Principal Issues: An individual (“Father”) is the only person actively engaged on a regular, continuous and substantial basis in the activities of the business of a corporation (“Opco”). The business of Opco is an excluded business for Father. Further to an estate freeze implemented in a previous year, a discretionary family trust (“Trust”) holds non-voting participating shares of Opco and Father holds preferred and voting shares of Opco. The beneficiaries of Trust are the wife of Father (“Mother”) and their only child (“Child”) aged 20. On December 30, 2021, Father dies. Situation A: Pursuant to the will of Father, a testamentary trust (“Trust C”) for the benefit of Child is set-up and 50% of the preferred shares owned by Father at the time of his death are transferred to Trust C for the benefit of Child. According to the will of Father, Trust C should pay $30,000 of income to Child annually and should be dissolved in the year Child reaches 36 years of age. If the amount of dividend paid by Opco to Trust C in a year is less than $30,000, Trust C may cause the redemption of a number of preferred shares sufficient to attain the amount of $30,000. On the redemption, Trust C will realize a deemed dividend under subsection 84(3) and the amount of deemed dividend will be allocated to Child. When Child attains the age of 36, the shares of Opco will be transferred to him and he will then ask for the redemption of the preferred shares and realize a deemed dividend in the amount of $100,000. Situation B: Pursuant to the trust indenture of Trust, Father has a power of appointment. Father exercised this power in his will and from the date of his death to the date of dissolution of Trust, Trust should pay $30,000 of income to Child annually and in the year Child reaches the age of 36, Trust will be dissolved and the capital of Trust will be transferred to Child. If Trust did not receive dividends of $30,000 from Opco in a year, Trust may cause the redemption of a number of preferred shares sufficient to attain the amount of $30,000. On the redemption, Trust will realize a deemed dividend under subsection 84(3) and the deemed dividend will be allocated to Child.
Position: Situation A: Yes. Situation B: No.
Reasons: Situation A: The rule is applicable, since Trust C acquired the Opco shares as a consequence of the death of Father for the benefit of Child. Situation: B The rule is not applicable for the years during which Trust owns the Opco shares, since Trust acquired the Opco shares before the death of Father. The rule will be applicable after the liquidation of Trust and the acquisition of the Opco shares by Child, since Child will acquire the shares as a consequence of the death of Father by virtue of the application of the power of appointment in the Father's will.
FEDERAL TAX ROUNDTABLE, OCTOBER 7, 2021
APFF CONFERENCE 2021
Question 18
Tax on Split Income and continuity rule
For several years now, following an estate freeze, a discretionary family trust (the "Trust") has held all of the Class C non-voting and participating shares of the capital stock of a private corporation ("Opco"). As part of the estate freeze, the common shares of the capital stock of Opco then held by Mr. X were exchanged for 1,000,000 Class E preferred shares of the capital stock of Opco. These Class E shares have a nominal ACB to Mr. X and paid-up capital ("PUC") and a redemption value of $1,000,000. They also entitle the holder to receive an annual non-cumulative dividend at a fixed rate ranging from 5% to 10% per annum, calculated on the redemption value. Mr. X also holds all of the voting shares of the capital stock of Opco.
Mr. X's spouse (Ms. X), and the 20 year old child of Mr. X and Ms. X (Child X), are beneficiaries of the Trust and none of them is involved in the business of Opco. Only Mr. X has been actively engaged on a regular, continuous and substantial basis in the business of Opco for more than five years, making the business of Opco an "excluded business" to him, within the meaning of the definition of that term in subsection 120.4(1). Opco is not a professional corporation and the FMV of the Class C shares of the capital stock of Opco held by the Trust has been determined to be $1,500,000 on December 30, 2021.
Opco's business is a "related business", as defined in subsection 120.4(1), in respect of Ms. X and Child X and any dividend amount distributed to them by the Trust will be subject to TOSI, provided that it qualifies as an "excluded amount" within the meaning of subsection 120.4(1).
SITUATION A
Mr. X died on December 30, 2021 and his will provided for a bequest of all of the voting shares and 500,000 Class E shares of the capital stock of Opco to Ms. X. The will also provided for a bequest to a testamentary trust for the benefit of Child X ("Trust X") of 500,000 Class E shares of the capital stock of Opco.
The will provided that Trust X was to provide an annual income of $30,000 to Child X until he reached the age of 35. If, in any year, the dividends paid by Opco on the 500,000 Class E shares of Opco's capital stock were insufficient to pay $30,000 to Child X, Trust X was required to redeem some of those shares to make up the difference.
The will provided that the capital of Trust X would be distributed to Child X in the calendar year in which he attained the age of 36. The sole trustee of Trust X was Ms. X.
On December 31, 2037, when Child X was 36 years old, Trust X is wound up and the remaining 100,000 Class E shares of Opco's capital stock are distributed to Child X without tax consequences. Child X requests the redemption of the Class E shares of the capital stock of Opco that he holds. By virtue of subsection 84(3), Opco is deemed to have paid and Child is deemed to have received a dividend in the amount of $100,000. The dividend is a taxable dividend to Child X.
Ms. X still personally holds all of the voting shares and a number of Class E shares in the capital stock of Opco having an FMV of at least 10% of the FMV of the capital stock of Opco. The Trust has not yet been wound up.
Questions to the CRA
(a) Is the amount of dividends totalling $30,000 received by Child X in a year an excluded amount pursuant to subparagraph 120.4(1.1)(b)(ii)?
(b) Is the $100,000 dividend amount deemed to be received by Child X as a result of the redemption of the Class E shares an excluded amount pursuant to subparagraph 120.4(1.1)(b)(ii)?
SITUATION B
The Trust Deed contains a designation clause. Under this clause, on the death of Mr. X, the beneficiaries of the Trust will be the persons expressly designated as such by Mr. X in his will. The right to elect will become effective upon the death of Mr. X. The Trust Deed specifies that the persons to whom Mr. X may exercise his power of election will be Ms. X and Child X.
Mr. X died on December 30, 2021. Mr. X's will provided for a bequest of all of the voting shares and 1,000,000 Class E shares in the capital stock of Opco to Ms. X.
The will provides that the trustee of the Trust will provide an annual income of $30,000 to Child X until he attains the age of 35. If, in any year, the dividends paid by Opco to the Trust on the Class C shares of the capital stock of Opco are insufficient to provide $30,000 to Child X, the Trust will be required to redeem a portion of the shares to make up the difference.
The will provides that the entire trust capital will be distributed to Child X in the calendar year in which he attains 36.
From the time of Mr X's death, the sole trustee of the Trust is a third party.
Ms. X still personally holds the voting shares and a number of Class E shares in the capital stock of Opco having an FMV of at least 10% of the FMV of Opco's capital stock.
Question to the CRA
Is the amount of dividends totalling $30,000 received by Child X in a year an excluded amount under subparagraph 120.4(1.1)(b)(ii)k?
CRA Response
General comments
Paragraph 120.4(1.1)(b) introduces a continuity rule in respect of, inter alia, inherited property. It applies to amounts that would, but for the application of that rule, be split income of a specified individual who attained 17 years of age before the year, in respect of property that was acquired by or on behalf of the specified individual as a consequence of the death of another person.
Subparagraph 120.4(1)(b)(ii) provides that, for the purposes of that subparagraph and the definition "excluded business" in subsection 120.4(1), if the other person was actively engaged on a regular, continuous and substantial basis in the activities of the related business in five preceding taxation years, the specified individual is deemed to have been actively engaged on a regular, continuous and substantial basis in the business throughout those five years.
Where subparagraph 120.4(1.1)(b)(ii) applies, the individual's income determined on the property acquired by or on behalf of the individual as a consequence of the death of a person will be an excluded amount to the extent that the amount, if received by the deceased person, would have been derived from an excluded business because the deceased person was actively engaged on a regular, continuous and substantial basis in the business throughout the preceding five taxation years, or was deemed by that subparagraph to be actively engaged in the business.
Paragraph 120.4(1.1)(b) provides, inter alia, that a property must be acquired by or on behalf of the specified individual as a consequence of the death of another person. Whether property is acquired by or on behalf of the specified individual because of the death of another person is a question of fact and law that can only be resolved after considering all of the relevant facts and circumstances of a particular situation.
Paragraph 248(8)(a) provides, inter alia, that a transfer, distribution or acquisition of property made under a taxpayer's will is considered to be a transfer, distribution or acquisition of property made as a consequence of the death of the taxpayer.
CRA answers to questions (a) and (b) of Situation A
First, for the purposes of this Situation, we have assumed that Child X is the sole beneficiary of the income and capital of Trust X.
Given that the Class E shares of the capital stock of Opco were acquired by Trust X pursuant to the terms of Mr. X's will, that acquisition is considered to be an acquisition made as a consequence of Mr. X's death by virtue of paragraph 248(8)(a). Since Child X is Trust X's sole beneficiary, Trust X's acquisition of the Class E shares of the capital stock of Opco was therefore made on behalf of Child X. Furthermore, upon the delivery of the capital by Trust X to Child X in the calendar year in which he turns 36 years old - as provided for in Mr. X's will - Child X will acquire, inter alia, the Class E shares of the capital stock of Opco. That acquisition will also be considered an acquisition of property made as a consequence of Mr. X's death. Consequently, the deeming rule in subparagraph 120.4(1.1)(b)(ii) will apply in respect of Child X. Child X will therefore be deemed to have been actively, regularly, continuously and substantially engaged in the business of Opco and Opco's business will be an excluded business for Child X. All dividends paid (or deemed to be paid) by Opco on the Class E shares of its capital stock and received (or deemed to be received) by Child X directly or indirectly through Trust X, will then be excluded amounts for Child X by virtue of subparagraph (e)(ii) of the definition of "excluded amount" in subsection 120.4(1).
CRA response to the question from Situation B
The Class C shares of the capital stock of Opco held by the Trust were not acquired by the Trust on behalf of Child X as a consequence of the death of another person, as the Trust already held such shares at the time of Mr. X's death. Consequently, the deeming rule in subparagraph 120.4(1.1)(b)(ii) cannot apply and the business of Opco will not be an excluded business for Child X. All dividends paid (or deemed to be paid) by Opco on the Class C shares of its capital stock and indirectly received (or deemed to be received) by Child X, through the Trust, will not be excluded amounts for Child X by virtue of subparagraph (e)(ii) of the definition of "excluded amount" in subsection 120.4(1).
Furthermore, upon the delivery of capital by the Trust to Child X in the calendar year in which he or she turns 36 years of age - as provided for in Mr. X's will - Child X will acquire, inter alia, Class C shares of the capital stock of Opco. That acquisition will be considered to be an acquisition of property made as a consequence of Mr. X's death and from that time on, the conditions for the application of the deeming rule in subparagraph 120.4(1.1)(b)(ii) will be satisfied and Child X will be deemed to have been actively involved on a regular, continuous and substantial basis in the business of Opco. Opco's business will therefore be an excluded business for Child X. Thus, as of the time Child X holds Class C shares of the capital stock of Opco, the income from those shares will be an excluded amount for Child X within the meaning of subparagraph (e)(ii) of the definition of "excluded amount" in subsection 120.4(1).
Yvon Beaudoin
(514) 496-6688
October 7, 2021
2021-090109