The essence of 104(13.4), as adopted, is two fold it deems the life interest trust to have a year end at the end of the day of death of the life interest beneficiary and it deems the capital gain arising on such death to be payable to the deceased beneficiary with the result that it must be included in the income of the deceased beneficiary s terminal year. 46
Paragraph 104(13.4)(b) effectively shifted the capital gain arising on the deemed disposition on death, as well as any other income earned in the short year deemed ended on death, to the life interest beneficiary s terminal return, such that it could no longer be taxed in the trust. 47
The greatest concern was that the life interest beneficiary s estate was responsible for the tax, even though it might never receive the assets, whereas the capital beneficiaries of the trust would receive the assets without bearing any part of the tax burden. Post mortem planning was also complicated due to the fact that any loss arising on the eventual redemption of private corporation shares held in the trust would be realized by the trust which was no longer the taxpayer reporting the capital gain on death. 48
It is not clear how CRA would apply subsection 160(1.4) and whether it would look first to the trust as expressed in the explanatory notes. Enforcement against the trust is further complicated as the calculation of the tax liability must be made at the level of the beneficiary, taking into account the beneficiary s tax rate, tax credits and losses. 49
There have been many suggestions since 104(13.4) was introduced as to clauses that may be included in wills to ensure that the tax is actually borne by the spousal trust rather than by the beneficiary s estate. Amending the will is not a solution where the individual who created the trust has already died or no longer has capacity. Query whether rectification would be possible in such cases? Where the tax liability is paid by the trust, caution must be exercised so as not to taint the status of the beneficiary s estate as a testamentary trust under subsection 108(1). A trust will not qualify as a testamentary trust where property was contributed otherwise than by an individual on or after the individual s death and as a consequence thereof, or where debt was incurred by the trust to a beneficiary or non arm s length person (subject to certain exceptions). There are also various timing and other issues to consider, such as whether the trust should voluntarily pay the tax or wait for an assessment, communication of information between trustees and executors of beneficiary s estate to determine the amount of the liability taking into account the beneficiary s tax attributes, interest charges to the estate if the trust pays tax after the beneficiary s due date, and potential trustee liability for non payment of tax by executors of estate. 50
Representations about the technical issues and potential inequities, were submitted to the Department of Finance by numerous organizations, including STEP. On November 16, 2015, the Department of Finance issued a letter acknowledging the concerns and indicating that it was prepared to make changes. Draft Legislation was released on January 15, 2016 addressing the concerns raised by the tax community with respect to life interest trusts and their beneficiaries. In essence, the amendments move the gain realized on the beneficiary s death back into the trust (where it was pre 2016), save where the trust and deceased beneficiary s GRE elect otherwise. The January 2016 draft amendments also provide relief with respect to the application of the charitable donation tax credit rules. This will be addressed by Colleen later in the paper. 51
The default rule will be that the gain on the beneficiary s death is taxed in the trust, with possibility to elect out provided certain conditions are satisfied. The death of the trust s creator must occur before 2017, but the death of the beneficiary may occur at any time. On death of the spouse beneficiary, the trustees must look back to the year of death of trust s creator to determine whether election is available. The election is not available for inter vivos spousal or common law partner trusts. 52
Prior to 2016, subsection 110.6(12) allowed a spousal or common law partner trust to claim the unused capital gains deduction of the life interest beneficiary. This provision was repealed effective January 1, 2016 when it essentially lost its purpose due to the transfer of the capital gain on death to the deceased life interest beneficiary. It is not clear why this provision has not been reinstated. It is hoped that this is simply an oversight which will be corrected when the draft legislation is adopted. 53
Although in most circumstances, it will be preferable (and simpler) to leave the capital gain in the trust, there are some situations where it may be advantageous to make the election, for example, where the deceased beneficiary has capital losses or unused capital gains exemption or would be taxed at a lower rate (perhaps due to graduated rates) than the trust. 54
It may be desirable to make the election where the assets of the trust include shares of a qualifying small business corporation and the spouse beneficiary has unused capital gain exemption. However, the election cannot be made in respect of some assets and not others. 55
If beneficiaries of trust and estate are not the same, estate beneficiaries may be unwilling to elect and assume tax liability of trust. Trustees and executors must consider their fiduciary duties. Professional advisors must determine who their clients are, and whether their role is to reduce the overall tax burden or simply to minimize the tax payable by their client. 56
