This paper will discuss a limited selection of Canadian income tax issues arising in estate administration1 as follows.
- Testamentary trust status
- Distribution to a non-resident beneficiary – section 116 compliance
- Reassessment issues – timing and who can be assessed
It is assumed that the estate is a resident of Canada for income tax purposes, i.e., applying the common law test of residence, 2 central management and control of the estate is in Canada.
I. Testamentary Trust Status
A critical requirement for graduated rate estate3 status is that the estate must be a testamentary trust as defined in subsection 108(1). A trust that is provided for in the Will of the deceased is not automatically a testamentary trust and a trust that is initially a testamentary trust may later cease to meet the statutory definition and therefore cease to be a testamentary trust. Loss of testamentary trust status at any time in the 36 months following the death of the deceased taxpayer results in loss of graduated rate estate status and a deemed year end.4 Graduated rate estate status is important for certain income tax advantages including, but not limited to, the following:
- Entitled to the benefit of the marginal rates of taxation for up to 36 months
- May have a non-calendar year end
- Not required to make tax instalment payments
- Greater flexibility with respect to charitable giving
The definition of "testamentary trust" in subsection 108(1) states that a testamentary trust is a trust that arose on and as a consequence of the death of an individual (the "Deceased"). The two exclusions in paragraphs (a) and (c) of the definition5 will cause a trust to not be a testamentary trust and while paragraph (d) thereof is considered an anti-avoidance rule, it is easy to fall into. These provisions are discussed below.
Testamentary Trust definition, paragraph (a) exclusion
Pursuant to paragraph (a) of the definition, a trust created by a person other than the Deceased will not qualify.
Testamentary Trust definition, paragraph (c) exclusion
Pursuant to paragraph (c) of the definition, if property is contributed to the trust otherwise than by the Deceased on or after the Deceased's death and as a consequence thereof, the trust will not qualify. The leading case on the meaning of "property ... contributed to the trust" is Greenberg Estate v. The Queen, 6 which held that a contribution was a voluntary payment, made for no consideration and for the purpose of increasing the capital of the estate.
For example, if the estate is a beneficiary of an inter vivos trust, CRA's view is that this is problematic.7 Further, while not entirely clear, it appears that if property pours into an estate upon the termination of an alter ego trust as a consequence of the death of the so-called primary or life beneficiary, the exclusion in paragraph (c) may be triggered for the following reasons:
- While at first instance, it might appear that the Deceased contributes the property to the estate, strictly speaking, property is contributed to the estate by the alter ego trust.
- Further, although the Deceased contributed property to the alter ego trust when such trust was settled, it is possible that the initially-contributed property may no longer exist at the time the alter ego trust terminates. If so, absent a substituted property or tracing concept (which is not provided for in the particular section), the property contributed by the alter ego trust is not the same property that the Deceased contributed upon settlement of the trust.
- Finally, while the death of the Deceased is a triggering event causing those clauses of the alter ego trust dealing with distribution upon the death of the Deceased as primary beneficiary to become operative, it seems that the property is contributed as a consequence of the terms of the alter ego trust rather than as a consequence of the Deceased's death. Arguably, paragraph 248(8)(a)8 may address this last concern, if the alter ego trust to be "a will or other testamentary instrument". This saving provision states that a transfer of property as a consequence of terms of "a will or other testamentary instrument" to be a transfer as a consequence of the death. However, while an alter ego trust is often colloquially referred to as a will substitute, it is not clear that it is a "testamentary instrument".
If the Deceased was the owner of an insurance policy where his/her estate is designated as beneficiary and the insurance proceeds are paid into the estate, this does not cause a problem with qualification. CRA does not regard the payment of the insurance proceeds as a contribution otherwise than by the Deceased, because the Deceased was the policy owner.9 This should also be the case where the estate is designated as beneficiary of the Deceased's registered plans (i.e., RRSP, RRIF, TFSA).
