Revenue Canada Taxation Head Office
XXX
G. Kauppinen Tel. (613) 957-3495
JUN 10 1987
Dear Sirs:
This is in reply to your letter dated February 5, 1987 wherein you requested our comments regarding a number of questions related to deceased taxpayers.
We have replied to each question in order:
Question 1
1. Section 70(1) of the Income Tax Act ("Act") taxes items accruing but not yet due or received at the date of death. If interest accrued to the date of death is never paid to the estate due to default by the debtor is the deceased still taxable on this "accrued" interest to the date of death? If so, is any relief available to the beneficiaries who later never collect this amount?
Our Opinion
If the interest receivable is considered to be a periodic payment which is included in the income of the deceased by virtue of subsection 70(1) of the Act, we would consider that a reasonable reserve for doubtful debts should be available to the deceased taxpayer on his final return pursuant to paragraph 20(1)(1) of the Act. Any amount so deducted will be included in computing the beneficiary's income for the first taxation year ending after the death of the taxpayer. Thereafter, the beneficiary will determine his yearly entitlement to any reserve.
Alternatively, we are of the opinion that subsection 70(2) of the Act could be applicable to the interest in question. Interpretation Bulletin 212R states at paragraph 2 that rights or things includes items which "when realized or disposed of", would have been included in computing the deceased taxpayer's income if he had been alive at that time. Where a beneficiary acquires a right or thing described in subsection 70(2), he is deemed to have acquired the asset at a cost equal to its fair market value pursuant to paragraph 69(1)(c) of the Act (unless subsection 70(3) of the Act applies). Where subsection 70(2) of the Act applies, disposition of the asset by the recipient will generally be on capital account. In a situation where such a debt becomes bad section 50 of the Act could have application
Where subsection 70(3) of the Act applies to a right or thing to which subsection 70(2) of the Act would have otherwise applied, any amount received on the realization or disposition of the right or thing shall not be included in computing the income of the recipient until the year of receipt. In such a case, no reserve is necessary if the amount is never received and it will have not been taxable to the deceased pursuant to either subsection 70(1) or (2) of the Act.
Question 2
2. Subparagraph 53(1)(e)(v) of the Act refers to an adjustment in the partnership interest in respect of rights or things owned by a partnership. You have asked that, if a taxpayer is a member of a farming partnership, do the rules of 70(2) of the Act have application to that partnership?
Our Opinion
Yes.
Question 3
3. Paragraph 248(8)(a) contemplates that a spousal trust rollover will be considered to have been made in certain cases involving provincial law for dependants. You have requested our opinion that, if a taxpayer dies without a Will and the Official Guardian becomes involved, a rollover is deemed to have been effected or that a rollover is only effected if the spouse pays off the Official Guardian within 3 years and therefore acquires the property or neither.
Our Opinion
We presume that this question contemplates a situation where, in order to satisfy the requirements of certain provincial law on an intestacy, a spouse is required to pay certain amounts to the estate (presumably to satisfy the rights of other beneficiaries) before receiving a capital property held by the estate.
It is our view that the payments to the Official Guardian and the subsequent transfer of the property to the spouse would be "as a consequence of the death of the taxpayer" for the purposes of subsection 70(6) and paragraph 248(8)(a) of the Act. However, to satisfy the provisions of subsection 70(6) of the Act, the property must vest indefeasibly in the spouse trust within 36 months after the death of the taxpayer or, where written application therefore has been made to the Minister by the taxpayer's legal representative within that period, within such longer period as the Minister considers reasonable in the circumstances. Therefore, unless there are unusual circumstances, the aforenoted payments would have to be made within 36 months of the date of the death of the taxpayer for the spousal rollover pursuant to subsection 70(6) of the Act to be available.
Question 4
4. In 1980, there was a vehicle on the market called a wrap around Income Averaging Annuity Contract ("IAAC") where the insurance company made a loan to the individual to buy an IAAC. You have requested our opinion that if an individual died and his spouse continued in his place with respect to the IAAC, she could deduct the interest on the loan the deceased had taken out to purchase the IAAC.
