Principal Issues: In a situation where a housing unit is subject to a usufruct created by the will (governed by the laws of the province of Quebec) of a deceased taxpayer, the deceased’s surviving spouse is the usufructuary, the deceased’s child is the bare-owner and the surviving spouse ordinarily inhabits the housing unit while it is subject to the usufruct: (1) Whether the principal residence exemption could be claimed by the deemed trust established by virtue of subsection 248(3) (“deemed trust”) with respect to the capital gain realized as a result of the death of the surviving spouse (the usufructuary) or as a result of the sale of the housing unit, as the case may be? (2) Whether the condition set out in subparagraph 70(6)(b)(ii) could be met despite the fact that a term is provided to the usufruct under the terms of the will? (3) What would be the tax consequences resulting from the surrender, by the usufructuary, of his/her right in the usufruct? (4) What would be the tax consequences resulting from the death of the bare owner or from the assignment of his/her rights in favour of the usufructuary?
Position: (1) Yes, subject to the other conditions of the definition of “principal residence” in section 54. (2) No. (3) General comments. (4) General comments.
Reasons: (1) The death of the usufructuary would cause the end of the usufruct and the termination of the deemed trust, which would imply the distribution of the housing unit to the bare owner. Upon the termination of the deemed trust, since the distribution of the property by the deemed trust, a trust referred to in subparagraph 104(4)(a)(i), would be made to a beneficiary other than the surviving spouse, subsection 107(4) would apply, such that subsection 107(2.1) would apply to the distribution of the property, which could result in a capital gain at the deemed trust’s level. Likewise, the sale of the residence could create a capital gain at the deemed trust’s level . The deemed trust, a personal trust, could claim the principal residence exemption under paragraph 40(2)(b), provided that the conditions for the property to qualify as a “principal residence” as defined in section 54 are all met. (2) In the situation where the will provides a term to the usufruct, this would result in a person other than the surviving spouse having the possibility to receive or obtain the use of any part of the income or capital of the trust in the spouse’s lifetime. As a result, the condition set out in subparagraph 70(6)(b)(ii) would not be met. (3) No proceeds of disposition would be deemed received for the purposes of subsection 106(2) when the usufructuary validly surrenders, without consideration and without directing in any manner who is entitled to benefit therefrom, his/her income interest in the deemed trust. The surrender would cause the termination of the deemed trust and the distribution of the property to the bare owner. Subsections 107(2.1) and (4) would apply to this distribution and it could be possible for the personal trust to claim the principal residence exemption under paragraph 40(2)(b), provided that the conditions for the property to qualify a “principal residence” as defined in section 54 are all met. (4) By effect of subsection 70(5) or paragraph 69(1)(b), as the case may be, the bare owner would be deemed to have received a consideration equal to the FMV of his/her capital interest in the deemed trust as a result of the deemed disposition at death or of the assignment of his/her right in favour of the usufructuary, as the case may be. Moreover, in the case of the assignment to the usufructurary, the assignment would cause the termination of the deemed trust such that the housing unit would be distributed to the usufructuary. This distribution would be subject to subsection 107(2).
FEDERAL TAX ROUNDTABLE OCTOBER 7, 2020
APFF CONFERENCE 2020
Question 5
Usufruct of a principal residence, right to exemption and obligation to disclose a provision
Where a usufruct is created after 1990 on a residence (for example, following the death of a father who makes a legacy of the usufruct to his surviving spouse and of the bare ownership to his daughter), the result is that, pursuant to paragraph 248(3)(a), the usufruct is deemed to be a trust (created by will in our example) and the property subject to the usufruct (the residence) is deemed to have been transferred to the trust as a consequence of the death of the testator and is then deemed to be held by the trust and not otherwise. There is thus a "tax fiction" that deems a trust to exist, but only for the purposes of the Income Tax Act for Canada (and Quebec). The surviving spouse thus becomes the owner of an income interest in the trust (in respect of her right of usufruct) and her daughter becomes the owner of a capital interest in the trust (by virtue of her bare ownership of the residence she inherited). Accordingly, they are both considered beneficiaries of the trust (subject to the concept of a "specified" beneficiary). A usufruct could also exist where a parent gives or sells the bare ownership of his or her residence to his or her child, but retains the usufruct (for example, until his or her death).
