Taxation and Estate Planning A Primerpeople.ucalgary.ca/~law/tutorials/L619/L619_Estate...2 These...

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Taxation and Estate Planning A Primer*

Faculty of Law The University of Calgary September 2004

2 * These Materials are based on Cullity, Brown and Rajan, Taxation and Estate Planning, 4th

Edition, 2002 (Carswell). Updated September 2002 by Annie Ta, C.A., LLB. Updated September 2004, Catherine Brown Copyright 2002, 2004

All rights reserved. These materials or parts thereof may not be reproduced or used in any manner without the prior written permission of the author.

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TABLE OF CONTENTS

Introduction ..................................................................................................................... 1 Chapter 1: Taxation on Death: Deemed Dispositions and Post Mortem Planning ........ 2 Introduction ..................................................................................................................... 2 I. Income .................................................................................................................... 2

1. Periodic Payments .......................................................................................... 2 Interpretation Bulletin IT-210R2 ...................................................................... 3

2. Rights of Things .............................................................................................. 4 II. Property................................................................................................................... 5

1. Capital Property .............................................................................................. 5 A. General ................................................................................................... 5

i. Fair Market Value............................................................................ 6 Interpretation Bulletin IT-140R3 ...................................................... 7

ii. Property Owned by the Deceased .................................................. 8 iii. Transfers as a Consequence of Death............................................ 8

B. Relieving Provisions for Capital Property ................................................ 8 i. Property Transferred to, or in Trust, for a Spouse or Common-Law

Partner ............................................................................................ 9 a. To a Spouse or Common-Law Partner.................................... 9

C. Vested Indefeasibly............................................................................... 10 Interpretation Bulletin IT-449R .............................................................. 11 1. To a Trust for a Spouse or Common-Law Partner (Conjugal Trust)

...................................................................................................... 14 2. Entitled to All of the Income .......................................................... 15 3. Transfers as a Consequence of Death.......................................... 15 4. Tainted Trusts ............................................................................... 16

Interpretation Bulletin IT-305R4 .................................................... 17 5. Residence of Trusts ...................................................................... 21

i. Transfers of Farm Property ................................................... 21 ii. Principal Residence .............................................................. 23

2. Land Inventory .............................................................................................. 24 3. Resource Properties ..................................................................................... 24 4. Eligible Capital Property ................................................................................ 24 5. Partnership Rights......................................................................................... 25

i. Death of an Active Partner .................................................................... 26 ii. Death of a Retired Partner .................................................................... 28

6. Life Estates ................................................................................................... 29 7. Taxable Canadian Property........................................................................... 30 8. Proceeds of Life Insurance............................................................................ 30 9. Other Property of the Deceased.................................................................... 31

III. Deductions, Credits and Exemptions .................................................................... 33 1. Deductions .................................................................................................... 33

A. From Income......................................................................................... 33 i. Reserves....................................................................................... 33 ii. Capital Gains Deduction ............................................................... 33 iii. Capital Losses............................................................................... 36

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B. Computation of Tax............................................................................... 36 i. Charitable Donations..................................................................... 36 ii. Medical Expenses ......................................................................... 37

2. Alternative Minimum Tax............................................................................... 38 3. Other Separate Returns ................................................................................ 39

Chapter 2: Taxation of the Estate, Testamentary Trusts and Beneficiaries................. 40 Introduction ................................................................................................................... 40

1. Transfers of Property to a Trust .................................................................... 41 2. Income Earned by the Trust .......................................................................... 42

A. Taxation of the Trust ............................................................................. 43 i. Pappas Estate v. M.N.R., 90 DTC 1646 (T.C.C.) .......................... 43 ii. Evans Estate v. M.N.R., [1960] SCR 391...................................... 44 iii. R v. Bronfman Trust, [1987] DTC 5059 (S.C.C.) ........................... 44

B. Taxation of Beneficiaries ....................................................................... 45 i. Amounts Payable to Beneficiaries................................................. 45 ii. Family Trust .................................................................................. 45

a. The Executor=s Year.............................................................. 45 b. Allocation of Trust Income..................................................... 46

C. Disclaimers, Releases and Surrenders ................................................. 47 i. Herman v. M.N.R., 61 DTC 700 (TAB).......................................... 47 Interpretation Bulletin IT-385R2 C Disposition of an Income Interest in a

Trust.............................................................................................. 48 D. Direction to Maintain Infants or Other Persons ..................................... 50

Interpretation Bulletin IT-446R C Legacies ......................................... 50 i. Wilson v. M.N.R., 55 DTC 1065 (SCC) ......................................... 51

ii. Saunders v. M.N.R., 51 DTC 292 (TAB) ............................................... 51 iii. B.A. Brown v. M.N.R., 52 DTC 53 (TAB)....................................... 51

E. Capital Gains......................................................................................... 52 F. Capital Gains Exemption....................................................................... 53 G. Deemed Income.................................................................................... 54 H. Amounts Deemed to be Payable to an Infant........................................ 55 I. Payments for the Maintenance of Property ........................................... 55 J. Amounts Subject to a Preferred Beneficiary=s Election ......................... 55 K. Benefits ................................................................................................. 56

i. Cooper v. The Queen, 88 DTC 6525 (F.C.T.D.) ........................... 56 3. Ancillary Conduct Provisions......................................................................... 57

A. Taxable Dividends................................................................................. 57 B. Exempt Dividends ................................................................................. 57 C. Taxable Capital Gains........................................................................... 58

Interpretation Bulletin IT-381R3 C Trusts C Capital Gains and Losses and the Flow-Through of Taxable Capital Gains to Beneficiaries.. 58

D. Foreign Tax Credit ................................................................................ 64 E. Refunds of Premiums under Registered Retirement Savings Plans ..... 64 F. Pension Benefits ................................................................................... 64 G. DPSPS and Death Benefits................................................................... 64 H. Non-Deductible Resource Royalties ..................................................... 65 I. Limitations............................................................................................. 65

4. Disposition of Income or Capital Interests ..................................................... 65

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5. Non-Resident Beneficiaries........................................................................... 67 Chapter 3: Gifts and Personal Trusts Inter Vivos ........................................................ 69

1. Taxation of the Donor at the Time of the Gift ................................................ 69 A. Trusts .................................................................................................... 70 B. Gifts to a Spouse, Common-law Partner or a Conjugal Trust ............... 70 C. Transfers to Alter Ego, Self-Benefit, and Joint-Partner Trusts ...... 71

i. Alter-Ego Trusts ............................................................................ 71 ii. Self-Benefit Trusts......................................................................... 71 iii. Joint-Partner Trusts....................................................................... 72

D. Deemed Dispositions ............................................................................ 72 E. Qualifying Dispositions.................................................................. 74 F. Gifts of Farm Assets.............................................................................. 74

2. Attribution to the Donor After the Gift ............................................................ 75 A. Transfers to a Spouse, Common-law Partner or to Certain Minors....... 76

i. Income and Losses ....................................................................... 76 a. Transactions Which Attract Attribution .................................. 76

Interpretation Bulletin IT-511R C Interspousal and Certain Other Transfers and Loans of Property................................................... 78

B. Transfers Through A Trust .................................................................... 79 C. Indirect Transfers of Property................................................................ 80 D. Exceptions to the Attribution Rules ....................................................... 82

i. Separate and Apart ....................................................................... 82 ii. Income from Business................................................................... 82 iii. Accumulating Trust Income........................................................... 82 iv. Residence ..................................................................................... 82 v. Reverse Attribution........................................................................ 82

a. Sullivan v. M.N.R., 91 DTC 43 TCC..................................... 82 vi. Taxable Capital Gains and Allowable Capital Losses ................... 83

a. Spouses or Common-law Partners ....................................... 83 b. Controlled Trusts................................................................... 83 c. Income Splitting by the Diversion of Income ......................... 84

vii. Subsection 56(4.1) ........................................................................ 87 3. Taxation of Inter Vivos Personal Trusts ........................................................ 87

A. The Rate of Tax .................................................................................... 87 B. Preferred Beneficiary=s Election ............................................................ 88

Appendix 1 .................................................................................................................... 89 Appendix 2 .................................................................................................................... 90 Appendix 3 .................................................................................................................... 91 Appendix 4 .................................................................................................................... 97 Appendix 5 .................................................................................................................. 101 Appendix 6 .................................................................................................................. 103 Appendix 7 .................................................................................................................. 106 Appendix 8 .................................................................................................................. 107 Appendix 9 .................................................................................................................. 108 Appendix 10 ................................................................................................................ 112 Appendix 11 ................................................................................................................ 119 Appendix 12 ................................................................................................................ 122

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Introduction These materials and the Computer Assisted Learning Program are designed to provide an

overview of the general provisions which impact on the taxation of trusts and estates. Three

major areas are discussed: Taxation on Death, Taxation of the Estates and Beneficiaries, and

Taxation of Gifts and Trusts Inter Vivos.

In taxation on death the general tax provisions which apply at death, the specific tax treatment of

various assets, and the special relieving provisions are discussed. An understanding of this

provision is critical to an understanding of the tax treatment of testamentary trusts. Taxation of

the Estate and Beneficiaries addresses the range of taxation issues which will arise in handling

the estate, any trusts created under the will and the tax treatment afforded to the beneficiaries.

Finally, in taxation of gifts and trusts inter vivos, the tax treatment of gifts or other transfers inter

vivos are considered. The materials include text, relevant case summaries and applicable

Interpretation Bulletins in these areas.

The Materials are based on the Income Tax Act as at February 6, 2002.

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Chapter 1: Taxation on Death: Deemed Dispositions and Post Mortem Planning Introduction Personal representatives have the responsibility of settling the deceased's account with the Canada Revenue Agency (the CRA). A return must be filed for the year of death (terminal year) and any tax outstanding with respect to that year or earlier years must be paid. As the amount of tax due can vary depending on the terms of the will and the decisions made by the personal representative, understanding and planning for income tax liability in the year of death and throughout the administration of the estate is important. Some of the more significant considerations are discussed below. They are divided into three general categories. First, the rules for computing income for the terminal year vary in a number of important respects from those that apply during a taxpayer's lifetime. The most significant of these provide the personal representative with a number of options or elections. Others deem certain types of property to have been disposed of by the deceased immediately prior to his/her death in return for proceeds generally equal to the fair market value of the property. In addition, rules throughout the Act1 provide special treatment with respect to reserves, the use of capital losses and other deductions and credits in the year of death. Second, a number of provisions provide special tax treatment for specific types of income and for capital property. These include provisions regulating rights to income that is still accruing at the date of the death, other “rights and thing’s” that would have produced income if disposed of before death, capital property, eligible capital property, resource properties and land that is the inventory of a business. Finally, there are a number of provisions that allow for the filing of separate returns. I. Income 1. Periodic Payments In computing the income of a taxpayer for the year of death, amounts that would have been income for that year if the taxpayer had lived must be included. A common example is accruing bank interest. As well, there may be certain amounts that, although not accrued during the taxpayer's lifetime, will be deemed to be income for the terminal year. Subsection 70(1) provides that, income that is payable periodically but that is still accruing at the date of death is subject to a notional severance and is deemed to have accrued in equal amounts from day to day. The amount deemed to have accrued before death is included in income for the terminal year. The remainder is income of the estate or income of any beneficiary to whom it is payable. Examples include amounts that represent accrued but unpaid wages or salaries, interest from bonds, rents, royalties or annuity payments.

1 All references to "the Act" and section references are to the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) as amended unless otherwise noted. This paper relies heavily on a paper presented in June 2002 at a conference run by the CBA, “Tax Law for Lawyers”.

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There are no special options or elections if income amounts fall within subsection 70(1). The inclusion in income in the year of death is obligatory. As this may not be the case with respect to other income amounts, such as rights or things (discussed below), the scope of the provision is of some importance. The CRA’s position with respect to what constitutes a periodic payment is indicated in the following Interpretation Bulletin:

Interpretation Bulletin IT-210R2 November 22,1996, Income of Deceased Persons - Periodic Payments and Investment Tax Credit 1. Under paragraph 70(1)(a), an amount payable on a periodic basis that was not paid to a taxpayer before the

taxpayer’s death is deemed to have accrued in equal daily amounts in the period for which the amount was payable. The value of the portion that is deemed to have accrued to the date of death is required to be included in computing the taxpayer’s income for the year of death. Paragraph 70(1)(a) applies to amounts of interest, rents, royalties, annuities (other than an interest in an annuity contract to which paragraph 148(2)(b) applies), remuneration from an office or employment, and other amounts payable periodically. This provision does not apply to amounts which had become payable before death.

Accrued interest

2. If a deceased taxpayer owned a term deposit or other similar investment on which interest was payable

periodically, interest accrued from the last date on which interest was payable up to the date of death would be included in income for the year of death under paragraph 70(1)(a). However, if the taxpayer also had on hand a matured investment (such as a matured Treasury Bill or uncashed matured bond interest coupons) at the date of death, any interest that was owing to the deceased taxpayer on the matured investment immediately before the date of death would be considered a right or thing for the purposes of subsection 70(2) to the extent the amount was not included or required to be included in the deceased’s income for the year or a preceding year. For information about the tax treatment of “rights or things,” refer to the current version of IT-212, Income of Deceased Persons – Rights or Things.

Accrued salary or wages

3. Only the amount of salary or wages accrued from the beginning of the pay period in which an employee dies to

the date of death is included in the employee’s income under paragraph 70(1)(a). When the amount due and unpaid is in respect of a prior pay period, such amount would be included in income under subsection 70(2). If, prior to the death of an employee, the employer is committed (say because of union bargaining) to pay retroactive salary or wage adjustments, but these are unpaid at the date of the employee’s death, the amount due to the employee is included in income under subsection 70(2).

Genuine doubt about the nature of income

4. Where there is genuine doubt about whether the nature of income earned before a taxpayer’s death is a

periodic payment or a right or thing, its treatment is generally resolved in favour of the taxpayer. As a result, the legal representative may report the income in question under paragraph 70(1)(a) or under subsection 70(2). In the latter case, depending upon the timing, an election under that provision may be made, or if the income has been transferred to beneficiaries, subsection 70(3) applies instead of subsection 70(2).

Deduction of related accrued expenses

5. Any accrued expenses related to the amount included in income under paragraph 70(1)(a) may be deducted

provided that the expenses would have been deductible if paid (e.g., interest expense and property taxes). When such expenses exceed the gross amount included in income, the excess is deductible from other income of the taxpayer.

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Reporting requirements 6. Amounts included in income under paragraph 70(1)(a) and any related accrued expenses that are deductible

are reported in the taxpayer’s “ordinary” income tax return for the year of death.

2. Rights of Things If the taxpayer had rights to income at the time of death (“rights or things") that did not fall within subsection 70(1), such rights also generally result in an income inclusion in the deceased's terminal year. Examples of rights or things listed by the CRA in Interpretation Bulletin IT-212R3 include dividends declared but unpaid, deferred cash purchase tickets, uncashed matured bond coupons and amounts in respect of which an amount has been deducted in computing income such as a "cash basis" inventory.2 Common to each is that "the amount when realized or disposed of would have been included in computing [the deceased's] income". Note that capital property, eligible capital property, land included in the inventory of a business, resource properties and interests in life insurance policies are not rights or things. The CRA takes the view that one crucial difference between rights or things (subsection 70(2)) and periodic payments (subsection 70(1)) is that payment under subsection 70(1) could not have been demanded by the deceased in his or her lifetime. Thus, if the amount was due or payable before death it will not fall within subsection 70(1). If it was not due before death it will fall within subsection 70(1) only if, as well, it is an amount payable on a periodic basis. In summary if the amount was not payable periodically or it was due before death, it may be a right or thing. Subsections 70(1) and (2) are obviously tidying-up provisions designed to tax unrealized amounts that would have been included in the deceased's income for the year or for a subsequent year if he or she had lived. As Interpretation Bulletins IT-210R2 and IT-212R3 indicate, the CRA will generally resolve any doubts as to the relationship between the two subsections in favour of the taxpayer. Of the two provisions, subsection 70(2) is the more attractive from the taxpayer's viewpoint. If applicable, the deceased's personal representative may:

i. file a separate return for rights of things;

ii. transfer rights or things to a beneficiary and thereby remove their value from the income of the deceased; or

iii. include the net value of the rights or things included in the deceased's income for the

year of death. If the personal representative does not choose either the first or the second alternative within one

2 By virtue of subsection 96(1.5) a former partner's right to share in the profits or losses of the partnership will be treated as a right or thing on death. The CRA will also permit amounts paid after the death in respect of a retiring allowance of the deceased to be treated as rights or things or taxed to the recipient at the option of the personal representative. Artists who have elected to value their inventory at nil may also treat it as a right or thing on death.

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year of the deceased's death or 90 days from the mailing of a notice of assessment, the third becomes mandatory. If the personal representative elects to file a separate return for rights or things, tax will be levied as if the deceased were, with respect to them, another person entitled to the deceased’s deductions and credits. In addition, the alternative minimum tax provisions in Division E.1 of the Act will not apply. If the option of transferring rights or things to a beneficiary is chosen, income is not realized until the recipient disposes of the right or thing. When such a disposition occurs, subsection 70(3) provides that the amount received on disposition, minus the cost of the right or thing, is to be included in the recipient’s income. The new cost to the recipient is deemed to be the total of the cost to the deceased not deducted by the deceased during his/her lifetime and any costs incurred by the recipient in acquiring the property from the estate. Subsection 70(3) applies to rights or things transferred to a beneficiary notwithstanding that other rights or things are retained in the estate. It is the CRA’s view however, that it is not possible to file a separate return for some rights or things but include others in the deceased's income for the year of death. If an election to file a separate return is made, it will, according to the CRA, cover all rights or things that were not transferred to a beneficiary within the year. II. Property 1. Capital Property A. General The policy of sweeping all unrealized income of the deceased into income also applies to unrealized taxable capital gains. Subsection 70(5) deems all capital property owned by the taxpayer immediately prior to his or her death to have been disposed of at that time in return for proceeds equal to fair market value. It follows that there may be a capital gain or capital loss and in the case of depreciable property, a recapture of capital cost allowance or a terminal loss. The deceased's personal representatives will normally acquire the property at a cost corresponding to the proceeds of disposition. If the property is depreciable property of a prescribed class, a further adjustment is required if the fair market value of the property immediately prior to death is less than the capital cost of the property to the deceased. In that case, the beneficiary is deemed by paragraph 70(5)(c) to have acquired for the property at a capital cost equal to that of the deceased and the excess of the deceased's capital cost over the deemed proceeds of disposition is treated as if it had been claimed by the beneficiary as capital cost allowance in previous years.3 Capital gains that arise by virtue of a deemed disposition under subsection 70(5) may qualify for the $500,000 capital gains deduction for qualified farm property and shares of a qualified small business corporation. In addition, if the deceased's capital property is transferred to a trust for a spouse or common-law partner (conjugal trust), the conjugal trust is entitled to claim a capital gains deduction

3 A number of other adjustments may also be required under paragraph 70(5) for certain depreciable assets such as buildings. See generally paragraph 70(5)(a) and subsection 13(21.2).

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for the taxation year in which the deceased's spouse or common-law partner died, to the extent that the spouse or common-law partner would have been able to claim an exemption if the eligible capital gains of the trust had been realized by the deceased's spouse or common-law partner directly [subsection 110.6(12)(c)]. There are three issues that generally arise around the operation of the deemed disposition rules in subsection 70(5).

1. What is fair market value at death and, in particular, what factors affect fair market value?

2. What assets are considered “owned” by a taxpayer immediately prior to death for purposes of subsection 70(5)?

3. When and under what circumstances will property be viewed for purposes of the relieving

provisions in subsection 70(5) as being transferred or distributed as a consequence of death?

i. Fair Market Value Subsection 70(5) deems capital property of a deceased person to be disposed of immediately before death for proceeds equal to fair market value at that time. In some cases the "value" of the deceased's property will be affected by the fact of death. For example, the deceased may have been a shareholder and the "key man" of an incorporated business. On death, his or her shares are deemed to have been disposed of at fair market value. Of ongoing concern to estate planners is whether transactions involving the corporation that occur either as a result of the death or shortly thereafter should be considered in the valuation of the corporation's net assets and, thus, the deceased's shares. This issue was addressed in Mastronardi Estate v. R.4 In the Mastronardi case, the deceased died suddenly and without warning. His private company was the beneficiary of a $500,000 life insurance policy on his life. The issue before the Federal Court was whether the life insurance proceeds should be included, for purposes of subsection 70(5), in valuing the shares of the company held by the deceased. The court held that it wasn’t until the instant of death that the company became entitled to the proceeds of the life insurance policy. Since the words “immediately before death” in subsection 70(5) refer to a span of time before death, the words could not be construed to import a requirement that capital property be valued taking into account the imminence of death. It follows that the value of the life insurance policy should not be included in the determining fair market value of the shares. Any victory won by the taxpayer in the Mastronardi decision was short lived. Subsection 70(5.3) now provides that in valuing shares held by the deceased, the cash surrender value of any life insurance policies held by the corporation on the life of the deceased must be considered. The logic underlying this requirement would appear to be that the corporation could liquidate the policy for its cash surrender value immediately prior to the death. [See Interpretation Bulletin IT-416R3, July 10, 1987, “Valuation of Shares of a Corporation Receiving Life Insurance Proceeds on Death of a Shareholder” and Information Circular IC 89-3 “Policy Statements on Business Equity Valuations”,

4 [1976] C.T.C. 572, 76 D.T.C. 6306 (F.C.T.D.).

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dated August 25, 1989]. This valuation rule was expanded in 2001 to apply in determining the fair market value of any property owned by the taxpayer immediately prior to death including an interest in a trust or partnership. It was also expanded to include life insurance policies held on the life of a related person and to the deemed disposition of trust assets under subsection 104(4). Notwithstanding the introduction of subsection 70(5.3), the decision in Mastronardi Estate remains important for its discussion of the point in time at which a disposition under subsection 70(5) occurs and the factors a court may consider in determining fair market value at that time. For example, if death was imminent due to a prolonged illness, that fact may be relevant in determining fair market value at death. Valuation problems may also occur if the shares are subject to a buy-sell agreement. Specifically, the pre-determined purchase price selected by the parties may not reflect current market values. The problem that may arise if the agreed price is used to determine proceeds for purposes of the buy -sell agreement is that the amount so selected, may not equal fair market value for purposes of subsection 70(5). The CRA’s views in resolving this issue are provided in the following Interpretation Bulletin:

Interpretation Bulletin IT-140R3 April 14, 1989, “Buy-Sell Agreements” Summary Taxpayers who own similar interests in a business or property often make such a similar interest subject to a buy-sell agreement. Although the form and content of buy-sell agreements may vary, they almost always provide for either the compulsory or optional sale of capital property by one person and either the compulsory or optional acquisition by another of the capital property owned by the former. The price may be certain, or may be determined as outlined in the agreement. This bulletin discusses buy-sell agreements that are in effect at the time of death of a person. Discussion and Interpretation 1. The rules in subsection 70(5) apply to property that is subject to a buy-sell agreement, unless the property can

be considered to vest indefeasibly in another person pursuant to subsection 70(6), 70(9), 70(9.2) or 70(9.6) or paragraph 70(5.2)(d) or (f). Whether the property vests indefeasibly in another person depends on the terms of the buy-sell agreement and the terms of the will (see the current issue of IT-449R).

2. When determining the proceeds deemed to have been received by the deceased pursuant to subsection 70(5), the

fair market value of the property subject to the buy-sell agreement must be determined at the time immediately before death. The CRA’s view is that, where the deceased and the surviving party to the buy-sell agreement (survivor) did not deal at arm’s length, it is a question of fact whether the fair market value for the purpose of subsection 70(5) will be determined with reference to the buy-sell agreement.

3. Where the deceased and a survivor did not deal at arm’s length at the time the agreement was made, the CRA’s

view is that paragraph 69(1)(b) applies when the estate sells the property to the survivor pursuant to the agreement and that it is a question of fact whether fair market value under paragraph 69(1)(b) will be determined with reference to the buy-sell agreement.

4. In fulfilling the obligation to sell the property to a survivor, the estate may realize a capital loss on

non-depreciable capital property or may be permitted to deduct a terminal loss on depreciable property. Subsection 164(6) provides some relief where, within the first taxation year of the estate, the legal

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representatives of the deceased dispose of capital property of the estate and incur a net capital loss, or dispose of all the depreciable property of a prescribed class and incur a terminal loss. The legal representative may elect in accordance with the conditions prescribed in section 1000 of the Regulations to treat all or part of such losses as if they were incurred in the year of death rather than in the first taxation year of the estate. No part of such losses may be deducted for a taxation year preceding the year in which the taxpayer died. (In the case of deaths occurring after 1984, an amended return for the year of death must be filed on behalf of the deceased to give effect to the application of such losses.) Any resulting refund would be paid or credited to the estate.

In summary, the CRA’s administrative practice is to accept the buy-sell price if the parties are at arm's length, but if the parties are not at arm's length; fair market value will remain a question of fact. The result is that if the deceased and the survivor are not at arm’s length, the deceased may be deemed for tax purposes to have received a different amount under the deemed disposition provisions in subsection 70(5), than the actual proceeds received under the buy-sell agreement. ii. Property Owned by the Deceased Since the provisions in subsection 70(5) apply to any capital property owned by the deceased immediately prior to death, a careful review of the deceased’s assets will be necessary. For example, consider the effect of subsection 70(5) in relation to property jointly owned by the deceased, and property held as a life estate.5 Such property rights are also subject to the deemed disposition rules. iii. Transfers as a Consequence of Death As discussed below, relief from the deeming provisions in subsection 70(5) is provided if property is transferred to a spouse, common-law partner (or conjugal trust), or in the case of qualified farm property, to children of the deceased taxpayer. This relief is predicated by the requirement that the property be transferred to the intended beneficiary in accordance with subsection 248(8). In summary, this provision requires that the property be transferred by will or other testamentary instrument, on intestacy or as the result of a disclaimer release or surrender. Subsection 248(8) is discussed in more detail below. B. Relieving Provisions for Capital Property The deemed disposition rules applicable on death may give rise to tax liability. If the property continues to be used by the deceased 's family, the tax liability is made more onerous if the estate does not have sufficient liquidity to discharge that liability without sale of the property. Fortunately, the Act contains a number of relieving provisions with respect to capital property that apply if the property is transferred either to the spouse or common-law partner of the deceased, to a trust for their benefit or in limited circumstances to the deceased’s children as a consequence of death. These relieving provisions are generally referred to as “rollovers”. Where a rollover occurs, the deceased is deemed to have disposed of his or her non-depreciable capital property for proceeds of disposition equal to the adjusted cost base of the property and, in the case of depreciable property, for proceeds equal to its undepreciated capital cost. As a result, the deceased taxpayer will not suffer capital gains or recapture by virtue of subsection 70(5). However, any tax liability that would otherwise have arisen is not forgiven; it is merely deferred until the property is subsequently

5 Para. 43.1(2)(a).

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disposed of by the transferee. Each of these relieving provisions is discussed below. The Act provides for a rollover of both depreciable and non-depreciable capital property transferred to the deceased's spouse or common-law partner or to a trust for either. There are additional rollovers for farm property and shares of a family farm corporation or interest in a family farm partnership transferred to the deceased's spouse, common-law partner, and a trust for either, or children. The Act also provides special rules to ensure that otherwise exempt capital gains on the deceased's principal residence continue to be exempt, under specified circumstances. i. Property Transferred to, or in Trust, for a Spouse or Common-Law Partner a. To a Spouse or Common-Law Partner Capital property transferred to a deceased's spouse or common-law partner as a consequence of death is not subject to the deeming provisions in subsection 70(5) if the following conditions are met:

• the deceased and his or her spouse or common-law partner are resident in Canada immediately before the death of the deceased6; and

• the property vests indefeasibly in the spouse or common-law partner within 36

months of the deceased's death and the fact of this vesting is established within 36 months of the death or such longer period as the Minister determines reasonable in the circumstances upon written application for any extension made within the period.

If these conditions are met, the property is deemed by subsection 70(6) to roll to the recipient at its tax cost unless the personal representative elects under subsection 70(6.2) to have subsection 70(5) apply. Such an election might be made, for example, to create capital losses or terminal losses in the deceased’s terminal year or to maximum otherwise available capital losses against current capital gains. There are four ways in which property can be rolled "as a consequence of death" to a spouse or common-law partner:

1. by will or other testamentary instrument [paragraph 248(8)(a)];

2. on an intestacy [paragraph 248(8)(a)];

3. by disclaimer, release or surrender of a beneficiary under a will or on an intestacy [paragraph 248(8)(b)];

4. as a consequence of provincial laws relating to spouses or common-law partners interests in

property [paragraph 248(9.1) and 248(23.1)]. Proof that vesting has occurred must be established within 36 months of the date of death or such

6 A 1996 amendment to the Canada-U.S. Tax Treaty will also permit a rollover to a spouse or common-law partner where the deceased was resident in the U.S. immediately before death.

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longer period as the Minister considers reasonable. Therefore, delay in taking steps to establish vesting may exclude the application of the rollover. Although what constitutes a reasonable period should be a question of fact, the Act leaves the matter to be determined by the Minister if written application is made within 36 months of the death. Presumably a delay in establishing vesting owing to litigation or a settlement of claims, or in order to determine estate liabilities, would be considered reasonable. The only real guidance on this question is Hillis et al. v. The Queen, 83 DTC 5365 (FCA), which illustrated the unfortunate results of unreasonable delays in administering an estate. Since that decision, the period for establishing vesting was increased from 15 to 36 months. Perhaps coincidentally, this closely matches the actual administration period in the Hillis case. The Hillis decision is probably also the reason for the introduction of subsection 248(23.1) that now specifically recognizes the effect of provincial legislation in determining the timing of the transfer to a spouse or common-law partner. The transfer is deemed to occur as a consequence of death if made to the spouse or common-law partner, or immediately before the time that is immediately before the death if it is made by the spouse or common-law partner to the deceased’s estate. In either case a rollover occurs notwithstanding that a provincial court order is made outside the 36-month period. C. Vested Indefeasibly Subsection 70(6) requires that the property "vest indefeasibly" in the spouse or common-law partner to achieve a rollover. Subsection 70(9) imposes a similar requirement for transfers of qualifying farm property to a child. Not surprisingly, a number of decisions have addressed the issue of when property vests indefeasibly for these purposes. One of the most important of these decisions is Boger Estate v. MNR [1993] CTC 81 (FCA. In Boger, the taxpayer, a farmer, died testate on March 10, 1979. A life estate in the home quarter was left to his widow and the remaining farm assets (seven quarter sections of land, farm equipment, livestock and grain) were left to his four daughters. The widow bought a Family Relief Act Application. At issue was whether the farm property vested indefeasibly in the children within the required time for purposes of the farm rollover in subsection 70(9), notwithstanding the outstanding Family Relief Act application. The Federal Court held that the property interest was granted under the will and had vested. Further, a vested interest is defeasible only if it is subject to a condition subsequent contained in the grant creating the interest. The Family Relief Act application did not therefore delay vesting, but a portion of the interest transferred to the children was retroactively affected by the court order. In summary, according to Boger, the test to determine whether an interest is vested indefeasibly is whether it is “subject to a condition subsequent or a determinable limitation set out in the grant”. A number of decisions have also examined the issue of vesting in the context of shareholder agreements. In W.R. Parkes v. MNR, [1986] 1 CTC 2262 and Greenwood Estate v. Canada, [1994] 1 CTC 310 (FCA)], the court held that shares subject to a mandatory buy sell agreement did not vest indefeasibly for purposes of the spousal rollover. In contrast, a right of first refusal in an agreement, which imposed an obligation to buy on the survivor but no obligation to sell on the beneficiary spouse, resulted in a finding that the shares had vested. [See Van Son Estate v. Canada, [1990] 1 CTC 182 (FCTD)]. Certain limitations also apply in determining whether vesting has occurred. For example, paragraph 248(9.2)(a) provides that property will be deemed not to have vested indefeasibly in a trust under

11

which a taxpayer’s spouse or common-law partner is a beneficiary if the trust is created by the will of the taxpayer, unless the property vested indefeasibly in the trust before the death of the spouse or common-law partner. The apparent purpose of this provision is to ensure that a rollover of property on the death of an individual will occur only in circumstances where the deferred gains will be recognized on the death of the beneficiary spouse or common-law partner. Similarly, paragraph 248(9.2)(b) provides that property will be deemed not to have vested indefeasibly in an individual (other than a trust), unless the property vested indefeasibly in the individual before the death of the individual. The CRA’s views on the meaning of "vested indefeasibly" are set out in the following Interpretation Bulletin:

Interpretation Bulletin IT-449R September 25, 1987, Meaning of “Vested Indefeasibly” Summary This bulletin deals with the meaning of the expression “vested indefeasibly” used in provisions of the Act which deal with the rollover of certain properties from one taxpayer to another. The bulletin also includes comments concerning requirements that must be met before the provisions referred to above can apply. Examples are given describing some circumstances in which the issue of whether property has vested indefeasibly is relevant. 1. The Act does not define the term “vested indefeasibly”. Accordingly, the meaning of this term must be

construed within the context of the provisions where it is used. In all the provisions indicated above “vested indefeasibly” refers to the unassailable right to ownership of a particular property that, in consequence of death of the owner, has been transferred or distributed either to a spouse, a spouse trust or a child of the deceased. In the CRA’s view a property vests indefeasibly in a spouse or child of the deceased when such a person obtains a right to absolute ownership of that property in such a manner that such right cannot be defeated by any future event, even though that person may not be entitled to the immediate enjoyment of all the benefits arising from that right. Where property is held in trust for the benefit of one or more persons it is the CRA’s view that such property normally vests indefeasibly in the trust and not in a beneficiary thereof. However, where the CRA is satisfied that a property is held in trust solely to carry out the terms of a will under which the ultimate and absolute ownership of that property is bequeathed to a particular individual and the trust arrangement is such that the individual’s ownership rights cannot be defeated by any future event and no other person has any right whatsoever to an immediate or future benefit from that property or that trust, the property will be considered to vest indefeasibly in that individual.

2. Property is considered to vest indefeasibly in the person to whom it is bequeathed when that person has an

enforceable right or claim to the ownership thereof. This will be so even though the formal legal conveyance and registration of ownership of the property has not been completed. Accordingly, the ownership of property described in a specific bequest in a will will vest in the beneficiary immediately after the death of the testator. The ownership of property emanating out of a non-specific bequest will vest in the beneficiary when such property has been identified and the beneficiary has a binding right to receive it.

Note: In the following paragraphs, references to subsections 70(9.4) and (9.5) and descriptions of requirements there under are applicable only with respect to transfers and dispositions made before 1988. Subsections 70(9.4) and (9.5) were repealed with respect to transfers and dispositions made after 1987 as a consequence of the introduction of the lifetime capital gains deduction.

3. The rollover provisions in subsections 70(5.2), (6), (9) and (9.2) of the Act and ITAR 26(18) (as well as 70(9.4)

of the Act with respect to transfers and dispositions occurring before 1988) will apply

(a) with respect to deaths occurring after 1984 if, within the period of 36 months after the death of a taxpayer it can be shown that property owned by the taxpayer immediately before the taxpayer’s death has, on or after the taxpayer’s death and as a consequence thereof (see 4 below), been transferred or

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distributed and has become vested indefeasibly in the transferee or distributee described in the relevant subsection. (If the Minister considers it reasonable in the circumstances, a period longer than 36 months may be allowed if requested in writing by the deceased’s legal representative before the end of the 36 month period following the date of the taxpayer’s death), and

(b) with respect to deaths occurring before 1985 if the property can, within 15 months after the death of

the taxpayer or such longer period as is reasonable, be established to have become vested indefeasibly within the 15 month period in the transferee or distributee described in the relevant subsection. However, with respect to a death occurring after 1981 and before 1985, the longer period for vesting, as described in (a) above, was available with respect to the deceased’s property provided that the deceased’s legal representative and each person to whom an interest in the property was transferred or distributed as a consequence of the death of the deceased had jointly elected on or before January 27, 1986 to have such longer period apply. The period of time allowed for vesting (including any approved extension to that period) as described in this paragraph is referred to hereinafter as “the relevant vesting period”.

4. Subsection 248(8) applies to transfers, distributions and acquisitions occurring after 1981. This subsection

provides that a transfer, distribution or acquisition of property shall be deemed to have occurred as a consequence of the death of a taxpayer where such transfer, distribution or acquisition was made

(a) pursuant to the terms of a will or other testamentary instrument of the taxpayer or of the application of

provincial statutory provisions governing intestate succession (in this bulletin referred to as “intestate succession provisions”) to the estate, or

(b) as a consequence of a disclaimer, release or surrender by a person who was a beneficiary under a

will or other testamentary instrument of the taxpayer or under intestate succession provisions.

Subsection 248(8) also provides that where a beneficiary, under a will or other testamentary instrument of a taxpayer or on the intestacy of a taxpayer, releases or surrenders any property that was property of the taxpayer immediately before the taxpayer’s death, such release or surrender shall not be considered to be a disposition of that property by the beneficiary provided that such release or surrender is made within the relevant vesting period.

5. The rollover provisions in subsections 70(9.1), 70(9.3) (as well as 70(9.5) with respect to transfers and

dispositions of property that occur before 1988) apply only where

(a) property has been transferred by a taxpayer to a spouse trust described in subsection 70(6) or 73(1),

(b) the taxpayer’s child is a capital beneficiary of the spouse trust and resident in Canada immediately before the death of the spouse, and

(c) the property has, upon and as a consequence of the death (see 4 above) of the spouse, been transferred

or distributed to and become vested indefeasibly in a child of the taxpayer. (This vesting requirement contrasts with the longer period of time permitted for the vesting of property under subsections 70(5.2), (6), (9) and (9.2) of the Act and ITAR 26(18).)

6. Where a taxpayer dies with or without a will and the taxpayer’s assets are allocated by the legal

representatives among the beneficiaries within the relevant vesting period in accordance either with discretions in the will or with intestate succession provisions, there is no requirement that property be left specifically to a particular beneficiary either under the will or by operation of the intestate succession provisions for those subsections to apply. The fact that the legal representatives exercised discretion in allocating assets among beneficiaries does not diminish the fact that the beneficiaries obtained the assets as a consequence of the deceased’s death.

7. Where ownership of the deceased’s property passes to a person pursuant to a court order given under a statute

such as a dependants’ relief Act or family law Act, it is the CRA’s position that ownership of such property for purposes of subsection 70(6), (9), (9.2) and (9.4) of the Act and ITAR 26(18) will be considered to vest indefeasibly in that person within the relevant vesting period provided that the court order is actually given within that period. Generally where an application has been made to a court under a dependants’ relief Act or

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a family law Act and within the aforementioned period of 36 months an application is made to the Minister for an extension of time, the fact that the application to the court is pending would mean that a delay in the vesting of the property until the judgment of the court is received would be regarded as reasonable in the circumstances.

8. The following examples describe some circumstances in which the issue of whether property has vested

indefeasibly is relevant:

(a) a man who wishes to ensure that the absolute ownership of his farm land will ultimately pass to his child after his widow has had the use of the property during his lifetime, could achieve this result by the terms of his will as follows:

(i) he could direct his executors to convey the land to his widow as life tenant and to his child as

remainder man. This would not involve the use of a trust.

(ii) he could direct his executors to hold the land in a spouse trust for the use and enjoyment of his widow during her lifetime and, on her death, to convey the land to his child.

Since (i) above does not involve a trust the provisions of paragraph 70(6)(b) do not apply. It is the CRA’s position that the farmland vests indefeasibly in the child on the death of the father. This same result would occur if it were a condition that the widow’s interest in the land terminates on her remarriage.

Since the trust described in (ii) above is a spouse trust, if the entire interest in the land becomes indefeasibly vested in the trustees of the spouse trust within the relevant vesting period, the cost of the land to the trustees will be its adjusted cost base to the taxpayer. Upon the death of the widow if the land is transferred or distributed to the child and becomes vested indefeasibly in the child as a consequence of the widow’s death and if the child was resident in Canada immediately before the widow’s death, subsection 70(9.1) provides that there will be a rollover of the land from the trustees to the child at the adjusted cost base of the land to the trust.

(b) Under the terms of his will, a man directs that his farm land be held in a spouse trust for his widow

during her lifetime and, on her death, that it be transferred to those of his children who survive his widow.

Since the trust is a spouse trust, the trustees of the trust will acquire the land at its adjusted cost base to the deceased. If on the widow’s death and as a consequence thereof the land becomes indefeasibly vested in those of the taxpayer’s children who are then alive, the land will be rolled out of the trust to the children at its adjusted cost base to the trust pursuant to subsection 70(9.1).

(c) Pursuant to the terms of a taxpayer’s will, farm land is directed to be held in a trust for the benefit of

the taxpayer’s child, to be distributed to the child when the child reaches a specified age and, if the child should die before that age, to be distributed to the child’s estate.

The CRA considers that the property vests indefeasibly in the child at the time of the taxpayer’s death. Whether the child on attaining the age of majority could demand the conveyance of the land even though the specified age had not been attained, will depend upon provincial law. If the taxpayer’s will had provided that the land would be distributed to other persons, for example the taxpayer’s grandchildren, if the child should die before attaining the specified age, the land would not vest indefeasibly in the child until the child attained the specified age .

(d) A taxpayer by her will directs that certain shares owned by her immediately before her death are to be distributed to a beneficiary. The shares, however, are subject to a buy-sell agreement.

Where the terms of the buy-sell agreement provide that it is compulsory for the executor of the taxpayer’s estate to sell and the other party to buy the shares, the shares will not be considered to vest indefeasibly in the beneficiary. Where, however, the terms of the buy-sell agreement merely give the other party an option to acquire the taxpayer’s shares which may or may not be exercised and the taxpayer’s executors transfer the shares to the beneficiary before the option is exercised, the shares will be considered to vest indefeasibly in the beneficiary at the time of the transfer. These same comments will apply where the beneficiary is a trust created by the taxpayer’s will and the executors

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are also trustees of the trust.

If the taxpayer in her will directs her executors to sell shares before settling her estate, the shares will not be considered to vest indefeasibly in any beneficiary.

(e) A taxpayer in her will directs that her farm land is to be transferred to her child but that before that

happens a mortgage or charge is to be put upon the land in order to provide funds to satisfy bequests to other beneficiaries.

Notwithstanding the fact that title to the land is encumbered by the mortgage or charge, the land will be considered to vest indefeasibly in the child.

1. To a Trust for a Spouse or Common-Law Partner (Conjugal Trust) Capital property that is transferred to a testamentary trust for a spouse or common-law partner also receives rollover treatment if the property vests indefeasibly in the trust within the stipulated 36-month period and the following requirements are met:

• the property is property of a taxpayer who was resident in Canada immediately before his or her death;

• on or after the taxpayer’s death, and as a consequence thereof, the property is transferred or

distributed to the trust;

• the trust is created by the taxpayer's will;

• the trust is resident in Canada immediately after the time the property vested indefeasibly in the trust;

• the spouse or common-law partner is entitled to receive all of the income of the trust that arises before the spouse's or common-law partner’s death;

• no person except the spouse or common-law partner may, before the death of the spouse or

common-law partner, receive or otherwise obtain the use of any income or capital of the trust; and,

• it can be established, within the period ending 36 months after the death of the taxpayer, that

the property vests indefeasibly in the trust. Perhaps the two most commonly offended rules in creating a conjugal trust relate to the allowed treatment of income and capital of the trust. The surviving spouse or common-law partner must be entitled to all of the income of the trust and no person except the spouse or common-law partner may receive or otherwise obtain the use of any of the trust income or capital. An encroachment on capital for the benefit of the spouse or common-law partner is entirely acceptable; however, the mere possibility of anyone else receiving a "benefit" from the trust assets during that lifetime of the spouse or common-law partner would appear to prevent the rollover. Two obvious questions emerge from these statutory conditions. First, what precisely is the meaning of "entitled to all of the income" as described in subparagraph 70(6)(b)(i)? Second, under what circumstances will another person be considered to receive or otherwise obtain the use of any income or capital of the trust?

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2. Entitled to All of the Income Although subsection 70(6) requires that the spouse or common-law partner be “entitled to all of the income” of the trust if a rollover is to be achieved, there are a number of qualifications to this general rule. First, in determining whether the recipient is entitled to receive all of the income of the trust arising during his or her lifetime, the Act provides that, subject to specific exceptions, the income of a trust is its income computed without reference to the provisions of the Act [subsection 108(3)]. Calculation of income amounts would, therefore, presumably conform to the requirements of equity and trust law. It follows that income computed using these rules would produce a different result than would income calculated for tax purposes. Most obviously, stock dividends and taxable capital gains may give rise to tax liability as a result of income generated but would not be income to which the spouse or common-law partner must be entitled for purposes of subsection 70(6). In addition, one of the specific exceptions listed in computing the income of a trust for this purpose is tax-free capital dividends. Second, according to subsection 108(4), a trust is considered to be a conjugal trust even though it is charged with payment of any income or profits tax in respect of any of its income for the purposes of the Act. Similarly, the trust will remain a conjugal trust notwithstanding a clear obligation imposed on the trust to pay any estate, legacy, and succession or inheritance duty payable in consequence of the testator's death in respect of any property of the trust or any income or capital interest in it. The CRA also provides two administrative concessions when determining whether the spouse or common-law partner is entitled to receive all of the trust income. First, if the will of the decedent provides for the establishment of the trust from the residual assets of the estate, the fact that income derived from the assets prior to the vesting in the trust is used to pay specific bequests or other testamentary debts will not preclude the trust from qualifying for a rollover. Second, the CRA applies the doctrine of constructive receipt in interpreting the requirement that the spouse or common-law partner must be entitled to receive all of the income of the trust that arises before her/his death. As a result, a provision in a will for the payment of any income of the trust to a person other than the spouse or common-law partner, on the condition that it be used solely for the benefit of the spouse or common-law partner, will not disqualify an otherwise qualifying conjugal trust. 3. Transfers as a Consequence of Death A number of the rollover provisions, including those applicable on transfers to a spouse, common-law partner or conjugal trust and transfers of farm property, require that the transfer occur "as a consequence of the death of the taxpayer". Paragraph 248(8)(b) provides that, for the purposes of the Act, a transfer, distribution or acquisition of property as a consequence of a disclaimer, release or surrender by a person who was a beneficiary under a will or on the intestacy of the deceased or his/her spouse or common-law partner is considered to be a transfer, distribution or acquisition of the property as a consequence of the death of the deceased or his/her spouse or common-law partner, as the case may be. Thus, if an effective disclaimer is made, property of the deceased acquired by Beneficiary A as a result of a disclaimer by Beneficiary B will be property transferred or distributed to Beneficiary A as a consequence of the death of the deceased. A reasonable time for this purpose is, according to subsection 248(9), within

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36 months after the death of the taxpayer or such longer period as is permitted upon written application to the Minister. Paragraph 248(8)(c) goes on to provide that a release or surrender by a beneficiary with respect to any property that was property of a taxpayer immediately before his/her death will not be considered a disposition of the property by the beneficiary. The phrase "release or surrender" was substituted for the term "renunciation" in the definition of occurrences as a consequence of death. The CRA has stated that the new words are used because they have "a clearer common law meaning" than the term "renunciation". Again, a valid release or surrender must occur within 36 months of the death of the taxpayer or such longer period, as the Minister considers reasonable. Whether a disclaimer of a non-qualifying interest in a conjugal trust will result in a rollover is not apparent in the act. Notwithstanding that a disclaimer is effective to cause a transfer to occur "as a consequence of death", paragraph 70(6)(b) imposes the further requirement that a trust for a spouse or common-law partner must be created by the deceased's will. Subsection 248(9.1) provides that a trust will be considered to have been created by a taxpayer's will if it was created "under the terms of the taxpayer's will" or "or by an order of the court in relation to the taxpayer’s estate . . . made pursuant to any law of a province providing for the relief or support of dependants". The legislation is silent about whether a trust that is compliant as a result of a disclaimer will qualify for a rollover. Notwithstanding, the CRA's current views expressed in IT-305R4, October 30, 1996, “Testamentary Spouse Trusts”, appear to suggest that a disclaimer by a beneficiary of an income or capital interest in an otherwise non-qualifying trust may result in rollover treatment if the disclaimer results in a purification of the trust. 4. Tainted Trusts A conjugal trust must entitle the deceased's spouse or common-law partner to receive all of the income of the trust that arises during his or her lifetime and must preclude any other person from receiving income or capital of the trust during that period. A testamentary instrument that directs the personal representative to pay the debts and discharge the liabilities of the testator, other than those specifically referred to in subsection 108(4), would, according to the CRA, taint a qualifying conjugal trust and prevent rollover treatment. Fortunately, relieving provisions were introduced in the form of subsections 70(8) and (9) to cure such a tainted trust. The general scheme of the relieving provisions is to permit the trust to qualify for the rollover if the personal representative elects and lists properties of the deceased at least equal to the value of the debts. These listed properties are then deemed to have been disposed of immediately prior to death for proceeds equal to their fair market value. For example, if the testamentary debts equaled $500, the personal representative could list shares in the trust with a cost base of $200 and a fair market value of $500. The result would be a deemed disposition of the shares at their fair market value of $500, instead of a deemed disposition of all the assets in the trust. As property in excess of the amount of the debts may have to be listed, the Act permits the personal representative to elect to realize only part of the capital gain or capital loss on one designated property in order to untaint the trust. This option may provide some additional flexibility in the terminal year than otherwise available under subsection 70(6.2). The election under that provision to exclude the conjugal rollover provisions does not include the option of realizing only part of the gain

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or loss on transferred property. The mechanics of the rules to untaint the trust are set out in the following Interpretation Bulletin:

Interpretation Bulletin IT-305R4 October 30, 1996, “Testamentary Spouse Trusts”, para’s 18-29 18. Subsection 70(7) provides a method for untainting some types of tainted spouse trusts, thus permitting the

rollover provided by subsection 70(6). This is possible when the debts, obligations and death duties referred to in 17 above are “testamentary debts” and the trust otherwise qualifies as a spouse trust. The term “testamentary debt” which is defined in paragraph 70(8)(c), means:

(a) any debt of the taxpayer, or any other obligation of the taxpayer to pay an amount, that was

outstanding immediately before his or her death, and

(b) any amount payable by the estate in consequence of the taxpayer’s death, other than any amount payable to any person as a beneficiary of the estate, including income or profits tax payable by or for the taxpayer for the taxation year in which he or she died and for any previous taxation year, and any estate, legacy, succession or inheritance duty payable in consequence of the taxpayer’s death.

Testamentary debts also include funeral and testamentary expenses and compensation to representatives for carrying out those duties which are normally exercised by an executor or administrator, that is, up to the point the estate properties are transferred or distributed to the beneficiaries or to the trustee of the tainted spouse trust or any other trust arising on death.

19. A trust for the benefit of a spouse is tainted in a manner that cannot be remedied by the method provided in

subsection 70(7) if certain types of obligations are to be met out of its property before the death of the spouse. Examples of such obligations include:

(a) a contingent liability to make good any deficiency that may arise in another trust created under the

same will,

(b) a liability for the payment of trustee fees applicable to other trusts under the will,

(c) an obligation to pay a bequest to another beneficiary out of the property of the estate that is held by the spouse trust, and

(d) a remarriage clause which, if the spouse remarries, would result in someone other than the spouse

being entitled to income or capital of the trust before the spouse’s death.

The trust is not tainted in this manner, however, if the debt or obligation to be met is:

(e) a testamentary debt (see 18 above), (f) a debt or obligation to the spouse, (g) a debt or obligation incurred for the benefit of the spouse, or (h) an obligation to pay fees to the trustee for the administration of the spouse trust.

20. In general terms, the method provided in subsection 70(7) to untaint a tainted spouse trust that is capable of

being untainted is to total all testamentary debts of the trust and deduct:

(a) any estate, legacy, succession or inheritance duty payable, in consequence of the taxpayer’s death, for any property of the trust, or for any interest in the trust (note that these amounts do not taint a spouse trust as explained in 14 above), and

(b) any debt secured by a mortgage on property owned by the taxpayer immediately before his or her

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death.

The remaining debts are referred to in paragraph 70(8)(b) as non-qualifying debts. In the deceased taxpayer’s regular income tax return for the year of death (that is, not a return filed under subsection 70(2), 104(23) or 150(4), or paragraph 128(2)(e)), the taxpayer’s legal representative must elect to have the trust treated as a spouse trust and list one or more properties of the trust (other than a net income stabilization account) having a total fair market value immediately after the taxpayer’s death at least equal to the total of the non-qualifying debts. The list may include money and if it alone is sufficient to cover the non-qualifying debts, no other properties need be listed. The trust is then deemed to be a spouse trust and capital properties listed against the non-qualifying debts are deemed to have been disposed of, by virtue of subsection 70(5), at fair market value immediately before the taxpayer’s death. As a result, any gains, income or losses arising from such deemed dispositions are included in computing the deceased’s income. The other capital properties transferred to the spouse trust qualify for the rollover provided in subsection 70(6). The following example illustrates how a tainted spouse trust may be untainted:

Testamentary debts

Income tax owing by the deceased $10,000 Business debt of the deceased 25,000 Mortgage on apartment building 80,000 Mortgage on land 10,000 Testamentary and funeral expenses 1,000 $126,000

To determine non-qualifying debts, deduct:

Mortgage on apartment building $80,000 Mortgage on land 10,000 $90,000

Non-qualifying debts $36,000 The executor then lists properties of the tainted spouse trust having a total fair market value immediately after death at least equal to these non-qualifying debts. For this purpose, paragraph 70(8)(a) defines the fair market value of a property as the amount, if any, by which its fair market value otherwise determined exceeds the amount of any debt secured by a mortgage on the property. Listed property:

Shares -Fair market value $9,000 Land - Fair market value 41,000 Less: Mortgage on the land 10,000 Net fair market value of the land 31,000 Net fair market value of list property $40,000

Capital gain or loss:

Shares - Fair market value $ 9,000 Adjusted cost base to the deceased 6,000

Capital gain $ 3,000

Land - Fair market value $41,000 Adjusted cost base to the deceased 30,000

Capital gain $11,000 The deemed disposition rules in subsection 70(5) apply to the capital properties so listed and, in this example, the total capital gain before any reduction under subparagraph 70(7)(b)(iii) (see 21 below) is $14,000 ($3,000 + $11,000).

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21. When the fair market value of all the properties listed exceeds the total non-qualifying debts (this excess is referred to as the “listed value excess”) and the taxpayer’s legal representative designates one capital property so listed (other than money and depreciable property) in the taxpayer’s return, the capital gain or loss on that property (from the deemed disposition under subsection 70(5)) will be reduced as a result of the formula in subparagraph 70(7)(b)(iii). Under subparagraph 70(7)(b)(iii), the capital gain or loss on the property is:

Fair market value of the one property minus the listed value excess

Capital gain or loss otherwise determined

x

Fair market value of the one property immediately after death

22. The following examples illustrate the application of the rule in subparagraph 70(7)(b)(iii). Example 1: The listed value excess in the example in 20 above is $4,000 ($40,000 - $36,000). In that example, assume that the legal representative has designated the shares that have been listed. Pursuant to subparagraph 70(7)(b)(iii), the capital gain on the shares is calculated as follows:

$3,000 x ($9,000 - $4,000) = $1,667 $9,000

Therefore, the total capital gain to be included in the deceased’s income is $12,667 ($1,667 + $11,000). The adjusted cost base of the two properties to the spouse trust is: land $41,000 (by virtue of paragraph 70(5)(b)) and shares $7,667 ($6,000 + $1,667, by virtue of clause 70(7)(b)(iv)(A)). Example 2: Same as example 1 above; however, assume that the adjusted cost base of the shares is $16,000 and that, consequently, the shares otherwise result in a capital loss of $7,000 ($9,000 - $16,000). The capital loss calculated in accordance with subparagraph 70(7)(b)(iii) is:

$7,000 x ($9,000 - $4,000) = $3,889 $9,000

Therefore, the net capital gain from the land and shares is $7,111 ($11,000 - $3,889). The adjusted cost base of the two properties to the spouse trust is: land $41,000 (by virtue of paragraph 70(5)(b)) and shares $12,111 ($16,000 - $3,889, by virtue of clause 70(7)(b)(iv)(B)). 23. Where non-qualifying debts include income tax payable by the deceased’s representative for the income tax

return for the year of death, the amount payable is calculated after giving effect to the provisions of paragraph 70(7)(b). It is therefore necessary to consider the effect that the listing of a particular property will have on the amount of tax payable. The adjustment of a capital gain or loss on a designated property pursuant to subparagraph 70(7)(b)(iii) may also have a significant effect in some circumstances. When the amount of the tax liability is a critical factor in the selection of properties to be listed (or the property to be designated), more than one notional tax calculation may be necessary.

24. The legal representative is not obliged to dispose of the listed properties of the trust to obtain the funds to pay

the non-qualifying debts. They may be paid from any available source of funds. 25. The legal representative is responsible for calculating the non-qualifying debts and the fair market value of

listed properties as accurately as possible from the facts available. When these calculations are subsequently determined to be incorrect, despite the reasonable efforts of the legal representative, and the value of the listed properties is actually less than the total of the non-qualifying debts, we will permit additional properties to be listed at that later time in order that the provisions of subsection 70(6) may still apply to the properties of the trust that are not listed.

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26. It is arguable that a trust in favour of a spouse created under a taxpayer’s will out of the residue of his or her estate is tainted by the distributions and payments necessary to establish the trust corpus. Under this interpretation, it is necessary to follow the procedures set out in subsection 70(7) when it is intended that the trust qualify as a spouse trust under subsection 70(6). Another view is that subsection 70(6) applies to such of the original properties of the estate as are retained to form a part of the trust corpus without the necessity of following the procedures described in subsection 70(7). Either interpretation is acceptable with the result that a trustee has the following options available when an otherwise qualifying spouse trust is created out of the residue of an estate:

(a) The trustee may choose to have the provisions of subsection 70(5) apply to all of the capital properties of the

estate. (b) By following the procedures described in subsection 70(7), the rules in subsection 70(6) will apply to those

capital properties of the spouse trust that are not listed and the rules in subsection 70(5) will apply to listed properties of the estate, subject to adjustment for any “listed value excess” (see 21 above).

(c) The trustee may choose to have subsection 70(5) apply to all of the capital properties of the estate that are

distributed or otherwise disposed of before the corpus of the spouse trust is established and have subsection 70(6) apply to such of the original capital properties of the estate as are retained as the property of the trust. The fact that, prior to the indefeasible vesting of the properties in the trust, income derived from these properties is used by the estate to pay specific bequests or testamentary debts does not preclude the trust from qualifying as a spouse trust.

The right to elect under subsection 70(6.2) (referred to in 2 above) is unaffected by the adoption of either option (b) or option 27. Although the treatment for tax purposes applicable to the acquisition of listed properties by a trust differs from

that applicable to the acquisition of the balance of the trust properties, listed properties are, nevertheless, properties of a spouse trust and subject to the special rules relating to spouse trusts found elsewhere in the Act (for example, the deemed disposition of such properties under paragraph 104(4)(a) upon the death of the spouse).

28. Whenever a tainted spouse trust capable of being untainted by subsection 70(7) is created, regardless of the

simultaneous creation under the will of other trusts to which subsection 70(7) is irrelevant, the legal representative has up to 18 months from the date of death to file the deceased’s final income tax return. This is the case whether or not such a trust is successfully untainted under paragraph 70(7)(b). This extended time for filing also applies to special returns that may be filed pursuant to subsection 150(4) and paragraph 104(23)(d). Although the due date for making an election under subsection 70(2), for rights or things of the deceased at the time of death, is indirectly extended if the extended filing date referred to above delays the mailing of a notice of assessment for the year of death, the basic rule (the later of one year after death and 90 days after the mailing of any notice of assessment for the year of death) remains unchanged. If death occurs on or before April 30 in a taxation year, the deceased’s legal representative has up to 6 months from the date of death to file the deceased’s income tax return for the immediately preceding taxation year. Otherwise, there are no extensions in the filing requirements for income tax returns of taxation years prior to the year of death.

Note: Bill C-36 contains a number of income tax measures announced in the February 27, 1995 budget. Among other things, the Bill will amend paragraphs 150(1)(b) and (d), applicable to the 1995 and later taxation years. As a result of these amendments, the due date for filing a deceased person’s income tax return may be extended if the deceased person, or the deceased person’s spouse, carried on a business in the year of death (except where the expenditures of the business are primarily the cost or capital cost of “tax shelters”). In such circumstances, the due date for filing the return is: • on or before June 15 of the year following the year of death if the individual died during the period January 1

to December 15; and • within six months after the date of death if the individual dies during the period December 16 to December 31

or during the period January 1 to June 14 of the following year (that is, before the individual’s filing due date for the previous year had the individual not died).

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29. Although the income tax return for the year of death may be filed within 18 months of death whenever a trust is untainted by an election provided for in subsection 70(7) so as to qualify as a spouse trust, interest at the prescribed rate will be assessed on any unpaid balance from the later of six months after death and April 30 of the year following death.

5. Residence of Trusts Generally, to qualify for a rollover to a conjugal trust for a spouse or common-law partner, the capital property must be transferred to "a trust ... that was resident in Canada". The Act contains no specific rule for determining the residence of a trust. Subsection 104(1) does, however, provide that a reference to a trust shall be read as a reference to "the trustee or the executor, administrator, heir or other legal representative having ownership or control of the trust property" unless the context otherwise requires. The residence of the majority of the trustees therefore appears the major determining factor in establishing the residence of the trust. [See Interpretation Bulletin IT-447, May 30, 1980, "Residence of a Trust or Estate".] A major exception to the rule that a spouse, common-law or conjugal trust must be resident for rollover treatment occurs by virtue of a 1996 amendment to the Canada-U.S. Tax Treaty ("the Treaty"). Article XXIXB (5) (1980), of the Treaty provides that if an individual was a resident of the United States immediately before that individual’s death, both the individual and the individual’s spouse or common-law partner are deemed to have been resident in Canada immediately before the individual’s death for the purpose of subsection 70(6). If certain additional conditions and the Canadian competent authority agree, a trust for that spouse or common-law partner will also be treated as being resident in Canada. Presumably similar treatment will be extended to common-law partners. i. Transfers of Farm Property Certain farm assets receive special treatment under the Act under both the deemed disposition rules and the provisions permitting the $500,000 lifetime capital gains deduction. Land and depreciable property of a prescribed class, which is used in the business of farming, may be transferred to a child7 of the deceased on a rollover basis. Further, dispositions of qualified farm property are eligible for the increased $500,000 lifetime capital gains deduction. Finally, unlike the rules, which apply to trusts for spouses and common-law partners, the deceased's personal representative may elect to realize all or any part of an accrued capital gain or recaptured depreciation on farm property transferred to a child. The rollover of farm property on death to a child of the deceased taxpayer under subsection 70(9) will occur if the following conditions are met:

• the child was resident in Canada immediately before the death of the deceased;

• the property is situated in Canada;

• before the taxpayer's death, the property was used principally in the business of farming in which the tax payer, the taxpayer’s spouse or common-law partner or any of the taxpayer’s

7 For purposes of the farming rollover provisions, the term Achild@ is extended to grandchildren, great-grandchildren and to other persons who, at any time, while under the age of 19 years, were in the custody and control of the deceased and wholly dependent upon the deceased for support.

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children was actively engaged on a regular and continuous basis;

• the property was transferred or distributed to the child as a consequence of the taxpayer's death; and

• it can be shown within 36 months after the taxpayer's death, or such longer period, as the

Minister considers reasonable in the circumstances following written application for such extension, that the property became vested indefeasibly in the child.

If these conditions are met, the deceased is deemed to have disposed of the property for proceeds equal to, in the case of depreciable property, the lessor of the capital cost and the cost amount to the taxpayer of the property immediately before the taxpayer’s death, and, in the case of the land, its adjusted cost base.

A rollover is also available pursuant to subsection 70(9.1) if the property is transferred to a trust for a spouse or common-law partner by will or during the deceased's lifetime, and on the death of that spouse or common-law partner, vests indefeasibly in a child of the deceased who is resident in Canada immediately before the death of the surviving spouse or common-law partner. For this rollover to occur, the property must have been used in the business of farming immediately before the death of the spouse or common-law partner. The intervening conjugal trust will make it immaterial whether it was so used during the lifetime of the deceased. As is the case for farm property transferred directly to a child under subsection 70(9), the trust may elect to realize all or any part of an accrued gain on farming property transferred to a child after the death of the spouse or common-law partner. Shares of the capital stock of a family farm corporation of the taxpayer and interests in a family farm partnership may also be transferred to a child of the taxpayer without realization of any or all of the accrued capital gains or capital losses [subsection 70(9.2)]. A family farm corporation or partnership is defined in subsection 70(10) to mean a corporation or partnership in which all or substantially all of the fair market value of the property was used principally in the course of carrying on the business of farming in Canada in which the person or a spouse, common-law partner, child or parent of the person was actively engaged on a regular and continuous basis. Shares of the capital stock of a corporation will also fall within the definition if all or substantially all of the corporate assets consist of shares of a corporation qualifying as a family farm corporation and/or family farm property. Provision is also made for a rollover of all or part of any accrued capital gain or loss, if under the terms of the trust document, such shares or interests are first transferred to a trust for a spouse or common-law partner and later distributed to a child of the testator upon the death of the surviving spouse or common-law partner [subsection 70(9.3)]. If farming property or shares or interests of a family farm corporation or partnership were transferred to a child by an inter vivos or testamentary transfer, and, as a consequence of the death of the child, the property is transferred to a surviving parent, the deceased child’s legal representative can elect that the transfer to the parent occur on a rollover basis.8

One of the most important legislative changes in the family farm area is with respect to how property may be transferred to a child. Recall that the rollover under subsection 70(9) is available only if the 8 See subsection 70(9.6).

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farm property is transferred or distributed to the child "as a consequence of the death" of the deceased. Prior to the introduction of subsection 248(8), there was concern that the rollover would be lost if a child was required to provide consideration to the deceased's estate in satisfaction of the terms of the deceased's will as a condition to acquiring the farm property. For example, it was not uncommon, in intergenerational transfers of farm property, for the deceased farmer to leave the family farm to one child provided that the child pay sufficient consideration to the estate to fund bequests to the other beneficiaries. Paragraph 248(8)(a) is said to have been added to ensure that the rollover is available in such circumstances. The CRA's position on intergenerational transfers of farm property is set out in Interpretation Bulletin IT-349R3, November 7, 1996, "Intergenerational Transfers of Farm Property on Death". ii. Principal Residence On the death of a taxpayer, the taxpayer’s principal residence, like the taxpayer’s other capital properties, is deemed to have been disposed of. However, a principal residence9 is given special treatment under the capital gains provisions of the Act. Any taxable capital gain arising on the disposition of the property is reduced according to a formula measuring the number of years that the property was the taxpayer's principal residence in the period during which the taxpayer was its owner. To achieve the reduction, the property must be designated as a principal residence in the year it is disposed of and no person can designate more than one principal residence for any year. If the principal residence was part of a farm, the taxpayer has two options. He or she may elect to notionally sever the principal residence from the farming property and calculate any gain on each property separately. Alternatively, the taxpayer may calculate the gain on the farm as if it did not include a principal residence, and then deduct $1,000 plus $1,000 for every year in which the taxpayer was resident in Canada and the property contained the taxpayer’s principal residence [paragraph 40(2)(c)]. The amount of the deemed proceeds on death will depend upon whether subsection 70(5) or (6) is applicable. If subsection 70(5) applies, any gain is computed in the same way as if the property had been disposed of during the taxpayer’s life. If subsection 70(6) applies, the spouse, common-law partner or conjugal trust will acquire the property at a cost equal to its adjusted cost base and no gain will be realized. In order to ensure that no gain attributable to a period in which the property was the principal residence of the deceased arises when the spouse, common-law partner or the conjugal trust subsequently disposes of it, the spouse or common-law partner or conjugal trust is deemed to have owned the property for each year in which it was owned by the deceased, to have occupied it as a principal residence for each year in which it was the deceased's principal residence and, in the case of a conjugal trust, to have been resident in Canada in each year in which the deceased was resident in Canada [subsection 40(4)]. Similarly, if a personal trust distributes property to a beneficiary in satisfaction of all or any part of the beneficiary’s capital interest in the trust in circumstances in which subsection 107(2) applies and the beneficiary later disposes of the property, the beneficiary is

9 The term Aprincipal residence@ is defined in section 54 and, in general terms, is a housing unit which is owned by the taxpayer, alone or jointly, and ordinarily inhabited in the year by the taxpayer, the taxpayer’s spouse or former spouse or dependant child.

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deemed to have owned the property since the trust last acquired it. [See Interpretation Bulletin IT-120R6, July 27,2003, “Principal Residence”.] A trust that is a personal trust may also generally claim a property as a principal residence for a taxation year if, in that year, an individual "beneficially interested" in the trust ordinarily inhabits the property or has a spouse, common-law partner, former spouse or common-law partner or child who ordinarily inhabits it. To qualify for the exemption, the principal residence must be designated by the trust in prescribed form and manner (definition of principal residence paragraph 54(c.1)). Each specified beneficiary must be listed in this designation by the trust for its taxation year and is treated as having personally designated the property as a principal residence for the calendar year ending in that year. Not more than one principal residence may be claimed, either directly or through a trust, by a family unit for a taxation year. 2. Land Inventory Land that is the inventory of a business conducted by the deceased is subject to a deemed disposition for proceeds equal to its fair market value immediately prior to the deceased's death [paragraph 70(5.2)(c)]. The excess of the proceeds over the cost of the land is included in computing the deceased’s income. There is an exception where the deceased was a Canadian resident taxpayer immediately before death and the land comprising the inventory vests within 36 months of the death [paragraph 70(5.2 (d))] in the deceased’s spouse or common-law partner or a conjugal trust. In that case a rollover occurs and the deceased’s proceeds of disposition and the cost of acquisition by the recipient are deemed to be an amount equal to the cost amount of the land to the deceased immediately before death. The tax consequences if the recipient subsequently disposes of the property will depend on whether the property was held by the taxpayer after the transfer as capital property or inventory. 3. Resource Properties Subject to the usual exceptions for property transferred to a spouse or common-law partner or a conjugal trust, Canadian and foreign resource properties are deemed to have been disposed of immediately prior to the deceased's death for proceeds equal to their fair market value [paragraph 70(5.2)(a)]. The acquisition cost to the taxpayer, who receives the property on the death of an individual is also considered to be equal to its fair market value. If the property vests indefeasibly in a spouse or common-law partner or a conjugal trust within 36 months of the death of the deceased, a rollover occurs. The personal representative may also elect, within limits, to immediately realize some or all of the deferred income [paragraph 70(5.2)(b)]. The recipient of the deceased's resource properties acquires the assets at a cost equal to the amount included in the deceased's income, or the amount deducted in computing the deceased's cumulative Canadian development expense or cumulative Canadian oil and gas property expense by virtue of the disposition. Any subsequent disposition by the recipient is governed by the general provisions of the Act applicable to dispositions of resource properties of a taxpayer. [See Interpretation Bulletin IT-125R4, April 21, 1995, "Disposition of Resources Properties".] 4. Eligible Capital Property Eligible capital property includes non-depreciable intangibles such as goodwill, incorporation costs and government rights. Generally, if a taxpayer carried on business prior to death, no amount is included in income in respect of these assets as a consequence of death. The person who acquires the

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deceased’s eligible capital property is deemed to have acquired it at a cost equal to the deceased’s proceeds. If the recipient continues to carry on the business of the deceased, he or she in effect acquires the cumulative eligible capital of the deceased and may claim a deduction in subsequent years with respect to it. If the recipient does not continue the business, the eligible capital property will become his or her capital property and is acquired at a cost equal to four-thirds the deceased's cumulative eligible capital. In effect a rollover occurs. As a result, any excess in the value of the property over that cost will be a capital gain of the recipient when he or she disposes of the property. [See IT-313R2, April 21, 1995, “Eligible Capital Property - Rules Where a Taxpayer has Ceased Carrying on Business or Has Died”.] 5. Partnership Rights If the deceased was a partner or a retired partner of a firm, his/her rights with respect to the partnership may give rise to capital gains or income under a number of the previous headings. The detailed rules for the taxation of partnership income are outside the scope of this work, but some reference to general principles is necessary for the purpose of explaining the treatment of a partner's rights in his/her terminal year. Unlike a corporation or a trust, a partnership is not a taxpayer. Its income each year is allocated and taxed to its members according to their respective shares under the partnership agreement [subsection 96(1)]. This does not mean that the partnership relationship is ignored for tax purposes. Before amounts of income can be allocated to the partners, income must first be computed at the partnership level as if the partnership were a separate person resident in Canada. It follows that most of the deductions, such as CCA, available in computing income, will be taken at the partnership level and cannot be allocated to particular partners. When income is allocated to members of the partnership, it retains its identity as income from a particular source. Similarly, when any excess of taxable gains over allowable capital losses incurred by the partnership is divided notionally among the partners, the proportionate share of each will be regarded as a taxable capital gain realized by that partner. If in a particular year the partnership has an excess of allowable capital losses over taxable capital gains, or other losses from a particular source, these are also allocated among the partners according to their shares under the partnership agreement. Amounts of income so allocated to a partner are included in his/her income for the calendar year in which the partnership's fiscal year ends, regardless of whether such amounts are actually received by the individual partners [paragraph 96(1)(f)]. A partner's interest in the partnership is capital property and a capital gain or a capital loss may arise when it is disposed of. If the interest was acquired after 1971, the adjusted cost base of the interest is the cost of acquisition plus or minus any adjustments required by section 53. Under paragraph 53(1)(e), amounts to be added to the cost will include contributions to the capital of the partnership, the partner's share in the profits or capital gains of the partnership for each of the partnership's fiscal years and the excess of life insurance proceeds received by the partnership over the adjusted cost basis under the policy. Deductions available for the purpose of computing the adjusted cost base include the partner's share of the partnership's losses for each of its fiscal periods, the amount of partnership's profits distributed to that partner and any distribution of, or in satisfaction of his/her share in, the partnership capital. It follows that the adjusted cost base of a partnership interest will fluctuate as profits are received by the partnership and are subsequently withdrawn by the partners. For this reason, the general rule that

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capital property cannot have a negative adjusted cost base is not applicable to partnership interests, so long as the partner retains the interest and the partnership continues to exist. Thus, where the adjusted cost base is negative, it will not give rise to a capital gain until there has been a disposition of the partners’ partnership interest [paragraph 40(3)(a)]. i. Death of an Active Partner The amount of income to be included in a deceased partner's terminal return will depend upon whether the death occurred before or after the date in the calendar year on which the partnership's fiscal period terminated and on whether the partners have elected an off calendar year end under subsection 249.1(4). Assuming such an election has not been made, and a second fiscal period does not end in the calendar year because of the individual’s death, The CRA regards the deceased's share of the profits of the partnership from the end of the last fiscal year of the partnership to the date of death, as a right or thing whose value must also be included in the terminal return unless a separate return is filed under subsection 70(2), or the right to receive the profits is transferred to a beneficiary under subsection 70(3). A further option that may be available to some personal representatives is to report the value of the right to profits for the stub period in a separate return pursuant to subsection 150(4). This can have the advantage of separating the amount from that of other rights or things, which are included in a return, filed under subsection 70(2). Generally, a separate return may be filed under subsection 150(4) if an individual dies after the end of a fiscal period of a business and a second fiscal period ends in the calendar year because of the individual’s death. Opportunities to file such separate returns were common prior to 1994 when individuals and partnerships could choose a fiscal period other than a calendar year. That opportunity effectively ended for fiscal periods ending after 1994 when most individuals, partners and professional corporations were required to use a calendar year end unless a special election was made under subsection 249.1(4). However, the ability to make this off calendar year election under subsection 249.1(4) and the transitional 10-year reserve rules for taxpayer’s that had a fiscal period ending in 1995 other than on December 31, 1995, provides two new opportunities to file a separate return under subsection 150(4). These are outlined below. First, taxpayers required to include amounts in income in respect of December 31, 1995, income are permitted a 10 year reserve to bring that amount into income. If the taxpayer dies before the reserve has been used up, the legal representative may claim the reserve in the year of death and report the amount as income on a separate return under subsection 150(4). Second, if the taxpayer elected under subsection 249.1(4) to retain an off calendar year end and the individual, including a partner who made the election dies, a second fiscal period may occur in the same calendar year. In that case a subsection 150(4) return may be filed. However, while the taxpayer was alive, an additional income inclusion was required under section 34.1 to recognize income that would have been earned to December 31. In effect tax was prepaid on this income. For 1998 and subsequent years an adjustment to recognize income under section 34.1 must be added to the terminal return for the second fiscal period [subsection 34.1(9)] if an election is made to do so or a subsection 150(4) return is filed. This amount may then be deducted from the subsection 150(4) return. The amount of the inclusion under subsection 34.1(9) is calculated using a formula that prorates total business for the fiscal period by multiplying it by the number of days in the short period as the numerator over total income for the fiscal period as the denominator. For 1996 and 1997 a personal representative that files a subsection 150(4) return also has the option of not adding an amount to the terminal return under subsection 34.1(9) and correspondingly not deducting it from

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income on the subsection 150(4) return. As the deceased's interest in the partnership is capital property, it will also be subject to a deemed disposition immediately prior to his/her death under either subsection 70(5) or (6). The interest will not be acquired by the estate as an interest in the partnership but, rather, as a right to receive partnership property [paragraph 100(3)(a)]. The significance of this is that the special rules that apply to a disposition of a partnership interest and to the computation of its adjusted cost base will have no application to the right received by the estate. Amounts received in satisfaction of the right would, however, be deducted from its adjusted cost base and a capital gain will arise if and when the adjusted cost base is reduced below zero. This would most commonly occur where the successor was a spouse or a spouse trust. Alternatively, a capital loss will be realized if the amount paid to the estate, or to a beneficiary of the estate in satisfaction of the right to receive partnership property, was less than the fair market value of the partnership interest immediately before the death of the partner. The fair market value of the deceased's partnership interest immediately before death will reflect the value of his/her share of profits for the stub period, therefore the value of the amounts that are rights and things on the death of the deceased is added to the adjusted cost base of the partnership interest. If this were not done the amount would be included in the income of the deceased, or of a beneficiary of his/her estate, as a right or thing. Where this occurs, it would increase the amount of any capital gain, or reduce the amount of any capital loss, on the disposition of the partnership interest. If the intent is to transfer rights or things to a beneficiary under subsection 70(3) the transfer cannot occur after the accrued income is capitalized in the partners’ capital account.

If at the time of his/her death the deceased had rights with respect to work in progress, its value may be treated as income of the deceased partner, income of the recipient, or capital. As a general rule, the value of the work in progress will be included in the fair market value of the deceased’s partnership interest. As a result, an amount that would have been income if the partner had lived to receive it will give rise to a capital gain on the deemed disposition of his/her interest immediately prior to death, or on a subsequent disposition by a spouse or by a spouse trust. This conversion of income to capital gain will be achieved at the expense of the continuing partners who must include in income the profits, which accrue when the work in progress is completed, without the benefit of a deduction for payments made to the estate in satisfaction of the deceased's rights. If, however, the partnership agreement provides that the estate of a beneficiary will be entitled to receive a share of the partnership income as compensation for the deceased's work in progress, the provisions of subsection 96(1.1) will apply and the estate or beneficiary will be treated as a member of the partnership with respect to that income. As a consequence the work in progress will be taxed as income in the hands of the estate or the beneficiary and will not be income of the continuing partners or of the deceased for his/her terminal year. The same treatment will be given to any payments made by the partnership to the deceased's estate or beneficiaries in recognition of his/her service and contribution to the partnership, if the partnership agreement provides that the payments are to be made out of income. Payments of income under subsection 96(1.1) do not affect the adjusted cost base of the estate, or beneficiary's, right to receive partnership property under section 98.2. In the above discussion, it has been assumed that the partnership would not be dissolved upon the death of the partner. The general rule under partnership legislation in most common law jurisdictions is that, unless the partners have agreed to the contrary, the death of a partner will cause the partnership to be dissolved. If this occurs, income or capital gains may be realized on dispositions of the partnership property to the former partners [subsections 98(1) and (2)]. If, however, the partnership property is transferred to a new Canadian partnership in which the only members were members of the predecessor partnership, the new partnership is deemed to be a continuation of the

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old partnership [subsection 98(6)] and a rollover of the partnership assets results. If there are only two members of the partnership, the death of one partner will lead to its automatic dissolution unless the partners previously agreed that the personal representatives of the deceased partner or some other person is to be admitted to the partnership when the death of one partner occurs. In the absence of such an agreement, a rollover may be available to the surviving partner with respect to partnership property distributed to him or her, if the survivor carries on the business of the partnership and continues to use the particular property in the business [subsection 98(5)]. ii. Death of a Retired Partner When a partner disposes of his/her interest on retirement, a capital gain or a capital loss may be realized according to the general rules of computing capital gains and losses. In many cases, however, it will neither be convenient nor desirable for the partnership, or the remaining partners, to pay a retiring partner the full value of his/her residual interest in the partnership immediately on retirement. Where the partnership is to discharge the interest by payments to be spread over a period, subsection 98.1(1) provides that the partnership interest will be deemed not to have been disposed of until all the payments have been received. In consequence, no question of any reserve under subparagraph 40(1)(a)(iii) will arise and no capital loss will be realized until all the payments have been received. In this situation, however, a capital gain will be realized if at any time the payments received by the partner in satisfaction of his/her residual interest reduce its adjusted cost base below zero. Subsection 98.1(1) applies only if the retired partner is to receive property from the partnership in satisfaction of his/her partnership interest. If the retiring partner had entered into a buy-sell agreement with the other partners, the sale of his/her interest would be subject to the normal rules, which govern dispositions of capital property. Partnership agreements will often provide for a retired partner to continue to receive a share of income from the partnership. This may reflect his/her share of work in progress at the date of retirement and it may also be in part a retiring allowance, which recognizes his/her service to the partnership and his/her contribution to its growth. In such a case subsection 96(1.1) will apply and will deem the retired partner to be a member of the partnership for the purpose of computing his/her income and that of the other partners. It follows that the share of income that is paid to the retired partner will not be allocated nor taxed to the other members of the partnership. If, under the agreement, the income is to be paid to the former partner's spouse, common-law partnership, estate or heirs, it is the recipient who will be deemed to be a member of the partnership. The right to receive income under an agreement of the kind described in subsection 96(1.1) is treated quite independently of any residual interest in the partnership. Payments of income pursuant to the right do not affect the adjusted cost base of the residual interest, and either may exist irrespective of the existence or non-existence of the other. Whether a payment to a retired partner is to be regarded as capital transferred to him in satisfaction of his/her residual interest, or income under subsection 96(1.1), depends upon the terms of the partnership agreement. Obviously, the first characterization may be more attractive to the former partner while the second may have a greater appeal to the continuing members of the partnership. The taxation consequences of the death of a retired partner are similar in principle to those that follow from the death of an active partner. The deceased's residual interest is considered capital

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property. Thus it is deemed to have been disposed of immediately prior to his/her death for proceeds equal to its fair market value if subsection 70(5) is applicable, or its adjusted cost base if the successor is a spouse or a spouse trust. In either case, the successor is deemed to have acquired a right to receive partnership property rather than an interest in a partnership. Amounts paid by the partnership in satisfaction of the right are deducted from the adjusted cost base and, if this becomes a negative amount, a capital gain will arise. If, at the time of his/her death, the retired partner had a right to receive income under an agreement of the type specified in subsection 96(1.1), this right is not capital property. Rather, it is a right or thing to which the provisions of subsection 70(2) and (3) apply. As the right to income is quite independent of, and is not reflected in the value of the residual interest in the partnership, there is no problem of double taxation and the value of the right or thing will not be added to the adjusted cost base of the residual interest. If income resulting from the deceased's right to a share of the partnership profits has been taxed under either of the alternatives in subsection 70(2), the general rule in paragraph 69(1)(c) will apply and the estate or the beneficiary who ultimately receives the right will acquire it at a cost equal to its fair market value. The beneficiary will be deemed to be a member of the partnership by virtue of subsection 96(1.1), and his/her cost will give rise to a deduction under subsection 96(1.3) as the income is allocated to him by the partnership. If the right is transferred to a beneficiary within the time specified for the application of subsection 70(3), the beneficiary will acquire the right at a cost equal to the cost, if any, to the deceased, and this amount will be deductible under subsection 96(1.3) as the income is allocated. Where the partnership agreement stipulates that the retired partner will receive income from the partnership until death with a guaranteed period which has not expired by the date of death, it is possible that only the right to receive income from the end of the partnership's last fiscal period to the date of death will be a right or thing for the purposes of subsection 70(2). Arguably, the estate or the beneficiary who is to receive the income for the remaining part of the period would be deemed to be a member of the partnership under subsection 96(1.1) and taxable with respect to it under the provision. (See IT-278R2 – “Death of a Partner or Retired Partner”, September 26, 1994). 6. Life Estates One method of avoiding the full impact of the deemed disposition rules on death was to transfer real property to a child or other beneficiary but retain a life estate or estate pur autre vie. In 1992, provisions were added to prevent this tax benefit. Where the provisions apply, the taxpayer is deemed to have disposed of the entire property including the retained life estate for proceeds equal to its fair market value at the time the remainder interest is disposed of, and to immediately reacquire the life estate at its fair market value. The result is a realization of any capital gain that has accrued on the entire interest in the property at the time the remainder interest is disposed of. Section 43.1 does not apply if the remainder interest is disposed of to a registered charity or certain other donees such as federal or provincial governments listed in section 118.1. On the death of the measuring life for the life estate, or estate pur autre vie, the life estate terminates. The person holding the remainder interest in the property at the time of death then acquires the entire interest in the property. The life estate holder is deemed to have disposed of the life estate immediately before death for proceeds equal to its adjusted cost base. Thus, no further capital gain or loss will arise. If the deceased and the holder of the remainder interest were not

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dealing at arm’s length immediately before the death, the adjusted cost base of the real property is increased by an amount by which the fair market value of the entire property exceeds the adjusted cost base of the remainder interest at that time. As a result, any loss on the termination of the life estate will not result in a capital loss to the deceased life estate holder. 7. Taxable Canadian Property The deemed disposition provision in subsection 70(5) generally applies where a non-resident individual dies owning taxable Canadian property. Taxable Canadian property includes an interest in real property, capital property used in a Canadian business, some trust and partnership interests, unlisted shares in private corporations resident in Canada, (including eligible capital property and inventory), unlisted shares of non-resident corporations that derive more than half their fair market value from Canadian real estate or resource properties, certain listed shares if the taxpayer and non-arm’s length parties owned 25% or more of the issued shares of any class of the capital stock, units of unit trusts, certain mutual fund trusts and certain interests in a non resident trust. The definition also includes any interest in or option in respect of taxable Canadian property, whether it currently exists or not. Thus an option to acquire shares in a corporation to be incorporated in the future would be caught by the definition. The amended definition generally applies after October 1, 1996. In the ordinary case, no rollover to a spouse or common-law partner would be available with respect to taxable Canadian property since one of the conditions necessary to achieve a deferral under subsection 70(6) is that the deceased taxpayer be a Canadian resident for Canadian tax purposes. Thus, a non-resident would fail to meet this threshold requirement. A rollover is now available under subsection 70(6) if the deceased was a U.S. resident and the property passes to that U.S. resident’s spouse, common-law partner or in some cases to a “conjugal trust”. This rollover is possible as a result of the Third Protocol to the Canada-United States Tax Treaty. Article XXIX B:5 deems the deceased taxpayer and the surviving spouse or common-law partner to be resident in Canada immediately before the taxpayer's death for the purposes of subsection 70(6). Similarly, a trust that would be a conjugal trust under subsection 70(6) if its U.S. resident trustees were Canadian residents may qualify for rollover treatment on application to the competent authority. 8. Proceeds of Life Insurance Generally, the recipient of life insurance will not be subject to tax on the insurance proceeds. However, if immediately prior to his/her death, the deceased as a policyholder had an interest in a policy on the life of some other person, the death of the policyholder will result in a disposition of the policy for tax purposes. If the policy is an exempt policy, the difference between the value of the interest and the adjusted cost basis of the policy will be included in computing his/her income for the terminal year [subsection 148(7)]. If the interest in a life insurance policy has been transferred to a surviving spouse or common-law partner as a consequence of death, a rollover is available. The surviving spouse or common-law partner will acquire the life insurance policy at its adjusted cost basis. Like other conjugal rollovers, subsection 148(8.2) is automatic unless an election is made in the policyholder’s return of income for the year not to have the subsection apply. Unfortunately, the same does not hold true where a life insurance policy on a child’s life, owned by the parent, is transferred to the parent by will. Ordinarily, subsection 148(8) would provide the rollover where the transfer is inter vivos. However, the CRA has stated that subsection 148(8) would not apply on death because the property is first transferred to the estate under the will and not directly to the child.

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9. Other Property of the Deceased In addition to the properties already discussed, the taxpayer may own other assets including deferred income pension plans such as Registered Retirement Savings Plans ("RRSPs") and Registered Pension Plans ("RPPs"), registered retirement income funds ("RRIFs") or deferred profit sharing plans ("DPSPs"). Each of these may create tax liability on death. As a general rule, all amounts received by a taxpayer from an RRSP are fully taxable as ordinary income in the year of receipt, whether received as retirement income in the form of annuity payments, as a return of premiums on the collapse of the plan [subsection 146(8)], or upon the annuitant's death [subsection 146(8.8)]. Notwithstanding this general rule, special provision has been made for the receipt of RRSP proceeds on the death of the annuitant. If the plan has not matured (i.e.) the deceased is not 69 or older, the amount in the plan is included in the deceased’s income for the terminal year unless all or a portion of the plan qualifies as a "refund of premiums" [subsection 146(8.9)]. To qualify as a refund of premiums, the amount must be paid to, or deemed to have been received by, the surviving spouse or common-law partner of the annuitant or children or grandchildren of the deceased who were financially dependent on the deceased. For this purpose it is assumed, unless the contrary is established, that a child is not financially dependent on the annuitant for support at the time of the annuitant’s death if the child’s income for the preceding taxation year exceeded basic personal income limits described in subsection 118(1). This amount equals $8,012 in 2004 and is indexed to inflation. If the child is mentally or physically infirm, the February 2003 Federal Budget increased the amount to $13,814 (indexed to inflation) for deaths that occur after 2002. The indexed amount is $14,912 for 2004. If the spouse, common-law partner or descendant is designated as the beneficiary under the provisions of the plan, the amounts in the plan will not fall into the estate of the deceased for most purposes and will be payable directly to the beneficiary rather than to the personal representative. If amounts in an unmatured plan are payable to the estate of the deceased they will qualify as a refund of premiums if they are allocated to, and distributed by, the personal representatives to the spouse, common-law partner or the dependant, as the case may be [subsection 104(27)]. If, however, the personal representative is obliged to retain and invest the amounts received out of the plan, subsection 146(8.1) permits the spouse, common-law partner or eligible dependant, to designate jointly with the personal representative that the amounts are deemed to have been received by the spouse, common-law partner or dependant as a refund of premiums. The amount of any refund of premiums is included in the income of the actual or deemed recipient in the year it was received. If the recipient is the spouse or common-law partner of the deceased and the amount is received or deemed to be received before the end of the year in which he or she attains the age of 69 years it can be rolled into an RRSP or an annuity contract without any tax liability in the year it is received [subparas. 60(1)(iv) and 60 (1)(v)]. If the amount is received after the end of the year in which the spouse or common-law partner attained the age of 69 years the only option available to prevent taxation of the full amount of the refund in the year of receipt will be the purchase of an annuity contract or where appropriate, a RRIF under which the beneficiary is an annuitant. A refund of premiums received, or deemed to be received, by a child or grandchild of the deceased may be used to acquire a qualifying annuity contract. If the dependant child or grandchild is under

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the age of 18, the entire lump sum can be used to purchase a fixed-term annuity for the benefit of the child or a trust under which the child is the sole person beneficially interested in amounts payable under the annuity while he or she is alive, provided that the term of the annuity, in years, is not greater than 18 minus the beneficiary's age. Where the child who was dependent upon the deceased annuitant as the result of the physical or mental infirmity of the child, there is a full and unfettered rollover to a child (or to a trust under which the child is the sole person beneficially interested while he or she is alive) for a life annuity or a term annuity up to age 90. The infirm dependant may also transfer the refund of premiums to an RRSP or RRIF. Where the annuitant dies after the maturity of the plan, the general rule is that an amount equal to the fair market value of all of the property of the plan will be included in his/her income for the terminal year, except to the extent that any part of such property qualifies as a refund of premiums to dependent children, or the surviving spouse or common-law partner is entitled to receive payments under the plan. In the latter case, he or she becomes the annuitant for the purposes of the Act and will be taxed on the payments as they are received. Alternatively, the spouse or common-law partner could roll the amount in the matured plan into his or her own unmatured plan RRSP if she has not attained the age of 69 years, or to a RRIF or to an annuity if she is 69 or older. If payments from the mature plan are to be made to the personal representatives of the deceased "for the benefit of the spouse or common-law partner of the deceased", the personal representatives and the beneficiary may jointly elect to have the beneficiary deemed to be the annuitant under the plan [subsection 146(8.91)]. If the amount is received by a child as a refund of premiums, the amount may be rolled into or used to purchase a qualifying annuity for the child.

Similarly, all amounts received out of or under an RRIF are generally received as income. If the annuitant dies, the fair market value of the remainder of the fund is included in income in the year of death [subsection 146.3(6)]. This result will be avoided if the annuitant has elected to extend the benefits to his/her spouse or common-law partner. In that case, if the annuitant dies before all the payments contracted for have been made, the remaining payments are continued in favour of the surviving spouse or common-law partner. As with RRSPs, taxation in the terminal year will also be avoided if all or a portion of the amount paid into the plan is paid to a financially dependent child or grandchild of the deceased as a designated benefit. This term is defined as an amount that would qualify as a refund of premiums if the fund were a registered retirement savings plan. A deduction is also available to offset the recipient's income inclusion where the eligible amount is transferred to an RRSP, RRIF or an annuity under which the child or grandchild is the annuitant. As with RRSP’s there is a presumption of financial dependency if the child's income did not exceed $8,012 in 2004 or, if the child is mentally or physically infirm – $14,912. The February 2003 Budget also extended rollover treatment to lump sum payments received out of a registered pension plan (RPP) by a financially dependent infirm child or grandchild as a consequence of the death of a supporting parent or grandparent. Again, in determining eligibility for the rollover subsection 146 (1.1) provides a rebuttable presumption that an infirm child is not financially dependent, if for the year preceding the parent or grandparent's death, the income of the child or grandchild exceeds $13,814 (indexed to inflation-$14,912 in 2004). The child may claim an offsetting deduction if the amount is paid into an RRSP or RRIF of the individual or is used to acquire a specified annuity.

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III. Deductions, Credits and Exemptions 1. Deductions Subject to a few special rules, the deductions that would have been available to the deceased if he or she had lived may be taken for the purpose of computing income or tax payable for the terminal year. In addition, a number of options or elections are available to relieve some of the tax burden that otherwise results from the deemed disposition rules on death. These special options and elections in most cases provide more flexibility than the general taxing provisions would otherwise allow. A. From Income i. Reserves During a taxation year prior to the year of death the taxpayer may have been entitled to a variety of deductions with respect to amounts that would otherwise have been included in his/her income for the year but for the fact that the amounts were not payable until some time in the future. For example, under subparagraph 40(1)(a)(iii) a taxpayer who disposes of capital property is, permitted to claim a reserve with respect to proceeds that are not due until a future year. A similar reserve is available under subparagraph 44(1)(e)(iii) in respect of replacement property where payment is not due until a later year. They will give rise to a gain of the taxpayer in the year in which the amounts become payable. Similar reserves are permitted for unpaid installments of the purchase price of property sold by the deceased in a business and for unearned commissions of insurance agents or brokers. Consistent with the policy of taxing the value of the deceased's unrealized rights to income for the year of his/her death, such reserves are generally not deductible in the year of death. An exception is made if the right to the amount in respect of which the reserve was allowed is transferred or distributed to the spouse or common-law partner of the deceased or to a trust for a spouse or common-law partner as a consequence of the death. If that is the case a deduction in respect of a reserve may be claimed for the terminal year if the personal representative and the transferee so elect. Thereafter the reserve will be treated as if it had been acquired originally by the spouse, or common-law partner or the conjugal trust as the case may be [subsection 72(2)]. ii. Capital Gains Deduction A discretionary deduction in computing the taxable income of an individual resident in Canada (other than a trust) is available in respect of net taxable capital gains realized in the year. This deduction is available where taxable capital gains resulted from a deemed disposition on death under subsection 70(5). The maximum lifetime capital gains deduction for an individual is $500,000 for dispositions of shares of qualifying small business corporations ("QSBC") and qualified farm property ("QFP"). Access to the deduction is restricted by a number of provisions in the Act discussed in more detail below. QFP is defined in subsection 110.6(1) as: property owned by an individual, the spouse or common-law partner of the individual or a partnership, an interest in which is an interest in a family farm partnership of the individual or the individual’s spouse or common-law partner that is;

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• real property owned by an individual that is used in the course of carrying on the business of farming in Canada by the individual who owns it, his/her spouse, common-law partner or children, his/her parents or a family farm corporation or partnership of the individual, his/her spouse, his/her common-law partner, his/her children or parents;

• shares of a family farm corporation owned by an individual or his/her spouse or his/her

common-law partner;

• an interest in a family farm partnership owned by an individual or his/her spouse or common-law partner; or

• eligible capital property provided certain requirements are satisfied.

Real property will only constitute QFP provided it is used in "carrying on the business of farming". There are different requirements that must be met to satisfy this test depending on whether the real property was acquired before or after June 17, 1987. Careful note should also be made of the different provisions that apply on rollovers of farm property to children. Although many of the farm assets eligible for the rollover will qualify for the capital gains deduction and vice versa, the requirements of the respective provisions are such that will not always be the case. QSBC shares will qualify for the deduction on gains from the disposition of QSBC shares where all of the following criteria are met [subsection 110.6(1)]:

• at the time of disposition the share must be a share of a Small Business Corporation ("SBC");

• the shares or shares for which they were substituted cannot have been held by anyone other than the individual or related persons throughout the 24-month period immediately preceding the disposition. In consequence, if the shares have been purchased from an arm's length third party and the new purchaser dies before the 24-month holding period expires no relief will be granted; and,

• more than 50% of the fair market value of the assets of the corporation were used in an

active business carried on primarily in Canada by the corporation or a related corporation, throughout the required holding period;

There are also provisions that prevent these requirements from being circumvented through the use of substituted shares. Basically these require that if a share has been substituted for another share during the 24-month holding period, the original share must have met the relevant tests in order for the substituted share to qualify as a QSBC share. Three exceptions from these general rules are made where shares are disposed of as a consequence of death. First, where shares of the deceased shareholder would otherwise be QSBC shares immediately before the deceased's death, but fail to qualify because the corporation itself did not meet the definition of small business corporation at that time, a relieving provision is available. Paragraph 110.6(14)(g) provides that the shares will be treated as QSBC shares if the corporation was a SBC at any time in the twelve-month period preceding the shareholder's death. As a result, a corporation

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which, for example, does not have "all or substantially all" of its assets engaged in an active business in Canada at the time of death will still be viewed as a SBC if the asset test was met at any time in the prior twelve month period. Second, paragraph 110.6(14)(c) treats a beneficiary of a personal trust as being related to the trust while he or she is a beneficiary. This may assist the beneficiary in satisfying the twenty-four month period of ownership required to meet the definition of a QSBC share. In addition, a personal trust will be treated as being related, in respect of shares of the capital stock of a corporation, to any person from whom it acquired those shares where, at the time the trust disposes of the shares, all beneficiaries of the trust (other than registered charities) are related to the person from whom the trust acquired the shares, (i.e.) the deceased. This will allow the estate or trust to dispose of the shares within twenty-four months of the death and the beneficiaries to claim the deduction. Third, special relief is offered with respect to life insurance policies owned by the corporation at the time of death. The fair market value of policy at any time prior to the taxpayer’s death is considered to be its cash surrender value at that time for purposes of the definitions of "qualified small business corporation share", "share of the capital stock of a family farm corporation" and "small business corporation"[paragraph 110.6(15)(a)]. Thus, where a corporation is the beneficiary of a life insurance policy under which a shareholder of that corporation (or certain other connected corporations) is the life insured, the cash surrender value of the policy is used to determine whether the corporation meets the assets test. Relief is also available if life insurance policy proceeds received by the corporation as a result of a shareholder's death are distributed by the corporation to fund an acquisition or redemption of shares under the terms of a buy-sell agreement. Specifically, the fair market value of such proceeds are treated as not exceeding the cash surrender value of the policy immediately prior to the shareholder's death to the extent that they are used, either directly or indirectly to redeem, acquire or cancel shares of the capital stock of that corporation (or of a connected corporation or a corporation connected to a connected corporation) that were owned by the person whose life was insured under the policy. In consequence, the redeemed shares will remain QSBC shares notwithstanding the infusion of life insurance proceeds to the corporation’s asset base. This relief is available only if the redemption, acquisition or cancellation occurs within twenty-four months after the death of the person whose life was insured under the policy, although the twenty-four month period may be extended upon written application to the Minister within that period. The capital gains deduction provisions do not apply with respect to the separate tax returns that may be filed on the deceased's behalf. This may cause a problem with respect to the separate returns that may be filed in respect of partnership or proprietorship income or trust income if the income from a partnership or trust includes capital gains that have been realized. A choice will have to be made between filing the separate returns and benefiting from the lower marginal tax rates and multiple credits that may apply in the separate returns and having access to the capital gains deduction. Amounts claimed under section 110.6 as a capital gains deduction during an individual's lifetime or in the year of death will also operate to reduce the total net capital losses for all taxation years that can be deducted in the year of death against income from all sources under subsection 111(2).

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iii. Capital Losses Capital losses incurred by the deceased in his or her lifetime cannot be transferred to the deceased’s estate or to the deceased’s successors. Allowable capital losses in the year of death and net capital losses carried over from prior years may be deducted from income from any source in the taxation year of death and the previous taxation year (subsection 111(2)). Capital losses used against other income must first be reduced by the total capital gains deduction previously claimed by the deceased. Thus, any allowable capital losses that cannot be offset against taxable capital gains realized are only deductible against other income to the extent they exceed the total of all capital gains deductions previously claimed. The deceased's personal representative may also elect to treat all or part of certain capital losses and terminal losses realized by the deceased's estate in its first taxation year as those of the deceased in his/her terminal year. Capital losses transferred in this manner may affect the capital gains deduction of the deceased under s.110.6 and result in a reduction in the deceased's tax. The capital losses that are eligible for this transfer are generally those that exceed the estate's capital gains in its first taxation year. The legal representative must, at or before the time of the election to transfer the losses, file an amended return for the deceased for the terminal year. Unlike losses incurred in the year of death, which may be carried back to the prior year, losses transferred under subsection 164(6) may only be deducted in computing the taxable income of the deceased in the year of death.

B. Computation of Tax

i. Charitable Donations Section 118.1 permits individuals to claim a non-refundable and non-transferable tax credit in respect of certain gifts made by them. The calculation of this credit is based on an individual's "total gifts" for the year as defined by subsection 118.1(1). Where the amount of total gifts for the year does not exceed $200, the tax credit is determined by multiplying 16% (the lowest personal tax rate) by the amount of total gifts. However, if the total gifts for the year exceed $200, the credit equals (16% x 200) + 29% (the highest personal tax rate) x the excess of total gifts over $200. For 1996 and subsequent years, an individual may claim inter vivos charitable gifts (other than gifts of cultural property or ecologically sensitive real property) up to 75% of income. For gifts of capital property, the income limit is increased by 25% of the capital gain or recapture that is included in income. None of these income restrictions apply in the year of death or preceding year. In both cases an individual may claim qualifying charitable gifts up to 100% of income. Under subsection 118.1(4), gifts made in the year of death (which, by virtue of subsection 118.1(5), include gifts made by will), are deemed to have been made in the immediately preceding taxation year to the extent that a credit is not actually taken in the year of death. This means that the unutilized portion of a donation may be used in calculating the tax credit available for the preceding year. To ensure that gifts made by will qualify for the credit in the terminal or prior year, the extent of the gift (specific property, amount or named percentage of the residue) should be clearly identifiable. The CRA is of the view that if a will grants the executor discretion to donate within a specified range, only the minimum in the range will qualify for a credit in the terminal or preceding

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year’s return. A donation over the minimum is considered to be at the trustee’s discretion and may be claimed in the estate return only. It is no longer the CRA's administrative practice to require that the specific charity to which the gift is to be made be named. However, the will should be sufficiently specific to make clear that a charitable gift is intended. A number of options are available with respect to gifts of capital property. Under the normal rules in paragraph 70(5)(a), when a taxpayer dies possessed of such capital property, it is deemed to have been disposed of by him or her for proceeds equal to fair market value. However, if the deceased makes a charitable or a Crown gift of that capital property, by will or otherwise, and the property has appreciated in value, the legal representative may elect to designate the amount of the gift at an amount not greater than the fair market value of the property and not less than the adjusted cost base. A similar rule applies to works of art described in inventory and donated by artists. The designated amount is deemed to be the value of the gift for purposes of determining the credit for charitable or Crown gifts and the proceeds of disposition of the property. The amount chosen should take into consideration the taxpayer's other capital gains or losses, charitable donations and income for the year and the capital gains deduction under section 110.6. Provision is also made for ecological gifts. If the deceased makes a cultural gift of Canadian cultural property as certified by the Canadian Cultural Property Export Review Board, by will or otherwise, its value is used in determining the credit for cultural gifts. A capital gain on the disposition of property that is a cultural gift is specifically exempt from tax provided that the property is disposed of within thirty-six months after death. [See IT-288R2, January 16, 1995, “Gifts of Capital Properties to a Charter and Others”, January 16, 1995.] There are also considerable gift planning opportunities around publicly traded securities. The capital gain inclusion rate on disposition of such shares to a charity is half of the regular inclusion rate or 25%, effective October 18, 2000. Notwithstanding, a charitable tax credit is available based on the fair market value of the securities gifted. Assuming a 50% tax rate, the amount saved will be equal to 12.5% of the difference between the value of the securities and their cost base (i.e. 12.5% of the gain). On the other hand, if the securities are sold and the net proceeds donated to charity, 50% of the gain must be included in income. Additional planning opportunities are available with respect to charitable donations of RRSP’s, RRIF’s and insurance proceeds made as a consequence of direct beneficiary designations to a registered charity. Such donations are also eligible for the charitable tax credit.

ii. Medical Expenses Section 118.2 allows a taxpayer to claim a tax credit for certain medical expenses. This credit is determined by multiplying 16% (the lowest personal tax rate) by the medical expenses paid within any twelve-month period ending in the year in excess of the lesser of $1,813 in 200410 and 3% of income for the year. In consequence, eligible medical expenses paid by the taxpayer or his/her legal representative within any selected period of twelve consecutive months, the last day of which falls within the taxation year in question, will qualify for purposes of the credit. For example, expenses paid in the period commencing on February 1, 2003 and ending January 31, 2004 would be eligible medical expenses for the taxpayer's 2004 taxation year. As a result, a taxpayer that suffered loss or had a small income in 2003 could claim the 2003 medical expenses in 2004. 10 As indexed under s. 117.1.

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The twelve-month period, within which medical expenses may be claimed, is extended in the case of a deceased individual. The legal representative may claim in the year of a taxpayer's death, medical expenses paid by the representative or the taxpayer within any twenty-four month period that includes the day of death. This concession is to recognize the heavy medical expenses often incurred in the final illness of an individual, some of which may not be paid until after his/her death. The CRA has also indicated that if the legal representative of a deceased individual has filed a return for the year of death and subsequently pays additional medical expenses, that an adjustment will be made in the medical expense tax credit if requested, to reflect such payments. 2. Alternative Minimum Tax There is no obligation to pay AMT in the year of death. Nonetheless the AMT provisions may affect the terminal return. For example, a taxpayer may carry forward the excess of his/her AMT over regular Part I tax in a particular year for seven years ("AMT carry forward"). Where tax that would otherwise be payable under Part I exceeds the minimum amount in a particular year ("Part I tax excess"), any unclaimed AMT carry forward may be used to reduce the Part I tax excess. As a result, tax that would otherwise be payable under Part I may be reduced by an AMT carry forward. The AMT carry forward provisions do not apply with respect to the separate returns that may be filed on the deceased's behalf. Given that AMT is not payable in the year of death, the legal representative should consider any elections that would result in the realization of capital gains on the deemed disposition of the deceased's qualified farm property or qualifying shares of a small business corporation. For example if the property were bequeathed to a spouse or common-law partner a rollover would otherwise occur. If the personal representative elects under subsection 70(6.2) so that subsection 70(5) applies and claims the capital gains exemption, the cost base of the property is increased without the possible penalty of AMT.

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3. Other Separate Returns In addition to the separate returns that may be filed for rights and things, separate returns may be filed if the deceased had income from a testamentary trust, a partnership of which he/she was a member, or a business of which he/she was the proprietor, if the death occurred after the close of the taxation year of the trust, partnership or business and before the end of the calendar year in which the taxation year ended. Such occurrences are, except in the case of a beneficiary or a testamentary trust, somewhat limited. Changes to the definition of fiscal period in section 249.1 (for fiscal periods after 1994) now generally require that the fiscal period of proprietors and partners must end in the calendar year. Notwithstanding, important opportunities to file a separate return remain. The first is with respect to the transitional reserve in respect of December 31, 1995, income. If an individual or partnership had a fiscal period other than December 31, 1995, they must bring that 1995 income into taxable income, subject to a 10-year reserve. If the individual dies before the reserve is exhausted, the legal representative may claim the remaining reserve in the year of death and report it as income on a separate return under subsection 150(4). The second occurs if the individual reports business income on an off calendar year basis and has filed the appropriate election under subsection 249.1(4) under those circumstances, a separate return may be filed under subsection 150(4) if a second fiscal period results in the calendar year as a result of the death. Note that an adjustment is required under subsection 34.1(9) to recognize income that would otherwise have been earned in the calendar year and to prorate its inclusion in the terminal return. This amount is deductible from the return under subsection 150(4). The ability to file a separate return will, of course, also remain available to the beneficiary of a testamentary trust. Subsection 150(4) provides that tax on the income reported in a separate return shall be paid as if the income were the income of another person. However, a number of special rules apply. For example, the deductions that may be claimed on those returns include the stock option deductions, the prospector and grubstaker's deduction, the employer's shares deduction, certain payments such as workmen’s compensation and social assistance, unemployment insurance benefit repayments, the home relocation loan deduction, and gifts to a religious order. These deductions may be divided among the terminal returns, but the total amount deducted among all returns must not exceed what could have been deducted if all income of the deceased was reported on the ordinary return. The personal credits (that is, basic personal, married, dependant children, and other dependants) and the age credit may be claimed on each separate return as well as on the ordinary return. The ability to claim multiple credits is one of the main reasons for filing separate returns. Certain other credits may be claimed on the separate returns and may be divided among the terminal returns; but again the total amount claimed is limited to what could have been claimed if all the deceased's income was reported on the ordinary return. (See IT-326R3 - Returns of Deceased Persons as “Another Person”, November 13, 1996.)

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Chapter 2: Taxation of the Estate, Testamentary Trusts and Beneficiaries Introduction A trust arrangement involves three parties: 1. The settlor of the trust who transfers property to the trustee for the benefit of specified

persons (the Beneficiaries). 2. The trustee who administers the property placed under his or her control until required to

transfer the property to the beneficiaries. 3. The beneficiaries who ultimately receive the trust property. Beneficiaries may have an

interest in the income of the trust, the capital of the trust or both. Under the Act, an estate whether testate or intestate, is considered to be a trust and is subject to all the taxation rules which apply to trusts. Trusts and estates are taxed as individuals. The trust may incur liability with respect to ordinary income which it receives and taxable capital gains which are realized during its existence. There are two major trust classifications for tax purposes: 1. Testamentary Trusts - which include all trusts arising as a consequence of the death of an

individual, all of the property of which was contributed either by the deceased, or by some other individuals on or after their death and as a consequence thereof [paragraph 108(1)(i)]; and,

2. Inter Vivos Trusts - which include all trusts other than testamentary trusts, and would apply

to trusts established while the settlor was alive as well as to unit trusts such as mutual funds and deferred income plans such as RRSPs [paragraph 108(1)(f)].

An important distinction is also made between Apersonal trusts@ and what are often referred to as Acommercial trusts@. A personal trust includes a testamentary trust and an inter vivos trust in which no interest has been acquired for consideration. In the typical family trust situation the trust would be a personal trust. For example, when a parent creates a trust for the benefit of his or her child, the child would not normally purchase the interest. Generally if an estate or trust has not received contributions from anyone other than the deceased and the beneficiaries are gifted their interest, the trust will fall both within the definition of a Atestamentary trust@ and a Apersonal trust@ for purposes of these provisions. Maintaining status as a testamentary trust will be important: Testamentary trusts are taxed like individuals at progressive rates under s. 117, whereas inter vivos trusts are taxed at the top marginal rates for individuals under s.122(1). Further, Apersonal trusts@ receive much more favourable tax treatment than commercial trusts, in particular when trust assets are transferred to the beneficiaries. When dealing with the trust or estate the duties of the personal representative will include:

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1. taking possession of the deceased=s assets; 2. paying debts, taxes and other testamentary expenses; 3. distributing the remaining property to the beneficiaries of the estate. Where a will creates more than one trust, each trust will be a separate taxpayer. If specific property is directed to be transferred to the trusts, any income from property remaining in the hands of the executors after the transfers of these specific properties to the trusts will continue to be income of the estate as a separate taxpayer. As a precaution against a taxpayer creating numerous identical trusts for the same beneficiaries to income split, subsection 104(2) permits the Minister to consolidate trusts if substantially all of the property of the trusts has been received from one person and if Athe various trusts are conditioned so that the income thereof accrues or will ultimately accrue to the same beneficiary, or group or class of beneficiaries@. Where these conditions are satisfied, the Minister can, in effect, treat the trusts as if they were a single trust whose income is the income of all the trusts. In analysing the overall tax treatment of trusts and beneficiaries there are 3 major areas which should be considered. 1. What is the tax result on the transfer of property to the trust? 2. How is income taxed once property is in the trust? How are the beneficiaries taxed on their

income from the trust? 3. What is the tax result when property is transferred from the trust? What results when a

beneficiary disposes of their interest in the trust other than for assets from the trust? These questions will be considered in this chapter. 1. Transfers of Property to a Trust Generally property will be acquired by the trust at its fair market value, following the disposition of the asset at its fair market value immediately prior to the demise of the deceased. The major exception to this rule is where a rollover has occurred (i.e. farm properties or as a result of a transfer to a spouse, common-law partner or conjugal trust). In the case of a rollover, the trust will acquire the asset at its cost amount to the deceased, subject to any election made by the personal representative. In the case of a transfer to a conjugal trust, the elected amount may be fair market value (subsection 70(6.2)), in the case of farm property, the elected amount may range between cost and fair market value (subsection 70(9)). To prevent the trust from delaying the realization of any further appreciation in the asset value indefinitely, deemed disposition provisions were added to the Act to ensure the disposition of capital property, certain resource properties and land inventory at the end of specified periods [subsection 104(4)].

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$ Where the trust qualified as a conjugal trust at the date of its creation the first deemed disposition will occur on the death of the spouse or common-law partner. If the property remains in the trust there will be further dispositions every 21 years.

$ If the trust did not qualify as a conjugal trust at its inception, dispositions will be

deemed to occur at 21 year intervals with the first period beginning on the later of January 1, 1972 and the date on which the trust was created.

If the property in the trust is capital property, whether depreciable or non-depreciable, the proceeds of disposition will be an amount equal to the fair market value of the property on the day on which the disposition is deemed to occur for taxation years ending after 1992. There were provisions which permitted certain trusts to elect to defer a deemed realization of capital gains or other income beyond the 21st anniversary of the later of January 1, 1972 and the day on which the trusts were created. Amendments to the Act prevent a deferral beyond January 1, 1999. 2. Income Earned by the Trust Income, including taxable capital gains, will be taxed to the estate or trust unless one of four conditions is satisfied.

$ The income is paid or payable to the beneficiary [subsection 104(6), (13) and (24)];

$ The income is deemed to be payable to an infant [subsection 104(18)];

$ When a preferred beneficiary elects to pay tax on accumulating income [subsection 104(12) and (14)];*****

$ The trustee makes payments in respect of property which he or she is required, under

the terms of the trust instrument, to maintain for the use of a beneficiary [subsection 105(2)].

Subject to certain exceptions, where one of the above conditions is met, all of the income will be deductible from the income of the trust and included in the income of a beneficiary or beneficiaries.

In addition, there may be cases in which beneficiaries will pay tax on benefits from the trust under subsection 105(1).

*****Preferred beneficiary elections under subsection 104(4) are eliminated for trust taxation years that begin after 1995 except with respect to beneficiaries entitled under subsection 118.3(11) to the tax credit for mental or physical impairment. See definition of Apreferred beneficiary@ in subsection 108(1).

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A. Taxation of the Trust Where none of the four exceptions exists, the income and taxable capital gains of the trust will be taxed at the rates applicable to individuals but, unlike an inter vivos trust, a testamentary trust is also permitted to have a taxation year other than a calendar year [paragraph 104(23)(a)]. Although a trust is not entitled to personal tax credits, the normal deductions available to individuals in computing their income may be taken to the extent that the activities of the trust satisfy the requirements for the deductions. The conduit deductions in respect of income payable to beneficiaries, income subject to a preferred beneficiary election or income applied for the maintenance of property for a beneficiary are to be taken after the ordinary deductions applicable to individuals have been made. Fees of executors and trustees for services in respect of the management of the estate will not be deductible unless they can properly be characterized as incurred for the purpose of earning income from a business or property or unless the executors= or trustees= principal business is advising with respect to the advisability of purchasing or selling specific shares of securities or includes the provision of services in respect of the administration or management of shares or securities and the fee is attributable to such services. [See IT-238R2, October 6, 1983, AFees Paid to Investment Counsel@: Appendix] The following cases consider the deductibility of certain fees and expenses by the trust. i. Pappas Estate v. M.N.R., 90 DTC 1646 (T.C.C.) Issue: Which legal fees are deductible in computing the estate=s income? Facts Held: The following legal fees were paid in the administration of the estate.

a. Costs of securing probate and locating and gathering the assets. $ Not deductible as they are unrelated to the earning of income.

b. Costs of determining the extent of a beneficiary=s entitlement. $ Not deductible as they are unrelated to the earning of income.

c. The cost of managing and supervising the activities of corporations whose shares were owned by the estate.

$ Not deductible. Expenditures incurred by a shareholder to make his or her company more profitable are not deductible in computing his or her income, as the possibility of increased dividends is too remote.

d. Devising and implementing tax reduction strategies. $ Not deductible. The minimization of taxes arising on the death of the testator can increase future income only by increasing the fund available for investment by the estate. Such a fund is a source of income and is therefore capital. Further, the Appellant did not carry on any business and did not exist to make a profit, therefore paragraph 18(1)(a) is applicable.

e. Cost of investing liquid assets. $ These costs might have been deductible under a different section (20(1)(bb)) but the Appellant did not discharge the onus of proof required to satisfy the court (no evidence was led).

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ii. Evans Estate v. M.N.R., [1960] SCR 391 Legal fees incurred for the purpose of establishing a right to an income interest in an estate were held to be deductible as expenses incurred for the purposes of earning income from property. iii. R v. Bronfman Trust, [1987] DTC 5059 (S.C.C.) Issue: Was the trust entitled to a deduction for interest paid on money borrowed for the purpose of making capital distributions to a beneficiary? The trustee=s argument was that the funds were borrowed to preserve an income producing asset. Held: A...In the present case the borrowed money was originally used to make capital allocations to the beneficiary for which the Trust received no property or consideration of any kind. That use of the borrowings was indisputably not of an income-earning nature. Accordingly, unless the direct use of the money ought to be overlooked in favour of an alleged indirect income-earning use, the Trust cannot be permitted to deduct the interest payments in issue in this appeal...@ Deductions must be claimed by the estate if they are to be used. The Act is clear that such deductions or other losses incurred by the estate cannot be passed on to the beneficiaries for the purpose of computing their income. The harshness of this rule has been alleviated to some extent by provisions that permit a trust to claim a deduction for less than the full amount of its income, including taxable capital gains, payable to a beneficiary. Subsection 104(13.1) provides a mechanism for a trust to designate to its beneficiaries their respective shares of that portion of the trust=s income distributions that has not been deducted in computing its income for the year. The amount of trust income so designated is deemed not to have been paid or to have become payable to the beneficiary in the year and accordingly it is not required to be included in the beneficiary=s income. Subsection 104(13.2) contemplates the situation where a trust has a non-capital loss carry forward from a prior taxation year and current taxable capital gains. In such circumstances, the trust may choose not to deduct the full amount payable under subsection 104(6) to allow the non-capital loss carry forward to absorb the current taxable capital gains. The designation in subsection 104(13.2) allows the trust to designate to its capital beneficiaries their respective shares of the portion of the potential deduction under subsection 104(6) that has not been deducted under that subsection or used in a designation under subsection 104(13.1). An amount so designated and included in the computation of trust income will not be subject to tax in the hands of a beneficiary when that amount, net after tax, is paid out to the beneficiary. This allows the trustee to, in effect, designate whether the benefit of the tax-free distribution to beneficiaries will flow to those who are entitled to receive taxable capital gains or to those who are entitled to receive other income. An income beneficiary can also agree to pay a trust=s tax liability as a result of a designation under 104(13.1) or (13.2). The beneficiary may choose to pay the tax on behalf of the trust because he or she is at a lower marginal rate than the trust would otherwise be, or because the

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payment of tax by the trust would reduce the value of the capital interests held by other beneficiaries. [See Appendix 6 - Interpretation Bulletin IT-342R, March 21, 1990, ATrusts - Income Payable to Beneficiaries@: Appendix] B. Taxation of Beneficiaries i. Amounts Payable to Beneficiaries As a general rule, where an amount which would otherwise be income of a trust is payable in the year to a beneficiary, it may be deducted from the income of the trust and will be included in computing the income of the beneficiary (subsection 104(13); Appendix 6 - Interpretation Bulletin IT-342R, March 21, 1990, ATrusts - Income Payable to Beneficiaries@). For this purpose it is provided that no amount shall be considered to be payable in a taxation year unless it was paid in the year to the beneficiary or unless the beneficiary was entitled in the year to enforce payment thereof (subsection 104(24). [See Appendix 5 - Interpretation Bulletin IT-286R2, April 8, 1989, ATrusts - Amounts Payable@] ii. Family Trust There are a number of important exceptions to the general rule that amounts may be deducted from a trust when they are paid or payable to a beneficiary. First, taxable capital gains that are deemed to be realized when capital property is distributed from a conjugal trust to a person other than the spouse or common-law partner before the spouse or common-law partner=s death, from an alter ego trust to a person other than the settlor before the settlor=s death or from a joint partner trust to a person other than the settlor or the spouse or common-law partner of the settlor before the later of the death of the settlor and the death of the spouse or common-law partner cannot be deducted in computing the income of the trust. A similar rule applies to taxable capital gains that arise as a consequence of an actual disposition by the trust or which are realized upon the death of a spouse or common-law partner who is a beneficiary of a conjugal trust. In either case, a designation under subsection 104(13.1) or 104(13.2) would appear to be required if the taxable capital gains are not also to be included in the income of beneficiaries to whom the property is distributed in the year. Second, for trusts other than personal trusts, or trusts created prior to 1985, an anti-avoidance provision will operate where it is reasonable to consider that one of the main purposes for the existence of any term, condition, right or other attribute of an interest in a trust is to give a beneficiary a percentage interest in the property of the trust that is greater than the beneficiary=s percentage interest in the income of the trust. Where these circumstances exist subsection 104(7.1) provides that no amount may be deducted under paragraph 104(6)(b) in computing the income of the trust. Again, where the trust is prevented from claiming the deduction a designation may be made under subsections 104(13.1) or (13.2). [Interpretation Bulletin IT-381R3, February 14, 1997, ATrusts - Capital Gains and Losses and Flow-Through of Taxable Capital Gains to Beneficiaries@] a. The Executor=s Year While an estate is being administered no beneficiary has any right to demand a payment of distribution of income or capital. It must follow that, strictly, no amount could be included in a

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beneficiary=s income as income payable to him during administration except insofar as amounts were actually paid. In practice, a deduction from the income of the trust and an inclusion in the income of beneficiaries are permitted by the CCRA if, in his or her accounts, the personal representative allocates the income to the beneficiaries and if all of the beneficiaries consent. The discussion in Interpretation Bulletin IT-286R2 ATrusts - Amounts Payable@ (Appendix 5)suggests that this practice is limited to the executor=s year and that it will apply only if that year and the trust=s taxation year coincide. In Grayson v. M.N.R., 90 DTC 1108 (TCC) the taxpayer was the sole executor and beneficiary under a Will. The estate appears to have been fully administered in its first taxation year which coincided with the executor=s year. It received interest income in that year and in the succeeding year and the executor reported such income as income of the estate. The Minister included the amounts in the taxpayer=s income for each year on the ground that they were payable to him qua beneficiary and the assessment was upheld. The decision is inconsistent with the statements with respect to The CCRA=s assessing practice in Interpretation Bulletin 286R2 (Appendix 5) as far as the first taxation year of the estate is concerned and even if the estate was fully administered before the end of the executor=s year, it would appear to be incorrect in law as far as the income of that year was concerned. The executor=s year is simply the first twelve months after the deceased=s death and is the period traditionally allowed to an executor to pay debts and generally settle the estate so that it is ready for distribution to the beneficiaries. The rule that executors cannot be compelled to pay legacies or distribute income or capital to beneficiaries in the year is quite firmly established and on that basis it could not be said that the taxpayer in his or her capacity as beneficiary was entitled in the first year to enforce payment of the interest income. The fact that the taxpayer in Grayson was both the sole executor and beneficiary may well have contributed to the decision although, strictly, that fact should have been irrelevant. For a variety of reasons, including tax disputes, many estates remain under administration for a period that extends significantly beyond the executor=s year. In such cases, beneficiaries could not legally demand payment of undistributed income and even if correct on its facts, the decision in Grayson should not be applicable. b. Allocation of Trust Income Beneficiaries must include in income amounts that are paid or payable by the trust. However, both the timing and source of funds distributed by the trust is clearly a matter for the personal representative to determine.

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1. Roy v. M.N.R., 78 DTC 1123 (TAB) Facts: Interest expense claimed by the estate was disallowed. This resulted in an income amount in the trust, which the Minister allocated to the beneficiary who was also the executor. Issue: Was the beneficiary taxable on the trust income? Held: No. You must distinguish between the executor and the beneficiary even when they are the same person. An estate=s income is taxable once it has been transferred to the beneficiaries, but the estate must be settled first. Here the debts were not all paid yet. If the interest was not deductible, the estate should have been taxed, not the beneficiary. 2. Ida Brown v. M.N.R., 50 DTC 218 (TAB) Facts: Subparagraph 60(a)(ii) provides that an annuitant under a will or a trust may deduct such part of the annual payment as she or he can establish was not paid out of the income of the trust. Ida was entitled to an annuity from the trust. The trust claimed capital cost allowance against its income to reduce its taxable income to nil. Ida was reassessed on the basis that if the trust had income, her annuity payment was from trust income not capital. Issue: Can the Minister determine the source of an annuity payment? Held: No. This would usurp the power of the executor. By making a payment when the income was nil for tax purposes, the executor was in effect making a decision to make the payment out of capital. This conclusion was consistent with the trust=s records. C. Disclaimers, Releases and Surrenders What happens if a beneficiary receives an income interest under a trust and has the right to enforce payment? Are there steps that the beneficiary can take to prevent the amount from being included in his or her income? i. Herman v. M.N.R., 61 DTC 700 (TAB) Facts: Husband died December 21, 1957. The Will provided that the income of the trust was to go to the widow during her life. On December 31, 1957 the widow signed a declaration disclaiming any interest in the income of the trust for the period ending March 31, 1958. Subsequent disclaimers were executed for future years. The Minister included the income of the trust in the widow=s income. Issue: Was the widow taxable on the disclaimed amounts? Held: No. The court rejected the Minister=s argument that the disclaimers were tantamount to an assignment because she knew who would get the disclaimed amounts. Where there has been an express and unqualified disclaimer by a beneficiary, nothing is payable to the beneficiary by the executors. There is also no disposition of the right to receive income from the trust.

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A disclaimer in the strict sense is essentially a refusal to accept a gift. If the donee does not disclaim within a reasonable time, acceptance will be presumed. If the donee does disclaim, the effect, for most purposes, is to avoid the gift ab initio. For tax purposes, this result will occur provided the disclaimer is made within 36 months of the date of death (subsection 248(8)). The concept of a disclaimer is often confused with a release or a surrender of an interest which has previously been accepted under a will or inter vivos trust instrument. While it is possible to argue that a true disclaimer of an income interest should be effective to prevent income from being taxed to the donee and that it should not be regarded as a disposition, it is not clear whether the same consequences will follow from a release or a surrender. The CCRA=s position on dispositions of income interests in a trust are set out in the following Interpretation Bulletin: Interpretation Bulletin IT-385R2 C Disposition of an Income Interest in a Trust Date: May 17, 1991 Reference: Subsection 106(2)(also subsections 56(2), 69(1), 74.1(1) and (2), 104(13), 106(1), (1.1) and (3), 108(3), 110.1(1), 112(1) and 138(6), paragraphs 108(1)(e) and 248(8)(c) and the definition of Apersonal trust@ in subsection 248(1)) This bulletin cancels and replaces Interpretation Bulletin IT-385R dated August 6, 1979. Summary This bulletin discusses the disposition of an income interest in a trust and the circumstances under which the proceeds are required to be included in the transferor=s income pursuant to subsection 106(2). The bulletin also considers the amount to be attributed to proceeds of disposition and the costs of the income interest that may be deducted. Discussion and Interpretation 1. Paragraph 108(1)(e) defines an income interest of a taxpayer in a trust. Where such an interest in a trust was created or materially altered after January 31, 1987 and acquired after 10:00 p.m. Eastern Standard Time on February 6, 1987, it is an income interest in a trust only if it is the right of a person as beneficiary to receive all or part of the income of a personal trust. Income of a personal trust (or the trust=s income referred to in 2 below) means income computed for trust accounting purposes and not for income tax purposes, and as further modified by subsection 108(3). A personal trust, as defined in subsection 248(1), is either a testamentary trust, or an inter vivos trust in which no beneficial interest was acquired for consideration payable to the trust or to a person who has made a contribution to the trust. For the purposes of the definition of a personal trust, love and affection will not be regarded as consideration. Further, the mere retention of an interest in the trust at the time the trust was created, by the individual or related individuals who settled the trust will not result in the disqualification of the trust as a personal trust. 2. Prior to the amendment of the definition as outlined in 1 above, an income interest in a trust was the right (whether immediate or future and whether absolute or contingent) of a person as a beneficiary under the trust to receive all or any part of the trust=s income. This definition continues to apply to such interests that were created before February 1, 1987, have not been materially changed after January 31, 1987 and were acquired not later than 10:00 p.m. Eastern Standard Time on February 6, 1987. 3. As a result of the amendment to the definition of an income interest, any interest in a trust defined in paragraph 108(1)(j) (other than an income interest acquired in the circumstances outlined in 1 and 2 above) is treated as a capital interest, whether or not that interest is a right to receive all or any part of the income or capital of the trust.

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Assignments and Other Dispositions 4. A taxpayer who assigns or disposes of an income interest in a trust in favour of another person will be subject to the provisions of subsection 106(2) and must include in income the proceeds of disposition. If the transaction is not at arm=s length and the proceeds are less than fair market value, the taxpayer will be deemed by virtue of subparagraph 69(1)(b)(i) to have received proceeds of disposition equal to the fair market value of the interest disposed of. Where the taxpayer disposes of an income interest by gift inter vivos, subparagraph 69(1)(b)(ii) applies with the result that the proceeds of disposition are deemed to be the fair market value of the income interest. 5. Where the assignment in favour of another person is a payment in respect of proceeds of disposition of an income interest in a trust when it is due and the assignee has a legal right to receive it, subsection 106(2) does not apply to the assignee, but the transaction may be governed by the provisions of subsection 56(2). 6. A payment, as described in subsection 106(3), to a taxpayer from a trust in satisfaction of all or part of the taxpayer=s income interest in the trust is not a disposition producing income under paragraph 106(2)(a), and no amount is included in the income of the taxpayer by reason of the payment. Disclaimer 7. A taxpayer who executes a disclaimer (not in favour of any person) of an income interest in a trust at the time the taxpayer becomes aware of it (or within a reasonable time thereafter) will be considered not to have acquired that income interest in the trust. Subsection 106(2) will, therefore, have no application in such a situation. For the purposes of this paragraph Adisclaimer@ includes a renunciation of a succession made under the laws of the Province of Quebec that is not made in favour of any person. A person who has accepted any funds from the trust in respect of an income interest in the trust or executes a Adisclaimer@ in respect of an income interest in the trust in favour of another person would be considered to have acquired the income interest and therefore would be unable to execute a valid disclaimer. Release or Surrender 8. Where a taxpayer formally releases or surrenders all or any part of an income interest in a particular trust in respect of future payments (amounts not due and payable at the time of the release or surrender) in favour of one or more other persons, the taxpayer will be deemed, by virtue of paragraph 69(1)(b), to have received proceeds of disposition equal to the fair market value at the time of the release or surrender of the income interest released or surrendered and must include that amount in income pursuant to subsection 106(2). It should be noted that paragraph 248(8)(c) does not apply to an income interest that arises upon the death of the deceased since such an interest could not have been property of the deceased immediately before death. 9. A taxpayer who for no consideration validly releases or surrenders an income interest in a trust in respect of future payments (not due and payable at the time the release or surrender is executed) and does not direct in any manner who is entitled to receive the benefits, will not be considered to have received any proceeds of disposition for the purposes of subsection 106(2). The result will be the same if the taxpayer designates or otherwise agrees which person or persons will benefit by reason of the release or surrender, if the same person or persons would be entitled to benefit in the same way under the trust without the taxpayer=s designation or agreement. However, the attribution rules of subsections 74.1(1) and (2) are considered to apply if the person or persons who benefit under the terms of the trust as a consequence of the release or surrender are persons described in those subsections. Cost of an Income Interest in a Trust 10. Subsection 106(1) permits a taxpayer to deduct an amount in respect of the cost of an income interest in a trust where amounts have been included in income either on the disposition of such interest pursuant to subsection 106(2), as described in 4 and 8 above, or where the taxpayer has income from the interest under subsection 104(13), or both. The amount that can be deducted in any year, however, cannot exceed the lesser of (a) that portion of the cost that was not deductible for previous years, and (b) the amount included in income for the year pursuant to subsections 104(13) and 106(2) minus, for interests acquired after 5:00 p.m. E.S.T. on November 26, 1985, the deductions allowed in respect of those amounts for the 1986 and subsequent taxation years under subsections 112(1) or 138(6) and, for the 1986 and 1987 taxation years under subsection 110.1(1).

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For the purposes of subsection 106(1), the cost to the taxpayer of an income interest in a trust acquired directly from the person who was a beneficiary in respect of the income interest will generally be the amount paid for it. However, if the interest was acquired from the beneficiary in a non-arm=s length transaction and the amount paid for it exceeded its fair market value, its cost will be deemed to be its fair market value by virtue of paragraph 69(1)(a) and, if the income interest was acquired from the beneficiary by way of gift, its cost will be deemed to be its fair market value by virtue of paragraph 69(1)(c). If the income interest was not acquired from a person who was a beneficiary in respect of the interest, its cost is deemed to be nil by virtue of subsection 106(1.1). D. Direction to Maintain Infants or Other Persons It is not uncommon for a testator or testatrix to bequeath the income from the estate to a surviving spouse or common-law partner for life and to couple the bequest with an indication of a desire that the spouse or common-law partner should use part of the income for the maintenance of infant children. The taxation consequences of such a gift vary according to the legal effect which a court would attribute to the stipulation with respect to the children=s maintenance. If the expression of desire is regarded as merely precatory it will not impose any legal obligation upon the surviving spouse or common-law partner and he or she will be taxed with respect to the entire income which is distributed. If a court would conclude that the words of the will indicate an intention to impose an obligation other tax consequences will follow. In general the beneficial recipient and not the spouse or common-law partner would be taxable on the amounts received. Consider the following Interpretation Bulletin and cases. Interpretation Bulletin IT-446R C Legacies Date: July 7, 1989 Reference: Section 9 Application This bulletin replaces and cancels Interpretation Bulletin IT-446 dated May 15, 1980. Paragraph 4 of the bulletin has been revised to reflect the fact that the former deduction in computing taxable income that was allowed for personal exemptions has been replaced, effective for 1988 and subsequent taxation years, by a tax credit. Current revisions are designated by vertical lines. Summary This bulletin discusses the tax liability on income from a legacy when the terms of the will specify that receipt of the legacy is conditional upon the recipient making payments to another person. Discussion and Interpretation 1. A testator may bequeath a business or property to a person (legatee) on condition that the legatee undertake to pay to another person (the recipient) stated amounts per month or year, usually for the balance of the recipient=s life. This situation may arise, for example, when a parent bequeaths property to a child on condition that the child provide for the maintenance of the parent=s spouse during the spouse=s lifetime. 2. A Alegacy@ or Abequest@ means a testamentary gift of personal property but could also refer to real property if the context requires it.

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3. Income from a legacy is considered to be income of the recipient and not of the legatee if the terms of the will establish that the stated amounts are secured by a charge on estate or trust income or on property bequeathed from which the income is derived. (The legatee=s income tax liability is limited to the amount of income beneficially retained by that person.) A charge would arise, for example, if a testator stipulated that the amounts be paid out of the profits from a business bequeathed or out of rental income from real property included in the legacy. 4. In contrast, income from a legacy is considered to be income of the legatee and not income of the recipient if acceptance of the legacy creates an unsecured personal liability of the legatee. This is the case when the will identifies the legatee as the person required to assume the obligation to make payments to the recipient and fails to identify the source from which the obligation is to be paid. Such an obligation could be paid from any source, whether capital or income or even borrowed funds, notwithstanding that the obligation may in fact be paid out of income from the business or property bequeathed. A characteristic of a personal liability is that it continues to exist even after the business bequeathed is no longer carried on or the property bequeathed has been disposed of. However, when the payments on account of this personal liability are for the support of the recipient, the legatee may be entitled to a personal tax credit in respect of the recipient, provided the recipient meets the requirements of section 118 to qualify as a dependant of the legatee. (Where the payments on account of this personal liability are for the support of the recipient for a taxation year before 1988, the legatee may be entitled to claim the recipient as a dependant, provided the recipient met the other applicable qualifications set out in former section 109 for that year.) The involuntary nature of the support does not change the fact that it is support. i. Wilson v. M.N.R., 55 DTC 1065 (SCC) Facts: The testator=s Will left certain premises and business to his son subject to his compliance with following terms: payment of succession duties, assumption of debts with respect to the premises and business, the payment of four legacies, a payment to the widow each month for life, and to maintain the widow=s residence. The land was charged with the last two obligations. The son sought to deduct the amounts charged against the land from income of the business. Issue: Were the amounts deductible? Held: Yes. The legacies were allowed as a business deduction because the charge was against land which was used for business purposes and rent would have had to have been paid otherwise by the business if it had to use other land. The charge was a specific charge against a business asset. ii. Saunders v. M.N.R., 51 DTC 292 (TAB) Facts: The Testator left residue of his estate to his son with the requirement that he pay $1,200/year for life to the widow. The son deducted the payments to the widow from income. Issue: Could the son deduct the legacy to his mother? Held: No. In construing the will there was no trust established for paying the annuity. There was no charge on any specific asset. The obligation was a personal one of the taxpayer on accepting the transfer of the property. iii. B.A. Brown v. M.N.R., 52 DTC 53 (TAB)

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Facts: On the death of both her parents, the daughter entered an agreement with the executors to resettle a trust left for her and her brother by receiving half of each estate on condition that she assume the liability to pay the life annuities directed in the trust for the care of two aunts. Issue: Were the payments made by the daughter to the annuitants deductible? Hold: No. The daughter had assumed a personal obligation. Payment of the annuities could not be construed as incurred for the purpose of earning income. E. Capital Gains The rules which govern the taxation of income payable to a beneficiary apply to taxable capital gains as well as to ordinary income. Where taxable capital gains have been paid by a trust resident in Canada throughout the executor year to a beneficiary who is resident in Canada the trust is permitted to designate that the beneficiary has received a taxable capital gain from a disposition of a capital property [subsection 104(21)]. When such a designation has been made the beneficiary will be able to deduct his or her own allowable capital losses from the taxable capital gains he or she is deemed to have incurred. The Act does not provide any method of determining whether a beneficiary has received an amount which represents a taxable capital gain of the trust. Where the trust incurs a capital gain and distributes the entire proceeds to a beneficiary there should be no difficulty. Suppose, however, a trustee sells a particular capital asset, incurs a capital gain of $100 and pays $25 to a beneficiary as an encroachment on capital. The $25 might be regarded as either from the taxable or non-taxable part of the capital gain. The provision which gives the trustee the power to designate that a beneficiary has incurred a taxable capital gain appears to be predicated on a prior determination that the amount which the beneficiary has received will in any event be included in his or her income. It does not deal with the initial question of the source of the beneficiary=s receipt. In the absence of any relevant statutory provision it appears that some attempt at tracing will have to be made. If that is correct, it would seem to follow that the manner in which receipts and disbursements appear in the accounts of the trust may be decisive. The express power to designate that part of the beneficiary=s income is a taxable capital gain incurred by him or her is subject to a requirement of reasonableness. For example, say a trust pays $10,000 to an income beneficiary in a year and, in the same year, exercises a power to encroach on capital in favour of a remainderman. The trust could not designate that a taxable capital gain incurred when an asset was sold for purposes of the capital encroachment was a taxable capital gain of the income beneficiary. There is no provision which permits a trust to pass its allowable capital losses through to its beneficiaries directly and the power of designation with respect to taxable capital gains applies only to the extent that such gains exceed the aggregate of its allowable capital losses for the year (other than allowable business investment losses) and any net capital losses that it deducted in the year. [See Interpretation Bulletin IT-381R3, February 14, 1997, ATrusts - Capital Gains and Losses and Flow-Through of Taxable Capital Gains to Beneficiaries@]

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F. Capital Gains Exemption Although a trust is not entitled to a capital gains deduction, the beneficiaries are entitled to use the deduction to offset taxable capital gains that they are deemed to have realized by virtue of a designation made by the trust (subsection 104(21.2)). For this purpose, a further designation of amounts included in the trust=s Aeligible taxable capital gains@ is required in respect of each beneficiary. The eligible taxable capital gains of the trust are, in effect, the part of the gains that have been designated as realized by beneficiaries in the year that would be eligible for the capital gains deduction under section 110.6 if that deduction was available to the trust in the same manner as to other individuals. The computation of the trust=s eligible taxable capital gains is made without reference to the $500,000 lifetime limits on the amount of the deduction that any individual can claim with respect to qualifying farm property or qualifying shares of a small business corporation. The taxable capital gains for which a deduction can be claimed by an individual are reduced not only by allowable capital losses and net capital losses but also by the Acumulative net investment loss@ of the individual. An individual=s cumulative net investment loss is, generally, the amount by which the aggregate of expenses deducted in computing income from property for years ending after 1987 exceeds the aggregate of amounts included in computing income from property for such years. The purpose of requiring amounts eligible for a capital gains deduction to be reduced by reference to a cumulative net investment loss is to prevent individuals from deducting expenses incurred in acquiring or maintaining capital property, such as interest expenses, in computing their income and, in addition, taxable capital gains realized on subsequent disposition of the property. The Act therefore requires a computation of the amount of the taxable capital gains designated by the trust to the beneficiaries that would be eligible for a capital gains deduction if such a deduction were available to the trust. That amount, the trust=s eligible taxable capital gains, is the maximum amount that can be offset by the capital gains deductions available to the beneficiary. As mentioned, the trust is required to allocate its eligible taxable capital gains among the beneficiaries by a further designation pursuant to subsection 104(21.2) (discussed further below). The amount allocated to each beneficiary will be deemed to be a taxable capital gain of the beneficiary for the purpose of determining the amount, if any, of the beneficiary=s available capital gains deduction and will be aggregated with his or her other taxable capital gains for that purpose. In consequence, the extent to which taxable capital gains designated by a trust to a beneficiary may be offset by the beneficiary=s capital gains deduction will be affected by the trust=s allowable business investment losses and cumulative net investment loss, by those of the beneficiary and by the extent to which the beneficiary has previously taken advantage of the $375,000 capital gains deduction. If the trust realizes, and designates to beneficiaries, taxable capital gains from dispositions of qualified farming properties or shares of qualified small business corporations, such gains must be allocated among the beneficiaries as taxable capital gains from dispositions of such properties by them. This will enable a beneficiary to take advantage of the $500,000 for dispositions of such properties. For this purpose, the proportion of the trust=s eligible taxable capital gains that would otherwise be allocated to the beneficiary is to be divided between gains from dispositions

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of qualified farming properties, shares of qualified small business corporations and other capital properties in the same proportions as gains, net of allowable capital losses other than allowable business investment losses, from each such category or property were realized by the trust in the year. An exception to the general rule that a trust is not entitled to a capital gains deduction in computing its taxable income applies to conjugal trusts for the year in which the spouse or common-law partner died. As any taxable capital gains realized by the trust as a consequence of the spouse or common-law partner=s death cannot be deducted from the income of the trust or designated to beneficiaries, the trust is permitted, in effect, to claim as a deduction in computing its taxable income, any part of the amount of its eligible taxable capital gains that the spouse or common-law partner could have claimed as a deduction pursuant to section 110.6 if he or she had realized such gains directly in the year. G. Deemed Income In some situations a trust will be deemed to have income which it has not actually received. This may occur, for example, on the death of a spouse or common-law partner beneficiary of a conjugal trust, on a distribution of capital of a conjugal trust to persons other than the spouse or common-law partner during his or her lifetime, on a distribution of capital in satisfaction of an income interest or on a distribution of capital to a non-resident beneficiary. There is a question whether such deemed amounts of income can be deducted in computing the income of the trust, or included in the income of the beneficiaries, as amounts payable to them. As far as amounts representing taxable capital gains deemed to be realized by a conjugal trust in the first two cases mentioned are concerned, it is clear that no deduction is available to the trust on the basis that such taxable capital gains were payable to beneficiaries who receive the property subject to the deemed disposition in the year. If the income is to be considered to have followed the property distributed, a designation by the trust under subsection 104(13.1) might strictly be required if the taxable capital gains are not also to be included in computing the beneficiaries= income. However, subsection 104(13) only includes in the income of a beneficiary amounts payable to him or her that, Abut for subsections (6) and (12)@ would be income of the trust. An amount that cannot be deducted by the trust under subsection 104(6) might not be covered by that language. In the other situations mentioned, where taxable capital gains are realized on dispositions by a trust in satisfaction of a beneficiary=s income interest or upon a distribution of property to a non-resident, the question whether the gains should be considered to be payable to the beneficiary will determine whether the trust is entitled to a deduction for such amounts and whether they will be included in the beneficiary=s income in the first case or subject to withholding tax in the second case. It is suggested that there should be no significant distinction between such cases and those in which the taxable capital gains are actually realized prior to distributions of the proceeds and that the taxable capital gains that were deemed to be realized should be considered to be payable to the beneficiary for purposes of the Act. A similar problem can arise when a trust realizes a recapture of capital cost allowance and subsequently distributes all of its assets in the same year. In this case it would seem easier to argue that the income was payable to the beneficiaries as actual proceeds of disposition will have been received and distributed by the trust.

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H. Amounts Deemed to be Payable to an Infant For taxation years ending prior to 1995, if income was accumulated in a trust that was resident in Canada for an infant whose right to it had vested, it was deemed by subsection 104(18) to be payable to him or so long as infancy was the only reason which prevented the infant from enforcing payment of it. No statutory guidelines were provided as to the meaning of infancy for purposes of the provision or when amounts would be considered vested. Such authority as did exist suggested that the right had to be absolutely and indefeasibly vested and that it was not sufficient that it be vested subject to be divestment. For taxation years ending after 1995 subsection 104(18) has added considerable clarity to the matter and provides as follows; Trust income will be considered payable to an individual in a taxation year only where:

i. the individual is less than 21 years of age at end of year, ii. the individual=s right to income is vested by the end of that year, iii. the individual=s right to income did not become vested because of the exercise or

non-exercise of a discretionary power, and, iv. the individual=s right to income is not subject to any future condition, other than a

condition that the individual survive to an age not exceeding 40 years. I. Payments for the Maintenance of Property It is not uncommon for trustees to be directed to pay for the maintenance and upkeep of a residence which a beneficiary is entitled to occupy. A reasonable part of such payment may be deducted from the income of the trust and, by virtue of subsection 105(2), is to be included in the income of the occupant. This is potentially problematic where the capital beneficiaries desire extensive improvements to be made to the property and is the income beneficiary (occupant) who is liable for the taxes. Therefore, it is important for the trust document to define what a Areasonable@ improvement is. The Act does not indicate how the test of reasonableness is to be applied. Presumably, payments made to discharge expenses which, under rules of trust accounting, would be regarded as income expenses will fall within the provision while payments which would normally be charged against capital would not be included. Amounts which are used to pay annual property taxes would be in the first category and payments for improvements would fall within the second. J. Amounts Subject to a Preferred Beneficiary=s Election The Act attempts to prevent taxpayers from unduly deferring the payment of tax by leaving income to accumulate in a trust. It does this by taxing accumulating income to the trust as an individual. As a result the effective rate of tax may be considerably higher than it would have been if the income had been spread among the persons who would ultimately receive it. This result can be avoided if the conditions for an election by preferred beneficiaries are present. The election must be made by the trust and the particular preferred beneficiary jointly in the prescribed manner (section 104(14)). If the beneficiary is an infant, the CCRA permits his or her election to be made by a parent, guardian or other legal representative. The effect is a deduction of the elected amount from the income which is retained by the trust and the inclusion of the

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elected amount in the income of the preferred beneficiary. The income is not paid to the beneficiary. Before an election can be made, it is necessary to establish, first that the beneficiary falls within the statutory definition of a preferred beneficiary and, second, that he or she has a share in the accumulating income for the purposes of the election. For trust tax years ending after 1995, a new definition of preferred beneficiary limits the class of beneficiaries to persons who may claim a tax credit for mental and physical impairment under paragraph 118 3(1)(a). The preferred beneficiary in addition to being a spouse, common-law partner or child, must also be suffering from a severe and prolonged mental or physical impairment which has been certified to restrict the ability of the individual to perform the basic task of living. It would appear that this exception to the expected complete abolition of the preferred beneficiary election was made in recognition of the fact that it might not always be in the best interests of an individual suffering from such an impairment to receive all of the trust income on an annual basis. The calculation of a preferred beneficiary=s share of the accumulating income and the calculation of accumulating income are set out in subsections 104(14) and (15). A preferred beneficiary=s share in the accumulating income of the trust is the Aallocable amount@. Generally, the allocable amount for a taxation year where the beneficiary=s interest in the trust is not entirely contingent on the death of another beneficiary who has a capital interest in the trust and who does not have an income interest in the trust, will equal the trust=s accumulating income for the year. In any other case, the allocable amount is nil. The definition of accumulating income was also amended to ensure that the maximum deduction allowable under subsection 104(6) with respect to amounts payable to a beneficiary be computed in calculating the accumulating income whether or not the amount was deducted by the trust. Finally, in the case of a post - 1971 spousal trust, accumulating income will exclude any gains realized by the trust in the year of the surviving spouses or common-law partners death from an actual or deemed disposition of trust property. K. Benefits Subsection 105(1) includes in the income of any taxpayer the value of all benefits from or under a trust, other than benefits that would otherwise be included in the taxpayer=s income (or benefits whose value would be deducted in computing the adjusted cost base of the taxpayer=s interest in the trust if, with one qualification, paragraph 53(2)(h) applied to such interest). The provision extends to benefits received by any taxpayer whether or not he or she is a beneficiary under the trust and no corresponding deduction is allowed to the trust. It appears that, as far as personal trusts are concerned, the range of benefits that would be included in the income of a beneficiary under subsection 105(1) is very narrow. Where, however, the taxpayer who receives the benefit is not a beneficiary of the trust and has no beneficial interest, a literal interpretation of the subsection in its present form would appear to treat even payments of capital as a taxable benefit. i. Cooper v. The Queen, 88 DTC 6525 (F.C.T.D.)

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Facts: A $400,000 interest free loan was made by the trust to a beneficiary (also co-executor). The Minister assessed an s. 105(1) interest benefit calculated under regulation 4300. Issue: Was there a benefit? Held: No. The court likened subsection 105(1) to section 15(1) and noted that an interest free loan benefit was not taxable under 15(1) but rather required the specific provisions of subsection 15(2) and section 80.4 to make it taxable. Therefore, subsection 105(1) was not broad enough to assess an interest benefit. 3. Ancillary Conduct Provisions Paragraph 108(5)(a) provides that, except as otherwise provided in Part I of the Act, an amount included in computing the income for a taxation year of a beneficiary as income payable to him, as income subject to a preferred beneficiary election or as a taxable benefit under section 105 is deemed to be income of the beneficiary for the year Afrom a property that is an interest in the trust and not from any other source@. The specific provisions that state that income of certain kinds will retain its character in the hands of the beneficiaries are exceptions to the general rule in paragraph 108(5)(a). The most important of the exceptions are as follows. A. Taxable Dividends Under subsection 104(19) a trust that is resident in Canada throughout the taxation year is permitted to designate that an amount which has been included in the income of a beneficiary represents a taxable dividend received from a taxable Canadian corporation. For taxation years that end after 2000, the designated portion is deemed for purposes of paragraphs 82(1)(b), 107(1)(c) and (d) and section 112, not to have been received by the trust and for the purposes of the Act other than Part XIII, to be a taxable dividend on the share received by the beneficiary. As a result, the trust will still be treated as having received the dividend even if it has been designated in favour of a beneficiary. In most cases, the trust will be allowed a corresponding deduction under subsection 104(6) to offset the income inclusion subject to restrictions related to alter ego trusts, joint partner trusts and post-1971 spousal partner trusts. This provision presupposes that an amount has been included in a beneficiary=s income under subsections 104(13), (14) or section 105. Unless this has happened, the provision has no application. [Appendix 7 - Interpretation Bulletin IT-524, March 16, 1990, ATrusts - Flow-through of Taxable Dividends to a Beneficiary - After 1987": Appendix]. B. Exempt Dividends As exempt dividends, including capital dividends, will not form part of the income of the trust they will not be included in computing the income of a beneficiary to whom they are paid pursuant to subsection 104(13). In consequence, no designation should be required for the purpose of removing such amounts from the income of the beneficiary. Subsection 104(20) requires such a designation to be made for the purposes of a number of specified provisions which relate to the calculation of losses on the disposition of the shares or an interest in the trust.

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C. Taxable Capital Gains If the trust has incurred capital gains in a year throughout which it was resident in Canada, the excess of the taxable part of capital gains over any allowable capital losses and net capital losses may be designated as a taxable capital gain of one or more beneficiaries from dispositions of capital property made by them. It is important to recognize that a designation under subsection 104(21) does not determine whether an amount is to be included in computing a beneficiary=s income. It presupposes that such an inclusion has been made and merely determines that the amount has the character of a taxable capital gain incurred by the beneficiary. Such a determination would permit the beneficiary to offset the taxable capital gain against his or her own allowable capital losses or net capital losses. A designation by a trust under subsection 104(21) does not determine the extent to which the beneficiary, in favour of whom the designation was made, may claim a capital gains exemption under section 110.6 in respect of his or her portion of the trust=s net taxable capital gains for the year. Subsection 104(21.2) contains the rules which will determine the amount which will be eligible for the exemption. If a trust designates an amount under subsection 104(21) in respect of a beneficiary for a taxation year, it must also, in its tax return for that designation year, designate a portion of its eligible taxable capital gains for the year in respect of the beneficiary. A beneficiary=s capital gain for the year for the purposes of claiming the capital gains exemption is the proportion of the trust=s eligible taxable capital gains for the designation year from the disposition of qualified farm, qualified small business corporation shares and other capital property that the designated amount under subsection 104(21) bears to the net taxable capital gain of the trust for the year. A trust=s Anet taxable capital gain@ is the amount by which its taxable capital gains for the year exceeds its allowable capital losses for the year and its annual gains limit for the year as determined under subsection 110.6(1), and the amount by which its cumulative gains limit, calculated under subsection 110.6(1) exceeds the aggregate of prior designations by the trust under subsection 104(21.2). The operation of subsections 104(21) and (21.2) is illustrated in excerpts from the following Interpretation Bulletin: Interpretation Bulletin IT-381R3 C Trusts C Capital Gains and Losses and the Flow-Through of Taxable Capital Gains to Beneficiaries Date: February 14, 1997 Reference: Subsections 104(21), (21.2) and (21.3) (also sections 3, 105, 110.6 and 111; subsections 104(4), (5), (5.3), (6), (7.1), (12), (13), (13.1), (13.2), (14), (18) and (24) and 107(4); the definitions of Aaccumulating income,@ Aeligible taxable capital gains,@ Apre-1972 spousal trust,@ Apreferred beneficiary@ and Atestamentary trust@ in subsection 108(1) and the definition of Apersonal trust@ in subsection 248(1); and paragraphs 53(2)(h) and 122(2)(d)) Application This bulletin cancels and replaces Interpretation Bulletin IT-381R2 dated November 29, 1991.

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Summary This bulletin discusses rules for determining a beneficiary=s income for tax purposes from a trust as well as the deductions available to the trust for its income distributions and allocations to beneficiaries. The discussion of these rules serves as the background for the main topics of the bulletin, which are $ the flow-through of net taxable capital gains of a trust to a beneficiary for purposes of determining the income

of the beneficiary; and $ the designation, to a beneficiary of a personal trust, of eligible taxable capital gains from dispositions of

qualified farm property or qualified small business corporation shares, to enable the beneficiary to claim a capital gains deduction.

Related subjects that are covered in the bulletin include $ the tax treatment of a trust=s taxable capital gains that are not included in the income of a beneficiary; $ the tax treatment of a trust=s unused capital losses; $ restrictions on the deductions with respect to taxable capital gains that may be claimed by spousal trusts; and $ rules to prevent double taxation of any income distributions that are not deductible by the trust or that it has

chosen not to deduct in full. The provisions discussed in the bulletin are intended $ to determine which amounts of income, including taxable capital gains, should be taxed in the hands of a trust

and which amounts should be taxed in the hands of its beneficiaries; and $ to ensure that the characterization of capital gains flowing from a trust to its beneficiaries is retained for their

income reporting purposes and, in the case of beneficiaries of personal trusts, for purposes of their claiming a capital gains deduction.

It should be noted that a discussion of the application of the 21-year deemed realization rule for trusts, as well as related rules, is outside the scope of this bulletin. Discussion and Interpretation Income of a Beneficiary of a Trust 1. The income, for income tax purposes, of a beneficiary of a trust for a particular taxation year may include the following: (a) the share of an amount included in the income of the trust that is paid or payable to the beneficiary in the year under the terms of the trust, to the extent that it was not included in the beneficiary=s income in a previous year (see subsection 104(13) and also subsections 104(18) and (24)); (b) that part of the Aaccumulating income@ of the trust that is designated to the beneficiary in a preferred beneficiary election (see subsection 104(14) and related provisions, including the definitions of Apreferred beneficiary@ and Aaccumulating income@ in subsection 108(1); see also the current version of IT-394, Preferred Beneficiary Election); (c) a benefit conferred on the beneficiary resulting from the maintenance, out of income of the trust, of a property for the beneficiary=s use (subsection 105(2)); or (d) any other benefit to the beneficiary in the year from or under the trust, except to the extent that it $ is otherwise required to be included in the beneficiary=s income for the year, or $ has been deducted under paragraph 53(2)(h) in calculating the adjusted cost base of the beneficiary=s interest

in the trust, or would be so deducted if paragraph 53(2)(h) applied to the beneficiary=s interest in the trust and were read without reference to clause 53(2)(h)(i.1)(B).

(Such other benefits are included in the beneficiary=s income under subsection 105(1)). Deductions in Computing Income of a Trust 2. As a general rule, amounts included in the income of a trust=s beneficiary under subsections 104(13), 104(14) or 105(2) (described in 1(a) to 1(c) above) are deductible by the trust under subsection 104(6) or 104(12), as applicable, in computing its income. A trust=s deduction under subsection 104(12) pertains to that part of the trust=s Aaccumulating income@ that is included in a beneficiary=s income under a subsection 104(14) preferred beneficiary election. Paragraph 104(6)(b) generally provides for a deduction by a trust of the following amounts: $ an amount included in the income of the trust that is paid or becomes payable to a beneficiary; and $ an amount included in a beneficiary=s income under subsection 105(2). A paragraph 104(6)(b) deduction is available to a trust if one of the other paragraphs in subsection 104(6) does not apply to it (these other paragraphs in subsection 104(6) pertain to certain special types of trusts, e.g., an employee trust or a trust governed by an employee benefit plan). There are certain restrictions on the amounts that a trust may deduct under paragraph 104(6)(b) or subsection 104(12). Restrictions that can apply with respect to capital gains (the

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main subject of this bulletin) are discussed in 11 through 16 below. Also, if a trust is entitled to a deduction under paragraph 104(6)(b), it may choose to deduct an amount that is less than the amount of its income distributions. This may be done, for example, to enable the trust to utilize, in a particular year, losses from prior years without affecting the ability of the trust to distribute its income currently. If a trust is precluded from deducting an amount or if a trust chooses to deduct an amount that is less than the amount of its income distributions, designations to prevent double taxation are available as discussed in 17 to 19 below. Capital Gains of a Trust 3. Under trust law, a capital gain realized by a trust is generally considered to be part of the capital of the trust. For income tax purposes, however, a taxable capital gain realized by a trust is included in computing its income. All or part of the amount of a taxable capital gain realized by a trust may, under certain circumstances, be included in the income of one or more of its beneficiaries under one of the provisions discussed in 1 above (note that, since such an amount included in the income of a beneficiary will also have been included in the trust=s income, a corresponding deduction could then be claimed by the trust as discussed in 2 above). Any amount of a taxable capital gain realized by a trust that is paid or payable to a beneficiary is included in the beneficiary=s income under subsection 104(13) (see 1(a) above). This could occur, for example, where the terms of the trust allow for an encroachment on the capital of the trust and the trustees determine by written resolution that an amount of a taxable capital gain realized by the trust will be paid or payable to a beneficiary. Also, although a taxable capital gain may not form part of trust income under trust law, it does enter into the calculation of Aaccumulating income@ (as defined in subsection 108(1) of the Income Tax Act) and thus an amount of a taxable capital gain can be included in the income of a preferred beneficiary by means of a subsection 104(14) preferred beneficiary election (see 1(b) above). The actions taken by the trustees of the trust that cause an amount of a taxable capital gain to be included in the income of a beneficiary under subsection 104(13) or (14) should not contravene the terms of the trust indenture. Finally, it should be noted that when an amount of a trust=s taxable capital gain is included in the income of a beneficiary under subsection 104(13) or (14), neither of those provisions deems the amount to be a taxable capital gain of the beneficiary (see, instead, the discussion of subsection 104(21) below). Flow-through of Taxable Capital Gains to a Beneficiary 4. For the Anet taxable capital gains@ (see 5 below) of a trust for a taxation year throughout which it was resident in Canada, provision is made in subsection 104(21) to preserve the character of such gains flowing through the trust to its beneficiaries resident in Canada and, if the trust is a mutual fund trust, to its non-resident beneficiaries. This flow-through of net taxable capital gains applies for purposes of sections 3 and 111 in determining a beneficiary=s income for the year and the amounts of losses from other years which the beneficiary may deduct in determining taxable income for the year, but not for purposes of a capital gains deduction in section 110.6 (in the case of a beneficiary of a personal trust, however, see 6 and 7 below). 5. A trust that has realized taxable capital gains in a particular taxation year may, within the limits of subsection 104(21), designate in its return of income for the year all or part of the amount of those gains as a taxable capital gain for the year of one or more beneficiaries. An amount designated to a beneficiary under subsection 104(21) must reasonably be considered to be part of the amount included in the beneficiary=s income for that year under any of the provisions referred to in 1 above (see also 3 above). The total of the amounts designated under subsection 104(21) may not exceed the amount of the trust=s Anet taxable capital gains@ for the year. For this purpose, subsection 104(21.3) provides that the amount of the trust=s net taxable capital gains equals the amount (if any) by which the trust=s taxable capital gains for the year exceed the total of (a) its allowable capital losses for the year, and (b) the amount of net capital losses of other years that are deducted by it in determining its taxable income for the year. As indicated in 18 below, the amount of taxable capital gains otherwise included in a beneficiary=s income for the year by reason of subsection 104(21) is reduced by any amount designated to the beneficiary for the year under subsection 104(13.2). Capital Gains Deduction Claims by a Beneficiary of a Personal Trust 6. If a Apersonal trust,@ as defined in subsection 248(1) of the Act, designates to a beneficiary an amount under subsection 104(21) in respect of its net taxable capital gains for a taxation year (see 4 and 5 above), subsection 104(21.2) provides that the trust shall also designate to the beneficiary an amount or amounts in respect of its

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eligible taxable capital gains, if any, for the year. (The calculation of a personal trust=s Aeligible taxable capital gains@ is discussed in 8 below.) A subsection 104(21.2) designation can occur only if the amount designated to the beneficiary under subsection 104(21) pertains to net taxable capital gains of the trust from the disposition of qualified farm property or qualified small business corporation shares. These are the two types of property that qualify for a section 110.6 capital gains deduction. There is a formula for each of these types of property in subsection 104(21.2). The effect of each of these formulas is that the amount designated to a particular beneficiary is equal to the beneficiary=s proportionate share of all the trust=s subsection 104(21) designations for the year to its beneficiaries in respect of its net taxable capital gains for the year minus all the trust=s subsection 104(13.2) designations for the year to its beneficiaries (see 18 below), to the extent that the amount so calculated represents eligible taxable capital gains of the trust for the year from the disposition of qualified farm property or qualified small business corporation shares (depending on which formula is being applied). 7. An amount designated to a beneficiary by a personal trust under either formula in subsection 104(21.2) is deemed to be a taxable capital gain of the beneficiary from a disposition (by the beneficiary) of his or her qualified farm property or qualified small business corporation shares (depending on which formula is being applied). The beneficiary=s deemed taxable capital gain occurs in the beneficiary=s taxation year in which the taxation year of the trust (for which the subsection 104(21) designation was made) ends. This deeming rule in the subsection 104(21.2) formulas applies only for purposes of the beneficiary=s claiming a section 110.6 capital gains deduction. It is important to note that the beneficiary must still meet all of the requirements of section 110.6 in order to claim a capital gains deduction. For example, a beneficiary who has already claimed the full $500,000 capital gains exemption in prior years would not be able to use a subsection 104(21.2) designation to claim any further capital gains deduction. 8. The amount of a personal trust=s Aeligible taxable capital gains@ for a particular taxation year is defined in subsection 108(1) as the lesser of two amounts: (a) the trust=s Aannual gains limit@ for the year (as determined under subsection 110.6(1)); and (b) the trust=s Acumulative gains limit@ at the end of the year (as determined under subsection 110.6(1)) less the total of all amounts designated by the trust to beneficiaries under subsection 104(21.2) for prior taxation years. Taxation of Trust on Taxable Capital Gains Not Included in Income of Beneficiary 9. Any portion of the amount of a taxable capital gain realized in a taxation year by a trust that is not included in the incomes of beneficiaries for that year (see 1 and also 3 above) is taxable in the hands of the trust. Such portion of the taxable capital gain, net after tax, remains as trust capital pending its distribution as such in accordance with the terms of the trust. Capital Losses 10. As indicated in 5 above, a trust=s allowable capital losses for a particular taxation year are netted against its taxable capital gains for the year when calculating its Anet taxable capital gains@ that can be designated to beneficiaries under subsection 104(21). However, if the trust=s allowable capital losses are greater than its taxable capital gains for the year, the resulting net allowable capital loss $ may not be designated to beneficiaries for the year, and $ may not be deducted by the trust in determining its income for the year. Instead, such net allowable capital loss is included in the trust=s Anet capital loss@ for the year. A trust=s net capital loss for a particular year $ may be applied against its taxable capital gains for another year or years in accordance with paragraph

111(1)(b) and the related rules in section 111; and $ if so applied, will reduce the trust=s Anet taxable capital gains@ for such other year or years as described in 5

above. If a trust=s net capital loss is carried back to an earlier year, the following should be noted: $ This will not cause any reduction to the amounts originally included in the income of the beneficiaries under

subsection 104(13) or 104(14) or section 105 with respect to that earlier year. $ The above-mentioned reduction to the trust=s Anet taxable capital gains@ for that earlier year may, however,

cause a reduction to the portion of the total amount included in the income of the beneficiaries that can be designated to beneficiaries as a deemed taxable capital gain under subsection 104(21). This would occur if the

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amount originally designated to the beneficiaries under subsection 104(21) is greater than the revised net taxable capital gains. (See 4 and 5 above.)

$ Furthermore, if the trust is a personal trust, any such reduction to the amount designated to the beneficiaries under subsection 104(21) may in turn cause a reduction to the amount designated to the beneficiaries under subsection 104(21.2) (i.e., for purposes of a section 110.6 capital gains deduction by the beneficiaries C see 6 and 7 above).

Restrictions on Deductions by Spousal Trusts 11. As indicated in 2 above, an amount of income of a trust that is paid or becomes payable to a beneficiary is generally deductible by the trust under paragraph 104(6)(b). However, a spousal trust as described in paragraph 104(4)(a) (sometimes referred to as a Apost-1971 spousal trust@) may not deduct under paragraph 104(6)(b) the amount of any taxable capital gains arising in the year from deemed dispositions of trust property that occur (a) under subsection 104(4) or 104(5) on the day on which the life tenant spouse dies (see also 14 below), or (b) under subsection 107(4) when the property is distributed to a beneficiary other than the life tenant spouse and the spouse is alive on the day the property is distributed. 12. Also, a spousal trust as described in paragraph 104(4)(a) may not deduct under paragraph 104(6)(b) an amount of income, including a taxable capital gain (if not already disallowed by the rule described in 11(b) above), that is paid or payable to a beneficiary other than the life tenant spouse if the spouse is still alive throughout the year in which the amount was so paid or payable. This restriction does not apply, however, if the trust altered its terms and conditions on or before December 20, 1991 to permit such a distribution. 13. By virtue of the definition of Aaccumulating income@ in subsection 108(1), taxable capital gains of $ a trust that is a Apre-1972 spousal trust,@ as defined in subsection 108(1), at the end of the year; $ a spousal trust as described in paragraph 104(4)(a); or $ a trust that elected under subsection 104(5.3) for a preceding taxation year that result from deemed dispositions of trust property under subsection 104(4), 104(5) or 107(4) are excluded from the trust=s Aaccumulating income@ for the year. As a result, they do not qualify for inclusion in a beneficiary=s income under a preferred beneficiary election as described in 1(b) above or for a deduction by the trust under subsection 104(12) as described in 2 above. 14. If the life tenant spouse of a spousal trust as described in paragraph 104(4)(a) dies during the trust=s taxation year, the following rules apply with respect to the trust=s taxable capital gains for the year if it ends after July 19, 1995: $ The trust will not be allowed to deduct for the year under paragraph 104(6)(b) any amount of a taxable capital gain that is paid or payable to a beneficiary other than the spouse if the amount is attributable to one or more dispositions by the trust of capital property (other than excluded property) before the end of the day on which the spouse dies. Thus, the trust will not be able to avoid the tax effect of a disallowance of a paragraph 104(6)(b) deduction for a taxable capital gain from a deemed disposition described in 11(a) above by means of a disposition of the property before the spouse dies. $ The Aaccumulating income@ of the trust for the year (as defined in subsection 108(1)) will be calculated as if

any disposition by the trust of capital property before the end of the day on which the spouse dies had not occurred. Thus, the trust will not be able to avoid the tax effect of a disqualification of a taxable capital gain from a deemed disposition described in 11(a) above as Aaccumulating income@ (for purposes of a preferred beneficiary election or a deduction under subsection 104(12) C see 13 above) by means of a disposition of the property before the spouse dies.

15. The restrictions discussed above cause the spousal trust itself to be taxable on a taxable capital gain described above, even if the amount of the taxable capital gain is otherwise payable by the trust to a beneficiary and to be included in the beneficiary=s income under subsection 104(13) (see 1(a) above). However, rules to eliminate double taxation of such income are discussed in 17 to 19 below. It should also be noted that a spousal trust may be able to claim a capital gains deduction under subsection 110.6(12) for its eligible taxable capital gains (see 8 above) for its taxation year that includes the day on which the life tenant spouse dies. Subsection 110.6(12) essentially makes available to the spousal trust after the spouse dies, subject to certain limitations, the spouse=s unused capital gains exemption. Anti-avoidance Rule

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16. A deduction by a trust under paragraph 104(6)(b) for an amount of trust income paid or payable to a beneficiary may be disallowed by an anti-avoidance rule relating to the improper allocation of income to beneficiaries that is contained in subsection 104(7.1). Should such a disallowance of a paragraph 104(6)(b) deduction occur, the rules for the elimination of double taxation, as discussed in 17 to 19 below, can be used. Double Taxation Relief 17. Generally, under the provisions of subsection 104(13) and paragraph 104(6)(b), the amount of income of a trust for a taxation year that is paid or becomes payable, within the meaning of subsections 104(18) and (24), to a beneficiary is subject to tax as income in the beneficiary=s hands and not in the hands of the trust (see 1(a) and 2 above). However, if a trust is prevented from deducting an amount of income that is paid or payable to a beneficiary (see 11 to 16 above) or if a trust chooses to deduct an amount that is less than the amount of its income distributions (see 2 above), such amount is also subject to tax in the hands of the trust. To eliminate this double taxation, designations may be made under subsections 104(13.1) or 104(13.2). 18. Subsections 104(13.1) and (13.2) can be used by a trust for any taxation year throughout which it is resident in Canada and not exempt from Part I tax by reason of subsection 149(1). Subsection 104(13.1) provides the mechanism for the trust to designate to its beneficiaries their respective shares of that portion of the trust=s income distributions that has not been deducted in computing its income for the year. The amount of trust income designated to a beneficiary under subsection 104(13.1) will be deemed, for the purposes of subsections 104(13) and 105(2), not to have been paid or to have become payable in the year to or for the benefit of the beneficiary or out of income of the trust. In other words, the amount will not be required to be included in the beneficiary=s income under subsection 104(13) or 105(2). A subsection 104(13.2) designation contemplates the situation in which a trust has a non-capital loss carry-forward from a prior taxation year and current taxable capital gains. In such circumstances, as indicated in 2 above, the trust may choose not to deduct the full amount to which it is entitled under paragraph 104(6)(b) in order to allow the non-capital loss carry-forward to absorb the current taxable capital gains. The designation in subsection 104(13.2) allows the trust to designate to its capital beneficiaries their respective shares (based on the trust=s subsection 104(21) designations) of the portion of the potential deduction under subsection 104(6) that has not been deducted under that subsection or used in a designation under subsection 104(13.1). An amount designated to a beneficiary for the year under subsection 104(13.2) $ is not included in the income of the beneficiary for the year under subsection 104(13) or 105(2); and $ reduces the amount of taxable capital gains otherwise included in the beneficiary=s income for the year by

reason of subsection 104(21). The provision in subsection 104(13.2) for the above-mentioned reduction of the subsection 104(21) amount does not apply, however, for purposes of applying the rules in subsection 104(21.2). Instead, subsection 104(21.2), in its own calculation, provides for a reduction of the subsection 104(21) amount by an amount designated under subsection 104(13.2). By virtue of paragraph 53(2)(h), an amount designated to a beneficiary by a trust under subsection 104(13.1) or (13.2) will generally reduce the adjusted cost base (AACB@) of the beneficiary=s capital interest in the trust. However, if the beneficiary=s capital interest is an interest in a Apersonal trust@ (as defined in subsection 248(1) of the Act) and the interest was acquired by the beneficiary for no consideration, there is no such ACB reduction under paragraph 53(2)(h). An amount designated under subsection 104(13.1) or (13.2) and included in the computation of the trust=s income will not be subject to tax in the hands of a beneficiary when that amount, net after tax, is paid out to the beneficiary. The designation of an amount as provided by subsections 104(13.1) and (13.2) is to be made by a trust in its return of income for the year under Part I of the Act. 19. An income beneficiary may agree to pay a trust=s tax liability arising from a designation under subsection 104(13.1) or (13.2). Often this is done because the payment of tax by the trust would reduce the value of the capital interests held by other beneficiaries. The payment of tax by the income beneficiary is not a contribution for the purpose of paragraph (b) or (c) in the subsection 108(1) definition of Atestamentary trust,@ nor is it a gift for the purposes of paragraph 122(2)(d). The payment must equal the tax payable by the trust on the income that is deemed not to have been paid or payable to the beneficiary because of the designation. The payment can be made by (a) reimbursing the trustee, (b) providing a cheque payable to the taxing authority, or (c) receiving a net amount from the trustee reflecting the beneficiary=s share of income less the relevant taxes payable by the trust.

