Principal Issues: Mr. X personally owned commercial rental property. On Mr. X’s death, the commercial rental property were transferred to a spousal trust ("Spousal Trust") for the benefit of his spouse, Mrs. X. Every year, Spousal Trust distributes all its net rental income to Mrs. X. Whether Mrs. X is subject to TOSI on the income distribution received from Spousal Trust under three assumptions: 1) Mrs. X’s son ("Son") is a trustee of Spousal Trust and manages the trust’s rental activities (repairs, collection of rents, etc.); 2) Son is not a trustee of Spousal Trust, is self-employed and manages the trust’s rental activities as in 1) above; and 3) Son is not a trustee of Spousal Trust and is an employee of the trust.
Position: No. If it is established that Spousal Trust does not carry on a business, the trust distribution would be an excluded amount in respect of Mrs. X under subparagraph (e)(i) of the definition “excluded amount” in subsection 120.4(1). If it is established that Spousal Trust does carry on a business, the trust distribution would be deemed to be an excluded amount 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 4
Trust, rental income and tax on split income
SITUATION
Jocelyne, a resident of Canada at all material times, has been the beneficiary of a spousal trust ("Trust") since the death of her husband Joseph.
During his lifetime, Joseph owned commercial rental properties, which were managed solely by him.
Trust's assets consist of only five commercial rental properties, in the order of $3,500,000, generating annual rental income of $250,000, which is distributed to Jocelyne.
All commercial rental properties came from Joseph.
Jocelyne has a son, Julien, from her marriage with Joseph. Julien is a resident of Canada at all relevant times.
In this regard, the following three hypothetical situations apply:
1. Julien is trustee of Trust and is engaged in the property management: repairs, rent collection, lease preparation and other matters.
2. Julien is not a trustee of Trust, is self-employed and, in that capacity, is engaged in the property management in the same way as described in the first situation.
3. Julien is not a trustee of Trust, is an employee of Trust and, in that capacity, performs the tasks described in the first situation.
Question to the CRA
Taking into account each of these three situations, can the rental income earned by Trust and distributed to Jocelyne be subject to the new rules for tax on split income?
CRA Response
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).
Regarding Jocelyne, the distribution received from Trust (the "Distribution"), unless it qualifies as an excluded amount, could constitute split income under clause (c)(ii)(D) of the definition of "split income" in subsection 120.4(1).
Indeed, Jocelyne is a specified individual (footnote 1) and the amount of the Distribution should be included in computing her income by virtue of subsection 104(13).
For 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 Distribution is income derived directly or indirectly from one or more related businesses with respect to Jocelyne.
As appears from the question as stated, the Distribution is derived solely from the assets held by Trust and not from any other related business with respect to Jocelyne. Thus, it is necessary to determine whether Trust carries on a related business with respect to Jocelyne.
The term "related business" in respect of a specified individual is defined in subsection 120.4(1) and includes, with respect to 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. As Julien is the son of Jocelyne, those individuals are connected by blood relationship by virtue of section 251(6) and are therefore related persons by virtue of subsection 251(2). Consequently, Julien is a source individual in respect of Jocelyne.
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.
For purposes of clause (c)(ii)(D) of the definition of "split income" in subsection 120.4(1), it must be reasonable to consider that the Distribution is income from the leasing of property by Trust in the case where a person who is related to Jocelyne is actively engaged on a regular basis in the activities of Trust related to the leasing of property.
To the extent that it was established that Julien actively engages on a regular basis in the activities of Trust, the Distribution could constitute split income for Jocelyne by virtue of clause (c)(ii)(D) of the definition of split income in subsection 120.4(1), except in the case of an excluded amount.
However, by virtue of subparagraph (e)(i) of the definition of "excluded amount" in subsection 120.4(1), the Distribution could be an excluded amount for Jocelyne if was not derived directly or indirectly from a related business in respect of Jocelyne.
In light of the foregoing, if it could be determined that the Distribution was not derived directly or indirectly from a related business in respect of Jocelyne, the Distribution would be an excluded amount with respect to Jocelyne and, therefore, would not be not included in the computation of her split income.
However, for the purpose of applying clauses (c)(ii)(C) or (D) of the definition of "split income" in subsection 120.4(1) with respect to the situation described in this question, if it was determined that the Distribution was derived directly or indirectly from a related business in respect of Jocelyne, the interpretive rule under subparagraph 120.4(1.1)(c)(ii) could apply in respect of Jocelyne so that the Distribution is deemed to be an excluded amount.
By virtue of subparagraph 120.4(1.1)(c)(ii), the amount that is Jocelyne'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 - Joseph – who was, immediately before his death, Jocelyne's spouse or common-law partner, if the amount were included in computing Joseph's income for his last taxation year.
The Distribution would have been an excluded amount in respect of Joseph since it was not derived directly or indirectly from a related business in respect of Joseph by virtue of subparagraph (e)(i) of the definition of "excluded amount" in subsection 120.4(1).
Since Joseph owned the commercial rental properties directly, and even under the assumption that Joseph derived income from a business, that business could not be classified as a related business.
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 on by a source individual in respect of the specified individual. Since Joseph could not be a source individual in respect of himself, the hypothetical business could not be a related business in respect of Joseph.
Jean Lafrenière
(613) 670-9013
5 October 2018
2018-076581
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 Since the question as stated indicates that Jocelyne is resident in Canada at all relevant times.
2 In subparagraph (a)(ii) of the definition of "related business" in subsection 120.4(1)).