Where the usufructuary surrenders (during his or her lifetime) his or her right to the usufruct without consideration and without indicating who may benefit from it, the Canada Revenue Agency ("CRA") considers that there has been a disposition of the income interest in the trust. In such a case, the proceeds of disposition of the usufruct are nil and the trust is "deemed" to be dissolved (Technical Interpretation 2010-0367371E5 (footnote 1)). The deemed dissolution of the trust therefore has the effect of a distribution of property to the capital beneficiary, the bare owner. Generally, the property will be transferred at its cost amount, but the trust may elect to transfer it at fair market value ("FMV").
Where the bare owner decides to dispose of his or her bare ownership interest in a residence, the CRA considers that there is a disposition of a capital interest in a trust. In order to determine whether there is a capital gain, the adjusted cost base ("ACB") of the capital interest must first be determined. If the bare ownership of the property is transferred to the usufructuary, the usufruct will be extinguished since the same person holds both the use and the bare ownership of the property. The trust will therefore be dissolved (Technical Interpretation 2006-0169371E5 (footnote 2) ).
Questions to the CRA
(a) Mr. X dies in 2020. Where the usufructuary is the spouse of the deceased, it is our understanding that there will generally be a tax rollover on the creation of the usufruct to the extent that the surviving spouse has the usufruct of the residence for life (a life usufruct). In effect, this would be a transfer to a spousal trust. If the residence is eventually sold a few years later before the death of the surviving spouse or if a deemed disposition occurs at the time of the spouse's death, our understanding is that the principal residence exemption could be claimed by the deemed trust based on the years the surviving spouse "ordinarily" inhabited the residence. Can the CRA confirm our understanding?
(b) What happens at the time of Mr. X's death if his spouse has only a usufruct for a limited number of years?
(c) What happens if the usufructuary surrenders her usufruct during her lifetime, regarding the tax impact on the deemed trust and on Ms. X, as well as the obligation to disclose a disposition?
(d) What happens if the bare owner assigns her bare ownership interest in the residence to her mother, the usufructuary (Ms X), or predeceases her mother, regarding the tax impact on the deemed trust and on the bare owner, as well as the obligation to disclose a disposition?
CRA Response to Question 5(a)
Where a taxpayer's will establishes a usufruct that is governed by the laws of the Province of Quebec, subsection 248(3) applies. In such circumstances, paragraph 248(3)(a) deems the usufruct to be a trust created by will and the property subject to the usufruct is deemed to have been transferred to the deemed trust as a consequence of the death of the testator. The property is also deemed, throughout the period that it is subject to the usufruct, to be held by the trust and not otherwise. Consequently, in the situation described, the residence would be held through a deemed trust in which Ms. X would hold an income interest and her daughter would hold a capital interest. Under paragraph 248(3)(d), Ms. X and her daughter would be deemed to be beneficially interested in the deemed trust.
Since the trust would have been created following Mr. X's death, it would be a "testamentary trust" as that term is defined in subsection 108(1), none of the exceptions provided for in that definition being applicable in the circumstances. Also, it would be a personal trust because the test set out in paragraph (b) of that definition in subsection 248(1) would be satisfied. To the extent that the conditions set out in subsection 70(6) are satisfied, the trust could qualify as a spousal trust. Among other things, under the terms of the will, no person other than Mr. X's spouse should be entitled during her lifetime to receive or otherwise obtain the use of any part of the income or capital of the trust. This would result in the residence being transferred to the deemed trust at a cost equal to its ACB to Mr. X as a consequence of his death.
Under Article 1162 of the Civil Code of Québec (footnote 4), usufruct is extinguished by the death of the usufructuary. Thus, the death of Mrs. X would cause the extinction of the usufruct, and consequently the end of the deemed trust, which would imply the transfer of the property to the bare owner, her daughter. At the time the deemed trust ceases to exist, since the distribution of the property, the residence, by the deemed spousal trust (a trust described in subparagraph 104(4)(a)(i)) would be made to a beneficiary other than Mr. X's spouse, subsection 107(4) would apply. That would have the effect of subsection 107(2.1) applying to the distribution of the property held by the trust to the bare owner. By virtue of paragraph 107(2.1)(a), the deemed trust would be deemed to have disposed of the property for proceeds equal to its FMV, and under paragraph 107(2.1)(b), the bare owner would be deemed to have acquired the property at a cost equal to its FMV.
The sale of the residence to a third party who acquired both Ms X's and her daughter's rights would also result in the realization of a capital gain or loss at the level of the deemed trust and would result in the extinction of the trust, since the qualities of usufructuary and bare owner would be combined in the same person, the third party purchaser.
In both of the above situations, a disposition of the residence for its FMV would then be recognized at the trust level, with the result that a capital gain could be realized at the trust level.