In situations where the parties determine that it would be advantageous to elect, they must be mindful of all the concerns originally raised in respect of 104(13.4). 57
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Making the election shifts the tax burden to the beneficiary s estate, which can avail itself of the beneficiary s unused capital gains exemption and losses. However, if the heirs are not the same as the capital beneficiaries of the trust, they may not be prepared to use these tax attributes or to pay the tax on the portion of the gain that is not sheltered by the exemption and losses. It is not possible to elect only to the extent of the available exemption and losses. 59
Without the election, traditional planning may be implemented. Making the election gives rise to the same issues as existed prior to the January 2016 draft amendments, notably capital gain and capital loss being realized in the hands of different taxpayers. 60
The loss carry back and late designation is the same strategy adopted to deal with the issue arising under subsection 104(13.4) as adopted and in effect since January 1, 2016. CRA confirmed at the 2015 STEP Roundtable that a late filed designation would be permitted to apply a loss carry back provided that the year was not statute barred and that there was no retroactive tax planning (Views 2015 0572101C6). 61
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Charitable Donations on Death Old rules: Donations made by Will were deemed to have been made by the deceased individual immediately prior to death. The donation value was determined as of the date of death, and the tax credits could be claimed on the Terminal T1 or the Prior year T1. Excess tax credits could not be claimed by the Estate. The old rules relied heavily on the CRA s interpretation of the individual s Will to determine whether the donation is claimed by the individual or the Estate. A mis match between the taxpayer and/or the taxation year could result in the inability to shelter the tax liability on death with the tax credits. 64
There are new rules for charitable donations made by a will, by designation of a charity as a beneficiary, and by an estate. The current rules apply to deaths after 2015 and strive to provide greater flexibility for executors to utilize charitable donation tax credits from property donated on or after an individual s death. While the expanded scope is welcome, the requirement that the estate be a GRE to qualify for them may trip up the unwary executor or professional advisor. Charitable Donations on Death Current Rules: GRE status is required in order to take advantage of the new charitable donation rules. If a GRE makes a gift of property it acquired on or as a consequence of death, or a gift of substituted property 1, the executor of the deceased s will is given the flexibility to allocate all or a portion of the gift amongst the following: 2 The individual s Terminal T1; The individual s prior year T1; The taxation year of the GRE in which the donation was made; and An earlier taxation year of the GRE. In addition, the executor has the option of having all or a portion of the gift carried forward by the Trust for five taxation years. (The carry forward period is available to the Estate while it is a GRE and continues after the 36 month period.) 1. S. 118.1(4.1), (5) and (5.1). 2. S. 118.1(1) definition total charitable gifts. 65
Charitable Donations on Death Current Rules (cont.): Gifts made by a trust or an estate that is not a GRE may be claimed by the trust only and carried forward five years. The donation will be deemed made by the estate and valued at the time that the property is transferred to the charity. 1 Gifts made by will are no longer deemed to be made by the individual immediately before death. This will likely make the administration of the estate more complicated, as the executor may not know the value of the donation (or the remaining estate) until the donation is actually made. Where a charity has been designated as the beneficiary of an RRSP, TFSA, RRIF, or death benefit on life insurance policy of the deceased, the donation will be deemed to have been made by the GRE, and is therefore eligible for the current rules. 2 Donations claimed on the Terminal T1 or on the prior year T1 continue to be eligible to offset 100% of taxable income, whereas the 75% threshold continues to apply for donations claimed by the estate. 3 New S.104(13.3) restricts a trust s ability to file a S.104(13.1) and S.104(13.2) designation where the trust s taxable income would be greater than nil. The designation will only allow the trust to use losses, but does not allow a trust to use tax credits. Donation tax credits could be lost as a result. The new legislation also allows individuals to claim donations made by their spouse. 4 However, gifts made by the Estate (by will) cannot be claimed by the spouse. 1. S.118.1(5). 2. S.118.1(4.1) and (5.2). 3. S.118.1(1) definition total gifts. 4. S.118.1(1)(c)(i)(A) definition total charitable gifts, previously allowed under CRA administrative practice. 66
