Principal Issues: A taxpayer died in 2018 at the age of 80. Following the taxpayer’s death, proceeds of a life-insurance policy and non-RRSP investments were transferred to a testamentary trust ("Trust") for the benefit of his spouse (“Spouse”). The non-RRSP investments represent the taxpayer’s savings earned throughout his life. Two of the taxpayer’s children are trustees of Trust. The management of the investments is passive and generates no business income. The management of the investments is done by one of the following: 1) the trustees of Trust; 2) a third-party; or 3) another child of the taxpayer who is neither a trustee nor a beneficiary of Trust but is an investment broker. Whether the investment income earned by Trust and distributed to Spouse would be subject to the tax on split income (“TOSI”).
Position: Generally not. The portion of a trust distribution attributable to taxable dividends from, or taxable capital gains from the disposition of, public company shares would not be subject to TOSI. The portion of a trust distribution attributable to interest that is not derived, directly or indirectly, from a related business in respect of a specified individual would not be subject to TOSI. If it is established that a portion of Trust’s distribution is attributable interest that is derived, directly or indirectly, from a related business in respect of Spouse, the distribution would be deemed to be an excluded amount in respect of Spouse under subparagraph 120.4(1.1)(c)(ii).
Reasons: According to the law.
FINANCIAL STRATEGIES AND INSTRUMENTS ROUNDTABLE 5 OCTOBER 2018
2018 APFF CONFERENCE
Question 3
Testamentary trust and tax on split income
SITUATION
Jean, age 80, died in 2018, leaving the proceeds of a life insurance policy and non-registered investments in a trust ("Trust"), of which Jeanne, his spouse, was the only beneficiary. Jeanne was a resident of Canada at all relevant times.
The non-registered investments came from the savings accumulated by Jean during his lifetime.
Two of Jean and Jeanne's children were appointed Trustees of Trust.
The investment management is passive and does not generate any business income.
Respecting the investment management, the following three alternative assumptions apply:
1. It is the two trustees who manage Trust’s investments.
2. The investment management has been outsourced to an independent third party.
3. The investment management has been entrusted to another child of Jean and Jeanne, who is neither trustee nor beneficiary of Trust, but who is a stockbroker.
Question to the CRA
Taking into account each of these three assumptions, can the investment income earned by Trust and distributed to Jeanne, the beneficiary of Trust, be subject to the new rules for a tax on split income?
CRA Response
First, for the purpose of this question, we have assumed that the proceeds of the life insurance policy were invested by Trust in investments similar to those it received as a result of Jean's death.
In addition, since the question as stated only briefly describes a hypothetical particular situation, including the composition of Trust's investment portfolio and the nature of the amounts included in computing its income, we have assumed that Trust's income from its investments consists of taxable dividends in respect of shares of a class listed on a designated stock exchange ("Dividends"), taxable capital gains from the disposition of such shares ("Capital Gains") and interest on debt obligations ("Interest").
The definition of "split income" in subsection 120.4(1) describes the types of income that are subject to the split income tax under subsection 120.4(2).
First, the amount representing the portion of the distribution received from Trust ("Distribution") relating to the Dividends would not be split income for Jeanne, as appears from the exceptions provided for in subparagraph (a)(i) and in clause (c)(ii)(A) of the definition of "split income" in subsection 120.4(1).
Second, the amount representing the portion of the Distribution that relates to the Capital Gains would not be split income for Jeanne by virtue of the exception provided in clause (e)(ii)(A) of the definition of "split income" in subsection 120.4(1).
Finally, unless it qualifies as an excluded amount, the amount representing the Interest portion of the Distribution could be split income under clause (c)(ii)(C) of the definition of "split income" in subsection 120.4(1). Indeed, Jeanne is a specified individual (footnote 1) and the amount of the Distribution must be included in the computation of her income by virtue of subsection 104(13). For the purposes of clause (c)(ii)(C) of the definition of "split income" in subsection 120.4(1), it must be reasonable to consider that the portion of that Distribution was income derived directly or indirectly from one or more related businesses in respect of Jeanne.
As appears from the question as stated, the Distribution was derived solely from the assets held by Trust and not from any other related business in relation to Jeanne. Thus, the question is whether Trust carries on a related business in respect of Jeanne.
The term "related business" in respect to a specified individual is defined in subsection 120.4(1) and includes, in respect of a trust (footnote 2) a business carried on by a trust if a source individual in respect of the specified individual is actively engaged on a regular basis in the activities of the trust related to earning income from the business.
The expression "source individual" in respect of a specified individual for a taxation year is defined in subsection 120.4(1) and means an individual (other than a trust) who, at any time in the year, is resident in Canada and related to the specified individual. Jeanne and her three children are individuals connected by blood relationship by virtue of section 251(6) and are therefore related persons by virtue of subsection 251(2). Consequently, under the assumption that Jeanne's children were resident in Canada at all relevant times, each of these children is a source individual in respect of Jeanne.
For the purposes of the definition of "related business", it must therefore be determined, inter alia, that: (1) Trust is carrying on a business; and 2) a source individual is actively engaged on a regular basis in the activities of Trust related to earning income from the business. These are essentially two questions of fact that can only be resolved after a comprehensive analysis of all the facts and circumstances with respect to a particular situation.
If it were determined that Trust does not carry on a business, the Interest portion of the Distribution would not be included in the computation of Jeanne's split income. Indeed, one of the conditions to be satisfied in the definition of "related business" in subsection 120.4(1) is that there must be in the first place a business carried on by an entity. Consequently, in the event that Trust does not carry on a business, the Interest could not come, directly or indirectly, from a related business in respect to Jeanne, but rather would come from property held by Trust.
If it were instead established that Trust is carrying on a business and that, under any of the scenarios contemplated in the question as stated, a source individual in respect of Jeanne is actively engaged on a regular basis in the activities of Trust related to earning income from the business, then the portion of the Distribution related to the Interest would come, directly or indirectly, from a related business in respect of Jeanne for the purposes of the application of clause (c)(ii)(C) of the definition of "split income" in subsection 120.4(1).
On the other hand, the interpretive rule provided in subparagraph 120.4(1.1)(c)(ii) could apply in respect of Jeanne so that the portion of the Distribution relating to the Interest is deemed to be an excluded amount.
By virtue of subparagraph 120.4(1.1)(c)(ii), the amount that is Jeanne's income from property is deemed to be an excluded amount to the extent that the amount would have been an excluded amount in respect of an individual - Jean – who was, immediately before his death, Jeanne's spouse or common-law partner, if the amount were included in computing Jean's income for his last taxation year.
The portion of the Distribution with respect to the Interest would be an excluded amount in respect of Jean since it was not derived directly or indirectly from a related business in respect of Jean by virtue of subparagraph (e)(i) of the definition of "excluded amount" in subsection 120.4(1).
Even assuming that Jean derived income from a business from these properties, this business could not qualify as a related business in respect of Jean.
Indeed, by virtue of subparagraph (a)(i) of the definition of "related business" in subsection 120.4(1), the business carried on by an individual must be carried out by a source individual in respect of the specified individual. Since Jean cannot be a source individual in relation to himself, the hypothetical business could not be a related business in respect of Jean.
Jean Lafrenière
(613) 670-9013
5 October 2018
2018-076580
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 Since Jeanne is resident in Canada at all relevant times.
2 In subparagraph (a)(ii) of the definition of "related business" in subsection 120.4(1)