Our Opinion
Pursuant to subsection 61.1(2) of the Act, any amount paid out of an IAAC contract subsequent to the death of the original annuitant is deemed to be a payment out of an IAAC contract and will therefore be included in the income of the recipient with no deduction for any capital element. However, if the IAAC was acquired prior to November 13, 1981 the restrictive provisions of paragraph 18(11)(a) of the Act would not be applicable and the related interest which would have been deductible by the deceased taxpayer will be deductible by the spouse who subsequently receives the annuity payments, provided she has a legal obligation to pay. that interest.
Question 5
5. Section 114.2 of the Act states that a claim for medical expenses cannot exceed the total allowable if separate returns were not filed for a deceased taxpayer. You assume that if net income on all terminal and separate returns totalled $40,000 that $1,200 of medical expenses could not be deducted (3% threshold) and any excess could be deducted on any return. You have asked if this is correct.
Our Opinion
As stated in interpretation Bulletin 326R at paragraph 3 therein, medical expenses in excess of 3% of aggregate net income of all terminal returns may be claimed on any return.
Question 6
6. You would appreciate our clarification as to when a taxpayer may make a separate return for rights or things pursuant to subsection 70(2) of the Act. It appears to you that if the item in question is passed to a beneficiary within the later of a) 1 year after death b) 90 days after the mailing of any notice of assessment for the year of death that this option is not available because subsection 70(3) of the Act would override subsection 70(2) of the Act. You have requested our view as to whether this is correct.
In your opinion, one situation where this appears unfair is where a partner's death does not trigger a year-end of the partnership. If the stub income is not eligible for treatment pursuant to subsection 150(4) of the Act and is distributed within the required time limit to a beneficiary, subsection 70(2) of the Act may not be available either.
If the above is correct, you have asked our opinion as to whether an election can be made to file a rights or things tax return where the Will specifies who will receive the asset but the asset is not distributed legally by the solicitor until after the time limits above.
Our Opinion
Where subsection 70(3) of the Act is applicable to a right or thing, subsection 70(2) of the Act will not be applicable to that right or thing.
In order for subsection 150(4) of the Act to be available, the death must have occurred before the end of the calendar year in which the last fiscal year of the partnership ended.
If subsection 150(4) of the Act is not available, the deceased partner's right to share in the profits of the partnership to the date of death is a right or thing eligible for an election pursuant to subsection 70(2) of the Act. Where the right to an amount which would otherwise have been included in income under subsection 70(2) of the Act is transferred or distributed to a beneficiary before this amount is capitalized (i.e. allocated to the deceased partner's capital account), subsection 70(3) will apply if the time for making an election under subsection 70(2) has not expired before the transfer or distribution.
If the aforenoted time limits have passed, then neither subsections 70(2) or (3) of the Act will be available and, assuming subsection 150(4) of the Act was not applicable, the amount will be taxable on the deceased partner's final return pursuant to subsection 70(1) of the Act.
Question 7
7. Section 13(21.1) of the Act contains rules adjusting terminal losses and capital gains on non-arm's length disposition. You have requested our opinion as to whether a transfer by Will to a son is considered to be a disposition to which this subsection applies?
Our Opinion
In our opinion, the provisions of section 70 of the Act would apply to deem dispositions by the deceased taxpayer immediately prior to his death. Subsection 13(21.1) of the Act would not apply in these circumstances.
Question 8
8. You have asked our view on the following. If a taxpayer had a right to terminate an annuity during his lifetime for a cash settlement but did not, can the commuted value of the annuity be reported as a right or thing?
Our Opinion
Generally, ordinary annuities which could have been terminated for a commuted amount prior to maturity during the taxpayer's lifetime will be considered to be a right or thing if any part of the settlement would have constituted income of the deceased had he received it while alive.
Question 9
9. Subsection 70(6.2) of the Act allows the legal representative of a deceased taxpayer to elect that a property which would otherwise qualify for a tax-deferred rollover be transferred at fair market value. Where the deceased owned several shares of a company, you have asked our opinion as to whether the representative can make the election in respect of some of the shares and not the rest?
