Tag: Income Tax Act
Changes made in 2016 to the Income Tax Act resulted in unfair treatment to disabled Canadians by restricting which types of trusts were eligible for a “principal residence exemption” (PRE). Now the Department of Finance has issued a letter of comfort, attempting to rectify these unfair changes.
What is the PRE?
In short, the PRE allows Canadians, when selling their principal residence, to avoid being taxed on their realized capital gains. Without this exemption, someone selling their principal residence would be taxed on 50% of their capital gains, which could be very significant when taking into account the value of the property.
Injustice with the Current Rules
The changes introduced in the Income Tax Act in 2016 meant only three categories of trusts could claim the exemption. The first was life interest trusts, the second was qualified disability trusts, and the third was inter vivos or testamentary trusts established for a minor child with one or more parents being deceased.
This definition significantly restricted the type of trusts that were eligible to claim the PRE. Because the second category, qualified disability trusts, are testamentary trusts (resulting from death), this meant that disabled taxpayers who were the beneficiaries of inter vivos trusts (not resulting from death) could not claim the exception and would have capital gains on their principal residence taxed at the highest rate.
In practice, this would result in an unexpected and significant amount of income tax being due 21 years after the creation of the trust, because after 21 years the trust will have been deemed to have disposed of its capital property. If a disabled beneficiary did not have enough funds available in the trust to pay the capital gains tax, there could be severe consequences.
In response to this problem, the Department of Finance has issued a comfort letter stating that it will make recommendations to the Minister of Finance to fix the issue. This would involve amending the Income Tax Act to permit certain inter vivos trusts to claim the PRE. This would also be subject to certain conditions. Firstly, the beneficiary needs to be a resident in Canada who is disabled (able to claim the disability tax credit). Secondly, the beneficiary must be a child, spouse, common-law partner, or former spouse or partner of the trust’s settlor. Thirdly and finally, no one other than the qualifying disabled beneficiary can receive the income or capital of the trust. If these three conditions are satisfied, the disabled beneficiary would be able to claim the tax exemption for their principal residence.
Fixing the injustice
This proposal was made recently and has not yet been implemented. Any laws that put disabled Canadians at a disadvantage, even inadvertently, ought to be changed and the injustice should be corrected. Implementation of these recommendations would be welcome and cannot arrive soon enough.
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Suzana Popovic-Montag & Sean Hess
Immigrants come to Canada from many countries around the world and when they die their estates in Canada can involve foreign beneficiaries and asset transfers. According to an article in the Ottawa Citizen, most Canadians don’t seem to have the foggiest notion of how many immigrants and refugees this country admits every year. When asked the question, during one of Citizenship and Immigration Canada’s annual tracking surveys, 43 per cent of the Canadian adults polled wouldn’t even hazard a guess. Fully one-third thought the number was less than 100,000 a year. In fact, from 2001- 2014 Canada opened its doors to about 250,000 immigrants and refugees a year. (Only nine per cent of those surveyed suggested a number remotely close to that.) Although this newspaper article is from August 27, 2014 the statistics are likely much the same today.
The total number of foreign-born Canadians is interesting. According to the 2016 Census, there were 7,540,830 foreign-born individuals who came to Canada through the immigration process, representing 21.9% or over one-fifth of Canada’s total population. This proportion is close to the 22.3% recorded during the 1921 Census, the highest level since Confederation in 1867. In urban areas the percentage is higher, with Toronto currently at approximately 46%. Historically, immigrants and their families have always comprised an ongoing significant contribution to Canada’s population composition.
So what are some of the challenges an estate trustee or lawyer faces when there is a deceased person with beneficiaries outside of Canada? There are many tax considerations to be dealt with on an average estate, even without any international aspects to it. One additional concern with international inheritance is Section 116 of the Income Tax Act which creates a potential additional obligation and liability for estate trustees and lawyers. Persons in Canada, who handle money that is paid to a “non-resident” will want to review Section 116 of the Income Tax Act . After reviewing the section everyone should consider whether a hold back of 25% of the monies to be paid would be appropriate, until further clearance is obtained.
