Principal Issues: Whether an alter ego trust could effectively be used to transfer property to the trust on a tax deferred basis, where any residual interest gifted to a charity would be valued at fair market value.
Position: The use of an alter ego trust may be effective, but certain conditions must be satisfied
Reasons: The wording of the legislation, however also note the impact of the deemed disposition rules in subsection 104(4) for purposes of valuing the residual interest to the charity
CRA Questions
CALU 2010 Roundtable
Question 7: Alter Ego Trust as a Charitable Remainder Trust
Charitable remainder trusts ("CRTs") have been used in Canada for many years, despite the fact there are no specific rules in the Income Tax Act dealing with such trusts. As written by the CRA in its Registered Charities Newsletter #27:
"A charitable remainder trust involves transferring property to a trust whereby the donor or beneficiary retains a life or income interest in the trust but an irrevocable gift of the residual interest is made to a registered charity. A registered charity can issue an official donation receipt for the fair market value of the residual interest at the time that the residual interest vests in the charity".
In that Charities Newsletter and in Interpretation Bulletin IT-226R, the CRA provides a number of requirements that must be satisfied for there to be a gift of a residual interest. These requirements include an irrevocable transfer of the property, vesting of the property in the charity at the time of transfer, and no ability to encroach on capital for the life tenant.
It is also the CRA's view that the gift to a CRT results in a taxable disposition of the entire property. However, the CRA takes the additional view that the donor can elect under subsection 118.1(6) for the proceeds of disposition to be not greater than the FMV of the property and not less than the ACB of the property. In other words, the donor does not have to recognize a gain on the transfer if he or she elects at the ACB of the property. The donation receipt would also be equal to the elected amount. If the fair market value of the residual interest of the property is less than the elected amount, the donation receipt, in the CRA's view, cannot be greater than the value of the residual interest.
With the above as background, the provisions in the Income Tax Act for alter ego trusts and joint partner trusts could effectively allow for a CRT if the alter ego beneficiary or the joint partner beneficiaries (as the case may be) do not have any capital encroachment rights and the other requirements for a CRT have been satisfied. As the rules in the Income Tax Act provide for an automatic rollover of certain properties to these trusts (unless the transferor elects out of the rollover rules), the rule in subsection 118.1(6) would not be needed to avoid any gain on the transfer.
Question
If an individual transferred property to an alter ego trust as described in the above paragraph, can the CRA confirm that there would be no recognition of a gain on the transfer of the property and a donation receipt could be issued by the registered charity beneficiary equal to the value of the charity's residual interest?
CRA's Response
Unless an election is made to the contrary, an individual may transfer property to an alter ego trust on a tax-deferred basis under subsection 73(1) of the Act provided the transfer is made in the circumstances described in subsections 73(1.01) and 73(1.02) of the Act.
Consequently, where an individual transfers property to an alter ego trust there would generally be no recognition of a capital gain. Consistent with IT-226R, where a gift is made to a registered charity of a residual interest in an alter ego trust, and there is no right to encroach on the trust's capital for the benefit of the settlor, an official donation receipt could be issued by the registered charity beneficiary in an amount equal to the value of the charity's residual interest at the time the particular interest vests, provided the fair market value of that interest can otherwise reasonably be established at that time.
It should be noted, however, that any accrued capital gains with respect to the trust's capital property as at the end of the day in which the settlor of the trust dies, would be taxed in the trust, pursuant to subsection 104(4) of the Act for that year. This factor would be relevant in establishing a reasonable estimate of the value of the residual interest in the trust to the charity at the time the trust is created.
Kimberly Duval
613-957-8585
May 4, 2010
2010-035946