March Grant Popowich, CA Partner, Tax Grant Thornton LLP. You ve lost that lovin feelin. 2 Edmonton Young Practitioners Group

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1 Tax Considerations Surrounding the Breakdown of Marriage March 2012, CA Partner, Tax You ve lost that lovin feelin Agenda > General rules > Tax considerations on the division of assets > Support payments 2

2 General Rules > Spouse or common-law partner > Subsection 69(1) of Income Tax Act (inadequate consideration non-arm's length parties) > Subsections 73(1) and 73(1.1) of Income Tax Act (tax-free transfer between spouses) 3 Spouse or common-law partner > Pre 1988 rules related to spouses only (legally married) > 1993 expanded to include a common law spouse > 2001 replaced with common law partner Could apply retroactively by election to Deleted reference to of the opposite sex 4

3 Subsections 73(1) and 73(1.01) Income Tax Act transfer between spouses > These provisions provide for the tax-free "rollover" of capital assets between individuals > The transferor has no gain to report > The transferee inherits the cost of the assets from the transferor 5 Subsections 73(1) and 73(1.01) Income Tax Act transfer between spouses continued Example: Shares in Divorce Co.: FMV $1,000,000 Cost $ 10,000 Inherent gain $ 990,000 If shares "rollover" to recipient, then the transferor has no gain (and no taxes) and recipient inherits a cost of $10,000. Note: The recipient also inherits the taxes (i.e. approx. $193,000) related to the inherent gain. 6

4 Subsections 73(1) and 73(1.01) Income Tax Act transfer between spouses continued Applies to > Transfers of capital property > To i) an individual s spouse or common law partner, or ii) a former spouse or common law partner of the individual in settlement of rights arising out of their marriage or common law partnership > Where both the individual and the transferor are resident in Canada 7 Subsections 73(1) and 73(1.01) Income Tax Act transfer between spouses continued > The transferor has the ability to elect to transfer at fair market value (i.e. to trigger losses watch superficial loss rules!) > Watch the attribution rules! > Capital gain/loss attribution rules apply unless there is a joint election that they will not apply > The attribution rules on income (not capital gains or losses) will not apply (when living separate and apart because of a breakdown of their marriage) 8

5 Subsections 73(1) and 73(1.01) Income Tax Act transfer between spouses continued Capital gain attribution rule example: Shares in Divorce Co.: FMV $1,000,000 Cost $ 10,000 Gain $ 990,000 9 Subsections 73(1) and 73(1.01) Income Tax Act transfer between spouses continued Capital gain attribution rule example (continued): If the shares in Divorce Co. are transferred by spouse A to spouse B Spouse B sells the shares for $1,000,000 before divorce is finalized (i.e. still spouses) No election is filed to avoid attribution Then The gain will be attributed to spouse A Spouse B receives $1,000,000 cash Spouse A receives a $193,000 tax bill from CRA 10

6 Tax considerations on the division of assets > Capital Property > General Considerations > Principal Residence > Portfolio Investments > Non-Capital Property > Inventory > Closely held corporations 11 Principal residence > Single Home > Rollover or elect out > Ensure T2091 designation is completed and filed if elect out of rollover > Multiple Homes > Limited to one per family > Ensure T2091 is filed as part of settlement 12

7 Portfolio investments > If considered capital property, can be rolled over at cost amount > Consider electing at FMV to use up capital losses on the transfer 13 Non-capital property inventory > Example: land of a real estate developer or inventory of a proprietor > General rules apply transfer at fair market value (no rollover) > Transfer to be avoided as transferor pays tax based on fair market value with no rollover provisions > Consider tax planning if asset must be transferred (ie. Roll to company/partnership, then transfer shares/units to former spouse) 14

8 Closely held corporations > Purchase of spouse s shares > Repurchase or redemption of shares > Freeze and redemption over time > Divisive reorganization 15 Closely held corporations share purchase > Share purchase > Rollover unless elect out of 73(1) > Availability of capital losses and/or capital gains exemption 16

9 Closely held corporations share purchase continued > Share purchase > Section 84.1 where shares purchased with another corporation > Could reclassify gain into deemed dividend > Applies when partners not at arms length > Question of whether at arms length immediately following divorce 17 Closely held corporations repurchase or redemption of shares > Allows for use of corporate funds to buy out one of the spouses > Results in deemed dividend to departing shareholder (taxes due April 30 th following year) > Capital dividend or eligible dividend treatment may be available 18