It is possible for a personal trust to claim the principal residence exemption provided for in paragraph 40(2)(b) to reduce the capital gain realized on the disposition of a property. That exemption is granted in respect of a property that is a "principal residence" as defined in section 54, taking into account subsection 40(4) in a situation where subsection 70(6) would have applied.
Subsection 40(4) would deem the deemed trust to have owned the residence throughout the period during which Mr. X owned it, and the residence would be deemed to have been the deemed trust's principal residence for any taxation year for which it would have been Mr. X's principal residence if Mr. X had designated it to be his principal residence.
As stated in paragraph (a.1) of the definition of "principal residence" in section 54, a property that is a housing unit may be a principal residence of a personal trust for a taxation year provided, inter alia, that the housing unit was ordinarily inhabited in the calendar year ending in the year by a specified beneficiary of the trust for the year, by the spouse or common-law partner or former spouse or common-law partner of such a beneficiary or by a child of such a beneficiary. In addition, the conditions set out in paragraph (c.1) of the definition of "principal residence" in section 54 must be satisfied for the property to be a "principal residence" of the trust. As stated in subparagraph (c.1)(ii) of the definition of "principal residence" in section 54, a specified beneficiary is an individual who, at any time in the calendar year ending in the year, is beneficially interested in the trust (footnote 5) and who ordinarily inhabited the housing unit or has a spouse or common-law partner, former spouse or common-law partner, or child who ordinarily inhabited it.
Since Ms. X would be beneficially interested in the trust under paragraph 248(3)(d), she could be considered a specified beneficiary as defined in subparagraph (c.1)(ii) of the definition of "principal residence" in section 54 to the extent that she ordinarily inhabited the residence during the years the deemed trust owned it by virtue of subsection 248(3). That would allow the deemed trust to designate the residence as its principal residence, provided that all the other conditions of the definition of "principal residence" in section 54 were also satisfied.
CRA Response to Question 5(b)
Whether a trust satisfies the conditions of subsection 70(6) and in particular the condition in subparagraph 70(6)(b)(ii) is a question of fact and law. In a situation where the will provides for a termination of the usufruct, the result would be that a person other than Mr. X's spouse could receive or obtain the use of any of the income or capital of the deemed trust during her lifetime. Consequently, it is the CRA's view that the condition in subparagraph 70(6)(b)(ii) would not be satisfied because, in order to meet that condition, the terms of the will must be such that no person other than the spouse or common-law partner of the deceased individual could, before his or her death, receive or otherwise obtain the use of any of the income or capital of the deemed trust.
Consequently, in this situation, upon Mr. X's death, subsection 70(5) would apply, with the result that he would be deemed to have disposed of the property subject to the usufruct, the residence, for proceeds equal to the FMV immediately before his death and the deemed trust would be deemed to acquire it as a result of the death at a cost equal to that FMV.
Mr. X could claim the principal residence exemption in paragraph 40(2)(b) in his final return, provided all the conditions of the definition of "principal residence" in section 54 were satisfied.
CRA Response to Question 5(c)
Under article 1162 of the C.C.Q., the forfeiture or renunciation of the usufructuary's right leads to the extinction of the usufruct. In the situation described, the forfeiture or renunciation of the usufruct would therefore result in the termination of the deemed trust, which would entail the return of the property to the bare owner.
As specified in paragraph 1.15 of Income Tax Folio S6-F2-C1 (footnote 6), Ms. X would not be considered to have received proceeds of disposition for purposes of paragraph 106(2)(a) as a result of the valid surrender, without consideration, of her income interest in the deemed trust to the extent that she makes no indication of who is entitled to benefit from it. A disposition of her income interest would then be recognized for nil proceeds of disposition. Ms. X could file an income tax return to report the disposition of her income interest in the deemed trust.
At the termination of the deemed trust, since the distribution of the residence by the deemed spousal trust (being a trust described in subparagraph 104(4)(a)(i)) would be made to its beneficiary, the bare owner, who was a beneficiary other than Mr. X's spouse, subsection 107(4) would apply. In that regard, the comments set out in the response to Question 5(a) regarding subsection 107(4) would apply.
