Principal Issues: Question 5A) a) When an immovable rental property has been transferred to a trust, whether the nature of the attributed income under subsection 75(2) retains its nature? b) If the attributed income retains its nature, how the CRA expects the tax practitioners to prepare and file the T3 Trust Income Tax and Information Return and the T3 Statement of Trust Income Allocations and Designations ("T3 Statement") in order to ensure that the rental income is considered in calculating the taxpayer's "RRSP deduction limit" under subsection 146(1)? Question 5B) Mr. X owns the controlling shares of the capital stock of Opco. A protective trust, settled by Mr. X, owns the remaining shares of the capital stock of Opco. Mr. X is the sole beneficiary of the protective trust. The shares owned by the protective trust have the following attributes: paid-up capital of $10; adjusted cost base of $10,000 and redemption value of $10,000. On the redemption by Opco of some shares owned by the protective trust, a deemed dividend is attributed to Mr. X by virtue of subsection 75(2) and the capital loss would be deemed to be nil by virtue of subsection 40(3.6). a) Whether the loss will be deemed to be nil in this situation. b) In the affirmative, whether the loss determined without reference to subsection 40(3.6) will be attributed to Mr. X. c) As a result of the application of paragraph 40(3.6)(b), whether the loss will be added to the adjusted cost base of the shares owned by Mr. X or to the adjusted cost base of the shares owned by the protective trust. d) If Mr. X does not own any shares of the capital stock of Opco and if all the shares of the capital stock of Opco are owned by the protective trust, whether the trust will be affiliated to Opco under section 251.1, and whether the answers to questions a), b) and c) will be different.
Position: Question 5A) a) When subsection 75(2) applies, the rental income from the immovable property is deemed to be income from property of that person. For purposes of calculating the "RRSP deduction limit" of the person referred to in subsection 75(2), that income from property may be included in his or her "earned income", as stated in the definition of that term in subparagraph146(1)(a)(iii). b) As the rental income from immovable property under subsection 75(2) retains its nature, this income should be reported in box 26 "other income" of the T3 Statement, followed by an asterisk referring to the footnotes area of the statement. In this area, the preparer should mention that the income included in box 26 constitutes net rental income from an immovable property subject to subsection 75(2) of the ITA. Question 5B) a) Yes, the loss will be deemed to be nil; b) The loss would not be attributed to anyone; c) The loss will be added to adjusted cost base of the shares owned by the protective trust; d) In this situation, the protective trust will still be affiliated to Opco and the answers to questions a), b) and c) would be the same.
Reasons: Based on our interpretation of relevant provisions of the Act and consistent with our positions in previous technical interpretations.
FEDERAL TAXATION ROUNDTABLE 10 OCTOBER 2014
2014 APFF CONFERENCE
Question 5
Protective Trust
An asset-protection trust to which subsection 75(2) applies has the effect of deeming the income to be that of the transferor.
At the 2010 Federal Roundtable, the CRA, in response to Question 43, indicated that any trust that controlled or received income, gains or profits in any one year was required to file a T3 return under subsection 204(1) of the ITR.
A) Rental income and RRSP deduction limit
Let's take the case of a protective trust realizing rental income relating to an immovable. Upon filing of the trust's income tax return and the subsequent attribution to the transferor, the rental income is "re-characterized" as "other income" (subsection 108(5)) on the T3 slip provided to the beneficiary.
For purposes of determining the "RRSP deduction limit", the concept of "earned income" in subsection 146(1) includes rental income, but does not take into account income earned as "other income".
As a result, the transferor would have a higher RRSP deduction limit if the rental income was earned personally than if it were earned by a protective trust and then allocated to the beneficiary/transferor.
B) Loss deemed to be nil under subsection 40(3.6)
Take the case of a protective trust with Mr. X as the sole beneficiary. The control bloc of shares of the corporation is held by Mr. X. The protective trust holds the other shares of the same corporation following a gift by Mr. X. The shares held by the trust have the following characteristics:
• Paid-up capital of $10
• Adjusted cost base: $10,000
• Redemption value: $10,000
Upon the redemption of shares held by the protective trust, the deemed dividend (pursuant to subsection 84(3)) to the trust will be taxed in the hands of Mr. X pursuant to subsection 75(2) and the capital loss is deemed to be nil under paragraph 40(3.6)(a).
Questions to the CRA
A) Rental income and RRSP deduction limit
a) Is this result in accordance with the Act according to the CRA?
b) According to the CRA, does the income allocated under subsection 75(2) retain its character?
c) If the attributed income retains its character, how does the CRA expect the T3 returns and slips to be filed on the basis that the rental income is considered in calculating the “RRSP deduction limit”?