10 Closely held corporations "wasting freeze" > Freeze and redemption over time > Where both spouses own shares of private company > One spouse exchanges common shares for fixed value, non-voting preferred shares redeemable for fair market value > Exchange can occur on a tax deferred basis > Agreement to redeem preferred shares over time > Allows for deferral of tax liability > Company can continue operating without requiring significant borrowings for one-time buyout > Does not allow for immediate clean break 19 Closely held corporations "butterfly" transaction (divisive reorganization) > Possible for parties to divide company assets into two separate companies > Can be done on a tax free basis so long as parties still spouses at time of reorganization > Advantage is a complete clean break > Disadvantages include valuation of corporate assets and fees tax rules are very complex 20

11 Closely held corporations "butterfly" transaction (divisive reorganization) > Divisive reorganization example H $500K W $500K Heartco Asset A FMV $500K Asset B FMV $500K 21 Closely held corporations "butterfly" transaction (divisive reorganization) > Wife incorporates new company (Hateco) > Wife transfers her shares of Heartco to Hateco in exchange for more shares of Hateco > Elects for transfer to occur on tax-deferred basis (s.85) 22

12 Closely held corporations "butterfly" transaction (divisive reorganization) > Divisive reorganization example H $500K W $500K Heartco $500K Hateco Asset A FMV $500K Asset B FMV $500K 23 Closely held corporations "butterfly" transaction (divisive reorganization) > Heartco transfers Asset B to Hateco and takes back preferred shares of Hateco worth $500K 24

13 Closely held corporations "butterfly" transaction (divisive reorganization) > Divisible reorganization example H $500K Heartco W $500K $500K $500K Hateco Asset A FMV $500K Asset B FMV $500K 25 Closely held corporations "butterfly" transaction (divisive reorganization) > Intercorporate shareholdings are redeemed for notes > Results in non-taxable intercorporate deemed dividends > Resulting notes are set-off against each other 26

14 Closely held corporations "butterfly" transaction (divisive reorganization) > Divisive reorganization example H W $500K $500K Heartco Hateco Asset A FMV $500K Asset B FMV $500K 27 Division of assets pensions and registered plans > RRSP s and RRIF s > Tax free transfer to spouse allowed when pursuant to settlement of rights arising out of breakdown of marriage > Completion of Form T2033, which gives direction to financial institution to execute transfer 28

15 Division of assets pensions and registered plans > RPP s > Tax free transfer to a RPP, RRSP or RRIF for the benefit of spouse/former spouse 29 Support payments > Spousal support versus child support > Required features 30

16 Support amount defined > The payments must be considered an allowance payable on a periodic basis > Must be for the maintenance of the recipient, the children of the recipient or both, and > The parties must be living separate and apart; payments required by order of a competent tribunal or a written agreement 31 Support payments spousal support versus child support > Spousal support payments taxable to recipient and deductible to payor if meet certain conditions > Child support payments made under order/agreement commencing after April 30, 1997 not taxable to recipient or deductible to payor 32

17 Support payments spousal support versus child support > Child support payments made under order/agreement commencing before May 1, 1997 may be taxable/deductible if certain conditions met > All support payments considered child support unless clearly identified as spousal support 33 Deductibility of legal fees > No specific provision in the Income Tax Act > Generally non-deductible, except for: > Costs to obtain order for child support > Costs incurred to enforce pre-existing rights to child support > Costs to defend against reduction of support 34

18 FAMILY LAW THE BASICS Presenter: Karin F. Schwab, FMC LLP March 7, 2012 FAMILY LAW THE BASICS 1. JURISDICTION AND FRAMEWORK - The Rules That Apply (a) Divorce versus Property (i) Divorce Act (ii) Matrimonial Property Act (b) Married versus Common-Law (i) Divorce Proceedings (a) Statement of Claim Q.B. (b) Agreements and Judgments (ii) Family Law Act (a) Application/forms (b) Q.B. or Provincial Court 2 (c) Process How To Get There (i) Court Process Pleadings (ii) Collaborative Process (iii) Mediation Karin F. Schwab Fraser Milner Casgrain