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D. Foreign Tax Credit The benefit of the credit for foreign taxes paid by the trust for a year throughout which it was resident in Canada can also be passed through to beneficiaries in whose income amounts have been included as income payable by the trust or as the subject of a preferred beneficiary election. Once again this can only be achieved through a designation by the trustee. The beneficiary is deemed by subsection 104(22) to have paid part of the foreign tax which is proportionate to the part of the income which the trustee designates that the beneficiary has received from the foreign source. The designation is made on a source by source basis which distinguishes between Abusiness-income tax@ and non-business income tax paid by the trust (see also IT-201 122, Foreign Tax Credit - Trust and Beneficiaries, February 12, 1996). The requirement of reasonableness applies to the designated amount. E. Refunds of Premiums under Registered Retirement Savings Plans Where personal representatives receive a payment out of a registered retirement savings plan after the death of the annuitant under the plan, subsection 146(8.1) permits the personal representative and a spouse, common-law partner or eligible dependant beneficiary to designate the amount of the payment as having been received by a beneficiary as a refund of premiums. The payment must have been a refund of premiums within the definition contained in paragraph 146(1)(h) if it had been made to the beneficiary under the terms of the plan. The provision does not require that the beneficiary should have actually received the amount from the estate. Where, for example, under the terms of the deceased=s will the executors have no power to distribute the amount to the beneficiary, the effect of the designation will be to deem the amount to be income of the beneficiary and permit the beneficiary to make a contribution equal to the designated amount to his or her own registered retirement savings plan. In such a case, the estate would not be taxable on the amount of the payment it received from the plan, instead the amount of the payment would be included in computing the beneficiary=s income and then deducted by the beneficiary in computing income by virtue of paragraph 60(1). As, however, the amount of the contribution would be fully taxable to the beneficiary when it emerged from the plan in the form of an annuity, the consequences will not always be beneficial to the beneficiary in such as case. The provision is more likely to be advantageous in cases where the personal representatives actually distribute the amount they receive to the beneficiary who then contributes that amount to his or her own registered retirement savings plan. F. Pension Benefits Pursuant to subsection 104(27), an amount received by an estate as a superannuation or pension benefit in a year throughout which it was resident in Canada can be designated by the estate as, in effect, retaining its character in the hands of certain beneficiaries to whom it may reasonably be considered to have been paid or payable in the year. If the beneficiary was the spouse or common law spouse of the deceased and the amount is a life annuity payment, it will qualify as pension income for the purposes of a pension credit of the spouse or common-law partner pursuant to subsection 118(3). The effect of a designation with respect to other amounts is, generally, to permit the beneficiary to transfer them into a registered retirement savings plan and to deduct them in computing income for the year. G. DPSPS and Death Benefits

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Similar provisions in subsections 104(27.1) and 104(28) apply to lump sum payments from deferred profit sharing plans and death benefits received by an estate that may reasonably be considered to be paid or payable to a beneficiary. In the former case the estate must be resident in Canada throughout the year. Note that the first $10,000 received as a death benefit is exempt from tax so it is important to take advantage of this conduit provision. The non-exempt portion of the death benefit received is included in the recipient=s income under paragraph 56(1)(a)(iii). (See also IT-50812, ADeath Benefits@, February 12, 1996). H. Non-Deductible Resource Royalties If a trust that is resident in Canada throughout the year pays non-deductible resource royalties to the Crown and certain other Crown agencies, it will have an amount included in its income that is not available for payment to beneficiaries. Such Aphantom income@ can be designated to beneficiaries in the proportions that reflect their respective shares of the income of the estate or trust computed without reference to the provisions of the Act. I. Limitations Most of the deductions which are available to a trust in computing its taxable income cannot be passed through to beneficiaries. Non-capital losses and net capital losses, for example, remain with the trust and their benefit will be lost if all of the income in each year is allocated to beneficiaries either as income payable to them or as income which has been subjected to a preferred beneficiary election. Any deduction for charitable donations will also be lost in such circumstances. The ability of a trust to limit the deduction for amounts payable to beneficiaries and to designate the excess as not payable to them has alleviated this problem and, in effect, increased the extent to which the trust is treated as a conduit for tax purposes. 4. Disposition of Income or Capital Interests A beneficiary may own an income interest, a capital interest, or both, in a trust. These interests may be disposed of by a sale or disposition to a third party or by distributions of property from the trust in satisfaction of the interest. An Aincome interest@ is defined in subsection 108(1) Aas a right (whether immediate or future and whether absolute or contingent) of the taxpayer as a beneficiary under a personal trust to, or to receive, all or any part of the income of the trust, including (after 1999) a right to enforce payment of an amount by the trust that arises as a consequence of any such right.@ If an income interest in a trust is assigned or disposed of to a third party in an arm=s length transaction, the proceeds must be included in income under paragraph 106(2)(a). Since the cost to a taxpayer of an income interest in a trust is deemed to be nil by subsection 106(1.1), the amount actually received will generally be the amount included in income. However, a cost base may attach to the income interest if any part of the interest was acquired by the taxpayer from a person who was a beneficiary in respect of the interest immediately before the acquisition, or the cost of any part of the interest was ever determined not to be nil under the taxpayer migration rules in section 128.1. If the interest disposed of includes a right to enforce

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payment from the trust and an amount has been included in income with respect to that amount, such amount is deducted from the proceeds of disposition. If the transaction is not at arm=s length and the proceeds are less than fair market value, the taxpayer will be deemed to have received proceeds of disposition equal to the fair market value of the interest disposed of. This amount is also treated as ordinary income in the year of disposition. If property of the trust is distributed in satisfaction of an income interest, subsection 106(3) applies. A distribution from a trust in satisfaction of all or part of an income interest in the trust is not a disposition that will produce income for the beneficiary under paragraph 106(2)(a). Therefore no amount is included in the income of the taxpayer by reason of the payment. The trust, however, is deemed to have disposed of the property for proceeds equal to its fair market value at the time of disposition per 106(3). Since the fair market value rule may give rise to a tax in the trust, the asset(s) distributed in satisfaction of the income interest should be selected with this in mind. A ACapital interest@ is defined in subsection 108(1) as a right to receive all or any part of the capital of the trust. As with income interests, after 1999 such rights include a right to enforce payment of an amount by the trust that arises as a consequence of any such right, but does not include an income interest in the trust. If a capital interest is assigned or disposed of to a third party a capital gain may result. The gain will be equal to the excess of the proceeds of disposition over the greater of the adjusted cost base (AACB@) of the capital interest or its cost amount. This rule cannot be used to create or increase a capital loss. The adjusted cost base of the interest is deemed to be nil notwithstanding paragraph 69(1)(c) unless the interest was acquired by the taxpayer from a beneficiary under the trust or the cost of any part of the interest was otherwise determined not to be nil under the taxpayer migration rules in section 128.1 or by virtue of an acquisition of control of a corporation under paragraph 111(4)(e). The >cost amount= of the capital interest represents the beneficiary=s proportionate share in the cost amount of the trust assets less its liabilities. There will be a reduction to the cost amount if the beneficiary assumes a debt owed by the trust. The result of the rules on dispositions of capital interests to third parties is that the capital beneficiary is not taxed on a gain that is greater than the gain that would have been realized if the trust had sold the trust asset for its value and allocated to the beneficiary his or her share. Consider the following example: A holds a capital interest in a personal trust with an ACB of zero. The trust holds one capital property with an ACB of $75,000 and a fair market value of $100,000. A sells her capital interest for $100,000.

Proceeds of Disposition $100,000 Less: Greater of - ACB $ 0 - Cost Amount $75,000 75,000 Capital Gain to A $ 25,000

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If the trust had sold the capital property for $100,000, a $25,000 capital gain would have been realized in the trust. If the gain were allocated to A under subsection 104(21) her tax position would be the same as if she had sold her interest to a third party. Where the trust distributes capital property to a beneficiary in satisfaction of all or part of a capital interest, the distribution from a personal trust will give rise to no realization of gains or losses. Under subsection 107(2), capital property will simply roll out of the trust at its cost amount to the trust. If the taxpayer had an adjusted cost base in their capital interest, the distribution may result in an increase to the cost base of the trust assets in their hands. This increase is equal to the specified percentage (see paragraph 107(2)(b)) of any excess of the adjusted cost base to the beneficiary of the capital interest over its cost amount to the beneficiary. A taxpayer=s capital interest in the trust is also deemed disposed of when the trust makes a distribution in satisfaction thereof. Proceeds of disposition will equal the cost at which the taxpayer is deemed to acquire the trust assets calculated as if all specified percentages were 100%, minus any eligible offset. The general rules in subsection 107(2) and the exception in subsection 106(3) for distributions in satisfaction of an income interest also apply to distributions of capital to a beneficiary who is a spouse or common-law partner of a conjugal trust. If a rollover of assets from the trust in satisfaction of a capital interest in the trust is not desired, three elections are available (see subsections 107(2.001), (2.002), or (2.01)). If either of these elections is made, subsection 107(2.1) will apply to the distribution and a rollover will not occur. If subsection 107(2.1) applies, the trust is deemed to have disposed of the property at the greater of its fair market value and its cost amount to the trust, the beneficiary is deemed to acquire the property at that amount. The beneficiary is also deemed to have disposed of their trust interest for an amount equal to the deemed proceeds to the trust minus the amount by which the fair market value of the distributed property exceeds the cost amount to the trust less any eligible offset. The beneficiary=s adjusted cost base is calculated under subsection 107(1) as the greater of the adjusted cost base otherwise determined and the cost amount to the trust of the distributed property. Subsection 107(2.1) also applies to all distributions to beneficiaries other than the relevant partner, joint partner or, in the case of an alter ego-trust, the person creating the trust, and certain distributions to non-resident beneficiaries. It should be noted that subsection 107(6) denies losses realized on dispositions of property by a person or partnership to the extent the loss accrued while the property was held by a trust in which neither the vendor or certain affiliated parties held a continuous capital interest, and the property was distributed to a beneficiary from the trust in satisfaction of all or part of a capital interest acquired after January 15, 1987. 5. Non-Resident Beneficiaries There are a few exceptional rules and special provisions which apply to Canadian trusts which have non-resident beneficiaries.

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In general, the rules for allocating income between the trust and its beneficiaries apply irrespective of the residence of the latter. Subject to any relevant treaty provision, income which is allocated to a non-resident beneficiary will be subject to withholding tax at a rate of 25% whether it is in the form of ordinary income or of taxable capital gains. There is no power to designate that an amount payable to a non-resident beneficiary is a taxable capital gain of the beneficiary. If both the trust and the beneficiary are resident outside Canada, the trust is not permitted to take any deduction for amounts payable to the beneficiary. Withholding tax will be levied on the amounts paid or credited to the trust from a Canadian source other than amounts included in the trust=s taxable income earned in Canada that is subject to tax pursuant to subsection 2(3) of the Act. Note that a non-resident cannot be a preferred beneficiary and hence no preferred beneficiary election can be available to such a person. Of the other special provisions, the one which will have the most frequent application establishes an exception to the general rule that no gains or losses will be realized when capital is distributed to a beneficiary of a trust which is not a conjugal trust. If the beneficiary is a non-resident, gains or losses will be realized under subsection 107(5) on a distribution in satisfaction of the beneficiary=s capital interest unless the property is taxable Canadian property or Canadian resource property. The provision is analogous to that which provides for a realization of capital gains and capital losses when an individual ceases to reside in Canada. Both are designed to ensure that gains which accrue while the property is owned in Canada do not escape taxation. As gains on taxable Canadian property will be subject to taxation irrespective of the residence of the beneficiary, it was not necessary to provide for a deemed realization when property of this type was distributed from a trust.

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Chapter 3: Gifts and Personal Trusts Inter Vivos There are three principal aspects of the treatment of gifts under the Act: 1. Taxation consequences to the donor at the time of the gift; 2. The possible attribution of income, losses, capital gains and capital losses thereafter, and; 3. In cases where the gift is made through a transfer to a trust, how the taxation of inter vivos

personal trusts differs from that of other trusts and in particular from trusts created by will.******

1. Taxation of the Donor at the Time of the Gift Paragraph 69(1)(b) provides that a taxpayer who makes a gift inter vivos or a disposition for less than full consideration in a non-arm=s length situation is deemed to have received proceeds of disposition equal to the fair market value of the subject matter of the gift or disposition. In consequence, if a gift of capital property is made, there may be a realization of capital gains, capital losses, a terminal loss or recapture of capital cost allowance. If the property is inventory of a business, income or losses may be realized by the donor. In case of an inter vivos gift, a bequest or inheritance, the donee is deemed by paragraph 69(1)(c) to have acquired the property at a cost equal to its fair market value. Although a gift of property is analogous to a sale at fair market value for the purposes of the Act, there will be situations in which an actual sale will be preferable for tax, as well as other reasons. In such cases it is provided in paragraph 69(1)(a) that, if the sale price in a non-arm=s length situation exceeds the fair market value, the purchaser will be deemed to have acquired the property at a cost equal to its fair market value. Note that there is nothing in the Act which reduces the vendor=s proceeds of disposition in such a case. In cases where property is sold in a non-arm=s length situation for an amount less than its fair market value at the time of the sale, paragraph 69(1)(b) deems the vendor=s proceeds of disposition to be equal to the fair market value of the property. The purchaser, however, will acquire the property at a cost equal to the actual purchase price as paragraph 69(1)(c), which otherwise deems the cost base to equal fair market value, applies only to taxpayers who have acquired property by ways of gift, bequest or inheritance and not to actual sales. [See Appendix

****** For purposes of this discussion an inter vivos trust can be either a personal trust or what is commonly

referred to as a commercial trust. An inter vivos trust is a trust in which any interest was acquired for consideration payable directly or indirectly to the trust or to any person who made a contribution to the trust by way of transfer, assignment or other disposition of the property. An exception is made for the settlor of the trust and other related settlors who may retain an interest in an inter vivos trust without affecting its status. Inter vivos trusts which are not personal trusts are subject to a number of anti-avoidance provisions. For example, a trust may designate that amounts received by a beneficiary have not been paid for purposes of including these amounts in the trust=s, not the beneficiary=s income. These amounts will reduce the cost base of the beneficiary=s interest where the trust is not a personal trust. Unless otherwise indicated the following discussion assumes a valid personal trust has been constituted.

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8 - Interpretation Bulletin IT-405, January 23, 1978, AInadequate Consideration - Acquisitions and Dispositions]. In light of the foregoing, when capital property is sold in a non-arm=s length situation rather than gifted, the sale should be effected for consideration equal to fair market value. In cases where there may be room for argument about the fair market value of the property, the agreement for sale should indicate clearly the parties= intentions that the purchase price should be an amount equal to the fair market value and a price adjustment clause should be included in the agreement. Such a clause might state that, if the fair market value of the property should be successfully challenged by the CCRA, the purchase price set out in the agreement shall be adjusted to the amount agreed between the parties and the CCRA, or otherwise determined in judicial proceedings, to represent the fair market value. A. Trusts If a gift is made by a transfer to a trustee for the intended donees, paragraph 69(1)(b) will apply and the donor will be deemed to receive proceeds of disposition equal to the fair market value of the property transferred. The trust as an individual taxpayer acquires the property at its fair market value under paragraph 69(1)(c). The beneficiaries of income interests will generally acquire them at a cost of nil except in an unusual case where they have purchased their interests or have acquired them from another beneficiary by way of gift (subsection 106(1.1)). A similar rule with respect to the cost of a capital interest in a trust including a personal trust is provided in subsection 107(1.1). Such an interest will have a cost of nil unless it was acquired by the taxpayer from a beneficiary who held the interest immediately before its acquisition by the taxpayer or unless the taxpayer paid an amount equal to the fair market value of the interest at the time it was Aissued@ to him or her. Although in most cases a beneficiary who has a capital interest in a trust will, by virtue of subsection 107(1.1), have acquired that interest at a cost of nil, it does not follow that capital gains will necessarily be realized if the beneficiary disposes of his or her interest. Special rules are provided in subsection 107(1) for determining the adjusted cost base of a capital interest and the cost of the capital interest is only one for the elements to be taken into consideration under that provision if the interest is disposed of. These special rules were considered in Chapter 2. B. Gifts to a Spouse, Common-law Partner or a Conjugal Trust Consistent with the treatment of testamentary gifts, rollovers are available with respect to inter vivos gifts of capital property to a spouse, common-law partner or a conjugal trust. The relevant provisions in subsection 73(1) are, however, somewhat broader than those in subsection 70(6) in that they extend to transfers of capital property to a former spouse or common-law partner in settlement of rights arising out of the marriage or common-law partner relationship. In addition, subsection 73(1.1) provides that, for the purposes of the rollover, the property will be deemed to be capital property to any person referred to in subsection 73(1) in whom the property vested. Where transfers are made to a spouse, common-law partner or to a conjugal trust, the conditions to be satisfied are essentially the same as those that apply to such transfers on death. On an inter vivos transfer to a spouse or common-law partner the parties must both be resident in Canada; and on a transfer to a conjugal trust the spouse or common-law partner must be entitled to

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receive all of the income of the trust that arises before the spouse or common-law partner=s death and no person other than the spouse or common-law partner can encroach on capital. In the case of a transfer to an inter vivos conjugal trust there is no requirement for indefeasible vesting within a particular period. As with testamentary gifts, the transferor may elect to exclude the operation of the rollover. The election must be made in the income tax return for the year in which the property was transferred. If such an election is made, the general rules in subsection 69(1) will apply and the proceeds of disposition and, (subject to any application of the superficial loss rules and any adjustment to cost base in paragraph 53(l)(f)), the cost of acquisition will be equal to the fair market value of the property. However, it should be noted that the making of the election will not prevent the application of subsection 104(4) upon the death of the spouse or common-law partner so that there will be a deemed realization of any capital gains that have accrued after the creation of the trust and before the death of the spouse or common-law partner. It would seem, therefore, that there will not usually be any benefit to be obtained by creating a trust that falls within subsection 73(1) and then electing to exclude the rollover unless the parties are seeking to avoid the operation of the attribution rules [See Appendix 9 - Interpretation Bulletin IT-325R2, January 7, 1994, AProperty Transfers after Separation, Divorce and Annulment@]. Where a transfer has been made to a former spouse or common-law partner, the rollover will be available whether or not the transfer has been made pursuant to a court order or a written agreement as long as it can be established that it was made in settlement of rights arising out of the marriage. Where the conditions in subsection 73(1) are satisfied, non-depreciable capital property which is the subject matter of an inter vivos gift will rollover at its adjusted cost base without any realization of gains or losses. A gift of depreciable property of a prescribed class will attract proceeds equal to a proportion of the undepreciated capital costs of all of the property of that class owned by the donor. The proportion is determined according to the ratio that the fair market value of the particular property bears to the fair market value of all of the properties of that class. C. Transfers to Alter Ego, Self-Benefit, and Joint-Partner Trusts

i. Alter-Ego Trusts Amended subsection 73(1) is now applicable not only to conjugal trusts, but also to alter ego trusts (see paragraphs 73(1.02)(a) and (d) and new subparagraphs 73(1.01)(c)(ii) and 73(1.02)(b)(i)). An alter ego trust is an inter vivos trust which was created after 1999 by an individual who had attained the age of 65 years at the time the trust was created. The individual must be entitled to receive all of the income of the trust and non person except the individual can receive or obtain the use of any of the income or capital of the trust until the individual's death. The individual must also not elect out of this provision pursuant to subparagraph 104(4)(a)(ii.1).

ii. Self-Benefit Trusts

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The new roll-over provisions also provide for a non-taxable transfer of capital property to a trust for the sole benefit of the individual creating the trust, known as the "self-benefit trust". This inter vivos trust must be created after 1999 and is a transfer of property by an individual to a trust. Unlike the alter ego trust, there is no age limit. Similar to an alter ego trust, the trust is created after 1999 and is an inter vivos trust and its capital property is transferred from an individual. The individual must be entitled to receive all of the income of the trust and no person except the individual can receive or obtain the use of any of the income or capital of the trust until the individual's death. Furthermore, no person (other than the individual) or partnership has any absolute or contingent right as a beneficiary under the trust.

iii. Joint-Partner Trusts The non-taxable rollover of capital assets pursuant to subsection 73(1.01) has been expanded to include joint partner trusts (defined by reference to paragraph 104(4)(a)). The requirements for rollover include:

(1) Transfer is by an individual to a trust; (2) Trust was created after 1999; (3) Trust is inter vivos; (4) Until the later of the death of the individual or the individual's spouse or common-law

partner, either the individual or the individual's spouse or common-law partner (as the case may be) must be entitled to receive all of the income of the trust, and no other persons can receive or obtain the use of any of the income or capital of the trust; and

(5) The individual has attained the age of 65 years of age when the trust was created. For the rollovers into conjugal, joint partner, alter ego, and self-benefit trusts the transferor is deemed to receive proceeds (1) in the case of depreciable property, equal to the proportionate share of the UCC of the property of that class immediately before the transfer; and (2) in any other case, equal to the ACB of the property immediately before the transfer. The transferee is deemed to acquire the assets at a cost equal to those proceeds.

D. Deemed Dispositions Alter ego trusts, joint partner trusts, and post-1971 conjugal trusts are treated virtually identically for the purposes of the deemed disposition rules in new subsections 104(4) to (5.2). Therefore, they are addressed together here for convenience. An alter ego trust is a trust for the purposes of new subsection 104(4). Consequently, the deemed disposition rules apply. This result follows from the new definition of "trust" in subsection 108(1) (which applies for the purposes of subdivision k), which includes an inter vivos trust, subject to specified exceptions. New paragraph (g) of that definition excludes from the trust definition those trusts "all interests in which, at that time, have vested indefeasibly." This exclusion could apply to an alter ego trust if all of the interests in the alter ego trust are vested indefeasibly in the sole beneficiary (that is, no person has any contingent right as a beneficiary under the trust). However, even if all of the interests in the alter ego trust have vested indefeasibly, new subparagraph (g)(i) of the definition of "trust" specifically carves out alter ego

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trusts from this exclusion. In other words, alter ego trusts are trusts under this definition, whether or not all interests have vested indefeasibly. As discussed below, this is of little practical significance unless the trust continues after the death of the individual who created the trust. The same provisions apply to joint partner trusts and post-1971 conjugal trusts. An alter ego trust will have its first deemed disposition on the death of the individual who created the trust. However, it is possible to elect out of the alter ego trust rollover under new subparagraph 104(4)(a)(ii.1), in which case the first deemed disposition date will be 21 years after the trust is created and every 21 years after that as long as the trust is in existence. A post-1971 conjugal trust can be an inter vivos trust or a testamentary trust. A post-1971 conjugal trust will have its first deemed disposition on the death of the individual's spouse or common law partner (as the case may be). Again, the deferral is consistent with existing rules with respect to spousal rollovers. A taxpayer of any age who is living in a conjugal relationship can transfer assets to a post-1971 conjugal trust. A joint partner trust will have its first deemed disposition on the death of the last to die of the individual and the individual's spouse or common law partner (as the case may be). It is possible to elect out of the rollover to a joint partner trust under new subsection 73(1). Such an election might be considered, for example, if the transferring partner has capital losses that can be offset against the resulting capital gain. As with the alter ego trust, an election out of the rollover provision under subsection 73(1) will not affect the deemed disposition on death. As with the alter ego trust, a joint partner trust can be created only by an individual who has attained the age of 65. If the individual's spouse or common law partner is significantly younger than the individual or has a longer life expectancy, it may be possible to achieve a significant tax deferral. The deferral of the deemed disposition to the later death accords with the existing rules with respect to spousal rollovers, which permit a deferral of tax on interspousal transfers until the death of the surviving spouse or common-law partner. The self-benefit trust is not a defined trust in the Act, but it is recognized in the rollover provisions in new subsection 73(1). The first deemed disposition date will depend on whether it is a trust as defined in subsection 108(1) for the purposes of subsection 104(4). Under the new definition of "trust" in subsection 108(1), a trust, all of the interests in which at that time are vested indefeasibly, is considered not to be a trust for the purposes of subsections 104(4), (5) and (5.2), among others. This rule is subject to a number of exceptions, which have the effect of treating a trust that would otherwise not be considered a trust as a trust for these purposes. Thus, in order to determine whether the 21-year deemed distribution rule applies, the trust deed must be reviewed on the 21st anniversary date and the following question answered: Are all interests in the trust vested indefeasibly at that time? The answer to this question may not always be yes. If all interests have not vested indefeasibly, the 21-year rule will apply. The relevant date for the deemed disposition of a self-benefit trust will depend on the terms of the trust. If the trust is not a trust as defined in subsection 108(1), no disposition will occur. If it meets the definition of "trust" for these purposes, the first deemed disposition will occur on the day that is 21 years after the day on which the trust was created.

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The deemed proceeds for the alter ego trust, joint partner trusts, conjugal trusts and self-benefit trusts are generally determined under new subsections 104(4) to (5.2). Subsection 104(4) applies in respect of each property (other than "exempt property") that was capital property (other than "excluded property" or depreciable property) or land inventory of a business to deem proceeds to be equal to fair market value at the end of the relevant day. Proceeds are determined with reference to new subsection 70(5.3). Subsection 70(5.3) applies when a life insurance policy is relevant in determining the fair market value of property to limit the fair market value of the life insurance policy to its cash surrender value immediately before the relevant time. This treatment is now extended to apply for the purposes of the deemed disposition rules in subsection 104(4) and section 128.1 (taxpayer migration). E. Qualifying Dispositions Section 107.4 introduces the concept of a rollover on a qualifying disposition. These new rollover provisions will apply on a transfer of non-capital property to a trust if the following conditions are met:

(1) There is a change in legal title but no change in beneficial ownership; (2) The disposition is not by a person resident in Canada to a non-resident trust; (3) Immediately after the transfer, no person other than the contributor holds an absolute or

contingent interest of any kind in the trust; (4) The proceeds are not determined under any other provision of the Act (disregarding

sections 69 and 73); and (5) Subsection 73(1) does not apply notwithstanding that certain conditions in subsection

73(1) were not met. For Qualifying Dispositions, the transferor's proceeds of disposition are deemed to be the cost amount of the property, unless the transferor elects otherwise. The transferee's cost base is also generally considered to be the cost amount of the property to the transferor, subject to a reduction if the FMV of the transferred property is less than its cost amount. If property is depreciable property or eligible capital property, new paragraphs 107.4(3)(d) and (e) parallel the existing rules for distributions of such property to trust beneficiaries in subsection 107(2). The cost to the transferor of a capital interest in the trust is generally deemed to be nil. The cost base of the income interest in the transferee trust will also be nil. Unless the taxpayer's cost base in the transferor trust is not nil, then two adjustments may be made to the cost amount.

F. Gifts of Farm Assets Gifts of specified farm assets including farm property that is land, depreciable property or eligible capital property and shares of a family farm corporation or interests in family farm partnerships may be transferred on a rollover basis to the taxpayer=s children (subsection 73(3) and (4)). Where the conditions in subsection 73(3) are satisfied, the provision applies and, unlike subsection 73(1), the taxpayer cannot elect not to have subsection 73(3) apply. However, the donor can choose to realize all or any part of his or her capital gain or capital loss, or where it is a depreciable property under subsection 73(3), to attract recapture in full or in part or to realize all or part of a terminal loss, as the case may be by transferring its interest for actual proceeds of disposition.

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In order to prevent an artificial creation of, or increase in, the amount of income or loss which will be realized, the provisions of subsection 73(3) have been further designed to ensure that the deemed proceeds of disposition (or actual proceeds in the case of a sale) and the cost of acquisition of the property are always within prescribed limits. Before land or depreciable property or eligible capital property will be brought within subsection 73(3), the recipient child must have been resident in Canada immediately before the gift and the property must have been used principally in the business of farming by the taxpayer, his or her spouse, common-law partner or any of his or her children at that time. There is no requirement that the child should continue to use the property in the business of farming. If at the time of a transfer of farm property the transferee is a child under the age of 18 years any capital gains or income realized on a subsequent disposition of the property by the child will be attributed to the transferor unless:

1. the original transfer was made at not less than the fair market value of the property;

2. the child reached the age of 18 years before the end of the taxation year in which he disposed of the property or;

3. the taxpayer was either deceased or no longer resident in Canada at the time of the

transfer by the child. Subsection 73(4) allows for a similar rollover to a child of the taxpayer of a Ashare of the capital stock of a family farm corporation@ or an Ainterest in a family farm partnership@. The definitions of these terms are those that apply to testamentary gifts of farming property to a child. The rules that determine the transferor=s proceeds of disposition under subsection 73(4) are essentially the same as those that apply to farming land under subsection 73(3). In consequence, the transferor is able to achieve a rollover or to realize all or part of the capital gains attached to the shares or the partnership interest if he or she so chooses [see Appendix 10 - Interpretation Bulletin IT-268R4, April 15, 1996, AInter Vivos Transfer of Farm Property to Child@]. 2. Attribution to the Donor After the Gift Most jurisdictions have provisions which are designed to prevent taxpayers from reducing their tax liability by diverting income to members of their family. The attribution rules operate by notionally ignoring the transfer of property for purposes of including any income, loss and in the case of spouses or common-law partners, capital gains or losses in the income of the transferor. The principal attribution provisions in the Act are contained in sections 74.1 - 74.5, 75, 75.1 and subsections 56(2), (4) and (4.1). Sections 74.1, 74.5, 75 and 75.1 are directed at income, losses, taxable capital gains and allowable capital losses from property which has been transferred to a spouse, common-law partner or to certain minors (subsection 74.1(2)) or which has been placed in a trust in which the donor retains some interest, or over which he can exercise some control. Among other things, subsection 56(2) addresses indirect payments or transfers made under the direction of or with the concurrence of the taxpayer. Subsection 56(4) is concerned with non-arm=s length transfers of rights to income by a taxpayer who retains the property from which the income will be derived, and finally, subsection 56(4.1) addresses low interest or no interest loans.

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A. Transfers to a Spouse, Common-law Partner or to Certain Minors i. Income and Losses Income or loss from property transferred or loaned by an individual, either directly or indirectly, to or for the benefit of that individual=s spouse, common-law partner or to certain minors is attributed to the individual and not included in the income of the spouse, common-law partner or minor, by virtue of subsections 74.1(1) and (2). Taxable capital gains or allowable capital losses realized on the disposition of property transferred or loaned by an individual to the individual=s spouse or common-law partner are also attributed to the individual, and not included in the computation of the spouse or common-law partner=s income, by virtue of section 74.2. In each case, attribution applies to income, gains or losses from the original property or property substituted for it. There is no attribution once the individual transferor or lender ceases to be a resident of Canada or is no longer alive. The terms of the provisions with respect to income attribution as they apply to spouses, common-law partners and minors are virtually identical and they can conveniently be considered together under the following headings: a. Transactions Which Attract Attribution 1. Transfers Subsections 74.1(1) and (2) will operate where property has been transferred Aeither directly or indirectly, by means of a trust or by any other means whatever, to or for the benefit of...@ the spouse, common-law partner or minor. The leading decision on the concept of Atransfer@ for this purpose is Fasken Estate v. M.N.R., [1948] Ex. CR 580, [1948] CTC 265, 4 DTC 491 per Thorson, P.: The word Atransfer@ is not a term of art and has not a technical meaning. It is not necessary to a transfer of property from a husband to his wife that it should be made in any particular form or that it should be made directly. All that is required is that the husband should so deal with the property as to divest himself of it and vest it in his wife, that is to say, pass the property from himself to her. The means by which he accomplishes this result, whether direct or circuitous, may properly be called a transfer. There is no attribution when transfers to a spouse, common-law partner or minor are made at fair market value and the conditions in paragraphs 74.5(1)(a), (b), and (c) are met. If, for example, one spouse or common-law partner transfers property to another and if the transferor elects not to have the subsection 73(1) rollover apply and receives consideration equal to the fair market value of the property at the time of the transfer, the attribution rules do not apply to any income, gains, or losses from the transferred property. This exception for fair market value transfers is a dramatic departure from the pre-1986 attribution rules. Prior to 1986, attribution would apply regardless of the purchase price paid for the property. Where the consideration for the transfer includes indebtedness, the debt must be structured in a fashion equivalent to a commercial loan or the exception will not apply. Notwithstanding, these attribution provisions will not apply to Asecond generation@ income.

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2. Loans One commonly used method to avoid attribution was the use of loans. Dunkelman v. M.N.R. [1960] Ex. CR 73, [1959] CTC 375, 59 DTC 1242 held in summary: It requires an unusual and unnatural use of the words Ahas transferred property@ to include the making of this loan. For who, having borrowed money and knowing he must repay it, would use such an expression to describe what the lender has done? Or what lender thinks or speaks of having transferred his property, when what he has done is to lend it? Or again, what casual observer would say that the lender, by lending, has transferred property? The reasoning in the Dunkelman case was followed in other decisions. The CCRA also confirmed that a Agenuine loan@ would not be treated as a transfer. As a result, the use of interest free demand loans between spouses, common-law partners or trusts of which spouses, common-law partners or minors were beneficiaries became a popular method of splitting income. Subsections 74.1(1) and (2) now specifically include loaned property in the attribution rules. As a result the use of low interest or no interest demand loans will no longer avoid the attribution provisions. Loans that bear a commercial rate of interest are excepted from the attribution rule. Subsection 74.5 (2) provides that if a loan is made with interest charged at a rate not less than a) the rate prescribed by regulation; or b) the rate to which arm=s length parties would have agreed, and if that interest is paid no later than 30 days after the end of each taxation year, the attribution rules do not apply to any income, gain, or loss in that taxation year. This exemption is not available in respect of loans originally made at a non-commercial rate of interest and subsequently brought within the requirements of subsection 74.5(2). A number of avoidance provisions are also in the Act. The income attribution rule in subsection 74.1(3) applies to a loan or transfer that is used to repay a prior loan with which property was acquired or that is used to reduce an amount payable with respect to that property. In addition, subsections 74.5(6) and (8) treat back-to-back loans and transfers as direct loans and transfers. If, for example, an individual makes a loan to a third party on the condition that the third party make a loan to the individual=s spouse or common-law partner, the property loaned to the third party is deemed to have been loaned to the spouse or common-law partner. Similarly, if an individual guarantees repayment of a loan made to his or her spouse or common-law partner, the loan is deemed by subsections 74.5(7) and (8) to have been made by the individual. The following Interpretation Bulletin provides some examples of the operation of these attribution provisions:

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Interpretation Bulletin IT-511R C Interspousal and Certain Other Transfers and Loans of Property Date: February 21, 1994 Reference: Section 74.2 and subsection 74.1(1)(also section 74.3 and subsections 56(4.1) to (4.3), 74.5(1) to (3), (5) to (12), 96(1.8), 248(5), (22), (23) and (25) and 252(4)) Application This bulletin cancels and replaces Interpretation Bulletin IT-511, dated December 30, 1987, primarily to describe relevant changes in the Income Tax Act since that bulletin was published. Summary This bulletin discusses a comprehensive set of rules intended to prevent a taxpayer and the taxpayer=s spouse from splitting income from property so as to reduce the total amount of tax payable on that income. Except where fair market value consideration is paid by the spouse or the parties are living separate and apart by reason of a breakdown of their marriage, income earned and capital gains and losses realized on property transferred or loaned from a taxpayer to the taxpayer=s spouse (and on property substituted for that property) are generally deemed to be the income, gains or losses of the taxpayer and not of the taxpayer=s spouse. The bulletin also discusses an anti-avoidance rule that applies, in certain cases, where an individual incurs indebtedness to acquire property, to attribute the income from the property (and on property substituted for that property) to the debtor. The provision applies where, among other things, the individual and the debtor do not deal at arm=s length and one of the main reasons for the indebtedness was to reduce or avoid tax. While this bulletin deals only with the attribution rules relating to spouses, subsections 74.1(2) and 75(2) also apply to attribute the income from property in certain circumstances. For comments on these subsections, see the current versions of IT-510, Transfers and Loans of Property made after May 22, 1985 to a Related Minor and IT-369, Attribution of Trust Income to Settlor respectively. The commentary below discusses the applicable rules in greater detail. Discussion and Interpretation 1. In this bulletin, the terms listed below have the following meanings: Transferred or Loaned Property: means all transfers or loans of property whether accomplished directly or indirectly, by means of a trust or by any other means. An indirect transfer occurs for example, where a husband and wife own all the shares of a corporation in a ratio of 90:10 and the corporation issues sufficient shares to the wife for consideration that is less than the fair market value of the additional shares to change the ratio of ownership to 50:50. A transfer includes a sale whether or not at fair market value, as well as a gift but does not include a genuine loan. Spouse: Subsection 252(4), which applies after 1992, expands the meaning of spouse to include a person of the opposite sex who at a particular time lives with the taxpayer in a conjugal relationship and either has so lived with the taxpayer throughout a 12-month period ending before that time, or the two individuals are the parents of the same child. Where individuals have lived with each other as spouses in the past, they shall be deemed to be living as spouses at any later time. However, if the spouses have lived apart for a period of at least 90 days because of a breakdown of their conjugal relationship, then commencing at the beginning of that 90 day period they will no longer be deemed to be living as spouses. A person can become the individual=s spouse either as a result of their marriage or as a consequence of the operation of subsection 252(4). Prior to 1993, a party to a common-law relationship was not regarded as a spouse in respect of that relationship. The rules in subsections 74.1(1) and 74.2(1) apply to a person who is an individual=s spouse or to a person who became the individual=s spouse after the loan or transfer of property was made to that person. The rules in sections 74.3 and 74.4 apply to a designated person which includes a person who at any time is an individual=s spouse.

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Note: On August 30, 1993 the Minister of Finance issued Amendments to the Income Tax Act and Related Statutes . Explanatory notes were issued which elaborate on the proposed changes. The Explanatory notes describe that subsection 252(4) will be amended to ensure that where the two individuals are considered to be spouses because they are the parents of the same child, they will be so considered only if they are the natural or adoptive parents of that child. If enacted as proposed the amendment will apply after 1992. Marriage: After 1992, by virtue of subsection 252(4), a reference to marriage includes a conjugal relationship between two individuals that would make them spouses of each other. Beneficially Interested: An individual is Abeneficially interested@ in a trust if the individual has any right (whether immediate or future, whether absolute or contingent or whether conditional on or subject to the exercise of a discretionary power by any person or persons) to receive any of the income or capital of the trust, either directly from the trust or indirectly through one or more other trusts. See 15 below for examples of situations where an individual is beneficially interested in a trust. Substituted Property: Paragraph 248(5)(a) provides that in the circumstances discussed in this bulletin, where a taxpayer has disposed of or exchanged a particular property and acquired other property in substitution for it and subsequently, by one or more further transactions, has effected one or more further substitutions, the property acquired by any such transaction is deemed to have been substituted for the particular property. B. Transfers Through A Trust A series of deeming provisions will result in payments to beneficiaries of a trust triggering attribution if loans or transfers are made to the trust. Specifically, a loan or transfer to a trust in which a designated person is beneficially interested is deemed by subsection 74.5(9) to be a loan or transfer to that person. Further, subsection 248(25) provides that a person is beneficially interested in a trust if that person has a right to receive any income or capital of the trust. That right can be immediate or future, absolute or contingent, or subject to the exercise of a discretion. Section 74.3 is an ordering provision that ensures that any income or taxable capital gains derived from property loaned or transferred to a trust is allocated, as far as possible, to those beneficiaries. The result is attribution to the transferor or lender when trust income is paid or payable to a beneficiary. For example, if Mr. A. and Mr. B. both transfer property to a trust in which Mr. A=s 16 year old son Jim is a beneficiary, any income received by Jim is deemed, subject to limits on the amount, to be derived from the property transferred by Mr. A. According to the CCRA, a designated person is beneficially interested in a trust if:

i. trust income is payable to the individual;

ii. income is held in trust and will be paid upon the individual=s attaining a certain age;

iii. the individual is one in respect of whom a preferred beneficiary election may be made;

iv. the individual is one of a class who has a remaindership interest under the trust. The

individual is beneficially interested in a non-discretionary trust even if the right to receive the income ends should the individual die before attaining the specified age and in a discretionary even if the trustees have full discretionary powers concerning the distribution of the capital or income of the trust so that the individual may in fact receive nothing from the trust. [Interpretation Bulletin IT-511, para. 11.]

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[See Appendix 11 - Interpretation Bulletin IT-510, December 30, 1987, ATransfers and Loans of Property Made After May 22, 1985 to a Related Minor@, para. 11 for an illustration of the operation of the section (Appendix). C. Indirect Transfers of Property The attribution rules refer to transfers of property made Adirectly or indirectly by means of a trust or by any other means whatever.@ That statement seems to suggest there must be an actual transfer of property before attribution will occur. Kieboom v. M.N.R. 9207C 6382 (FCA), however, suggests that an actual transfer of property is not necessary. In Kieboom there was an increase in the authorized share capital of Kieboom=s corporation by the addition of a class of non-voting AA@ shares, 8 of which were issued for nominal consideration to Kieboom=s wife, A. In a second transaction, 8 class AA@ shares were issued (also for a nominal consideration) to each of his children. After each of the share transactions, Kieboom=s equity in the corporation decreased substantially. Kieboom was reassessed on the basis of a Agift@ made as a result of the shares issued and attribution on the dividends later declared. When the gifting provisions of subparagraph 69(1)(b)(ii) are read in light of the avoidance provisions of paragraph 245(2)(c) (as it then read), it is difficult to see how Kieboom could avoid the gift which resulted, particularly given the very specific language in subparagraph 69(1)(b)(ii) which applies where the taxpayer has disposed of Aanything@ by way of gift inter vivos. The more difficult question, however, relates to attribution. In the transaction involving the children the court held that Kieboom had transferred an Aeconomic interest@ to his children of the Class AA@ shares. The Minister also argued that the identical transfer to the spouse was not a gift but a spousal transfer. Were the Minister successful, when the shares were transferred to the children, the result would be that the deemed gain in her hands on the deemed disposition of her Class AA@ shares, (which resulted from the reduction in her economic interest following the issuance of Class AA@ shares to the children) would be attributed back to Kieboom by virtue of former subsection 74(2). The Minister further sought to attribute to Kieboom the dividends subsequently received by Mrs. Kieboom on her Class AA@ shares based on the argument that the transfer of the Aeconomic interest@ to her had resulted in a flow of dividends to her which should also be attributed to Kieboom. Goetz, T.C.J., found a distinction between the transfer of an Aeconomic interest@ and the transfer of actual shares. He concluded: AIf shares have not been transferred by the Appellant to his wife Adriana, then attribution of income (ss. 74(1)) cannot happen. It is a principle of corporate law that dividends attach and flow to shares...not to economic interests.@ He used the same reasoning to dispose of the Minister=s other attribution argument concerning Mrs. Kieboom=s deemed gift arising out of the issuance of the Class AA@ shares to the children. However, Linden, J.A., at the court of Appeal, stated that Mr. Kieboom had Adivested himself of certain rights to receive dividends should they be declared@ and that the shares which Mrs. Kieboom acquired were also taxable as Asubstituted property@ pursuant to subsection 248(5) as it may be said that she substituted the shares she purchased for the property she received from her husband@. In addition to attribution on the dividends, the Federal Court of Appeal held that the

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deemed capital gain on the disposition of Mrs. Kieboom=s economic interest to her children pursuant to section 69 must also be attributed to the taxpayer under former subsection 74(2). The problem of attribution where the corporate vehicle is involved remains an ongoing problem under the attribution rules. Subsections 74.1(1) and (2) attempt to deal with indirect income splitting where an individual has transferred or loaned property Aeither directly or indirectly, by means of a trust or by any other means whatever.@ However, because a shareholder has no ownership interest in the property of a corporation, that wording does not extend to, for example, a transfer to a corporation of which a spouse, common-law partner or minor is a shareholder. Section 74.4 is designed to prevent income splitting through a transfer or loan to a corporation by attributing deemed interest to the transferor in specified circumstances. The section will apply where one of the main purposes of a transfer or loan by an individual to a corporation is to reduce the individual=s income and to benefit, either directly or indirectly, by means of a trust or any other means, a designated person in respect of the individual. A designated person is defined in subsection 74.5(5) as the individual=s spouse, common-law partner or a person under 18 years of age who does not deal at arm=s length with the individual or who is the individual=s niece or nephew. If the purpose test is met, attribution applies in respect of the period after the loan or transfer throughout in which the designated person is a specified shareholder of the corporation, the individual is a resident, and the corporation is not a small business corporation. The amount, which is included in the individual=s income as interest under section 74.4, is determined by applying the prescribed interest rate to the outstanding amount of the loan or transfer, less any interest received by the individual and less five-fourths of any taxable dividends received by the individual on shares that were received from the corporation as consideration for the transfer or loan and that were excluded consideration. For the purposes of this calculation, excluded consideration as defined in subsection 74.4(1) is consideration received by the individual for the transfer or loan to the corporation that is indebtedness, a share of the capital stock of the corporation, or a right to receive either debt or shares. The outstanding amount is, in the case of a transfer of property, the amount by which the fair market value of the property exceeds the fair market value of the consideration (other than excluded consideration) received. In the case of a loan of money or other property, the outstanding amount is the amount by which the principal amount of the loan or the fair market value of the property exceeds the fair market value of any repayment of the loan (other than a repayment that is excluded consideration). The provisions in subsection 74.4 would not cure the attribution problem complained of in Kieboom, nor would the re-worded attribution rules contained in sections 74.1 and 74.2. A Atransfer@ of property is still required for the attribution rules to apply, not merely the transfer of an underlying economic interest. However, this may not be the end of the matter. In Kieboom the Minister did not argue the indirect payment provisions of subsection 56(2). That section (discussed below) includes in the income of a taxpayer any payment or transfer made by him as a benefit which he desires to confer on the recipient. It would appear, however, that the extent to which the corporate veil will be ignored for the purposes of the attribution provisions has not been finally determined.

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D. Exceptions to the Attribution Rules i. Separate and Apart Subsection 74.5(3) provides that there will be no attribution of income or losses under subsection 74.1(1) while the spouses or common-law partners are living separate and apart pursuant to a court order or a written separation agreement. A similar rule applies to attribution of capital gains and capital losses under section 74.2 only if the transferor and the spouse or common-law partner complete an election to exclude that provision and the transferor files the election with his or her income tax return for the year in which the spouses or common-law partners separated. ii. Income from Business In Robins v. M.N.R. one of the grounds for the decision against attribution was that money provided by the husband had been used to purchase an interest in a partnership which dealt in real estate and which produced business income for the wife. Noël, J. stated that the provisions applied only to income from property. This position has been accepted by the CCRA (see Appendix 11 - Interpretation Bulletin IT-510 dated December 39, 1987, para. 3 ATransfers and Loans of Property made after May 22, 1985 to a Related Minor@, and Lackie v. R. (1979), 79 DTC 5309 at 5311 (FCA), where it was stated that it was common ground that subs. 74(1) does not apply to business income). iii. Accumulating Trust Income Trust income which is permitted to accumulate for the ultimate benefit of a spouse, common-law partner or minor will not be attributed if it is not deducted from the income of the trust and included in that of the beneficiary. As the accumulating income of an inter vivos trust which was created after 1971 is taxed at the minimum federal rate of 29%, this is generally not advantageous. iv. Residence It is clear that only income which is derived in a year in which the transferor was resident in Canada can be attributed to him. v. Reverse Attribution Subsection 74.5(11) is targeted at artificial transactions. It provides that sections 74.1 to 74.4 will not apply to a loan or transfer where it may reasonably be concluded that one of the main reasons for the transfer or loan was to reduce the amount of tax that would otherwise be payable. Consider the following decision: a. Sullivan v. M.N.R., 91 DTC 43 TCC Facts: Mrs. Sullivan incorporated a company, subscribed and paid for 1,000 common shares and sold them to Mr. Sullivan for $1,000. At the same time, Mr. Sullivan transferred all the issued shares of H. Ltd. to O Ltd. under a subsection 85(1) rollover. H. Ltd. paid substantial

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dividends to O Ltd. from 1983-1985. O Ltd. then paid substantial dividends to Mr. Sullivan in respect of the 1,000 shares he had acquired from his wife. Mrs. Sullivan relied on subsection 74(1) to include these dividends in her income. The Minister refused to recognize this treatment and included them in the taxpayers income. Issue: Whether the attribution rules in subsection 74(1) apply to include the dividends in the wife=s income. Held: The funds needed by O Ltd. to pay the dividends came originally from H Ltd. and full consideration for the shares of H. Ltd. had to be accounted for in Mr. Sullivan=s hands. Therefore, all the dividends had to be included in Mr. Sullivan=s income to the extent they had come from H. Ltd. as a result of the operation of subsection 85(1). Subsection 74(1) did not apply. vi. Taxable Capital Gains and Allowable Capital Losses a. Spouses or Common-law Partners Attribution of taxable capital gains and allowable capital losses on property transferred or loaned by one spouse or common-law partner to the other is governed by subsection 74.2(1). There is no similar provision of general application to such gains and losses which are realized on property which has been transferred to a minor or to a trust in which a minor is beneficially interested. Section 75.1 does, however, attribute back any taxable capital gains or allowable capital losses realized on farming property which has been the subject matter of a rollover to an infant child in circumstances which fall within subsection 73(3) or 73(4). Where an individual is deemed to have a taxable capital gain under the attribution rules the deeming rules will also apply to treat the capital gain as a capital gain for purposes of determining any losses from income which may be deductible or the capital gain exemption available for that individual. b. Controlled Trusts Where property is transferred to a trust the transfer will be ignored for tax purposes if:

1. the property, or substituted property, may revert to the person who placed it in the trust;

2. if the transferor has power to determine who will ultimately receive such property; or

3. if the transferor has power to veto any dispositions of such property during his or her lifetime.

