G. Thornley (613) 957-2101 AUG - 4 1988
Dear Sirs:
Re: Proposed Subsections 56(4.1) to (4.3) of the Income Tax Act (the "Act") Bill C-139, First reading in the House of Commons on June 30, 1988)
This is in reply to your letter of June 15, 1988 requesting our views with respect to the application of the proposed subsections to loans or gifts from a parent to a child where the funds are used to acquire a deferred income investment product. In your hypothetical example, the child is between 15 and 18 years of age and the investment income is taxed under subsection 12.2(3) of the Act.
Our comments, which follow the point order of your questions, assume that the proposed legislation will be passed in its present form and that the proposed amendments are applicable with respect to loans outstanding after 1988, except that in the case of loans made before 1989, the amendments do not apply to income relating" to any period ending before 1989.
Our Comments
1) The present attribution rule (subsection 74.1(2) of the Act) and the proposed rules do not apply to income generated from gifted property to or for the benefit a person who is 18. This is particularly so with respect to the proposed subsections as they relate, in their present form, to loans only.
2) Where, in the circumstances of your example, funds have been loaned to a child who turns 18 before 1989 there is no attribution to the parent in 1988 under subsection 74.1(2) or under the proposed subsection. The 18 year old will report any income in his own 1988 return. If the loan remains outstanding after 1988 the new, proposed attribution rules will attribute the income from the loaned funds to the parent.
3) Where the child is 18 after 1989 the income earned from the loaned funds will be subject to the proposed subsections and will thus be attributable to the parents.
4) Your next question is not quite clear, however you appear to be asking what rules apply when a child who has been loaned money by his parents, repays that loan prior to 1989 at a time when he is under 18. Although the attribution rules in subsection 74.1(2) are no longer applicable in the year a child turns 18, they do not cease to be applicable where the loan is repaid but the child is not yet 18 and will not be to a subsequent year.
5) As indicated by you, proposed subsection 56(4.2) provides an exemption from the attribution rules contained in proposed subsection 56(4.1) for loans that bear a commercial rate of interest and where the interest payable on the loan for the year and preceding years has been paid not later than 30 days after the end of each relevant year. The onus of proof is on the taxpayer to demonstrate, where required, that the loan is repaid. This could be in the form of a cancelled cheque, bank statements or any appropriate audit trail. It may also involve a disclosure of the source of funds used to repay the loan.
6) Where a child, in the circumstances of your hypothetical example, who is 18 in 1988, elects annual accrual it that year at a time when 1988 is the second year of a three year accrual, the attribution rule in subsection 74.1(2) would attribute 1987 accrued income to the parent. The 1988 income would be attributed to the child. In order to avoid the new attribution rules from applying in 1989 the loan would have to be repaid during 1988.
7) Once an election under subsection 12.2(4) is revoked by a taxpayer in accordance with subsection 12.2(4.1), no further election can be made under subsection 12.2(4).
We trust our comments will prove helpful.
Yours truly,
A. GLEN THORNLEY for Director Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch