) Either: Property can revert to settlor or person selected by settlor after creation of the trust, or Settlor has veto over disposition by trust of property. 27 Jesse Brodlieb Whose Income Is it Anyway? 75(2) Reversionary trust rule Results: Income on property or substituted property attributed to settlor. AND 107(4.1) will apply no tax-deferred rollout (really, really bad). 28 Jesse Brodlieb

15 Whose Income Is it Anyway? Kiddie Tax: 29 Tax on split income basic idea is to prevent diverting certain private income sources to minor children Applies where income is: Dividends on non-listed shares Shareholder benefit Partnership income from the provision of services by a non-arm s length person Certain trust income Non-arm s length capital gains Jesse Brodlieb Whose Income Is it Anyway? Questions? Thank you! 30 Jesse Brodlieb

16 Leigh Somerville Taylor B.A.(Hons), J.D., LL.M.(Tax) LST Tax Law Leigh Somerville Taylor Professional Corporation Trust Litigation Brent Kern Family Trust (2014 FCA 230) Brogan Family Trust (2014 ONSC 6354) 32

17 Trust Litigation Brent Kern Family Trust (2014 FCA 230) Double tax? 33 Trust Litigation Subsection 75(2) of the Act 75(2) Where, by a trust created in any manner whatever since 1934, property is held on condition (a) that it or property substituted therefor may (i) revert to the person from whom the property or property for which it was substituted was directly or indirectly received (in this subsection referred to as the person ), or (ii) pass to persons to be determined by the person at a time subsequent to the creation of the trust, or (b) that, during the existence of the person, the property shall not be disposed of except with the person s consent or in accordance with the person s direction, any income or loss from the property or from property substituted for the property, and any taxable capital gain or allowable capital loss from the disposition of the property or of property substituted for the property, shall, during the existence of the person while the person is resident in Canada, be deemed to be income or a loss, as the case may be, or a taxable capital gain or allowable capital loss, as the case may be, of the person. 34

18 Trust Litigation Sommerer v. Her Majesty the Queen, 2012 FCA 207 [57] I conclude that the Crown s proposed interpretation is wrong because it is based on the incorrect premise that subsection 75(2) can apply to a beneficiary of a trust who transfers property to the trust by means of a genuine sale. Justice Miller reached the same conclusion through a comprehensive application of the principles of statutory interpretation to specific words and phrases in subsection 75(2). His main conclusion is stated succinctly at paragraph 91 of his reasons: once properly unravelled and viewed grammatically and logically, the only interpretation is that only a settlor, or a subsequent contributor who could be seen as a settlor, can be the "the person" for purposes of subsection 75(2) of the Act. 35 Trust Litigation Brent Kern Family Trust Facts: Series of transactions effecting estate freeze for two corporations 36

19 Trust Litigation Brent Kern Family Trust Facts (cont d): 37 Trust Litigation Brent Kern Family Trust Decision of the Tax Court: Sommerer applies Subsection 75(2) of the Act did not apply; the trust purchased the property for valuable consideration No reversionary transfer 38

20 Trust Litigation Brent Kern Family Trust Decision of the Tax Court: [28] Appellant s counsel also raised reasons why he felt the decision in Sommerer is wrong as opposed to inapplicable: insufficient contextual and purposive analysis, use of faulty hypotheticals, unintended universal removal of a common type of transaction from the ambit of subsection 75(2) and possibly absurd future consequences as a result of the decision. This Court s response is simple. The Tax Court of Canada is not a review court for unequivocal decisions of the Federal Court of Appeal. This Court is required to follow and apply the statements of law handed down by the Federal Court of Appeal; stare decisis is a hierarchal process. The ratio decidendi within Sommerer, as outlined in paragraph 57 of the appeal decision, now comprises pronounced law; challenges to such required deference by this Court are also part of a well known hierarchical process. 39 Trust Litigation Brent Kern Family Trust Decision of the Tax Court (cont d): [29] To encapsulate, the Appellant trust purchased 100 common shares of Holdco ( Alberta Ltd.) for valuable consideration from OPCO (Wilf s Oilfield). OPCO was also an enduring beneficiary under the Appellant trust. As such, subsection 75(2) does not apply to the dividend declared on the Holdco shares which comprised the property. The dividend income is not attributable to OPCO, but instead remains to the benefit and for the account of the Appellant 40

