Agenda. Graduated Rate Estates Qualified Disability Trusts Subsection 104(13.4) Estate Donations Subsection 104(13.3)

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1 Kim G C Moody FCA, TEP Darryl R Antel LLB Moodys Gartner Tax Law LLP December 16, 2014 Agenda Graduated Rate Estates Qualified Disability Trusts Subsection 104(13.4) Estate Donations Subsection 104(13.3) 1

2 Testamentary Trusts Where Did We Come From? The Legislation: Testamentary Trust [subsection 108(1)]: a trust that arose on and as a consequence of the death of an individual Note that there is no limitation on how long it has been since the death of the individual or how many trusts are created by the individual s death Subsection 117(2): The tax payable under this Part by an individual [provides for the graduated rates beginning at 15% and ending at 29%] Per subsection 104(2) a trust is an individual subject to multiple trust anti-avoidance rule. Subsection 122(1): Notwithstanding section 117, the tax payable under this Part for a taxation year by an inter vivos trust [is at the highest marginal rate; i.e. 29%] Per subsection 108(1) an inter vivos trust is a trust other than a testamentary trust 3

3 Testamentary Trusts Where Did We Come From? Income Tax Payable Tax Payable at Highest Marginal Tax Differential Rate (39%) $43,953 (25%) $10,988 $17,142 $6,154 Next $43,954 (32%) $14,065 $17,142 $3,077 Next $48,363 (36%) $17,411 $18,862 $1,451 TOTAL: $42,464 $53,146 $10,682 (1) Tax rates are combined federal and Alberta rates. (2) Income amounts represent maximum of each federal income bracket/tier, other than highest bracket/tier. (3) Every $1 of income greater than that shown in the table has no tax differential; i.e. this is in the top federal income bracket/tier and is taxed at a rate of 39%. (4) Other than the Total Row, tax payable is non-cumulative (i.e. does not include tax payable for income in lower bracket/tier). (5) Note that a trust cannot claim personal credits. 4 Testamentary Trusts Where Did We Come From? TESTATOR S WILL TESTA- MENTARY TRUST #1 TESTA- MENTARY TRUST #2 TESTA- MENTARY TRUST #2 BENEFICIARY #1 BENEFICIARY #2 BENEFICIARY #3 Access to three additional graduated rates [subject to subsection 104(2) s application]; i.e. an additional graduated rate for each beneficiary. Subsections 104(13.1) and (13.2) allowed the income to be taxed in the hands of the trust, but payable to beneficiaries. 5

4 Testamentary Trusts Where Did We Come From? Over the years, there was little, if any, application of the subsection 104(2) multiple trust anti-avoidance rule by the CRA. Provincial rate shopping with the use of subsections 104(13.1) and (13.2) proliferated. Budget 2013 announced intention to consult on whether graduated tax rates for testamentary trusts was still appropriate. June 3, 2013 Department of Finance releases consultation paper that proposed to eliminate graduated rates and asks for submissions by December 2, Many interested parties including STEP and The Joint Committee on Taxation of the Canadian Bar Association and Chartered Professional Accountants of Canada Joint Committee make submissions. 6 Testamentary Trusts Where Did We Come From? Joint Committee makes 11 page submission and essentially makes recommendation to maintain status quo content/uploads/2013/11/dec _jct-submission_testamentary- Trusts.pdf No compelling policy reason for change. Parliament considered such a change in 1972 chose not to make change Royal Commission on Taxation (the Carter Commission ) analyzed graduated rates but made no recommendations. White Paper on Taxation entitled Proposals for Tax Reform issued in 1969 by Federal Government introduced new proposals for trust and estates but ultimately Parliament did not adopt such proposals and maintained status quo. 7

5 Testamentary Trusts Where Did We Come From? Joint Committee commented on proposed 36 month period for a graduated rate estate to have graduated rates. Joint Committee suggested that the 36 month period be replaced with a reasonable period of administration. Budget 2014 announced the Government s intention to proceed with its proposals as outlined in its consultation period. Essentially, all submissions ignored. August 29, 2014, draft legislation released. 8 Graduated Rate Estates August 29, 2014 Draft Legislation Only two subsets of testamentary trusts will be afforded graduated rate taxation: Graduated Rate Estate ( GREs ) Qualified Disability Trusts Subsection 122(1) Change (Effective 2016): Notwithstanding section 117, the tax payable under this Part for a taxation year by a trust (other than a graduated rate estate or qualified disability trust) is [at the highest marginal rate; i.e. 29%] 9

