Principal Issues: Implications of a transfer of property from a discretionary trust to a Canadian corporation wholly owned by a new discretionary trust.
Position: CRA will typically apply GAAR in this situation.
Reasons: The transactions described circumvent the application of subsection 104(5.8), paragraph 104(4)(b) and the Act as a whole.
APFF FEDERAL TAX ROUNDTABLE 6 OCTOBER 2017
APFF CONFERENCE 2017
Question 14
Avoidance of the 21-year rule and application of GAAR
Various discretionary family trusts holding capital properties with significant appreciation in their values are currently approaching their 21st anniversary. Their trustees are considering various alternatives to avoid the deemed disposition of their capital properties that would otherwise occur on that date, under the rule commonly known as the "21-year rule" in subsection 104(4). A common approach to avoiding the 21-year rule is to distribute capital assets with an unrealized gain to a beneficiary residing in Canada on a rollover basis under subsection 107(2).
Where the beneficiary is an individual, the realization of the capital gain inherent in the distributed property is deferred and, subject to a possible spousal rollover, will occur when the beneficiary disposes of the property or upon his or her death, if that occurs before the beneficiary has disposed of the property. Notwithstanding this, there are considerations that may make it impractical to distribute the property of the trust immediately to a beneficiary who is an individual. A distribution to another trust, which is itself a beneficiary of the discretionary trust, or a distribution to a corporate beneficiary may appear to be attractive alternatives. However, in the case of a distribution described in subsection 107(2) for the benefit of a beneficiary who is another discretionary trust, subsection 104(5.8) would apply in such a way as to prevent deferral of the application of the 21-year rule. As a general rule, the trustees of the beneficiary trust would then be subject to the 21-year rule as of the date of the transferor trust's 21st anniversary.
If the terms of the trust so permit, the trustees may instead choose to distribute the property of a Canadian-resident discretionary trust ("OLd Trust") nearing its 21st anniversary to a corporate beneficiary ("Canco"), all of whose shares would be held by a newly created discretionary trust ("New Trust"). To the extent that Canco resided in Canada and was a beneficiary of the OLd Trust under the governing trust indenture, and assuming no exceptions were applicable, the distribution could be subject to subsection 107(2), thereby deferring the realization of the capital gain inherent in the distributed property.
Consequently, the OLd Trust, if it still existed on its 21st anniversary, would no longer hold any property on that date, so that the application of subsection 104(4) would have no consequences on that date. In addition, subsection 104(5.8) would not apply to modify the application of subsection 104(4) to the New Trust, since the OLd Trust would not have transferred any property directly to the New Trust.
Questions to the CRA
- Can the CRA confirm whether it agrees with this conclusion?
- Would the answer be different in a situation where the realization of the capital gain inherent in the property distributed to Canco could not be realized at a date subsequent to the death of the discretionary beneficiaries who were alive on the 21st anniversary? In such a situation, the timing of the realization of the capital gain may be comparable to what occurs where the property is distributed prior to the 21st anniversary of the OLd Trust to a beneficiary who is an inidivual. However, the property would remain indirectly held by the New Trust, a discretionary trust, in the meantime.
CRA Response to Question 14(a)
The transactions described effectively result in Old Trust indirectly transferring property to New Trust on a tax deferred basis, thereby avoiding the application of the anti-avoidance provision in subsection 104(5.8) of the Act and restarting the 21-year clock. Thus, the capital gains that would otherwise be realized by Old Trust would be deferred beyond its 21st anniversary while the property continues to be held in a discretionary trust arrangement. Furthermore, the trustees of the New Trust are provided with another 21 years to decide who from the potential beneficiaries will receive the property, which could result in deferring the unrealized gain beyond the lifetime of the individual beneficiaries alive on the date of the Old Trust’s 21st anniversary.
Generally, it is the CRA’s view that such planning circumvents the anti-avoidance rule in subsection 104(5.8) of the Act in a manner that frustrates the object, spirit and purpose of that provision, the deemed disposition rule in paragraph 104(4)(b) and the scheme of the Act as a whole as it relates to the taxation of capital gains. It is also the CRA’s view that if a distribution is made by an existing discretionary trust to a Canadian resident corporation wholly owned by a new discretionary trust resident in Canada, it will generally be inferred that the primary purpose of such distribution is to defer the income tax otherwise applicable in respect of the 21-year deemed disposition pursuant to subsection 104(4) of the Act. The CRA has significant concerns regarding these transactions and will apply the general anti-avoidance rule when faced with a similar set of transactions unless substantial evidence supporting its non-application is provided.
The CRA is also concerned that the proposed transactions may be repeated where the terms of New Trust are similar to those of Old Trust. Thus the realization of the capital gains inherent in the property could be deferred for several generations or indefinitely. This contravenes one of the underlying principles in the taxation of capital gains regime, which is to prevent the indefinite deferral of tax on capital gains.
As a result, the CRA will not provide any Advance Income Tax Ruling where such a structure is proposed to be put in place unless substantial evidence supporting the non-application of GAAR is provided.
CRA Response to Question 14(b)
Our response would not be different even if the transactions put in place ensured that the realization of the capital gain inherent in the transferred property could not be postponed beyond the lifetime of the Old Trust's discretionary beneficiaries, who could have received property directly before the 21st anniversary. Even under these circumstances, the CRA is of the view that such transactions would effectively permit taxpayers to circumvent the anti-avoidance rule in subsection 104(5.8) in a manner that frustrates the object, spirit and purpose of that provision, the deemed disposition rule in paragraph 104(4)(b) and the scheme of the Act as a whole. It is the CRA’s view that the object, spirit and purpose of these provisions is that realization of gains on property in a discretionary family trust should occur at least every 21 years. There are specific situations provided for in the Act to which the 21-year deemed disposition rule does not apply. In the CRA’s view, the Act does not contemplate any deferral beyond a 21-year period while property is directly or indirectly held in a discretionary trust and therefore, this situation raises the same tax policy concerns as in the situation described above.
Mélanie Beaulieu
(613) 670-8905
October 6, 2017
2017-072032