Our Opinion
Yes.
Question 10
10. The Ontario Family Law Reform Act now allows a wife of a deceased to accept the terms of the deceased's Will or to have her equity calculated under the equalization rules. If she acquires an asset from the estate in the equalization process, you have requested our opinion as to whether the rollover pursuant to subsection 70(6) of the Act will be available.
Our Opinion
In our view, subsection 70(6) of the Act will be available in the circumstances you have outlined provided the property in question vests indefeasible in the spouse within the time limits required by that subsection.
Question 11
11. A cash basis farmer can treat receivables and inventories as rights or things. You have posed the following questions:
(a) Can cash basis payables be deducted from income in full in the year of death regardless of when paid?
(b) Is there a requirement to deduct them against the same return of the deceased on which the related income shows up?
(c) Who gets the expense deduction if the assets are passed to the beneficiaries pursuant to subsection 70(3) of the Act?
(d) Is there any problem deducting cash basis payables for livestock feed if the livestock has been sold before the death of the taxpayer?
Our Opinion
In our view, the answers to the foregoing questions are as follows:
(a) Yes.
(b) Yes.
(c) To the extent that a property which would have been a right or thing is transferred or distributed to a beneficiary pursuant to the provisions of subsection 70(3) of the Act, the beneficiary will be entitled to deduct any expense incurred in respect of items being brought into his income if the expense was of such a nature that, had the taxpayer not died, it would have been allowable as a deduction in computing his income.
(d) As stated in Interpretation Bulletin 427 at paragraph 6 therein, where a farmer who determines income using the "cash" method dies possessed of an inventory of livestock, the value of the livestock is a right or thing for purposes of subsections 70(2) and (3) of the Act. As stated in Interpretation Bulletin 212R at paragraphs 5 and 6 therein, in calculating the "value" of rights and things, there may be deducted amounts payable or expenses incurred at the date of the taxpayers death in respect of one or more of the rights or things being brought into income, if they would have been an allowable deduction to the taxpayer had he not died. Where deductions allowable pursuant to the foregoing exceed the gross amount of the rights or things, the Department considers that the excess is deductible from other income of the taxpayer.
In our opinion, since the livestock could have been considered rights or things had it not been sold prior to the taxpayer's death, the value of the livestock feed would be deductible from other income of the taxpayer on either the subsection 70(1) return or the subsection 70(2) return.
Question 12
12. Catherine Brown in a paper at the 1986 Canadian Tax Foundation indicated that new subsection 248(8) of the Act will serve to allow a rollover pursuant to section 70 of the Act where an option is granted to someone who themselves would have qualified for the rollover. She notes that in future this would cover a situation like Penner vs MNR 84 DTC 1444. You have requested our views on the foregoing.
Our Opinion
In our opinion, because paragraph 248(8)(a) of the Act contains the words "acquisition of property under or as a consequence of the terms of the Will or other testamentary instrument", the acquisition of property upon the exercise of a testamentary option shall be considered an acquisition of property as a consequence of the death of the taxpayer or the taxpayer's spouse, as the case may be, for the purposes of section 70 of the Act. Therefore, the rollover provisions will be available in these circumstances provided all other relevant provisions of section 70 of the Act are also satisfied.
Question 13
13. Subsection 248(1) of the Act defines death benefits. You have asked our opinion as to whether a closely held family corporation can pay a death benefit to a widow of the former sole shareholder. If so, you have asked whether it is necessary for the payment to be previously authorized in the corporate records.
Our Opinion
Pursuant to subsection 248(1) of the Act a death benefit means the aggregate of amounts received by a taxpayer in a taxation year upon or after the death of an employee in recognition of the employee's service in an office or employment. "Office" includes the position of a corporate director.
Assuming the deceased taxpayer was in fact an officer or employee of the corporation and not just its sole shareholder, a payment to his widow could be taxable as ordinary income (i.e. deferred compensation), a retiring allowance or a death benefit. With regard to the distinction between deferred compensation and a retiring allowance, we refer you to Interpretation Bulletin 337R2, paragraphs 7 and 8. If an employee dies prior to retirement, a payment (which is not deferred compensation) to a spouse or other dependent in recognition of the employee's service will generally be considered to be a death benefit. If an employee dies after retirement and his spouse then receives such a payment in recognition of the employee's service, this payment would normally be considered to be a retiring allowance.
