Blog: Changes coming to taxation of estates, trustsJanuary 6th, 2016
2016 Changes to the Taxation of Estates, Testamentary and Life Interest Trusts:
Implications to Post-Mortem Tax Planning Involving Shares of Private Corporations
When an individual dies owning shares of a private corporation, post-mortem tax planning alternatives are evaluated by the estate trustees and their professional advisors with a view to eliminating or minimizing the instance of double taxation. A similar analysis is undertaken when assets are owned by a life interest trust (i.e., alter ego trust, joint partner trust, or spousal trust) after the death of the life tenant.
When an individual dies owning private corporation shares, typical post-mortem planning may incorporate share redemptions or cancellations that occur within the first taxation year of the estate. Technically, this type of strategy is referred to as “164(6) planning”, in reference to the subsection of the Income Tax Act (Canada) (the “Act”) that comes into play. This technique generally eliminates the capital gain realized upon death by creating both a capital loss and a dividend that are realized by the estate upon the redemption or cancellation of the same private company shares. Double taxation is eliminated, as subsection 164(6) of the Act allows the capital loss to be carried back from the estate to the terminal tax return of the deceased. Only one level of tax is then paid; that is, by the estate on the dividend.
In situations in which a life tenant dies, and a life interest trust owns shares of a private corporation, there is also the realization of a deemed disposition and capital gains tax payable on the shares. Following the life tenant’s death, the life interest trust will typically undergo a transaction within the subsequent three years to redeem or cancel the shares of the private corporation and create the capital loss and a resulting deemed dividend taxable to the trust. The capital loss can be carried back under Section 111 of the Act to the trust return for the taxation year of the life tenant’s death to generally offset the capital gain that was realized on the deemed disposition of the shares. Again, this planning effectively results in the elimination of the capital gain and a realization of a dividend by the trust, so that double taxation is avoided.
Beginning in 2016, estates, testamentary trusts, and life interest trusts will be subject to new income tax legislation (see Bad News for Testamentary, Spousal Trusts – Major Changes to the Estate Taxation Rulebook are on the Way, MaryAnne Loney, The Lawyers Weekly, Vol. 34, No. 42, March 20, 2015).
One of the implications of the new legislation is that only an estate that qualifies as a Graduated Rate Estate (“GRE”) will have the ability to utilize the subsection 164(6) technique. It is therefore imperative that estate trustees of estates owning shares of private corporations and their advisors take the appropriate steps to ensure that the estate qualifies as a GRE and does not become tainted.
Perhaps of greater concern are the changes imposed on life interest trusts. When the life tenant dies, the new legislation results in the capital gain arising upon the deemed disposition to be taxable in the life tenant’s personal income tax return and not within the life interest trust itself. If the loss plan described above is subsequently pursued, a mismatch will occur. There is no provision within the Act to allow the trust to elect to apply the capital loss realized on the shares’ redemption or cancellation against the capital gain that was reported by the life tenants at the time of their death.
One solution to this mismatch may be to carry back the subsequent loss to the trust taxation return for the year in which the life tenant died. The estate trustees would then file a subsection 104(13.2) designation. This designation would “pull back” the capital gain from the deceased’s personal tax return to the trust to be offset by the carried-back capital loss. Currently, the Act does not permit a late-filed subsection 104(13.2) election. Many have wondered about the Canada Revenue Agency’s (“CRA”) administrative policy on this matter. At the 2015 STEP Annual Conference, the CRA noted that they would generally accept a late-filed subsection 104(13.2) designation and would reassess a beneficiary’s return if the tax year to which it relates is not statute-barred and so long as the designation “does not constitute retroactive tax planning other than loss carry back”.
The comments that were made by the CRA are far from definitive. Until the late-filed subsection 104(13.2) designation method is tested by actual filings after the new 2016 income tax legislation is operative, uncertainty in the strategy will remain.
This article was originally published in The Lawyers Weekly. View the published article here: Karen Slezak & Ali Spinner – Changes coming to taxation of estates, trusts
Connect With The Authors
Karen Slezak BBA, CPA, CA, CFP, TEP – Karen is a partner with Crowe Soberman’s Tax Group and leads the firm’s Estates & Trusts Group. She is a frequent speaker at conferences on tax minimization and wealth accumulation strategies for high net-worth individuals and is often quoted in major dailies such as the Globe and Mail and the Toronto Star.
Connect with Karen via email or call 416.963.7109
Alexandra (Ali) Spinner BA, MMPA, CPA, CA, TEP– Ali is a partner in the firm’s Tax Group. She is involved in all aspects of the firm’s domestic and international tax practices. She is also experienced in estate and trust planning, corporate structures, reorganization and tax planning.
Connect with Ali via email or call 416.963.7129
This article has been prepared for the general information of our clients. Specific professional advice should be obtained prior to the implementation of any suggestion contained in this article.