Testamentary Trust definition, paragraph (d) anti-avoidance re indebtedness
The anti-avoidance rule in paragraph (d) of the definition was enacted at a time when all testamentary trusts enjoyed the benefit of marginal rates and was intended to prevent income splitting whereby individuals would lend funds to the trust so the estate could generate investment income taxed at marginal rates. While the marginal rate advantage is no longer automatically available, paragraph (d) remains part of the definition and can be inadvertently triggered. Paragraph (d) is triggered where the trust incurs a debt to a "specified party" or has a debt that is guaranteed by a "specified party". A "specified party" is a beneficiary or a person who is non-arm's length with a beneficiary of the trust. Therefore, if the estate has an amount owing to a beneficiary or any person who is non-arm's length to a beneficiary, this is problematic unless the situation fits into one of the following exclusions:
- a debt of the trust to a
"specified party" who is a beneficiary because the
"specified party" in its capacity as beneficiary can
enforce payment of income or capital gains of the trust.
This exclusion likely derives from the "payable" prerequisite for income of the trust to be taxed in the hands of a beneficiary pursuant to subsection 104(13) and deducted from the income of the trust pursuant to subsection 104(6). An amount is deemed not to be payable for this purpose unless it is paid or the beneficiary is entitled to enforce payment.10 In this case, although the trust has an amount owing to the beneficiary, this debt obligation does not trigger paragraph (d).
- a debt of the trust owed to a
"specified party" which arose because of a
service11 rendered by the "specified party" to
or for the benefit of the trust.
For example, if a "specified party" is a professional who has billed the trust for his/her professional services, it appears that the resultant debt obligation of the trust should not trigger paragraph (d). If a "specified party" charges the trust a fee for guaranteeing a loan, it seems that the debt obligation arising from the guarantee fee may not trigger paragraph (d), because it arises from a service provided, but the loan itself should be reviewed.
- a debt owed to the "specified party" if:
- the debt arises because the "specified party" made a payment on behalf of the trust
- the trust reimburses the "specified party" in full within 12 months of the payment12
- it is reasonable to conclude that the
"specified party" would have been willing to make the
payment if the "specified party" and the trust were
arm's length (the "Arm's Length Reasonableness
It is important to note that the Arm's Length Reasonableness Requirement does not apply where the trust is the estate of the Deceased and the payment is made within the first 12 months following death.13 See further discussion below.It is not clear how the Arm's Length Reasonableness Requirement should be applied. Under the ITA, a beneficiary of a trust is deemed to be non-arm's length with the trust.14 Does the Arm's Length Reasonableness Requirement mean that one ignores the fact that causes the non-arm's length relationship, i.e., that the particular "specified party" is a beneficiary of the estate? If so, then it seems that the expectation of receipt of funds or property under the terms of the Will cannot in and of itself be the reason that the "specified party" would be willing to make the payment. The preamble to the Arm's Length Reasonableness Requirement uses the words "it is reasonable to conclude." This suggests an objective test. Arguably, an arm's length person would be willing to pay an amount on behalf of another person if there are arrangements for reimbursement in place, perhaps in writing, and the arm's length person is satisfied with the covenant to reimburse. The latter imports a creditworthiness check and possibly compensation such as interest.
Where an estate is illiquid, caution must be exercised with respect to paragraph (d). For example, a "specified party" could pay funeral expenses or other expenses on behalf of the estate and as long as he/she is fully reimbursed within 12 months of death, paragraph (d) is not triggered. Providing assistance for funding of tax liability may be problematic as the taxes may not be payable within the first 12 months following death and therefore would not be reimbursed within 12 months of death. For example, where an individual passes away in January, the terminal income tax return is not due until April 30 of the following calendar year, which is more than 12 months following death. In this case, if a "specified party" pays the tax liability on behalf of the estate at the time of filing of the terminal income tax return, he/she will necessarily not be reimbursed until greater than 12 months following death. It is important to note that written application may be made to CRA to extend the above period, but the written application must be submitted within the statutorily stipulated 12 month period, i.e., within the 12 months following death. Also, the extension is subject to CRA's determination of reasonableness. Absent such extension, the Arm's Length Reasonableness Requirement must be satisfied where the reimbursement is made outside the first 12 months following death. The choice of 12 months following death may seem arbitrary,15 but it aligns with the so-called executor's year.
1. Unless otherwise indicated all statutory references herein are to the Income Tax Act (Canada), RSC 1985, c.1 (5th Supp.), as amended (the "ITA").
2. See Fundy Settlement v. The Queen, 2012 SCC 14.
3. See subsection 248(1), ITA definition of "graduated rate estate". There are other requirements too.
4. See subsection 249(4.1), ITA.
5. Paragraph (b) is an exclusion relating to some trusts created before November 13, 1981 and has been assumed to be irrelevant for purposes of this discussion.
6. 97 DTC 1380 (TCC), at paragraph 10.
7. For example, see CRA document no. 2011-0417391E5, June 26, 2012 and 2013-0493671C6, October 11, 2013. See also question 3, 2016 STEP Roundtable.
8. Paragraph 248(8)(a) states:
"For the purpose of this Act,
(a) a transfer, distribution or acquisition of property under or as a consequence of the terms of the will or other testamentary instrument of a taxpayer or the taxpayer's spouse or common-law partner or as a consequence of the law governing the intestacy of a taxpayer or the taxpayer's spouse or commonlaw partner shall be considered to be a transfer, distribution or acquisition of the property as a consequence of the death of the taxpayer or the taxpayer's spouse or common-law partner, as the case may be".
9. See question 2, 2008 STEP Roundtable.
10. See subsection 104(24), ITA.
11. For this purpose, a service is stated not to include a transfer or loan of property.
12. Application may be made to the Minister for a longer period but the application must be made within the 12 month period.
13. Similar to the above, application may be made to the Minister for a longer period.
14. See paragraph 251(1)(b), ITA.
15. Based on the legislative history, it appears that in the earlier version of draft legislation that culminated in current definition of "testamentary trust" and in particular, the anti-avoidance rule in paragraph (d) therein did not contain any exception to the Arm's Length Reasonableness Requirement. The Department of Finance released a comfort letter dated April 28, 2004 presumably in response to representations indicating that it would recommend a modification to the Arm's Length Reasonableness Requirement and a portion of such comfort letter is reproduced below:
"In your letter you have expressed concern that the last condition in subparagraph (d)(iii) of that definition—that the specified party would have been willing to make the payment if the specified party dealt at arm's length with the trust or estate—will, in practice, not be satisfied in the case of the vast majority of estates of deceased individuals. We understand from your letter that this is because of the legal limitations placed on the estate executor's ability to deal with property of the estate, such that family members of a deceased individual will often undertake to make payments on behalf of the estate—for example, the payment of funeral expenses or a tax liability—without any expectation, or arrangement to the effect, that the reimbursement by the estate of such payments include an arm's length amount of interest. As a result, under that proposed paragraph of the definition "testamentary trust" the estate would lose its status under the Act as a testamentary trust.
We are of the view that the loss of an estate's status as a testamentary trust, in these circumstances, would be inconsistent with the policy objectives of proposed paragraph (d) of the definition. Therefore, we are prepared to recommend a modification to proposed subparagraph (d)(iii) of the definition "testamentary trust", to provide that the requirement in clause (C) of that subparagraph—that the specified party would have been willing to make the payment if the specified party dealt at arm's length with an individual's estate—not apply where the payment for or on behalf of an estate is made within the first 12 months after the individual's death (or, where written application has been made to the Minister of National Revenue by the estate within that 12 months, within any longer period that that Minister considers reasonable in the circumstances). As a result, where the remaining conditions of proposed subparagraph (d)(iii) of that definition are satisfied, to the extent that the circumstances do not involve an attempt to use the estate as a vehicle for income splitting, the anti-avoidance provisions of the Act would not be expected to apply to cause the estate to lose its status as a testamentary trust."
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