In a closely held corporation, the amounts of such payments (which are not deferred compensation) must be reasonable. The Department considers a reasonable amount to be the maximum amount which could be transferred to an RRSP pursuant to paragraph 60(j.l) of the Act if the payment had been a retiring allowance as defined pursuant to subsection 248(1) of the Act.
There is no necessity for the payment to have been previously authorized in the company's records.
Question 14
You wish our opinion on certain questions regarding the "executor's year". You have posed the following specific questions:
14. (a) Paragraph 4 of Interpretation Bulletin 286R refers to the fact that if the trustee is given discretion over the payment of income of a trust then no amount is payable until he exercises his discretion. Does this discretion refer to whom the amounts are paid to or when the amounts are paid?
(b) Paragraph 5 of Interpretation Bulletin 286R mentions that the common-law rule will not suffice to justify a one-year executor rule in a trust. However, if even one beneficiary objects to such treatment, the full income will be taxable in the trust (to the extent that it was not actually paid during the year). Does this in effect give permission to use the one year rule if any of the beneficiaries wish to have the executor do it?
(c) Does the requirement that no income is paid out of a trust in the first year in order to have an executor's year refer to a taxation year or 12 months from the date of death? For example, suppose a taxpayer dies on February 1, 1986. If income was realized in June, a July 31, 1986 year-end was picked and the distribution to the beneficiaries took place on November 11, 1986, would an executor's year be allowed to the trust?
Our Opinion
(a) In our view, the discretion could refer to whom the amounts are paid and/or when the amounts are paid.
(b) Yes. However, it is a question of fact as to when an estate is considered to be wound-up. If the executor does not intend to file another return or requests a clearance certificate based on the returns filed for the executor's year, the return is considered to be a final return and the estate would be considered to have wound-up during the executor's year even if the actual distribution occurs shortly thereafter. In our view, amounts could be paid during the first taxation year of a testamentary trust, for instance, due to the exercise of trustee discretion, and the common-law rules relating to an "executor's year" could still apply for amounts which are not paid out and are therefore taxed in the trust.
(c) In our opinion, normally an executor's year will cover a period of up to 12 months after the death of the taxpayer. In certain cases, for example, if a Will was being contested, more than one "executor's year" may be permitted.
However, as stated in (b) above and using your example, if the estate could have been wound up on July 26 (being its first year-end) the distribution would be considered to have been made during the period February 1, 1986 to July 31, 1986. If however, the estate could not have been wound-up prior to July 31, then the income earned during the period February 1 to July 31 would be taxable to the trust. The trust would then have a second taxation year from August 1, 1986 to November 11, 1986. Assuming all assets of the trust are distributed at that date and the trust is then wound up, any income earned on the assets of the trust during the period August 1 to November 11 which was not actually paid out could be considered to be also taxable to the trust if the beneficiaries so desire and the trust could not have been wound up prior to November 11.
Question 15
15. You have requested our opinion as to whether the 1986 tax changes to paragraph 109(1)(a) of the Act mean that, in computing any claim on a deceased taxpayer's return for a spouse the deceased taxpayer's representative would have to include the spouse's income for the entire year rather than only up to the date the deceased taxpayer died.
Our Opinion
As outlined in Interpretation Bulletin 191R2, in the year in which a taxpayer dies the amount which the deceased may claim for support of the deceased's spouse will be determined pursuant to paragraph 109(1)(a) of the Act taking into account the income of the spouse for the entire year in which the death occurred.
We trust the foregoing is the information you require.
These opinions are our best interpretation of the law as it applies generally. They may, however, not always be appropriate in the circumstances of a particular case and, as stated in paragraph 24 of Information Circular 70-6R, they are not binding on this Department.
Yours truly,
for Director Financial Industries Division Rulings Directorate Legislative and Intergovernmental Affairs Branch