6 Graduated Rate Estates August 29, 2014 Draft Legislation Graduated Rate Estate Defined - the Legislation: Subsection 248(1) Addition (Effective for 2016): "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 that time is no more than 36 months after the death; the estate is at that time a testamentary trust; [provide deceased s SIN in estate s return]; 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 no other estate designates itself as the graduated rate estate of the individual in a return of income under Part I for a taxation year that ends after Graduated Rate Estates August 29, 2014 Draft Legislation Amendments to subsection 249(1) (definition of taxation year ) will essentially force all testamentary trusts, other than a GRE to have a deemed December 31, 2015 year end if their existing fiscal period is a non-calendar period. T3 s for all testamentary trusts (other than GREs) for the 2015 taxation year due March 31, Tax preparers should start planning. 11

7 Some Related Amendments to the Income Tax Act: Graduated Rate Estates August 29, 2014 Draft Legislation No tax Installments for GREs Legislated in new paragraph 156.1(2)(c) Subsection 104(23) amended to apply only in respect of GREs (not all testamentary trusts) and paragraph (e) repealed Post-Mortem Planning Subsection 164(6) and subparagraph 112(3.2)(a)(iii) is only applicable to GREs (i.e. implementation of the 50% Solution ) not sure why limited only to GREs. Nil Gain on Donation of Certain Securities and Ecological Gifts Subparagraphs 38(a.1)(ii) and 38(a.2)(ii) applicable only to GREs 12 Graduated Rate Estates August 29, 2014 Draft Legislation no other estate designates itself as the graduated rate estate of the individual The legislation appears to contemplate that a single deceased can have multiple estates, at least for tax purposes Is this possible? When would this occur? Are multiple wills considered multiple estates? (i.e. multiple wills with different executors and/or beneficiaries) Are all testamentary trusts an estate? Is no other estate only for greater certainty? GRE meanstheestatethatarose 13

8 Graduated Rate Estates Potential Issues If it is possible for a single deceased to have multiple estates, or if CRA administers the Act as if this is possible, What are the potential issues? Which of the estates will/should get to designate itself for GRE status? What if different executors/legal representatives exist? Current multiple-testamentary trust plans (less than 36 months old in 2016) the Will would not have contemplated which trust should get to designate itself for GRE status. 14 Graduated Rate Estates Potential Issues Issue with Multiple Estates Example: Will/Estate-1 of the individual holds the shares of the deceased s family Opco Will/Estate-2 of the individual consists of cash to be donated to a registered charity Recall that: Subsection 164(6) and subparagraph 112(3.2)(a)(iii), i.e. the necessary provisions to implement the 50% Solution, are only applicable to GREs, not estates in general [The 50% Solution is only implemented when CDA is available and utilized.] Only one of Will/Estate-1and Will/Estate-2 can designate itself as the GRE of the individual? If correct, you must choose between Will/Estate-1 implementing the 50% Solution and Will/Estate-2 s having flexibility in applying its donation credits (as explained later, this is only available to GREs) If Will/Estate-2 were donating an ecological gift, there would not be a nil capital gain on disposition, unless it was the designated GRE 15

9 Graduated Rate Estates Qualified Disability Trust ( QDT ) Graduated rates will be afforded if the testamentary trust meets the new definition of QDT under subsection 122(3). Overly simplified, QDT must be: a) testamentary trust; b) resident in Canada; c) elect to be a QDT, made jointly with one or more beneficiaries, in its T3 return; and d) The SIN of the electing beneficiary(ies), is disclosed in the T3 return. Electing beneficiary must have mental or physical impairment (118.3(1)(a) (b)). Very narrow application. US style throwback tax now applicable for any capital distributions made to non-disabled beneficiary(ies) new paragraph 122(1)(c). Very complex and narrow disappointing. 16

10 Types of Trusts: Trust Taxation Existing Law Spousal/Common-Law Partner Trusts Trust settled by individual during lifetime or at death (rollover available) Settlor s spouse entitled to all income during spouse s lifetime No other person entitled to income or capital during spouse s lifetime Deemed disposition of trust assets on death of spouse/common law partner subsection 104(4). AlterEgoPartnerTrusts Trust settled by individual at least 65 years old (rollover available) Settlor entitled to all income during his lifetime No other person entitled to income or capital during settlor s lifetime Deemed disposition of trust assets on death of settlor subsection 104(4) Joint Spousal/Common-Law Partner Trusts Trust settled by individual and/or individual s spouse/common law partner at least 65 years old (rollover available) Settlors, or settlor and settlor s spouse/common law partner, (as applicable) entitled to all income during their lifetimes No other person entitled to income or capital during lifetime of last to die of settlors, or settlor and settlor s spouse/or common law partner (as applicable) Deemed disposition of trust assets on second to die subsection 104(4). 18 Trust Taxation Existing Law Deemed Dispositions Spousal/Common-Law Partner Trusts, Alter Ego Trusts and Joint Spousal/Common-Law Partner Trusts: are not subject to the 21-Year Deemed Disposition Rule have a deemed disposition at fair market value of the trust s property on the death of: o in the case of a Spousal/Common-Law Partner Trust, on the spouse s death o in the case of an Alter Ego Trust, on the settlor s death o in the case of a Joint Spousal/Common-Law Partner Trust, the last to die of the settlors, or settlor and settlor s spouse s, death (as applicable) It is the trust who has the deemed disposition and is liable for the tax 19