Many interest groups, including STEP, wrote to Finance to request changes to the current rules for trusts and donations, including a recommendation to extend the increased flexibility for donations made by estates past the 36 month period, for reasons such as estate litigation. The January 2016 proposed changes to S.118.1(5.1) and the definition of total charitable gifts in S.118.1(c)(i)(C) extend the flexibility for donations made up to 60 months by a GRE for this purpose the 36 month requirement for a GRE is disregarded, however, all other GRE must continue to be met. Donations made by the Estate after 36 months and within the 60 month period can be applied to: Terminal T1; Prior year T1; Current year of Estate; and Carried forward 5 years by the Estate. 67
The donations cannot be carried back to a prior year of the Estate. As noted in the February 12, 2016, letter from STEP to Finance, a concern is raised in the circumstances where post mortem planning relating to private company shares is carried out by the Estate. For example, where a S. 164(6) loss carry back to the Terminal T1 is made, and a deemed dividend is included in the Estate s income. If the donation were made by the Estate in a subsequent year (after 36 months due to estate litigation), the donation credit would not be available to shelter the tax on the deemed dividend. As a result, all or a portion of the donation credit could be stranded. A recommendation is made to amend the proposed changes to include a carry back of the donation tax credit to any prior year of the estate or GRE. 68
A recommendation was made to modify the increased flexibility for donations available for Estates to also apply to all Life Interest Trusts; however, no changes were proposed by Finance. The January 2016 proposed changes did, however, address another concern raised for Life Interest Trusts (spousal trusts, alter ego trusts, joint partner trusts etc.). The current rule in S.104(13.4)(a) results in a deemed year end of the trust on the death of the Life Interest Beneficiary this makes it impossible for the Trustees to make a donation to shelter the tax on the deemed gain in the same taxation year. The proposed change to S.118.1(c)(ii)((C) definition total charitable gifts allows donations to be claimed on the deemed year end of the Trust, provided the donation is made by the tax filing due date of the calendar year in which the death occurred. For example, if the beneficiary dies on December 1, 2016, there would be a deemed year end for the Trust on this date. The filing due date for this return would be March 31, 2017. Provided the donation is made by March 31, 2017, the donation tax credit could be claimed on the December 1, 2016 Trust return. 69
To be eligible, the property donated must have been held by the Trust at the time of the death of the benefit (or substituted property). Overall, this is a great change; however, the timeframe for the Trustees to make donations is very tight, particularly for deaths that occur late in the year. 70
For Life Interest Trusts, in order to obtain a donation tax credit, the gift must otherwise qualify as a donation. Finance has not proposed any changes nor has the CRA issued anything definitive in this regard. Under the old and current rules, CRA and Finance have stated that no donation credit will arise if a charity is receiving the amount as a capital beneficiary of the Life Interest Trust. In addition, in order for a donation to be considered a gift: The trustees must have the discretionary power under the terms of the Will or Trust to make gifts; The trustees must exercise this power; and Property must be transferred to the charity. These requirements put a significant amount of pressure on trustees to exercise this discretion and make donations quickly (often by March 31 st of the year following death). For Life Interest Trusts, it is important to provide the Trustee with the discretionary power to make donations. Various interest parties have written to Finance to request amendments and/or clarification with respect to testamentary gifting of a residual interest in the trust property (i.e., Charitable Remainder Trusts). 71
These rules extend to Charitable Remainder Trusts ( CRT ). Inter vivos CRT: If an individual settles a Trust with property, the income of which may be used for one or more beneficiaries during their life time, with the capital being donated upon the death of the beneficiaries, the individual would be entitled to a donation tax credit in the year the Trust is established. In oversimplified terms, the amount of the donation will depend on the facts, however, the donation will be based on the net present value of the future gift, after considering the life expectancy of the beneficiaries and other factors. Under the old rules, a Testamentary CRT could give the same result, because the gift was deemed to have been made by the individual on death and claimed on the Terminal T1. Under the current rules, however, there are concerns whether a Testamentary CRT still works. Issues created by the new GRE rules include: The donation is no longer claimed on the Terminal T1; Is the remainder interest property (or substituted property) owned by the deceased on death? Is a 36 month (or proposed 60 month) window realistic to assume the beneficiaries will die and the donation will be made? Is the charity a capital beneficiary of the life interest trust? If so, no donation credit. To address these issues, more legislative changes are required. 72
