Principal Issues: Whether or not a testamentary trust is part of an affiliated group that controls Opco and whether or not subsection 40(3.6) could apply to a redemption of preferred shares of Opco held by the testamentary trust in two scenarios, the first were the redemption is made for cash and the second were the redemption is settled by the issuance by Opco of a promissory note? Whether or not in scenario 2 the testamentary trust could be considered to have de facto control of Opco by holding a debt receivable from Opco after the redemption of the preferred shares?
Position: Limited information does not permit to conclude on the first issue. De facto control is a question of fact.
Reasons: General comments on the issue of de facto control.
Financial Strategies and Financial Instruments Roundtable, 11 October 2013
2013 APFF Conference
Question 4
Subsection 40(3.6) - Limitation of spousal trust losses in post mortem planning context
A discretionary inter vivos trust held 100% of the participating voting common shares of Opco, a corporation carrying on an active business. The four children were beneficiaries. The settlor of the trust was the children's uncle.
A testamentary spousal trust held 100% of the non-voting, non-participating, redeemable preferred freeze shares. The preferred shares were valued at approximately 50% of the value of Opco. After the death of the surviving spouse, the same four children were equal beneficiaries of the testamentary trust. The settlor of the trust was the testator, that is, the father of the children.
No other shares were issued by Opco.
Following the death of the spouse, the testamentary trust was taxed on the capital gain on the preferred shares. The testamentary trust remained in effect for some time after death. The family considered, as a post-mortem plan to eliminate double taxation, a repurchase of preferred shares to create a capital loss that could be carried back to retroactively eliminate the deemed capital gain on the death of the spouse.
Question to the CRA
In the following two scenarios, is the testamentary trust part of the same affiliated group of persons, as defined in subsection 251.1(3), with the inter-vivos discretionary trust which controls Opco, with the consequence that the testamentary trust is affiliated with Opco under subparagraph 251.1(1)(b)(ii), and would be denied the loss realized on the redemption by subsection 40(3.6)?
1- The redemption of the testamentary trust’s shares occurs in cash by the testamentary trust for the total redemption value of the preferred shares. The testamentary trust has no de facto control of Opco after the redemption.
2- The redemption of the testamentary trust’s shares occurs through the issuance of a note by Opco payable to the testamentary trust. As a result, the testamentary trust remains the creditor of Opco after the redemption.
CRA response
On the basis of the limited information contained in the statement of this question and the generality of the question as to whether the testamentary trust and the inter vivos discretionary trust would constitute a "affiliated group of persons" within the meaning of the definition of that term in 251.1(3), it appears to us that the primary concern in this particular situation is whether after the redemption of all of the preferred shares of the capital stock of Opco held by the testamentary trust, it could be argued that the testamentary trust would have de facto control of Opco. If that were the case, the testamentary trust and Opco would be affiliated persons under subparagraph 251.1(1)(b)(i).
The concept of control, for the purposes of the definition of "affiliated group of persons" in subsection 251.1, means controlled, directly or indirectly, in any manner whatever, as provided for in the definition of "controlled" in subsection 251.1(3). Consequently, the concept of de facto control in subsection 256(5.1) must therefore be taken into account for the purposes of applying section 251.1.
Subsection 256(5.1) provides that, for the purposes of the Act, where the expression “controlled, directly or indirectly in any manner whatever,” is used, a corporation shall be considered to be so controlled by another corporation, person or group of persons at any time where, at that time, the corporation, person or group of persons “has any direct or indirect influence that, if exercised, would result in control in fact of the corporation”.
In Scenario 1, it appears to us that in the absence of control in fact otherwise being present, the testamentary trust would not be affiliated with Opco after the repurchase of the preferred shares it held.
In Scenario 2, since the testamentary trust is a creditor of Opco, the question is therefore to determine whether the testamentary trust, because of the holding of this debt representing 50% of the net value of Opco, is a dominant entity i.e. that it has a direct or indirect influence on Opco whose exercise would result in de facto control of Opco.
In this regard, as stated in paragraph 23 of Interpretation Bulletin IT-64R4, the ownership of a large debt of a corporation which may become payable on demand is one of the factors to be considered in determining whether there is de facto control in a particular situation. This factor, however, was considered of little importance in Technical Interpretation XXXXXXXXXX in a situation where the debt represented virtually all the net value of a corporation but all its assets consisted of readily marketable securities which could serve to repay the debt held by an estate without imperiling its investment operations.
In Scenario 2, if the holding of the debt by the testamentary trust after the redemption represented a direct or indirect influence the exercise of which would result in de facto control of Opco, then Opco would be affiliated with the testamentary trust under 251.1(1)(b)(i). Consequently, subsection 40(3.6) would apply to deem the loss to be nil. In such a case, the exception provided for in paragraph 40(3.61) could not apply since the testamentary trust is not an estate.
Marc Séguin
2013-049365