21 Trust Litigation Brent Kern Family Trust Decision of the Federal Court of Appeal: [3] In our view there is no reviewable error in the trial judge s finding that Sommerer applied, given that Sommerer decided that ss. 75(2) applies only to a settler or contributor and not where there is a fair market value disposition into the trust. [5] Like the trial judge in this case (at para. 27) we conclude that this Court in Sommerer spent considerable time analyzing the text, content and purpose of the subsection, or at least sufficiently enough to arrive at a correct interpretation of ss. 75(2). In our view, counsel for the appellant has not pointed to any fundamental matter that was overlooked sufficient to justify intervention on the basis of Miller v. Canada (Attorney General) 2002 FCA 370 at para Trust Litigation Consider Re Pallen Trust, 2014 BCSC

22 Trust Litigation Brogan Family Trust (2014 ONSC 6354) Who needs notice? 43 Trust Litigation Rectification generally Rescind or revise transaction by Court order Four elements Prior agreement Common intention Documentation that does not reflect intention Common mistake 44

23 Trust Litigation The Canada Revenue Agency Binding the Canada Revenue Agency through selfhelp remedies Prejudice to third parties, including the Canada Revenue Agency 45 Trust Litigation Case authorities Her Majesty the Queen v. Sussex Square Apartments Limited, 2000 DTC 6548 Juliar v. Her Majesty the Queen, 2000 DTC Ontario Inc. v. Bramco Holdings Co. et al (1994), 17 O.R. (3d) 571, aff d 21 O.R. (3d)

24 Trust Litigation Brogan Family Trust Facts: Motion to set aside rectification Order No notice to the Canada Revenue Agency Rectification of trust agreement re: distributions to minor beneficiares 47 Trust Litigation Brogan Family Trust Issues: [8] The issues are firstly whether the CCRA brought this motion forthwith as required by the rules; secondly whether the CCRA has standing to bring this motion as a party affected by a judgement as required by the rules ;1 and finally whether the respondents breached a requirement that the CCRA should have been served with the rectification application. 48

25 Trust Litigation Brogan Family Trust Canada Revenue Agency as a party affected? [13] I am not persuaded that as contemplated by the rules, the CCRA was affected by the order of McLean, J. The respondents were not obliged to file a return until the end of the year well after the order was obtained. When the return was filed at the end of the year, then tax liability if any, could be ascertained.5 I don t accept the CCRA s contention that tax liability was established at the moment of the sale with the amount of the tax to be determined after the return was filed by the respondents. To accept the CCRA s argument would in principle implicate the CCRA as tax collector in virtually every proceeding in the courts involving damages for termination of employment, personal injury income loss claims, family matters, or for the purchase and sale of a business. 49 Trust Litigation Brogan Family Trust Re: motion to be brought forthwith [18] While the CCRA may consider the various steps in the delay as important for explanation purposes, the CCRA is stuck with the delay. In this case, according to the evidence, the auditor was reporting to the very group within the CCRA that others in the department would have turned to for advice concerning rectification orders. It is no answer that the particular auditor did not understand rectification orders. Someone in the chain of supervision did. Even after the order was referred to counsel within the CCRA, it still took two months for the motion to be launched. 50

26 Trust Litigation Brogan Family Trust Re: motion to be brought forthwith (cont d) [18 cont d] The Quebec Superior Court considered a ten month delay was not unreasonable.17 However, that determination was made after a contextual analysis consistent with Article 489 of the Civil Code of Quebec, similar to the Ontario Rule. The parties in that case had obtained a rectification judgement after having received Notices of Assessment of several millions of dollars from the CCRA, concealed their activities and constructed a number of transactions with the sole intention of undermining the Notices of Assessment so that tax would not be payable. For example, the parties had obtained a sealing order of the rectification proceedings after the proceedings had been conducted in camera to keep the proceedings secret, and the CCRA had to take steps to unseal the court file before bringing their proceedings. Here, no explanation was provided for the two month delay. The rule anticipates promptness. It provides that the motion to set aside not only be served forthwith but names the first available hearing date that is at least three days after service of the notice of motion. 51 Trust Litigation Brogan Family Trust Re: requirement for notice: [21] In the cases shown to me where the CCRA did participate, either it was a creditor or no issue was made of the CCRA s participation. In other words, in the absence of anything explicit, it seems that the Trustees gave notice to the CCRA on the advice of counsel. [22] I conclude that the CCRA is only required to be given notice of a proposed rectification proceeding when the CCRA s legal interests might be directly affected by the outcome of the rectification proceeding, such as where the CCRA is a creditor and the rectification would affect its rights.23 Otherwise, the CCRA might be made a party when so advised by counsel that notice should be given to the CCRA. [23] Here, the respondents were explicitly advised by counsel that it was not necessary that the CCRA be given notice. It is also quite clear that the CCRA was not a creditor at the time the rectification proceedings were brought. Its legal interests were unaffected. 52

27 Trust Litigation Consider Fairmont Hotels Inc. et al v. A.G. Canada, 2014 ONSC