As in the case where the termination of the deemed trust resulted from the death of the usufructuary, and given that the deemed trust would be a personal trust, it would be possible for the deemed trust in this situation to claim the principal residence exemption under paragraph 40(2)(b) to reduce the capital gain realized as a result of the termination of the usufruct, provided that the conditions of the definition "principal residence" in section 54 were all satisfied in respect of the residence. Pursuant to paragraph 150(1)(c), the deemed trust would be required to file an income tax return, within 90 days of the end of the year, to report the disposition of the residence and, if applicable, to designate the property as its principal residence. In addition, Form T1079 "Designation of a Property as a Principal Residence by a Personal Trust" ("T1079") would also be required to be completed (footnote 7).
CRA Response to Question 5(d)
Pursuant to article 1162 of the C.C.Q., usufruct is extinguished by the union of the qualities of usufructuary and bare owner in the same person. Thus, in the situation described, following the transfer by the bare owner of her rights to the usufructuary, the usufruct would be extinguished. The end of the deemed trust would then be recognized, so that the property would be considered to be distributed to Ms X, who would at that time have the qualities of both usufructuary and bare owner.
The transfer of her rights in the usufruct to the usufructuary would constitute a disposition of her capital interest in the deemed trust, as to which the rules in subsection 69(1) would apply. The effect of paragraph 69(1)(b) is that the bare owner would be deemed to have received consideration equal to the FMV of the bare ownership of the residence as a result of the transfer to the usufructuary. Furthermore, by virtue of paragraph 107(1)(a), subsection 107(1.1) and the definition of "cost amount" in subsection 108(1), for the purpose of computing a taxpayer's capital gain from the disposition of a capital interest in a personal trust, the ACB of the interest disposed of on such a disposition is generally deemed to be the cost amount of the trust property immediately before the disposition. In this situation, the ACB of the bare owner's capital interest at the time of the transfer of her rights to the usufructuary would be equal to the deemed trust's ACB of the property it holds, the residence. If subsection 70(6) had applied to the transfer of the residence to the deemed trust following Mr. X's death, this ACB would therefore be equal to Mr. X's ACB of the residence at the time of his death. The transfer by Mr. X's daughter of her interest to her mother could therefore result in a capital gain. Pursuant to paragraph 150(1)(d) (footnote 8), Mr. X's daughter would be required to file an income tax return to report the disposition of her capital interest in the trust.
As noted above, the termination of the trust would be recognized at that time, along with the distribution of the residence by the deemed trust to Ms. X. Since that disposition would result in the disposition of her entire capital interest in the deemed trust, subsection 107(2) would apply. In this case, under paragraph 107(2)(a), the trust would be deemed to dispose of the residence at its cost amount and, consequently, it would not realize any capital gain. For her part, Ms. X would be considered to have acquired by gift the capital interest in the deemed trust, previously held by her daughter, so that paragraph 69(1)(c) would apply. Consequently, the cost to Ms. X of her capital interest in the deemed trust would be deemed to be equal to the FMV of the bare ownership of the residence disposed of by her daughter to her. Thus, under paragraph 107(2)(b), she would be deemed to acquire the residence at a cost equal to that same FMV. Pursuant to paragraph 150(1)(c) (footnote 9), the deemed trust would be required to file an income tax return, within 90 days of the end of the year, to report the distribution of the residence under subsection 107(2) to Ms. X.
The result would be essentially the same for the bare owner in the event that she predeceased her mother while the usufruct still existed. At the time of her death, the bare owner would be deemed to have disposed of her capital interest in the deemed trust. Paragraph 70(5)(a) would deem the bare owner to dispose of her capital interest for proceeds of disposition equal to the FMV of that interest (footnote 10) immediately before her death. Pursuant to paragraph 150(1)(b), an income tax return would be required to be filed by her legal representatives to report the disposition of her capital interest in the trust.
Nathalie Boyer
(450) 926-7039
October 7, 2020
2020-085217
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 CANADA REVENUE AGENCY, Technical Interpretation 2010-0367371E5, August 17, 2010.
2 CANADA REVENUE AGENCY, Technical Interpretation 2006-0169371E5, 25 September 2006.
3 Provided that the other conditions set out in section 70(6) are also fulfilled, which implies, inter alia, that the usufruct would not be subject to any condition that could compromise or revoke the rights of the usufructuary spouse.
4 CCQ-1991 (“CCQ”).
5 As defined in subsection 248(25) ITA.
6 CANADA REVENUE AGENCY, Income Tax Folio S6-F2-C1, "Disposition of an Income Interest in a Trust".
7 Section 2301 of the Income Tax Regulations, C.R.C., c. 945 ("I.T.R.").
8 See also subparagraph 150(1.1)(b) (ii) I.T.A.
9 See also section 204(1) ITR.
10 FMV of the bare ownership of the residence.