19 FAMILY LAW THE BASICS 2. CHILD SUPPORT The Right of the Child (a) Federal Child Support Guidelines (i) Parenting Arrangements (ii) Guideline Income A. Employed (gross income) B. Self-employed C. Income in excess of $150, (iii) Section 3 Support (iv) Extraordinary Expenses (Sec. 7) (v) Undue Hardship 3 Karin F. Schwab Fraser Milner Casgrain FAMILY LAW THE BASICS CHILD SUPPORT The Right of the Child cont d (b) Family Law Act (i) Application (ii) Orders (iii) Duration (c) Unique Features (i) Ongoing Disclosure (ii) Ongoing Review and Validation (iii) MEP Enforcement of Orders and Agreements 4 Karin F. Schwab Fraser Milner Casgrain

20 FAMILY LAW THE BASICS 3. SPOUSAL SUPPORT No Simple Answers (a) Applicable Principles (i) Advantages and Disadvantages 5 (ii) Apportion Financial Consequences (iii) Relieve Economic Hardship (iv) Promote Economic Self-Sufficiency (v) Conditions, Means, Needs A. Length of marriage B. Roles in the marriage C. Income/earning ability D. Property division Karin F. Schwab Fraser Milner Casgrain FAMILY LAW THE BASICS SPOUSAL SUPPORT No Simple Answers cont d (b) Entitlement (i) Compensatory (ii) Contractual (iii) Needs Based (c) Amount (i) Standard Living in Marriage (ii) Children (iii) Age (iv) Income (v) Income Generating Capacity (vi) Assets and Income Generating Capacity (vii) Health (viii) Plans in the Marriage 6 Karin F. Schwab Fraser Milner Casgrain

21 FAMILY LAW THE BASICS SPOUSAL SUPPORT No Simple Answers cont d (d) Duration (i) Long-term Traditional indefinite/review (ii) Time Limited Support fact specific (iii) Double Dipping (e) Process to Calculate (i) Gross Income (what to include) (ii) Child Support (iii) Budget (iv) Spousal Support Guidelines (v) Tax Effect (vi) Cash Flow 7 Karin F. Schwab Fraser Milner Casgrain FAMILY LAW THE BASICS SPOUSAL SUPPORT No Simple Answers cont d (f) Lump Sum Exception Not Norm (i) How to Calculate (ii) When Appropriate (iii) Tax Effect (g) Waivers of Support (h) Adult Interdependent Partners (i) Relationship of Interdependence (ii) 3 Years (iii) Some Permanence 8 Karin F. Schwab Fraser Milner Casgrain

22 FAMILY LAW THE BASICS 4. MATRIMONIAL PROPERTY (a) Common-law Property - Not Covered by Statute (i) Constructive/Resulting Trust (ii) Unjust Enrichment/Deprivation (iii) Evidentiary Challenges A. Length of relationship B. Child rearing C. Other contributions D. Financial contribution E. Joint venture (iv) Tax Treatment 9 Karin F. Schwab Fraser Milner Casgrain FAMILY LAW THE BASICS MATRIMONIAL PROPERTY cont d (b) Property Division in Divorce (i) Jurisdiction A. Residency B. 2 Years after divorce/separation C. After spouse is deceased D. Property in Alberta and outside Alberta (c) Asset Categories (i) Exemptions 7(2) A. Inheritance B. Pre-marriage C. Injury awards D. Gifts 10 Karin F. Schwab Fraser Milner Casgrain

23 FAMILY LAW THE BASICS MATRIMONIAL PROPERTY cont d (ii) Just and Equitable 7(3) A. Section 8 factors (i) Contributions of each party (ii) Duration of marriage (iii) Post separation acquisition (iv) Agreements (v) Dissipation (vi) Tax liabilities B. 2 Years after divorce/separation C. After spouse is deceased D. Property in Alberta and outside Alberta (iii) Divisible Presumption of Equal Division 7(4) 11 Karin F. Schwab Fraser Milner Casgrain FAMILY LAW THE BASICS MATRIMONIAL PROPERTY cont d (d) Challenges (i) Valuation A. Experts B. Timing (ii) Tracing 12 Karin F. Schwab Fraser Milner Casgrain