11 New Subsection 104(13.4) August 29, 2014 Draft Legislation Surprising addition to the Act. Relevant to: 2016 and later taxation years Spousal/Common-Law Partner Trusts, Alter-Ego Trusts and Joint Spousal/Common-Law Partner Trusts Effect on Deemed Disposition at Death: Deemed year end for the trust on day of death however filing date for such a deemed year end is still normal deadlines (90 days after December 31) All of the trust s income for that year is deemed payable to the deceased beneficiary o As such, although the trust has not distributed its property to the deceased beneficiary, the tax burden for the trust s deemed disposition of that property is shifted to the deceased Deceased bears the tax burden Trust has the assets associated with that tax burden 20 New Subsection 104(13.4) Potential Issues TESTATOR TESTATOR S CHILDREN: RESIDUAL BENEFICIARIES (no entitlement during testator s spouse s life) SPOUSAL TRUST TESTATOR S SPOUSE: INCOME BENEFICIARY (remarries Larry ) *The existence of the trust prohibits the testator s spouse from spending the capital of the testator s estate on Larry, while still providing the spouse with a source of income. Additionally, upon the testator s spouse s death, the capital of the trust is accessible by the testator s children, and the testator s spouse has no ability to gift this amount to Larry. 21

12 New Subsection 104(13.4) Potential Issues The Perceived Abuse: Provincial rate shopping for the tax on the deemed disposition at death? Not entirely clear what the tax policy objective is with new subsection 104(13.4). The Collateral Damage: Tax Liability/Mismatching Issues New subsection 160(1.4) makes the trust and the deceased jointly and severally liable for the tax payable of the deceased as a result of subsection 104(13.4). Alleviates the mismatching issues from CRA s perspective as a creditor Leaves uncertainty and issues for taxpayers 22 New Subsection 104(13.4) Potential Issues Though Finance s Technical Notes indicate that CRA will utilize subsection 160(1.4) to firstly go after the trust for the tax owing, the trust may have a civil claim against the deceased s estate that would re-surface the mismatch. Even if the trustees of the trust do not want to pursue a civil action against the deceased s estate, they may have no choice given the fiduciary duties to the beneficiaries. Though careful drafting may alleviate this issue for future trusts, what about those trusts already in existence and those to be created by Wills where the testator, though alive, no longer has capacity to change his/her testamentary wishes? 23

13 New Subsection 104(13.4) Potential Issues Joint Committee made submission on subsection 104(13.4) (and other issues) on September 26, Again, submission effectively ignored. Is Finance sympathetic to subsection 104(13.4) issues? Bill C-43, which contains GRE, subsection 104(13.4) and other material discussed herein is expect to receive Royal Assent before end of year. content/uploads/2013/11/sept-2014_joint- Committee-on-Taxation_Amendments-to-Trustand-Estate-Rul...pdf 24

14 Estate Donations Existing Law Donations by Will and direct designations of RRSP, RRIF, TFSA and Life Insurance Designations are deemed to have been made by the individual in the individual s year of death [subsections 118.1(5) to 118.1(5.3)] The old legislation often created timing-valuation issues; for example: Will donates asset to registered charity Asset is worth $200k on the date of death Administration of the estate is delayed and the actual transfer of property to the charity is delayed until five years after the date of death of the donor Asset is worth $50k on the date the donation is made Registered charity issues a charitable receipt for $50k Deceased s terminal return claims a charitable donation credit for a $200k donation and has a respective $50k charitable receipt 26 Estate Donations New Legislation Much of section will be amended (effective 2016): The gift is not deemed to have been made by the deceased There is no modification (deeming) of when the gift was made The GRE can allocate donations made to any of: the deceased s year of death the deceased s year prior to the deceased s year of death the year the GRE made the gift any year of the GRE prior to the year the GRE made the gift cannot allocate donation can allocate donation can allocate donation can allocate donation can allocate donation What if the estate made the donation here? 2014 (tax year earlier than tax year preceding tax year of death) 2015 (tax year preceding tax year of death) 2016 (tax year of death) (tax year donation made and within 36 months of death) > 36 months after death 27

