Pam Prior, GVA, Enterprise, Ruth March, East, Enterprise, Siobhan Monaghan and Carla Hanneman, GTA, KPMG Law, Canadian Tax Adviser, November 24, 2015. The Department of Finance recently released a letter responding to concerns regarding the new estate and trust rules which were raised by the Joint Tax Committee, the Conference for Advanced Life Underwriting, and STEP Canada ("the Organizations"). In the letter, Finance states that it sees value in further discussions with the Organizations, as it wants to confirm its understanding of the main issues raised. In the letter, Finance also describes possible options for addressing the issues. The two issues specifically addressed in the letter deal with the tax liability arising from deemed dispositions as a result of the death of a life interest beneficiary (e.g., a spouse beneficiary in spousal trust, a settlor in an alter-ego trust and the survivor of the settlor and their spouse in a joint partner trust) and possible wasted donation tax credits trapped in a trust.
Under the new regime, effective January 1, 2016, all of the trust's income will be taxed in the deceased beneficiary's terminal tax return instead of in the trust. The result is that the tax liability will be borne by the beneficiary's estate. This will be the case even though the trust's property will be enjoyed by the trust's capital beneficiaries. If the beneficiaries of the deceased's estate are different from the trust's capital beneficiaries, the tax may be unfairly borne by persons who are not entitled to the assets.
In its letter, Finance outlines an option for addressing this issue: the legislation could be amended to tax income that is deemed to be recognized upon the death of the life interest beneficiary in the trust, in certain circumstances.
In the letter, Finance acknowledges that in certain cases donation tax credits may be "stranded" in a trust because of the new rules. For instance, if a trust makes a gift of property after the life interest beneficiary's death, the donation tax credit will be in the trust but the income and capital gains realized from the death of the life interest beneficiary and the resulting income tax liability will be in the deceased beneficiary's final tax return instead of in the trust's return. As a result, the tax liability is incurred by the estate but the donation tax credit is claimable by the trust. The donation tax credit may be "stranded" in the trust if the trust does not have income tax otherwise payable against which it can deduct the donation tax credit.
This issue is exacerbated under the new rules because the new rules deem the trust's taxation year to close at the end of the day on which the death occurs. Gifts made by the trust after the end of that day would be considered to have been made in a later taxation year of the trust. As a result of this, the donation tax credit would no longer apply to the trust's taxation year in which the death occurs—the credit would only be available in that later year or in a carry forward year.
Finance states that this issue may have a negative impact on charitable giving.
Finance states that an amendment to the legislation could include a provision permitting a trust to allocate the eligible amount of a donation made by the trust after the life interest beneficiary's death—but during the calendar year in which the death occurs—to the trust's deemed taxation year in which the death occurs.
In the letter, Finance indicates that it will consider whether the possible fixes above should be recommended to the Minister of Finance and whether additional amendments may be necessary. Finance is interested in the Organization's comments on its proposed options for dealing with the issues identified.
The new rules are effective January 1, 2016. For more details on these rules, see the following KPMG publications and resources:
Information is current to November 24, 2015. The information contained in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's National Tax Centre at 416.777.8500416.777.8500