The 2016 Federal Budget eliminated the proposed legislation that would extend the zero capital gains inclusion rate to donations of cash proceeds from the sale of Private Company Shares and Real Estate. The new GRE rules cause concerns relating to gifts of Private Company Shares by the GRE to a Public Foundation. The GRE is deemed not to deal at arm s length with the charity because the charity is beneficially interested in the Trust; accordingly, the gift would not be an excepted gift and would therefore be a non qualifying security. This could be a concern when shares are not expected to be sold or redeemed in the near future. Further discussion on this topic is outside the scope of this presentation. 73
For the GRE flexible donation rules to apply, S.118.1(5.1)(b) requires a gift of property acquired by the Estate on and as a consequences of death (or substituted property). During the 2015 STEP conference CRA Q&A #11, the CRA clarified their position on substituted property for shares of private companies in respect of two scenarios (paraphrased here for simplicity): Property (e.g. cash) received as dividends on the shares would not be considered substituted property. As part of post mortem planning, if the shares of the private company were exchanged for shares of another corporation, and the shares of the other company were redeemed, the redemption proceeds would be considered substituted property. It is important to consider the source of donated property, especially after post mortem planning implemented. 74
S.118.1(5)(b) deems the gift to be made by the Estate at the time the property is donated. Previously, the value of the property gifted on death was relevant. Now the value of the property is determined at the time it is donated. If a property increases in value, the Estate will likely have a capital gain (in addition to the deemed capital gain on the Terminal T1). This should be okay, as the amount of the donation credit would also increase, and this would offset the increased tax on the capital gain. However, if the value of the property decreases in value, the amount of the donation credit would not fully offset the amount of the capital gain on death unless a S.164(6) loss carryback plan is implemented. To protect against value fluctuations, Executors should consider making the donations as soon as possible (and definitely while a GRE or within the 60 month window). 75
The donation of a listed security will have a zero capital gain inclusion rate S.38(a.1). New subparagraph (ii) extends this treatment to the donation of listed securities by a GRE. The January 2016 proposed amendments extend it further for donations made by the Estate within the 60 month window provided the Estate meets all of the GRE criteria (except the 36 month requirement). This beneficial treatment is not available to Life Interest Trusts (because S.70 did not deem the disposition to occur). If the value of the listed security changes after death and before the donation, there will be no impact on the zero capital gain on death it will still be zero. However, the amount of the donation will be the value of the security at the time of donation. If the Terminal T1 return is due to be filed before the donation is made, a cash flow concern arises. The Terminal T1 would need to reflect the gain on the deemed disposition of the securities, and would not reflect the donation credit. Tax would be payable and interest could apply, until the Terminal T1 is amended to reflect the donation. 76
When an individual dies holding shares of a private company, post mortem planning is often required to prevent double or triple taxation. Depending on the post mortem plan implemented, the tax payable on the value of the shares can be payable by: Terminal T1 if no planning, if shares are subsequently sold, or if pipeline planning implemented (and possibly bump planning). (NOTE: WHEN CONSIDERING A PIPELINE PLAN, S.84(2) MUST BE CONSIDERED! Further discussion is outside the scope of this presentation.) Estate if S.164(6) loss carry back planning. Generally, the objectives include matching to ensure: The tax is payable by the eventual owner of the shares; Any losses triggered on the planning can be applied against related gains; and Any significant donation credits can be applied against the tax payable on the value of the shares. If significant donations are planned, anticipating and possibly modelling out the possible post mortem plans would be recommended, to identify where the tax sticks. This way the planner can ensure that the Will and/or the Trust document provide the appropriate terms to enable the donation tax credits to that offset the tax. 77
The new flexible donation rules make matching of the donation credit against the tax payable on the value of the shares much easier, provided the Estate is a GRE, and the donation is made within 36 months. As previously mentioned, a donation by the Estate within the 37 60 month window would not work well with a S.164(6) loss carry back plan or a hybrid plan, because the Estate cannot carry the donation credit back to a prior year. Maintaining GRE status is very important! If at risk of losing status, Executors should make the donation as soon as possible. When an individual has multiple wills, there was a lot of uncertainty a year ago regarding whether one or more estates were created on the death of the individual. During the 2015 STEP conference CRA Q&A, CRA confirmed their position that only one estate will be created for tax purposes. This helps simplify the matching of the donations. 78