Full attribution of income, losses, taxable capital gains and allowable capital losses from property transferred to a trust will also result. The application of subsection 75(2) does not depend on whether the property was disposed of by the transferor to the trust at fair market value. [See Appendix 12 - Interpretation Bulletin IT-369R, March 12, 1990, AAttribution of Trust Income to Settlor@]

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c. Income Splitting by the Diversion of Income Income splitting by a taxpayer through the diversion of income to other persons is also discouraged by the Act. Subsections 56(2) and (4) and more recently (4.1) deem income to be income of the person who is beneficially entitled to it. Subsection 56(4) applies where a taxpayer transfers or assigns to a non-arm=s length person the right to an amount that would otherwise be included in the taxpayer=s income. Subsection 56(2) is broader and not restricted to non-arm=s length relationships. It provides that where a taxpayer directs or concurs in the making of a payment or transfer of property to a person and where the payment or transfer is for the taxpayer=s benefit or is a benefit that the taxpayer wishes to have conferred on the other person, then the payment or transfer must be included in the taxpayer=s income. Unlike the attribution rules, neither subsection 56(2) nor subsection 56(4) specifically excludes the amount that is included in the taxpayer=s income from the other person=s income, thereby, leaving open the possibility of the same income being taxed twice. Subsection 56(2) has been used by the CCRA to attack, for example, income splitting through a corporation. One tax planning technique that is used to split income between spouses or common-law partners is to form a corporation and have both spouses or common-law partners subscribe for shares at a nominal price. Provided that each spouse or common-law partner uses his or her own funds to acquire the shares, neither subsection 74.1(1) nor subsection 74.2(1) would apply to any dividends or gains. Consider the following decisions: 1. Her Majesty The Queen v. Jim A. McClurg, 91 DTC 5001 (S.C.C.) Facts: Three classes of shares were issued in the corporation. Dividends were paid out only to the wife under a discretionary dividend clause. The wife also contributed to the business. Issue: Did subsection 56(2) apply to attribute part of the wife=s dividends back to her husband? Held: No. The purpose of subsection 56(2) is to ensure that payments that would have been received by the taxpayer are not diverted to a third party as an anti-avoidance technique. The Court held that dividend payment does not fall within subsection 56(2) because, until a dividend is declared, the profits belong to the corporation as a juridical person. An allocation pursuant to a discretionary dividend clause is not different from the payment of a dividend generally. In both cases, but for the declaration, the dividend would remain part of retained earnings. If it was held otherwise, corporate directors potentially could be found liable for the tax consequences of any declaration of dividends made to a third party. This would violate fundamental principles of corporate law and the realities of commercial practice and overshoot the purpose of subsection 56(2). In addition, this was a legitimate business relationship given the guarantees and active part the wife played in business. Payments received by Mrs. McClurg were a legitimate quid pro quo for her contributions and not an attempt to avoid taxes. Finally, Mr. McClurg acted in his capacity as director in declaring dividends, not in his personal capacity.

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Dickson C.J.=s dicta in McClurg left open the question of whether subsection 56(2) would apply to dividend income where the recipient had not made any contribution to the corporation. Consider the following decision: 2. Her Majesty The Queen v Neuman [1996] CTC (F.C.A.) Facts: Mr. Neuman, was a partner in a Winnipeg law firm. He and his partners owned the shares of a corporation (ANewmac@) which had a management contract with the law firm and owned commercial property in downtown Winnipeg. In 1981 Mr. Neuman froze his equity in Newmac by transferring his Newmac shares to a holding corporation (AMelru@) in exchange for voting Class AG@ preferred shares of Melru. Mr. Neuman subscribed for one voting common share of Melru and his wife subscribed for 99 Class AF@ non-voting shares of Melru, paying with $99 of her own money. Subject to certain priorities as to payment, the amounts of dividends to be declared on each class of outstanding Melru shares were in the directors= discretion. Mrs. Neuman was sole director of Melru. In 1982 she declared dividends of $5,000 on Mr. Neuman=s Class AG@ preferred shares and $14,800 on her own Class AF@ shares, which she immediately loaned to Mr. Neuman for a demand promissory note, funded by dividends received by Melru from Newmac. All necessary steps were taken to ensure that the Melru dividends were declared in compliance with Manitoba corporate law. Mrs. Neuman did not make any other contributions to Melru. Mrs. Neuman died before the $14,800 loan was repaid. Issue: Did subsection 56(2) apply to attribute the dividends paid by Melru to Mrs. Neuman to Mr. Neuman? Held: Subsection 56(2) applies where four conditions are met: (FCA)

1. there is a payment or transfer of property to a person other than the taxpayer;

2. the taxpayer directs or concurs in the payment or transfer;

3. the payment or transfer is for the taxpayer=s benefit or for the benefit of some other person on whom the taxpayer wished to have the benefit conferred; and

4. the payment or transfer would have been included in computing the taxpayer=s income if

it had been made to him instead of the other person. All of these conditions were met in this case. In particular, the FCA found that Mr. Neuman had concurred in the declaration of the dividend based on the following:

1. Mr. Neuman, as an officer of Melru, acted as Chairman of the Board meeting at which the dividends were declared;

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2. The amounts of the dividends paid were recommended by Mr. Neuman and the minutes

authorizing them were signed by him as Chairman of the Board of Directors of Melru;

3. Mr. Neuman waived his right to receive proportional dividends on his common share of Melru when dividends were declared on Mrs. Neuman=s Class AF@ shares;

4. Mr. Neuman executed a shareholders= resolution ratifying the declaration of dividends

and thereby permitted the dividend on the Class AF@ shares to be declared in contravention of the Articles of Melru.

In Neuman, the FCA concluded that Mr. Neuman Ahad acted beyond the call of simple adviser and actively participated in the director=s decision making@ which amounted to concurrence with the declaration of the dividend. However, the FCA emphasized that active participation is not necessary, and passive or implicit acquiescence may be sufficient to trigger subsection 56(2). Since McClurg was decided by the Supreme Court of Canada, the CCRA had taken the position that subsection 56(2) may apply to dividends paid by a closely-held corporation to a shareholder who has not made an Aadequate contribution,@ financial or otherwise, to the corporation. The FCA decision in Neuman supported this position. Fortunately, the Supreme Court of Canada (98 D7C 6297) reversed the FCA decision in Neuman and clarified that subsection 56(2) cannot apply to dividend income, even in respect of a non-arm=s length shareholder who has made no legitimate contribution to the company. The SCC ruled that subsection 56(2) cannot apply to dividend income since, if the dividend is not paid to a shareholder, it remains with the corporation as retained earnings. The problems of interpreting subsection 56(2) within the corporate context is also illustrated by the case below. 3. Winter et al v. The Queen, 90 DTC 6681 (FCA) Facts: The taxpayer caused shares in a corporation he controlled to be sold to his son-in-law for $100 per share. He also gifted his own shares to his daughter and reported the share proceeds as $100 per share. The CCRA added $54,673 to the taxpayer=s income as a taxable capital gain on the gift to the daughter under section 69, and $648,368 pursuant to subsection 56(2) as the value of the benefit conferred by him on his son-in-law. (The CCRA reassessed the share value at $1,089 per share.) Issue: Was subsection 56(2) applicable to attribute this amount to the taxpayer on the sale to his son-in-law? Held: The appellant argued that the taxpayer had not conferred the benefit because the shares sold were owned by the corporation and not him. He had only acted as the director. The appellant also argued that because the son-in-law held shares in the corporation at the time of the transfer he was already subject to tax under subsection 15(1). In consequence the taxpayer should not be taxed under subsection 56(2) if his son-in-law could be taxed under section 15. The court held that subsection 56(2) applied and that subsection 15(1) did not apply as the son-in-law acquired the benefit as a son-in-law not as a shareholder.

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vii. Subsection 56(4.1) Section 74.1 attributes income to an individual who loans or transfers money or other property to or for the benefit of his or her spouse, common-law partner or certain minors. Subsection 56(4.1) extends the income attribution rules beyond those in section 74.1 to situations where an individual (including certain trusts) resident in Canada has loaned property directly or indirectly to another individual with whom he or she does not deal at arm=s length, and it may be reasonably be considered that one of the main reasons for the loan was to reduce or avoid tax by causing income from the property to be included in the income of that other individual. Any income from the property, or from any property substituted therefor, is attributed to the lender unless the loan is a bona fide loan. 3. Taxation of Inter Vivos Personal Trusts In general, the income, losses, capital gains and capital losses of an inter vivos personal trust are subject to the same rules as those which apply to testamentary trusts. There are, however, a number of respects in which such inter vivos trusts receive less favourable treatment than testamentary trusts. In the case of a trust created after November 12, 1981, any subsequent contribution of property other than by an individual on his or her death will not qualify as a testamentary trust; instead it would be an inter vivos trust. (See definitions of Atestamentary trust@ and Ainter vivos trust@ in subsection 108(1)). A. The Rate of Tax The income of an inter vivos trust which was created on or after June 18, 1971 is taxed at the federal level at a flat rate of 29 percent. The obvious purpose of the flat rate tax is to reduce the income splitting advantage which might otherwise be obtained by allowing part of the income of an inter vivos trust to accumulate in the trust so that it would be taxed to the trust as a separate taxpayer. In addition, tax at the rate of 36% may be imposed under Part XII.2 of the Act, on all income earned by a trust from the conduct of the business in Canada or from the ownership of Canadian real property, resource property, or timber property and on taxable capital gains arising from the disposition of such businesses or properties, to the extent that such income is currently distributable to beneficiaries. This tax was added to the Act to correct a perceived unfairness with respect to the allocation of the tax burden where there are non-resident and certain other designated beneficiaries. If there are no designated beneficiaries and the trustee certifies that this is the case the tax is not imposed. Non-residents or other designated beneficiaries receive their share of trust income after deduction of the Part XII.2 tax. In addition, tax must be withheld by the trust on the 64% after tax amount distributed to non-residents at either the standard rate of 25% or the lower applicable treaty rate. Where Part XII.2 tax is payable by a trust it may be deducted in computing the trust=s income by virtue of subsection 104(30). Resident beneficiaries who receive the after tax income must gross

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up the amount to reflect the tax paid and are then allowed a credit for their share of the Part XII.2 tax to offset their tax otherwise payable. Any excess Part XII.2 tax is refundable. If the trust accumulates part of its income and distributes less than 64% of its designated income the withholding tax is calculated using 100/64 of the distributed amount, to recognize the tax paid on the accumulating income by the trust. This result will also occur where the trust elects to deduct less than the full amount of its currently deductible income under subsection 104(6). [See Interpretation Bulletin IT-406R2, May 11, 1990, ATax Payable by an Inter Vivos Trust@] B. Preferred Beneficiary=s Election The rules which govern the availability of a preferred beneficiary=s election under an inter vivos trust vary in one important respect from those which apply to testamentary trusts. The concept of a preferred beneficiary is defined in terms of the beneficiary=s relationship with the settlor of a trust. In the case of a testamentary trust, this presents no particular problem as the settlor of such a trust is simply the individual who created it. The term Asettlor@ is defined more restrictively for inter vivos trusts and it is possible that such a trust will have no settlor. If this is so, there will be no preferred beneficiaries and, in consequence no possibility of a preferred beneficiary=s election. Where an inter vivos trust has been created by the transfer, assignment or other disposition of property by one individual, he will be the settlor at any time at which the aggregate of his or her contributions of property from the time that the trust was created to the particular time exceeds the value of the contributions made by all other persons since the creation of the trust. In such a case only the individual who created the trust can be the settlor. If the contributions of other persons disqualify him, the trust will have no settlor unless and until he makes further contributions which are sufficient in value to offset the value of the contributions made by other persons. Where a trust was created by joint contributions of an individual and his or her spouse or common-law partner, the two of them will together constitute the settlor at any time when the aggregate of the values of their contributions exceeds that of the contributions made by other persons. [See Interpretation Bulletin IT-374, May 16, 1977, AMeaning of >Settlor=@].

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Appendix 1

Interpretation Bulletin IT-416R3,

July 10, 1987, AValuation of Shares of a Corporation Receiving Life Insurance

Proceeds on Death of a Shareholder@ 1. Paragraph 70(5)(a) deems the property of a deceased person to have been disposed of immediately before death for proceeds equal to the fair market value of the property at that time. 2. The property referred to in 1 may include shares of a corporation the value of which depends at least in part upon the value of a life insurance policy under which the decedent was the person whose life was insured. The corporation's interest in the policy may be direct or it may be through its ownership of shares of another corporation. In either case, for deaths occurring after December 1, 1982, subsection 70(5.3) provides that the value of the policy immediately before death shall be its cash surrender value at that time as determined under paragraph 148(9)(b) (see 3 below). Where the death occurred prior to December 2, 1982, the comments in paragraphs 4 and 5 below apply. 3. In determining the cash surrender value of a policy for the purposes of subsection 70(5.3), paragraph 148(9)(b) provides that policy loans outstanding, policy dividends payable and any interest payable upon such dividends shall be disregarded. In addition to those specific exclusions, the Department also considers that prepaid premiums and dividends left on deposit are not elements of the cash surrender value of a policy although their values, and the values of those elements specifically excluded, may affect the values of the shares of a corporation which is the owner and beneficiary of the policy. Death of Shareholder before December 2, 1982 4. Where subsection 70(5.3) does not apply, the insurance policy, as a component of the assets underlying the shares, will be valued in accordance with normal valuation practices taking into consideration all facts relevant to the particular case. In this regard, the value established for the insurance policy immediately before death should be based on relevant factors relating to the deceased shortly before death, eg, the day prior to death (see 5 below). 5. Major factors that should be taken into account are: (a) the cash surrender value, if any, of the policy, (b) the life expectancy of the insured based on mortality tables, and (c) the state of the health of the insured as it would be known to other persons. For example, the value of an insurance policy could approach its face value if it were known that the insured had a terminal illness or was critically injured as a result of an accident and not expected to recover. Conversely, it would have little added value if a person in apparently excellent health were to die unexpectedly as a result of an accident or heart attack. For valuation purposes the state of health of the insured prior to death would override the effect of an unexpected death due to a cause not related to any known health problem. Therefore, if a person with terminal cancer died from an unexpected heart attack the actual cause of death would not be relevant in the valuation, but the fact that the person had terminal cancer would.

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Appendix 2

Interpretation Bulletin IT-447, May 30, 1980

AResidence of a Trust or Estate@ 1. The residence of a trust or estate (hereinafter referred to as a trust) in Canada, or in a particular province or territory within Canada, is a question of fact to be determined according to the circumstances in each case. However, a trust is generally considered to reside where the trustee, executor, administrator, heir or other legal representative (hereinafter referred to as the trustee) who manages the trust or controls the trust assets resides. 2. The trustee who has management and control of the trust, while he or she may not have physical possession of the trust assets, will be the person who has most or all of the following powers or responsibilities: (a) control over changes in the trust's investment portfolio, (b) responsibility for the management of any business or property owned by the trust, (c) responsibility for any banking, and financing, arrangements for the trust, (d) control over any other trust assets, (e) ultimate responsibility for preparation of the trust accounts and reporting to the beneficiaries of the trust, and (f) power to contract with and deal with trust advisors, eg, auditors and lawyers. 3. In certain cases, more than one trustee may be involved in exercising the management and control over the trust. If one such trustee clearly exercises a more substantial portion of the management and control than the others, the trust will reside in the jurisdiction in which that trustee resides. Where two or more trustees exercise relatively equal portions of the management and control of the trust, and trustees exercising more than 50 per-cent of such management and control reside in one jurisdiction, the trust will reside in that jurisdiction. 4. In some cases it may not be clear who has management and control of the trust and in these situations the Department will examine other factors relating to the trust to determine residence. The most important of these factors are: (a) the location where the legal rights with respect to the trust assets are enforceable, and (b) the location of the trust assets. The residence of the beneficiaries of a trust and domicile of the settlor are not considered to be relevant except in situations as described in 5 below. 5. Normally residence of a trust is dependent upon residence of the trustee or trustees who can exercise management and control of the trust. In some situations the facts may indicate that a substantial portion of the management and control rests with some other person such as the settlor or the beneficiaries. In these situations the residence of this other person may be considered to be the determining factor for the trust regardless of any contrary provisions in the trust agreement. 6. Where an individual exercises the management and control of a trust, the residence of that individual is determined based on the normal factual tests for determining the residence of an individual. 7. Where a corporation exercises the management and control of a trust, the residence of that corporation is determined based on the normal factual tests for determining residence of a corporation. An exception to the general rule may be encountered where the management and control of a trust is exercised by a branch office, for example, a branch of a trust company. In these circumstances, the trust may be determined resident in the jurisdiction where the branch office is located even though the corporation itself is resident outside that jurisdiction. 8. In some situations, after examination of all factors, it may be determined that a trust is resident in Canada notwithstanding that another country may consider the trust to be resident in that country. 9. Pursuant to paragraph 94(1)(c) a trust not otherwise resident in Canada may be deemed to be a resident in Canada for the purposes of Part I of the Act if the trust is such that the amount of the income or capital of the trust to be distributed at any time to any beneficiary of the trust depends upon the exercise by any person of, or the failure by any person to exercise, any discretionary power. 10. Subsection 75(2) provides that, where property is transferred by a person to a trust created after 1934 on condition that the property, or property substituted for it, may revert to that person or pass to persons designated by him or her or that during his or her lifetime the property may be disposed of only with his or her concurrence, any income or loss or taxable capital gain or allowable capital loss from the property, or property substituted for it, is attributable to that person during his or her lifetime while he or she is resident in Canada. In such situations attribution applies whether or not the trust is resident in Canada. 11. The foregoing are the considerations viewed as relevant in determining the residence of a trust or estate in ordinary situations. Regard may be had to other factors where the purported residence of a trust or estate appears to have been motivated by reasons of tax avoidance.

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Appendix 3


November 7, 1996, AIntergenerational Transfers of Farm Property on Death@

Discussion and Interpretation 1. In this bulletin, the terms listed below have the following meanings: AAll or substantially all@: when the level of 90% of whatever is being measured is reached, the Aall or substantially all@ requirement is considered to have been met. AChild@: The definition of Achild@ in subsection 70(10) and the description in subsection 252(1) expand the usual meaning of child to include: (a) a child of the taxpayer whether born within or outside marriage; (b) a spouse of a child; (c) a child of the taxpayer's spouse (Astep-child@); (d) an adopted child; (e) a grandchild; (f) a great-grandchild; and (g) a person adopted-in-fact. To be adopted-in-fact for the purposes of (g) above, paragraph 252(1)(b) provides that an unrelated person will be deemed to be a taxpayer's child if that person is wholly dependent on the taxpayer for support and if the taxpayer has, in law or in fact, custody and control of the person (or had such custody and control immediately before that person turned 19 years old). ACost amount@ is defined in subsection 248(1) for depreciable property of a prescribed class as the proportionate share of the undepreciated capital cost of property of a prescribed class that the capital cost of the property is of the capital cost of all the property in that class that the taxpayer owns at that time. The capital cost of the depreciable property is adjusted as described in 19 below. AParent@: Subsection 252(2) extends the usual meaning of Aparent.@ A parent of a child includes an individual: (a) who is a natural parent, a step-parent or an adoptive parent of the child; (b) who is a natural parent, a step-parent or an adoptive parent of the child's spouse; or (c) of whom the child is or was considered to be a child. When a person who has not attained 19 years of age is under the custody and control of an individual and the individual is receiving support payments from an agency responsible for the person's care, the individual is not the parent of the person since the person is not wholly dependent on the individual. The definition of spouse is relevant to an understanding of who is a parent. ASpouse@: A person can become an individual's spouse either as a result of their marriage or as a consequence of the operation of subsection 252(4). The subsection expands the meaning of Aspouse@ to include what is generally referred to as a Acommon-law@ spouse. ASpouse trust@: As described in subsection 70(6) or 73(1), a spouse trust is a trust created by will or by an instrument which becomes effective during a taxpayer's lifetime entitling the taxpayer's spouse, during his or her lifetime, to receive all of the income of the trust and allowing no one but the spouse (before the spouse's death) to receive or obtain the use of any of the income or capital of the trust. See the current version of IT-305, Testamentary Spouse Trusts for more information on spouse trusts. AUsed principally in the business of farming@: A property is considered to be used principally in the business of farming if more than 50% of its use is in that business. For example, where a property is used for farming and for some other purpose, if more than 50% of the property's use is for farming then it will qualify as being used principally in the business of farming. If part of the property is lying idle, then that part cannot qualify as being used principally in the business of farming. Direct Transfer to Child and Indirect Transfer Through a Spouse Trust (Subsections 70(9) and (9.1)) 2. Subsection 70(9) contemplates a transfer or distribution of property from the taxpayer's estate as a consequence of death (see also 17 and 18 below) to the children of the deceased. It does not apply to any sale of property by the estate unless, by virtue of subsection 248(8), the transfer or distribution of the property pursuant to the sale is considered to be a transfer or distribution of the property as a consequence of the taxpayer's death. In addition, subsection 70(9) applies only to property that is land in Canada that is capital property or depreciable property in Canada of a prescribed class that is owned by the taxpayer immediately before death and thus does not apply to such property owned at that time by a partnership or corporation.

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3. The following are examples of transfers or distributions of property to which subsection 70(9) may apply (see also 17 and 18 below): (a) A father and his son operate a farm in partnership; the father owns the farm property which he leases to the partnership. On the father's death, the farm property passes to the son by direct bequest (see 14 and 16 below). (b) A mother and her son operate a farm in partnership and own the farm property jointly (it is not partnership property). On the mother's death, her interest in the farm property passes to the son by virtue of the joint ownership. (c) A father operates a farm and owns the farm property. On his death, the farm property is held in trust for his son, and by the terms of the trust it vests indefeasibly in the son although it is not transferred to him until he attains a certain age. (The meaning of Avested indefeasibly@ is not defined in the Act but its meaning for purposes of subsections 70(9), 70(9.1), 70(9.2) and 70(9.3), among others, is set out in the current version of IT-449, Meaning of AVested Indefeasibly.@ In addition, subsection 248(9.2) describes two situations where property is deemed not to have vested indefeasibly.) (d) A father operates a farm and owns the farm property. The terms of his will provide that his son is to receive the land but, before any transfer or distribution can be made, a mortgage or charge must be placed on the land in order to provide funds to satisfy cash bequests to other beneficiaries. Notwithstanding that his title must be encumbered in this manner, the land will be considered to vest indefeasibly in the son and, for purposes of subsection 70(9), there will be no time limit for payment of the cash bequests to other beneficiaries. On the other hand, if the will provides that the son may receive the land only after the payment of certain amounts to other beneficiaries within a stipulated time following his father's death, the son would only meet the requirements of subsection 70(9) if he makes the required payments within the stipulated time period and that period is within the time period provided in subsection 70(9). The son's adjusted cost base of his inherited land in such cases is not increased by the required payments to beneficiaries. 4. Subsection 13(21.1) may redetermine the amount that the legal representative of the taxpayer has elected under subsection 70(9). Subsection 13(21.1) generally provides that where a building and the land on which it is located are disposed of, a terminal loss on the sale of the building is reduced to the extent of any gain on the sale of the land. The subsection will apply where the elected amount which is the proceeds of disposition for a building is less than the lesser of the capital cost of the property and its cost amount to the deceased taxpayer and the elected amount for land exceeds the cost amount of that land immediately before the taxpayer's death. Where subsection 13(21.1) applies to redetermine a deceased taxpayer's proceeds of disposition, the elected amount for the building will be increased to restrict the potential terminal loss, while the elected amount for the land will be reduced by a corresponding amount. Subsection 13(21.1) may similarly apply where an election has been made under subsection 70(9.1) as though the reference to Adeceased taxpayer@ were to Aspouse trust.@ See the current version of IT-220, Capital Cost Allowance C Proceeds of Disposition of Depreciable Property for more information on subsection 13(21.1). 5. Subsection 70(9.1) does not require that the trust, the taxpayer's spouse, or the child must be using the property in a farming business immediately before the death of the taxpayer's spouse. Therefore, a rollover under subsection 70(9.1) would be allowed where, during the period between the settlement of the spouse trust and the death of the spouse, the farm property was rented or leased to anyone who used it in a farming business. In addition, there is no requirement that the child continue to use the farm property in the business of farming after its transfer or distribution in order to qualify for the rollover under subsections 70(9) or (9.1). 6. A rollover from a tainted spouse trust (a trust created under a will in favour of the deceased's spouse that does not meet the qualifications outlined in subsection 70(6)) to a child on the death of the spouse is not permitted under subsection 70(9.1) or subsection 70(9.3) as those provisions apply only to the spouse trust described in subsections 70(6) or 73(1). However, a rollover under subsection 70(9.1) or 70(9.3) would be permitted if the tainted spouse trust was untainted by means of an election under subsection 70(7) as described in the current version of IT-305, Testamentary Spouse Trusts. 7. If a spouse trust described in subsection 70(6) or 73(1) is varied with the consent of all the beneficiaries in order that farm property will pass to one or more of the beneficiaries who are children of the settlor upon the death of the spouse and the requirements of subsection 70(9.1) are otherwise satisfied after the trust is varied, the rollover provisions of subsection 70(9.1) will apply to determine the proceeds to the trust and the cost to a child beneficiary of such farm property as is transferred or distributed to a child of the settlor pursuant to the terms of that varied trust. Family Farm Corporations and Partnerships (Subsections 70(9.2) and (9.3)) 8. Pursuant to subsection 100(3), a taxpayer who inherits an interest in a partnership but is not a member of, or does not by virtue of the inheritance become a member of, that partnership is deemed to have acquired a right to receive partnership property and not to have acquired an interest in a partnership. Consequently, since subsections 70(9.2) and 70(9.3) provide only for a rollover of a partnership interest in a family farm partnership, but not partnership property, those rollover provisions will not apply to that particular inheritance. 9. There is no provision in either subsection 70(9.2) or 70(9.3) for a rollover to a child on the death of an individual of a residual partnership interest described in section 98.1. Section 98.2 sets forth the rules governing a transfer of

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such a residual partnership interest on the death of an individual. In those rules, it is provided that a taxpayer (e.g., a child inheritor) who acquires such a residual partnership interest is deemed to have acquired a right to receive partnership property and not to have acquired a partnership interest to which subsections 70(9.2) and 70(9.3) might otherwise apply. 10. Subsection 70(9.3) does not require the spouse trust, spouse, or child to be actively engaged on a regular and continuous basis in the corporation's business of farming. For partnership property, subsection 70(9.3) requires that the property that is transferred to the spouse trust must be an interest in a family farm partnership immediately before the transfer. However, on the subsequent transfer to the child the subsection only requires that, immediately before the death of the spouse, the interest in the partnership be used in the business of farming in Canada and that all or substantially all of its property be used in that business. 11. The definitions of Ainterest in a family farm partnership@ and Ashare of the capital stock of a family farm corporation@ in subsection 70(10) require that Aall or substantially all@ of the fair market value of the property owned by the partnership or corporation be used in the business of farming. The question of whether Aall or substantially all@ of the property is used in the business of farming for purposes of subsection 70(10) is discussed in the current version of IT-268, Inter Vivos Transfer of Farm Property to Child. The departmental practices described there for purposes of inter vivos transfers to a child apply equally for purposes of the testamentary transfers discussed in this bulletin. AFarming Business@ and AUsed in the Business of Farming@ 12. It is a question of fact to be decided on an individual case basis whether a particular farming operation constitutes a farming business at any particular time. Some of the criteria which should be considered in making this determination are set out in the current version of IT-322, Farm Losses. However, if in a taxation year a new farming operation has been initiated, or a previous operation has been reactivated after several years of inactivity, it may be difficult to determine that a farming business was carried on at a particular time in that year. In this regard, refer to the current version of IT-364, Commencement of Business Operations, which contains comments relevant to determining the commencement or recommencement of a business. 13. Even though a farm owner (individual) may engage the services of another person to undertake virtually all of the work associated with the farming activities (custom working), the farm property may still be considered to have been used by the owner in the business of farming for purposes of subsection 70(9) or 70(9.1) where that owner, to the extent that the circumstances of the particular farming operations allow, exercised general management and control of the overall farming operations. 14. A lessor of farm property is not considered to be using the property in the business of farming. Thus, the property which immediately before the lessor's death was leased to another person (including a sharecropper) is not eligible for transfer or distribution under subsection 70(9) unless it was used principally in the business of farming by a lessee who is the spouse or child of the lessor and that person was actively engaged in the business on a regular and continuous basis. 15. The term Asharecropper@ means a farmer who is a tenant and gives a share of the crop to the landlord in lieu of rent. There may be other types of sharing arrangements, for example, where an individual is actually an employee of the farm owner and not a tenant and receives a share of the crop as remuneration for services rendered. Under such an arrangement the farm property may be eligible for transfer or distribution under subsection 70(9). Actively Engaged on a Regular and Continuous Basis 16. Subsection 70(9) and the definitions in subsection 70(10) of Ashares of the capital stock of a family farm corporation@ and Ainterest in a family farm partnership@ require that a person be Aactively engaged on a regular and continuous basis@ in the business of farming. Whether a person is Aactively engaged on a regular and continuous basis@ is a question of fact; however, it is considered that the requirement is met when the person is Aactively engaged@ in the management and/or day to day activities of the farming business. Ordinarily the person would be expected to contribute time, labour and attention to the business to a sufficient extent that such contributions would be determinant in the successful operation of the business. Whether an activity is engaged on a Aregular and continuous basis@ is also a question of fact but an activity that is infrequent or activities that are frequent but undertaken at irregular intervals would not meet the requirement. Occurrences as a Consequence of Death 17. Subsection 248(8) expands the usual meaning of transfers of property as a consequence of the death of a taxpayer or the taxpayer's spouse for the purposes of the Act. It provides that a transfer, distribution or acquisition of property will be considered to have occurred as a consequence of the death of a taxpayer or the taxpayer's spouse where such transfer, distribution or acquisition was made (a) under, or as a consequence of, the terms of a will or other testamentary instrument of the taxpayer or of the taxpayer's spouse, (b) as a consequence of the law governing the intestacy of the taxpayer or of the taxpayer's spouse, or (c) as a consequence of a disclaimer, release or surrender by a beneficiary under a will, other testamentary instrument or on the intestacy of a taxpayer or the taxpayer's spouse.

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Subsection 248(8) also provides that where a beneficiary under a will, other testamentary instrument or on the intestacy of a taxpayer releases or surrenders any property that was property of the taxpayer immediately before the taxpayer's death, such release or surrender will not be considered to be a disposition of that property by the beneficiary. 18. Subsection 248(9) describes Adisclaimer@ and Arelease or surrender@ for the purposes of subsection 248(8). A disclaimer involves an outright refusal to accept a gift, share or interest under a will, with no stipulation as to how the taxpayer's legal representatives should distribute the disclaimed property. A disclaimer of property in favour of another person is not a true disclaimer but an assignment. However, when such a disclaimer or assignment would achieve the same effect as a simple disclaimer without any assignment, a disclaimer is considered to have been made for the purposes of subsections 70(9), (9.1), (9.2) and (9.3). In Quebec a disclaimer includes a renunciation of a succession made under the laws of that province that is not made in favour of any person. For any of the subsections to apply, a disclaimer must be made within 36 months of the taxpayer's death or, upon written application to the Minister within that period, within such longer period as the Minister considers reasonable in the circumstances (see 32 below). A release or surrender made under the laws of a province (other than the Province of Quebec) must not be in favour of a particular person. For the Province of Quebec, a release or surrender means an inter vivos gift of an interest in, or right to property of, a succession made to the person who would have benefitted had the donor renounced the succession but not in favour of anyone. A release or surrender, whether made within the Province of Quebec or otherwise, must be made within the same time as a disclaimer is made, as described above. Depreciable Property 19. Subsection 70(13) provides that certain adjustments previously made to the capital cost of depreciable property of a prescribed class under subsection 13(7) do not apply for the purposes of section 70. These adjustments under subsection 13(7) provide that the capital cost of depreciable property may be limited to an amount that is less than the fair market value in cases where a non-income producing depreciable property begins to be used for producing income, where the income producing use of a depreciable property increases and where there is a non-arm's length acquisition of a depreciable property. The capital cost to a deceased taxpayer of depreciable property affected by the adjustments is readjusted for the purposes of determining the proceeds of disposition of that property in paragraphs 70(9)(b) and 70(9.1)(b). 20. Subsection 70(14) generally provides that, where two or more depreciable properties of a prescribed class are disposed of at the same time because of a taxpayer's death, section 70 and the definition of Acost amount@ apply as if each property were disposed of in the order designated by the taxpayer's legal representative or the trust, where subsection 70(9.1) applies. Where no such designation is made in the appropriate income tax return, the Minister may designate the order. The ability to designate the order of disposition becomes relevant where some property of a prescribed class can be transferred to a beneficiary at the cost amount of the property while other property must be disposed of at fair market value. For example assume that $ a deceased taxpayer had two depreciable properties in a prescribed class, $ the properties were used principally in the business of farming, $ one of the properties was bequeathed to the taxpayer's child while the other was bequeathed to a family friend, $ each property had a cost of $1,000 and had a fair market value of $800 immediately before the deceased's death and $ the undepreciated capital cost of the class was $1,200. If the property that was bequeathed to the child is designated as being the first one disposed of, pursuant to subsection 70(9), the deceased is deemed to have received proceeds of disposition equal to the lesser of the capital cost and the cost amount of the property. Since the capital cost of the property is $1,000 and, pursuant to the definition in subsection 248(1), the cost amount of the property is $600, the taxpayer's undepreciated capital cost of the property in the class will be reduced to $600 ($1,200 - $600) following the disposition to the child. When the remaining property is disposed of to the family friend, pursuant to paragraph 70(5)(a), the deceased is deemed to have received proceeds of disposition equal to the fair market value of the property, that is, $800. As the undepreciated capital cost in the class is $600, there will be a recapture of capital cost allowance of $200. If the property that was bequeathed to the family friend is designated as being the first one disposed of, pursuant to paragraph 70(5)(a), the deceased is deemed to receive proceeds of disposition equal to the fair market value of the property, that is $800. This reduces the cost amount, that is, the undepreciated capital cost in the class, to $400. When the remaining property is disposed of to the child, pursuant to subsection 70(9), the deceased is deemed to have received proceeds of disposition equal to the lesser of the capital cost and the cost amount of the property. As the cost amount is the lesser amount there is no recapture of capital cost allowance. However, pursuant to paragraph 70(9)(c), the capital cost of the property to the taxpayer's child is deemed to be $1,000 and the child is deemed to

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have taken capital cost allowance on the property of $600. Thus, while there is no immediate recapture of capital cost allowance, the recapture has not been avoided but rather deferred until the child disposes of the property. Property Depreciable Pursuant to Part XVII 21. The rollovers under subsections 70(9) and 70(9.1) for depreciable farm property apply only to depreciable property of a prescribed class. Subject to 26 below, property on which a taxpayer is claiming, or has claimed, capital cost allowance only under Part XVII of the Regulations would therefore not qualify for a rollover under subsection 70(9). Similarly, where a spouse trust is claiming, or has claimed, capital cost allowance only under Part XVII before transfer or distribution of such property from that spouse trust to a child upon the death of the settlor's spouse, that property would not qualify for a rollover under subsection 70(9.1). Where the aforementioned rollover provisions do not apply, paragraph 70(5)(a) would deem such property held by a taxpayer immediately before death to be disposed of at its fair market value at that time and paragraph 70(5)(b) would deem that same property to be acquired by any transferee, including the taxpayer's child, at that same amount. In the case of Part XVII property held in a spouse trust at the time the spouse beneficiary dies, the provisions of subsection 107(2) in conjunction with paragraph (f) of the definition of Acost amount@ in subsection 248(1) would apply to deem such property to be disposed of at its cost amount to the trust immediately before its distribution to the surviving beneficiaries and to be acquired by those beneficiaries, including children, at that cost amount plus any adjustment thereto pursuant to paragraph 107(2)(b). Neither subsection 104(4) nor subsection 104(5) provides for the deemed disposition of Part XVII property by a trust. 22. Subsection 20(2) of the ITAR effectively provides that capital cost allowance claimed under Part XI of the Regulations on property acquired before 1972 is recapturable while capital cost allowance claimed thereon under Part XVII is not unless any property that could have been included under Part XVII has been included in a class under Part XI. Further, Part XVII property which is transferred or distributed to a child or trust after 1971 and is depreciable property of the transferee is required to be included in a prescribed class under Part XI of the Regulations by the transferee, since property acquired after 1971 may not be depreciated pursuant to Part XVII of the Regulations. 23. For a deceased taxpayer, any capital gains on Part XVII property, except the portion accrued before December 31, 1971 (exempt by subsection 20(1) of the ITAR), must be reported in the year of death since paragraph 70(5)(a) deems the taxpayer to have disposed of that property immediately before death. 24. For a spouse trust that distributed Part XVII property to surviving beneficiaries, including children, on the death of the spouse, there will be no capital gains to the trust at the time the property is distributed because such property is deemed to be disposed of under subsection 107(2) at its cost amount. 25. Subsection 20(1) of the ITAR will operate to preserve the tax-free status of a pre-1972 capital gain, if any, to a child who has after 1971 acquired Part XVII property from a spouse trust which in turn acquired the property before 1972 and owned them without interruption from December 31, 1971 until the date of disposition to the child. Subsection 20(1) of the ITAR will also preserve the tax-free status of a pre-1972 capital gain on Part XVII property acquired after 1971 either by a spouse or a spouse trust from a taxpayer (settlor). However, this provision will not preserve the tax-free status of a pre-1972 capital gain on Part XVII property acquired after 1971 by a child on the death of a parent, because when subsection 70(5) applies on the transfer, subsection 20(1) of the ITAR does not apply due to the exception in paragraph 20(1)(b) of the ITAR (see also the current version of IT-217, Capital Property Owned on December 31, 1971 C Depreciable Property). 26. Notwithstanding that a leasehold interest in farm land (including a grazing lease) acquired before 1972, on which capital cost allowance has been claimed only under Part XVII of the Regulations before a taxpayer's death or before the transfer of such property by a spouse trust to a child, is technically not depreciable property of a prescribed class, the Department will nevertheless accept it as qualifying for a rollover under subsections 70(9) and 70(9.1) if the taxpayers involved or their representatives so signify in writing. ITAR Provisions C Land 27. Where subsection 70(9) applies to a transfer of land that was owned by the taxpayer on December 31, 1971 (or that was owned on June 18, 1971, by a person who did not deal at arm's length with the taxpayer and no arm's length owners intervened to the date of such transfer), subsections 26(3) and (5) of the ITAR preserve the tax-free zone in the hands of the transferee in the usual way (see the current version of IT-132, Capital Property Owned on December 31, 1971 C Non-arm's Length Transactions). 28. Where subsection 70(9.1) applies to a transfer or distribution of land from a spouse trust subsections 26(3) and 26(5) of the ITAR also preserve the tax-free zone in the usual way for the child inheritor. ITAR Provisions C Depreciable Property of a Prescribed Class 29. By virtue of subsection 20(1.1) of the ITAR, the tax-free zone may also be preserved for depreciable property of a prescribed class transferred pursuant to subsection 70(9) (see the current version of IT-217). In effect, subsection 20(1.1) of the ITAR provides that subsection 20(1) of the ITAR does not apply on the death of the taxpayer (transferor) but only at the time the child inheritor disposes of the property.

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30. Although there is no reference to subsection 70(9.1) in subsection 20(1.1) of the ITAR, it is considered that the tax-free zone is similarly preserved by subsection 20(1) of the ITAR for depreciable property of a prescribed class transferred or distributed by a spouse trust to a child. Miscellaneous Comments 31. For the purposes of the rollover provisions described in section 70 (a) the child relationship must exist at the time of death, and (b) a reference to Achild@ can be read as a reference to Achildren.@ 32. A taxpayer's representative who wishes to request an extension of the 36-month period for establishing the indefeasible vesting of property in a child or the making of a disclaimer, release or surrender should write to the Director of the nearest Revenue Canada tax services office.

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Appendix 4


April 21, 1995, ADisposition of Resource Properties@

1. Canadian resource property is defined in subsection 66(15) as any property of the taxpayer that is: (a) any right, licence or privilege to explore for, drill for or take petroleum, natural gas or related hydrocarbons in Canada; (b) any right, licence or privilege to: (i) store underground petroleum, natural gas or related hydrocarbons in Canada; or prospect, explore, drill or mine for minerals in a mineral resource in Canada; (c) any oil or gas well in Canada or any real property in Canada the principal value of which depends upon its petroleum or natural gas content (but not including any depreciable property used or to be used in connection with the extraction or removal of petroleum or natural gas therefrom); (d) any rental or royalty computed by reference to the amount or value of production from an oil or gas well in Canada or from a natural accumulation of petroleum or natural gas in Canada; (e) any rental or royalty computed by reference to the amount or value of production from a mineral resource in Canada; (f) any real property in Canada the principal value of which depends upon its mineral resource content (but not including any depreciable property used or to be used in connection with the extraction or removal of minerals therefrom); or (g) any right to or interest in any property described in any of (a) to (f) above, other than such a right or interest that the taxpayer has by virtue of being a beneficiary of a trust. Foreign resource property is defined in subsection 66(15) as a property outside Canada that would be a Canadian resource property if it were located in Canada. Oil or gas well is defined in subsection 248(1) and means any well (other than an exploratory probe or a well drilled from below the surface of the earth) drilled for the purpose of producing petroleum or natural gas or of determining the existence, location, extent or quality of a natural accumulation of petroleum or natural gas. Mineral resource is defined in subsection 248(1) and means: (a) a base or precious metal deposit; (b) a coal deposit; (c) a bituminous sands deposit, oil sands deposit or oil shale deposit; or (d) a mineral deposit in respect of which: (i) the Minister of Energy, Mines and Resources has certified that the principal mineral extracted is an industrial mineral contained in a non-bedded deposit; (ii) the principal mineral extracted is calcium chloride, diamond, gypsum, halite, kaolin or sylvite; or (iii) the principal mineral extracted is silica that is extracted from sandstone or quartzite. Mineral, defined in subsection 248(1), includes bituminous sands, calcium chloride, coal, kaolin, oil sands, oil shale and silica, but does not include petroleum, natural gas or a related hydrocarbon not expressly referred to in this definition. Disposition and proceeds of disposition, both defined in section 54, are also used in the context of dispositions of resource properties, under subsections 59(5) and 66.4(5). These terms, therefore, have the same meaning for dispositions of resource properties as they do for capital gains purposes. However, dispositions of resource properties are specifically excluded from capital gains treatment by subparagraphs 39(1)(a)(ii) and (ii.1). Canadian resource property 2. The disposition of a Canadian resource property described in (b), (e) or (f) of that definition or any right to or interest in any such property (see (g) of that definition) results in a reduction to the taxpayer's cumulative Canadian development expense (CCDE), under F of the definition of CCDE in subsection 66.2(5). The amount of the reduction to CCDE is equal to the proceeds receivable from the disposition less outlays or expenses made or incurred for the purpose of the disposition and that are not otherwise deductible for the purposes of Part I of the Act (the net proceeds of disposition). Similarly, when a taxpayer disposes of a Canadian resource property described in (a), (c) or (d) of that definition or any right to or interest in any such property (see (g) of that definition) and the proceeds from the disposition become receivable, the net proceeds of disposition reduces the taxpayer's cumulative Canadian oil and gas property expense (CCOGPE), under F of the definition of CCOGPE in subsection 66.4(5).

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If a credit balance occurs in the CCOGPE in respect of a taxation year, such a balance must be deducted when calculating the CCDE, under L of the definition of CCDE in subsection 66.2(5). If there is a credit balance in the CCDE in respect of a taxation year, such a balance must be included in income, under paragraph 59(3.2)(c) and subsection 66.2(1). Foreign resource property 3. When a taxpayer disposes of a foreign resource property in a taxation year, and the proceeds from the disposition become receivable (see 4 below), the net proceeds of disposition (see 2 above) is included when calculating the taxpayer's income for that year, under subsection 59(1). Amount receivable 4. An amount becomes receivable when a collectible right to the amount is acquired. Thus, the recipient must have a clearly legal, though not necessarily immediate, right to receive an amount. Amounts to be received under Adelay rentals,@ for example, do not have to be accounted for until the year in which they become receivable. Delay rentals are, for example, payments made under certain petroleum and natural gas leases in order to: (a) extend the time in which drilling must begin; or (b) keep the lease in existence after drilling has begun but has been halted. General 5. Generally, in a non-arm's length transfer for no proceeds, or for proceeds less than the fair market value of the transferred property, or in the case of a gift, the transferor is deemed to receive proceeds of disposition equal to the fair market value of the resource property, under paragraph 69(1)(b). This does not apply, for example, where property is transferred on a tax-deferred basis under section 85. The proceeds of disposition for a resource property are deemed to be nil when a taxable Canadian corporation is wound-up under the conditions of subsection 88(1). If subsection 88(1) applies, subsection 88(1.5) deems the parent company to be the same corporation as, and a continuation of, the subsidiary for the purposes of sections 66.2 and 66.4 (and also subsection 59(3.3), sections 66, 66.1 and 66.7 and section 29 of the Income Tax Application Rules). In an amalgamation to which section 87 applies, resource properties are considered to become property of the new corporation and no disposition occurs. Furthermore, for the purposes of sections 66.2 and 66.4 (and also subsection 59(3.3), sections 66, 66.1 and 66.7 and section 29 of the Income Tax Application Rules), subsection 87(1.2) deems the new corporation to be the same corporation as, and a continuation of, each predecessor corporation in an amalgamation of: a) a corporation and one or more of its subsidiary wholly-owned corporations (as defined in subsection 87(1.4)); or b) two or more corporations each of which is a subsidiary wholly-owned corporation of the same person. However, the deeming provisions under subsection 87(1.2) cannot affect the determination of any predecessor corporation's fiscal period, taxable income or tax payable. Partnerships 6. If a resource property that is disposed of belongs to a partnership, subsections 66.2(6) and 66.4(6) provide that the proceeds of disposition, which become receivable by the partnership during a fiscal period, are deemed to be receivable by each partner to the extent of the partner's share thereof. The proceeds of disposition are deemed to be receivable for the partner's taxation year in which the partnership's fiscal period ends (except as described in 7 below). 7. When a non-resident person is a member of a partnership that is deemed under paragraph 115(4)(b) to have disposed of a Canadian resource property, the partner's share of the partnership's deemed proceeds of disposition of each such property reduces that partner's CCDE (under subsection 66.2(7)) or CCOGPE (under subsection 66.4(7)), as the case may be, in the taxation year of the non- resident person that is deemed to have ended under paragraph 115(4)(a). Involuntary dispositions 8. An Ainvoluntary disposition@ of a property is a disposition where the proceeds of disposition are either compensation for property taken under statutory authority, or the sale price of property sold to a person by whom notice of an intention to take it under statutory authority was given (see Interpretation Bulletin IT-271, Expropriations C Time and Proceeds of Disposition). Subsection 44(2) states the rules for determining the time at which a taxpayer is deemed to have made an involuntary disposition, and the time at which the proceeds of disposition are deemed to become receivable. 9. If an involuntary disposition of a Canadian resource property occurs, a taxpayer may make an election under section 59.1. The effect of this election is to exclude from income all (or a portion) of the proceeds of disposition that would otherwise be included in income to the extent that the taxpayer makes or incurs expenditures on Canadian exploration expenses (CEE), Canadian development expenses (CDE) or Canadian oil and gas property expenses (COGPE) in the immediately following ten taxation years (and so designates these expenditures under this election). 10. A taxpayer may make this election by requesting, in the taxpayer's return of income for the taxation year in which the proceeds of disposition are deemed to have become receivable, that section 59.1 apply to the proceeds of disposition to the extent allowed (see 11 below). In the subsequent ten taxation years, the taxpayer must designate

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the CEE, CDE or COGPE (the designated resource expenses) that are to be offset against the amount of the election. This designation must be indicated in the return of income for the taxation year in which the expense is made or incurred. If a tax return is filed electronically, the election and subsequent designations must be filed in paper form. 11. The amount of the proceeds of disposition that is subject to the election is the least of: (a) all amounts that become receivable for an involuntary disposition of Canadian resource property to the extent that they have been included in the amount referred to in paragraph (a) of the description of F in the definition of CCDE in subsection 66.2(5), or paragraph (a) of the description of F in the definition of CCOGPE in subsection 66.4(5) of the taxpayer; (b) the credit balance in the CCDE that must be included in income under paragraph 59(3.2)(c); and (c) the income for the year before the application of section 59.1. 12. If the amount of the proceeds of disposition under the election is more than the total of the taxpayer's designated resource expenses for the subsequent ten taxation years, the taxpayer's return of income for the year of the election will be reassessed, under paragraph 59.1(b). Under such a reassessment, an amount equal to the excess of the elected proceeds of disposition over the designated resource expenses will be added to income, and any additional tax, interest or penalty may be assessed notwithstanding that the income tax return for the year would otherwise be statute barred under subsections 152(4) and (5). 13. Paragraph 59.1(c) deems the designated resource expenses not to be CEE, CDE or COGPE, as the case may be, except for the purposes of subsections 66(12.1), (12.2), (12.3) and (12.5) and for the purpose of calculating the taxpayer's earned depletion base under section 65 and Part XII of the Income Tax Regulations. Thus, the designated resource expenses cannot also be treated as CEE, CDE or COGPE for which the taxpayer could claim a deduction. The exception ensures that any recovery of the designated resource expenses will, as provided for in subsections 66(12.1), (12.2), (12.3) and (12.5), give rise to an income inclusion. Farm-out transactions 14. It is possible to have a disposition under a farm-out transaction that does not give rise to proceeds of disposition. This paragraph provides three examples of farm-out transactions in the oil and gas industry that do not give rise to proceeds of disposition. The following terminology is used in these examples. AEquipping costs@ refers solely to equipment acquired to be used at the wellsite primarily for the purpose of producing petroleum substances from a completed well including a pump or other artificial lift equipment, the flow lines and production tankage serving the well, a heater, dehydrator or other wellsite facility for the initial treatment of petroleum substances produced from the well to prepare such production for transportation to market. Equipping costs excludes any such equipment, installation or facility that is, or is intended, to be a production facility, or any property described in paragraphs (b), (c) or (d) of the definition of Agas or oil well equipment@ in subsection 1104(2) of the Income Tax Regulations. AProduction facility@ generally means any facility serving or intended to serve more than one well. This includes any battery, separator, compressor station, gas processing plant, gathering system, pipeline, production storage facility or warehouse. AUnproven resource property@ refers to a resource property for which proven reserves have not been attributed. Proven reserves for an oil and gas resource property are the estimated quantities of petroleum and natural gas which geological and engineering data demonstrate, with reasonable certainty, to be recoverable in the future under existing economic and operating conditions. Examples of farm-out transactions $ In a simple farm-out transaction, an owner (a farmor) of an unproven resource property may transfer a part interest in the property to another person (a farmee) in exchange for exploration and development work on the transferred property. The farmee undertakes to perform (and pay for) farm-out services on the property, in the form of exploration and development expenses. $ In a typical farm-out transaction, a farmor may transfer to the farmee all of the working interest in an unproven resource property in exchange for a percentage royalty in the production from the resource property comprising oil and gas rights. The farmee agrees to pay for exploration and development and equipping costs. After the farmee recovers the total of the exploration and development and equipping costs incurred on the property (Apayout@), a percentage of the working interest reverts to the farmor together with a pro rata ownership interest in the depreciable property that was acquired to equip the well. To the extent that the disposition by a farmor (in a simple farm-out or a typical farm-out transaction) of an interest in an unproven resource property can be considered an exchange for farm-out services, in the form of exploration or development costs and equipping costs incurred by the farmee, the disposition does not give rise to proceeds of disposition to the farmor that are accounted for in the manner outlined in 2 above. Similarly, the payout transaction referred to in the typical farm-out transaction above does not give rise to any proceeds of disposition. $ In a widespread farm-out transaction, a farmee agrees to conduct exploration and development work on a farmor's unproven resource property in exchange for an interest in some other property (another unproven resource property or other property) of the farmor.

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Widespread farm-outs in which the farmee receives unproven resource property of the farmor, in exchange for farm-out services in the form of exploration and development work by the farmee in another unproven property of the farmor, will not give rise to proceeds of disposition, whether or not the unproven resource property is contiguous to the property explored and developed by the farmee. Widespread farm-outs in which the farmor transfers property other than unproven resource property will be treated as a disposition by the farmor for proceeds of disposition equal to the fair market value of the property transferred as of the date the widespread farm-out was entered into. The farmee's cost of the transferred property will equal the proceeds of disposition of the farmor. Furthermore, subsection 66(12.1) will apply to reduce exploration and development expenses incurred by the farmee for the transferred property. The discussions regarding simple, typical and widespread farm-outs in the oil and gas industry generally apply to the mining industry. Deceased taxpayers 15. Under subsection 70(5.2), and for the purposes of subsection 59(1), paragraph (a) of the description of F in the definition of CCDE in subsection 66.2(5) and paragraph (a) of the description of F in the definition of CCOGPE in subsection 66.4(5), resource properties are deemed to be disposed of immediately before death by the deceased for proceeds of disposition equal to their fair market value at that time, subject to the rules discussed in 17 below. The deemed proceeds of disposition receive similar tax treatment as those for proceeds of disposition previously described in this bulletin. 16. If, subsequent to the reduction for the deemed proceeds of disposition to the CCDE or the CCOGPE, a debit balance remains, a deduction in an amount not exceeding 30% of the residual CCDE, or not exceeding 10% of the residual CCOGPE, may be claimed in the year of death, under subsections 66.2(2) and 66.4(2) respectively. No further deduction is allowed for any unclaimed balances. 17. Paragraph 70(5.2)(b) provides that where a resource property was owned by a taxpayer resident in Canada immediately before death, and if it can be shown, within the period ending 36 months after the death of the taxpayer (or where written application therefor 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), that the property has become vested indefeasibly in the taxpayer's spouse (who was resident in Canada immediately before the taxpayer's death) or a trust described in paragraph 70(6)(b), the following rules apply: (a) The deceased taxpayer's legal representative may specify, in the deceased individual's income tax return referred to in paragraph 150(1)(b), the amount of the proceeds of disposition deemed to have been received. However, this amount may not exceed the fair market value of the property immediately before death. (b) The cost of acquisition to the spouse or trust is the portion of the amount specified by the deceased taxpayer's legal representative. This amount is included in the deceased's income under subsection 59(1) or included in the amount determined under paragraph (a) of the description of F in the definition of CCDE in subsection 66.2(5), or paragraph (a) of the description of F in the definition of CCOGPE in subsection 66.4(5), as the case may be, for the property. 18. The additional tax payable where subsection 70(5.2) applies may be paid in up to ten equal consecutive annual instalments when the conditions in subsection 159(5) are met (see Form T2075, Election to Defer Payment of Income Tax, under Subsection 159(5) of the Income Tax Act, by a Deceased Taxpayer's Legal Representative or Trustee).

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Appendix 5


April 8, 1988, ATrusts C Amount Payable@

1. Subsection 104(6) of the Act, which permits a trust to deduct certain amounts in computing income, applies to an Aemployee trust@ and a Atrust governed by an employee benefit plan@ in paragraphs 104(6)(a) and (a.1) respectively while paragraph 104(6)(b) applies to any other trust. This bulletin deals only with income deductions allowed under subsection 104(6) to trusts to which paragraph 104(6)(b) applies. AEmployee trusts@ and Atrusts governed by employee benefit plans@ are dealt with in IT-502. See IT-342 for information concerning amounts to be included in computing the income of a beneficiary of a trust to which paragraph 104(6)(b) applies. 2. Subject to the limitations on spouse trusts as explained in 3 below, a trust to which paragraph 104(6)(b) applies can, by virtue of that paragraph, deduct from its income for a taxation year such part of its income, including its net taxable capital gains, as was payable in the year to a beneficiary. However, the amount so deducted must, by virtue of subsection 104(13), be included in the income of the beneficiary to whom it was payable. The meaning of Aan amount payable in a taxation year@ is defined in subsection 104(24) as an amount (a) that is paid in the year to the person to whom it was payable, or (b) with respect to which the person to whom it was payable is entitled in the year to enforce payment. 3. In computing income for a taxation year a trust described in paragraph 104(4)(a) (i.e., a spouse trust) is, by virtue of paragraph 104(6)(b), prevented from deducting such part of its income as was payable in the year to a beneficiary out of taxable capital gains or other income arising as a consequence of a disposition of property under subsection 104(4) or (5) or 107(4) unless (a) the trust was created before November 13, 1981, and (b) the disposition was made to a person referred to in any of subparagraphs 110(1)(a)(i) to (vii) or to Her Majesty in right of Canada or a province. Applicable with respect to taxation years ended after September 30, 1983 and before 1986, paragraph 104(6)(b) imposed the same restriction with respect to taxable capital gains arising as a consequence of a deemed disposition, under subsection 104(5.1), of indexed securities owned under an indexed security investment plan. 4. Although the beneficiaries of a trust may have the power to amend the trust deed at any time so as to cause the income to be payable to them, the mere presence of this unexercised power is not a basis for treating trust income as being payable for purposes of subsections 104(6) and (24). An amount becomes payable only when the power has in fact been exercised and the trust deed amended accordingly. Furthermore, even though some or all of the beneficiaries are themselves tax exempt, the trust is nevertheless taxable on its income except to the extent that such income is payable to its beneficiaries. However, for the 1987 and subsequent taxation years, a trust will be exempt from Part I tax on its taxable income if it is a prescribed master trust that holds investments exclusively for registered pension funds or plans and elects to have the provisions of paragraph 149(1)(o.4) apply. 5. Where a beneficiary can enforce payment of an amount in respect of trust income by forcing the trustee, in accordance with the terms of the trust deed, by common or statute law or by some other authority, to wind up the trust, it is the Department's view that no amount becomes payable until such time as the beneficiary exercises the authority and in fact causes the trust to be wound-up, except to the extent that an amount is otherwise paid or payable at an earlier date. This view also applies where the right of a beneficiary to demand a payment of income is subject to the approval of a third party provided for in the trust deed to deal with such matters; no amount is payable until a demand for payment of income has been duly approved by the third party. If a trustee has been given the discretion to distribute any part of the income of the trust, then no amount is payable until the trustee's discretion has been exercised. 6. Under common law rules, the initial 12-month period for a testamentary trust, commencing with the date of the settlor's death, is referred to as the Aexecutor's year@ and the right to income of the trust is, during the executor's year, unenforceable by a beneficiary of the trust. In spite of such common law rules, where the initial taxation year of a testamentary trust coincides with the executor's year and where the sole reason for the rights of a beneficiary being unenforceable is the existence of an executor's year, the Department will consider the income of the trust for that year to be payable to the beneficiary or beneficiaries of the trust pursuant to subsection 104(24). However, if even one beneficiary of the trust objects to this treatment with respect to the executor's year, the income of the trust for that year, to the extent that it was not actually disbursed during that year, will be taxed in the hands of the trust. In any case where the trust has been wound-up and the final T-3 return is filed for a period which terminates before the end of the executor's year, the income of the trust (including taxable capital gains) earned for that period is considered to have been paid to the beneficiaries of the trust in the calendar year in which that period ends, except

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for any part of the trust's income that was disbursed by the trustee to persons other than beneficiaries pursuant to the deceased's will or the operation of law (e.g., the will stipulated that debts are to be paid out of income). 7. Pursuant to subsection 104(18) income is considered to be payable for purposes of subsections 104(6) and (13) where (a) the income is held in trust for a minor whose right thereto has vested, and (b) the only reason that it was not payable was because the beneficiary was a minor. The right referred to in (a) does not have to vest indefeasibly. The requirement in (b) will be complied with where the terms of the trust provide that the amount be withheld solely because the beneficiary is a minor. However, where the terms of the trust agreement provide that the payment may be withheld for any reason other than that described in (b) above, subsection 104(18) does not apply. This would be the case where, for example, a trustee is given discretionary power by the terms of a trust agreement to withhold trust funds and chooses to withhold income of the trust because either the beneficiary or the beneficiary's guardian is not in need of funds. Mutual Fund Trusts 8. The mere right of a unit-holder to redeem units on demand would not be sufficient to meet the payment enforcement requirements of subsections 104(6) and (24). Any income allocation must be accompanied by a valid resolution or declaration of the trustees whereby the unit-holders acquire an irrevocable right to enforce payment. By this means the income allocated is subject to tax in the hands of the unit-holders. A clause in the trust agreement, conferring on the unit-holders a legal right to enforce payment of the trust's income in the year, would have the same result. 9. The amount payable does not have to be paid in cash. An allocation of additional units in relation to the unit-holder's interest in the trust income would also be an amount payable in the year for the purposes of subsection 104(6). 10. Special rules are provided in subsection 52(6) in order to avoid double taxation when an amount payable was not paid in fact, but capitalized by the trust. See IT-390, AUnit Trusts C Costs of Rights and Adjustments to Cost Base@.

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Appendix 6

Interpretation Bulletin IT-342R,

March 21, 1990, ATrusts C Income Payable to Beneficiaries@

1. Pursuant to paragraphs 104(13)(a) and (c), an amount payable to a beneficiary out of the income of a trust (see Designations/Allocations to Beneficiaries in the Guide to the T3 Trust Return) for the year is required to be included in computing the income of the beneficiary for the year, whether or not paid to that person in the year, and shall not be included in computing the income of the beneficiary for a subsequent year in which it is paid. In addition, under subsection 105(2) a reasonable portion of amounts paid out of the income of a trust for the upkeep of property maintained under the terms of the trust arrangement for the use of a life tenant or other beneficiary (page 2 of Form T3) is required to be included in the income of the life tenant or other beneficiary for the taxation year for which the amounts were paid. For taxation years of trusts beginning after 1987 certain designated amounts paid or payable to a beneficiary may be excluded in computing the income of the beneficiary (see 4 below). Meaning of AAmount Payable@ 2. Pursuant to subsection 104(24), an amount is not considered to be payable in a taxation year unless it is paid in the year to the person to whom it is payable or the person to whom it is payable is entitled in the year to enforce payment thereof. However, subsection 104(18) provides that where a right to the income of a trust has vested in a minor, income of the trust which has not become payable in the year to such beneficiary, solely because the beneficiary was a minor, shall be deemed to have become payable in the year. It should be noted that foreign accrual property income of a non-resident trust is included in the income of a beneficiary pursuant to paragraph 104(13)(c) to the extent that the amount may reasonably be considered to have become payable to a beneficiary within the meaning of subsection 104(24). That amount is deductible by the non-resident trust by virtue of subsections 94(3) and (4). Flow-Through of Deductions 3. For taxation years of trusts beginning before 1988, deductions for capital cost allowance and terminal losses, in respect of depreciable property owned by a trust, may be claimed in determining the taxable income of the trust. Alternatively, trustees may designate that a specified amount of capital cost allowance and terminal losses be flowed-out and deducted by beneficiaries in determining their income. Also, for taxation years of trusts beginning before 1988, subsection 104(17) permits a designation of depletion allowance so that depletion on certain types of resource property owned by a trust may be deducted by beneficiaries from the income payable to them by the trust. Effective for taxation years of trusts commencing after 1987, capital cost allowance, terminal losses and depletion are deductible only in determining the income of a trust (page 2 of Form T3). Consequently income payable by a trust to beneficiaries in years commencing after 1987 is no longer eligible for the aforementioned deductions by beneficiaries. Designation of Trust Income Payable to Beneficiaries 4. For taxation years of trusts commencing after 1987, paragraph 104(6)(b) allows a trust to deduct from its income less than the full amount of its income that was paid or payable to its beneficiaries. To facilitate this, subsection 104(13.1) permits a trust resident in Canada throughout the year, other than a trust exempt from tax by reason of subsection 149(1), to designate to its beneficiaries their respective shares of that portion of the trust's income payable to them in the year under subsections 104(13) or 105(2) that has not been deducted by the trust under paragraph 104(6)(b). Similarly, subsection 104(13.2) allows the same type of trust to designate to its beneficiaries their respective shares of that portion of taxable capital gains payable to them in the year under subsection 104(13) pursuant to subsection 104(21) that has not been deducted by the trust under paragraph 104(6)(b) or used in the designation under subsection 104(13.1). The designated amounts under subsections 104(13.1) and (13.2) are deemed not to have been paid or to have become payable in the year to or for the benefit of the beneficiaries for the purposes of subsections 104(13) and 105(2). Consequently, the designated amounts are taxable to the trust and not to the beneficiaries. Subsection 104(13.1) enables a trust which must pay out all of its income to its beneficiaries to use its non-capital losses from prior taxation years without affecting the ability of the trust to distribute its income currently. Subsection 104(13.2) contemplates the situation where a trust has net-capital or non-capital loss carryforwards from a prior taxation year and current taxable capital gains. In such circumstances, the trust may choose not to deduct the full amount to which it is entitled under subsection 104(6) in order to allow the net-capital or non-capital loss carryforwards to absorb the current taxable capital gain (page 3 of Form T3). For taxation years of trusts beginning before 1988, there is no provision in the Act which permits the taxation to the trust of amounts that are otherwise required to be included in computing the income of a beneficiary.

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As regards trusts not resident in Canada, all amounts that become payable to beneficiaries are included in their income with the exception of (a) proceeds of disposition of part or all of the interest of a beneficiary in a trust, or (b) where the trust is a personal trust, as defined in subsection 248(1) (see 5 below), a distribution of capital. Adjustments to Adjusted Cost Base 5. Amounts designated by a trust pursuant to subsections 104(13.1) or (13.2), as described in 4 above, may reduce the adjusted cost base of the capital interest of the beneficiary in the trust. In the case of beneficiaries of a personal trust, there is no reduction of the adjusted cost bases of their capital interests unless they were acquired for consideration. A personal trust, defined in subsection 248(1), is either a testamentary trust or an inter vivos trust in which no beneficial interest was acquired for consideration payable to the trust or to a person who has made a contribution to the trust. However, the mere retention at the time the trust was created of an interest in an inter vivos trust by the individual or related individuals who settled the trust will not result in the trust not qualifying as a personal trust. For the purposes of the definition of a personal trust, love and affection will not be regarded as consideration. In general, trusts other than personal trusts may be described as commercial trusts and designations pursuant to subsection 104(13.1) or (13.2) will reduce the adjusted cost base of the capital interest of the beneficiary in such trusts in accordance with paragraph 53(2)(h). When Income is Earned 6. The amounts required to be included in computing the income of a beneficiary for a taxation year under subsections 104(13) and 105(2) are considered to have been earned by the beneficiary on the last day of the taxation year of the trust and are thus in respect of the taxation year or years of the trust which ended in the taxation year of the beneficiary. Where the beneficiary is a non-resident of Canada on the last day of the trust's taxation year, the amounts referred to above are subject to withholding tax pursuant to paragraph 212(1)(c), except where the exemptions provided in subsections 212(9), 212(10) and, for 1987 and prior taxation years, 212(11.1) are applicable. Phantom Income 7. Pursuant to subsection 104(29), certain income of a trust, sometimes referred to as phantom income, may be designated by the trust and, as a result, is deemed to have become payable to particular beneficiaries by the trust. For taxation years of trusts commencing after 1987, this designation may be made only by a trust for a taxation year throughout which it was resident in Canada. Such designated amounts, which would otherwise be taxable to the trust, may be treated as income of beneficiaries of the trust under subsection 104(13) and may be deducted in determining the income of the trust pursuant to subsection 104(6). The amount in respect of which a trust may make this designation is the aggregate of (a) non-deductible charges under the Petroleum and Gas Revenue Tax Act pursuant to paragraph 18(1)(l.1), (b) non-deductible Crown charges under paragraph 18(1)(m), (c) Crown payments included in income under paragraph 12(1)(o), and (d) income inclusions resulting from transactions with the Crown which take place at other than fair market value under subsections 69(6) and (7), less the aggregate of (e) the resource allowance available to the trust under paragraph 20(1)(v.i), and (f) amounts which would be included in the income of the trust but for section 80.2 (reimbursement of Crown charges). Pursuant to paragraphs 104(29)(c) and (d), the amount of the designation is limited to the proportion of the phantom income, as calculated in (a) to (f) above, that the trust-purpose income payable to all beneficiaries is of the total trust-purpose income for the year. Trust-purpose income is income of the trust determined without reference to the Income Tax Act. The total amount of the designation, subject to the limit imposed above, may be allocated among the beneficiaries provided that the allocation to a particular beneficiary is reasonable having regard to the proportion of trust-purpose income included in the income of that beneficiary. Part XII.2 Tax 8. Part XII.2 of the Act was added applicable to the 1988 and subsequent taxation years and it assesses a special tax on the designated income, as defined in subsection 210.2(2), of certain trusts. Part XII.2 tax generally applies where designated income of a trust is payable during the year to designated beneficiaries (generally non-residents and exempt persons) as defined in section 210, but does not apply, where, throughout the year, the trust was (a) a testamentary trust, (b) a mutual fund trust, (c) a trust exempt from tax by reason of subsection 149(1), (d) a trust described in subparagraph 108(1)(j)(ii) or (iv), or (e) a non-resident trust. These provisions are intended to ensure that designated income earned by trusts for the benefit of non-residents and exempt persons will be subject to full tax rates rather than the lower non-resident tax rates under Part XIII or no rate at all in the case of exempt persons.

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When a trust is subject to Part XII.2 tax and has taxable resident beneficiaries, or non-resident beneficiaries whose tax liability is computed under Part I of the Act, or both, a pro rata share of the Part XII.2 tax can be designated by the trust in respect of any of the aforementioned beneficiaries. Such share of tax is then deemed by subsection 210.2(3) to be an amount paid on account of the tax payable under Part I for the beneficiary's taxation year in which the taxation year of the trust ends. The amount deemed by subsection 210.2(3) is also deemed, by subsection 104(31), to be an amount in respect of the income of the trust for the year that has become payable by the trust to the beneficiary at the end of the year. That amount is included in the beneficiary's income under subsection 104(13). Subsection 104(31) applies to taxation years of trusts commencing after 1987. Part XII.2 tax may be calculated on Form T3 Trust Schedule 4.

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Appendix 7

Interpretation Bulletin IT-524,

March 16, 1990, ATrusts C Flow Through of Taxable Dividends to a Beneficiary C After 1987"

1. A trust that is resident in Canada throughout a taxation year in which it receives a taxable dividend on a share of the capital stock of a taxable Canadian corporation may, pursuant to subsection 104(19), designate in its return of income for a particular taxation year, in respect of a beneficiary resident in Canada, such portion of the taxable dividend as may reasonably be considered to be part of the amount that is required to be included in computing the beneficiary's income for that particular year as: (a) an amount Apayable@ under subsection 104(13), (b) an amount upon which the trust and a preferred beneficiary have elected under subsection 104(14), or (c) a benefit under section 105 conferred upon a beneficiary by the trust. 2. In determining whether the portion of a taxable dividend to be designated in respect of a particular beneficiary may reasonably be considered to form part of that beneficiary's income, all the circumstances, including the terms and conditions of the trust arrangement, are considered. An amount so designated is deemed to be received by the beneficiary and not by the trust for purposes of computing dividend income of both the trust and the beneficiary. 3. The particular beneficiary is required to include the deemed dividend in income. If the beneficiary is an individual (other than a trust which is a registered charity), the dividend gross-up under paragraph 82(1)(b) and the dividend tax credit under section 121 apply. If the beneficiary is a corporation, it is normally eligible for the intercorporate dividend deduction under subsection 112(1). However, the corporate beneficiary may be subject to the provisions of Part IV or of Part IV.1 of the Act in respect of the dividend it is deemed to have received. 4. To the extent that taxable dividends received by a trust from taxable Canadian corporations are not designated to beneficiaries under subsection 104(19), the gross-up provisions of paragraph 82(1)(b) apply to the trust and it is eligible for the dividend tax credit under section 121. While the dividend tax credit is available to the trust in respect of undesignated taxable dividend income, it can be fully utilized only if the tax otherwise payable by the trust under Part I of the Act is equal to or is in excess of the credit. 5. In a case where there is only one beneficiary or where all beneficiaries share pro-rata in each type of income, the trust may deduct, to the greatest extent possible, expenses against income other than taxable dividends in order to obtain the maximum possible flow-through of the dividend tax credit to such beneficiary or beneficiaries, provided that an allocation of the expenses in this manner is not contrary to trust law or the trust agreement. However, in a case where all beneficiaries do not share pro-rata in each type of income, expenses that clearly pertain to the dividend income must be deducted against such income prior to its being designated to the beneficiaries.

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Appendix 8


January 23, 1978, AInadequate Consideration - Acquisitions and Dispositions@

1. Except as expressly provided in the Act, where a taxpayer acquires anything from a person with whom he or she does not deal at arm's length at an amount in excess of its fair market value, the taxpayer is deemed by paragraph 69(1)(a) to have acquired it at its fair market value. This provision has the effect of counteracting any attempt by the taxpayer to inflate the cost of a property in a non-arm's length transaction. 2. The vendor or transferor of the property is required to include the actual proceeds received in computing his or her income. 3. Except as expressly provided by the Act, where anything is disposed of by a taxpayer to a person with whom he or she does not deal at arm's length for no proceeds or for proceeds less than its fair market value, under paragraph 69(1)(b) the taxpayer is deemed to have received proceeds equal to its fair market value. Therefore, except in cases specially provided by the Act, a taxpayer is prevented from reporting artificially reduced amounts of proceeds in computing income. 4. The word Aanything@ as contained in the expressions Aacquired anything@ and Adisposed of anything@ has a broad meaning and can include both tangible and intangible property. 5. In the situations described above, where it can be shown that the transfer occurred at an amount other than the fair market value by reason of an honest error and not by a deliberate attempt to evade or avoid tax, the Department may permit an adjustment in the amount of the proceeds of disposition or purchase price to reflect the amounts deemed by paragraph 69(1)(a) or 69(1)(b) to have been paid or received. The onus will be on either or both taxpayers, as the case may be, to substantiate a claim that the incorrect valuation was caused by an honest error. 6. The practice of permitting an increase in the cost for the purposes of the party who acquired the property does not generally apply in circumstances where beneficial treatment has been obtained by another means; for example, where paragraph 69(1)(b) and clause 89(1)(c)(ii)(B) could both apply in the case of a transfer of property into a corporation, and where the result of allowing an increase in the cost might be that the corporation would obtain a cost base of fair market value for the asset and an addition to paid-up capital at the same time. Price Adjustment Clauses 7. With respect to situations described in either 1 or 3 above, the taxpayer involved may find price adjustment clauses useful provided they comply with the requirements as set out in Interpretation Bulletin IT-169. Appropriation of Property to Shareholder 8. Except where the above-mentioned price adjustment clauses are properly applicable, when a corporation acquires property from a shareholder at an amount in excess of its fair market value or when it disposes of property to a shareholder for no proceeds or for proceeds less than its fair market value, subsection 15(1) may apply.

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Appendix 9

Interpretation Bulletin IT-325R2, January 7, 1994,

AProperty Transfers After Separation, Divorce and Annulment@ Discussion and Interpretation C Subsection 73(1) Rollover 1. Subsection 73(1) allows capital property to be transferred between living persons on a tax-deferred rollover basis to: (a) the spouse of a taxpayer (see 7 below); (b) the former spouse of a taxpayer, in settlement of rights arising out of their marriage; (c) a spousal trust (see 8 below); or (d)in certain cases, to a former Acommon-law@ spouse (see 11 and 12 below). Unless the taxpayer (the transferor) elects not to have the rollover apply (see 5 below), the realization of accrued gains and losses, including any terminal losses or the recapture of capital cost allowance, is postponed until the recipient (the spouse, former spouse or trust) disposes or is deemed to dispose of the property. The values or amounts that apply to subsection 73(1) rollovers are discussed in 3 and 4 below. Some examples of how subsection 73(1) operates are contained in the current version of IT-209, Inter-Vivos Gifts of Capital Property to Individuals Directly or Through Trusts. 2. The property transferred must be a capital property as defined by paragraph 54(b), meaning: (a) any depreciable property of the transferor, and (b) any other property that when disposed of would result in a capital gain or capital loss to the transferor. For subsection 73(1) to apply, both the transferor and the recipient must be resident in Canada at the time of the transfer. This rollover applies to transfers to a spouse or a spousal trust at any time after 1971. Transfers to a former spouse in settlement of rights arising out of marriage, as well as certain transfers to a former common-law spouse (as discussed in 8 and 9 below), are only eligible if the transfer takes place after 1977. Depreciable Property 3. Paragraph 73(1)(e) provides that, in the case of depreciable property, the transferor is deemed to have received proceeds equal to the undepreciated capital cost of the property. The recipient is deemed to have acquired the property for the same amount. If the transferor has more than one property in a prescribed class of depreciable property, but is transferring only part of the property in that class, the undepreciated capital cost of that property is transferred in proportion to its fair market value as determined immediately before the time of transfer, as follows: Fair Market Value of the

Transferred Property --------------------------------------- x Undepreciated Capital Cost of that Class Fair Market Value of All the Property of that Class Subsection 73(2) applies to transfers of depreciable property where the transferor's capital cost is more than the recipient's cost determined under paragraph 73(1)(e). In such cases, for the purposes of sections 13 and 20 and any regulations made under paragraph 20(1)(a), subsection 73(2) deems the capital cost to the recipient of the depreciable property to be the same amount that was the capital cost of the property to the transferor. Any capital cost allowance already claimed for that property by the transferor is deemed to have been allowed to the recipient in years prior to the transfer. Non-depreciable Property 4. Paragraph 73(1)(f) provides that where non-depreciable property, such as land or personal-use property, is transferred, the transferor is deemed to have received proceeds equal to the adjusted cost base of the particular property. The recipient is deemed to have acquired the property for the same amount. Election Not to Have Subsection 73(1) Rollover Apply 5. If the conditions in subsection 73(1) are met, the rollover applies automatically. However, for transfers of property after 1979, the transferor may elect, on a property by property basis, not to have the rollover apply to the property transferred. In such a case, the general rules in section 69 apply to any non-arm's length transfers or gifts and the transferor is generally considered to have disposed of the property for proceeds equal to the fair market value of the property at the time of transfer. As a result, the transferor will realize any capital gain or recapture of capital cost allowance or sustain any capital loss or terminal loss at the time of the transfer. The recipient of the property will be considered to have acquired the property for an amount equal to the transferor's proceeds of disposition. 6. There is no official form for the election not to have the subsection 73(1) rollover apply. This election is normally made by the transferor simply reporting the full tax consequences of the disposition on his or her Income Tax Return for the year of the transfer. This election may result in the transferor realizing a capital gain against which any existing capital losses or unused capital gains deduction may be applied. (However, if the transferor and the recipient

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remain spouses, a capital loss realized on such a disposition of property may be disallowed as a Asuperficial loss@ pursuant to paragraph 54(i) and subparagraph 40(2)(g)(i).) Meaning of Spouse or Former Spouse 7. For transfers of property before 1993, the term Aspouse@ in this bulletin refers to persons who are legally married to each other. However, after 1992, the term Aspouse@ has an extended meaning for all purposes of the Act including property transfers under subsection 73(1). Under subsection 252(4), two individuals of the opposite sex will be considered to be spouses of each other when they are cohabiting in a conjugal relationship and either (a) they have so cohabited throughout the preceding 12 months, or (b) they are the natural or adoptive parents of the same child. Generally, in cases of the annulment of either void or voidable marriages, provisions in the Act relating to spouses will apply to the parties of annulled marriages between the time of the supposed marriage and the declaration of annulment. Subsection 252(3) provides that, for purposes of subsection 73(1), Aspouse@ and Aformer spouse@ includes a party to a void or voidable marriage, as the case may be, with the result that a former spouse includes both a divorced person and a party to a marriage which has been annulled. Transfers to a Former Common-Law Spouse 8. Certain transfers of capital property made after July 13, 1990 and before 1993 to a former common-law spouse are subject to the subsection 73(1) rollover. To qualify, the transfer must be: (a) made to an individual of the opposite sex with whom the taxpayer cohabited in a conjugal relationship before the date of the order; and (b) made pursuant to an order for support or maintenance of the individual, where that order is made by a competent tribunal in accordance with the applicable provincial laws. As indicated in 7 above, the definition of Aspouse@ after 1992 includes many Acommon-law@ relationships. 9. Transfers of capital property made by a taxpayer before July 14, 1990 pursuant to a decree, order or judgment of a competent tribunal in accordance with prescribed provisions of the law of a province, and made to an individual who was the taxpayer's partner in a common-law relationship, are treated in the same way as transfers to a former spouse, if the individual: (a) had entered into a written agreement with the taxpayer in accordance with such provisions, or (b) had been a partner with the taxpayer in a common-law relationship of some permanence as described in prescribed provisions of the law of a province. The relevant provisions of the provincial laws are prescribed by subsection 6500(1) of the Regulations. Although only provisions of the Ontario Family Law Reform Act, 1978, dealing with transfers of property to satisfy support obligations are actually prescribed, this is considered to include similar provisions under the Ontario Family Law Act. Transfer to a Spousal Trust 10. Paragraph 73(1)(c) allows rollover treatment when capital property is transferred to what is known as a spousal trust. This is a trust created by the taxpayer (the transferor) under which: (a) the taxpayer's spouse is entitled to receive all of the income of the trust that arises before his or her death; and (b) no person except the spouse may, before the spouse's death, receive or otherwise obtain the use of any of the income or capital of the trust. 11. A spousal trust continues to be a spousal trust even after a divorce or an annulment. Subsection 104(4) will apply so that the spousal trust is normally deemed to dispose of its capital property, other than depreciable property, at fair market value on the death of the spouse. (Special rules apply to pre-1972 spousal trusts.) Trust Created to Make Alimony or Maintenance Payments 12. When a taxpayer creates a trust to make alimony or maintenance payments to a spouse or former spouse and subsection 75(2) applies to the trust, the trustee is considered to be acting as an agent for the taxpayer. The income and taxable capital gains of the trust are deemed to be the income and taxable capital gains of the taxpayer and are taxable in the taxpayer's hands. However, the taxpayer is allowed a deduction under paragraph 60(b), (c) or (c.1) if the payments otherwise qualify and the amount is taxable to the spouse under paragraph 56(1)(b), (c) or (c.1). Meaning of Transfer 13. The term Atransfer@ has a broad meaning that encompasses virtually any means by which ownership or title to property is conveyed from one person to another, or to a trust. It therefore includes a sale of property, whether or not it was made at fair market value. However, it does not include a genuine loan. 14. In addition, some provinces have enacted legislation declaring that a spouse has a specified interest in certain property owned by the other spouse or providing for such a determination by a court. Property that passes under these provisions may not constitute a Atransfer@ under the general legal meaning. For greater certainty, subsection 73(1.1) deems a transfer to have occurred in many of these cases. Subsection 73(1.1) applies if, by the operation of the provisions of a provincial law prescribed by subsection 6500(2) of the Regulations, or by virtue of a decree, order or judgment of a competent tribunal made in accordance with such provisions, a recipient referred to in 1 above

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(a) acquires or is deemed to have acquired, (b) is deemed or declared to have or is awarded, or (c) has vested in him or her, property that was a capital property of the transferor (or would have been but for such provisions). In these cases, that property is, for the purposes of subsection 73(1), deemed to be a capital property that has been transferred to the recipient. (The references to provincial laws in subsection 6500(2) of the Regulations are considered to include similar provisions under the current family laws of those provinces.) Note: If a measure contained in the draft Amendments to the Income Tax Act and Regulations issued by the Minister of Finance on August 30, 1993, is enacted as proposed, subsection 73(1.1) will not be limited to transfers made pursuant to provincial laws that are prescribed by Regulation. As amended, subsection 73(1.1) will apply to a transfer of the type described in 14 above that is made after July 13, 1990, provided the transfer is made under the laws of a province or because of a decree, order or judgment of a competent tribunal made in accordance with such provincial laws. Transfer to Satisfy Obligation for Equalization Payment 15. In some cases, an obligation to make an Aequalization payment@ arising under the Ontario Family Law Act, or a similar provision under the law of another province, may be satisfied or settled by a transfer of a capital property between the spouses or former spouses. Such a transfer would be considered to be in settlement of rights arising out of the marriage for the purposes of paragraph 73(1)(b), and is eligible for the rollover provided it otherwise qualifies. Attribution Rules 16. Even if a subsection 73(1) rollover applies to a transfer, capital property transferred between spouses may still be subject to the rules in sections 74.1 and 74.2 concerning the attribution of income and capital gains to the transferor. The attribution rules are discussed in greater detail in the current version of IT-511, Interspousal and Certain Other Transfers and Loans of Property Made After May 22, 1985, and the following points are noteworthy: (a) The attribution rules cease to apply after divorce. (b) The rules concerning the attribution of income do not apply for the period that the parties are living separate and apart by reason of a marriage breakdown. (c) The rules concerning the attribution of capital gains and losses do not apply to dispositions of property while the parties are living separate and apart by reason of a marriage breakdown, if the parties jointly elect not to have section 74.2 apply. (d) The attribution rules do not apply if fair market consideration is paid for the property transferred and an election is made to not have the subsection 73(1) rollover apply. Property Subject to an Interest of a Spouse Under a Matrimonial Regime in the Province of Quebec 17. Subsections 248(22) and (23) set out rules that apply after July 13, 1990 to govern property in which both spouses have an interest under a matrimonial regime and which therefore could be subject to partition on dissolution of that matrimonial regime. These rules only apply to matrimonial property regimes created under the civil law in Quebec (or in another civil law jurisdiction) that involve some common interest between the spouses, such as a community of property. These rules clarify the tax treatment of the income and capital gains attributable to the property during the matrimonial regime and upon its dissolution. 18. Property that has been continuously owned by one spouse since before the property became subject to the matrimonial regime is deemed by paragraph 248(22)(a) to be owned exclusively by that spouse, even though the other spouse has an interest in the property. Accordingly, all income and capital gains from that property while it is subject to the matrimonial regime are attributable to the owner spouse. 19. Property not meeting the conditions in 18 above is deemed by paragraph 248(22)(b) to be owned exclusively by the spouse who has the administration of it, with the same tax consequences as outlined in 18 above. This rule would apply to common property that is subject to the particular matrimonial regime from the moment it is acquired. It would also apply to property that was disposed of or gifted by one spouse in favour of the other during the existence of the matrimonial regime. 20. Subsection 248(23) deems a transfer to have occurred as a result of certain property allocations on the dissolution of the matrimonial regime. A matrimonial regime may be dissolved (a) by the death of a spouse, (b) upon separation or divorce, or (c) by a change from one type of matrimonial regime to another, e.g., from a community of property regime to a partnership of acquests or, if the parties move from Quebec, to a system in place in another jurisdiction. 21. Upon dissolution of the matrimonial regime, the property in which the spouses have a common interest may be allocated between the spouses (or between a spouse and the estate of a deceased spouse, as the case may be). This allocation is referred to as a partition in civil law and operates as a judicial division of property. Subsection 248(23) provides that the allocated property is deemed to have been transferred from one spouse to the other if, immediately after a dissolution of a matrimonial regime, the spouse to whom a property is allocated is not the same spouse (or that spouse's estate) who was the deemed owner of the property immediately before the dissolution. (As discussed in

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18 and 19 above, subsection 248(22) sets out the rules to determine who was the deemed owner before the dissolution.) This deemed transfer takes place immediately before the dissolution of the matrimonial regime. Accordingly, the realization of accrued gains may be postponed by virtue of the subsection 73(1) rollover. Where the conjugal relationship continues and the dissolution of the matrimonial property regime arises as a result of a simple change from one form of matrimonial regime to another (e.g. from community of property to separation of property), the attribution rules discussed in 16 above will also apply to such a transfer. 22. In the case of a dissolution of a matrimonial regime following the death of one spouse, a deemed transfer under subsection 248(23) resulting from an allocation of property to a spouse would occur immediately before the deemed disposition on death set out in subsections 70(5) and (6). As a result, any property so allocated to the deceased spouse or to that spouse's estate, would also be subject to the deemed disposition on death rules in the hands of the deceased spouse. Similarly, property deemed to be owned by the deceased spouse and that was allocated upon the dissolution of the matrimonial regime to the surviving spouse will be deemed to have been transferred to the surviving spouse immediately before the deemed disposition on the death of the deceased spouse. As a result, the deemed disposition on death set out in subsections 70(5) and 70(6) will not apply at this time to this property in the hands of the surviving spouse. Note: The preceding comments may be affected by the draft Amendments to the Income Tax Act and Regulations issued by the Minister of Finance on August 30, 1993. If enacted as proposed, the draft legislation amends subsection 248(23) and adds subsection 248(23.1). Consequently, in cases of dissolution or death occurring after December 21, 1992, property transferred between spouses as a result of the dissolution of a matrimonial regime occurring as a consequence of the death of a spouse will not be governed by subsection 248(23) as explained in 22 above, but rather by new subsection 248(23.1), as explained in 23 below. Transfers After Death 23. Subsection 248(23.1) will apply to certain transfers of property occurring after the death of a taxpayer who dies after December 21, 1992, if the transfer is made as a consequence of the laws of a province relating to spouses' interests in property that result from marriage. This subsection applies not just to transfers resulting from rights under matrimonial regimes under the civil law of Quebec, but also to transfers made as a consequence of the laws of other provinces that provide for the sharing of property used by spouses during marriage. Where these conditions are met, subsection 248(23.1) applies as described below to the following two situations. (a) If property is transferred to the person who was the taxpayer's spouse at the time of the taxpayer's death, that property shall be deemed to have been disposed of as a consequence of the taxpayer's death. As a result, such transfers may benefit from the tax-deferred rollover of property between spouses on death, which is provided for in subsection 70(6). (b) If property is transferred from the person who was the taxpayer's spouse at the time of the taxpayer's death and the transfer is made to that deceased taxpayer's estate, that property shall be deemed to have been transferred immediately before the time that is immediately before the death of the taxpayer. As a result, such transfers may benefit from the tax-deferred rollover between living spouses, which is provided for in subsection 73(1).

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Appendix 10


April 15, 1996, AInter Vivos Transfer of Farm Property to Child@

1. In this bulletin, the terms listed below have the following meanings: Child: The definition of Achild@ in subsection 70(10) (which also applies to section 73 by virtue of subsection 73(6)) and the description in subsection 252(1) expand the usual meaning of child to include: (a) a child of the taxpayer whether born within or outside marriage; (b) a spouse of a child; (c) a step-child; (d) an adopted child; (e) a grandchild; (f) a great-grandchild; and (g) a person adopted-in-fact. To be adopted-in-fact for the purposes of (g) above, paragraph 252(1)(b) provides that an unrelated person will be deemed to be a taxpayer's child if that person is wholly dependent on the taxpayer for support and if the taxpayer has, in law or in fact, custody and control of the person (or had such custody and control immediately before that person turned 19 years old). Eligible capital property includes agricultural quotas. Land of a taxpayer includes, for purposes of subsection 73(3), an interest in a parcel of land held jointly or in common with one or more other persons. Parent: Subsection 252(2) extends the normal meaning of Aparent.@ A parent of a child includes an individual: (a) who is a natural parent, a stepparent or an adoptive parent of the child; (b) who is a natural parent, a stepparent or an adoptive parent of the child's spouse; or (c) of whom the child is or was considered to be a child. If a person who has not attained 19 years of age is under the custody and control of an individual and the individual is receiving support payments from an agency responsible for the person's care, the individual is not the parent of the person since the person is not wholly dependent on the individual. The definition of spouse is relevant to an understanding of who is a parent. Spouse: A person can become an individual's spouse either as a result of their marriage or as a consequence of the operation of subsection 252(4). The subsection expands the meaning of Aspouse@ to include what is generally referred to as a Acommon-law@ spouse. Farm Property Transferred 2. Subsection 73(3) applies when a parent while living transfers, to his or her child, property used in a farming business by the parent, the parent's spouse or child. (See 6 below for further details.) The property may be land in Canada, depreciable property in Canada of a prescribed class, or eligible capital property of a business carried on in Canada. The transfer may be by way of sale or gift. If the parent transfers a particular piece of farm property for an amount of actual proceeds of disposition (consideration) within the relevant limits set out in (a) to (c) below, that amount is deemed to be the parent's proceeds of disposition and the cost of acquisition of that property to the child. Such a transfer is commonly referred to as a Arollover.@ If the consideration is in excess of the greater of the applicable limits described in (a) to (c) below, then the greater of those limits is deemed to be the parent's proceeds of disposition and the child's cost of acquisition. On the other hand, if the consideration is less than the lesser of the applicable limits in (a) to (c) below, then the lesser of those limits is deemed to be the parent's proceeds of disposition and the child's cost of acquisition. Under the rules in paragraphs 73(3)(a) (for depreciable property of a prescribed class), 73(3)(b) (for land) or 73(3)(b.1) (for eligible capital property), a parent's deemed proceeds of disposition may be: (a) in the case of depreciable property of a prescribed class, any amount between the fair market value of the property and its undepreciated capital cost as determined pursuant to clause 73(3)(a)(ii)(B) (see below); (b) in the case of land, any amount between the fair market value of the property and its adjusted cost base; and (c) in the case of eligible capital property of a business of the parent, any amount between the fair market value of the property and the amount determined in the formula in clause 73(3)(b.1)(ii)(B) (see below). Clause 73(3)(a)(ii)(B) provides that the undepreciated capital cost of a depreciable property is the proportionate share of the undepreciated capital cost of the class that the fair market value of the property is of the fair market value of all the property in that class.

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The amount in clause 73(3)(b.1)(ii)(B) is equal to 4/3 times the proportionate share of the cumulative eligible capital of the business that the fair market value of the eligible capital property is of the fair market value of all the eligible capital property of the business. A4/3@ is required, in view of the 3/4 inclusion rate for eligible capital property, to place the child in the same tax position as the parent concerning the property. In applying these rules, the fair market value, adjusted cost base, undepreciated capital cost of property and the cumulative eligible capital, as the case may be, are computed immediately before the time of transfer. 3. The following are examples of the application of paragraph 73(3)(b): (a) Farm land with an adjusted cost base of $8,000 and a fair market value of $14,500 is transferred to a farmer's child. Case 1 Case 2 Case 3 Case 4 Case 5 If the agreed selling price is $7,000 $8,000 $13,500 $16,000 NIL The deemed proceeds will be $8,000 $8,000 $13,500 $14,500 $8,000 (b) Farm land with an adjusted cost base of $8,000 and a fair market value of $6,500 is transferred to a farmer's child. Case 1 Case 2 Case 3 Case 4 Case 5 If the agreed selling price is $6,000 $6,500 $8,000 $9,500 NIL The deemed proceeds will be $6,500 $6,500 $8,000 $8,000 $6,500 4. Pursuant to paragraph 73(3)(c), section 69 does not apply in determining the proceeds of disposition of depreciable property, land or eligible capital property under subsection 73(3). 5. The application of the rules in paragraphs 73(3)(a), (b) and (b.1) requires the determination of an amount described in those paragraphs as Athe proceeds of disposition otherwise determined.@ For purposes of those provisions, the term Aproceeds of disposition otherwise determined@ generally means the amount of consideration paid or payable by a child on a transfer of farm property. In the case of a gift, there is no consideration paid or payable and, because of paragraph 73(3)(c), section 69 does not apply to otherwise determine the proceeds of disposition on such a transfer. In addition, subsection 20(1) of the ITAR has no application in determining Aproceeds of disposition otherwise determined@ for purposes of paragraph 73(3)(a). Similarly, subsection 21(1) of the ITAR does not apply in determining Aproceeds of disposition otherwise determined@ for purposes of paragraph 73(3)(b.1). 6. The provisions of subsection 73(3) apply only if: (a) the child was resident in Canada immediately before the transfer; (b) the property was, before the transfer, used principally in the business of farming (see 21 to 26 below); and (c) the parent, the parent's spouse or any of their children was actively engaged on a regular and continuous basis in that business (see 27 below). The parent is not required to be resident in Canada at any time. In addition, subsection 73(3) applies only to property owned by the parent immediately before the transfer to a child and thus is not applicable to property owned at that time by a partnership or corporation. With regard to the property transferred, the land must be capital property of the parent. There are no requirements as to the use of the land, depreciable property or eligible capital property after its transfer. 7. In certain circumstances, the Department will regard a remainder interest in land as Aland@ for the purposes of subsection 73(3). If all of the parties to the transaction agree in writing that the remainder interest transferred to the child isAland@ to which subsection 73(3) applies and that its fair market value immediately before the time of transfer for the purposes of that subsection is the full value of the land not discounted by any life interest not transferred to the child, the Department will view the transaction accordingly. 8. Subject to the comments in 31 and 32 below, the parent's deemed proceeds of disposition under subsection 73(3) is, in the case of land and depreciable property of a prescribed class, deemed by paragraph 73(3)(d) to be the child's cost of acquisition. In the case of eligible capital property, the child is deemed by paragraph 73(3)(d.1) to have acquired a capital property at a cost equal to the parent's deemed proceeds of disposition, except in cases where the child continues to carry on the business previously carried on by the parent or the parent's spouse or any of their children. In such cases, the child is deemed to have acquired an eligible capital property and to have made an eligible capital expenditure at a cost equal to the aggregate of the parent's deemed proceeds of disposition and 4/3 of the unrecaptured portion of any deduction taken by the parent under paragraph 20(1)(b) prior to the transfer. Pursuant to paragraph 73(3)(d.2), if the transfer to a child occurs after February 22, 1994, and if the child subsequently disposes

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of eligible capital property acquired in circumstances to which subsection 73(3) applied, an amount may be added to Q in the definition of Acumulative eligible capital@ in subsection 14(5) for the purposes of determining the amount deemed by subparagraph 14(1)(a)(v) to be the child's taxable capital gain and the amount to be included under subparagraph 14(1)(a)(v) or paragraph 14(1)(b) in calculating the child's income. (If the transfer to the child occurred before February 23, 1994, an amount may be added to Q for the purposes of determining the amount to be included under paragraph 14(1)(b) in calculating the child's income.) The amount is determined as the amount, if any, determined for Q for the parent's business times the proportionate share of the fair market value of the property transferred to the fair market value of all the eligible capital property of the parent's business. The amount determined for Q and the fair market values are determined immediately before the time the property is transferred. 9. When the amount that is the deemed cost to the child of depreciable property of a prescribed class under paragraph 73(3)(d) is less than the parent's capital cost thereof, the capital cost of the property to the child is deemed to be the amount that was its capital cost to the parent. The difference between these two amounts is deemed by paragraph 73(3)(e) to have been allowed to the child as capital cost allowance and thus may be subject to recapture in the event of a subsequent disposition by the child. 10. A taxpayer who disposes of qualified farm property, as defined in subsection 110.6(1), may be eligible for the capital gains deduction under subsection 110.6(2) on taxable capital gains arising from the disposition. Situations in which Subsection 73(3) Applies: 11. The following are some examples of situations in which subsection 73(3) would apply, assuming all conditions of that provision are otherwise met: (a) a taxpayer may transfer farm property in stages or piecemeal (partial dispositions) over any number of years. The onus is on the taxpayer to establish that a legal transfer is made on each occasion; (b) the transfer of a part of a farm property to the taxpayer's spouse under subsection 73(1) does not preclude a transfer of the remainder to a child under subsection 73(3); (c) a taxpayer may sever and transfer to a child farm land upon which the child may construct a residence; (d) a taxpayer may transfer a farm property to several children in undivided shares; (e) a taxpayer who is a sole owner of farm property may arrange for transfer of ownership of that property to a child in such a manner that the child becomes a joint tenant or tenant in common with the taxpayer in that property; (f) provided the substance of a transaction is to effect the immediate transfer of the beneficial ownership (that is, all the incidents of title such as possession, use and risk) of a farm property from a taxpayer to a child, such taxpayer may in certain instances (subject to departmental approval on an individual basis) transfer farm property under subsection 73(3) notwithstanding that legal title in the property so transferred continues to be held by the taxpayer, or some third party as security against payment of the sale price of that property or against payment of a loan taken by the child to purchase that property. For example, the Department has agreed that subsection 73(3) could apply when a child borrowed money from a Farm Loan Board to purchase a farm at less than fair market value from a parent, and the Board required that the parent first sell that property to them and they, in turn, would resell it to the child under an Agreement for Sale, thus retaining title to that real estate as security against the loan; (g) a taxpayer may transfer a farm property to a partnership if all the partners are the taxpayer's children; and (h) a taxpayer may transfer farm land to a child and retain a life interest in the land for the taxpayer, for the spouse of the taxpayer or for the taxpayer and the spouse jointly (see 7 above). Situations in which Subsection 73(3) Does Not Apply: 12. The following are some situations in which subsection 73(3) would not apply: (a) a taxpayer cannot transfer farm property to a corporation and have subsection 73(3) apply even though all the shareholders are the taxpayer's children; and (b) a taxpayer cannot use subsection 73(3) to defer a capital gain attributable to a principal residence located on, and transferred with, farm land being transferred to a child under that subsection because a principal residence is not a depreciable property of a prescribed class. However, paragraphs 40(2)(b) or 40(2)(c) could apply to such gain if the conditions in the definition of Aprincipal residence@ in section 54 are met, (see the current version of IT-120, Principal Residence). Trusts for Minors 13. A parent may transfer property described in subsection 73(3) (see 2 above) or 73(4) (see 14 below) to a trust solely for the benefit of his or her minor child. However, for property transferred to such a trust to qualify for a rollover under either of those subsections the following additional conditions must be met: (a) the trust must be irrevocable; (b) the terms of the trust must provide for the property to be held in trust for the exclusive benefit of the child and there must not be any trust provision which could have the effect of depriving the child of any rights as the beneficial owner of the property; and (c) the terms of the trust must provide for the distribution of the property to the child absolutely upon reaching a certain age and for the distribution of that property to the child's estate upon the child's death before that age. Family Farm Corporations and Partnerships

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14. Subsection 73(4) applies when a parent while living transfers, to his or her child, property that was immediately before the transfer a share of the capital stock of a family farm corporation owned by the parent or an interest in a family farm partnership owned by the parent. (See 17 and 18 below for a discussion of Ashare of the capital stock of a family farm corporation@ and Ainterest in a family farm partnership@ respectively.) The child must be resident in Canada immediately before the transfer. If the amount of the proceeds of disposition otherwise determined is either equal to or falls between the fair market value and the adjusted cost base of the property, then that amount is deemed to be the parent's proceeds of disposition. In any other case, if the proceeds of disposition otherwise determined (see 15 below) are greater than both the fair market value and the adjusted cost base of the transferred property, the greater of those amounts is deemed to be the proceeds of disposition and, if less than both of those amounts, the lesser of those amounts is deemed to be the proceeds of disposition. The child is deemed to have acquired the shares or partnership interest at a cost equal to the parent's deemed proceeds of disposition. 15. Consistent with 5 above, for purposes of subsection 73(4) the term Aproceeds of disposition otherwise determined@ generally means the amount of consideration paid or payable by a child on a transfer of the above-mentioned shares or partnership interests. In addition, pursuant to paragraph 73(4)(b), section 69 does not apply in determining the proceeds of disposition of such property. 16. Even though a partnership interest in a family farm partnership may have a negative adjusted cost base at the time it is transferred under subsection 73(4), that negative amount must not be included in the computation of the deemed proceeds of disposition of that partnership interest under subsection 73(4). In such a case, the deemed proceeds of disposition under subsection 73(4) and the resultant gain under subsection 40(1) on disposition of the partnership interest are computed as if the adjusted cost base were nil. However, subsection 100(2) would apply in this situation to require that, in computing the amount of the transferor's gain on the disposition of the partnership interest, there be included, in addition to the amount of the gain normally computed under subsection 40(1), the amount of the aforementioned negative adjusted cost base immediately before the transfer. 17. A Ashare of the capital stock of a family farm corporation@ of a person at a particular time is defined in subsection 70(10) to mean a share of the capital stock of a corporation owned by the person at that time where, at that time, all or substantially all of the fair market value of the property owned by the corporation was attributable to: (a) property that has been used by (i) the corporation, (ii) another family farm corporation in which the person or a related family member of the person was a shareholder, (iii) the person, (iv) a related family member of the person, or (v) a partnership, an interest in which was an interest in a family farm partnership of the person or of a related family member of the person principally in the course of carrying on the business of farming in Canada in which the person or a related family member of the person was actively engaged on a regular and continuous basis; (b) shares of the capital stock or indebtedness of one or more corporations all or substantially all of the fair market value of the property of which was attributable to property described in 17(c) below; or (c) properties described in 17(a) and (b) above. In determining the fair market value of a share of the capital stock of a family farm corporation, subsection 70(12) deems the fair market value of a net income stabilization account to be nil. For the purposes of this paragraph and 18 below, a related family member of the person is a spouse, child or parent of the person. Note: In April, 1995 the Minister of Finance issued Amendments to the Income Tax Act and Related Statutes. The proposed amendments include one to subparagraph (a)(i) of the definition Ashare of the capital stock of a family farm corporation@ in subsection 70(10). If the subparagraph is amended as proposed, for 1994 and subsequent taxation years, it will read: Athe corporation or a corporation related to it,.@ The proposed amendment affects (a)(i) and (ii) above. Explanatory notes were issued which elaborate on the proposed amendment. The Explanatory notes describe that the amendment will allow the property used in the qualifying farming business of one corporation to be held not only by that corporation or a sister corporation but also by a subsidiary or parent corporation of that corporation. 18. An Ainterest in a family farm partnership@ of a person at a particular time is defined in subsection 70(10) to mean an interest owned by the person at that time in a partnership where, at that time, all or substantially all of the fair market value of the property of the partnership was attributable to: (a) property that has been used by (i) the partnership, (ii) the person, (iii) a related family member of the person, or (iv) a family farm corporation in which the person or a related family member of the person was a shareholder,

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principally in the course of carrying on the business of farming in Canada in which the person or a relate family member of the person was actively engaged on a regular and continuous basis; (b) shares of the capital stock or indebtedness of one or more corporations all or substantially all of the fair market value of the property of which was attributable to property described in 18(c) below; or (c) properties described in 18(a) and (b) above. 19. It is a question of fact to be determined on an individual basis whether, for purposes of the definitions of Ainterest in a family farm partnership@ and Ashare of the capital stock of a family farm corporation@ in subsection 70(10), Aall or substantially all@ of the property of a corporation or partnership is attributable to qualifying use. However, if 90% in terms of fair market value of the property of a family farm corporation or family farm partnership is used principally in qualifying use, then the Aall or substantially all@ requirement will be considered to have been met. Transfers to Parent 20. If property which was acquired by a child under subsection 73(3) or 73(4) has been transferred or distributed to his or her parent as a consequence of the child's death, the child's legal representative may elect under subsection 70(9.6) in the final return to have the rollover provisions of subsection 70(9) or 70(9.2) apply. See the current version of IT-349, Intergenerational Transfers of Farm Property on Death for a discussion of subsections 70(9), (9.2) and (9.6). Used Principally in the Business of Farming by a Parent, or by his or her Spouse or Child 21. With regard to 6 and 19 above, for purposes of subsection 73(3) and the definitions of Ashare of the capital stock of a family farm corporation@ and Ainterest in a family farm partnership@ in subsection 70(10), it is always a question of fact whether a particular property (for example, land or depreciable property of a prescribed class) is used principally in a farming business. In resolving this question the use of the property as a whole must be considered. 22. Generally, for purposes of subsection 73(3) and the definitions of Ashare of the capital stock of a family farm corporation@ and Ainterest in a family farm partnership@ in subsection 70(10), a property is used principally in a farming business if its primary use (that is, more than 50% of its use) is in respect of the farming business operation as opposed to use in concurrent corporate or partnership operations that may even be ancillary or related to the farming operation such as, for example, storage or trucking of farm products for others or contract harvesting. In this context a residence owned by a corporation will be regarded as used principally in the course of carrying on the business of farming if more than 50% of its use is as accommodation for persons who are actively employed in the farming business or their dependants. Furthermore, the residence must be provided to the persons in their capacity as employees rather than as shareholders and the residence must be part of the business operation in that it provides accommodation for employees whose services may be required at virtually any time by virtue of the nature of the farming operations. If the 50% farming business usage test is not met by a particular property then it will be included in the group of property acquired for investment or non-qualified uses. 23. It is also a question of fact whether a particular farming operation constitutes a farming business at any particular time. Some of the criteria which should be considered in making this determination are set out in the current version of IT-322, Farm Losses. An additional criterion exists in cases where farming operations have not been undertaken previously, or at least in recent years, on property owned by an individual, a family farm corporation or a family farm partnership (see 17 and 18 above). In such cases, before the rollover provisions of subsection 73(3) or 73(4) can apply, if a new farming operation has been initiated, whether specifically in anticipation of a rollover under one of those provisions or not, in order to establish that a farming business is being carried on all of the work associated with and required to initiate a viable farming business should be instituted and completed to the extent it is reasonably possible to do so in a given fact situation. 24. Assuming that a farming business is being carried on and that the property is in fact used in that farming business, it also must be determined on a fact basis whether a particular taxpayer, or the spouse or child of the taxpayer, is carrying on that particular farming business. In this regard, a taxpayer, a spouse or a child is considered to be carrying on a particular farming business when that person, to the extent that the circumstances of the particular farming operation allow, determines, for example, which fields will be planted, the type of crops to be seeded and the times for spraying and harvesting. The fact that the services of another person may be engaged for a negotiated sum of money to undertake all or part of the work associated with the farming activity (a relationship commonly referred to as Acustom working@) would not disqualify a taxpayer (farm owner) from rolling farm property to a child under subsection 73(3). Subsection 73(3) states, in part, that A... the property was, before the transfer, used principally in the business of farming... .@ There is no requirement that the property be used immediately before the transfer in the business of farming. However, if the property is used for some purpose other than farming for some period of time, a question may arise as to whether the property was used primarily for that other purpose rather than in the business of farming. 25. A lessor of farm property is not considered to be using the property in the business of farming. Thus, the property which immediately before the transfer was leased to another person (including a sharecropper) is not eligible for transfer under subsection 73(3) unless it was used principally in the business of farming by a lessee who

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is the spouse or child of the lessor and the lessee was actively engaged in the business on a regular and continuous basis. 26. In the preceding paragraph Asharecropper@ means a farmer who is a tenant and gives a share of the crop to the landlord in lieu of rent. There may be other types of arrangements, for example, when an individual is actually an employee of the owner of the farm and not a tenant and receives a share of the crop as a remuneration for services rendered. Under such an arrangement, the farm property may be eligible for transfer under subsection 73(3). Actively Engaged on a Regular and Continuous Basis 27. Subsection 73(3) and the definitions in subsection 70(10) of Ashares of the capital stock of a family farm corporation@ and Ainterest in a family farm partnership@ require that a person be Aactively engaged on a regular and continuous basis@ in the business of farming. Whether a person is Aactively engaged on a regular and continuous basis@ is a question of fact. However, the requirement is considered to have been met when the person is Aactively engaged@ in the management and/or day to day activities of the farming business. Ordinarily the person would be expected to contribute time, labour and attention to the business to a sufficient extent that such contributions would be determinant in the successful operation of the business. Whether an activity is engaged on a Aregular and continuous basis@ is also a question of fact but an activity that is infrequent or activities that are frequent but undertaken at irregular intervals would not meet the requirement. If farming is not the chief source of income, that is, subsection 31(1) applies, it may be more difficult to demonstrate that the taxpayer, the taxpayer's spouse or the taxpayer's child was actively engaged on a regular and continuous basis in the business of farming. Reserves 28. If a taxpayer transfers property to a child at an amount in excess of its adjusted cost base and subsection 73(3) or 73(4) applies, a reserve may be claimed under subparagraph 40(1)(a)(iii) for the uncollected proceeds computed as described in the current version of IT-236, Reserves C Disposition of Capital Property. Pursuant to subsection 40(1.1), in its application to transfers of farm property (as described in 2 above) and a share of a family farm corporation or an interest in a family farm partnership to a child who was resident in Canada immediately before the transfer, this reserve is limited to a maximum period of 9 years. In computing the taxpayer's capital gains over this period at least 1/10 of the capital gain on disposition must be included in the year of disposition, and at least 1/10 of that gain must be included in computing the taxpayer's capital gains for each of the 9 subsequent taxation years subject, of course, to any overriding effect of the application of clause 40(1)(a)(iii)(A) for the calculation of the reasonable reserve, as described in the current version of IT-236, which might accelerate this reporting. Attribution 29. Subsection 75.1(1) provides that when a taxpayer's property has been transferred to a child in circumstances such that subsection 73(3) or 73(4) applied, taxable capital gains and allowable capital losses from dispositions of the transferred property by the child are deemed to be those of the taxpayer. Subsection 75.1(1) does not apply, if: (a) the taxpayer is dead or no longer resident in Canada at the time of the disposition by the child; (b) the child attains the age of 18 years before the end of the taxation year in which the disposition takes place; or (c) the transfer to the child was made at not less than the fair market value of the property immediately before that transfer. Property that is land in Canada, depreciable property in Canada of a prescribed class, a share of the capital stock of a family farm corporation, or an interest in a family farm partnership is subject to subsection 75.1(1). 30. For transfers and loans of property the rules in subsection 74.1(2) apply to attribute to a taxpayer income (but not business income) from farm property (as described in 2 above), an interest in a family farm partnership or a share in a family farm corporation, or property substituted therefor, transferred to and owned by a related minor. The current version of IT-510, Transfers and Loans of Property made after May 22, 1985 to a Related Minor discusses the income attribution rules as they affect related minors. ITAR Provisions C Land 31. If the farm land transferred, which is subject to the provisions of subsection 73(3), was owned by the taxpayer on December 31, 1971 (or if a person who did not deal at arm's length with the taxpayer owned the property on June 18, 1971 and no arm's length owners intervened to the date of such transfer), subsections 26(3) and 26(5) of the ITAR preserve the tax-free zone in the usual way (see the current version of IT-132, Capital Property Owned on December 31, 1971 C Non-Arm's Length Transactions, and subsection 26(19) of the ITAR). ITAR Provisions C Depreciable Property of a Prescribed Class 32. Subsection 20(1) of the ITAR may preserve the tax-free zone for depreciable property of a prescribed class transferred under subsection 73(3), when the taxpayer's deemed proceeds of disposition exceed the property's capital cost (see the current version of IT-217, Capital Property Owned on December 31, 1971 C Depreciable Property). ITAR Provisions C Eligible Capital Property 33. Subsection 21(1) of the ITAR has no application in determining the amount of a parent-transferor's deemed proceeds of disposition of eligible capital property under paragraph 73(3)(b.1) of the Act. However, once such an amount is computed under paragraph 73(3)(b.1), that amount represents an amount payable for purposes of section 14 of the Act (in particular E of the definition of Acumulative eligible capital@ in subsection 14(5)) and can be

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reduced by the provisions of subsection 21(1) of the ITAR if the conditions of that subsection are otherwise met. When subsection 21(1) of ITAR applies to reduce the amount payable, the child-transferee's cost of acquisition of the eligible capital property (see paragraph 73(3)(d.1) of the Act) is subject to a similar reduction under subsection 21(2) of ITAR since the child acquires that property in a non-arm's length transaction. ITAR Provisions C Family Farm Corporations 34. If a taxpayer owned shares of the capital stock of a family farm corporation on June 18, 1971 and continuously thereafter until the time of transfer to a child after 1971, then subsection 26(5) of the ITAR would apply to preserve that taxpayer's tax-free zone to the child if the other provisions of that subsection are met. However, if the taxpayer acquired such shares between June 19, 1971 and December 31, 1971 and transfers them after 1971 in a non-arm's length transaction to which subsection 73(4) of the Act applies (see 14 above), subsection 26(5) of the ITAR is technically not applicable and there is no provision similar to subsection 26(19) of the ITAR (see 31 above) to preserve the tax-free zone on those shares. Nevertheless, it is the Department's practice not to deprive the child in such a situation of the benefit of the tax-free zone. Consequently, the Department will permit such a transferee (child) to use subsections 26(5) and related subsection 26(3) of the ITAR instead of paragraph 73(4)(c) of the Act to establish the adjusted cost base of such shares transferred whether by gift or in any other manner. Property Depreciable Pursuant to Part XVII 35. Property on which a parent is claiming, or has claimed, capital cost allowance only under Part XVII of the Income Tax Regulations before making an inter vivos transfer thereof to his or her child does not qualify for a rollover under subsection 73(3) of the Act. Instead, the parent's proceeds of disposition of such property must be computed either under subsection 20(1) of the ITAR or, if the conditions of that subsection are not met, under section 69 of the Act. In any case where subsection 20(1) of ITAR applies to determine a parent's deemed proceeds of disposition of Part XVII property that subsection will also preserve the parent's tax-free zone for such property to his or her child. (See the current version of IT-217.) 36. Once Part XVII property is transferred by a parent to his or her child after 1971, if it is depreciable property of the child, it is required to be included in a prescribed class under Part XI of the Regulations, since property acquired after 1971 may not be depreciated pursuant to Part XVII of the Regulations. 37. Notwithstanding that a leasehold interest in land used in a farming business (when that leasehold interest was acquired prior to 1972 and capital cost allowance was claimed thereon only under Part XVII of the Regulations) is technically not depreciable property of a prescribed class, the Department will nevertheless accept it as qualifying for a rollover under subsection 73(3) of the Act if the taxpayers involved so request in writing.

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Appendix 11


December 30, 1987, ATransfers and Loans of Property Made After May 22, 1985 to a Related Minor@

1. For the purposes of this bulletin, the following terms and their meanings are explained: Transferred or Loaned Property C means all transfers or loans of property whether accomplished directly or indirectly, by means of a trust or by any other means whatever. A transfer includes a sale whether or not at fair market value, as well as gifts but has never included a genuine loan. [(Prior to May 23, 1985 loans that were not considered genuine (see IT-260R) were treated as transfers but this distinction is no longer necessary.) Reference to IT-260R cancelled by ITD-4 dated September 30, 1997.] Related Minor C a person who is under 18 years of age, and who (a) does not deal with the individual at arm's length (eg a parent and a child or other descendant whether by blood relationship or adoption, do not deal at arm's length C see IT-419), or (b) is a niece or nephew of the individual. Beneficially Interested C An individual is Abeneficially interested@ in a trust if the individual has any right (whether immediate or future, whether absolute or contingent or whether conditional on or subject to the exercise of a discretionary power by any person or persons) to receive any of the income or capital of the trust either directly from the trust or indirectly through one or more other trusts. See 12 below for examples of situations where an individual is beneficially interested in a trust. Substituted Property C Paragraph 248(5)(a) provides that in the circumstances discussed in this bulletin, where a taxpayer has disposed of or exchanged a particular property and acquired other property in substitution therefor and subsequently, by one or more further transactions, has effected one or more further substitutions, the property acquired by any such transaction is deemed to have been substituted for the particular property. Attribution of Income from Transferred or Loaned Property 2. Subsection 74.1(2) provides that where an individual has transferred or loaned property (including money) to a related minor or to a trust in which a related minor is beneficially interested at any time, any income or loss from the property or property substituted therefor is deemed to be income or loss of the individual for a taxation year unless the minor has attained the age of 18 years before the end of the year; see 15 to 18 below for additional exceptions to the rule. Application of Attribution Rules 3. It is necessary to distinguish between income or loss from property and income or loss from a business. Subsection 74.1(2) does not apply to attribute business income or losses even if the business operates with some or all of the property obtained originally from the transferor. 4. Income or loss derived from the investment or other use of the income from transferred property is not attributed to the transferor and thus for income tax purposes is income or loss of the transferee. For example, interest on any interest allowed to accumulate is not attributed to the transferor and is income of the transferee. 5. Pursuant to subsection 74.1(3) the attribution rules in subsection 74.1(2) apply to transferred or loaned property which is used either to repay, in whole or in part, borrowed money that was used, in whole or in part, to acquire property or to reduce an amount payable in respect of that property. 6. As it applies to a related minor (a Aspecified person@ under subsection 74.5(8)) subsection 74.5(6) provides that where an individual has transferred or loaned property to a third party (a) and that property or property substituted therefor is, or (b) on condition that any property be transferred or loaned directly or indirectly by the third party to or for the benefit of a related minor, pursuant to paragraph 74.5(6)(c), the property transferred or loaned by the third party is deemed to have been transferred or loaned by the individual to or for the benefit of the related minor, and pursuant to paragraph 74.5(6)(d) any consideration received by the third party is deemed to have been received by the individual. 7. Subsection 74.5(7) provides that where an individual is obligated either absolutely or contingently to effectively ensure repayment in whole or in part of a loan or any interest in respect thereof made by a third party directly or indirectly to or for the benefit of a related minor, (a) the property loaned by the third party is deemed to have been loaned by the individual to or for the benefit of the related minor, and (b) interest paid on the loan by the individual is ignored for the purposes of paragraphs 74.5(2)(b) and (c) (see 17 below).

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8. Subsection 74.5(9) provides that where an individual has transferred or loaned property to a trust in which a related minor is beneficially interested the transfer or loan is deemed to be for the benefit of the related minor. 9. As it applies to a related minor (a Adesignated person@ under subsection 74.5(5)), paragraph 74.3(1)(a) applies where an individual has transferred or loaned property to a trust in which a related minor is beneficially interested at any time and determines an amount that is deemed to be the income of the related minor which is included in the individual's income pursuant to subsection 74.1(2). 10. Pursuant to paragraph 74.3(1)(a) the income of the minor described in 9 above is the lesser of (a) the minor's income under paragraph 12(1)(m) from the trust, and (b) the proportion of the income earned by the trust from the transferred or loaned property that (i) the minor's income under paragraph 12(1)(m) from the trust is of (ii) the aggregate income from the trust of all persons each of whom is throughout the year a related minor or the individual's spouse. In (b) the Aincome earned by the trust@ excludes capital gains and is calculated before deductions are made under subsections 104(6) and (12). 11. An example of the operation of paragraph 74.3(1)(a) follows: An individual transfers, for no consideration, bonds which pay interest of $1,200 per annum to a family trust the beneficiaries of which are the individual's three children, two of whom are less than 18 years of age throughout the year. The trust's income prior to any deductions under subsections 104(6) or (12) is $1,500. Each beneficiary has an equal entitlement to the trust income all of which is payable in the year. The two related minors are designated persons. The income from the transferred bonds in respect of each of the related minors is the lesser of: (a) the income of the designated person from the trust ($500, ie, 1/3 of $1,500), and; (b) A H B/C where A A is the income of the trust from the transferred property ($1,200), B B is the income of the relevant minor from the trust ($500), and C C is the income of all the designated persons from the trust ($1,000). $1,200 H $500/$1,000 = $600 Thus the amount of income attributed to the individual in respect of each related minor is $500. 12. The following are examples of situations where an individual is beneficially interested in a trust: (a) trust income is payable to the individual; (b) income is held in trust and will be paid upon the individual's attaining a certain age; (c) the individual is one in respect of whom a preferred beneficiary election may be made; (d) the individual is one of a class who has a remaindership interest under the trust. The individual is beneficially interested in the trust in (b) even if the right to receive the income ends should the individual die before attaining the specified age and in (c) even if the trustees have full discretionary powers concerning the distribution of the capital or income of the trust so that the individual may in fact receive nothing from the trust. 13. Where depreciable property is transferred to a related minor and the minor has no other property of the same class as the property transferred, the income or loss from the property attributed to the transferor should reflect any amount of capital cost allowance, terminal loss or recapture of capital cost allowance in respect of the class which would otherwise be taken into account in computing the income of the minor. Where depreciable property is transferred to a related minor and the minor has other property of the same class as the property transferred, in computing the income or loss from the property attributed to the transferor (a) a reasonable portion of the capital cost allowance claimed by the minor in respect of the class (which portion may not exceed the maximum capital cost allowance that would be deductible in respect of the transferred property if the property were in a separate class) may be deducted, and (b) a terminal loss or recapture of capital cost allowance which arises and would otherwise be included in computing the income of the minor in respect of the class of depreciable property should be taken into account to the extent that such amount can reasonably be considered to relate to the transferred property. After the year of disposition of the transferred property and provided a substitute depreciable property is not acquired by the minor, there is no attribution of capital cost allowance, terminal loss or recapture of capital cost allowance that arises in respect of the class. 14. Where income arises from depreciable property transferred to a trust the amount attributed to the transferor is determined as described in 10 above, even though the trust's income calculation includes amounts in respect of capital cost allowance, terminal loss and recapture of capital cost allowance in respect of the class. Exclusions

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15. Subsection 74.1(2) does not apply to attribute income or loss to a transferor that relates to a period (a) following the death of the transferor or transferee or (b) throughout which the transferor is not resident in Canada. 16. Pursuant to subsection 74.5(1), income or loss from transferred property does not attribute to the transferor where (a) the sale or other transfer is made for consideration equal to fair market value of the transferred property, and (b) the sale price or other consideration for the transfer is (i) fully paid by the transferee in cash or kind (and not from property furnished by the transferor), or (ii) satisfied in whole or in part by indebtedness in respect of which interest is charged at a rate not less than the lesser of the rate of interest prescribed for the purposes of subsection 161(1) and the rate that would be agreed upon between arm's length parties under similar circumstances at the time that the indebtedness is incurred, if all such interest is paid not later than 30 days after the end of the year in which it becomes payable. 17. Pursuant to subsection 74.5(2), subsection 74.1(2) does not apply in respect of loans where interest is charged on the indebtedness at a rate not less than the lesser of the rate of interest prescribed for the purposes of subsection 161(1) and the rate that would be agreed upon between arm's length parties under similar circumstances at the time the indebtedness is incurred, if all such interest is paid not later than 30 days after the end of the year in which it becomes payable. When such a loan is forgiven the exemption in subsection 74.5(2) ceases to apply and section 80 becomes applicable. 18. Pursuant to paragraph 74.5(12)(b), the attribution rules described in 2 above do not apply to a transfer of property to a related minor when transferred as or on account of an amount paid that is (a) deductible in determining the payer's income for the year, and (b) required to be included in the payee's income. For example, the payment of money to a related minor as remuneration for services provided in a business conducted by the payer is a transfer of property, but, where conditions (a) and (b) are satisfied, not a transfer to which attribution applies. In such cases, any income or loss arising from any subsequent investment of the remuneration by the minor is not attributable to the payer. Capital Gains and Losses 19. Where property is transferred to a related minor or to a trust where a related minor is beneficially interested, subsection 74.1(2) does not apply to attribute to the transferor any taxable capital gain or allowable capital loss arising from a subsequent disposition of that transferred property by the minor or the trust. However, in respect of the inter vivos transfer of certain farm property to a child under 18 years of age, section 75.1 may apply to attribute to the transferor any taxable capital gain or allowable capital loss from the disposition of the transferred property by the child (see IT-268R3). 20. Any taxable capital gains and allowable capital losses on dispositions of property which are attributable to a transferor by virtue of section 75.1 may be included in computing the transferor's lifetime capital gains deduction under section 110.6. Artificial Attribution 21. Subsection 74.5(11) provides that the attribution rules do not apply where one of the main reasons for a transfer or loan of property or a series thereof is to reduce the amount of income tax that would be payable on the income or gains. Dividend Tax Credit 22. Subsection 82(2) provides, in effect, that where the transferor of property includes in income a dividend received or deemed to be received by the transferee from a taxable Canadian corporation, the transferor is required to gross-up the dividend and is entitled to the dividend tax credit. Non-Resident Transferee 23. Where an amount paid or credited to a non-resident of Canada is included in another taxpayer's income by virtue of sections 74 to 75 and is thereby subject to tax under Part I of the Act, subsection 212(12) provides that non-resident withholding tax is not exigible on such amount. Liability for Payment of Tax 24. Where as a result of a transfer of property an amount (including a taxable capital gain from the disposition of the transferred property) has been included in the income of a transferor for a taxation year by virtue of sections 74 to 75.1, the transferee and transferor are jointly and severally liable under paragraph 160(1)(d) for any increase in the transferor's Part I tax liability resulting from the inclusion of that amount in income. Furthermore, paragraph 160(1)(e) provides that the transferee and transferor are jointly and severally liable for any liability of the transferor under the Act in respect of the year in which the transfer took place or any preceding taxation year, to the extent that, at the time of the transfer, the fair market value of the transferred property exceeded the fair market value of any consideration received for it. Notwithstanding the joint and several liability described above, section 160 does not limit the liability of the transferor under the Act.

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Appendix 12

Interpretation Bulletin IT-369R,

March 12, 1990, AAttribution of Trust Income to Settlor@

1. The provisions of subsection 75(2) may apply where property is held under any trust established since 1934, other than those trusts referred to in 2 below. Unlike (for example) section 74.3, the application of subsection 75(2) does not depend upon a Aloan@ or Atransfer@ of property, but upon the fact that property is Aheld@ by the trust under one or more of the conditions described in 3(a), (b) and (c) below. A genuine loan to a trust would not by itself be considered to result in property being Aheld@ by the trust under one or more of these conditions (i.e., would not by itself result in the application of subsection 75(2)), if the loan is outside and independent of the terms of the trust. For a discussion on when a loan can be considered genuine, see the current version of IT-258, Transfer of Property to a Spouse and IT-260, Transfer of Property to a Minor. Where subsection 75(2) applies, certain amounts derived from property held by the trust are attributed to the person from whom the property was directly or indirectly received. Subsection 75(2) ceases to apply if the person dies or ceases to be resident in Canada. 2. Subsection 75(2) does not apply where the particular property is held by trusts listed in subsection 75(3). These include (a) trusts governed by certain deferred income plans, (b) employee trusts, (c) related segregated fund trusts, (d) vacation pay trusts, (e) non-resident trusts in certain circumstances, and (f) prescribed trusts. With respect to 2(f), there are no prescribed trusts as of the date of publication of this bulletin. 3. The Aproperty@ referred to in subsection 75(2) includes Asubstituted property@, as defined by subsection 248(5). Any income or loss from the property, as well as any taxable capital gain or allowable capital loss from the disposition of it, is attributed to the person from whom the property was directly or indirectly received if the terms of the trust are such that the property (a) may revert to that person, (b) may be distributed to beneficiaries determined by that person at a time after the trust was created, or (c) may only be disposed of with the consent of, or at the direction of, that person while alive. Subsection 75(2) may apply to any income from, or any gain or loss from the disposition of, property received from a person who, by the exercise of a power of appointment, may determine the beneficiaries to whom that property may pass. It may also apply where the property may revert to the person from whom it was received as a consequence of the death of the last of all other beneficiaries under the trust. 4. Although any income, gain and loss in respect of property received from a person is attributed by subsection 75(2) to that person only during a period when that person is resident in Canada, the application of the attribution rules does not depend upon the person having been resident in Canada at the time the property was received by the trust. 5. In applying subsection 75(2), it is necessary to distinguish between income or loss from property and income or loss from a business. The subsection does not apply to attribute business income or losses even if the business operates with some or all of the property received from the particular taxpayer. 6. Any income or loss derived from the investment or other use of the earnings from property (or property substituted therefor) received from a person is not attributed to that person. For example, if the property received from a person is money which is deposited by the trust into a bank account, the interest on the initial deposit will attribute to that person but interest on the interest left to accumulate in the bank account will not attribute. 7. Any non-business income or loss derived from the investment or other use of proceeds of disposition of a property (or a property substituted therefor) received from a person will attribute to that person. For example, if the property received from a person is a building which is subsequently disposed of for $100,000, yielding a taxable capital gain of $20,000, not only will the taxable capital gain attribute to that person but also so attributable will be any non-business income earned on the $100,000 proceeds. 8. For purposes of the capital gains deduction under section 110.6, any taxable capital gain or allowable capital loss attributed to a person in a taxation year pursuant to subsection 75(2) is deemed, by virtue of subsection 74.2(2), to have arisen from the disposition by that person, in that year, of the property on which the gain or loss was realized. Consequently, a taxable capital gain attributed to a person under subsection 75(2) is eligible for the capital gains deduction to the same extent and in the same manner as if the gain had been realized directly by that person.

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Note: The Federal Budget released by the Minister of Finance on February 22, 1994 proposes to eliminate the $100,000 capital gains deduction for gains realized on dispositions of property occurring after February 22, 1994 and for gains brought into income after 1994 by the capital gains reserve mechanism. The Budget further proposes that individuals (other than trusts) and certain personal trusts and partnerships could elect to crystallize accrued gains in order to use any portion of the $100,000 capital gains deduction available under the law. For more information on these proposed changes, reference should be made to budget documents. 9. Subsection 75(2) refers to a Aperson@, which is defined by subsection 248(1) to include a Acorporation@. Although the lifetime of a corporation is indeterminate, the Department's view is that this fact would not preclude the attribution of trust income to a corporation in circumstances where subsection 75(2) would otherwise apply. 10. Subsection 212(12) provides that where an amount is attributed to a person under subsection 75(2) on account of an amount paid or credited to a non-resident, no Part XIII tax is payable upon that amount. Similarly, the Department considers that an amount which has been attributed to a person under subsection 75(2) is normally to be excluded from the income of a resident beneficiary to whom it was paid or payable in the year, and from the income of the trust where it was not paid or payable to the resident beneficiary. 11. Generally, it is the settlor who transfers property to a trust described in subsection 75(2) and to whom the income therefrom is attributed. Nevertheless, it is the Department's view that a person other than the settlor may transfer property to a trust under one or more of the conditions described in 3(a) to (c) above and become subject to the attribution rules of the subsection. 12. Since a transfer to a trust described in 75(2) is often not at arm's length, certain of the arrangements to which subsection 75(2) applies may result in subsection 160(1) applying to both the trust and the person from whom property was received. Where subsection 160(1) applies to a subsection 75(2) situation, the transferor and transferee are jointly and severally liable to pay (a) that part of the transferor's Part I tax, for each taxation year, that is attributable to the subsection 75(2) attribution, and (b) an amount equal to the lesser of (i) the transferor's tax liability for the year in which the property was transferred and for any preceding year, and (ii) the amount by which the fair market value of the property, at the time it was transferred, exceeds the fair market value, at that time, of the consideration given for the property.

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