Principal Issues: ABSB raised a scenario involving a reserve amount claimed in respect of a disposition by a trust of QSBC shares or QFFP. When the amount is included in income of a beneficiary of the trust in the subsequent taxation year, what LCGE amount is the capital gains deduction which the beneficiary may claim based on?
Position: The capital gains deduction which the beneficiary may claim will be based on the LCGE for the taxation year in which the disposition occurred.
Reasons: Subsection 110.6(31) would apply to the beneficiary.
August 3, 2018
Legislation Section HEADQUARTERS Stakeholder Relations Division Income Tax Rulings Individual Returns Directorate Directorate Assessment and Benefit Services Branch Phillip Kohnen (613) 670-8916 Attention: Carol Beaudry 2018-075535
Estate claiming a capital gains reserve
This is in response to your submission dated April 20, 2018, wherein you requested our views in regard to a scenario in which an estate claims a capital gains reserve. Your submission raised the following questions, which can be summarized as follows:
- When a trust claims a capital gains reserve, and the amount of the reserve is included in income in the subsequent year and flows through the trust to a beneficiary, does the gain retain all of its attributes?
- When the beneficiary reports the gain in the subsequent year are they subject to the lifetime capital gains exemption (“LCGE”) maximum amount in the year they report the gain, or are they only allowed to use the LCGE maximum that was in place when the trust reported the original disposition and claimed the capital gains reserve?
- Does the reserve amount of the trust flow through to the individual when the gain is dispersed?
Our comments
All statutory references in this document are to the Income Tax Act, R.S.C. 1985, (5th Suppl.) c. 1, as amended.
Subparagraph 40(1)(a)(iii) generally allows a trust to claim a deduction for a reasonable reserve in computing its capital gain for a taxation year from a disposition of property.
Pursuant to subparagraph 40(1)(a)(ii), the amount claimed by a trust as a reserve for a particular taxation year must be included in computing the trust’s capital gain from the disposition of that property in the immediately following year.
Where the requirements of subsection 104(21) are met, a trust can designate an amount in respect of its net taxable capital gains for a taxation year (as determined in subsection 104(21.3)) in respect of a beneficiary in whose income the amount was included pursuant to paragraph 104(13)(a), subsection 104(14) or section 105. The amount so designated by the trust is deemed to be a taxable capital gain of the beneficiary, for purposes of sections 3 and 111.
If the trust that has designated an amount pursuant to subsection 104(21) is a personal trust (as defined in subsection 248(1)) it must also designate an amount to the beneficiary in respect of its eligible taxable capital gains, in accordance with subsection 104(21.2). By virtue of the postamble to subsection 104(21.2), the capital properties referred to in clause (ii)(A), (B) or (C), as applicable, are deemed to have been disposed of by the beneficiary, for the purposes of section 110.6.
Subsections 110.6(2) and (2.1) generally allow an individual that is resident in Canada (other than a trust) to claim a capital gains deduction against their taxable capital gains in respect of dispositions of qualified farm or fishing property and qualified small business corporation shares respectively.
However, pursuant to subsection 110.6(31), where an individual includes an amount in income in a particular taxation year because of subparagraph 40(1)(a)(ii), the capital gains deduction that may be claimed is limited to the remaining LCGE for the taxation year in which the property was disposed. This ensures that a taxpayer cannot benefit from a future year increase to the LCGE by claiming a reserve in the year of disposition of the property.
Conclusion
To summarize, the comments provided above can be applied to the questions raised in your submission as follows:
- As noted, the reserve amount which the trust claims is included in calculating its capital gain in the following year. Where a net taxable capital gain in respect of this gain is designated to a beneficiary by a personal trust, the trust must also designate an amount in respect of its eligible taxable capital gains (if any). Such a designation results in the relevant property being deemed to have been disposed of by the beneficiary of the trust, for purposes of the capital gains deduction in section 110.6.
- Where the amount of the reserve from a particular year is included in the trust’s income for the following year, and is included in the income of, and designated in respect of, a beneficiary of the trust, in our view, subsection 110.6(31) ensures that the capital gain deduction which may be claimed by the beneficiary is based on the LCGE for the taxation year in which the property was disposed.
- As noted above, when a trust claims a reserve in a particular taxation year, that amount must be included in the calculation of the trust’s capital gain for the following year. Where the amount is in turn included in the income of a beneficiary of the trust and designations pursuant to subsections 104(21) and (21.2) are made in respect of the amount, it is our view that subsection 110.6(31) applies because the amount is included in the beneficiary’s income because of subparagraph 40(1)(a)(ii).
We trust these comments will be of assistance to you.
Yours truly,
Phillip Kohnen, CPA, CMA, TEP
Manager, Trust SectionI
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch