Principal Issues: Whether the exemption from “tax on split income” (“TOSI”) in paragraph (b) of the definition of “excluded amount” is still applicable to an amount derived from “substituted property” within the meaning of subsection 248(5), for property acquired in a transfer described in paragraph 160(4).
Position: An amount derived from a property acquired under the circumstances described in subsection 160(4) is an “excluded amount” under paragraph (b) of the definition of “excluded amount” in subsection 120.4(1). Such definition of “excluded amount” in paragraph (b) does not specifically provide that an amount derived from a property substituted to the said property acquired under those circumstances described in the preamble of subsection 160(4) is an “excluded amount”.
Reasons: Wording of the Act and previous CRA’s positions.
CALU Roundtable – May 2024
Question 10 – TOSI and Marriage Breakdown
Background
If property is transferred to a separated spouse as a result of marriage breakdown, the tax on split income (endnote 1) (“TOSI”) rules won’t apply to income or capital gains on that property. (endnote 2) The special rule in subsection 160(4) of the Income Tax Act (the “Act”) specifically applies to the transferred property and property “substituted therefor”. Subsection 248(5) of the Act, which applies for the purposes of the Act, has specific rules for determining whether property is deemed to have been substituted for the particular property.
Fact Situation
Spouse A owns 80% of the common shares in the capital stock of Opco with the adult children of Spouse A and B owning the remaining 20% of the common shares. Spouse A and B are living separate and apart due to the breakdown of their marriage at the end of the year. In that same year, pursuant to a separation agreement, Spouse A transfers 20% of the common shares in the capital stock of Opco (the “Common Shares”) to Spouse B such that paragraph (b) of the “excluded amount” definition in subsection 120.4(1) of the Act will be satisfied in the future. For the purposes of section 120.4 of the Act, Spouse B is deemed to not be related to Spouse A at any time in a year as, at the end of the year, they are living separate and apart due to marriage breakdown. (endnote 3) However, the children of Spouse A and B continue to be “source individuals” to Spouse B. Subsequent to the transfer of the Common Shares to Spouse B and in the same taxation year, Opco undergoes a corporate reorganization and Spouse B’s Common Shares are converted to preference shares in the capital stock of Opco (the “Preference Shares”).
Question
Can CRA confirm that the exemption from TOSI in paragraph (b) of the definition of “excluded amount” is still applicable to the Preference Shares owned by Spouse B?
CRA Response
An amount that derives from “property acquired by the individual under a transfer described in subsection 160(4)” is an “excluded amount” under paragraph (b) of the definition of “excluded amount” in subsection 120.4(1) of the Act and is excluded from “split income”, as defined in subsection 120.4(1) of the Act, of a specified individual for a particular taxation year.
A transfer described in subsection 160(4) of the Act means a transfer of a property to a taxpayer’s spouse or common law partner pursuant to a decree, order or judgment of a competent tribunal or pursuant to a written separation agreement and, at that time, the taxpayer and the spouse or common-law partner were separated and living apart as a result of the breakdown of their marriage or common-law partnership. The special rule in paragraph 160(4)(a) of the Act provides that subsection 160(1) of the Act will not apply with respect to any income from, or gain from the disposition of, the transferred property, as described in the preamble of subsection 160(4) of the Act, or property substituted therefor.
In technical interpretation 2004-0101701E5, the CRA was of the view that when a definition is a deeming provision, as is the case with the definition in subsection 248(5) of the Act, it must relate to the word that Parliament is trying to define. In order for the definition to apply to a specific provision, the word being defined must be found in the provision in question.
We are of the view that in order to apply to an amount from a property substituted to the property that is acquired in a transfer described in subsection 160(4) of the Act, the definition of “excluded amount” under paragraph (b) in subsection 120.4(1) of the Act should specifically indicate that, as is the case for several provisions of the Act. Accordingly, an amount derived from a “substituted property”, within the meaning of subsection 248(5) of the Act, for property acquired in a transfer described in subsection 160(4) of the Act would not be an “excluded amount” pursuant to paragraph (b) of the definition of “excluded amount” in subsection 120.4(1) of the Act.
In the given situation, Spouse B acquired the Common Shares in a transfer described in subsection 160(4) of the Act and subsequently exchanged the Common Shares and acquired the Preference Shares in substitution therefor. The Preference Shares are substituted property to the Common Shares and were not acquired by Spouse B in a transfer described in subsection 160(4) of the Act. Accordingly, an amount received by Spouse B from the Preference Shares would not constitute an “excluded amount” to Spouse B under paragraph (b) of the definition of “excluded amount” in subsection 120.4(1) of the Act.
Consequently, TOSI could apply to Spouse B in respect of an amount derived from the Preference Shares if the applicable conditions were met and no other exclusions applied.
Nathalie Aubin
2024-100581
May 7, 2024
ENDNOTES
1 Tax on split income is determined under subsection 120.4(2) of the Act.
2 Paragraph (b) of the definition of “excluded amount” in subsection 120.4(1) of the Act which references subsection 160(4) of the Act.
3 Paragraph 120.4(1.1)(e) of the Act.