Thank you for attention,
If a Registered Retirement Savings Plan passes outside of an Estate, for example to a spouse or child, who pays the tax – the recipient beneficiary or the Estate?
In order to answer this question, first consider the terms of the Will.
If the Will does not clearly set out who is responsible, attention must be turned to the statute and common law.
According to section 160.2(1) of the Income Tax Act, the deceased testator and the recipient of the RRSP are jointly and severally liable for the payment of the tax. The section specifically states that “…the taxpayer and the last annuitant under the plan are jointly and severally, or solidarily, liable to pay a part of the annuitant’s tax…”.
Ontario common law has, however, held that the payment of any tax liability with respect to an RRSP remains the primary obligation of the estate. Payment should be sought from the RRSP recipient, only if there are insufficient assets in the estate to satisfy the tax obligation.
In Banting v Saunders, Justice J. Lofchik held that:
“…the estate, rather than the designated beneficiaries, is liable for the income tax liability arising from the deemed realization of the R.R.S.P.’s and R.R.I.F.’s so long as there are sufficient assets in the estate including the bequest to Banting, to cover the debts of the estate and it is only in the event that there are not sufficient assets in the estate to cover all liabilities that the beneficiaries of the R.R.S.P.’s and the R.R.I.F.’s may be called upon.”
Nonetheless, as set out in O’Callaghan v. The Queen, the CRA may first seek payment directly from the RRSP recipient, instead of the estate, especially if there is a possiblity that there are insufficient assets in the estate to satisfy the tax.
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Under the common law, trustees are not permitted to take compensation unless authorized to do so by the will or trust document, an agreement of all the beneficiaries, or court order. In Ontario, trustees have a statutory right to compensation. Section 61 of the Trustee Act provides for two types of compensation arrangements: (i) the “fair and reasonable allowance for the care, pains and trouble, and the time expended in and about the estate” or (ii) compensation “fixed by the instrument creating the trust”.
Bequests made under a will, being capital distributions, are not taxed as income in Canada. On the other hand, compensation claimed by an estate trustee will be subject to income tax.
But does an estate trustee have an obligation to charge HST on the compensation?
The Canada Revenue Agency (CRA) takes the position that executor’s compensation received for administrating an estate, not performed “in the regular course of business”, is income from employment or an office under section 3 of the Income Tax Act (“ITA”). This compensation is therefore subject to income tax for the year the compensation is paid, even if the work was performed over the course of two or more years. An executor who does not administer estates “in the regular course of business” does not appear to have an obligation to charge HST in addition to the compensation.
If the executor’s compensation is considered to be income from employment or an office, the estate trustee or administrator must request a payroll account be opened for the estate and generate a t4 slip for the estate trustee or executor. Pursuant to section 153(1) of the ITA, the estate must withhold an amount determined by the Income Tax Regulations.
If the executor administers estates “in the regular course of business,” HST must be imposed pursuant to Part IX of the Excise Tax Act (“ETA”). Accordingly, trust companies must charge HST for any compensation claimed. Whether a lawyer must charge HST on compensation for administration of an estate is a question of fact. A lawyer whose regular practice includes the administration of estates must charge HST on claimed compensation. Conversely, a lawyer who does not administer estates as a part of his or her practice but acts as an executor for the estate of a friend or family may not be under an obligation to charge HST on the compensation they claim. In this case, the compensation would be considered income from employment or an office rather than income earned in the regular course of business.
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Earlier this week I blogged about planning considerations for establishing a testamentary trust that may qualify as a graduated rate estate. To continue on the topic of planning consideration in light of the recent changes to the Income Tax Act, I thought it would be fitting to highlight some considerations regarding the newly introduced Qualified Disability Trust (the “QDT”).
One planning technique that is commonly used when disabled beneficiaries are involved is a Henson Trust. It is important that testators understand that the creation of a Henson Trust does not automatically qualify as a QDT since the disabled beneficiary must be a recipient of the Disability Tax Credit. Accordingly, it would be prudent to highlight that it is possible that the income earned from the Henson Trust may be subject to top-rate taxation.
It is also quite common for a testator to identify the beneficiaries of a testamentary trust as a class of beneficiaries such as children or issue. However, given that testamentary trusts are now taxed at the highest rates, a testator may wish to specifically name the beneficiaries of the Trust in the event that the named beneficiary becomes disabled during the length of the testamentary trust. In doing so, the testator will have satisfied one of the requirements for the Trust to be designated as a QDT.
The limit of one QDT election per beneficiary also raises some estate planning challenges. It may be necessary to explore planning solutions in situations where the named beneficiary of an insurance trust and a testamentary trust is disabled. In this case, the testator may want to consider whether both trusts are necessary.
It is extremely important that clients understand the estate planning challenges that arise when attempting to take advantage of the graduated rate of taxation, and should discuss any estate planning options with a tax professional before a final decision is made.
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Our blog has previously discussed Graduated Rate Estates (“GRE”) and changes to the Income Tax Act, which now limit the benefit of graduated rates of taxation for up to 36 months from the date of death if the estate qualifies as a testamentary trust, and is designated as a GRE in its first taxation year.
Changes to the tax benefits of testamentary trusts raise a number of planning considerations that should be considered when making an estate plan. First, when drafting a testamentary trust, a key consideration should be whether it would be beneficial to the estate and its beneficiaries to delay the distribution of the estate for up to three years to potentially maximize the progressive taxation rates of all income in the trust.
If a testamentary trust is established with a view to take advantage of the new tax regime, then another important consideration is the extent of discretion that a testator wishes to grant to his or her Estate Trustee. Since an estate must maintain its status as a GRE, a testator may wish to clearly direct his or her Estate Trustee to take steps necessary to use or manage the estate assets in a manner that is consistent with the GRE requirements set out in section 248(1) of the Income Tax Act. Alternatively, the testator may wish to authorize his or her Estate Trustee to determine whether it is necessary or beneficial to preserve the estate’s status as a GRE in light of circumstances that may arise post-mortem.
All estate planning considerations that are intended to take advantage of changes to the Income Tax Act should be discussed with a tax professional throughout the estate planning process.
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In Kuchta v The Queen, 2015 TCC 289, the Tax Court of Canada had occasion to consider some interesting issues with respect to the meaning of “spouse” in the Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.) (the “ITA”) and a spouse’s joint and several liability for a deceased spouse’s tax liabilities on death.
Ms. Kuchta was married to Mr. Juba (the “Deceased”) at the time of his death in 2007. Ms. Kuchta was the designated beneficiary of two of the Deceased’s RRSPs, and she accordingly received $305,657.00 upon the Deceased’s death. The Deceased was assessed by the Minister of National Revenue (the “Minister”) and found to owe $55,592.00 in respect of his 2006 taxation year. After the Deceased’s Estate failed to pay that amount, the Minister assessed Ms. Kuchta for the amount owing, pursuant to s. 160(1) of the ITA. This section provides that where a person has transferred property to their spouse, the transferee and transferor are jointly and severally liable to pay the transferor’s tax.
Ms. Kuchta’s position was that, three of the four requirements of s. 160(1) were met, but that the last requirement had not been met. Ms. Kuchta stated that she was not the Deceased’s spouse at the time of transfer of the RRSPs, as it occurred immediately after the Deceased’s death, at which point their marriage had ended. The Court, therefore, had to consider (a) when should the relationship between Ms. Kuchta and the Deceased be determined; and (b) does the word ‘spouse’ in s. 160(1) include a person who was, immediately before a tax debtor’s death, his or her spouse?
With respect to issue (a), if the relationship is determined at the time that Ms. Kuchta was designated as beneficiary of the RRSP, they would have been married, whereas if the relationship were determined at the time of transfer, they would not have been married. The Court easily concluded that the relationship should be determined at the time of transfer. It then had to determine whether the word “spouse” in s. 160(1) is sufficiently broad to include Ms. Kuchta at the time of transfer. That is, whether it included widows and widowers.
The Court undertook a “textual, contextual and purposive analysis of the word ‘spouse’ in subsection 160(1).” After a lengthy and thorough analysis, the Court concluded that the word ‘spouse’ must have been intended to include widows and widowers. It found that Parliament used both the legal and colloquial meanings of the term in the ITA, which differ from each other, thus presenting conflicting interpretations and ambiguity. However, the purposive analysis was found to point to an interpretation that includes widows and widowers.
Ultimately, therefore, Ms. Kuchta was found jointly and severally liable for the Deceased’s unpaid taxes, as a result of the beneficiary designation of the Deceased’s RRSPs. It will be interesting to see how this case applies going forward, and we should keep in mind that the Minister may be able to collect on unpaid taxes from the beneficiary of a Deceased’s RRSP.
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A couple of months ago, I blogged about a letter from the Department of Finance in which it addressed concerns regarding amendments to the Income Tax Act (the “ITA”) that have come into force as of January 1, 2016. The stated purpose of the letter was to confirm the Department of Finance’s understanding of the issues raised and to describe an option for responding to these issues. There was no promise that the option would be pursued or that any action would be taken.
However, on January 15, 2016, the Department of Finance released draft legislative proposals that would modify the income tax treatment of certain trusts and their beneficiaries. The legislative proposals, along with explanatory notes, can be found here.
Currently paragraph 104(13.4)(a) of the ITA provides that upon the death of a beneficiary of a spousal trust, the trust’s taxation year will be deemed to come to an end on the date of the individual’s death. Subsequently, according to paragraph 104(13.4)(b), all of the trust’s income for the year is deemed to have become payable to the lifetime beneficiary during the year, and thus must be included in computing the beneficiary’s income for their final taxation year. This has been raised as an issue due to paragraph 160(1.4) which makes the trust and the beneficiary jointly and severally liable for the portion of the beneficiary’s income tax payable as a result of including the income from the trust. As such, it is possible that the beneficiary could be responsible for the full income tax liability, to the benefit of the trust and the trust’s beneficiaries.
According to the draft legislation, paragraph 104(13.4)(b) is to be amended and 104(13.4)(b.1) is to be added, such that (b) does not apply to a trust unless all the requirements are met and the trust and the beneficiary’s graduated rate estate jointly elect that (b) apply. It would, therefore, be up to the trust and to the estate of the beneficiary to determine whether they wish the trust’s income to be included in the income of the beneficiary for their final taxation year.
There was also an issue raised with respect to the stranding of charitable tax credits. This situation could arise if a trust were to make a charitable donation after the beneficiary’s death. As the trust’s income for the year has to be included in the beneficiary’s income, consequently, the trust would have no income against which to deduct tax credits. Based on the draft legislation, as long as the beneficiary and the trust do not jointly elect for 104(13.4)(b) to apply, the trust’s income will be included in the trust’s tax return, and any charitable donation tax credits should be able to be deducted from that income.
The press release issued with the draft legislation stated that the Department of Finance had released the draft legislative proposals for consultation and welcomed interested parties to provide comments by February 15, 2016.
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Now that the 2016 year has begun, there are several amendments to the Income Tax Act, R.S.C., 1985, c. 1 (5th Supp) (the “ITA”) that have come into force. Some of these amendments have been discussed on this blog before. Among these amendments is the introduction of the “qualified disability trust” (the “QDT”).
The requirements for a QDT can be found in s. 122(3) of the ITA, and are as follows:
i. At the end of the trust year, a QDT must be a testamentary trust that arose on and as a consequence of an individual’s death;
ii. The trust must be resident in Canada for the trust year; and
iii. The trust and the named beneficiary or beneficiaries must have made a joint election for the trust to be a QDT.
Section 122(3) now also includes requirements for the beneficiary of a QDT:
i. Section 118.3(1)(a) to (b) must apply to the beneficiary for the individual’s taxation year in which the trust year ends, meaning that the beneficiary must be eligible for the disability tax credit; and
ii. The beneficiary can only jointly elect for one trust to be a QDT.
If a trust meets the requirements for a QDT, it will not be subject to the new rules with respect to flat top rate taxation that are now applicable to testamentary trusts. This is an important qualification, because prior to the amendments that came into force January 1, 2016, all testamentary trusts were subject to graduated rates of taxation. Now, however, trusts will only have the benefit of the graduated rates for the first 36 months following the death of a testator, during which period they will be called “Graduated Rate Estates” (“GREs”). Therefore, the QDT has significant benefits with respect to taxation of trusts.
As noted above, however, the requirements for a QDT are far from simple. With respect to the disability tax credit, there are particular requirements and limitations for eligibility. The assessment of whether a particular individual will be eligible for the disability tax credit is done by a doctor, not a financial advisor, and it can be difficult to predict whether or not someone will qualify.
There are also some elements of the QDT which may raise planning challenges, including the limit of one QDT per beneficiary. For example, if the grandparents of a disabled grandchild have chosen to create a testamentary trust for the benefit of their grandchild, only one grandparent is able to have the trust qualify as a QDT. Furthermore, the joint election for the trust to be a QDT must be made each year, and each year the beneficiary must qualify for the disability tax credit. As such, the status of the trust may change from year to year, and must accordingly adapt to the changing application of the tax rules.
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In just over a month, starting on January 1, 2016, a number of amendments to the Income Tax Act will be coming into effect. These changes have been discussed on this blog before. On November 16, 2015, the Department of Finance issued a letter addressed to the Joint Committee on Taxation of the Canadian Bar Association and Chartered Professional Accountants of Canada, the Conference for Advanced Life Underwriting, and the Technical Tax Committee of STEP Canada. The purpose of the letter was to address the submissions of these organizations regarding certain amendments to the income taxation of trusts and estates, particularly concerns with respect to the income tax treatment of certain trusts subject to deemed realization on the death of a beneficiary.
With respect to tax deferral for alter ego trusts and spousal trusts, the new rules in subsection 104(13.4) provide that, upon death of the beneficiary, all the trust’s income for the trust’s taxation year must be included in computing the beneficiary’s income for the beneficiary’s final taxation year when the trust’s year ends (which will be the end of the day on which the beneficiary dies). Subsection 160(1.4) then makes the trust jointly and severally liable with the beneficiary for the portion of the beneficiary’s income tax payable due to inclusion of the trusts’ income.
There was an issue raised with respect to concerns that the amendments may apply in some cases with unfair and unintended results, within which were two sub-issues.
The first issue was the possibility that the income tax liability falling to the beneficiary will be ultimately borne by the beneficiary’s estate, even though the trust’s property, including any income, will be enjoyed by the trust’s beneficiaries, in some cases to the exclusion of the estate’s beneficiaries.
The second issue was the possibility that charitable donation tax credits could become stranded in the trust. If a trust makes a charitable gift of property after the death of the beneficiary, and the trust’s income is then deemed to be included in the beneficiary’s income, the trust will have no income against which to deduct any donation tax credit.
The Department of Finance, in discussions with the organizations to whom the letter was addressed, came up with an option to respond to these concerns. It was noted in the letter that the suggested solution would involve amending paragraph 104(13.4)(b) so that it would not apply to a trust in respect of the death of a particular beneficiary unless several factors are met, including that the beneficiary’s graduated rate estate and the trust jointly elect to have the paragraph apply. Accordingly, if no election is made, the tax liability for the trust’s income would remain with the trust.
With respect to the “stranding” of donation tax credits, the Department of Finance noted that the option above would include provision for a trust to be permitted to allocate the eligible amount of a donation made by the trust after the beneficiary’s death to its taxation year in which the death occurs.
Nothing has been implemented with respect to these issues or suggested options yet, nor is there a guarantee that the amendments will be implemented. However, the Department of Finance appears open to discussion and to working toward a solution that addresses the concerns raised.
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