15 (Some of) The Legislation: Estate Donations New Legislation The definitions of total charitable gifts, total cultural gifts and total ecological gifts in subsection 118.1(1): Preamble: to the extent not otherwise deducted (i.e. Executor selects in which year to take the deduction) Clause (c)(i)(c): Donations made by the GRE can be applied to the Individual s year of death and the Individual s preceding year, if subsection 118.1(5.1) applies Clause (c)(ii)(b): Donations made by the GRE can be applied to the GRE s year in which the donation was made and its preceding years, if subsection 118.1(5.1) applies 28 Estate Donations New Legislation (Some of) The Legislation Cont d: Subsection 118.1(5.1) applies if: The donation is from the deceased s estate or is substituted property thereof or The donation is deemed by subsection 118.1(5.2) to have been made in respect of the death Subsection 118.1(5.2) deems RRSP, RRIF, TFSA and Life Insurance designations to have been made in respect of the death 29

16 Recap of Trust Taxation Where Did We Come From? A trust may deduct from its income amounts paid or payable to its beneficiaries [paragraph 104(6)(b)] See subsection 104(24) re amount payable A beneficiary must include amounts paid or payable to it in the beneficiary s income [subsection 104(13)] Subsections 104(13.1) and 104(13.2) allows a trust to designate income and taxable capital gains paid or payable to a beneficiary not to have become paid or payable Result: Beneficiary receives actual payment but trust pays the tax associated with earning that amount 31

17 Recall: Recap of Trust Taxation Where Did We Come From? Income Tax Payable Tax Payable at Highest Marginal Rate (39%) Tax Differential $43,953 (25%) $10,988 $17,142 $6,154 Next $43,954 (32%) $14,065 $17,142 $3,077 Next $48,363 (36%) $17,411 $18,862 $1,451 TOTAL: $42,464 $53,146 $10,682 Using subsection 104(13.1) and 104(13.2), the separate graduated rates of a testamentary trust could be utilized while still paying the amount to which those graduated rates were applied to the beneficiary. The income earned by both the beneficiary personally and through the testamentary trust is in the beneficiary s hands, but it has been subject to the two separate marginal rates (i.e. income splitting). Similar use for provincial rate shopping. 32 Alberta Trusts A Basic Plan Facts: 1. Mr. Apple is resident in B.C. and is 75 years of age. 2. Mr. Apple is married to Mrs. Apple who is also 75 years old. Mr. and Mrs. Apple are not U.S. citizens. 3. Mrs. Apple has $10 million of capital property that generates approximately 5% income each year. 4. Mrs. Apple is concerned about B.C. probate costs upon her eventual passing. 5. Mrs. Apple would like to reduce taxation of the annual property income that is realized on her portfolio. 6. Mrs. Apple would also like to reduce income tax exposure upon her eventual passing. 33

18 Alberta Trusts A Basic Plan Consider: 1. Mrs. Apple transfers her portfolio to a joint partner trust. 2. JPT is drafted so that subsection 75(2) will not apply. This will likely require that Mrs. Apple can not access the capital during her lifetime. 3. Majority of trustees of JPT are resident in Alberta. 4. Trustees designate that subsections 104(13.1) and (13.2) apply to portfolio income. 34 New Subsection 104(13.3) Effective Any designation made under subsection (13.1) or (13.2) [of section 104] by a trust in its return of income under this Part for a taxation year is invalid if the trust s taxable income for the year, determined without reference to this subsection, is greater than nil. In English: One can only utilize subsections 104(13.1) and 104(13.2) to the extent the trust has losses or tax credits to fully offset the trust s entire tax liability for the year. Per the previous slides, the effect is: o GREs cannot be used to income split o Provincial rate shopping is done using subsections 104(13.1) and (13.2). 35

19 New Subsection 104(13.3) Notable Issues CBA-CPA Joint Committee on Taxation (Sept. 26, 2014): It is not clear whether taxable income is intended to be computed without regard to specified future tax consequences (i.e., loss carry-backs). We assume that the implications of a designation being invalid, and then ceasing to be invalid due to loss carry-backs, would be complex administratively, such that the Canada Revenue Agency ( CRA ) may be reluctant to agree that taxable income should be computed with regard to losscarry-backs. On the other hand, generally where taxable income is measured without regard to specified future tax consequences, the Act specifically so provides, which suggests that loss carry-backs should also be taken into account. 36 New Subsection 104(13.3) Notable Issues Is there an end-run around subsection 104(13.3)? If distribution is delayed a year, the trust pays the tax and capitalizes the amount. Once capitalized the amount can be distributed to beneficiaries without tax. Caution when dealing with a spousal trust the individual is entitled to receive all of the income of the trust 37