Under the current rules, where shares of a private company are held by a Life Interest Trust, there could be a horrible mis match between the tax payable on the deemed capital gain on the death of the beneficiary and the donation tax credit. In many cases, the tax would be payable on the Terminal T1 of the Life Interest Beneficiary, and the donation credit would be stranded in the Trust. Under the current rules, the S.164(6) loss carry back plan with a late filed S.105(13.2) designation is the only plan where the Trust could donate to offset the tax. For Life Interest Trusts, many interest groups requested Finance to address the mis match between the tax liability on the Terminal T1 of the Life Interest Beneficiary, and a subsequent donation made by the Trust. The January 2016 proposed changes applicable to Life Interest Trusts alleviate many of the mis match problems. The proposed S.104(13.4)(b.1) effectively reverts everything back to the old rules, where the tax on the deemed disposition on the death of the Life Interest Beneficiary is payable by the Trust. This makes matching of donations made by the Trust to the tax much easier under most post mortem plans. 79
The top part of this table illustrates where the tax sticks under various post mortem plans. The bottom part of the table illustrates where the donation could be made. For shares of private companies owned by individuals, with proper planning, it should be possible to offset the tax with the donation credit. 80
Current rules: For shares of private companies held by a Life Interest Trust, under the current rules the tax would be payable on the Terminal T1 of the Life Interest Beneficiary, whereas, the donation credit would only be available to the Trust (a mis match). The Loss Carry Back plan is the only plan where a donation credit could offset the tax, because the resulting deemed dividend is taxed in the Trust. Alternatively, the Estate of the Life Interest Beneficiary would need to make donations from other property owned by the Beneficiary. Proposed rules: The proposed changes are very welcome we re effectively back to the old rules to match donations. If an election is made to tax the Trust income on the spouse s Terminal T1, careful planning will be required if donations are contemplated. 81
John dies holding: Public company shares $6 m to be donated; Other investments $15 m to go into a spousal trust where wife is entitled to income only, no capital encroachment; capital to go to charity after wife s death; RRIF $1 m charity designated as beneficiary under the plan; Common shares of private OPCO $10 m (nil ACB and PUC) to go to adult children. John s Alter Ego Trust holds: Preferred shares of a different private company (remainder of a wasting freeze; nil ACB and PUC) $20 m ability to encroach on capital, on John s death 50% to adult children and 50% to charity. 82
The Executor must designate the Estate as a GRE. 83
Public company shares $6 m donated: Zero capital gains inclusion rate on Terminal T1 if donated within 60 months by GRE; Donation credit flexibility if donated within 36 months; The amount of the donation credit will be based on the value of the public company share at the time it is transferred to the charity; If donated within the 37 60 month period, cannot claim donation credit on prior year of Estate: For OPCO post mortem planning, donation credits could be stranded if using loss carry back plan; Would need to use alternative plan where tax is payable on the Terminal T1 this may not be the optimal post mortem plan. 84
Other investments $15 m spousal trust: No tax triggered on death due to spousal rollover; Under old rules would likely be a Charitable Remainder Trust and ~$7 m donation credit available on Terminal T1; Under current rules, donation deemed made when GRE makes the donation is granting of residual interest considered property owned on death? Unlikely wife will die and the property donated within 60 month period; uncertainty regarding donation credit on death of spouse if charity is considered a capital beneficiary of the spousal trust; Consider giving trustees discretion to make donations after wife s death. 85
RRIF $1 m donated Income tax triggered on Terminal T1 ~$.5 m; Donation deemed made by the GRE, flexible rules available, likely apply credit of ~$.5 m against tax on RRIF. 86
OPCO shares $10 m gifted to adult children Tax on capital gain on death ~$2.5 m; Post mortem planning required to prevent double tax. Depending on which plan implemented, tax will be payable either on Terminal T1 or by Estate; Executor would need to match the donation credit from the public company shares against the tax on the shares. 87
Alter Ego Trust Preferred shares $20 m 50% to children and 50% to charity Tax on capital gain on death ~$5 m Post mortem planning required to prevent double tax. Depending on which plan implemented, tax will be payable either on deemed year end of Trust on death, or in a subsequent year of the Trust. Trustee would need to match the ~$5 m donation credit against the tax on the gain If tax sticks on date of death return Trustee would need to act quickly to implement the post mortem planning and make the donation by March 31 st of the following year. If tax sticks to a subsequent year of the trust Trustee has more time to implement planning and make the donation. Trustee must ensure that the property donated was owned by the Trust on John s death (or substituted property). If preferred shares redeemed and cash donated, the cash should be considered substituted property. If more than 50% of the Trust property was donated, some donation tax credits would likely not be utilized (tax on capital gain less than donation credit; unable to apply donation credit to tax liability on John s personal estate). 88
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