B) Loss deemed to be nil under subsection 40(3.6)
a) Can the CRA confirm that the loss will effectively be deemed nil in such a situation?
b) If yes, will the loss calculated without reference to subsection 40(3.6) be attributable to Mr. X or to the protective trust?
c) When applying paragraph 40(3.6)(b), can the CRA indicate whether the loss will be added to the adjusted cost base of the other shares held by Mr. X or to those held by the protective trust?
d) Assuming that Mr. X does not hold any of the shares of the corporation and that all of the shares (including the control bloc of shares) are held by the protective trust:
(i) Would the trust be affiliated with the corporation under section 251.1?
(ii) Would the CRA's answers to (a), (b) and (c) be different?
CRA Response to Question 5(a)
Where an immovable rental property has been transferred to a trust by a person and all the conditions set out in subsection 75(2) are met, the income from that rental property or from any rental property substituted therefor ("Substituted Rental Property") is, during the existence of the person while the person is resident in Canada, deemed to be income of the person. This income is equal to the amount by which the gross income from the lease of the real property transferred to the trust, or any Substituted Rental Property substituted therefor, exceeds the deductible expenses relating thereto. It should be noted that business income is not subject to subsection 75(2).
Subsection 108(5) does not have the effect of modifying the application of subsection 75(2). In our view, the net rental income from the lease of the real property transferred to the trust or any Substituted Rental Property retained therein preserves its character and the transferee must include this net rental income in his or her return of income for the taxation year.
For the purpose of calculating the "RRSP deduction limit" of the person subject to subsection 75(2), as defined in subsection 146(1), the income from the rental property transferred to the trust or any Substituted Rental Property therein is included in his or her "earned income", as defined in paragraph 146(1)(a)(iii).
Since the net income from the lease of real property or any Substituted Rental Property retains its character for the purposes of subsection 75(2), we are of the view that such income should be entered in box 26 "Other Income" on Form T3 Statement of Trust Income Allocations and Designations (the T3 slip) of the subject trust followed by an asterisk referring to the space on the slip for notes. In this space, the preparer of the slip should note that the income shown in box 26 constitutes net income from the lease of real property referred to in subsection 75(2).
As stated above, the person who transferred the property to the trust should enter that property income as net rental income on line 126 of his or her income tax return for the particular taxation year and include that income in "earned income" for the purposes of calculating his or her "RRSP deduction limit" under subsection 146(1).
CRA Response to Question 5(b)
a) Paragraph 40(3.6)(a) provides that where a taxpayer disposes, to a corporation that is affiliated with the taxpayer immediately after the disposition, of a share of a class of the capital stock of the corporation, the taxpayer's loss from the disposition is deemed to be nil.
In the case described in question 5(b), Mr. X and the corporation are affiliated under subparagraph 251.1(1)(b)(i) given that Mr. X controls the corporation. The asset-protection trust and the partnership are also affiliates under subparagraph 251.1(1)(g)(ii) as the corporation is affiliated with Mr. X, who is a "majority-interest beneficiary" of the asset-protection trust within the meaning of subsection 251.1(3). In addition, in this example, the asset-protection trust and the partnership are affiliates both before and after the disposition of the shares of the corporation's capital stock in favour of the corporation.
Thus, all the conditions set out in paragraph 40(3.6)(a) are met. Accordingly, the loss resulting from the disposition by the asset-protection trust in favour of the corporation of a share in its capital stock would be deemed to be nil.
b) A loss deemed to be nil under paragraph 40(3.6)(a)(i) cannot be attributed to anyone. The amount of such loss is subject to the rules set out in paragraphs 40(3.6)(b) and 53(1)(f.2).
c) Assuming that, after the redemption of shares of the capital stock of the corporation held by the asset-protection trust, the trust still holds at least one share of a class of the capital stock of the corporation, the amount of the loss should be added in computing the adjusted cost base of a share of a class of the capital stock of the corporation held by the asset-protection trust immediately after the disposition, in accordance with the calculation in paragraph 40(3.6)(b). In effect, the taxpayer subject to subsection 40(3.6) is the asset-protection trust.
d) (i) The asset-protection trust would be a person who controls the corporation. The trust would therefore be affiliated with the corporation under subparagraph 251.1(1)(b)(i).
(ii) The answers to questions (a), (b) and (c) would not be different. Given that the asset-protection trust and the partnership would be persons affiliated both before and after the disposition of the shares of the capital stock of the corporation to the corporation, the same reasoning as described above would apply in the analysis of questions (a), (b) and (c).
Marie-Claude Routhier
(613) 957-9768
Urszula Chalupa
(613) 957-2124
2014-053824