While all reasonable care has been taken in the preparation of this text and related study

materials, neither STEP Canada nor any of the authors accept responsibility for any errors
it may contain or for any loss sustained by any person placing reliance upon its contents.
Readers of this publication and related study materials should not render legal, accounting,
or other professional advice unless authorized to do so by their respective governing bodies.

© STEP Canada, 2010, First Edition

© STEP Canada, 2015, Second Edition
© STEP Canada, December 2017, Third Edition

All rights reserved. No part of this work covered by the publisher’s copyright may be
reproduced or copied in any form or by any means (graphic, electronic, or mechanical,
including photocopying, recording, taping, or information and retrieval systems) without
the written permission of the publisher.

ii
 PREFACE

“Taxes are the price we pay for civilization.” — Oliver Wendell Holmes, Jr.

LIMITS AND SCOPE OF COURSE AND EDITIONS

This course covers the taxation of trusts and estates in Canada from the basic to
intermediate levels.

Until 2016, the tax rules in the Income Tax Act (Canada) affecting trusts and
estates had remained almost completely static since the major tax reform in
1972, when taxation of capital gains was first introduced in Canada. In 2016,
major changes were made, which included the loss of the graduated rates of
tax for most testamentary trusts, new rules for certain life interest trusts, and
changes to the tax treatment of charitable gifts made in a Will. As of December
2017, tax rules affecting trusts and estates are continuing to change. Signifi-
cant changes were announced by the Department of Finance on July 18, 2017,
amended in several announcements in October 2017, and again in December
2017. None of these proposals are yet law, and it is very possible that the pro-
posals as they now stand will be further amended, abandoned, or replaced with
alternate changes. Some of the current proposed changes are scheduled to be
effective in 2018. The STEP student resources website will provide updates to
these changes.

The 2017 proposals are not included in this text, although reference is made in
key places where the new rules are anticipated to have significant impact. Pri-
marily affected will be income splitting in Chapters 7 and 10, and estate plan-
ning for business succession in Chapter 10. The introduction of changes to the
tax on split income (TOSI) rules, formerly referred to most often as the “kiddie
tax,” if enacted, will apply to adults where there is an interest in a private corpo-
ration, and both dividends and gains from interests in private corporations will
potentially be subject to TOSI. Much of the income splitting and business suc-
cession planning for small business may be affected. The STEP student resources
website will also contain updates to matters that are adjusted annually, such as
the U.S. exemption amounts for gift tax and estate tax and the annual lifetime
capital gains exemption limit.

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Preface

The first edition, published in 2010, was replaced by the second edition in 2015.
The second edition included clarifications and updates to the formation and
residence of a trust arising from case law, along with a discussion of the 2016
changes that were not yet then in effect. The discussion of the rules as they
were prior to 2016 was largely retained in the second edition. The third edition
has been completely revised to be more current and to fully reflect the 2016
changes, with only reference to the prior rules. It is up-to-date as of December
31, 2017, with the exception of the proposed changes announced July 18, 2017,
and the subsequent fallout.

A number of other changes have been made to the third edition. A new section
has been added to Chapter 2 to cover the basics of taxation of corporations and
their shareholders and to lay the foundation for the expanded section in Chapter
8 on post-mortem tax planning for private corporations. The sections in Chap-
ter 4 on alter ego trusts, joint partner trusts, and qualifying spousal trusts has
been rewritten to consolidate common elements and reflect the 2016 changes,
as amended. Chapter 4 has also been updated to reflect the current proposals
for the use of the principal residence exemption by trusts, which are in effect
(mostly for 2016 and subsequent years) but not yet law. The section on regis-
tered plans in Chapter 7 has been rewritten for greater clarity. A new section in
Chapter 10 consolidates the planning strategies for disabled beneficiaries. Chap-
ter 11 has been updated to reflect CRA’s new policy for the voluntary disclosure
program, and Chapter 12 has been updated with the exemption amounts in
effect for 2017.

The first three chapters serve as a foundation for those with little or no back-
ground in the study of tax. For those who have training in basic Canadian taxa-
tion, this part of the course will already likely be within your knowledge and
understanding.

Chapters 4 through 7 cover the taxation of trusts and their beneficiaries, and the
taxation of deceased persons at an intermediate level. Those with a tax back-
ground may not be familiar with all these rules if their tax expertise lies outside
the trust and estates area.

Chapters 8, 9, 10, and 12 are an introduction to tax planning and international tax
issues. Chapter 11 focuses on administration and enforcement. Although there is
a review of basic trust concepts at the beginning of Chapter 4, knowledge of all

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 Preface

material in the Law of Trusts, the first course in the STEP Diploma for Canada, is
assumed for this course.

The discussion throughout this text is based on the assumption that all relevant
parties — including any individual, corporation, beneficiary, trustee, trust, or
other entity — are residents of Canada except where otherwise specifically indi-
cated. The federal tax statute, the Income Tax Act (Canada),1 is simply referred to
as “the Act” throughout.

The study of income tax can be a daunting task. Tax concepts are relatively easy
to understand on their own, but thorough understanding of any tax system in
the 21st century requires much study, a tolerance for detail, and at the same
time the ability to see how the intricate rules fit into the system as a whole. It is
the combination of multiple rules, exceptions, qualifications of exceptions, the
interaction of the rules with each other, and the resulting circular reasoning that
makes tax law so challenging.

This course will not delve into the detailed provisions of the Act, as this is prop-
erly left to those who specialize in tax law. Rather, students will gain an under-
standing of tax principles and concepts and how they apply to trusts and estates.
This course will also provide the groundwork for the more complex understand-
ing of tax planning that is required in the Trust and Estate Planning Course. The
content will not always match students’ background, but it is expected that parts
of the course will provide new learning for every student and that the first three
chapters will prepare the novice for the more challenging content to follow.

William Blake said, “You never know what is enough unless you know what is
more than enough.” This was never more apt than in the study of tax. The text
delves into detail in some areas in order to assist students not only to understand
the complexity of the subject but to appreciate the taxation of trusts and estates
in the overall context of the Canadian income tax system. Tax law as it applies to
a particular topic never operates in a vacuum and must be approached with an
understanding of the tax system as a whole, even though for the purposes of this
course, an understanding of the taxation of trusts and estates is the objective.

NOTE: Unless otherwise notified, all content of this book will be examinable.

1 Income Tax Act, R.S.C.1985, c. 1, (5th Supp.), as amended.

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Preface

PURPOSE: TO ACCURATELY IDENTIFY TAX ISSUES AND FACILITATE ADDRESSING

THEM

The focus of this course is to impart knowledge and understanding of the tax
rules as they apply to trusts and estates. Its purpose is not to set students on the
road to becoming tax advisors but to enable them to recognize tax issues that
arise in their existing areas of practice and to ensure that tax issues are appro-
priately addressed.

A client may be blithely unaware of the need for tax advice, or may think that
previous advice is sufficient for the current circumstances. This course will
enable students to explain where and why tax advice is needed. It will also fur-
ther alert students to potential planning opportunities that may exist and assist
them with recognizing potential pitfalls or traps that could result in dangerous
tax consequences. Students will appreciate the benefits tax planning can pro-
duce, and should gain the knowledge and skills required to be able to identify
opportunities, alert the client, provide meaningful explanations at a conceptual
level, and refer the client to an appropriate tax professional.

SPECIFIC USE OF AND REFERENCE TO THE INCOME TAX ACT

It will not be necessary for students to memorize or independently refer to the

provisions of the Act. There are references to specific provisions of the Act, but
this is primarily for future reference and updating and is mostly intended to
assist those who are already working with the Act on a regular basis in their
profession. The Act is one of the most difficult statutes to read, let alone under-
stand, and its length alone makes it unwieldy. As one well-known tax expert has
written:

To be sure, income tax law is complex and intimidating. First the size of
the Income Tax Act (and Regulations) at nearly 2000 printed pages is in
itself enough to cause anyone anxiety. Add to that the rate at which it
grows and changes annually and the volume of case law that emerges
each week. The cumulative effect of the statutory amendments and the
volume of judicial decisions are incremental and intimidating even to
tax practitioners.2

This course will provide excerpts of whatever specific sections or wording of

the Act are required or helpful. But students are not expected to read or refer

2 Vern Krishna, Income Tax Law (Toronto: Irwin Law, 1997) at xix.

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 Preface

specifically to sections of the Act. However, in some cases, references to specific

sections have entered the vocabulary of tax practitioners, and it is helpful for
the non-tax professional to understand what these mean. Two examples would
be the “section 85” rollover and a “subsection 75(2) problem.” The former refers
to a tax-deferred transfer of property to a corporation, and the latter refers to
an attribution rule applicable to settlors of trusts. Specific sections of the Act are
used at times to describe a particular rule or principle. Where possible, the sec-
tion number that is related to the applicable rule will be included in the head-
ings where the rule is described.

WARNING

The author and STEP Canada have made every effort to ensure that these materi-
als are accurate and up-to-date. However, there may be errors or omissions, and
students are warned to verify all information and statutory or other references.
Tax law is in a constant state of change, requiring experts who specialize in tax
law to be vigilant and remain current. Parliament enacts new rules and amend-
ments. New regulations are passed. The Canada Revenue Agency (CRA) changes
its position on an issue or makes public statements or issues a publication that
reinterprets the application of the law. Or the courts hand down a decision that
makes new law. Accordingly, these materials are intended to prepare students
for the examination leading to the STEP Diploma. They do not cover all topics
exhaustively and are not intended to be the basis for providing advice to clients.

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 TABLE OF CONTENTS

PREFACE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iii

LIST OF ACRONYMS AND ABBREVIATIONS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xiii

Chapter 1–Introduction to Canadian Income Tax Law

1.1 History of Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–5

1.2 Development of Tax Law in Canada . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–8

1.3 Canada’s Tax System Today . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–10

1.4 The General Scheme of the Income Tax Act . . . . . . . . . . . . . . . . . . . . . 1–15

1.5 Other Primary Sources of Tax Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–17

1.6 Secondary Sources of Tax Law: Government Publications and

Interpretation of Tax Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–19

1.7 Researching Primary and Secondary Sources of Tax Law . . . . . . . 1–21

1.8 Using Tax Professionals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–22

1.9 Common Tax Errors with Respect to Trusts and Estates . . . . . . . . . 1–25

1.10 Concepts in the Income Tax System . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–27

Chapter 2–Tax Basics, Taxation of Sources of Income of Trusts, and Taxation

of Corporations and Their Shareholders

2.1 Introduction : Taxation of Trusts and Individuals . . . . . . . . . . . . . . . . . . 2–3

2.2 Calculating Net Income for Individuals . . . . . . . . . . . . . . . . . . . . . . . . . . 2–8

2.3 Calculating Taxable Income for Individuals . . . . . . . . . . . . . . . . . . . . 2–24

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2.4 Calculating Tax Payable For Individuals . . . . . . . . . . . . . . . . . . . . . . . . 2–25

2.5 Basic Taxation of Corporations and Their Shareholders . . . . . . . . . 2–28

Chapter 3–Taxation of Capital Gains

3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–3

3.2 Calculation of Capital Gains and Capital Losses: General Rules . . . . 3–9

3.3 Lifetime Capital Gains Exemption (LCGE) . . . . . . . . . . . . . . . . . . . . . . 3–16

3.4 Rollovers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–20

3.5 Capital Losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–25

Appendix: Excerpts from Definitions in the CRA’s Capital Gains Guide . . . . 3–29

Chapter 4–Taxation of Trusts

4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–5

4.2 Review of Trust Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–7

4.3 Basic Rules Relating to the Taxation of Trusts . . . . . . . . . . . . . . . . . . . 4–17

4.4 Transfer of Capital Property to a Trust . . . . . . . . . . . . . . . . . . . . . . . . . . 4–33

4.5 Distribution of Capital Property from a Trust . . . . . . . . . . . . . . . . . . . 4–36

4.6 Termination of a Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–39

4.7 Types of Trusts for Tax Purposes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–40

4.8 Twenty-One-Year Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–67

4.9 Alternative Minimum Tax (AMT) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–70

4.10 Preferred Beneficiary Election on Accumulating Income for

Disabled Beneficiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–70

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4.11 Principal Residence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–72

4.12 Charitable Donation Made by Trusts and Estates . . . . . . . . . . . . . . . 4–75

4.13 Key Study Points . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–78

Chapter 5–Completing the T3 Trust or Estate Return

5.1 Requirements to File Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–5

5.2 Specific Matters Relating to the T3 for the First Year of the Estate
or GRE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–8

5.3 Information Required in the T3 Return . . . . . . . . . . . . . . . . . . . . . . . . . 5–11

5.4 Determining and Reporting Net Income on the T3 . . . . . . . . . . . . . 5–15

5.5 Designations and Allocations to Beneficiaries in Computing Net

Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–18

5.6 Determining Taxable Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–22

5.7 Tax Consequences Where There Are Non-Resident

Beneficiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–24

5.8 Liability of the Personal Representative for Tax and Clearance

Certificates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–26

5.9 Key Study Points . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–28

Chapter 6–Taxation of Beneficiaries

6.1 Taxation of Income to a Beneficiary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–3

6.2 Benefits Conferred by a Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–9

6.3 Income in the Form of Outlays for Upkeep of Trust Property . . . . 6–10

6.4 Flow-Through of Source of Income to a Beneficiary . . . . . . . . . . . . 6–11

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6.5 Cost of Capital Property Received from a Trust . . . . . . . . . . . . . . . . . 6–15

6.6 Dispositions by a Beneficiary of an Income Interest or a Capital

Interest in a Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–15

6.7 Distributions to Non-Resident Beneficiaries . . . . . . . . . . . . . . . . . . . . 6–19

6.8 Key Study Points . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–25

Chapter 7–Taxation of Deceased Individuals and the Terminal Return

7.1 Introduction to Taxation on Death . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–5

7.2 Necessary and Elective Returns for Deceased Person . . . . . . . . . . . . . 7–7

7.3 Due Date for Filing Returns for a Deceased Person for the Year of
Death and Prior Years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–8

7.4 Payment of Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–10

7.5 Liability for Payment of Taxes and Clearance Certificate . . . . . . . . 7–10

7.6 Preparation of the T1 Return or Final Return for the Year of

Death . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–11

7.7 Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–11

7.8 RRSPs and RRIFs on the Death of the Annuitant . . . . . . . . . . . . . . . . 7–14

7.9 Other Registered Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–24

7.10 Deemed Dispositions at Death . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–25

7.11 Deductions from Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–31

7.12 Net Capital Losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–32

7.13 Non-Refundable Tax Credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–33

7.14 Alternative Minimum Tax (AMT) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–35

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7.15 Rights or Things Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–35

7.16 Key Study Points . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–36

Chapter 8–Post-Mortem Tax Planning

8.1 Introduction to Post-Mortem Tax Planning . . . . . . . . . . . . . . . . . . . . . . 8–3

8.2 Elections Relating to Taxation of the Deceased in the Year of

Death . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–4

8.3 Loss Utilization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–11

8.4 Post-Mortem Planning with Spousal Trusts . . . . . . . . . . . . . . . . . . . . 8–13

8.5 Tax Attributes of Property and Distributions of Property in Specie

(in Kind) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–15

8.6 Tax Attributes of Property and Dividing Assets Between a

Spouse and Other Beneficiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–16

8.7 Mitigating the Double Tax on Shares of Private Corporations . . . 8–16

8.8 Key Study Points . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–29

Chapter 9–Attribution Rules and Income Splitting

9.1 Basic Concepts of Attribution and Income Splitting . . . . . . . . . . . . . . . . . . 9–3

9.2 Income Attribution on Transfers and Loans for the Benefit of a

Spouse or Related Person Under Age 18 . . . . . . . . . . . . . . . . . . . . . . 9–5

9.3 Attribution Back to Settlor/contributor Where Property Held in

Trust: Subs. 75(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–12

9.4 Tax on Split Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–20

9.5 Exceptions to Attribution Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–24

9.6 Some Basic Income-Splitting Techniques . . . . . . . . . . . . . . . . . . . . . . 9–25

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9.7 Examining Blair’s Inheritance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–28

9.8 Key Study Points . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–30

Chapter 10 –Basic Tax Planning for Trusts and Estates

10.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–5

10.2 Using Trusts for Income Splitting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–10

10.3 Planning Options for Funding Educational Expenses . . . . . . . . . . 10–14

10.4 Using the Spousal Rollover and Spousal Trusts . . . . . . . . . . . . . . . . 10–17

10.5 Using GREs and Other Testamentary Trusts to Income Split . . . . . . . . . . 10–23

10.6 Tax Planning for Disabled Beneficiaries . . . . . . . . . . . . . . . . . . . . . . . 10–26

10.7 Estate Freezing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–28

10.8 Key Study Points . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–47

Chapter 11–Administration and Enforcement

11.1 Compliance and Enforcement Under the Act . . . . . . . . . . . . . . . . . . 11–3

11.2 Requirement to File Returns and Pay Tax Owing . . . . . . . . . . . . . . . 11–4

11.3 Requirement to Pay Instalments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–6

11.4 Requirements to Withhold and Remit and Penalties for Failure . . . 11–6

11.5 Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–7

11.6 Penalties for Filing Late Tax Returns and Information Returns . . . 11–8

11.7 Assessments and Reassessments of Tax . . . . . . . . . . . . . . . . . . . . . . . . 11–9

11.8 Enforcement Powers: Audits, Demands for Information, and

Search Warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–9

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11.9 Collection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–11

11.10 Joint and Several Liability Under the Act . . . . . . . . . . . . . . . . . . . . . . 11–11

11.11 Clearance Certificates and Certificates of Compliance . . . . . . . . . 11–12

11.12 Notices of Objection, Appeals, Reassessments, and Tax

Litigation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–12

11.13 Deductions from Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–14

11.14 Offences Under the Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–14

11.15 Solicitor and Client Privilege . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–15

11.16 Relief from Interest and Penalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–15

11.17 Tax Avoidance and Evasion and Ethical Issues for the Advisor . . . 11–18

11.18 Key Study Points . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–20

Chapter 12–Foreign Jurisdiction Tax Issues

12.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–5

12.2 U.S. Estate Tax for Canadian Residents Who Are Non-Resident
Aliens of the U.S. (NRAs) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–6

12.3 U.S. Estate Tax for U.S. Citizens Living in Canada . . . . . . . . . . . . . . . 12–17

12.4 U.S. Gift Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–19

12.5 Taxation of Canadians in Other Jurisdictions on Gifts and

Inheritance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–21

12.6 Offshore Trust Planning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–22

12.7 Annual Foreign Reporting Requirements . . . . . . . . . . . . . . . . . . . . . 12–23

12.8 Key Study Points . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–23

xv
Table of Contents

TABLE I – TABLE OF LEGISLATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . TL-1

TABLE II – TABLE OF CRA PUBLICATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . TCRA-1

TABLE III – TABLE OF CASES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .TC-1

GLOSSARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . G-1

BIBLIOGRAPHY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .B-1

INDEX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . I-1

xvi
 LIST OF ACRONYMS & ABBREVIATIONS USED

ABIL allowable business LCGE lifetime capital gains

investment loss exemption
ACB adjusted cost base LPP listed personal property
AET alter ego trust NAL non-arm’s length
AMT alternative minimum tax NRA non-resident alien
CCA capital cost allowance PRE principal residence
CCPC Canadian-controlled private exemption
corporation PUC paid-up capital
CDA capital dividend account PUP personal use property
CESG Canadian Education Savings Q-DOT qualifying domestic trust
Grant QDT qualified disability trust
CGE capital gains exemption QLIT qualified life interest trust
CNIL cumulative net investment QPP Quebec Pension Plan
loss
QSBCS qualified small business
CPP Canada Pension Plan corporation share
CRA Canada Revenue Agency QST qualified spousal or
DTC dividend tax credit common-law partner trust
FMV fair market value RDSP registered disability savings
GAAR general anti-avoidance rule plan

GRE graduate rate estate RDTOH refundable dividend tax on

hand
GRIP general rate income pool
RESP registered education savings
IC Information Circular
plan
IT Interpretation Bulletin
RRIF registered retirement income
ITF account in trust for account fund
JPT joint spousal or common-law RRSP registered retirement savings
partner trust plan
LBT life benefit trust SBC small business corporation

xvii
List of Acronyms & Abbreviations Used

T1 Return General Income Tax and TFSA tax-free savings account

Benefit Return TOSI tax on split income
T3 Return Trust Income Tax and UCC undepreciated capital cost
Information Return

xviii
 CHAPTER 1
INTRODUCTION TO
CANADIAN INCOME TAX LAW

LEARNING OBJECTIVES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–5

1.1 HISTORY OF TAXATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–5

1.1.1 In the Beginning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–5

1.1.2 No Taxation without Representation . . . . . . . . . . . . . . . . . . . . . 1–6
1.1.3 English Tradition and the Magna Carta . . . . . . . . . . . . . . . . . . . 1–6
1.1.4 Rights of the Government to Tax . . . . . . . . . . . . . . . . . . . . . . . . . 1–7
1.1.5 Challenges to Tax Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–7
1.2 DEVELOPMENT OF TAX LAW IN CANADA . . . . . . . . . . . . . . . . . . . . . . 1–8

1.2.1 Powers to Tax under the Canadian Constitution . . . . . . . . . . 1–8

1.2.2 The Income Tax Act, Canada (the Act) . . . . . . . . . . . . . . . . . . . . . 1–8
1.2.3 Tax Policy and Factors Shaping Tax Law and the
“Practice” of Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–9
1.3 CANADA’S TAX SYSTEM TODAY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–10

1.3.1 Basic Concepts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–10

1.3.2 The Legislative Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–10
1.3.2.1 Introduction to the House of Commons . . . . . . 1–10
1.3.2.2 Bills and Draft Legislation . . . . . . . . . . . . . . . . . . . . 1–11
1.3.2.3 Coming into Force Provisions . . . . . . . . . . . . . . . . 1–11
1.3.2.4 Grandfathering and Transitional Rules . . . . . . . . 1–12
1.3.3 Taxation of Canadian Residents and Non-Residents . . . . . 1–14
1.3.3.1 Canadian Residents Are Taxed on Worldwide
Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–14
1.3.3.2 Non-Residents Are Taxed Only on Canadian
Source Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–14
1.3.4 Federal and Provincial Taxation and Collection . . . . . . . . . 1–14
1.3.4.1 Federal and Provincial Taxation . . . . . . . . . . . . . . 1–14

1–1
 1.3.4.2 Federal and Provincial Tax Returns and
Payment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–15
1.4 THE GENERAL SCHEME OF THE INCOME TAX ACT . . . . . . . . . . . . . 1–15

1.5 OTHER PRIMARY SOURCES OF TAX LAW . . . . . . . . . . . . . . . . . . . . . . 1–17

1.5.1 Regulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–17

1.5.2 Income Tax Application Rules (ITARs) . . . . . . . . . . . . . . . . . . . 1–17
1.5.3 Tax Treaties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–18
1.5.4 The OECD Model Tax Convention . . . . . . . . . . . . . . . . . . . . . . 1–18
1.5.5 Case Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–19
1.6 SECONDARY SOURCES OF TAX LAW: GOVERNMENT
PUBLICATIONS AND INTERPRETATION OF TAX LAW . . . . . . . . . . 1–19

1.6.1 Interpretation (IT) Bulletins and Income Tax Folios

(ITFs) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–19
1.6.2 Information Circulars (ICs) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–20
1.6.3 Guides . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–20
1.6.4 Technical Interpretations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–20
1.6.5 Advance Rulings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–20
1.6.6 Income Tax Technical News (ITTNs) and Income Tax
Folios (ITFs) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–21
1.6.7 Department of Finance Comfort Letters . . . . . . . . . . . . . . . . 1–21
1.7 RESEARCHING PRIMARY AND SECONDARY SOURCES OF TAX
LAW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–21

1.8 USING TAX PROFESSIONALS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–22

1.8.1 Importance of Tax Advice to an Estate . . . . . . . . . . . . . . . . . . 1–23

1.8.2 Examples of Failure to Use Tax Professionals During
Estate Administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–24
1.8.2.1 The Freeze Gone Wrong . . . . . . . . . . . . . . . . . . . . . 1–24
1.8.2.2 Lost Opportunity to Use the Capital Gains
Deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–24
1.8.3 Importance of Obtaining Foreign Tax Advice . . . . . . . . . . . 1–25

1–2
1.9 COMMON TAX ERRORS WITH RESPECT TO TRUSTS AND
ESTATES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–25

1.10 CONCEPTS IN THE INCOME TAX SYSTEM . . . . . . . . . . . . . . . . . . . . . . 1–27

1.10.1 Concepts Re Income from a Source . . . . . . . . . . . . . . . . . . . . 1–27

1.10.2 Concepts Re Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1–28
1.10.3 Other Concepts and General Terms . . . . . . . . . . . . . . . . . . . . 1–29

1–3
 Chapter 1
Introduction to
Canadian Income Tax Law

Learning Objectives
Knowledge Objectives:
• Understand the primary and secondary sources of tax law and how they are
created.

Skills Objectives:
• Explain how tax legislation is enacted.
• Describe the primary and secondary sources of tax law.
• Locate and use Canada Revenue Agency (CRA) publications.

1.1 HISTORY OF TAXATION

1.1.1 In the Beginning

Taxation is probably as old as civilization. It figures prominently in ancient cul-

tures as well as modern, and has been a catalyst of history: the rise and fall of
civilizations and their rulers have often been influenced, if not instigated, by wise
or poor tax policy. In about 930 B.C.E.,1 biblical Israel split after King Solomon’s
rule because his successor ruthlessly refused to cut taxes, leaving only the tribe
of Judah loyal to the House of David as the state of Judea. In ancient China, the
first emperor of China, Ch’in shih-huang-ti, who united China into one nation
and commenced construction of what was to become the Great Wall, had his
dynasty crumble only four years after his death because of uprisings over his

1 Before Current Era.

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1.1.2 Chapter 1 – Introduction to Canadian Income Tax Law

brutal tactics, including crushing levels of taxation. And at least one historian
has linked the downfall of Napoleon at Waterloo to his failure to develop a solid
tax system. His poorly funded military campaigns, eventually surviving on plun-
der rather than sound fiscal policy, left him vulnerable to the better-financed
British forces, who were financially supported by a superior income tax system.2

History abounds with such examples. In modern history, and with the rise of
democracy, the opposing forces of fiscal necessity and civil discontent with taxa-
tion have played out in the development of the principle that the government
cannot impose taxes without due process. In the English tradition of common
law, this has its roots in the Magna Carta and the restraints it placed on the
monarchy.

1.1.2 No Taxation without Representation

It has been a political mantra of civilized society in the Western world for many
centuries that there can be “no taxation without representation.” The origin of
this slogan predates the American Revolution, although it is popularly identified
with the Boston Tea Party — the dumping of tea into the Boston harbour in pro-
test over British taxation of tea sent to the colonies. Certainly, the slogan has its
roots in the timeless struggle between the power of rulers to extract funds from
the public and the rising dissent of those bearing the financial burden of the
fees and taxes.

1.1.3 English Tradition and the Magna Carta

The Magna Carta has been interpreted as enshrining the principle of “no taxa-
tion without representation” as a tenet of constitutional law, although not until
many centuries later was this actually articulated. This document, ironically
called “magna” not because of its significance but because of its length, was
signed by King John in 1215 to placate a contingent of violent barons who were
furious over inept policies and mismanagement, including the abuse of feudal
contracts, an unsuccessful military campaign resulting in the loss of Normandy,
and excessive taxation. Ultimately, the rambling document, considered one of
the most important documents in the history of democracy, was organized into

2 Charles Adams, For Good and Evil: The Impact of Taxes on the Course of Civilization, 2nd ed. (Lanham,
Maryland: Madison Books, 2001) at 351. This book is an excellent review of the effect of tax policy on
the course of history and in modern times.

1–6
HISTORY OF TAXATION 1.1.5

63 sections, a mere footnote in size compared with the length of our federal tax
statute today.

The Magna Carta has been interpreted over subsequent centuries to restrict the
rights of the monarchy in many respects, including the unlimited right to tax. In
the early 17th century, Sir Edward Coke’s writings about the Magna Carta influ-
enced its effect on history and the development of constitutional law. The noted
jurist used the document as a weapon against the oppressive tactics of the Stu-
art kings, proclaiming that even kings must comply with the common law and
declaring to Parliament in 1628 that “Magna Carta . . . will have no sovereign.”

1.1.4 Rights of the Government to Tax

The British constraints on the monarch’s powers carry over into Canadian con-
stitutional law, as the Canadian federal legal system is based on the British tra-
dition and the common law.3 No tax is valid unless enacted by a representative
government. Both constitutional law and tradition require that taxes be imposed
and collected only by an act of Parliament or a provincial Legislature. There is
no legal authority to collect income taxes until tax legislation has been passed
and receives Royal Assent.

1.1.5 Challenges to Tax Law

Challenges to tax law are rare but not unprecedented. In 1998, the Supreme
Court of Canada declared Ontario’s probate fees an invalid form of tax in the
landmark decision of Re Eurig Estate4 because it was imposed by regulation,
not by statute. The estate was successful in avoiding probate fees, although the
provincial government was given the right to retroactively fix the law so that
probate fees previously collected under the existing regulation, except for those
payable by the Eurig estate, could be confirmed by statute. The challenge had
been closely watched by the estate planning community because probate fees
tripled in Ontario under the New Democratic Party (NDP) government and simi-
lar high fees were in place in B.C. and other provinces, making probate fee plan-
ning a significant component of estate planning.

A fee can be levied by regulation. Regulations under provincial statutes are passed
by the Lieutenant Governor in Council, but as a tax the “probate fee” could only be

3 A history of the common law system is set out in the Law of Trusts course.
4 Re Eurig Estate, [1998] 2 S.C.R. 565.

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1.2 Chapter 1 – Introduction to Canadian Income Tax Law

valid if authorized directly by the provincial Legislature through a statute. The case
lost at trial and on the initial appeal. Ultimately, it went all the way to the Supreme
Court of Canada, where the full court of nine justices sat and in a 7–2 split decision
the challenge was finally successful. The court held that the fee was a tax on several
grounds. The quantum, or amount, of the fee bore no nexus, or relationship, to the
service provided, as the administrative cost to issue a grant of letters probate did not
vary with the value of the estate. In addition, the fee did not simply offset the cost
of granting probate but was levied for the public purpose of raising revenue and to
defray the costs of court administration in general.

Since the tax was a direct tax, it was within the power of the province, but only
through the Legislature, not by regulation. The court said that even if the Legis-
lature could delegate the right to prescribe the rates of tax by regulation, it had
to do so in clear and unambiguous language, which had not been done.

1.2 DEVELOPMENT OF TAX LAW IN CANADA

1.2.1 Powers to Tax under the Canadian Constitution

The taxation powers of the federal and provincial governments are set out in the
Constitution Act, 1867 (formerly the British North America Act, 1867). Federal
Parliament has the power to pass laws to raise money “by any mode or system
of taxation.” The Legislature of each province has the authority to make laws in
relation to direct taxation within the province in order to raise revenue for pro-
vincial purposes. These powers of taxation between the federal government and
the provinces overlap, and both governments are empowered to levy income
taxes and retail sales taxes.

1.2.2 The Income Tax Act, Canada (the Act)

At the time of Confederation, most government revenue was raised from indirect
taxes in the form of customs and excise. Income tax was first introduced by the
Income War Tax Act in 1917,5 then a mere 20 pages. Comparing the original with
the massive Act of today makes it obvious that our system of taxation reaches far
beyond the simple object of raising revenue. A summary of the legal and politi-
cal process responsible for the evolution of tax law and this statute follows.

5 As a “temporary” measure to raise funds for the war effort.

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DEVELOPMENT OF TAX LAW IN CANADA 1.2.3

1.2.3 Tax Policy and Factors Shaping Tax Law and the “Practice” of Tax

Modern tax law has many purposes. These include:

• to raise revenue to pay for public expenditures,

• to create incentives to stimulate economic growth,
• to implement and fund social policy,
• to encourage or reward certain behaviour, and
• to achieve an equitable redistribution of wealth.

Tax policy is inherently political. Federal budgets can make or break a govern-
ment, and the tax measures introduced by successive finance ministers are often
essential to the implementation of political policy. The introduction of the goods
and services tax (GST)6 in Canada sparked a heated national debate that domi-
nated the tax landscape for years. During the 1993 federal election campaign,
the promise to abolish the unpopular tax won the Liberals re-election. But when
the government failed to deliver on the promise, one Member of Parliament who
had tied her seat to the promise was forced to resign (although she regained her
seat in the subsequent by-election).7

Corporations and individuals will often go to great lengths and expense to mini-
mize their contribution to government coffers. The role of the tax professional
has been to seek out the means to accomplish this task, and the law comes
under constant scrutiny to detect opportunities to tread the path of conduct that
attracts the least liability. The pastime of squinting at loopholes by tax advisors
to accommodate their clients has been described by one leading tax academic as
“intellectual embroidery.”8

The government, in response to aggressive tax planning, is on the alert for per-
ceived abuses. One objective of tax changes is to close so-called “loopholes” in
the law. The tension among the government’s use of the tax system to implement
policy, the need for revenue, and the zeal of taxpayers to reduce their exposure
has resulted in a multifaceted tax system that requires years of study and expe-
rience to master. In a somewhat dubiously named section “The Joy of Learning

6 Now harmonized with many provincial sales taxes regimes as the harmonized sales tax (HST).
7 Sheila Copps made the unfortunate campaign promise that she would resign if the tax were not
abolished and bent to political pressure to make good her word, resigning in May 1996 only to be re-
elected the next month.
8 Attributed to Neil Brooks, Osgoode Law School.

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1.3 Chapter 1 – Introduction to Canadian Income Tax Law

Tax Law” in Materials on Canadian Income Tax, this “dance” to the “tax tango”
between the legislators and tax professionals is colourfully (and somewhat irrev-
erently) described:

Tax law is also intellectually exciting because it constitutes the rules of

a fast game played by dedicated people for high stakes. Bright tax law-
yers, accountants and economists in the Department of Finance attempt
to implement government policy by drafting provisions of the income
tax law. As soon as these provisions are announced, a small army of
dedicated and imaginative tax lawyers and accountants — being paid an
indecent amount of money — begin to apply their minds to how they
might advise their clients to find ways around the laws. The courts are
called in to resolve disputes. Department of Finance officials respond
with proposed amendments to the legislation, in an often vain attempt
to preserve the integrity of the government’s initial policy judgments.
Wealthy individuals, their representatives, and the business community
frantically lobby for relief. The financial press takes sides. Politicians ful-
minate. Tax teachers pontificate. As tax law students you have front-row
seats to this high stakes game.9

1.3 CANADA’S TAX SYSTEM TODAY

1.3.1 Basic Concepts

A listing of basic concepts and introduction to general tax terminology is included

at 1.10.3. This listing is intended as an introduction only, and more formal defini-
tions are contained in the glossary (see p. G1).

Tax law is a creature of statute. The primary sources of tax law are the laws
(statutes) enacted by federal Parliament and the provincial Legislatures, the reg-
ulations enacted under the authority of the statutes, and the case law that inter-
prets their application. Secondary sources include publications by administrative
bodies of government (ministries) — usually Canada Revenue Agency (CRA).

1.3.2 The Legislative Process

1.3.2.1 Introduction to the House of Commons

Federal income tax law and tax policy are the responsibility of the
Department of Finance. Periodically, usually at least once a year, the

9 Tim Edgar, Jinyan Li, & Daniel Sandler, Eds., Materials on Canadian Income Tax, 12th ed. (Toronto:
Carswell, 2000) at 3.

1–10
CANADA’S TAX SYSTEM TODAY 1.3.2.3

Minister of Finance will introduce a “budget” in the House of Commons

that announces economic policy, publishes the state of the nation’s and
the government’s finances, and introduces changes to the law to imple-
ment new policies. Changes are sometimes introduced by press release
outside the House of Commons, in a break from parliamentary tradition.
In addition, technical changes to the Act are sometimes introduced by a
technical bill without any public fanfare or warning.

Following the budget in the House of Commons, income tax proposals

and amendments are tabled in the House in a written document known
as a Notice of Ways and Means Motion. Draft legislation to implement
the proposal is introduced sometime later in the form of a bill.

1.3.2.2 Bills and Draft Legislation

Bills, in the form of draft legislation, are subject to debate in the House
of Commons and must pass three “readings,” or votes, in the House of
Commons before they can go to the Senate for additional debate and
approval. During the bill stage in the House of Commons, changes may
be made and the bill may go to committee. Changes may also be made
by the Senate, although this is unusual for tax legislation and does not
occur without Cabinet’s approval. After a bill has passed both the House
of Commons and the Senate, it must receive “Royal Assent” in the form
of approval by the Governor General or a deputy of the Governor Gen-
eral, who is the Queen’s representative in Canada. Upon receiving Royal
Assent, the bill becomes law.

1.3.2.3 Coming into Force Provisions

In tax law, the date that particular amendments are effective is extremely
important. A major transaction, such as the takeover of a large public
corporation, may be affected significantly by a tax change. The Depart-
ment of Finance will usually indicate timing within the Notice of Ways
and Means Motion. For example, the effective date may be for all trans-
actions not completed before the day of the budget. If the impact could
be significant, there may be a time period after the budget to permit
transactions to be completed before the change takes place. There is
a tradition that relieving provisions takes place as of the date of the

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1.3.2.4 Chapter 1 – Introduction to Canadian Income Tax Law

budget, but this is not necessarily the case. Each particular change or
amendment may have its own coming into force provision.

Enacted tax law governs the filing position of a taxpayer. The process
of changing proposed or amended legislation into current tax law can
be a lengthy process. Given the fact that proposed or amended leg-
islation may have an effective implementation date that precedes the
date it received Royal Assent, taxpayers are routinely faced with the
dilemma of determining their filing position based on either current tax
law or proposed legislative changes. Although only tax legislation that
has received Royal Assent has the force of law, CRA does have a policy
of permitting taxpayers to determine their filing position on the basis
of proposed or amended legislation. In situations where a taxpayer fol-
lowed CRA’s policy and filed based on proposed legislation, and that
proposed legislation was later vacated, taxpayers are expected to take
immediate steps to put their affairs back in order based on the current
tax law.10 It should be noted that CRA’s policies do not have the force of
law, and CRA does not always adhere to its policies. In Edwards v. R.,
CRA refused to follow its administrative policy to assess based on pro-
posed legislative changes.11

1.3.2.4 Grandfathering and Transitional Rules

In addition to the coming into force provisions of income tax amend-
ments, there are often complex transitional rules or permanent relieving
rules called “grandfather” provisions. Transitional rules usually provide
a limited period of time during which relief is available with respect to
the application or effect of the new legislation. Relief may be for all tax-
payers or only those who would be affected by the new rules because
of transactions that are underway or not fully completed. Grandfather-
ing usually provides permanent relief from changes in legislation to cer-
tain taxpayers.

An example of a time-limited transitional rule was the election permitted

in 1994 with respect to changes to the lifetime capital gains exemption.
The $100,000 capital gains exemption available on all types of capital
property was eliminated February 22, 1994. However, an election was

10 See Income Tax Technical News No. 44 (Archived, April 14, 2011).
11 Edwards v. R., 2012 FCA 330.

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CANADA’S TAX SYSTEM TODAY 1.3.2.4

available to “bump up” the cost of capital property owned on that date,
which in effect permitted an individual taxpayer to take advantage of
the old rule on a future disposition of the property on gains accruing to
that date. The availability of the election was time-limited. The election
was made by filing Form T664 with the 1994 tax return. If the election
was not made, no further relief was available under the old rules.

Two examples of more permanent grandfathering follow.

Certain “stop-loss” rules may reduce the loss an estate realizes on share
redemption.12 A new stop-loss rule came into effect for dispositions of
shares by an estate after April 26, 1995. It affected estate planning where
corporately held life insurance was used to minimize tax on death of the
insured.13 Generous grandfather provisions still in effect protect certain
taxpayers from the impact of this rule; the new stop-loss rules do not
apply where there was a pre-existing agreement to purchase insurance,
such as in a shareholder agreement or where there was pre-existing
insurance — even where the death benefit is substantially increased.14

Another example is the grandfathering available for the definition of

qualifying farm property eligible for the lifetime capital gains exemp-
tion. Changes to the law imposed a more stringent requirement regard-
ing the level of farming activity and the income it produced in order
for property to qualify. However, grandfather provisions exist whereby
property last acquired before June 18, 1986, either by the taxpayer or by
certain related persons from whom the taxpayer subsequently obtained
the property is subject to a less onerous test.15

12 Subs. 112(3.2) of the Act.

13 The use of the loss carryback from the estate’s first tax year to the terminal return of the deceased
person (subs. 164(6)) was reduced where tax-free dividends from the capital dividend account were
paid on the shares. These specific rules go beyond the scope of this course.
14 In general terms, the rule does not apply with respect to life insurance policies in place on or before
April 26, 1995, or where life insurance is subsequently purchased as the result of an agreement in
writing executed before April 27, 1995, although the actual grandfather provisions are much more
complex than outlined here.
15 See para. 110.6(1.3)(c).

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1.3.3 Chapter 1 – Introduction to Canadian Income Tax Law

1.3.3 Taxation of Canadian Residents and Non-Residents

1.3.3.1 Canadian Residents Are Taxed on Worldwide Income

Canadian residents — including individuals, trusts, and corporations
— are taxed on their worldwide income (i.e., income from all sources
whether located in Canada or otherwise). The Canadian tax system is
based on residency, in contrast to the U.S. system of taxation, which is
based on citizenship. Under the U.S. system, all U.S. citizens, wherever
resident, are taxed on their worldwide income.

1.3.3.2 Non-Residents Are Taxed Only on Canadian Source Income

Non-residents of Canada are only taxed on certain income that is
sourced in Canada. A non-resident may be eligible for treaty relief on
certain sources of income, and a foreign tax credit may be available in
the taxpayer’s own country of residence to reduce tax liability in that
country in respect of Canadian tax paid. Certain payments of income
from Canadian sources to non-residents are subject to withholding tax
at source. In some cases, no further tax treatment or compliance may be
required.

For example, dividends payable to non-resident shareholders by Cana-

dian corporations may be subject to withholding tax. In other cases, a
non-resident may be required to file a tax return in Canada on Cana-
dian source income, and any withholding tax or other Canadian tax
already paid will be credited against the liability or refunded as appro-
priate. Examples include the requirement to file a tax return to report
Canadian employment income or capital gains on disposition of certain
capital property located in Canada. This course will focus on taxation
of Canadian residents, although non-resident issues will be covered to
the extent that they are relevant to the obligations of Canadian entities
or the relationship of Canadian taxpayers to non-resident persons. See
Chapter 6 for additional information about taxation of non-residents.

1.3.4 Federal and Provincial Taxation and Collection

1.3.4.1 Federal and Provincial Taxation

The basic rules for income taxation are contained in the Act. This stat-
ute is a federal statute; Canadian taxpayers are also subject to provincial

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THE GENERAL SCHEME OF THE INCOME TAX ACT 1.4

income tax. However, a separate study of provincial legislation is not

necessary. Generally, the provincial income tax systems parallel the fed-
eral rules, and income subject to federal tax is the base for provincial
taxation. Provincial taxation for individuals and trusts is the provincial
rate of tax applied to income as calculated under the federal rules after
provincial adjustments, if any. Quebec is the exception; it has its own
income tax base and system separate from the federal system.

1.3.4.2 Federal and Provincial Tax Returns and Payment

A harmonized tax reporting and tax collection system is in place for
individuals and trusts, with a single tax return and separate schedules to
calculate the amount of provincial tax. The federal government receives
all payments and takes responsibility for collecting and transferring the
provincial tax payable by individuals to the provinces. Quebec is an
exception to this. Individuals resident in Quebec, or those carrying on
business in the province, must file a separate Quebec income tax return.

1.4 THE GENERAL SCHEME OF THE INCOME TAX ACT

An understanding of the Act’s organization is helpful for a general understanding

of the tax system and is essential to the tax professional, who needs to navigate
the specific provisions. Statutes, including the Act, are generally divided into
sections and subsections, and further subdivisions of paragraphs and subpara-
graphs. In longer statutes, such as the Act, the sections themselves are further
organized by being divided into Parts, with those parts being further divided
into Divisions and Subdivisions. The Act has over 261 sections divided into more
than 17 parts. For example, ss. 2 to 127 are organized into several Divisions of
Part I, including section numbers, divisions, and subdivisions (see Figure 1.1).
Part I sets out most of the rules for the taxation of individuals, corporations,
partnerships, and trusts. For those who practise tax, it is helpful to understand
the various groupings of rules. In Part I, for example, Division B includes all
the rules for computation of income; capital gains and losses are dealt with in
Subdivision c; and most of the specific rules relating to trusts are contained in
Subdivision k, comprising ss. 104 to 108. In most cases in this course, we will be
dealing with the taxation of income under Part I of the Act.

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1.4 Chapter 1 – Introduction to Canadian Income Tax Law

Figure 1.1: The Income Tax Act, Part I

PART I — INCOME TAX

Division A — Liability for Tax: s. 2

Division B — Computation of Income
Basic Rules: ss. 3–4
Subdivision a — Income or Loss from an Office or Employment
Basic Rules: s. 5
Inclusions: ss. 6–7
Deductions: s. 8
Subdivision b — Income or Loss from a Business or Property
Basic Rules: ss. 9–11
Inclusions: ss. 12–17
Deductions: ss. 18–21
Ceasing to Carry on Business: ss. 22–25
Special Cases: ss. 26–37
Subdivision c — Taxable Capital Gains and Allowable Capital Losses: ss. 38–55
Subdivision d — Other Sources of Income: ss. 56–59.1
Subdivision e — Deduction in Computing Income: ss. 60–66.8
Subdivision f — Rules Relating to Computation of Income: ss. 67–80.5
Subdivision g — Amounts Not Included in Computing Income: s. 81
Subdivision h — Corporations Resident in Canada and Their Shareholders: ss. 82–89.1
Subdivision i — Shareholders of Corporations Not Resident in Canada: ss. 90–95
Subdivision j — Partnerships and Their Members: ss. 96–103
Subdivision k — Trusts and Their Beneficiaries: ss. 104–108
Division C — Computation of Taxable Income: ss. 109-–114
Division D — Taxable Income Earned in Canada by Non-Residents: ss. 115–116
Division E — Computation of Tax
Subdivision a — Rules Applicable to Individuals: ss. 117–122.5
Subdivision a.1 — Canada Child Tax Benefit: ss. 122.6–122.64
Subdivision a.2 — Working Income Tax Benefit: ss. 122.7–122.71
Subdivision b — Rules Applicable to Corporations: ss. 123–125.1
Subdivision c — Rules Applicable to All Taxpayers: ss. 126–127.41

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OTHER PRIMARY SOURCES OF TAX LAW 1.5.2

1.5 OTHER PRIMARY SOURCES OF TAX LAW

Sources of law are referred to as primary and secondary sources. Primary sources
of law are those that are legally enforceable and include legislative-based law,
either by statute (an act of Parliament if federal or of the Legislature if provin-
cial) or by regulation authorized by Cabinet under a statute or as the result of a
judicial decision — known as case law. Tax law has several primary sources:

• the Income Tax Act (or Act), a federal statute,

• regulations made under the authority of the Act,
• case law,
• Income Tax Application Rules (ITARs), and
• Canada’s income tax conventions or tax treaties entered into with
other countries.

1.5.1 Regulations

In addition to the Act, which is the law passed by Parliament, further rules
called regulations are made under the authority of the Act by the Governor in
Council. The regulations contain many details of tax law and can be changed
by Order in Council by the government without the scrutiny of Parliament or
political debate. When the Act refers to something being “prescribed,” this means
it is contained in the regulations. For example, the rates of interest charged on
unpaid taxes referred to in the Act are “prescribed” in Part XLIII, or ss. 4300
through 4302, of the regulations made under the Act. These rates are updated
every quarter. Another example is the rules relating to capital cost allowance
deductible from income from a business or property, including the classification
of depreciable property and the rates of depreciation set out in Part XI of the
regulations, being ss. 1100 through 1106.

1.5.2 Income Tax Application Rules (ITARs)

The Canadian income tax system was the subject of major reform in 1972, largely
resulting from the report of the Carter Commission. Among other things, the taxa-
tion of capital gains was introduced into Canada for the first time. Previously the
Canadian courts had ruled that the taxation of “income” did not include capital
gains. This was in contrast to the jurisprudence and tax base in the U.S., which
always considered that income included capital gains. Due to the extent of the
changes in the law, an extensive series of transitional rules (grandfathering) were

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1.5.3 Chapter 1 – Introduction to Canadian Income Tax Law

introduced to provide a bridge between the old rules in effect prior to 1972 and
the new rules that came into effect in January 1972. These specific rules are con-
tained in the Income Tax Application Rules, and although they are of less impor-
tance as time passes, they are still relevant in many cases.

An example is the rules relating to determining the cost of capital property held
prior to 1972 for the purposes of calculating a capital gain or capital loss on a
subsequent disposition. ITAR 26 provides rules that set out how this cost is to
be calculated so that a taxpayer is neither unduly penalized for unrealized gains
that existed on Valuation Day (V-Day) nor is able to take advantage of an artifi-
cial loss that exists solely because there was a drop in value on V-Day that was
subsequently recouped.

1.5.3 Tax Treaties

Canada and many other countries have entered into agreements, called tax con-
ventions or tax treaties, to relieve the potential double tax burden of persons who
have connections in both countries. These treaties may reduce the rate of with-
holding tax on payments of tax on source made to non-residents of Canada who
are resident in a treaty country. They may also have tiebreaker rules that deter-
mine, as between the two countries, the residence of an individual or other tax-
able entity for tax purposes where residence may exist in both countries. Where
applicable, tax treaties take priority over Canadian tax law, as set out in the Act,
and specific legislation is passed by Parliament for this purpose. For example, the
rates of withholding on payments made to non-residents of Canada who are resi-
dents of countries with whom Canada has a treaty or tax convention are those set
out in the applicable treaty, not those set out in the Act.16

1.5.4 The OECD Model Tax Convention

Most treaties that Canada has negotiated are based on the OECD Model Tax Con-
vention created by the Organisation for Economic Co-operation and Develop-
ment (OECD). Canada and most modern Western democracies are members of
the OECD, with 30 members in all. Its objectives include the support of sustain-
able economic growth, assisting other countries’ economic development, growth
in world trade, the promotion of international business, and helping govern-
ments improve their public policies to make the most out of globalization. There
are certain provisions in the model treaty that most Canadian treaties contain.

16 Taxation of non-residents and rates of withholding are set out in Part XIII, being ss. 212–218.1 of the Act.

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SECONDARY SOURCES OF TAX LAW: GOVERNMENT PUBLICATIONS AND INTERPRETATION OF TAX LAW 1.6.1

For example, generally non-residents of a treaty country are exempt from tax on
capital gains realized on property, other than real property, located in the treaty
country.

1.5.5 Case Law

Just as in other areas of law, disputes regarding the application of a statute can
be settled by resorting to the courts. This process is called litigation. To under-
stand assessments and the appeal process, see Chapter 11.

In the Canadian legal system, court decisions, or “case law,” create binding
precedents with respect to the particular issues in dispute, and tax law is no
exception. However, the application of case law to a particular situation is not
straightforward, as a particular decision can turn on its unique facts and be dis-
tinguishable from a future dispute. Tax cases start at Tax Court and there are
appeals available to the Federal Court of Appeal and the Supreme Court of Can-
ada. The higher the court, the more persuasive the decision; lower courts must
follow the decisions of a higher court, while higher courts may overrule their
own previous decisions and the decisions of the lower courts.

1.6 SECONDARY SOURCES OF TAX LAW: GOVERNMENT PUBLICATIONS

AND INTERPRETATION OF TAX LAW

Sources of tax law that are not legally enforceable are referred to as secondary
sources of law. They include administrative policy developed by departments of
the civil service with respect to the administration, interpretation, and enforce-
ment of laws and regulations. For example, the Canada Revenue Agency (CRA)
publishes Income Tax Folios (currently being added to on a regular basis as they
replace the old Interpretation Bulletins), which represent CRA’s interpretation
of the Act and do not have the force of law. However, they can be very helpful
in explaining, in everyday language, the purpose and application of tax law on
various topics. Students are encouraged to browse the “Taxes” section of the
Canada.ca website and the Income Tax Folios and other CRA publications on
topics covered in this course.

1.6.1 Interpretation (IT) Bulletins and Income Tax Folios (ITFs)

Launched in 2013, Income Tax Folios (ITFs) represent CRA’s interpretation and
administration policies on specific tax topics. They are web-based, enabling
CRA to keep them up-to-date. New ITFs are published from time to time. The

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1.6.2 Chapter 1 – Introduction to Canadian Income Tax Law

folios are organized by broad categories into seven series, subdivided into topic-
specific chapters, and will result in a phase-out of Interpretation (IT) Bulletins.
As a result of this change, IT Bulletins have all been given an “Archived” des-
ignation. Archived IT Bulletins continue to have valid status and are current to
the effective date stated in each publication. The archived version will not be
updated but will be cancelled when replaced by an Income Tax Folio.

1.6.2 Information Circulars (ICs)

Information Circulars (ICs) are published by CRA to provide information on

administrative and procedural matters. They are unaffected by the changeover
from IT Bulletins and ITNNs to ITFs.

1.6.3 Guides

Guides are published by CRA to assist taxpayers in complying with the Act’s
requirements, including the preparation and filing of tax returns and tax forms.
For example, the T3 Trust Guide (Form T4013) contains detailed instructions for
completing the T3 Trust Income Tax Return.

1.6.4 Technical Interpretations

CRA is often asked to provide its view regarding how the Act will apply to a
hypothetical situation. While not binding on CRA, these views may be published
to assist tax practitioners in advising taxpayers. In addition, it is possible to call
CRA by telephone to ask minor questions regarding the application of a particu-
lar rule or section of the Act. CRA can review its database of written Technical
Interpretations to assist the caller. If the question is unique, the caller will be
asked to submit a written request.

1.6.5 Advance Rulings

A taxpayer can formally ask CRA to explain how it will assess a proposed trans-
action. This is a service that the taxpayer must pay for. The Advance Ruling that
results may be published for the general information of the public on a “no
names” basis, and although they do not have the force of law, they are bind-
ing on CRA with regards to the particular proposed transaction as long as the
facts provided are accurate and complete. The rulings are only binding between
CRA and the taxpayer requesting the ruling. Other taxpayers can review the

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RESEARCHING PRIMARY AND SECONDARY SOURCES OF TAX LAW 1.7

published rulings as a well-researched interpretation of tax law given a certain

set of facts, but they cannot rely on the ruling to be binding.

1.6.6 Income Tax Technical News (ITTNs) and Income Tax Folios (ITFs)

Income Tax Technical News (ITNNs), like IT Bulletins, provide CRA’s interpreta-
tion and administration policies on specific tax topics. Along with IT Bulletins,
ITTNs have been archived and are gradually being cancelled as their content is
incorporated into new Income Tax Folios as they are published.

1.6.7 Department of Finance Comfort Letters

Comfort letters are provided to taxpayers from the Department of Finance to

address issues identified by taxpayers, including filing and compliance issues
related to the Income Tax Act. However, these do not have the force of law and
only apply to the taxpayer to whom they are issued.17 Generally these matters
are unintended tax consequences resulting from current or proposed tax law
and the letter provides assurance that the Department of Finance will recom-
mend to the Minister of Finance that an amendment to the Income Tax Act or
proposed legislation be made to correct the situation.

CRA’s policy on assessing a taxpayer’s filing position, stated at the Roundtable at

the 2009 Annual Canadian Tax Foundation Conference, is that they will not reassess
taxpayers who have filed on the basis of, and in conformity with, a comfort letter.

1.7 RESEARCHING PRIMARY AND SECONDARY SOURCES OF TAX LAW

CanLII is a non-profit organization managed by the Federation of Law Societies of

Canada. CanLII’s goal is to make Canadian law accessible for free on the Internet.
It contains most federal and provincial statutes, and most case law from Canadian
jurisdictions.18 Federal laws, including the Act, are available on the “Justice Laws
Website” of the federal Department of Justice.

Most of the government publications mentioned earlier are available to the pub-
lic online through Canada.ca in the “Taxes” section.19

17 TI2009-0345781E5.
18 www.canlii.org/en/index.php.
19 www.canada.ca.

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1.8 Chapter 1 – Introduction to Canadian Income Tax Law

The following CRA publications, among many others, are available:

• Advance Rulings
• Information Circulars (ICs)
• (Archived) Interpretation (IT) Bulletins
• (Archived) Income Tax Technical News (ITTNs)
• Income Tax Folios (replacing IT Bulletins and ITTNs)
• Forms, including tax returns
• Guides
• Pamphlets
• Tax Information Sheets
• Tax Schedules
• Technical Interpretations

1.8 USING TAX PROFESSIONALS

Many different professionals practise in the area of trusts and estates, among them
tax advisors, who are usually lawyers or accountants. If one is to practise in the
trusts and estates area, it is important to have a solid grasp of the tax treatment of
trusts, estates, and their beneficiaries, even if one is not a tax advisor. Most trans-
actions involving trusts and estates, including their creation and dissolution, have
tax consequences. Minimizing tax exposure and deferring the payment of tax for
as long as possible is often the primary objective for creating a trust, and is part of
every well-crafted estate plan. This course will provide the background to identify
where tax issues, tax problems, and tax planning opportunities arise. Once this is
recognized, it is important to obtain the advice of the appropriate tax expert.

Taxation is a specialty area for both lawyers and accountants. This means not
every lawyer or accountant gives tax advice, and even those specializing in taxa-
tion do not necessarily specialize in taxation of trusts and estates. Professionals
in both law and accounting practise tax; however, the specific practices do not
overlap completely. In general, both tax lawyers and tax accountants provide tax
planning advice, but each has their own particular area of tax practice. Some-
times the best tax advice is to make a referral. As world-famous oil firefighter
Red Adair said, “If you think it’s expensive to hire a professional to do the job,
wait until you hire an amateur.”

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USING TAX PROFESSIONALS 1.8.1

Accountants generally perform the “compliance” tax functions, which include the
preparation of tax returns and other income tax elections and filings. Accountants
may be involved in discussions with CRA if a client is being audited. Lawyers
implement transactions — that is, they would be the appropriate profession-
als to draft and advise on the specific documents implementing an estate plan,
including Wills, trusts, articles of incorporation, and shareholder agreements.

Lawyers also represent taxpayers in the courts. If there is a tax assessment or

reassessment that is disputed, both lawyers and accountants may negotiate with
Canada Revenue Agency at the reassessing stage. However, if the dispute is not
resolved and the matter goes to court, lawyers are required. While some matters
can go before the Tax Court with an agent, it is generally recommended that tax-
payers be represented by legal counsel.

In making a referral to a lawyer or accountant, the composition of the team of

advisors is also an important consideration. Depending on the particular situation,
many advisors with different expertise may be required, including, for example,
appraisers, U.S. tax advisors, accountants, lawyers, insurance agents, investment
advisors, and lenders. In addition, the particular client may have a long-standing
advisor (be it lawyer, accountant, investment advisor, or other) whom he or she
trusts and who must be included in making all final decisions. Advisors need to
work together for the benefit of the client to ensure that services are not dupli-
cated, resulting in unnecessary cost, nor overlooked, leaving gaps in issue identifi-
cation and implementation or providing a result that does not “fit” the client.

The discussion below is intended to illustrate the need for personal representa-
tives of an estate to obtain tax advice and to provide examples of the perils of
failing to do so. These examples are fictitious but could easily occur in reality.
The technical content in these examples will be covered in this course.

1.8.1 Importance of Tax Advice to an Estate

One of the duties of an executor is to obtain tax advice. Failure to do so may

expose the executor to liability if tax advantages were available but not imple-
mented. Such “advice” goes beyond merely engaging someone to prepare the
tax returns for the estate, although this is required also. There are numerous
post-mortem tax opportunities or pitfalls to avoid. Failure to get and follow the
appropriate advice may be considered negligent. This could result in beneficia-
ries suing the executors — not a pretty prospect in any event but even worse

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1.8.2 Chapter 1 – Introduction to Canadian Income Tax Law

where executors are family members. Some examples of problems arising from
failure to obtain tax advice follow.

1.8.2 Examples of Failure to Use Tax Professionals During Estate

Administration

1.8.2.1 The Freeze Gone Wrong

Richard Freeze implemented a costly estate plan whereby the shares of
his company, Big Freeze Ltd., were reorganized into an estate freeze,
which left him with preferred shares having a fixed value and an accrued
capital gain. As part of the freeze, Richard signed a new Will creating
a spousal trust for his wife, Dora; their two children, along with Dora,
were the executors.

When Richard died, none of the executors thought to consult a tax advi-
sor or the professionals who carried out the estate plan. In order to dis-
tribute funds from Big Freeze to Dora, the executors had Big Freeze buy
back the “freeze” shares held by Richard’s estate in return for $1,000,000.

In doing so, they prematurely triggered tax of more than $220,000,

which could have been deferred until Dora’s death. In addition, if the
capital gains exemption were available, they gave up the potential
opportunity to eliminate or reduce the liability by using both Richard’s
and Dora’s lifetime capital gains exemption to shelter the $1,000,000
gain on the shares of Big Freeze. They also gave up other post-mortem
tax planning strategies that may have resulted in a tax-free distribution
from the corporation.

1.8.2.2 Lost Opportunity to Use the Capital Gains Deduction

Marjorie Schmidt passed away at the age of 92. At the time of her death,
she owned farm property that had been in the Schmidt family for gen-
erations. The property was in an area now being developed for subur-
ban housing and was worth $1,500,000 at the time of her death, with a
cost of $60,000. Vernon, Marjorie’s husband, died five years earlier, leav-
ing everything to her. The terminal tax return for Vernon, prepared by a
family friend, showed that all his property was disposed of at his cost,
since the spousal rollover was available. Vernon had unused losses on
his stock market online trading at the time of his death.

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COMMON TAX ERRORS WITH RESPECT TO TRUSTS AND ESTATES 1.9

Marjorie’s children consulted a tax accountant, who explained that the

gain on the farm property of $1,440,000 would be partly sheltered by
Dora’s lifetime capital gains exemption (CGE) available on the farm
property, but that the tax bill on the capital gain not sheltered by the
CGE would be a liability of the estate. The accountant also determined
that a few alterations to Vernon’s terminal return could have resulted in
major tax savings both on Marjorie’s death. Had there been an election
out of the spousal rollover in Vernon’s terminal return to trigger a gain
on the farm property, it could have been sheltered by Vernon’s unused
CGE, and any balance could have been offset by the stock market loss-
es.20 The gain on the farm property reported in Vernon’s terminal return
would have “bumped up” the cost of the farm property to Marjorie and
would have sheltered additional gains of that amount on Marjorie’s
death, which in combination with her CGE may have fully sheltered the
farm property from tax on her death.

1.8.3 Importance of Obtaining Foreign Tax Advice

In addition to Canadian tax advice, it may be appropriate to obtain tax advice

from advisors with expertise in the tax laws of other jurisdictions. For helpful
highlights on the circumstances where this may be required, see Chapter 12. In
particular, U.S. citizenship or ownership of U.S. real property may warrant U.S.
advice. In any U.S. cross-border situation, it is best to engage an advisor who has
not only the foreign tax qualifications but also the Canadian cross-border experi-
ence. Any foreign tax advisor should work in conjunction with a Canadian tax
advisor to ensure that the issues of both jurisdictions, and any treaty relief, are
adequately explored.

1.9 COMMON TAX ERRORS WITH RESPECT TO TRUSTS AND ESTATES

In addition to the lengthy examples of problems listed in 1.8.2 where profes-

sional advice is not obtained in the administration of an estate, the following
represent some common errors that take place where tax law intersects with
trusts and estates.

20 As we shall observe later (see 7.12.1), in the year of death capital losses are 100% deductible against
income from any source, whereas, as we will learn in Chapter 3, during an individual’s lifetime, capital
losses are only deductible against capital gains but are carried forward indefinitely.

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1.9 Chapter 1 – Introduction to Canadian Income Tax Law

• Tax Filing Requirements. Failure by trustees to comply with the

requirements for trusts to file trust tax returns, report income, and pay
tax or failure to address the allocation of income to a beneficiary. Fail-
ure by advisors to inform trustees of their tax and compliance obliga-
tions when trusts are established. (See Chapters 5, 7, and 11.)
• 21-Year Rule. Failure by advisors to warn trustees about, or for
trustees to learn and plan for, the 21-year rule either when trusts
are created or as the 21-year anniversary date approaches. (See
Chapter 4.)
• RRSPs and RRIFs. In making beneficiary designations, drafting
a Will, and administering an estate, failure to understand the tax
implications on death for the owner of a registered retirement sav-
ings plan (RRSP) or registered retirement income fund (RFIF) —
and who pays the tax on death. (See Chapter 7.)
• Application of Subs. 75(2). Failure to recognize when the “settlor
attribution rule” or rule in subs. 75(2) of the Act applies to a trust.
(See Chapter 9.)
• U.S. Estate and Gift Tax. Failure to identify potential U.S. estate
and gift tax issues, including identifying “U.S. Persons” who may be
subject to entirely different rules even if resident in Canada. (See
Chapter 12.)
• U.S. Income Tax for Beneficiaries and Shareholders. Failure
to recognize the need for U.S. income tax advice in advising and
implementing trust, estate, or tax planning, including an estate
freeze, where there are U.S. family members who may be beneficia-
ries or shareholders. (See Chapters 10 and 12.)
• Personal Liability. Failure by executors and trustees to protect
themselves from personal liability by obtaining a clearance certifi-
cate. (See Chapters 7 and 11.)
• Payment of Tax and Offences. Failure to file returns or pay tax in
accordance with the Act, thereby incurring additional liability for
penalties and interest, or in extreme cases risking prosecution for
offences under the Act with the potential for more onerous penal-
ties and/or imprisonment. (See Chapter 11.)

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CONCEPTS IN THE INCOME TAX SYSTEM 1.10.1

1.10 CONCEPTS IN THE INCOME TAX SYSTEM

There are many concepts in income tax law, which has its own dialect that can
be confusing to the novice. The formal definitions contained in the Act are not
necessarily used here, and these explanations are mostly in everyday language.
Students are directed to the glossary for more precise wording that includes the
terms of the Act (i.e., the formal definitions). At the introductory stage, knowl-
edge of these concepts and the terms used to identify them will assist students
in understanding some of the basic terminology commonly used by tax practi-
tioners and how specific rules fit into the overall scheme of the Income Tax Act
(the Act).

1.10.1 Concepts Re Income from a Source

• Income. The Canadian income tax system imposes tax on income.

Income inclusions are the subject of many provisions of the Act.
Conceptually, income is the value of money or its equivalent
received from property, employment, business, or (for tax pur-
poses) capital gains. Section 3 of the Act sets out the basic rules
for including these sources of income in a taxpayer’s return for a
year, and income from both inside or outside Canada is specifically
included. The income inclusions in s. 3 add in gains from the dis-
position of capital property. However, for trust law purposes, gains
from capital property are considered capital receipts and are not
included in the use of the word “income.” See also the discussion
of “capital gains” below.
• Income from Property. Income from property can take the form
of interest on bank deposits or mortgages, dividends from shares
of corporations, or rents from real property.
• Income from Employment. Income from employment includes
salary, wages, and benefits received as compensation by employees
in payment for their labour or service. Employment income is often
referred to as remuneration or compensation.
• Income from Business. This refers to the income earned from car-
rying on an activity with a view to a profit. Businesses generate
revenue, and on financial statements for accounting purposes this
is called “gross income.” Expenses incurred to earn revenue are

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1.10.2 Chapter 1 – Introduction to Canadian Income Tax Law

deducted to calculate net income. It is net income that is the profit

from a business.
• Business Distinguished from Hobby. A business is an activity
carried on with a view to a profit. An activity that is not carried on
for profit, but rather for entertainment, is a hobby, not a business.
Stamp collecting, for example, is a hobby if it is a pastime for plea-
sure. However, if the activity in collecting stamps is for profit (i.e.,
the person is a dealer in stamps who trades stamps full-time as a
livelihood), then the activity is a business.
• Business Income vs. Employment Income. Business income can
be distinguished from employment income by the nature of the
relationship. There is a “master and servant” relationship between
an employer and an employee whereby the employer is able to dic-
tate the tasks to be performed and the manner, including time and
place, in which they are to be performed. An individual who works
for one business, whose duties are subject to the direction of a
supervisor, and whose hours of work and amount of pay are set by
the supervisor or business, is an employee whose pay is employ-
ment income. A consultant who provides services to a number of
clients on a project basis is not an employee, and the consultant’s
fees would be considered business income.

1.10.2 Concepts Re Property

• Capital Gains. The excess of the sale proceeds of capital property

over its cost is a capital gain. Capital gains are not considered to be
income in trust law but are considered a capital receipt (for a full
exploration of the taxation of capital gains, see Chapter 3). Prior to
1972, capital gains were not subject to tax in Canada because they
were not considered “income” at common law, nor were there any
specific rules in the Act to include them. In 1972, specific rules were
introduced to include gains from capital property in income subject
to tax.21 However, it is important to understand that although capi-
tal gains are included in income under the Act, the word “income”
is still not considered to include capital gains at common law. This
is particularly important in the law of trusts and estates where the

21 While beyond the scope of this course, it is noteworthy that the Act distinguishes the term “income”
from “capital gains” in many provisions, requiring an especially careful reading of these terms.

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CONCEPTS IN THE INCOME TAX SYSTEM 1.10.3

use of the word “income” in a trust document does not include

capital gains. A requirement to pay income to a beneficiary in a
Will, for example, without any further wording, does not require or
authorize the payment of capital gains.
• Capital Property and Inventory. Property that is held for the
purpose of earning income from the property is said to be capital
property. Examples include bonds that earn interest, securities that
earn dividends, and real property acquired to earn rental income.
Property that is held for personal use without any income-earning
purpose may also be considered capital property, such as the fam-
ily home or an antique car collection, and such property falls into
a special category called personal use property on which losses
are denied. Property that is acquired in the course of carrying on
a business for the purpose of reselling it at a profit is inventory,
not capital property, and the sale proceeds would be included in
business income. For example, goods purchased by a merchant to
be resold in a retail outlet are inventory, not capital property. Most
property that is not inventory is considered capital property in the
Canadian tax system.
• Depreciable Property and Capital Cost Allowance. Property that
is used by a business in carrying out its activities, and not for the
purpose of resale, is capital property. An example is machinery and
equipment used in manufacturing products. Most capital property
acquired to be used to earn income from a business or from prop-
erty will qualify as depreciable property. The cost of depreciable
property is not fully deductible when it is purchased, since the
value of the property extends into future years. Instead, the tax-
payer is permitted to deduct a portion of the cost of the property
over a number of years. The deductible portion of the cost of depre-
ciable property is called depreciation for accounting purposes and
capital cost allowance for tax purposes. They are calculated dif-
ferently on financial statements and tax returns. This is discussed
more fully at 2.2.3.1, Capital Cost Allowance and Terminal Loss.

1.10.3 Other Concepts and General Terms

• Attribution. Attribution refers to the tax consequences of certain

rules in the Act to block some forms of income splitting. These

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1.10.3 Chapter 1 – Introduction to Canadian Income Tax Law

rules cause the income or capital gain, as the case may be, to be
taxed back or “attributed” back to the original owner of the prop-
erty. The word “attribution” is not used in the Act per se, but the
rules are commonly referred to as the attribution rules.
• Deductions. Deductions are amounts that can be deducted from
income. Expenses incurred in holding capital property to produce
income can be deducted from that income. This would include
interest expense on the cost of borrowing to purchase the prop-
erty, the cost of maintenance and repairs, and the cost of advertis-
ing the property for rent. An employee may deduct contributions to
an RRSP and car expenses where the use of the vehicle is required
to carry out the duties of employment. A business may deduct the
cost of wages and benefits paid to its employees.
• Income Splitting. Income splitting is a tax reduction strategy
where one person transfers or shifts income to another so that the
tax liability is less than it would be if the income were reported in
the transferor’s return. A common income-splitting technique is to
make contributions to a spousal RRSP in the expectation that with-
drawals will be taxed at a lower rate in the spouse’s return in the
future. Most income-splitting strategies work because of the gradu-
ated or marginal rates of tax applicable to individuals. If income
can be shifted to a family member who is in a lower marginal tax
bracket, less tax is payable. Income splitting is often done between
individuals within families, as this keeps the savings in the fam-
ily. However, income splitting can involve complex transactions
that include corporations and trusts. While a host of rules prevent
income splitting, legitimate strategies also exist.
• Income Sprinkling. This is a form of income splitting whereby
income is distributed, or “sprinkled,” among members of a group of
persons, usually on a discretionary basis, to achieve the optimal tax
savings from the use of individual graduated tax rates or other tax
benefits such as the lifetime capital gains exemption. Income sprin-
kling is usually achieved through a discretionary trust.
• Matching. Matching is an accounting principle, but it is also prev-
alent in the tax system. The concept is that expenses should be
deducted only against the income they are incurred to produce.
The timing of the expenses is not relevant in matching. Take the

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CONCEPTS IN THE INCOME TAX SYSTEM 1.10.3

example of a retail business with a tax year ending December 31,

2017. If employees are not paid until January, the January payroll is
still deductible against the December revenue under the matching
principle. For accounting purposes, the wages paid in January for
services rendered in December would be accrued in the 2017 year
financial statements and would be deductible for tax purposes in
the 2017 tax year as well. The Act is full of specific rules that are
based on the matching principle. The system of claiming capital
cost allowance (depreciation for accounting purposes) for property
used in a business over a number of years is one example. Capi-
tal cost allowance distributes the cost of depreciable property over
the useful life of the depreciable property to the business, thereby
“matching” the cost of the property to the income stream.
• Progressive Tax System. Canada’s system of tax on income is pro-
gressive. A progressive system is one that imposes a greater rate
of tax on those who have higher levels of income. This is accom-
plished through the marginal rates of tax for individuals. Deduc-
tions from income are considered regressive since they reduce
tax at a greater rate for those with more income who are taxed
at higher marginal rates. For example, deductions such as mov-
ing expenses and child care expenses provide a greater tax benefit
to those who earn more, and are therefore regressive. Tax credits
are consistent with a progressive tax system, since they provide an
identical tax benefit to all taxpayers no matter what their level of
income, but they shelter a greater amount of income from tax for
those who are taxed at lower marginal rates.
• Rollover. A rollover is a transfer of property that has no immedi-
ate tax consequences. Normally, a transfer of capital property, be it
a gift or a sale, results in a disposition that has tax consequences.
For transfers of capital property, a rollover takes place at the trans-
feror’s tax cost base and the recipient of the property inherits the
transferor’s tax cost. The tax attributes of the property are “rolled
over” to the new owner. Some rollovers are automatic unless an
election is made for the rollover not to apply; the transfers from
one spouse to another are an example, called the “spousal roll-
over.” Other rollovers require an election in order for the transfer
to apply; the transfer of property to a corporation in exchange for

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1.10.3 Chapter 1 – Introduction to Canadian Income Tax Law

shares is an example, called the “section 85 rollover” because the

election is made under s. 85 of the Act.
• Tax Credits. A tax credit is an amount that can be deducted from
tax payable. A non-refundable credit can only be used to reduce tax
payable. Where the tax credit exceeds the tax, the excess is disre-
garded. In contrast, in the case of refundable tax credits, the excess
is refundable to the taxpayer. Personal tax credits, the tuition tax
credit, and the dividend tax credit are examples of non-refundable
tax credits. The investment tax credit, available on the purchase of
certain property used in a business, is a refundable tax credit. Most
tax credits available to individuals are non-refundable.
• Tax Expenditures. Tax expenditures refer to tax-reducing mea-
sures that achieve a social or economic benefit. Such measures
include exemptions, deductions, credits, or deferrals that are not
intrinsically related to the calculation of income. Deductions of sal-
ary or wages paid by a business to its employees are not tax expen-
ditures but are normal expenditures incurred to earn income. The
political tax credit, on the other hand, bears no relationship to a
particular source of income, and is intended to help support politi-
cal parties and the democratic process. The loss of revenue created
by tax expenditures is one of the less visible aspects of government
spending, as it is reverse revenue generated by tax policy.

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 CHAPTER 2
TAX BASICS, TAXATION OF SOURCES OF INCOME OF
TRUSTS, AND TAXATION OF CORPORATIONS AND THEIR
SHAREHOLDERS

LEARNING OBJECTIVES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–3

2.1 INTRODUCTION: TAXATION OF TRUSTS AND INDIVIDUALS . . . 2–3

2.1.1 Limited Scope of Chapter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–3

2.1.2 Use of Tax Preparation Software as a Study Aid . . . . . . . . . . . 2–4
2.1.3 Taxation of Trusts as Individuals . . . . . . . . . . . . . . . . . . . . . . . . . . 2–5
2.1.4 Basic Rules for Individuals Resident in Canada . . . . . . . . . . . . 2–5
2.1.5 Marital Status . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–6
2.1.6 Trusts and Individuals Compared . . . . . . . . . . . . . . . . . . . . . . . . 2–6
2.2 CALCULATING NET INCOME FOR INDIVIDUALS . . . . . . . . . . . . . . . . 2–8

2.2.1 Income from Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–9

2.2.1.1 Joint Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–10
2.2.1.2 Interest Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–10
2.2.1.3 Deductions from Interest Income . . . . . . . . . . . . 2–11
2.2.1.4 Dividends from Taxable Canadian
Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–11
2.2.1.5 Eligible Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–15
2.2.1.6 Mutual Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–15
2.2.1.7 Deemed Dividend on Redemption of Shares
of a Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–15
2.2.1.8 Foreign Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–16
2.2.1.9 Rental Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–17
2.2.2 Recapture of Capital Cost Allowance and Income from
Other Sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–17
2.2.2.1 Capital Gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–17
2.2.2.2 Income from an Office or Employment . . . . . . . 2–17
2.2.2.3 Income from a Business . . . . . . . . . . . . . . . . . . . . . 2–17

2–1
 2.2.2.4 Deferred Pension Plans . . . . . . . . . . . . . . . . . . . . . . 2–18
2.2.2.5 Income from a Trust . . . . . . . . . . . . . . . . . . . . . . . . . 2–19
2.2.2.6 Recapture of Capital Cost Allowance on
Depreciable Capital Property . . . . . . . . . . . . . . . . 2–19
2.2.3 Deductions in Calculating Net Income . . . . . . . . . . . . . . . . . 2–20
2.2.3.1 Capital Cost Allowance and Terminal Loss . . . . 2–20
2.2.3.2 Carrying Charges and Interest Expenses . . . . . . 2–22
2.2.3.3 Interest Incurred to Purchase Preferred
Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–23
2.2.3.4 Contributions to Registered Plans and
Beneficiary Designations . . . . . . . . . . . . . . . . . . . . 2–23
2.3 CALCULATING TAXABLE INCOME FOR INDIVIDUALS . . . . . . . . . 2–24

2.3.1 Non-Capital Losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–24

2.4 CALCULATING TAX PAYABLE FOR INDIVIDUALS . . . . . . . . . . . . . . 2–25

2.4.1 Tax Rates for Individuals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–25

2.4.2 Non-Refundable Tax Credits . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–25
2.4.3 Alternative Minimum Tax (AMT) . . . . . . . . . . . . . . . . . . . . . . . 2–27
2.5 BASIC TAXATION OF CORPORATIONS AND THEIR
SHAREHOLDERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–28

2.5.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–28

2.5.2 Creation and Characterization of a Corporation as a
Legal Person . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–28
2.5.3 Benefits of Incorporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–29
2.5.4 Shareholder Rights and Design of Share Capital . . . . . . . . 2–30
2.5.5 Corporate Structures and Groups . . . . . . . . . . . . . . . . . . . . . . 2–32
2.5.6 Taxation of Corporate Income and Tax Rates on
Business Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–33
2.5.7 Integration and the Individual Shareholder . . . . . . . . . . . . . 2–35
2.5.8 Refundable Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–36
2.5.9 Part IV Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–37
2.5.10 Capital Dividend Account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2–37
2.5.11 Sale of Shares and Redemption of Shares . . . . . . . . . . . . . . 2–37

2–2
 Chapter 2
Tax Basics, Taxation of Sources of
Income of Trusts, and Taxation of
Corporations and Their Shareholders

Learning Objectives
Knowledge Objectives:
• Understand the taxation system of Canada, the taxation of sources of income
of a trust, and the basic rules relating to corporations and their shareholders.

Skills Objectives:
• Explain the basic rules for taxation of individuals.
• Describe how income from property and other sources is taxed.
• Describe and compare how individuals and trusts are taxed.
• Describe how income is taxed in a corporation and the tax rules relating to
corporate distributions to shareholders.

2.1 INTRODUCTION : TAXATION OF TRUSTS AND INDIVIDUALS

2.1.1 Limited Scope of Chapter

To understand the taxation of trusts, it is necessary to understand how indi-

viduals are taxed, since trusts are taxed as individuals. For the purposes of this
course, the taxation of an individual is also relevant with respect to taxation of
an individual in the year of death; while some of the basics are covered in this
chapter, the detailed specific rules for taxation of an individual on death are in
Chapter 7. Tax planning for trusts and estates also requires an understanding

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2.1.2 Chapter 2 – Tax Basics, Taxation of Sources of Income of Trusts, and Taxation of Corporations and Their Shareholders

of taxation of corporations and their shareholders, as many tax planning strate-

gies involve transfers to or from corporations or involve the succession of family
businesses that are incorporated as private corporations.

This chapter covers some of the basic rules for taxation of individuals, the
sources of income relevant to trusts, and corporations and their shareholders.
It is meant to be a “primer” particularly aimed at those students with little or
no tax background. Rules relating to individuals and trusts are covered in 2.1,
2.2, 2.3, and 2.4. Not all rules for the taxation of individuals are relevant to this
course, and this chapter should not be relied upon as a complete survey of the
rules for the taxation of individuals. For example, income from a business and
income from an office or employment are only briefly discussed. The material on
taxation of corporations and shareholders is even more limited; the objective is
to provide enough detail for students to understand the planning concepts and
corporate components of the planning strategies discussed mainly in Chapters 8
and 10 without overwhelming the non-tax professional. The many complex rules
for corporations and shareholders should be left to those whose professional
practice focuses in this area.

2.1.2 Use of Tax Preparation Software as a Study Aid

In the years before access to tax preparation software, many people were famil-
iar with the rules for the taxation of individuals because they manually prepared
their own tax returns for filing by April 30 every year. Today, manual return
preparation is rare, and individuals generally know little about the actual rules
relating to the computation of net income, taxable income, and tax payable.

Computer-generated returns provide convenience and improve accuracy but at

the expense of understanding how income is computed and taxed. For example,
the gross-up and dividend tax credit mechanism applicable to dividends received
from taxable Canadian corporations is a multistep process made virtually invis-
ible when software is used. The data entry process prompts the tax software to
automatically calculate the dividend tax credit and its effect on federal and pro-
vincial tax payable without the individual needing to understand or even have
knowledge of the underlying rules of the Act.

Notwithstanding the above comments, the judicious use of tax preparation soft-
ware can assist students in seeing how the rules actually operate and affect the
calculation of net income, taxable income, tax payable, and so on. In reviewing

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INTRODUCTION : TAXATION OF TRUSTS AND INDIVIDUALS 2.1.4

some of the rules in this chapter and Chapter 7, it may be helpful to students to
make pro forma calculations using personal return software to achieve a work-
ing understanding of the rules and their application (see also Chapter 3).

It may also be helpful to examine the T1 Guide, General Income Tax and Benefit
Guide, for general information regarding the taxation of individuals.

2.1.3 Taxation of Trusts as Individuals

Trusts are taxed as individuals. It is essential to understand how individuals are

taxed in order to understand the taxation of trusts. In addition, individuals are
usually the beneficiaries of personal trusts; so much of the tax planning in trusts
and estate planning involves minimizing tax for individuals.

2.1.4 Basic Rules for Individuals Resident in Canada

Under s. 2 of the Act, tax is payable by every person resident in Canada on their
taxable income.

An individual will be resident in Canada if they ordinarily reside in Canada.1

Where an individual resides in Canada and in some other country, the income
tax treaty between Canada and that other country may contain tiebreaker rules
to determine in which country the individual is resident for the purposes of tax-
ation in Canada and the other country. An individual will be taxable for the year
under the provincial tax system in the province where they were resident at the
end of the calendar year (e.g., if someone was resident in Alberta from January 1
to December 30, and then moved to a higher tax jurisdiction on December 31,
they will be deemed to have been resident in the higher tax jurisdiction through-
out the entire year, possibly resulting in the payment of a high amount of tax if
withholdings during the year were taken at a much lower rate). The taxation of
non-residents of Canada is not covered in this course, except to the extent that
it affects a Canadian trust making distributions to a non-resident beneficiary. See
Chapter 6 for more details on taxation of non-resident beneficiaries.

Section 3 of the Act is the basic rule for computing net income. Net income
means income from the sources listed “net” of expenses permitted under the
Act that are incurred to earn that income. Section 3 provides that a taxpayer’s
income is computed by including the following amounts in income:

1 See Income Tax Folio S5-F1-C1: Determining an Individual’s Residence Status.

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2.1.5 Chapter 2 – Tax Basics, Taxation of Sources of Income of Trusts, and Taxation of Corporations and Their Shareholders

• income from all sources inside and outside Canada from each
office, employment, business, and property;
• plus the amount by which the taxpayer’s taxable capital gains for
the year exceeds the allowable capital losses for the year;
• less certain deductions permitted in computing net income.

Once net income is calculated, certain additional deductions are permitted in

calculating taxable income. These include unused non-capital losses and net
capital losses from other taxation years and the capital gains deduction. Once
taxable income is calculated, the income tax rates can be utilized to compute the
amount of tax payable. This calculation is done for both federal tax and provin-
cial tax.

2.1.5 Marital Status

A number of unique rules apply to a taxpayer who is married. A taxpayer may

be able to claim the personal tax credit for a spouse or common-law partner.
Transfers of property between spouses usually take place on a rollover basis.
Transfers to a spouse may trigger the attribution rules (for a discussion, see
Chapter 9). Most of these unique rules apply whether the individual is legally
married or has a common-law partner, including a relationship with a person of
the same sex. “Spouse” is not defined in the Act, but it is generally accepted that
it means persons who are legally married. Married same-sex partners would be
considered spouses under the Act.

“Common-law partner” is defined in subs. 248(1) to include a person who co-

habits in a conjugal relationship with the taxpayer either for a continuous period
of one year or for any period of time while raising a child together. It includes
same-sex partners who are not legally married. In most cases, the income tax
rules that apply to married persons also apply to persons in a common-law
relationship.

2.1.6 Trusts and Individuals Compared

Trusts are generally taxed as individuals. However, the rules for taxation of trusts
and individuals are not identical. What follows is an overview of taxation of
trusts and individuals compared without mention of exceptions and other spe-
cial rules discussed elsewhere in this or other chapters.

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INTRODUCTION : TAXATION OF TRUSTS AND INDIVIDUALS 2.1.6

Individuals are taxed on a calendar-year basis and are taxed at marginal, or

graduated, tax rates. Details of the tax rates applicable to trusts, and their year-
ends for tax purposes, are in Chapter 4. Graduated rate estates (GREs), like indi-
viduals, are taxed at the marginal or graduated tax rates, but, unlike individuals,
they have a choice with respect to year-end for tax purposes. Inter vivos trusts
and testamentary trusts other than GREs are taxed on a calendar-year basis, like
individuals, but, unlike individuals, they are taxed on all income at the highest
marginal tax rate applicable to individuals. NOTE: Prior to 2016, all testamen-
tary trusts were able to choose their year-end and were entitled to the graduated
rates of tax. Trusts are, with some exceptions, deemed to dispose of all property
every 21 years. Individuals are not subject to the 21-year deemed disposition
rule, but they are subjected to deemed disposition of all capital property on
death.

Individuals must file their tax return for the calendar year on or before April 30
of the following year, with the exception of self-employed persons, who may file
their tax returns on or before June 15 of the year following the taxation year. In
the latter case, taxes payable for the prior calendar year are still due on April 30.
A trust tax return is due on or before the 90th day following the end of its taxa-
tion year.

An individual is entitled to claim the non-refundable personal tax credits. Trusts

are not eligible for these credits.

One significant disadvantage of the trust structure is the inability to transfer

losses through a trust to a beneficiary. Trusts generally serve as a conduit, and
income can be flowed through the trust to a beneficiary and taxed as if the
income were received directly. However, the conduit principle breaks down
where there is a loss in the trust for the year except where the attribution rules
apply (see Chapter 9). Losses cannot be passed through a trust to a beneficiary,
and losses may be trapped in the trust unless an election to allocate income oth-
erwise taxed to a beneficiary is available.

Individuals may claim the capital gains exemption; trusts may not.2 However
trusts may act as a conduit for capital gains to a beneficiary. And capital gains
made payable to and designated by a trust to an individual beneficiary may be
eligible for the capital gains exemption.

2 There is one exception for a qualifying testamentary or inter vivos spousal or common-law partner
trust (QST) in the year in which the surviving spouse or common-law partner dies.

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2.2 Chapter 2 – Tax Basics, Taxation of Sources of Income of Trusts, and Taxation of Corporations and Their Shareholders

An individual is a legal person; however, a trust is not a legal person. The Act
treats a trust as an individual for tax purposes, but essentially it is the trustees
who take on the persona of the taxpayer under the Act.

Individuals, including trusts, are subject to alternative minimum tax (AMT).

Individuals may claim the principal residence exemption, but it is only available
to certain life interest trusts and under limited circumstances. It is possible for a
trust to flow through the principal residence exemption to the beneficiaries by
transferring the residence to the beneficiaries (see 4.11).

2.2 CALCULATING NET INCOME FOR INDIVIDUALS

A resident of Canada must include worldwide income from five basic sources,
under s. 3.

• Employment income
• Business income
• Property income
• Capital gains and losses
• Other specific sources of income

For the purposes of studying the taxation of trusts and trust beneficiaries, the
most important sources of income are property income and capital gains and
losses. A trust may have business income, although this is rare in the case of a
personal trust unless by virtue of being a member of a partnership (usually a
“limited” partnership member) that carries on a business. A trust will not have
employment income since it cannot itself perform personal services.

There are some receipts that do not fall within the Canadian income tax system
and are not taxable as income. These include lottery winnings, inheritances and
gifts, and the death benefit paid under a life insurance policy. Lottery winnings
are considered windfalls and are not generally taxable. However, in a recent
case3 the Minister of National Revenue tried to establish that two brothers who
purchased large numbers of sports lottery tickets should have their winnings
taxed as income from a business as they were essentially carrying on a busi-
ness. The Tax Court of Canada found that the taxpayers were “not professional

3 Leblanc v. Canada, 2006 TCC 680.

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CALCULATING NET INCOME FOR INDIVIDUALS 2.2.1

gamblers who asses their risks, minimize them and rely on inside information
and knowledge and skill.” Since the gambling activities were of a personal nature
and their conduct fell short of carrying on a business, the lottery winnings were
not taxable.

With respect to gifts and inheritances, these are not generally not taxable to the
recipient. Generally, the tax consequences fall upon the maker of the gift or the
estate of the deceased person. Technically, there is no gift or inheritance tax in
Canada. However, making a gift or dying and leaving an estate may be taxable
events if there are unrealized gains on the property gifted or owned on death.
Generally, there is a “deemed disposition” for proceeds of disposition equal to
fair market value upon death or upon a gift or transfer to a person with whom
the donor does not deal at arm’s length. In some cases, such as where property is
given to a spouse or common-law partner, there is a rollover on the gift or transfer
of capital property, meaning the transfer takes place at the donor/transferor’s cost
or the adjusted cost base (ACB)4 and the recipient receives or inherits the trans-
feror’s ACB.

2.2.1 Income from Property

The rules for determining income from property are contained in ss. 9 to 37 of
the Act. Generally, income from property is the profit that is earned from capital
property. Included in income from property are:

• dividends paid on shares in the capital stock of a corporation;

• interest paid on investments such as bank deposits, guaran-
teed investment certificates (GICs), loans, mortgages, bonds, and
debentures;
• rental income from real estate or other income from leased prop-
erty; and
• royalty income earned on the ownership of intellectual property or
other non-tangible property such as patents and mineral rights.

Where capital property is sold or disposed of, the receipt is not income from
property. Instead, the transaction is treated on “capital account” and one-half of
the capital gain, being the proceeds of disposition less the costs of disposition
and the ACB, is included in income (see Chapter 3).

4 See Chapter 3 for a discussion of a taxpayer’s adjusted cost base (ACB).

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2.2.1.1 Chapter 2 – Tax Basics, Taxation of Sources of Income of Trusts, and Taxation of Corporations and Their Shareholders

Financial institutions, corporations, mutual funds, and trusts are required to

prepare information slips reporting the investment income earned and paid or
allocated to investors or beneficiaries in respect of property held by them for
the benefit of the investor or beneficiary. The information slips may show the
amounts of dividends, interest, foreign income, and foreign withholding tax that
are taxable or applicable to the recipient during the year. A Canadian corpora-
tion or financial institution will prepare a T5 slip showing these amounts. A trust
will prepare a T3 slip showing the amounts of income to be allocated to benefi-
ciaries. Mutual funds are generally organized as trusts and will report income to
a unit holder on a T3 slip.

2.2.1.1 Joint Accounts

Where an individual has a joint account or joint investment account
with another person, the income from such account must be reported in
proportion to the individual’s contribution to the account. Joint accounts
with certain related persons, including a spouse and a minor child, may
be subject to the attribution rules (see discussion in Chapter 9).

2.2.1.2 Interest Income

Interest income is the compensation received for the use of borrowed
money, and may include interest paid on:

• bank accounts,
• term deposits,
• GICs,
• Canada Savings Bonds,
• Treasury bills (T-bills), and
• earnings on life insurance policies.

Individuals are permitted to recognize the timing of interest income

under para. 12(1)(c) of the Act either on the receivable method, the
cash method, or the anniversary day accrual method. An individual may
use any of the three methods for each investment, but once the method
is chosen it must be used consistently for that particular investment.
Under the receivable method, interest is included in income only when
it is legally due and payable. Under the cash method, interest is taken

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CALCULATING NET INCOME FOR INDIVIDUALS 2.2.1.4

into account for tax purposes only if it has actually been received in the
year. The anniversary day accrual method may override the other meth-
ods chosen by the taxpayer where the deferral of inclusion in income
is longer than one year. The anniversary day accrual method requires
that interest be recognized for every 12-month period from the date
the investment was made, regardless of whether or not any interest has
actually been paid.

2.2.1.3 Deductions from Interest Income

Generally, income from property is the profit made from the property.
Expenses incurred to earn the interest income may be deducted from
gross revenues. Such expenses include:

• interest on funds borrowed to acquire interest-bearing securi-

ties or other income-producing property,
• investment counselling fees,
• costs incurred to obtain financing, and
• accounting fees for record keeping and determining income
from property.

2.2.1.4 Dividends from Taxable Canadian Corporations

Dividends from taxable Canadian corporations5 are subject to special
treatment where the recipient is an individual. Dividends are increased,
or “grossed up,” by a percentage of the actual dividend received6 and
also generate a non-refundable tax credit7 called the “dividend tax
credit” (DTC), which is available to reduce tax payable on all sources of
income. The grossed-up dividend is called the “taxable dividend,” and
this is the amount included in income. The amount of the gross up
depends on whether the dividends are “eligible dividends” (see 2.2.1.5),
which have a higher gross up and thereby have more preferred tax treat-
ment, or other dividends (i.e., non-eligible dividends). The dividend tax
credit is calculated as a percentage of the gross up.

5 Essentially a corporation resident or incorporated in Canada that is not a not-for profit corporation.
6 See subparas. 82(1)(a)(i) and (b)(i) for gross up on regular dividends and subparas. 82(1)(a)(ii) and
(b)(ii) for gross up on eligible dividends.
7 S. 121.

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2.2.1.4 Chapter 2 – Tax Basics, Taxation of Sources of Income of Trusts, and Taxation of Corporations and Their Shareholders

The gross-up and dividend tax credit rates are calculated separately in
the calculation of federal tax payable and provincial tax payable; each
province has its own gross-up and dividend tax credit calculation for the
purpose of calculating provincial tax. Figure 2.1 shows the federal rates
of gross up and DTC. The gross-up and dividend tax credit amounts are
subject to frequent changes by both the federal and provincial govern-
ments. In October 2017, for example, the federal government announced
a reduction in the small business tax rate for Canadian-controlled pri-
vate corporations and a consequential reduction in the gross up on non-
eligible dividends to 16% for 2018 and 15% for subsequent years. Since
the DTC is a percentage of gross up, this will decrease as well.

Figure 2.1: Dividends from Taxable Canadian Corporations to Individuals:

2016 and Subsequent Years

Federal Calculations Shown

NOTE: Provinces have their own dividend tax credit rates and provincial tax will affect the tax
treatment as well.
Gross Up as a % of Taxable Dividend Dividend Tax Credit
Actual Dividend
Eligible Dividends 38% 1.38% of actual dividend 6/11 of gross up or 20.73% of
actual dividend
Non-Eligible Dividends 17% 1.17% of actual dividend 21/29 of gross up or 12.31% of
actual dividend

Figure 2.2 shows an example of the effect of different provincial calcu-

lations on an actual dividend of $60,000. This also demonstrates how
beneficial the gross-up and dividend tax credit mechanism is for those
who have no other sources of income — very little tax is payable on
$60,000 of income if the only source of income is those dividends. If
there were additional income from employment or other sources, sub-
stantially more tax would be payable on the $60,000 dividend.

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CALCULATING NET INCOME FOR INDIVIDUALS 2.2.1.4

Figure 2.2: Tax on Actual Dividend of $60,000 Paid by a Taxable Canadian

Corporation to an Individual

NOTE: Rates as of May 2017; amounts approximate and may include or exclude
adjustments such as provinical rebates or alternative minimum tax (AMT).
Province/Territory Eligible Non-Eligible
British Columbia $ 267 $ 5,065
Alberta $ 267 $ 6,319
Saskatchewan $ 267 $ 6,190
Manitoba $ 3,272 $ 9,621
Ontario $ 267 $ 3,904
Quebec $ 2,894 $ 7,339
New Brunswick $ 267 $ 7,613
Nova Scotia $ 3,156 $ 8,513
Newfoundland $ 5,085 $ 7,595
Prince Edward Island $ 1,466 $ 8,382
Northwest Territories $ 267 $ 2,734
Nunavit $ 267 $ 3,766
Yukon $ 267 $ 4,909

In summary:

• “Gross up” is the additional amount added to dividend income.

• “Taxable dividend” is the actual dividend received plus the
gross up; it is fully taxable and may also be referred to as the
“grossed-up dividend.”
• “Dividend tax credit” is the non-refundable tax credit; it is based
on a percentage of the gross up.8
• For eligible dividends received after 2011, the federal gross-up
amount is 38% of the actual dividend federally.
• For non-eligible dividends received in 2016 and subsequent
years, the gross up is 17% of the actual dividend federally9 (see
Figure 2.1).
• The provinces have their own percentages for gross-up and
dividend tax credits for dividends from a taxable Canadian
corporation.

8 Dividend tax credit is in the Act, s. 121.

9 Subject to proposed changes announced October 2017 by the federal government, as noted above.

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2.2.1.4 Chapter 2 – Tax Basics, Taxation of Sources of Income of Trusts, and Taxation of Corporations and Their Shareholders

In theory, the gross up is said to represent the tax that has been paid on
income taxed at the corporate level. In practice, there is no direct rela-
tionship between the gross up and tax paid by the payor corporation.

The operation of the gross-up and dividend tax credit (DTC) mechanism
is important to understand as it affects individuals differently at differ-
ent levels of income who are taxed at different marginal rates. Dividends
taxed in the highest tax brackets are taxed at a rate less than ordinary
income as a result of the dividend tax credit, even when the additional
tax on the gross up is factored in. In fact, individuals in all tax brackets
are taxed at lower rates on dividends than ordinary income, although
the effect can be slightly discounted where the gross up pushes the
level of income into a higher tax bracket.

The effect of the gross-up and DTC mechanism for individuals in the
lower tax brackets includes the following:

• DTC can be applied to offset tax on all sources of income,

with the result that tax on other income from other sources
can be reduced or eliminated if not all the DTC is required to
offset the tax on the taxable dividend. Any unused portion is
non-refundable.
• Receiving income in the form of taxable dividends reduces the
overall tax rate for those in the lower tax brackets as compared
with the rate on other sources of income.
• Significant amounts of taxable dividends can be received tax-
free by an individual who has little or no other income because
of the dividend tax credit.
• As a result, dividends can be used very effectively to income
split between high-income individuals and their lower income
family members, assuming none of the attribution rules or tax
on split income rules are applicable. This is known as the “divi-
dend tax credit effect” (for further discussion, see 9.4.1).

Dividends from corporations other than taxable Canadian corporations

(i.e., corporations incorporated outside Canada) and received by an
individual are treated as regular income. If tax is withheld at source on

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CALCULATING NET INCOME FOR INDIVIDUALS 2.2.1.7

the payment of the dividends, a deduction or foreign tax credit10 may be

available in Canada.

2.2.1.5 Eligible Dividends

Eligible dividends are dividends paid from income not subject to the
small business deduction. This would include all dividends from pub-
licly traded Canadian corporations and any dividends paid by Canadian-
controlled private corporations (CCPCs) from income not subject to
the small business deduction. In general, the small business deduction
operates to reduce the rate of tax on a limited amount of annual income
($500,000 federally) for CCPCs on their active business income.

In order to pay eligible dividends, a corporation must “designate” a

dividend as an “eligible dividend,” thereby permitting the recipient to
claim the enhanced dividend tax credit. A CCPC can only pay an eligible
dividend to the extent of its “general rate income pool” (GRIP), which
tracks retained earnings that were taxed at the high corporate tax rate.
A corporation resident in Canada that is not a CCPC can pay eligible
dividends unless it has a positive balance in its “low-rate income pool.”

2.2.1.6 Mutual Funds

Mutual funds, like trusts, are treated as conduits. Any investment income
earned by a unit holder of a mutual fund is reported by the mutual fund
to a unit holder in the year. Distribution from a mutual fund to a unit
holder will be added to the unit holder’s cost base of the investment in
the mutual fund. When the unit holder redeems the unit, a capital gain
or loss will result in the same manner as a disposition of shares, even
though the unit is disposed of back to the issuer. Mutual funds are gen-
erally organized as trusts and will report income to a unit holder on a
T3 slip.

2.2.1.7 Deemed Dividend on Redemption of Shares of a Corporation

The sale of shares back to the issuing corporation — either for repur-
chase, cancellation, or as part of a redemption or retraction — is treated
as a deemed dividend to the extent that the proceeds exceed the paid-up
capital (PUC) of the shares. Generally, the PUC of shares in a corporation

10 Foreign tax credit may be limited with a deduction available under subss. 20(11) or 20(12).

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2.2.1.8 Chapter 2 – Tax Basics, Taxation of Sources of Income of Trusts, and Taxation of Corporations and Their Shareholders

is the stated capital amount shown in the financial statements of a cor-

poration in respect of a particular class of shares and represents the
original subscription price for the shares. Where the taxpayer’s ACB of
the shares exceeds the paid-up capital, a corresponding capital loss may
occur in addition to the deemed dividend. A capital loss occurs because
the amount of the deemed dividend is not included in the proceeds of
disposition where shares are sold back to the issuing corporation or are
cancelled or redeemed. Thus, the proceeds of disposition (as reduced)
may be less than the ACB, resulting in a capital loss. This is particularly
relevant on the death of a shareholder since the ACB of the shares held
by the estate will be equal to the fair market value at the time of death
due to a deemed disposition.

This unique treatment of the disposition of shares back to the issuing

corporation is very important in post-mortem tax planning (for more
detail, see Chapter 8).

2.2.1.8 Foreign Income

Property income from foreign investments, such as interest on bonds
issued by entities not resident in Canada or dividends paid by corpora-
tions not resident in Canada, must be included in income in Canadian
dollars. An individual may convert income received in a foreign cur-
rency either at the rate at the time the transaction took place or may
convert all transactions for the year on the average rate of conversion
for that particular currency for the year. The average rate of conversion
is published by CRA annually for each particular currency.

The gross amount of foreign income is included in income even if the

payment of foreign income was subject to withholding tax. However,
any foreign tax that is paid on income received from another country
may be available as a non-refundable foreign tax credit to reduce Cana-
dian tax on income from that country.11 The foreign tax credit reduces
Canadian tax only to the extent that Canadian taxes are paid in that year
on sources of income on a country-by-country basis.

11 Under subss. 126(1) and (2) of the Act.

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CALCULATING NET INCOME FOR INDIVIDUALS 2.2.2.3

2.2.1.9 Rental Income

Rental income is compensation for allowing another person to use capi-
tal property. In most cases, rental income is received from the owner-
ship of real property. However, rental income could also be received
for other types of property such as the rental of vehicles, construction
equipment, and the like.

Expenses incurred to earn rental income are deductible. Where expenses

for a rental property exceed the rental income, a loss may be generated.
However, there are special rules relating to capital cost allowance (the
amount of the cost of capital property that is deductible in a particular
year) that may restrict the computation of a loss from real estate rental
property.

2.2.2 Recapture of Capital Cost Allowance and Income from Other Sources

2.2.2.1 Capital Gains

An individual’s taxable capital gains less allowable capital losses for the
year are included in income under s. 3 of the Act (for a more detailed
discussion, see Chapter 3).

2.2.2.2 Income from an Office or Employment

Subsection 5(1) of the Act states that all remuneration for an office or
employment — including salary, wages, commissions, and gratuities —
is included in employment income on a received basis. An employee is
not required to include employment income that was not received in a
particular year, even though it may have been earned in that year. In
addition, an employee must include all taxable benefits from employment
in income. A more detailed discussion of the taxation of employment
income is not included here, since generally it is not relevant to the taxa-
tion of trusts and beneficiaries.

2.2.2.3 Income from a Business

A taxpayer’s income from a business for a year is the profit from that
business. Profit from a business is calculated in financial statements
according to financial reporting and accounting standards developed
within the accounting profession. Profit from the business for accounting

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2.2.2.4 Chapter 2 – Tax Basics, Taxation of Sources of Income of Trusts, and Taxation of Corporations and Their Shareholders

purposes is then adjusted under specific rules provided for in the Act.
Revenues from a business are included and deductions are available
to the extent that expenses were incurred for the purpose of earning
the business income. Where expenses exceed revenues, the loss will be
deductible against other sources of income, providing that the business
is carried on with a reasonable expectation of profit.

Where an individual carries on business, this may be done either as:

• a sole proprietor,
• through a partnership, or
• through a corporation.

Only where an individual carries on business as a sole proprietor will

the income be characterized as income from business in computing the
individual’s income. If the individual is carrying on business with other
persons, it will normally be included as income from a partnership. A
partnership is generally defined as carrying on business in common
with a view to a profit. Partnership income is computed at the partner-
ship level, generally in the same manner as income from a business is
computed, and then the income or loss from the partnership is allocated
to each individual partner, who then includes the income or loss in his
or her computation of income.

Where a business is conducted through a corporation, the individual

will not have income from a business, since the business is not carried
on by the individual. Instead, the individual will own shares of the cor-
poration and derive income from the corporation either in the form of
wages, benefits, or other remuneration or a dividend paid on the shares
of the corporation.

There are many rules relating to the taxation of income from a business
and a partnership for an individual. These will not be covered here, as
they are beyond the scope of this course.

2.2.2.4 Deferred Pension Plans

An individual must report any and all amounts received under a pension
plan in the year. These may include amounts from a registered pension

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CALCULATING NET INCOME FOR INDIVIDUALS 2.2.2.6

plan, registered retirement savings plan, registered retired income fund,

or the like.

Income from any foreign pension plan must also be included. As with
other forms of foreign income, the gross amount of foreign pension
income must be reported.

2.2.2.5 Income from a Trust

Income from a trust must be included in computing net income under
para. 12(1)(m) of the Act. Generally, a beneficiary of a trust must
include income that is paid or payable from the trust to the beneficiary
in the year. A testamentary trust that is a graduated rate estate (GRE)
may choose its tax year-end. Where an individual is a beneficiary, the
amount of income to be included from the trust is the income from the
trust from the taxation year of the trust that ends in the calendar year of
the individual. This could result in a deferral of recognition of income
from a GRE to an individual beneficiary. Income from other trusts paid
or payable to a beneficiary will be taxed to the beneficiary in the same
taxation year as it was received by the trust.

Generally, a trust is treated as a conduit for the sources of income. The

character of the income allocated to a beneficiary may be designated as
dividends, capital gains, or foreign income, for example, if these sources
of income were received by the trust. Where the character of the income
is not specifically designated or is not eligible for designation, the
income will be characterized as income from a trust.

The trust is required to prepare a T3 slip reporting income allocated to

beneficiaries. The beneficiary must report income from the T3 slip in his
or her tax return. For the taxation of beneficiaries, see Chapter 6.

2.2.2.6 Recapture of Capital Cost Allowance on Depreciable Capital

Property
When depreciable property of a particular class is sold for an amount in
excess of the undepreciated capital cost (UCC) of that class, the excess,
not exceeding the original cost of the property of the class, is treated as
an income receipt called “recapture,” referring to a recapture of the capi-
tal cost allowance (CCA) previously claimed. Recapture operates to “tax

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2.2.3 Chapter 2 – Tax Basics, Taxation of Sources of Income of Trusts, and Taxation of Corporations and Their Shareholders

back” the CCA previously claimed to the extent it has been recouped on
a subsequent disposition of the depreciable property. The amount of the
recapture treated as an income receipt is limited to the original capital
cost of the property of the class, since any amount received in excess
of the original cost of the class was never claimed as CCA and is treated
as capital gain. As explained in Chapter 3, only half of a capital gain is
included in income.

For a full discussion of CCA and the tax treatment of depreciable prop-
erty, see 2.2.3.1 and in particular the example that illustrates the calcula-
tion of the recapture and capital gain when the one property in a class
is sold for an amount in excess of the original cost. In that example, in
year 7, the trust sells the property for net proceeds of $1,500,000, which
is $500,000 over the original cost. The result would be a recapture of all
the previously claimed CCA as an income inclusion and a capital gain of
$500,000.

2.2.3 Deductions in Calculating Net Income

2.2.3.1 Capital Cost Allowance and Terminal Loss

Depreciable property is capital property acquired for the purpose of
earning income from property or a business. The cost of depreciable
property is not deductible as an expense in the year incurred since this
would offend the matching principle; depreciable property normally
has a useful life over a number of years, and so the cost of such prop-
erty is spread out over a number of years to better reflect the cost of the
property over its useful life and to better “match” the calculation of net
income or profit generated by that property over the years.

For tax purposes, the cost of each type of depreciable property is pooled
into a specific “class” of depreciable property and each class has its
own depreciation rate. For example, Class 8, with a depreciation rate of
20%, includes furniture, appliances, photocopiers, and electronic com-
munications equipment such as fax machines and electronic telephone
equipment. Class 10, with a depreciation rate of 30%, includes computer
hardware and systems software.

The “pooled” amount in each class is called the undepreciated capital

cost (UCC). The UCC for each class is a running balance adjusted each

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CALCULATING NET INCOME FOR INDIVIDUALS 2.2.3.1

year. A portion of the UCC, called capital cost allowance (CCA), may be
claimed as a deduction each year. The CCA is calculated as an annual
percentage rate of the UCC of the class as at the end of the prior year
on a diminishing balance basis. The claim for CCA is optional, and the
rules provide for the maximum amount that may be claimed in any year.
Each year the UCC is increased by the cost of any acquired property
of that class in the year and is reduced by the CCA claimed in the year
and any proceeds of disposition of any property in the class. If all the
property of the class is disposed of and any UCC balance remains, the
full remaining balance of the UCC may be deducted in that year as a
terminal loss.

The following example may be helpful.

Figure 2.3: Example of Capital Cost Allowance

CAPITAL COST ALLOWANCE

Original Cost $ 1,000,000
Class 1: 4% CCA rate
Capital Cost Undepreciated
Allowance (CCA) Capital Cost (UCC) at
Claimed Year-End
Year 1* $ 20,000 $ 980,000

Year 2 $ 39,200 $ 940,800

Year 3 $ 56,448 $ 884,352
Year 4 $ 53,061 $ 831,291
Year 5 $ 49,877 $ 781,413
Year 6 $ 46,885 $ 734,529
$ 265,471
* Only 2% CCA claimed in year of acquisition.

Assume a trust holds a rental commercial building for seven years. The
cost (excluding land) was $1,000,000, which is added to the UCC of
Class 1, with a rate of 4%. The property is the only property in its class.
Assume in the first year, the maximum CCA available is subject to the
“half-year rule” so that only $20,000 was claimed, but the full 4% was
claimed for years 1 through 6 for a total of $288,113 of CCA, leaving a
UCC at the end of year 6 of $734,529. If the property is sold in year 7 for
$600,000, the UCC balance at the end of year 7 will be $134,529. How-
ever, since there will no longer be any property remaining in the class

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2.2.3.2 Chapter 2 – Tax Basics, Taxation of Sources of Income of Trusts, and Taxation of Corporations and Their Shareholders

owned by the trust, the entire remaining UCC balance will be deductible
in the year as a terminal loss.

If the property were sold instead for $1,500,000, there would be recap-
ture of previously claimed CCA of $265,471 and a capital gain of
$500,000 (see 2.2.2.6).

Neither the cost of land nor the cost of intangible capital property, such
as investments in securities, are depreciable property for tax purposes;
neither land nor financial instruments are “consumed” in the process of
using them to earn income. Certain intangible capital property, such as
goodwill, used to be classified as eligible capital property with its own
set of separate rules but as of January 1, 2017, is included in Class 14.1
at a rate of 5%.

The rules for CCA are complex and the details are not included in the
scope of this course. The “pooling” of UCC into classes, and the excep-
tions to the pooling requirement, affect the calculation of UCC, CCA,
recapture, and terminal loss in ways that are not discussed here; nor
is the “half-year rule” that limits the CCA available in the year prop-
erty is acquired. Detailed rules also restrict the amount of CCA available
on rental real estate, as generally CCA cannot be claimed to create or
increase a loss.

2.2.3.2 Carrying Charges and Interest Expenses

Carrying charges and interest expenses will be deductible from income
if paid to earn investment income. These amounts include:

• management fees (other than administration fees for registered

plans),
• fees for investment advice, and
• fees for tax return preparation to the extent they relate to com-
puting income for a business or property.

In addition, interest paid on borrowed funds is deductible under

para. 20(1)(c) of the Act if paid or payable in the year pursuant to a
legal obligation to pay interest on:

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CALCULATING NET INCOME FOR INDIVIDUALS 2.2.3.4

• borrowed money used for the purpose of earning income from

a business or property, or
• an amount payable for property acquired for the purpose of
gaining or producing income from property or for a business.

Interest on money borrowed to acquire property that is not for the

purpose of earning income is not deductible. For example, interest on
money borrowed to contribute to registered plans — including a regis-
tered retirement savings plan (RRSP), tax-free savings account (TFSA),
registered education savings plan (RESP), or registered disability sav-
ings plan (RDSP) — is not deductible.

2.2.3.3 Interest Incurred to Purchase Preferred Shares

Generally, interest is deductible where it is incurred for the purpose of
earning income. Where preferred shares are purchased, the dividends
paid on the preferred shares may be fixed. Where the rate of dividend
return is less than the interest cost, CRA’s administrative policy is that
the borrowing cost will be deductible up to the amount of the taxable
dividend (i.e., the amount of the dividend plus the gross up).

2.2.3.4 Contributions to Registered Plans and Beneficiary Designations

An individual may deduct contributions to a registered retirement sav-
ings plan (RRSP) made in the year or within 60 days following the
calendar year. The amount of contributions to an RRSP that may be
deducted is subject to an annual contribution limit based on the les-
sor of 18% of “earned income” for the previous taxation year and the
deduction limit for the particular year ($26,010 for 2017 and $26,230 for
2018). Any unused contribution room for prior taxation years may be
carried forward and is available for deduction in the current or future
years. An individual may defer the deduction of an RRSP contribution
made within the contribution limits to a later year. This may be to the
individual’s advantage if there is a lower amount of income in the cur-
rent year and the deduction will be more valuable in a future year with
more income, where the individual’s income is in a higher marginal tax
bracket.

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2.3 Chapter 2 – Tax Basics, Taxation of Sources of Income of Trusts, and Taxation of Corporations and Their Shareholders

One important feature of RRSPs and registered retirement income funds

(RRIFs) (which are funds that have been converted from RRSPs) is that
an individual may designate a beneficiary for such plans upon death.
This permits the plan proceeds to be transferred outside the individual’s
estate and not subject to distribution under the terms of the individual’s
Will. In addition, the plan proceeds will not be subject to provincial pro-
bate fees where a named individual is a beneficiary. However, there are
a number of potential pitfalls of direct beneficiary designations, includ-
ing the possibility of an inequitable division of assets where the estate
bears the tax on the RRSP or RRIF on death but the named beneficiaries
of the RRSP or RRIF receive the funds tax-free.

The rules relating to RRSPs and RRIFs are complex. Tax treatment on
death of these plans is included in Chapter 7. As these plans have sig-
nificant tax consequences on death, planning aspects are included in
other chapters as well.

2.3 CALCULATING TAXABLE INCOME FOR INDIVIDUALS

Once net income has been calculated, certain deductions are available in calcu-
lating taxable income. These include:

• non-capital losses of other years,

• net capital losses of other years, and
• capital gains deduction.
For a discussion of the deduction of net capital losses and the capital gains
deduction, see Chapter 3.

2.3.1 Non-Capital Losses

Where a loss from a property, business, or employment is incurred in a taxation

year, such loss is deductible against other sources of income in the current year.
Where such losses are in excess of income from other sources in the year, the
non-capital loss for the year may be carried back to offset income in the three
prior taxation years or carried forward to offset income in the 20 subsequent
taxation years.12

12 Para. 111(1)(a).

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CALCULATING TAX PAYABLE FOR INDIVIDUALS 2.4.2

2.4 CALCULATING TAX PAYABLE FOR INDIVIDUALS

An individual pays tax at the graduated tax rates, which are applied to taxable
income.13 Individuals pay both federal tax and provincial tax, and the calcula-
tions are done on separate schedules in the individual tax return. For residents
of Quebec, or for individuals resident in other provinces who have business or
partnership income earned in the province of Quebec, a separate Quebec tax
return must be filed.

2.4.1 Tax Rates for Individuals

The individual graduated rates of federal tax are set out in the Act,14 not in the
regulations. To the federal rates are added the provincial rates, depending on the
individual’s province of residence on the last day of the particular taxation year.
Combined provincial and federal rates of tax for individuals can be used for
trusts. Trusts are not entitled to the personal tax credits, and only certain trusts
are entitled to the graduated rates, being graduated rate estates and qualified
disability trusts (see Chapter 4). CRA publishes a chart showing the various pro-
vincial rates on its website. Many publishers in the tax field and many account-
ing firms also provide tables showing the rates of tax for a particular year and
province. Some also include additional tables showing the rates of tax on taxable
dividends, eligible dividends, and capital gains. Each of these sources of income
has a different tax rate than regular income because of the dividend tax credit
in the case of dividends and the 50% inclusion rate in the case of capital gains.

2.4.2 Non-Refundable Tax Credits

Once tax is calculated, any tax withheld at source, tax installments paid by the
taxpayer, and tax credits available are applied to reduce or eliminate tax payable
for the year.

Individuals are entitled to a number of non-refundable personal tax credits.

These include the basic personal amount, child amount, age amount, pension
income amount, disability amount, spouse or common-law partner amount, and
the amount for an eligible dependant. These credits are applied against the com-
putation of federal tax and provincial tax separately. Trusts are not entitled to
any of these non-refundable personal tax credits.

13 Under subs. 117(2).

14 S. 117.

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2.4.2 Chapter 2 – Tax Basics, Taxation of Sources of Income of Trusts, and Taxation of Corporations and Their Shareholders

The dividend tax credit is discussed above (see 2.2.1.4 and 2.2.1.5) under div-
idends. The foreign tax credit is discussed above (see 2.2.1.8) under foreign
income.

A donation tax credit is available for gifts to a charity or other organization that
is a “qualified donee.” A qualified donee includes a Canadian registered char-
ity, a registered Canadian amateur athletic association, and a listed university
outside Canada that is prescribed to be a university, the student body of which
ordinarily includes students from Canada. The donation tax credit for individuals
is calculated as a percentage of the “eligible amount” of the donations (i.e., gifts
made to qualifying organizations, including registered charities). The federal rate
is 15% on the first $200 of eligible donations and 29% on any donations in
excess of $200. To this is added the provincial donation tax credit.15 Registered
charities are listed on CRA’s website under “Charities Listing,” although gifts to
other organizations may also be eligible.

Included in the eligible amount are donations in the year, unclaimed donations
in the previous five years, and any unclaimed donations made by the taxpayer’s
spouse or common-law partner in the year or five previous years. There is a limit
on the eligible amount equal to 75% of net income in the year, subject to excep-
tions for gifts of certified cultural property or ecologically sensitive land (100%).
The limit for eligible gifts in the year of death, or deemed to be made in the year
of death, is 100% of the eligible amount. The 100% limit on eligible gifts also
applies to the year immediately prior to death where if the eligible gifts avail-
able have not been fully utilized in the year of death.

Donations made after March 20, 2013, by qualifying first-time donors are entitled
to an additional federal donation tax credit of 25% on the first $1,000 of mon-
etary donations, in addition to the regular federal donation tax credit.

For a discussion of the special rules relating to donation of shares and other
rules relating to donations on death and by a graduated rate estate or for a grad-
uated rate estate within the first five years following death, see 4.12 and 7.13.3.

15 CRA has published a chart showing the various provincial rates on its website.

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CALCULATING TAX PAYABLE FOR INDIVIDUALS 2.4.3

2.4.3 Alternative Minimum Tax (AMT)

Alternative minimum tax (AMT) is an additional amount of tax that may be pay-
able in a particular year if certain types of income or deductions are received.16
It is intended to limit the advantage of certain incentives, or preferred income,
by preventing a taxpayer from reducing tax on income below a certain thresh-
old. AMT is applicable to individuals and trusts.

Tax is calculated under the AMT rules, and if this tax exceeds the tax payable
under Part I of the Act, the additional amount of tax is payable as the AMT tax.
The AMT payable can be carried forward for up to seven years (the minimum
tax carryover) to reduce Part I tax payable in a subsequent year to the extent
that the minimum tax rules do not apply in that subsequent year.

AMT is not applicable to the following:

• the year of death of an individual (the terminal return),

• the year of death of the settlor beneficiary of an alter ego trust
(AET), or
• the year of death of the last to die of the spouse or settlor of:
{ a joint spousal or common-law partner trust ( JPT), and
{ a qualifying spousal or common-law partner trust (QST).

In each of the above circumstances, there is a deemed disposition on death in

the return for the year in which AMT is not applicable. Accordingly, in the year
in which AMT is not applicable, the trust or estate, as the case may be, may be
entitled to a refund of AMT paid in previous years.

At the federal level, the minimum tax is 15% of the “net adjusted taxable income
for minimum tax” (known as “AMT Income”) (see Figure 2.4). AMT takes taxable
income and adjusts it with certain incentive items, subject to a $40,000 exemp-
tion. The $40,000 exemption is not available to trusts except a trust that qualifies
as a graduated rate estate. If 15% of the AMT income is more than the federal tax
otherwise payable on taxable income calculated under Part I of the Act, the excess
is payable in the year. The AMT for the year creates a minimum tax carryover that
may be refunded in a future year. AMT is fully refundable in the year of death. The
provinces have their own minimum tax calculations.

16 The minimum tax rules are in Division E.1 of Part I in ss. 127.5–127.55.

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2.5 Chapter 2 – Tax Basics, Taxation of Sources of Income of Trusts, and Taxation of Corporations and Their Shareholders

Figure 2.4: Calculation of Net Adjusted Taxable Income for Minimum Tax (AMT Income)

1. Taxable income otherwise calculated under Part I.

2. Plus certain adjustments in respect of the following amounts in the year:
• taxable dividends, including eligible dividends from Canadian corporations;
• taxable capital gains;
• loss on a rental property resulting from capital cost allowance;
• employee stock option deductions;
• loss from resource property or flow-through shares resulting from certain deductions, expenses, or allowances;
• loss from a limited partnership or tax shelter partnerships.
3. Less a basic exemption of $40,000.

2.5 BASIC TAXATION OF CORPORATIONS AND THEIR SHAREHOLDERS

2.5.1 Introduction

Knowledge of the basic concepts of taxation of corporations and their sharehold-

ers is helpful to fully understand the taxation of trusts and estates. Trusts and
estates may hold shares and receive income from corporations in the form of
dividends. Tax planning for the owner manager of a corporately held family busi-
ness may use trusts to achieve tax planning for themselves and family members.
And estates may need to undertake complex corporate post-mortem planning to
achieve tax-efficient succession for ownership and control of private corporations.
The main purpose of including this material in this course is to provide a back-
ground for post-mortem planning for shares of private corporations in Chapter
8. This section does not limit the discussion only to what is necessary for this
purpose in order that students may appreciate the bigger picture within which
post-mortem tax planning for private corporations takes place. Unfortunately, it is
difficult to provide a simple “primer” on the topic of taxation of corporations and
their shareholders. Including some content that broadly outlines very complex
rules is unavoidable.

2.5.2 Creation and Characterization of a Corporation as a Legal Person

A corporation is a legal entity, and in the Act a “person” includes a corporation.

A corporation is not an individual, and the word “individual” in the Act can only

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BASIC TAXATION OF CORPORATIONS AND THEIR SHAREHOLDERS 2.5.3

refer to trusts or “natural” persons — that is, humans or individuals in the con-
ventional meaning of the word.

Corporations are taxed on the same sources of income from property and a
business as an individual, although corporations do not receive income from
employment. Special rules deal with how income of a corporation is taxed.

A corporation is created, or “incorporated,” by the first directors filing an appli-

cation for a corporate charter, in modern corporate statutes called “articles of
incorporation,” and the government approving the application and issuing the
articles of incorporation. The directors of the corporation are in charge of man-
aging the affairs of the corporation. Corporations have sets of rules to operate.
These include the statute under which they were incorporated, the articles of
incorporation, and the by-laws of the corporation. The directors usually serve a
one-year term and are elected annually by the shareholders, who are the own-
ers of the corporation. Upon incorporation, the first shareholders subscribe for
shares in the capital stock of the corporation, and the corporation issues shares
in the capital stock of the corporation (said to be “from treasury”) to the share-
holders in exchange for money or other valuable consideration. The original
consideration for issuing shares is added to the capital account of the corpora-
tion as “stated capital” of the shares for corporate law and accounting purposes.
Stated capital forms the basis for “paid-up capital” for tax purposes, although
there are some adjustments. Generally, paid-up capital can be returned to share-
holders tax-free.

2.5.3 Benefits of Incorporation

Corporate ownership provides protection from creditors to its shareholders, as a

shareholder is not responsible for the debts of the corporation (unless there is a
personal guarantee). The other benefits of operating a business through corpo-
rate ownership include:

• perpetual existence,
• a unified entity where complex transactions can be authorized by
one legal person,
• separation of the business as a going concern from owners (the
owners can change but the business continues),

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2.5.4 Chapter 2 – Tax Basics, Taxation of Sources of Income of Trusts, and Taxation of Corporations and Their Shareholders

• enhanced credibility (important for customers, suppliers, lenders

and investors),
• access to capital (by issuing shares or debt to investors or lenders
— subject to securities law), and
• income tax advantages (including the low corporate tax rate and
small business deduction).

2.5.4 Shareholder Rights and Design of Share Capital

A shareholder does not have a beneficial interest in the property owned by the
corporation. A shareholder’s interest in a corporation is through share owner-
ship, and in some cases a shareholder will also hold debt owed by the corpora-
tion to the shareholder. Owner managers of incorporated businesses and other
individual shareholders often assume that they “own” the property of the cor-
poration. This is incorrect, even if the individual is the sole shareholder. There
is legal separation of ownership — a corporation, as a separate legal entity,
owns its own property. The shareholder owns the shares of the corporation
and, through voting rights on the shares, has the right to elect the directors
of the corporation. The shareholder cannot appropriate corporate assets except
by legal means — such as upon the declaration by the board of directors of
dividends payable to shareholders or, if the shareholder is also an employee, by
payment of compensation.

Most corporations are incorporated for the purpose of earning profit from a
business or income from property. Distribution of profits or net income after
expenses from a corporation can be made by declaring dividends payable on the
shares of the corporation. Corporate law prevents dividends from being paid if
the corporation is, or after the payment of a dividend would become, insolvent
— that is, unable to pay its liabilities as they come due — or the value of the
corporation’s assets is, or would be after the payment of dividends, less than its
liabilities. Such dividends are said to be “illegal,” and directors may be person-
ally liable to the creditors or others in respect of the payment of dividends in
such circumstances.

In a private corporation (i.e., not a publicly traded corporation) or closely held

corporation, where there are individual shareholders who are active in the busi-
ness, distributions from the corporation may, in addition to dividends, be by way
of compensation, such as salary, benefits, and bonuses in respect of employ-
ment. Generally, these amounts will be tax-deductible by the corporation from

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BASIC TAXATION OF CORPORATIONS AND THEIR SHAREHOLDERS 2.5.4

its income as an expense, and will be received by the employee/shareholder as

income or benefits from employment. This contrasts with the treatment of divi-
dends paid by the corporation. Dividends are not deductible, and when received
by an individual shareholder are taxed as dividends. The treatment of dividends
received by an individual shareholder is discussed at 2.2.1.4.

Ownership of a corporation is through shares in the corporation. Shares origi-

nally issued by the corporation for payment authorized by the board of directors
are said to be issued “from treasury.” The amount paid for the shares to the cor-
poration is the “stated capital” and usually this is the “paid-up capital” (PUC) for
tax purposes, subject to adjustments in some circumstances beyond the scope of
this material. Generally, the PUC can be returned tax- free to shareholders.

A corporation may be authorized in its articles of incorporation to issue dif-

ferent classes of shares. Different rights may attach to each class of shares. For
example, some classes may be voting, others may not. Some may have a prefer-
ential right to dividends over other classes of shares. Declaration of dividends
may be at the complete discretion by the board of directors, or may be subject to
minimum or maximum annual amounts or fixed annual amounts. Some shares
may increase in value with the value of the corporation, or others may have a
fixed value by virtue of the corporation’s right to redeem them at any time for
a specified amount. Share terms usually include the right of the specific class of
shares to participate in the distribution of corporate assets on the winding up or
dissolution of the corporation.

Common shares are typically shares that grow in value with the corporation, are
entitled to vote, and are entitled to discretionary dividends. Share terms can be
designed to achieve specific objectives, and the corporate structure potentially
provides a great deal of flexibility with respect to rights of ownership, value,
control, and priority as between classes of shares. Dividends are declared sepa-
rately on each class of shares. This permits flexibility with respect to distribution
of profit as different persons can hold different shares to vary pay out.

Shareholders have the right to the distribution of corporate assets upon the dis-
solution of the corporation. However, they stand last in line behind secured
creditors and other creditors of the corporation. As between different classes of
shares, the share terms set out in the articles of incorporation will set out the
priorities as to payments to shareholders. Usually payment of dividends declared

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2.5.5 Chapter 2 – Tax Basics, Taxation of Sources of Income of Trusts, and Taxation of Corporations and Their Shareholders

but unpaid come first, and then return of capital to any preferential shares, and
common shareholders are typically last.

2.5.5 Corporate Structures and Groups

A corporation can be a shareholder of another corporation, and business inter-

ests are often organized into corporate groups. In family business situations, it
is common to have the shares of an operating business, “Opco,” wholly owned
by another corporation, typically called a “parent” corporation, or “Holdco” for
short. A corporation wholly owned by another is called a subsidiary corporation,
and subsidiary corporations owned by the same Holdco or parent are called “sis-
ter” corporations.

Separate businesses or particular property may be held in separate corporations

within a corporate group, often held by a common parent corporation or group
of parent corporations. For example, a parent corporation may own Opco but
hold the real property used in the business in another corporation.

From an ownership perspective, groups of individual shareholders may hold

their shares in separate Holdcos. For example, two brothers own a business,
and they each may have their own Holdcos that together hold the shares of
one or more common Opcos. In addition, the various attributes of ownership
can be separated by virtue of the share attributes of particular classes of shares
issued by a corporation. Shares may have a right to vote, or not. Shares may
have a fixed value or a value that fluctuates with the value of the corporation as
a whole. Shares may have rights to dividends or may have limited or no rights
to dividends. By virtue of share structure and ownership, control, value, growth,
and return may all differ for shareholders of separate classes of shares in the
same corporation.

In addition to limited liability and tax benefits, the corporate structure provides
an opportunity for diversity of ownership and complex business organization.
There are disadvantages. While there are tax benefits, to be discussed below, the
corporate structure has the potential for double tax. This is because a corpora-
tion is taxed on its income, and shareholders are taxed on distributions from a
corporation.

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BASIC TAXATION OF CORPORATIONS AND THEIR SHAREHOLDERS 2.5.6

2.5.6 Taxation of Corporate Income and Tax Rates on Business Income

A corporation calculates its income from business and property in much the
same manner as an individual. Income from a business or from property for tax
purposes is the net income after deducting expenses incurred for the purpose of
earning the income and other allowable deductions under the Act.

Corporations do not have graduated rates of tax. They have different rates of
tax on different sources of income. A corporation will pay fixed rates of tax at
both the federal and provincial levels. Income from an active business carried
on in Canada by a Canadian-controlled private corporation (CCPC) is subject to
a lower rate of corporate tax than other income as a result of the small business
deduction (SBD) available on the first $500,000 of business income.17 There is
no special reduction in tax for investment income earned in a corporation, and
a CCPC will pay tax on investment income at rates approaching 50% depending
on the province, and this can result in tax payable on such income at a rate of
tax higher than the marginal tax rate of an individual shareholder. A CCPC does
get relief on investment income, however, when it pays taxable dividends (i.e.,
dividends that are not capital dividends) through a refundable tax mechanism
via the refundable dividend tax on hand (RDTOH) account.

The federal rate of tax on income from property is 38.7% in 2017, for a com-
bined federal and provincial rate of approximately 50% depending on the
province. Income from a business is subject to lower corporate tax rates, and
further reductions in rates are available on certain income as a result of the
small business deduction and the manufacturing and processing tax credit.

Since 2012, the general corporate federal tax rate on business income has been
15%.18 This is achieved through various provisions in the Act expressed as a
basic federal rate of 38% less a 10% federal tax abatement — for income earned
in a province, less the 13% general rate reduction.19 To the federal rate is added
the provincial rate of tax so that generally the combined corporate tax rate is
from 25% to 34% on business income.

Corporations, whether resident or non-resident, are taxed on business income in

the province in which they have a permanent establishment, which is a defined

17 The provinces have their own lower rates as well.

18 This is not the rate for income from property, which is subject to the higher rate.
19 Subpara. 123(1)(a), subs. 124(1), and s. 123.4. A personal services business, which receives income
similar to employment income, is taxed at a higher rate.

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2.5.6 Chapter 2 – Tax Basics, Taxation of Sources of Income of Trusts, and Taxation of Corporations and Their Shareholders

term. Separate corporate and provincial tax returns must be filed. Income earned
from multiple permanent establishments in Canada is allocated by a formula
based on gross income as a proportion of salaries and wages.

A CCPC will be entitled to a reduction in tax, called the small business deduction
(SBD), on its income from an active business carried on in Canada. The SBD for
years ending after 2017 results in a federal corporate tax rate of 10.5%, a reduc-
tion of 4.5%.20 The SBD is also available provincially, although each province has
its own particular rules. The SBD is not available on all income, and as of July
2017, the maximum income eligible for the SBD, called the “small business limit,”
is $500,000. In order to prevent multiple access to the SBD within related corpo-
rate groups, corporations that are “associated” with one another must share the
small business limit. The association rules are complex, but associated corpora-
tions will include (but are not limited to) those controlled by the same person,
including another corporation, or group of related persons or corporations.21

The SBD is not available in respect of income from a “specified investment

business” unless there are more than five full-time employees in the business
throughout the year. The principal purpose of a specified investment business is
to earn income from property, including interest, dividends, rents, and royalties.
This rule prevents property income from being converted into business income
in a corporation in order to claim the SBD.

Since income earned by a corporation is taxed in the corporation, dividends

received by a taxable Canadian corporation from another taxable Canadian
corporation will not be subjected to tax again in the Canadian tax system,22
preventing the same income from being taxed multiple times. The gross-up
and dividend tax credit mechanism applicable to dividends received by an
individual from a taxable Canadian corporation is not applicable to dividends
received by a corporation.

The Canadian tax system taxes corporate income once, and in theory there is no
second layer of tax liability until a dividend is paid to an individual shareholder
(or a non-resident). The double layer of tax at the corporate and individual
shareholder levels is subject to a number of adjustments and special rules. The
principle of integration is that an individual should pay neither more tax, nor

20 On October 20, 2017, the Department of Finance announced its intention to further lower the rate to
10% effective January 1, 2018, and 9% effective January 1, 2019.
21 Subss. 125(2), (3), and (4).
22 S. 112.

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BASIC TAXATION OF CORPORATIONS AND THEIR SHAREHOLDERS 2.5.7

less tax, on income earned thorough a CCPC than on income earned directly.
The SBD is an adjustment to active business income that reduces the effect of
double tax at the corporate and individual level.

In an owner manager situation, the corporation can “bonus down” so that the
income of the corporation does not exceed the small business limit in any year,
and instead salary or a bonus is made payable to the owner manager, who pays
tax at the individual graduated rates on such income. This would ensure that
income in excess of the small business limit is not taxed at a rate higher than
the top personal rate. “Owner manager” refers to an individual who owns and
controls a business, and who is also the primary decision maker in the manage-
ment and operations of the business. Often the owner is also the founder of the
business, and often there are other family members who participate along with
the owner manager in the ownership control and running of the business.

2.5.7 Integration and the Individual Shareholder

A corporation distributes profits to its owners, the shareholders, by virtue of

payment of dividends to shareholders. Such dividends are taxable in the hands
of the shareholder. Thus, there are two incidents, or levels of taxation, for corpo-
rations and their shareholders: first on income at the corporate level and second
on dividends paid to shareholders. For CCPCs, there are mechanisms in place
to reduce the overall tax burden on corporate profit distributed to individual
shareholders. These mechanisms include the refundable dividend tax on hand
(RDTOH) on investment income, the capital dividend account (CDA), and Part
IV tax.23

The objective or concept, called “integration,” is to tax corporations and indi-

vidual shareholders in a manner that neither provides any tax advantage nor
any disadvantage to individuals earning income through a corporation as com-
pared with individuals earning the same income directly. These mechanisms
are extremely complex in their details and do not always produce the intended
results; that is, they do necessarily successfully “integrate” the corporate tax
burden and the individual tax burden in a manner that achieves integration.

23 Students may find Moodys Gartner Tax Law blog, Moodys Gartner musings, to be helpful. See, for
example, the December 9, 2015, edition, “Federal tax rate increases for Canadians,” currently at https://
moodysgartner.com/federal-tax-rate-increases-for-canadians, as it not only provides an update to the
ever-changing tax rates but also illustrates the relationship between corporate and personal tax and
how it achieves integration, at least in the province of Alberta. No doubt, updated subsequent blogs
will appear that further update the rates and the number-crunching exercise to illustrate integration.

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2.5.8 Chapter 2 – Tax Basics, Taxation of Sources of Income of Trusts, and Taxation of Corporations and Their Shareholders

A corporation is not a conduit in the way a trust is a conduit for income being
passed through to beneficiaries. It is much more complicated, unfortunately, and
only an outline of the concepts is included here to assist students in understand-
ing the basic concepts in order to appreciate estate planning and post-mortem
planning for shareholders of closely held corporations.

2.5.8 Refundable Tax

Investment income (i.e., income from property) and the taxable portion of capi-
tal gains24 are taxed in a corporation at the highest corporate tax rate. Depending
on the province, this rate may be as high as 50%. In order to achieve integration,
a portion of the tax on investment income is refunded at the corporate level
when a dividend is paid to an individual shareholder. Part IV tax payable by a
private corporation on portfolio dividends is also fully refundable when divi-
dends are paid.

When a CCPC receives investment income and capital gains from property (rents,
royalties, interest, the taxable portion of capital gains — i.e., 50% of the gain),
a portion of the income goes into a refundable tax account called a refundable
dividend tax on hand (RDTOH). 25 When taxable dividends26 (dividends that
are not capital dividends) are paid by the corporation, a refund of tax from the
RDTOH account is generated based on a portion of the taxable dividend paid
(i.e., the amount of the dividend). For each $3 of dividend paid, $1 is refunded
to the corporation from the RDTOH account — that is, an amount equal to
one-third of the amount of the dividend paid is eligible for a dividend refund if
there is sufficient balance in the RDTOH account. If the shareholder is another
CCPC, the amount of the RDTOH of the corporate shareholder is increased by
the refund of the RDTOH received by the payor CCPC, so there is a flow-through
of the RDTOH. The refundable tax system reduces the double tax on income
from property earned by a CCPC, which is ultimately distributed to an individual
shareholder. The Part IV tax on taxable dividends is also added to the RDTOH
and fully refundable.

24 A 50% income inclusion rate for capital gains applies to all taxpayers under s. 38.
25 Commencing 2016, the rate of RDTOH is 30.67% of investment income, although this rate is adjusted
from time to time. It is calculated only at the federal level.
26 When discussing dividends paid by a corporation in the corporate context, the term “taxable dividend”
typically means a dividend that is “taxable” to distinguish it from a capital dividend that is not taxable
to the recipient. This can be confusing as when referring to a dividend received by an individual,
the “taxable dividend” refers to the amount of the grossed-up dividend, not the actual amount of the
dividend paid.

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BASIC TAXATION OF CORPORATIONS AND THEIR SHAREHOLDERS 2.5.11

2.5.9 Part IV Tax

Dividends received by one taxable Canadian corporation from another are gen-
erally deductible under s. 112 of the Act, as the profits from which the dividends
are paid, in theory, have already been subjected to tax at the corporate level and
should not be taxed again until distributed to an individual. Private corporations
pay Part IV tax27 on portfolio dividends, that is, dividends received from a cor-
poration other than a connected corporation.28 A CCPC that receives dividends
from another corporation is subject to a special tax called Part IV tax. The pur-
pose of Part IV tax is to prevent an individual from deferring the second level
of tax payable on dividends by parking those dividends in a CCPC. The Part IV
tax is like a prepayment of tax at the individual level. Part IV tax is added to
the corporation’s RDTOH, and when taxable dividends are paid by the CCPC,
a refund is generated. There are special rules for dividends between connected
corporations.

2.5.10 Capital Dividend Account

The tax-free portion of capital gains and life insurance proceeds are added to
the capital dividend account (CDA) of a CCPC. Dividends declared to be “capital
dividends” may be paid from the CDA as a tax-free dividend to a shareholder.
If the shareholder is a CCPC, the CDA of the shareholder is increased by the
amount of the capital dividend. The purpose of the CDA is to permit an indi-
vidual to receive life insurance proceeds and the tax-free portion of any capital
gains through a CCPC without paying any tax in the same way as if the individ-
ual shareholder had received the receipt directly. There are stop-loss rules where
the deemed dividend on a sale of or redemption of shares back to the issuing
corporation is a capital dividend.

2.5.11 Sale of Shares and Redemption of Shares

When a shareholder sells shares, the proceeds of disposition less the tax cost of
the shares, called the adjusted cost base (ACB), will be a capital gain. If those
shares were originally issued from treasury, the cost will usually be the stated
capital (and also the same amount as the PUC). The purchasing shareholder will

27 Part IV tax is 38 1/3% on dividends received after 2015 from a corporation not connected to the
recipient. Prior to 2016, the rate was 33 1/3%.
28 “Connected” is a defined term where one of the corporations have voting control of the other
corporation or one corporation owns more than 10% of the voting shares and more than 10% of the
fair market value of all the shares of the other corporation.

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2.5.11 Chapter 2 – Tax Basics, Taxation of Sources of Income of Trusts, and Taxation of Corporations and Their Shareholders

have a cost equal to the purchase price of the shares, and assuming the seller
realized a gain on the transaction, the cost to the new shareholder will be in
excess of the PUC of the shares.

When a shareholder sells shares back to the issuing corporation, this can be
way of redemption, retraction, or purchase for cancellation, or it can be upon
dissolution of the corporation. “Redemption” usually refers to the corporation
exercising a right to purchase the shares; “retraction” refers to the right of the
shareholder to sell shares back to the corporation. Whatever the legal rights
being exercised, a sale of the shares back to the corporation has a different tax
result than a sale of shares to any other purchaser: the difference between the
purchase price and the PUC is considered to be a deemed dividend paid to the
shareholder.29

Upon redemption, the shareholder is also considered to have sold the shares to
the corporation for proceeds of disposition equal to the purchase price less the
amount of the deemed dividend.30 This typically creates a capital loss that accom-
panies the deemed dividend. However, there are “stop-loss” rules that reduce
the capital loss for deductible intercorporate dividends, or where the dividends
generated are tax-free capital dividends. The capital loss that is created upon a
redemption of shares is important in post-mortem planning for shares of CCPCs.

Example

Assume shares are being redeemed to the corporation for $1,000, with a PUC of $100 and an ACB (cost) of $500. There is
a deemed dividend of $900 ($1,000 sale price less PUC of $100). There is a capital loss of $400 (proceeds of disposition
are $100 – $1,000 less $900 – and ACB is $500). The deemed dividend will be subject to the same gross-up and dividend
tax credit mechanism as other dividends if the corporation is a taxable Canadian corporation and the shareholder is an
individual.

29 Subss. 84(2) and 84(3).

30 Para. (j) of the definition of “proceeds of disposition” in s. 54.

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 CHAPTER 3
TAXATION OF CAPITAL GAINS

LEARNING OBJECTIVES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–3

3.1 INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–3

3.1.1 Overview of Taxation of Capital Gains and Losses . . . . . . . . . 3–3

3.1.2 History of Capital Gains Tax in Canada . . . . . . . . . . . . . . . . . . . . 3–5
3.1.3 Capital and Income Receipts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–6
3.1.3.1 Sale of Real Property — Capital or Income . . . . . . 3–8
3.1.3.2 Sale of Securities — Income or Capital
Account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–8
3.1.3.3 Election to Treat Canadian Securities on
Capital Account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–8
3.1.4 Terminology: “Income” in Tax Law and Trust Law . . . . . . . . . . 3–9
3.2 CALCULATION OF CAPITAL GAINS AND CAPITAL LOSSES:
GENERAL RULES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–9

3.2.1 General Computation of Gain or Loss . . . . . . . . . . . . . . . . . . . . 3–9

3.2.2 Adjusted Cost Base (ACB) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–11
3.2.3 Adjusted Cost Base of Identical Properties . . . . . . . . . . . . . . 3–11
3.2.4 Proceeds of Disposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–12
3.2.5 Deemed Dispositions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–12
3.2.6 Expenses of Disposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–13
3.2.7 Claiming a Reserve for Deferred Proceeds . . . . . . . . . . . . . . 3–13
3.2.8 Principal Residence Exemption (PRE) . . . . . . . . . . . . . . . . . . . 3–14
3.3 LIFETIME CAPITAL GAINS EXEMPTION (LCGE) . . . . . . . . . . . . . . . . 3–16

3.3.1 General Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–16

3.3.2 Qualified Small Business Corporation Share (QSBCS) . . . . 3–17
3.3.2.1 Definition of Qualified Small Business
Corporation Share (QSBCS) . . . . . . . . . . . . . . . . . . 3–17

3–1
 3.3.2.2 Definition of Canadian-Controlled Private
Corporation (CCPC) . . . . . . . . . . . . . . . . . . . . . . . . . . 3–18
3.3.2.3 Definition of Small Business Corporation
(SBC) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–18
3.3.2.4 Treasury Shares and Incorporation of a
Partnership or Sole Proprietorship — QSBCS . . . 3–18
3.3.2.5 Relieving Provision on Death for QSBCS . . . . . . 3–19
3.3.2.6 LCGE Not Available If under 18 and Sale
Non-Arm’s Length . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–19
3.3.3 Qualified Farm or Fishing Property . . . . . . . . . . . . . . . . . . . . . 3–19
3.4 ROLLOVERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–20
3.4.1 Concept of Rollover . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–20
3.4.2 Qualifying Transfers — Inter Vivos . . . . . . . . . . . . . . . . . . . . . 3–20
3.4.3 Transfers to a Spouse or Qualifying Spousal
Testamentary Trust as a Consequence of Death . . . . . . . . . 3–21
3.4.4 Spousal Trusts in Tax Planning . . . . . . . . . . . . . . . . . . . . . . . . . 3–21
3.4.5 Rollover of Farm or Fishing Property . . . . . . . . . . . . . . . . . . . 3–22
3.4.6 Transfers to Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–23
3.4.7 Transfers to and from Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–24
3.5 CAPITAL LOSSES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–25

3.5.1 Superficial Loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–25

3.5.2 Business Investment Loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–25
3.5.3 Personal Use Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–26
3.5.4 Listed Personal Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–27
3.5.5 Capital Loss Carrybacks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–27
3.5.6 Using Net Capital Losses in Current Year . . . . . . . . . . . . . . . . 3–28
3.5.7 Capital Losses on Death . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–28
APPENDIX
EXCERPTS FROM DEFINITIONS IN THE CRA’S CAPITAL GAINS
GUIDE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3–29

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 Chapter 3
Taxation of Capital Gains

Learning Objectives
Knowledge Objectives:
• Understand the taxation of capital gains and utilization of capital losses.

Skills Objectives:
• Describe how capital gains are taxed.
• Explain the capital gains exemption and the principal residence exemption.
• Explain the utilization of capital losses.

3.1 INTRODUCTION

3.1.1 Overview of Taxation of Capital Gains and Losses

Section 3 of the Act requires a taxpayer to include net taxable capital gains in
income. The rules for determining net taxable capital gains will be covered in
this chapter.

Essentially, a capital gain is realized by a taxpayer when there is a disposition of

capital property for proceeds of disposition in excess of the taxpayer’s adjusted
cost base for the property.1 Similarly, a taxpayer will have a capital loss when
the proceeds of disposition are less than the taxpayer’s adjusted cost base of the
property.

1 The definitions of the italicized words will be discussed in this chapter.

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3.1.1 Chapter 3 – Taxation of Capital Gains

The taxation of capital gains is important in the study of estates and trusts.

• The reduction or deferral of capital gains is a major component of

estate planning:
{ to reduce the impact of the deemed disposition of capital prop-
erty on death, and
{ to maximize access to the capital gains deduction.
• Trusts are used to reduce the impact of capital gains tax:
{ by shifting capital gains to multiple beneficiaries,
{ by income splitting capital gains with minors, and
{ by multiplying access to the capital gains deduction.

Capital gains taxation has a number of unique characteristics.

• Only 50% of gains are included in income.

• A reserve for proceeds not yet collected is available over five years.
• Capital losses may only be deducted against capital gains.
• Certain properties may receive preferred tax treatment, including:
{ a principal residence,
{ certain farm properties,
{ certain fishing properties, and
{ shares of certain small business corporations.
• Certain transactions are tax-deferred, including:
{ transfers between spouses and common-law partners, and
{ transfers to corporations in exchange for issued shares.

The 50% inclusion rate on capital gains results in a taxpayer receiving more
favourable tax treatment on capital gains compared with other types of receipts.
Consequently, taxpayers who have gains will wish to characterize these gains as
capital gains. However, taxpayers who have losses may seek to have them char-
acterized as losses on income account so they are not subject to the 50% dis-
count, and further so they may be deducted against any source of income rather
than being restricted to reducing taxable capital gains. If a taxpayer has a history
of treating a particular type of transaction as a capital transaction, it is unlikely

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INTRODUCTION 3.1.2

they will be able to treat a similar type of transaction as creating an income loss
in the future (as discussed later in the chapter).

The appendix to this chapter includes the definitions relevant to the taxation of
capital gains that are included in the Capital Gains Guide.2 They are for refer-
ence only and do not represent the actual provisions of the Act.

3.1.2 History of Capital Gains Tax in Canada

Prior to 1972 in Canada, capital gains were tax-free. The taxation of capital gains
was introduced in part to replace inheritance taxes. At one time both the federal
and provincial governments rendered inheritance taxes on the death of an indi-
vidual based on the value of their property passing on death. This is no longer
the case in any jurisdiction in Canada.

In the United States, capital gains tax has been in effect since 1862, when it was
introduced to finance the Civil War. In Britain, capital gains taxes have been in
place since the 1960s.

Currently in Canada, capital gains are subject to a 50% inclusion rate, which
means that only half of the calculated monetary gain is included in income. The
taxable portion of a capital gain is called a “taxable capital gain.” The inclusion
rate has been subject to several adjustments since 1972 (see Figure 3.1).

Figure 3.1: Inclusion Rate for Taxable Capital Gains

Period Inclusion Rate

1972 to 1988 50%
1988 to 1990 66.67% (2/3)
1990 to February 2000 75%
February 2000 to October 2000 66.67% (2/3)
October 2000 to present 50%

The changing inclusion rate is relevant today with respect to loss carryforwards
of net capital losses from previous years. These must be adjusted according to
the year in which they were incurred, in order that the appropriate amount is
calculated to reduce current taxable capital gains.

2 Guide T4037, Capital Gains Guide.

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3.1.3 Chapter 3 – Taxation of Capital Gains

A lifetime capital gains exemption (LCGE) for individuals was first introduced in
1985. The original exemption permitted individuals to shelter $500,000 of capital
gains on all capital property, but in 1988 the amount was reduced to $100,000,
leaving the $500,000 exemption only for certain property. The $100,000 capital
gains exemption available on all types of capital property was abolished com-
pletely in 1994; it is still relevant today with respect to current dispositions of
property on which the exemption was crystallized as part of the grandfather-
ing rules when the $100,000 exemption was abolished. The restricted $500,000
lifetime exemption was retained: this sheltered the gain on shares of a qualified
small business corporation and qualified farm property. Qualified fishing prop-
erty became eligible for the LCGE in 2006.

The “restricted” lifetime limit referred to in the previous paragraph remains

today, and has increased over the years from $500,000 to $750,000 in 2007 and
to $800,000 in 2014.3 Since 2014, the LCGE has been indexed annually for infla-
tion. For dispositions in 2015, 2016, and 2017, it was $813,600, $824,176, and
$835,714, respectively. The lifetime limit for qualified farm property and qualified
fishing property on dispositions on or after April 21, 2015, is equal to the greater
of $1,000,000 or the amount of the indexed lifetime limit as previously noted.

3.1.3 Capital and Income Receipts

Not all gains or losses on the sale of property are characterized as capital gains
or losses. A gain or loss on the disposition of property could be an income gain
or loss, depending on whether the transaction is a capital transaction or an
income transaction. The tax treatment is different, and a taxpayer needs to deter-
mine how to report the gain or loss.4

A common description of the difference between capital property and property

that is treated on income account is “the tree versus the fruit.” Was the property
acquired for the purpose of reaping the fruit of the tree, in which case the prop-
erty is akin to the tree and will be treated as capital property? Or, on the other
hand, was fruit acquired for the purpose of resale profit, in which case there was

3 Since this is now the only capital gains exemption available, it is no longer referred to as “restricted”
and the term is used only in an historical context.
4 See IT-218R (Archived), Profit, Capital Gains and Losses from the Sale of Real Estate, Including
Farmland and Inherited Land and Conversion of Real Estate from Capital Property to Inventory and
Vice Versa; IT-459 (Archived), Adventure or Concern in the Nature of Trade; and IT-479R (Archived),
Transactions in Securities, and its Special Release (Archived), IT-479RSR.

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INTRODUCTION 3.1.3

no intention to hold the property for the purpose of earning income from it and
the gain on the sale of property will be considered on income account?

Where property is obtained for the purpose of earning income from its resale,
the gain is considered profit from a business or from a transaction in the nature
of trade. These characterizations of receipts are considered to be “on income
account” and are included in the taxpayer’s return as such, without the 50% tax-
free portion applicable to capital gains.

The question as to whether the sale of property is on income or capital account

depends on the taxpayer’s intention, at the time of purchase, in acquiring and
holding the property. There is no real definition of “capital” or “income” in the Act,
so taxpayers and their advisors must rely on the case law, and Canada Revenue
Agency’s (CRA) interpretation of the case law, to assist in determining the differ-
ence between capital and income transactions. Generally this is a question of fact,
which depends on the particular circumstances. However, the case law has set out
certain factors that are helpful in determining this issue, including the following:

• intention, at the time of purchase, as demonstrated by the taxpay-

er’s actions,
• the relation of the transaction to the taxpayer’s regular business,
• the nature of the transaction,
• the holding period,
• the type of financing used (i.e., short-term or long-term),
• the number and frequency of transactions, and
• the nature of the property disposed of.
The major factor is intention, and many of the other factors are used as guides in
determining the taxpayer’s intention. Property held for personal use is generally
characterized as being on account of capital.

If the taxpayer acquired the property as an investment, in order to earn income

from the property while holding the property, it is likely that the property will
be considered capital property. An example would be where real property is
purchased for the purpose of earning rental income. On the other hand, where
the person acquires property for the purpose of resale profit, the property will
not be considered capital property and any gain on the sale of the property
will be considered business income. An example is where a person purchases

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3.1.3.1 Chapter 3 – Taxation of Capital Gains

a number of rental properties and flips them within a short period of time for a
profit (even though rental income was earned while the property was held).

3.1.3.1 Sale of Real Property — Capital or Income

The sale of real property has often been litigated with respect to the
issue of whether gains or losses are on income or capital account. Where
the purchaser of real property has a secondary intention to resell it at a
profit if the primary intention is frustrated, the gain may be on income
account.5 The factors CRA uses in determining whether a sale of real
estate represents the sale of capital property or not are listed in para. 3
of IT-218R6 and include:

• the taxpayer’s intention with respect to the real estate at the

time of its purchase,
• the taxpayer’s occupation,
• the existence of financing,
• the length of time the real estate was held,
• the factors that motivated the sale of the property, and
• any evidence that the taxpayer and any associates dealt exten-
sively with real estate.

3.1.3.2 Sale of Securities — Income or Capital Account

Generally, the CRA considers common shares in a corporation’s stock to
be capital property, even where no income is paid in the form of divi-
dends on the shares. This is because there was a prospect of dividends
being paid on the shares and it is the board of directors who declare the
dividend, even though the corporation may not have a history of paying
dividends on its common shares.7

3.1.3.3 Election to Treat Canadian Securities on Capital Account

A taxpayer may elect to have all transactions in Canadian securi-
ties treated as capital transactions by filing Form T123, Election on

5 The leading case is Regal Heights Ltd. v. MNR., [1960] S.C.R. 902 (S.C.C.).
6 IT-218R (Archived), Profit, Capital Gains and Losses from the Sale of Real Estate, Including Farmland
and Inherited Land and Conversion of Real Estate from Capital Property to Inventory and Vice Versa.
7 See IT-479R (Archived), Transactions in Securities, and its Special Release (Archived), IT-479RSR.

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CALCULATION OF CAPITAL GAINS AND CAPITAL LOSSES: GENERAL RULES 3.2.1

Disposition of Canadian Securities, along with his or her tax return.8

Once the election is made, it will apply to all transactions in Cana-
dian securities, and the election cannot be revoked. This may result in
favourable treatment when the taxpayer realizes capital gains but not
as favourable treatment when the taxpayer realizes losses. A trader or
dealer in securities cannot make this election.

3.1.4 Terminology: “Income” in Tax Law and Trust Law

As noted above, there is no definition of the term “income” in the Act. Section 3
of the Act lists the items that are to be included in net income. Capital gains are
specifically included in this list. However, at common law for trust law purposes,
the term “income” does not include capital gains, which are instead considered to
be capital receipts and not income. Confusion or ambiguity in the terminology is
difficult to avoid, as “income” used in tax commentary invariably means amounts
included in income for tax purposes, including capital gains. However, in most
cases in this chapter, the use of the word “income” refers to a receipt that is not a
capital gain, unless specifically noted. In addition, the use of the word “capital,” at
least in this chapter, will not refer to capital gains unless specifically noted.

3.2 CALCULATION OF CAPITAL GAINS AND CAPITAL LOSSES: GENERAL RULES

Most of the rules for capital gains and losses are in ss. 38 to 55 of the Act.9 Sec-
tion 54 includes many of the relevant definitions. The rules relating to the capital
gains deduction are in s. 110.6 of the Act (see Figure 3.2).

3.2.1 General Computation of Gain or Loss

The computation of a capital gain or loss is determined for each property by

deducting the adjusted cost base and the expenses of disposition from the pro-
ceeds of disposition.10 Take the example of the gain on the sale of the shares of
Flash Bulb Ltd. (see Figure 3.3). Where the remainder is positive, there is a capi-
tal gain. Where the remainder is negative, a capital loss results.

At the end of the taxation year, taxable capital gains and allowable capital losses
on all properties are added together separately in the aggregating formula under
s. 3. One-half of the capital gains for the year are included in income under s. 3

8 Subs. 39(4).
9 Part I, Division B, subdivision c.
10 Subs. 40(1).

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3.2.1 Chapter 3 – Taxation of Capital Gains

as “taxable capital gains.” One-half of the capital losses for the year are deducted
in the computation of income under s. 3 of the Act as “allowable capital losses”
(see Figure 3.3 for an example of this general computation).

Figure 3.2: Terminology for Capital Gains and Losses and Lifetime Capital Gains
Exemption

Capital gain Proceeds of disposition less the adjusted cost base

Taxable capital gain
Capital loss
Allowable capital loss
Net capital gains for the year
Net capital loss for the year or “current”
net capital loss
Net capital loss carryforward
Lifetime capital gains exemption
Capital gains deduction
50% of the capital gain
Adjusted cost base less the proceeds of disposition
50% of the capital loss
Taxable capital losses in the year less allowable capital losses in the year
Allowable capital losses in the year less taxable capital gains in the year
Net capital losses of other years available to be applied against net taxable capital
gains for the year
Amount of capital gains from depositions of qualifying property that can be
sheltered from tax, being $750,000 in 2013 and $800,000 in 2014
Amount available to reduce taxable capital gains from dispositions of qualifying
property

Figure 3.3: Example of General Computation of Gains and Losses

Capital Gain on Shares of Flash Bulb Ltd.

Proceeds of Disposition $ 90,000
less expenses of disposition $ 1,400
less adjusted cost base $ 23,600 $ (25,000)
Capital gain or capital loss $ 65,000
Taxable capital gain $ 32,500

Capital Loss on Shares of Risky Hot Tip Corp.

Proceeds of Disposition $ 1,000
less expenses of disposition $ 300
less adjusted cost base $ 41,700
$ 42,000 $ (42,000)
Capital loss $ (41,000)
Allowable capital loss $ (20,500)

The amount of any allowable capital losses in excess of taxable capital gains is
not deductible from income in the year. Rather the amount becomes a “net capi-
tal loss” of the year and may be available to offset taxable capital gains of the

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CALCULATION OF CAPITAL GAINS AND CAPITAL LOSSES: GENERAL RULES 3.2.3

three prior or any subsequent taxation years. There are exceptions in the year of
death of the taxpayer and the year prior to death. In these cases, allowable capi-
tal losses can be deducted against any type of income.

3.2.2 Adjusted Cost Base (ACB)

Generally, the adjusted cost base (ACB) of capital property is its original pur-
chase price plus any costs incurred to acquire the property.11 Acquisition costs
may include commission, brokerage fees, and land transfer tax.

Special rules exist with respect to property held before 1972. The Income Tax
Application Rules (ITARs) contain a number of transitional rules relating to the
major tax reforms introduced in Canada in 1972. ITAR 26 operates generally to
exempt gains that have accrued prior to 1972. Individuals are entitled to elect
to use the value of capital property as at December 31, 1971, as the acquisition
cost of any property held since before that time. December 31, 1971, is known
as Valuation Day, or V-Day, under this rule.

In addition to the original purchase price, the cost of capital improvements

may be added to the ACB of the property. For example, where an individual
purchases a vacation property and undertakes major repairs and renovations
— such as a new roof, new wiring, and plumbing or other major construction —
these costs may be added to the ACB of the property.

3.2.3 Adjusted Cost Base of Identical Properties

Special rules exist to calculate the ACB of properties that have identical charac-
teristics but may have been acquired at different times and for different costs of
acquisition. Where identical properties are acquired, the ACB of such properties is
the aggregate of the cost of all such properties divided by the number of identi-
cal properties held. The most common type of identical property is shares of the
same class in the capital stock of a corporation. This rule results in a “weighted
average” cost base. When assets are acquired in a foreign currency, the cost base
should be calculated using the exchange rate on the date of the purchase.

11 The term “adjusted cost base” (ACB) is defined in s. 54 as the capital cost to the taxpayer as of that
time; capital cost is not defined in the Act.

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3.2.4 Chapter 3 – Taxation of Capital Gains

3.2.4 Proceeds of Disposition

Proceeds of disposition are generally the sale price that a vendor receives on
the sale of property. If the sale price includes consideration other than money,
the fair market value of that consideration will be included in the proceeds.
There is no discount for proceeds that are not immediately payable, although
the taxpayer may be entitled to claim a reserve where payment of the proceeds
is deferred (see 3.2.7).

Generally, a capital gain or loss would be included in the computation of income

when there is an actual transfer of the property by the owner. A transfer of prop-
erty that may trigger a capital gain or capital loss is generally called a “disposi-
tion” in the Act. The term “disposition” is defined in subs. 248(1) and includes:

• an actual sale,
• involuntary transfers such as expropriation, and
• cancellation, redemption, repurchase. or retraction of a share of a
corporation or other security.

3.2.5 Deemed Dispositions

In addition, many situations can occur in which the Act has particular rules
that trigger a “deemed disposition” of capital property. A deemed disposition of
capital property for proceeds of disposition equal to the fair market value of the
capital property occurs in each of the following circumstances:

• immediately before the death of an individual,

• whenever the disposition is by way of gift,
• where the use of property changes from personal use to business
use or vice versa, and
• where the taxpayer ceases to be a resident of Canada (i.e., depar-
ture tax).

Whenever there is a disposition of capital property, either actual or deemed, a

calculation must be made to determine whether it is a capital gain or loss.

If the assets are recorded or sold in a foreign currency, the actual or deemed
proceeds must be calculated using the exchange rate on the date the sale closes
or the deemed disposition occurs.

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CALCULATION OF CAPITAL GAINS AND CAPITAL LOSSES: GENERAL RULES 3.2.7

3.2.6 Expenses of Disposition

Expenses of disposition include all costs incurred to complete the disposition

of the property. These are deductible when arriving at the capital gain or loss.
Expenses of disposition include legal fees to complete the sale agreement, bro-
kerage fees or commissions to agents, real estate commission fees, advertising,
and mortgage discharge fees.

3.2.7 Claiming a Reserve for Deferred Proceeds

Where the proceeds of disposition are received over a number of years, a taxpayer
may be able to deduct a reserve and reduce the amount of capital gains included
in income from that property in a particular taxation year. A reserve is claimed by
filing Form T2017, Summary of Reserves on Dispositions of Capital Property.

Generally, a reserve is available over a five-year period so that in the fourth year
after the year of the disposition the remaining part of the gain not yet reported
must be included in income. A minimum of 20% of the gain must be reported in
the year of disposition, although if more than 20% has been received, then the
amount to be reported may be greater (e.g., if 40% is received in the first year,
then 40% must be reported in the first year). On a cumulative basis, at least 20%
of the gain must be reported in the first year, 40% in the second, 60% in the
third, 80% in the fourth, and 100% in the fifth year.

For example, if 55% of the gain has been reported by the end of the second year
(i.e., if 55% of the proceeds have been received), then only 5% must be reported
in the third year if no less than an additional 5% is received in that year.

This reserve is optional and there may be times where accelerating the realiza-
tion of the gain by not claiming some or all of the reserve may be considered.

Where an individual sells certain types of assets to the individual’s own child
(including shares of a small business corporation, land used in farming, and
shares of a family farm corporation or fishing corporation), the capital gain may
be deferred for a maximum period of up to nine years, with a minimum of 10%
of the capital gain being reported in the year of disposition and an additional
10% every year thereafter. The amount included in income will be increased
where the timing of the proceeds payable exceeds these amounts.12

12 Subs. 159(5).

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3.2.8 Chapter 3 – Taxation of Capital Gains

3.2.8 Principal Residence Exemption (PRE)

The principal residence exemption (PRE) shelters any gain on the sale of prop-
erty that is an individual’s residence. Generally, where a couple owns only one
residence at a time, the rules will operate to shelter the entire capital gain on
the sale of each residence. However, where more than one residence is owned
by a “family unit,” it is only possible to shelter the gain on one residence during
the years of multiple-residence ownership. A family unit includes the taxpayer,
his or her spouse or common-law partner, and any children under the age of 18.
For periods of ownership before 1982, it is possible that couples may be able to
each claim a separate PRE, depending on how title to the properties was held.

The definition of principal residence is broad. Section 54 of the Act defines the
term “principal residence” to include a housing unit and a share in a co-op hous-
ing corporation. The property must be ordinarily inhabited by the taxpayer, the
taxpayer’s spouse or common-law partner, former spouse or common-law part-
ner, or child of the taxpayer. If a trust owns the residence, the property may
qualify for the exemption if the beneficiary of the trust or a person related to the
beneficiary ordinarily inhabited the residence. However, if any beneficiary of the
trust designates the property as their principal residence for the period during
which it was owned by the trust, then the other beneficiaries of the trust will be
deemed to have also used the exemption for those years and cannot use it for
any other property.

The requirement that the property be ordinarily inhabited is generously inter-

preted by CRA. There is no requirement that the property be used as a residence
more than any other residence owned by the taxpayer. In this respect, the use
of the term “principal” is a misnomer. For example, vacation properties or other
properties that have only seasonal use or occasional use may qualify, although
the taxpayer should be able to prove that he or she went there regularly (at least
annually) and ordinarily inhabited the property.

Where the residence is located on land that exceeds one-half hectare, the excess
land will not ordinarily be eligible for the exemption. If the additional property
is necessary for the use and enjoyment of the property, it may qualify. However,
the interpretation of this exception is narrow and generally will only include
such items as road access or municipal minimum lot size requirements.

The rules relating to the PRE are complex. Income Tax Folio S1-F3-C2, Principal
Residence, sets out the rules and CRA’s administrative policy with respect to them

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CALCULATION OF CAPITAL GAINS AND CAPITAL LOSSES: GENERAL RULES 3.2.8

in some detail. The PRE is claimed by designating a property as a principal resi-

dence for a particular taxation year. The designation of a property as a principal
residence need only be made when the property is actually sold or otherwise dis-
posed of under the Act (e.g., when it is deemed to have been disposed of in the
year of death). Form T2091(IND)-WS, Principal Residence Worksheet, can assist
in claiming the PRE and should be filed with the designation Form T2091(IND),
Designation of a Property as a Principal Residence by an Individual (Other Than
a Personal Trust), in the return for the tax year in which the property is disposed
of. See Figure 3.4 for the formula for calculating the PRE.

Figure 3.4: Principal Residence Exemption (PRE) Formula

1 + Number of years designated as a principal residence

Proceeds of disposition x
Number of years owned

The “one plus ” in the formula shelters gains where a taxpayer sells one resi-
dence and purchases another within the same year. However, the use of the “one
plus ” in the formula makes it advantageous for a taxpayer to always claim the
PRE on the sale of a qualifying residence, so that a portion of the capital gain
will be sheltered even if the taxpayer does not designate the property as a prin-
cipal residence for any particular taxation year.

As can be seen from the formula, the PRE is an election for each year in which
the property was owned. Ownership for this purpose includes any calendar
year in which the taxpayer owned property. For example, if the property was
acquired December 15, 2002, and was disposed of January 3, 2004, the number
of years in the formula would be three, since the taxpayer owned the property
for at least one day in each of three calendar years. When more than one prop-
erty qualifies for the PRE in a particular year, the property with the greatest gain
per year should be selected.

Certain trusts are also entitled to the PRE, as are individual beneficiaries of trusts
for periods during which the property was held by a trust (see 4.11, Principal
Residence).

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3.3 Chapter 3 – Taxation of Capital Gains

3.3 LIFETIME CAPITAL GAINS EXEMPTION (LCGE)

3.3.1 General Requirements

NOTE: The lifetime limit on the LCGE is indexed for inflation annually. You are responsible for accessing STEP student resource
materials to inform yourself of the amounts applicable in the current calendar year. The student tutorial for the May exam
in each year will include the updated amounts, and/or the amounts will be included in an update available in the student
resources section of the STEP website.

NOTE: See STEP Update on Tax Changes in the student resources section of the STEP website to review the status of tax
proposals first introduced in 2017 that may change access to the LCGE.

An individual is permitted to shelter capital gains on qualifying property dur-

ing his or her lifetime by using the lifetime capital gains exemption (LCGE).
Initially set at $500,000 in 1985, the lifetime limit was increased over the years
until 2014, when it was increased to $800,000 and then indexed for inflation
every year thereafter. The lifetime limit was $750,000 in 2013, $800,000 in 2014,
$813,600 in 2015, $824,176 in 2016, and $835,714 in 2017. Qualifying property
(discussed in more detail below) includes shares of a small business corporation
and certain interests in farming or fishing properties (with an enhanced lifetime
limit of $1,000,000 for farm and fishing properties) (see 3.1.2, History of Capital
Gains Tax in Canada).

The LCGE is available to every individual but is not generally available to trusts,
although eligible capital gains may be allocated to beneficiaries who may be
able to claim the LCGE (see 4.3.8.5). Where property is held by a corporation,
the sale of the property by the corporation will not qualify for the LCGE. The
sale of corporation shares by an individual shareholder may qualify, if the cor-
poration is qualifying property.

The rules relating to the LCGE are in s. 110.6 of the Act. The term “exemption”
is generally used to refer to the amount of capital gain (not taxable capital gain)
sheltered. The lifetime limit is the maximum amount of the “exemption” that can
be sheltered as of any particular year and refers to the capital gain, not the tax-
able capital gain. The term “deduction” is used when referring to the actual rules
used in calculating the deduction from the amount of taxable capital gains to be
included in income and is half the amount of the “exemption” claimed.

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LIFETIME CAPITAL GAINS EXEMPTION (LCGE) 3.3.2.1

The capital gains deduction is claimed by filing Form T657, Calculation of

Capital Gains Deduction. The utilization of the capital gains deduction may be
restricted if the individual has a cumulative net investment loss (CNIL) or has
claimed an allowable business investment loss (ABIL) in the past.

Similarly, the amount of LCGE claimed will reduce the amount of allowable busi-
ness investment loss that a taxpayer can claim in the future.

Finally, alternative minimum tax can apply when the LCGE is used.

3.3.2 Qualified Small Business Corporation Share (QSBCS)

Gains from the disposition of shares qualify for the LCGE if the share is a quali-
fied small business corporation share (QSBCS).

3.3.2.1 Definition of Qualified Small Business Corporation Share (QSBCS)

The definition of a QSBCS is in s. 110.6. The share must be a share of a
corporation that meets three primary tests.

1. The 24-Month Holding Period Test. For the 24-month period

prior to the disposition, the shares cannot be held by anyone
other than the individual or a related person.
2. The 50% Test. Throughout the 24-month holding period, more
than 50% of the fair market value of the assets of the corporation
must be used in an active business carried on primarily in Canada.
3. The 90% Test. At the time of the disposition, the shares must
be shares of a small business corporation (SBC). As described
below (see 3.3.2.2), an SBC is a Canadian-controlled private cor-
poration (CCPC) where all or substantially all (90%) of the fair
market value of the corporation’s assets were used principally
in an active business carried on primarily in Canada.

In computing the value of the assets to meet the 50% test and the 90%
test, debt and shares of connected corporations13 may be included if those
corporations also meet the 50% test and the 90% test at the relevant times.

13 Connected corporations are defined in the Act but will not be discussed here.

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3.3.2.2 Chapter 3 – Taxation of Capital Gains

3.3.2.2 Definition of Canadian-Controlled Private Corporation (CCPC)

A Canadian-controlled private corporation (CCPC) is defined in
subs. 125(7) of the Act as:

• a private corporation (defined in subs. 89(1) as not a publicly

traded corporation or controlled by a publicly traded corpora-
tion — i.e., not listed on a stock exchange),
• a Canadian corporation (defined in subs. 89(1) as incorporated)
• not controlled by non-residents or publicly traded corporations,
and
• not controlled by a combination of non-residents and public
corporations.

3.3.2.3 Definition of Small Business Corporation (SBC)

A small business corporation (SBC) is defined in subs. 248(1) as a CCPC
where all or substantially all (90%) of the fair market value (FMV) of the
assets of the corporation are:

• used principally (50% or more) in an active business carried on

primarily in Canada by the corporation or a corporation related
to it, or
• shares or debt of other small business corporations connected
with the corporation, or
• a combination of the above.

3.3.2.4 Treasury Shares and Incorporation of a Partnership or Sole

Proprietorship — QSBCS
In applying the 24-month holding test, shares issued from treasury by a
corporation within the two-year period prior to disposition are consid-
ered to have been owned by another person. The result is that the time
for the holding period commences when the shares are issued. However,
two exceptions exist. Shares issued from treasury will not be deemed to
be owned by an arm’s-length person prior to issue if the consideration
was other shares or where the shares were issued in exchange for all or
substantially all (90%) of the assets used in an active business carried

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LIFETIME CAPITAL GAINS EXEMPTION (LCGE) 3.3.3

on by the transferor.14 This permits a sole proprietor or a partnership to

incorporate an existing business and immediately qualify for the LCGE.

3.3.2.5 Relieving Provision on Death for QSBCS

A relieving provision is available where a deceased person held shares
at the time of death that otherwise qualified but failed to meet the 90%
test at the time of death. The shares will qualify for the LCGE if they met
the 90% test at any time within the 12-month period prior to the share-
holder’s death (para. 110.6(14)(g)).

3.3.2.6 LCGE Not Available If under 18 and Sale Non-Arm’s Length

Capital gains realized on the sale of shares of a private corporation and
received by an individual who has not attained age 17 before the year
are taxed as non-eligible dividends and subject to tax on split income as
discussed at 9.4. Since the amount of the actual gain is deemed not to
be a capital gain for tax purposes, no LCGE is available.

3.3.3 Qualified Farm or Fishing Property

Qualified farm or fishing property used in the business of farming or fishing by

the individual owner or the spouse, child, grandchild, or parent is eligible for
the LCGE. Dispositions on or after April 21, 2015, include an enhanced lifetime
limit so that the total limit available is equal to the greater of the regular indexed
lifetime limit and $1,000,000 (see subs. 110.6(2.2)).

The term “qualified farm or fishing property” is defined in subs. 110.6(1) and
includes real or immovable property or a fishing vessel used in the course of
carrying on a farming or fishing business in Canada, shares of a family farm or
fishing corporation, and an interest in a farm or fishing partnership. For partner-
ships and corporations to qualify, the definitions of a share of a farm or fish-
ing corporation and interest in a farm or fishing partnership in subs. 110.6(1)
require property owned by the corporation or partnership to be used in in the
business of farming or fishing, with rules similar to the definition of qualifying
shares of a small business corporation (i.e., the 24-month test, the 50% test, and
the 90% test).

14 Para. 110.6(14)(f).

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3.4 Chapter 3 – Taxation of Capital Gains

The Act sets out what constitutes using property in the course of carrying on a
farming or fishing business for the purposes of the definition in subs. 110.6(1.3).
The rules for qualified farm or fishing property acquired prior to June 18, 1987,
are more lenient. Real property used by a family member principally in the
course of carrying on the business of farming in Canada in the year of disposi-
tion, or in at least five years during which the property was owned by a family
member, may qualify.

3.4 ROLLOVERS

3.4.1 Concept of Rollover

A number of dispositions of capital property may be deemed to take place for

proceeds of disposition equal to their adjusted cost base (ACB). In most cases,
the cost of acquisition to the transferee is the ACB of the transferor. In effect, the
tax attributes of the property transferred are carried over to the new owner of
the property, and the tax consequences of the transfer are delayed until the new
owner disposes of the property. These tax-deferred transactions are commonly
called “rollovers,” although the term “rollover” is never used in the Act. The most
common rollover for individuals is the spousal rollover, but many others are
used. The following is a list of the most common rollovers of capital property:

• transfers to a spouse, common-law partner, or qualifying spousal

or common-law partner trust (whether inter vivos or testamentary),
• transfers to a corporation in exchange for shares,
• intergenerational transfers of farm property, and
• certain transfers to and from a trust.

3.4.2 Qualifying Transfers — Inter Vivos

Under subs. 73(1) of the Act, there is a rollover for “qualifying transfers” as
defined in subs. 73(1.01). Qualifying transfers include transfers to:

• the individual’s spouse or common-law partner,

• the former spouse or common-law partner of the individual in set-
tlement of rights arising out of their relationship,
• a qualifying spousal or common-law partner trust (QST),
• an alter ego trust (AET), and

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ROLLOVERS 3.4.4

• a joint partner or common-law partner trust ( JPT).

By definition, qualifying transfers are inter vivos transfers. For a discussion of

and rollover to a QST, AET, and JPT, see Chapter 4.

An individual can elect out of these automatic rollovers if desired.

3.4.3 Transfers to a Spouse or Qualifying Spousal Testamentary Trust as a

Consequence of Death

There is a rollover for capital property transferred to a spouse or common-law

partner as a consequence of death15 under subs. 70(6). The rollover applies
where the spouse inherits property directly or it is transferred to a qualifying
spousal trust. A testamentary spousal trust qualifies for the rollover if the follow-
ing criteria are met:

• the trust must be created by the taxpayer’s Will or by a court order

providing for dependant relief or support under provincial law;16
• the terms of the trust must provide that:
{ only the spouse or common-law partner is entitled to receive all
of the income of the trust that arises before his or her death, and
{ no person except the spouse or common-law partner may
receive or otherwise obtain the use of any of the capital of the
trust during the lifetime of the spouse or common-law partner;
and
• the property must vest indefeasibly in the trust within 36 months
after the death of the taxpayer.

3.4.4 Spousal Trusts in Tax Planning

Spousal trusts or common-law partner trusts that qualify for the rollover either
under subs. 70(6) for trusts created during the lifetime of the settlor or under
subs. 73(1) for testamentary trusts have many advantages in tax and estate plan-
ning. Qualifying spousal trusts (QSTs) are useful for non-tax reasons, such as
when an individual wants to give ownership but not control of the property to

15 See subs. 248(23.1) of the Act, which includes transfers to a spouse or common-law partner on an
intestacy as being a consequence of death.
16 See subs. 248(9.1).

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3.4.5 Chapter 3 – Taxation of Capital Gains

a spouse or to preserve the capital of the property for the ultimate benefit of
another person but wants to have the spouse benefit from the property during
the spouse’s lifetime. The main advantages of a QST from a capital gains per-
spective include:

• a rollover of capital property to the trust, and

• the deemed disposition every 21 years for trusts is deferred until
the death of the surviving spouse.

In this material, the terms “spousal trust,” “spouse trust,” or “spousal and common-
law partner trust” will include a reference to a trust that qualifies under the Act
for this special treatment. Where such a trust does not qualify, it will be called a
“tainted” or “non-qualifying” spousal trust. In some cases, the spousal trust will
be referred to as a “qualifying spousal trust (QST).” Different language may be
used in Chapter 12 when discussing U.S. estate and gift tax and spousal trusts that
qualify for special tax treatment under U.S. tax law known as “qualifying domestic
trusts (QDOTs).”

3.4.5 Rollover of Farm or Fishing Property

Intergenerational transfers of farm or fishing property to a child, including a

grandchild,17 are subject to rollover treatment.18 This rollover is available for
inter vivos transfers and transfers that occur as a consequence of death.19 Land
or depreciable property used principally (50%) in the farming or fishing busi-
ness is eligible. The property must meet the following requirements:

• Before the death of the taxpayer or the transfer, the property must
have been used principally in a fishing or farming business carried
on in Canada.
• Before the death of the taxpayer or the transfer, the spouse or
common-law partner, or a child or parent of the taxpayer, must
have been actively engaged in the farming or fishing business on
a regular contact or continuous basis.
• The child to whom the property is transferred must be a resident
of Canada immediately before the transfer.

17 See subss. 70(10), 73(6), and 252(1) for the definition of the term “child” for this purpose.
18 See IT-268R4 (Archived), Inter Vivos Transfer of Farm Property to Child, and IT-349R3 (Archived),
Intergenerational Transfers of Farm Property on Death.
19 Subs. 70(9) for testamentary transfers and subs. 73(3) for inter vivos transfers.

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ROLLOVERS 3.4.6

• Where the transfer is a consequence of the death of the taxpayer,

the property must vest indefeasibly in the child within 36 months
of the taxpayer’s death.

This rollover is available whether the real property used in farming is owned
directly or whether the farm property is held through a family farm or fishing
corporation or a family farm or fishing partnership. It is also available where the
transfer is effected through a trust.

On death, para. 70(9.01)(b) allows the legal representative to elect out of the
rollover of farm or fishing property in a range between the fair market value
(FMV) and the adjusted cost base (ACB) in the case of land or between the FMV
and the undepreciated capital cost (UCC) in the case of depreciable property.
This is unlike the option to elect out of many other rollovers (such as the spou-
sal rollover, where there is an all-or-nothing rollover on specific property). The
availability of this election permits post-mortem tax planning, such as utilizing
any remaining lifetime capital gains exemption (LCGE) in the final return and
bumping up the tax cost to the recipient beneficiary.

For inter vivos intergenerational transfers of farm or fishing property, the pro-
ceeds of disposition may also be in a range between the FMV and the ACB in the
case of land or between the FMV and the UCC for depreciable property. How-
ever, in this case, the amount depends on the actual proceeds of disposition, not
an elected amount.

The farm or fishing property rollover should not be confused with the capital
gains exemption (CGE) available on qualifying farm or fishing property. The
rollover is only a deferral of tax, as the recipient child inherits the ACB of the
parent; whereas the LCGE provides a complete tax saving (i.e., there is a “bump”
in the cost of the property to the recipient to the extent the transferor was able
to use the LCGE).

3.4.6 Transfers to Corporations

Corporate transactions, including transfers to corporations and corporate reor-

ganizations, are subject to a number of tax deferral and other rollover rules. The
details of these rules are not covered here, although they may be referred to in
more detail in some of the later chapters (see Chapters 8 and 9).

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3.4.7 Chapter 3 – Taxation of Capital Gains

Section 85 of the Act permits a transfer of property to a corporation in exchange

for shares on a rollover basis if the transferor and the transferee jointly elect
in prescribed form. The amount specified on the election will be the proceeds
of disposition to the transferor and the cost of the property to the transferee.
The elected amount is generally between the ACB and the FMV. For depreciable
property, the range is generally between the UCC and the FMV.

Section 85.1 of the Act permits share-for-share exchanges in the capital stock of
the same corporation to take place on a rollover basis.

Shares of a corporation may also be disposed of in a tax-deferred transaction

under s. 86 where there is a reorganization of capital of the corporation effected
by filing articles of amendment, where the new class of shares is not already
authorized, or by a share exchange agreement if the shares are already autho-
rized. Share exchanges that take place under conversion rights in the terms of
the shares are also tax-deferred.

While s. 86 provides for the share exchange to be tax-free, a s. 85 election can

be used on a share exchange to elect to create a gain, if desired. Practitioners
often refer to this combination as a “dirty 86.”

3.4.7 Transfers to and from Trusts

A number of rollovers are available on transfers of property to and from trusts.

In general, the transfer of property to a trust takes place at the property’s market
value. However, there are exceptions, including transfers to a qualifying spouse
or common-law partner trust, an alter ego trust, and a joint partner or common-
law partner trust. In general, a transfer of property from a personal trust to a
beneficiary in satisfaction of the capital interest in the trust takes place on a roll-
over basis. There are exceptions, such as where the beneficiary is a non-resident
or where the trust was subject to the attribution rules in subs. 75(2) (in which
case there will be a deemed disposition of any asset transferred to anyone other
than the original settlor). (For details, see Chapters 4 and 6.)

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CAPITAL LOSSES 3.5.2

3.5 CAPITAL LOSSES

3.5.1 Superficial Loss

The superficial loss rules prevent a taxpayer from artificially recognizing a capi-
tal loss. A superficial loss is deemed to be nil and is defined in s. 54 as a loss
from the disposition of particular property where:

• during the period that begins 30 days before and ends 30 days
after the disposition, the taxpayer or an affiliated person acquires
the same or an identical property, and
• the taxpayer or an affiliated person owns the same property or an
identical property at the end of the 30-day period.

As discussed, identical properties include shares of the same class in the capital
stock of a corporation (see 3.2.3, Adjusted Cost Base of Identical Properties).
The term “affiliated person” is defined in subs. 251.1(1) to include both an indi-
vidual and a spouse or common-law partner of the individual as well as indi-
viduals, corporations, and partnerships that are connected with each other in
specific ways.20

Where the superficial loss rules apply, the cost base of the property of the affili-
ated person is adjusted so that the affiliated person may recognize the “pregnant
loss” upon a subsequent disposition. Essentially, the loss is not denied, but it is
deferred until there is a disposition to a non-affiliated person.

3.5.2 Business Investment Loss

An allowable business investment loss (ABIL) is one-half of a business invest-

ment loss defined in para. 39(1)(c) as the loss incurred on the disposition of
shares of an small business corporation (SBC) or the disposition of a loan to an
SBC. For purposes of claiming an ABIL, the corporation would qualify as an SBC
if it was an SBC at any time in the 12 months before the loss was incurred. (For
the definition of SBC, see 3.3.2.3.)

In the case of an actual disposition, the transferee must be a person with whom
the transferor deals at arm’s length. In cases where the entire amount of a loan
has become uncollectible or when the loss relates to shares of an insolvent or
bankrupt company, an actual disposition is not required in order to realize the

20 Listed in paras. 251(1)(b) to (f).

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3.5.3 Chapter 3 – Taxation of Capital Gains

loss. In these cases, the taxpayer must file an election under subs. 50(1) to deem
the debt or shares to have been disposed of for nil proceeds and to be reac-
quired for a nil cost base. Failure to file the election can result in the denial of
the loss. A subs. 50(1) election may be permitted to be filed late under the tax-
payer relief provisions, but penalties can be assessed.

Allowable business investment losses can be deducted against all sources of

income and are not restricted to offsetting taxable capital gains. Any unused
portion of an allowable business investment loss in the year in which it was
incurred can be carried back three years or forward 10 years. If it is not used
within this period, it then becomes a net capital loss.

3.5.3 Personal Use Property

Personal use property is any property used by the taxpayer, or a person related
to the taxpayer, for personal use or enjoyment.21 Where the taxpayer is a trust,
property owned by the trust but used by a beneficiary of the trust, or any per-
son related to a beneficiary, for personal use or enjoyment will be personal use
property. This would include an individual’s home, car, boat, vacation property,
and home furnishings.

The Act contains a stop-loss rule in respect of any loss incurred on the sale of
personal use property. Any loss from the disposition of personal use property is
deemed to be nil. This rule recognizes that personal use property is consumed
by the taxpayer during ownership, and it is not appropriate to permit a tax
advantage where the loss represents the benefit derived from ownership. How-
ever, gains on the disposition of personal use property are taxable as capital
gains.

In order to keep small transactions from being subject to tax, the Act deems the
cost and the proceeds of disposition of personal use property to be the greater
of the actual amount and $1,000. Purchases and sales of personal use property
for less than $1,000 fall below the threshold for tax purposes. The gain on the
sale of household items or furniture at a garage sale, for example, need not be
reported unless the proceeds of any one item exceeds $1,000, and even then,
the cost is deemed to be no less than $1,000.22

21 Defined in s. 54.
22 A further rule prevents taxpayers from taking undue advantage of the $1,000 minimum rule by
breaking up a sale into partial dispositions.

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CAPITAL LOSSES 3.5.5

3.5.4 Listed Personal Property

Listed personal property is a subset of personal use property. The definition is

very specific and includes:

• works of art,
• rare books,
• jewellery,
• stamps, and
• coins.

Losses from the sale of listed personal property may be offset against gains from
the sale of listed personal property. Unused losses may be carried back three years
or forward seven years and deducted against gains on listed personal property.
The $1,000 minimum rule noted above for personal use property applies.

3.5.5 Capital Loss Carrybacks

Where allowable capital losses exceed taxable capital gains in a particular taxa-
tion year, the unused loss, called a “net capital loss,” can be carried back to the
three previous taxation years or forward to any subsequent taxation year.23 Net
capital losses do not expire, and they can be carried forward indefinitely.

However, net capital losses may only be applied to reduce taxable capital gains
in a taxation year to the extent that the taxable capital gains were not offset by
allowable capital losses for the year.

The request for loss carryback of a net capital loss from the current year should
be filed with the tax return for the current year. CRA will reassess the prior year
to adjust taxable income for that prior year and issue a refund if applicable. For
example, a net capital loss arising in the 2009 taxation year may be carried back
to reduce the taxable income for any of the 2008, 2007, and 2006 taxation years,
to the extent that taxable capital gains were included in the computation of net
income in those years.

If the taxable capital gains of a prior year were offset by non-capital losses car-
ried forward or back, the taxpayer can adjust the application of losses to use the

23 Para. 111(1)(b).

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3.5.6 Chapter 3 – Taxation of Capital Gains

allowable capital losses and thereby refresh the non-capital losses to be used
against other types of income.

3.5.6 Using Net Capital Losses in Current Year

Net capital losses may be carried forward indefinitely. If taxable capital gains
exceed allowable capital losses in the current year, it is possible to apply any
unused net capital losses of previous years to reduce the amount of such taxable
capital gains.

3.5.7 Capital Losses on Death

Special rules apply to the deduction of capital losses in the year of death and the
immediately preceding year. The deduction of allowable capital losses arising in
the year of death, as well as net capital loss carryforwards, is permitted against
all sources of income in these years (see 7.12.1).

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EXCERPTS FROM DEFINITIONS IN THE CRA’S CAPITAL GAINS GUIDE

APPENDIX
EXCERPTS FROM DEFINITIONS IN THE CRA’S CAPITAL GAINS GUIDE

Capital Gains — 2016 T4037(E) Rev.16

What’s New for 2016?

Lifetime capital gains exemption limit — For dispositions in 2016 of qualified

small business corporation shares, the lifetime capital gains exemption (LCGE)
limit has increased to $824,176. For more information, see “What is the capital
gains deduction limit?”

Disposition of a principal residence — If you sold your principal residence in

2016, the sale must now be reported, along with any principal residence desig-
nation, on Schedule 3, Capital Gains (or Losses). See Chapter 6 [of Capital Gains
2016 T4037(E) Rev. 16] for more information on reporting requirements. Under
proposed changes, the CRA will be able to accept a late designation in certain
circumstances, but a penalty may apply. For more information, go to “Reporting
the sale of your principal residence for individuals (other than trusts)” and select
question 7.

Definitions

This section describes, in a general way, technical terms that we use in this
guide. Whenever practical, we define technical terms in detail in the applicable
chapters.

Note

Throughout this guide, we use the terms sell, sold, buy, and bought to describe
most capital transactions. However, the information in this guide also applies to
other dispositions or acquisitions, such as when you give or receive a gift. When
reading this guide, you can substitute the terms disposed of or acquired for
sold or bought, if they more accurately describe your situation.

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 Chapter 3 – Taxation of Capital Gains

Abbreviations — The following is a list of some of the abbreviations that we

use in this guide:

ABIL — Allowable business investment loss

ACB — Adjusted cost base
CCA — Capital cost allowance
CNIL — Cumulative net investment loss
FMV — Fair market value
LPP — Listed personal property
RFL — Restricted farm loss
UCC — Undepreciated capital cost

Adjusted cost base (ACB) — usually the cost of a property plus any expenses
to acquire it, such as commissions and legal fees.

The cost of a capital property is its actual or deemed cost, depending on the
type of property and how you acquired it. It also includes capital expenditures,
such as the cost of additions and improvements to the property. You cannot add
current expenses, such as maintenance and repair costs, to the cost base of a
property.

For more information on ACB, see Interpretation Bulletin IT-456R [Archived],

Capital Property — Some Adjustments to Cost Base, and its Special Release.

Advantage — The advantage is generally the total value of any property, ser-
vice, compensation, use or any other benefit that you are entitled to as partial
consideration for, or in gratitude for, the gift. The advantage may be contingent
or receivable in the future, either to you or a person or partnership not dealing
at arm’s length with you.

The advantage also includes any limited-recourse debt in respect of the gift at
the time it was made. For example, there may be a limited-recourse debt if the
property was acquired as part of a gifting arrangement that is a tax shelter. In this
case, the eligible amount of the gift will be reported in box 13 of Form T5003,
Statement of Tax Shelter Information. For more information on tax shelters and
gifting arrangements, see guide T4068, Guide for the Partnership Information
Return (T5013 Forms).

Allowable capital loss — is your capital loss for the year multiplied by the inclu-
sion rate for that year. For 2001 and subsequent years, the inclusion rate is 1/2.

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EXCERPTS FROM DEFINITIONS IN THE CRA’S CAPITAL GAINS GUIDE

Arm’s length transaction — refers to a transaction between persons who act

in their separate interests. An arm’s length transaction is generally a transaction
that reflects ordinary commercial dealings between parties acting in their sepa-
rate interests.

“Related persons” are not considered to deal with each other at arm’s length.
Related persons include individuals connected by blood relationship, mar-
riage, common-law partnership or adoption (legal or in fact). A corporation and
another person or two corporations may also be related persons.

“Unrelated persons” may not be dealing with each other at arm’s length at a par-
ticular time. Each case will depend upon its own facts. The following criteria will
be considered to determine whether parties to a transaction are not dealing at
arm’s length:

• whether there is a common mind which directs the bargaining for

the parties to a transaction;
• whether the parties to a transaction “act in concert” without sepa-
rate interests; “acting in concert” means, for example, that parties
act with considerable interdependence on a transaction of common
interest; or
• whether there is de facto control of one party by the other because
of, for example, advantage, authority or influence.

For more information, see Income Tax Folio S1-F5-C1, Related persons and deal-
ing at arm’s length.

Business investment loss — see Allowable business investment loss.

Canadian-controlled private corporation — is a private corporation that is a

Canadian corporation other than:

a. a corporation controlled, directly or indirectly in any way, by one

or more non-resident persons, by one or more public corporations
(other than a prescribed venture capital corporation), by one or
more corporations described in paragraph c), or by any combina-
tion of the above;
b. a corporation that would be controlled by one person if that one
person owned all the shares of any corporation that are owned

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 Chapter 3 – Taxation of Capital Gains

by any non-resident person, by any public corporation (other than

a prescribed venture capital corporation), or by a corporation
described in paragraph c); or
c. a corporation, a class of the shares of capital stock of which is
listed on a designated stock exchange.

Canadian security is:

• a share of the capital stock of a corporation resident in Canada;

• a unit of a mutual fund trust; or
• a bond, debenture, bill, note, mortgage, hypothecary claim, or simi-
lar obligation issued by a person resident in Canada.

Prescribed securities are not considered to be Canadian securities.

Capital cost allowance (CCA) — in the year you buy a depreciable property,
such as a building, you cannot deduct its full cost. However, since this type of
property wears out or becomes obsolete over time, you can deduct its capital
cost over a period of several years. This deduction is called CCA. When we talk
about CCA, a reference is often made to class. You usually group depreciable
properties into classes. You have to base your CCA claim on the rate assigned to
each class of property.

Capital gain — you have a capital gain when you sell, or are considered to have
sold, a capital property for more than the total of its adjusted cost base and the
outlays and expenses incurred to sell the property.

Capital loss — you have a capital loss when you sell, or are considered to have
sold, a capital property for less than the total of its adjusted cost base and the
outlays and expenses incurred to sell the property.

Capital property — includes depreciable property, and any property which, if sold,
would result in a capital gain or a capital loss. You usually buy it for investment pur-
poses or to earn income. Capital property does not include the trading assets of a
business, such as inventory. Some common types of capital property include:

• cottages;
• securities, such as stocks, bonds, and units of a mutual fund trust;
and

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EXCERPTS FROM DEFINITIONS IN THE CRA’S CAPITAL GAINS GUIDE

• land, buildings, and equipment you use in a business or a rental

operation.

Common-law partner — this applies to a person who is not your spouse, with
whom you are living and have a conjugal relationship, and to whom at least one
of the following situations applies. He or she:

a. has been living with you in a conjugal relationship, and this cur-
rent relationship has lasted at least 12 continuous months;
Note
In this definition, “12 continuous months” includes any period you
were living separate and apart for less than 90 days because of a
breakdown in the relationship.

b. is the parent of your child by birth or adoption; or

c. has custody and control of your child (or had custody and con-
trol immediately before the child turned 19 years of age) and your
child is wholly dependent on that person for support.

Deemed acquisition — expression used when you are considered to have

acquired property, even though you did not actually buy it.

Deemed cost — refers to the price of property you are considered to have
acquired, even though you did not actually buy it.

Deemed disposition — expression used when you are considered to have dis-
posed of property, even though you did not actually sell it.

Deemed proceeds of disposition — expression used when you are considered

to have received an amount for the disposition of property, even though you did
not actually receive the amount.

Depreciable property — usually capital property used to earn income from a

business or property. The capital cost can be written off as CCA over a number
of years.

Disposition (dispose of) — usually an event or transaction where you give up

possession, control, and all other aspects of property ownership.

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 Chapter 3 – Taxation of Capital Gains

Eligible amount of the gift — this is generally the amount by which the fair
market value (FMV) of the gifted property exceeds the amount of an advantage,
if any, received or receivable for the gift. For more information, see Pamphlet
P113, Gifts and Income Tax.

The advantage is generally the total value of any property, service, compensa-
tion, use or any other benefit that you are entitled to as partial consideration for,
or in gratitude for, the gift. The advantage may be contingent or receivable in
the future, either to you or a person or partnership not dealing at arm’s length
with you.

The advantage also includes any limited-recourse debt in respect of the gift at
the time it was made. For example, there may be a limited-recourse debt if the
property was acquired as part of a gifting arrangement that is a tax shelter. In
this case, the eligible amount of the gift will be reported in box 13 of Form
T5003, Statement of Tax Shelter Information. For more information on tax shel-
ters and gifting arrangements, see guide T4068, Guide for the Partnership Infor-
mation Return (T5013 Forms).

Eligible active business corporation — generally, this is a taxable Canadian

corporation, where all or substantially all of the fair market value (FMV) of its
assets are used principally in an active business carried on primarily in Canada
by the corporation or by a related active business corporation while the investor
holds the shares, or for at least 730 days of the ownership period. It can also
be shares of, and/or a debt issued by, other related active business corporations
or a combination of such assets, shares, or debt.

Note

An eligible active business corporation does not include:

• a professional corporation;
• a specified financial institution;
• a corporation whose principal business is leasing, renting, devel-
oping, or selling real property that it owns or any combination of
these activities; and
• a corporation where more than 50% of the FMV of its property (net of
debts incurred to acquire the property) is attributable to real property.

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EXCERPTS FROM DEFINITIONS IN THE CRA’S CAPITAL GAINS GUIDE

Eligible capital property — property that does not physically exist but gives
you a lasting economic benefit. Examples of this kind of property are goodwill,
customer lists, trademarks, and milk quotas.

Eligible small business corporation — generally, this is a Canadian-controlled

private corporation, where all or substantially all of the FMV of its assets are used
principally in an active business that is carried on primarily in Canada by the
corporation or an eligible small business corporation related to it. It can also be
shares of, and/or a debt issued by, other related eligible small business corpora-
tions or a combination of such assets, shares, or debt. The issuing corporation
must be an eligible small business corporation at the time the shares were issued.

Note

An eligible small business corporation does not include:

• a professional corporation;
• a specified financial institution;
• a corporation whose principal business is leasing, renting, devel-
oping, or selling real property that it owns or any combination of
these activities; and
• a corporation where more than 50% of the FMV of its property (net
of debts incurred to acquire the property) is attributable to real
property.

Excepted gift — a gift of a share you made to a donee with whom you deal at
arm’s length. The donee cannot be a private foundation. If the donee is a chari-
table organization or public foundation, it will be an excepted gift if you deal
at arm’s length with each director, trustee, officer, and official of the donee. For
more information, see “Non-qualifying security.”

Fair market value (FMV) — is usually the highest dollar value you can get for
your property in an open and unrestricted market, between a willing buyer and
a willing seller who are acting independently of each other.

Flow-through entity — we explain this term in “What is a flow-through entity?”

Inclusion rate — generally, the inclusion rate for 2016 is 1/2. This means that you
multiply your capital gain for the year by this rate to determine your taxable capital

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 Chapter 3 – Taxation of Capital Gains

gain. Similarly, you multiply your capital loss for the year by 1/2 to determine your
allowable capital loss. For a list of previous year inclusion rates, see “Inclusion rate.”

Listed personal property (LPP) — is a type of personal-use property. The prin-

cipal difference between LPP and other personal-use properties is that LPP usu-
ally increases in value over time. LPP includes all or any part of any interest in
or any right to the following properties:

• prints, etchings, drawings, paintings, sculptures, or other similar

works of art;
• jewellery;
• rare folios, rare manuscripts, or rare books;
• stamps; and
• coins.

Net capital loss — generally, if your allowable capital losses are more than your
taxable capital gains, the difference between the two becomes part of the calcu-
lation of your net capital loss for the year.

Non-arm’s length transaction — a transaction between persons who are related

to each other. However, a non-arm’s length relationship might also exist between
unrelated individuals, partnerships or corporations, depending on the circum-
stances. For more information, see the definition of “arm’s length transaction.”

Non-qualifying real property — generally, non-qualifying real property is

real property that you or your partnership disposed of after February 1992 and
before 1996.

It also generally includes the following property you or your partnership dis-
posed of after February 1992 and before 1996, if its fair market value is derived
principally (more than 50%) from real property:

• a share of a capital stock of a corporation;

• an interest in a partnership;
• an interest in a trust; or
• an interest or an option in any property described above.

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EXCERPTS FROM DEFINITIONS IN THE CRA’S CAPITAL GAINS GUIDE

Non-qualifying securities — are securities you donated to a qualified donee.

Non-qualifying securities generally include:

• a share of a corporation with which you do not deal at arm’s length

after the donation was made;
• your beneficial interest in a trust in certain circumstances;
• an obligation of yours or of any person or partnership with whom
you do not deal at arm’s length after the donation was made; or
• any other security issued by you or by any person or partnership with
whom you do not deal at arm’s length after the donation was made.

Non-qualifying securities exclude:

• shares, obligations, and other securities listed on a designated stock

exchange; and
• obligations of a financial institution to repay an amount deposited
with the institution.

For more information on non-qualifying securities, go to “Non-qualifying security.”

Outlays and expenses — are amounts that you incurred to sell a capital prop-
erty. You can deduct outlays and expenses from your proceeds of disposition
when calculating your capital gain or loss. You cannot reduce your other income
by claiming a deduction for these outlays and expenses. These types of expenses
include fixing-up expenses, finders’ fees, commissions, brokers’ fees, surveyors’
fees, legal fees, transfer taxes, and advertising costs.

Personal-use property — refers to items that you own primarily for the per-
sonal use or enjoyment of your family and yourself. It includes all personal
and household items, such as furniture, automobiles, boats, a cottage, and other
similar properties.

Prescribed security — generally includes:

• a share of a corporation (other than a public corporation) whose

value at the time you dispose of it comes mainly from real estate,
resource properties, or both;
• a bond, debenture, bill, note, mortgage, or similar obligation of a
corporation (other than a public corporation) that you do not deal

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 Chapter 3 – Taxation of Capital Gains

with at arm’s length at any time before you dispose of the security;
and
• a share, bond, debenture, bill, note, mortgage, or similar obligation
you acquire from a person with whom you do not deal at arm’s length.

A prescribed security is not considered to be a Canadian security.

Proceeds of disposition — usually the amount you received or will receive for
your property. In most cases, it refers to the sale price of the property. This could
also include compensation you received for property that has been destroyed,
expropriated, or stolen.

Public corporation — is a corporation that is resident in Canada and:

• has a class of shares listed on a designated Canadian stock

exchange; or
• is a corporation (other than a prescribed labour-sponsored venture
capital corporation) that has elected, or has been designated by the
Minister of National Revenue, to be a public corporation. Also, at
the time of the election or designation, the corporation complied
with prescribed conditions concerning the number of its sharehold-
ers, the dispersal of ownership of its shares, and the public trading
of its shares.

Qualified donees — are as follows:

• registered charities;
• registered Canadian amateur athletic associations;
• registered national arts service organizations;
• registered housing corporations resident in Canada set up only to
provide low-cost housing for the aged;
• registered municipalities in Canada;
• registered municipal or public bodies performing a function of
government in Canada;
• the United Nations and its agencies;

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EXCERPTS FROM DEFINITIONS IN THE CRA’S CAPITAL GAINS GUIDE

• registered universities outside Canada that are prescribed to be

universities the student body of which ordinarily includes students
from Canada;
• Her Majesty in Right of Canada, a province, or a territory; and
• before June 23, 2015, registered foreign charitable organizations
to which Her Majesty in right of Canada has made a gift. For gifts
made after June 22, 2015, registered foreign charities (which now
include foreign charitable foundations) to which Her Majesty in
right of Canada has made a gift.

Qualified farm or fishing property — is certain property you or your spouse

or common-law partner owns. It is also certain property owned by a family-farm
or fishing partnership in which you or your spouse or common-law partner
holds an interest.

Qualified farm or fishing property (QFFP) includes:

• a share of the capital stock of a family-farm or fishing corporation

that you or your spouse or common-law partner owns;
• an interest in a family-farm or fishing partnership that you or your
spouse or common-law partner owns;
• real property, such as land, buildings, and fishing vessels; and
• eligible capital property, such as milk and egg quotas, or fishing
licenses.

For more information on what is considered to be qualified farm or fishing prop-

erty, see guides:

• T4003, Farming and Fishing Income,

• RC4060, Farming Income and the AgriStability and AgriInvest Pro-
grams Guide, or
• RC4408, Farming Income and the AgriStability and AgriInvest Pro-
grams Harmonized Guide.

Qualified small business corporation shares — a share of a corporation will

be considered to be a qualified small business corporation share if all the fol-
lowing conditions are met:

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 Chapter 3 – Taxation of Capital Gains

• at the time of sale, it was a share of the capital stock of a small busi-
ness corporation, and it was owned by you, your spouse or common-
law partner, or a partnership of which you were a member;
• throughout that part of the 24 months immediately before the share
was disposed of, while the share was owned by you, a partnership
of which you were a member, or a person related to you, it was a
share of a Canadian-controlled private corporation and more than
50% of the fair market value of the assets of the corporation were:
{ used mainly in an active business carried on primarily in Can-
ada by the Canadian-controlled private corporation, or by a
related corporation;
{ certain shares or debts of connected corporations; or
{ a combination of these two types of assets; and
• throughout the 24 months immediately before the share was dis-
posed of, no one owned the share other than you, a partnership of
which you were a member, or a person related to you.
Generally, when a corporation has issued shares after June 13, 1988, either to
you, to a partnership of which you are a member, or to a person related to you,
a special situation exists. We consider that, immediately before the shares were
issued, an unrelated person owned them. As a result, to meet the holding-period
requirement, the shares cannot have been owned by any person other than you,
a partnership of which you are a member, or a person related to you for a
24-month period that begins after the shares were issued and that ends when
you sold them. However, this rule does not apply to shares issued:

• as payment for other shares;

• for dispositions of shares after June 17, 1987, as payment of a stock
dividend; or
• in connection with a property that you, a partnership of which
you were a member, or a person related to you disposed of to the
corporation that issued the shares. The property disposed of must
have consisted of either:
{ all or most (90% or more) of the assets used in an active busi-
ness carried on either by you, the members of the partnership
of which you were a member, or the person related to you; or

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EXCERPTS FROM DEFINITIONS IN THE CRA’S CAPITAL GAINS GUIDE

{ an interest in a partnership where all or most (90% or more) of

the partnership’s assets were used in an active business carried
on by the members of the partnership.

Real property — property that cannot be moved, such as land or buildings. We

commonly refer to such property as “real estate.”

Recapture — when you sell a depreciable property for less than its capital cost,
but for more than the undepreciated capital cost (UCC) in its class, you do not
have a capital gain. However, if there is a negative UCC balance at the end of the
year, this balance is a recapture of capital cost allowance. You have to include
this amount in income for that year.

Small business corporation — is a Canadian-controlled private corporation in

which all or most (90% or more) of the fair market value of its assets:

• are used mainly in an active business carried on primarily in Can-

ada by the corporation or by a related corporation;
• are shares or debts of connected corporations that were small busi-
ness corporations; or
• are a combination of these two types of assets.

Spouse — applies only to a person to whom you are legally married.

Taxable capital gain — is the portion of your capital gain that you have to
report as income on your income tax and benefit return.

If you realize a capital gain when you donate certain properties to a qualified
donee or make a donation of ecologically sensitive land, special rules will apply.
For more information, see “Calculating your capital gain or loss” and “Capital
gains deferral for investment in small business.”

Terminal loss — occurs when you have an undepreciated balance in a class of

depreciable property at the end of the tax year or fiscal year, and you no lon-
ger own any property in that class. You can deduct the terminal loss when you
calculate your income for the year. For more information on terminal losses, see
“Recapture of CCA and terminal losses.”

Undepreciated capital cost (UCC) — generally, UCC is equal to the total capital
cost of all the properties of the class minus the capital cost allowance you claimed

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 Chapter 3 – Taxation of Capital Gains

in previous years. If you sell depreciable property in a year, you also have to sub-
tract from the UCC one of the following two amounts, whichever is less:

• the proceeds of disposition of the property (either actual or

deemed) minus the outlays and expenses incurred to sell it; or
• the capital cost of the property.

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 CHAPTER 4
TAXATION OF TRUSTS

LEARNING OBJECTIVES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–5

4.1 INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–5

4.2 REVIEW OF TRUST LAW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–7

4.2.1 Creation of a Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–8

4.2.1.1 Essential Parties to a Trust . . . . . . . . . . . . . . . . . . . . . 4–9
4.2.1.2 The Three Certainties . . . . . . . . . . . . . . . . . . . . . . . . 4–10
4.2.1.3 Certainty of Intention . . . . . . . . . . . . . . . . . . . . . . . . 4–11
4.2.1.4 Certainty of Subject . . . . . . . . . . . . . . . . . . . . . . . . . 4–11
4.2.1.5 Certainty of Objects . . . . . . . . . . . . . . . . . . . . . . . . . 4–11
4.2.1.6 Property Must Be Transferred to the Trustee . . . . 4–11
4.2.2 A Trust Acts through Its Trustees . . . . . . . . . . . . . . . . . . . . . . . 4–12
4.2.3 Failure to Create a Trust: The Antle Decision . . . . . . . . . . . . . 4–12
4.2.4 Other Failed Trust Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–15
4.2.5 Informal Trusts and “In Trust For” (ITF) Accounts . . . . . . . . . 4–15
4.3 BASIC RULES RELATING TO THE TAXATION OF TRUSTS . . . . . . . 4–17

4.3.1 Scheme of Taxation of Trusts under the Act . . . . . . . . . . . . . 4–17

4.3.2 A Trust Is Taxed as an Individual . . . . . . . . . . . . . . . . . . . . . . . . 4–18
4.3.3 Residence of a Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–18
4.3.3.1 CRA’s View: Income Tax Folio S6-F1-C1,
Residence of a Trust or Estate . . . . . . . . . . . . . . . . . . 4–20
4.3.3.2 Residence of a Trust Both in Canada and
Outside Canada . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–22
4.3.4 Tax Rates Applicable to Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . 4–22
4.3.5 Taxation Year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–22
4.3.6 Discretion to Tax Multiple Trusts as One . . . . . . . . . . . . . . . . 4–24
4.3.7 Trust Is a Conduit for Income . . . . . . . . . . . . . . . . . . . . . . . . . . 4–25

4–1
 4.3.7.1 Income Paid or Payable Included in Income
under Subs. 104(13) . . . . . . . . . . . . . . . . . . . . . . . . . 4–25
4.3.7.2 Deduction from Income by the Trust under
Subs. 104(6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–26
4.3.7.3 Income Payable Where Trust Is Discretionary
as to Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–26
4.3.7.4 Income Paid or Payable by an Estate during
the Executor’s Year . . . . . . . . . . . . . . . . . . . . . . . . . . 4–26
4.3.7.5 Exception to Conduit Principle: Income Paid
or Payable to a Beneficiary Is Not Taxed in
the Hands of the Beneficiary . . . . . . . . . . . . . . . . . 4–27
4.3.7.6 Exception to Conduit Principle: Income
Not Paid or Payable to a Beneficiary May Be
Taxed in the Hands of the Beneficiary . . . . . . . . 4–27
4.3.7.7 Exception to Conduit Principle: Where
Attribution Rules Apply . . . . . . . . . . . . . . . . . . . . . . 4–27
4.3.7.8 Exception to Conduit Principle: Losses Do
Not Flow Through to a Beneficiary . . . . . . . . . . . 4–28
4.3.8 Trust Is a Conduit for Sources of Income . . . . . . . . . . . . . . . . 4–28
4.3.8.1 Dividends from Taxable Canadian
Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–29
4.3.8.2 Eligible Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–30
4.3.8.3 Capital Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–30
4.3.8.4 Net Taxable Capital Gains . . . . . . . . . . . . . . . . . . . . 4–30
4.3.8.5 Lifetime Capital Gains Exemption (LCGE) . . . . . 4–31
4.3.8.6 Foreign Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–32
4.3.9 Election to Have Income Taxed in the Trust under
Subss. 104(13.1), 104(13.2), and 104(13.3) . . . . . . . . . . . . . . 4–32
4.4 TRANSFER OF CAPITAL PROPERTY TO A TRUST . . . . . . . . . . . . . . . 4–33

4.4.1 Is It a Disposition? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–33

4.4.2 Taxable Dispositions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–35
4.4.3 Tax-Deferred Dispositions: Rollover Transfers to Trusts . . . . 4–35

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4.5 DISTRIBUTION OF CAPITAL PROPERTY FROM A TRUST . . . . . . 4–36

4.5.1 Rollover under Subs. 107(2) on Distribution of Trust

Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–37
4.5.2 Other Tax Consequences of Subs. 107(2) Rollovers . . . . . . 4–37
4.5.3 Election by Trust Out of Rollover on Distribution
of Principal Residence or Other Property:
Subs. 107(2.001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–38
4.5.4 Exceptions to the Rollover on Distribution of Trust
Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–38
4.5.5 Distributions to Non-Resident Beneficiaries . . . . . . . . . . . . 4–39
4.6 TERMINATION OF A TRUST . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–39

4.7 TYPES OF TRUSTS FOR TAX PURPOSES . . . . . . . . . . . . . . . . . . . . . . . . 4–40

4.7.1 Personal Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–44

4.7.2 Inter Vivos Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–44
4.7.3 Testamentary Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–45
4.7.3.1 Graduated Rate Estates (GREs) and Qualified
Disability Trusts (QDTs) . . . . . . . . . . . . . . . . . . . . . . 4–47
4.7.3.2 Loss of Testamentary Status . . . . . . . . . . . . . . . . . 4–49
4.7.4 Life Insurance Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–51
4.7.5 Self-Benefit Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–53
4.7.6 Lifetime Benefit Trust (LBT) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–54
4.7.7 Qualifying Life Interest Trusts (QLITs): Alter Ego Trusts
(AETs), Joint Partner Trusts (JPTs), and Qualifying
Spousal Trusts (QSTs) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–54
4.7.7.1 Non-Tax Planning Advantages of Life
Interest Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–57
4.7.7.2 Tax Disadvantages of Qualifying Life Interest
Trusts: AETs, JPTs, and QSTs . . . . . . . . . . . . . . . . . . 4–59
4.7.7.3 AET Specific Requirements . . . . . . . . . . . . . . . . . . 4–60
4.7.7.4 JPT Specific Requirements . . . . . . . . . . . . . . . . . . . 4–61
4.7.7.5 QST Specific Requirements . . . . . . . . . . . . . . . . . . 4–62

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 4.7.8 Trusts for Minor Beneficiaries . . . . . . . . . . . . . . . . . . . . . . . . . . 4–63
4.7.8.1 Legal and Tax Planning Reasons for a Trust . . . 4–63
4.7.8.2 Tax Planning Uses of Trusts for Minors . . . . . . . . 4–64
4.7.8.3 Payments to or on Behalf of Minors . . . . . . . . . . 4–65
4.7.9 Age 40 Trusts Permit Accumulating Income to Be Taxed
to Under-Age-21 Beneficiaries — Subs. 104(18) . . . . . . . . . . 4–66
4.8 TWENTY-ONE-YEAR RULE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–67

4.8.1 General Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–67

4.8.2 The 21-Year Deemed Disposition Rule Is Not a
Duration Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–68
4.8.3 The 21-Year Rule Compared with Other Trust Law Rules . . . . 4–69
4.8.4 Qualifying Spousal and Common-Law Partner Trusts
(QSTs) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–69
4.8.5 Alter Ego and Joint Partner Trusts (AETs and JPTs) . . . . . . 4–69
4.8.6 Exception for Interests Vested Indefeasibly . . . . . . . . . . . . . 4–69
4.9 ALTERNATIVE MINIMUM TAX (AMT) . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–70

4.10 PREFERRED BENEFICIARY ELECTION ON ACCUMULATING

INCOME FOR DISABLED BENEFICIARIES . . . . . . . . . . . . . . . . . . . . . . 4–70

4.10.1 Filing Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–71

4.11 PRINCIPAL RESIDENCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–72

4.11.1 Transfer of a Principal Residence to a Trust . . . . . . . . . . . . . 4–72

4.11.2 Use of the Principal Residence Exemption (PRE) by a
Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–72
4.11.3 Proposed Changes to Principal Residence Exemption
Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–74
4.11.4 Transferring Principal Residence Out of Trust . . . . . . . . . . . 4–74
4.12 CHARITABLE DONATION MADE BY TRUSTS AND ESTATES . . . . 4–75

4.12.1 Value of Donation Where Gift in Kind of Capital

Property in a Will . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–78
4.13 KEY STUDY POINTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4–78

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 Chapter 4
Taxation of Trusts

Learning Objectives
Knowledge Objectives:
• Understand the taxation of trusts and transfers to and from trusts.

Skills Objectives:
• Explain the tax rules on creation of a trust.
• Describe how trusts and trust distributions are taxed.
• Identify the special tax rules applicable to trusts.

4.1 INTRODUCTION

This chapter and all chapters following it will assume that students have a basic
understanding of the Canadian tax system and a general understanding of the
taxation of individuals, income from property, and capital gains and losses.
Tax law applies to trusts as if they are individuals (see Chapters 2 and 3). This
chapter examines trusts from a tax perspective and discusses some of the rules
unique to trusts and the tax treatment of certain specific types of trusts.

Tax law as it applies to trusts may not be consistent with trust law, and the dif-
ferences will be explained and clarified. The following is a summary of the taxa-
tion of trusts:

• Canadian residents are taxed on income from all sources world-

wide — s. 3.

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4.1 Chapter 4 – Taxation of Trusts

• A trust is taxed as an individual and the trustees are the taxpayers

for the trust, without personal liability — subs. 104(1). However, a
trust does have its own Trust Account Number or Trust Identifica-
tion Number for tax purposes.
• The Supreme Court of Canada decided as recently as 2012 that the
residence of a trust is where central management and control is
exercised, changing the previous rule that the residence of a trust
is the residence of the trustee(s).
• A trust is a conduit through which income and the tax attributes of
income may flow to beneficiaries.
• Some trusts have definitions that exist only in tax law and have
specific tax treatment in the Act, including:
{ a qualifying spousal or common-law partner trust (QST),
{ an alter ego trust (AET),
{ a joint spousal or common-law partner trust ( JPT),
{ a graduated rate estate (GRE), and
{ a qualified disability trust (QDT).
• Unique tax rules apply generally to all or most trusts, including:
{ Income paid or payable to beneficiaries is deductible by the
trust, and taxable to the beneficiaries, unless a special election
is made.
{ Except for distributions of certain property to non-residents,
distributions of income by a trust are not subject to any with-
holding by the trust.
{ The 21-year rule creates a deemed disposition of capital prop-
erty (and some other property) every 21 years for proceeds of
disposition equal to fair market value (FMV).
{ A trustee will be personally liable for distributions made with-
out a clearance certificate.
{ Except for distributions to non-residents, a distribution of prop-
erty in satisfaction of a capital interest in a trust takes place on
a rollover basis.

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REVIEW OF TRUST LAW 4.2

{ Most contributions or transfers of property to settle a trust are

gifts that are treated as dispositions for proceeds equal to FMV
of the property transferred, although some transfers to trusts
take place on a rollover basis.

Each of these points will be covered in more detail in this chapter or Chapter 6.

4.2 REVIEW OF TRUST LAW

Trusts are a product of English law dating back to the Middle Ages and the
feudal system. The Courts of Chancery first developed the concept of a trust
to provide relief from unjust consequences that would otherwise result from
the application of the common-law rules where land was held subject to uses.
Uses were a method of land ownership utilized to defer or avoid the obligations
attached to land ownership, perhaps the first form of tax planning.

While each province has statutes setting out specific rules relating to trusts,
estates, and trustees, the bulk of trust law has been developed by the courts
throughout common-law jurisdictions under the law of equity (now embodied in
the common law). To a large extent, the statute law relating to trusts embodies
and expands on the common-law principles. Canadian courts will look not only
to Canadian decisions but also to those from elsewhere in the commonwealth
and the U.S., all of which have an English legal heritage.

Under Canadian constitutional law, trusts are a matter of provincial jurisdiction

as set out in the Constitution Act, 18671 (formerly called the British North Amer-
ica Act). The provinces have the exclusive right to make laws relating to prop-
erty and civil rights within the province. The common-law provinces in Canada
(all provinces except Quebec) have adopted the English common law, which
also applies to trusts. Each province has its own statutes dealing with the law
of trusts. Quebec is a jurisdiction with its legal system based on the civil code
originating in Napoleonic France. Quebec law does not recognize the concept
of a trust in the same manner as it is understood under the common law in the
other provinces.

A trust is difficult to define specifically, and resort must be made to the prin-
ciples laid down in the common law over centuries. A trust is not a legal entity
or a legal person (like a corporation), but rather it is a relationship. Unlike a

1 See Chapter 1.

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4.2.1 Chapter 4 – Taxation of Trusts

corporation, a trust does not have to register with any government authority to
exist, and no formal charter or document is necessary for the creation of a trust.2

It is important to understand the legal nature of a trust and the legal require-
ments for the creation of a trust, since the existence of a trust relationship has
specific tax consequences that will be entirely different if no trust has been cre-
ated. Where one or more trusts have been created for tax planning purposes,
the courts will be particularly vigilant in their analysis of the legal requirements
for the creation of a trust, which will be determined according to trust law prin-
ciples rooted in the common law.3

More than one complex tax plan has unravelled because the courts decided that
a trust was not legally created. Tax planners must not take the niceties of trust
law for granted in planning and implementing tax strategies. Failure to seek and
heed the advice of a lawyer with expertise in trust law may leave the strategy
open to attack, with inappropriate tax results.

4.2.1 Creation of a Trust

A trust is created when property is transferred or “settled” by a person (the set-

tlor) to another person (the trustee) with an intention to create a trust (i.e., with
the intention that the trustee hold the property in trust for the benefit of other
persons (the beneficiaries)). The transfer of property to settle the trust will be by
way of gift, since there is no consideration. A trust may also be created where
the settlor makes a declaration that the property is held in trust for the benefit
of another person, in which case the settlor and the trustee are the same person
and no actual transfer of property takes place upon the declaration.

The transfer of property to create a trust is often called a settlement or a contribu-

tion, and it must be a true gift (i.e., a voluntary transfer without consideration).4
A sale of property to another person subject to conditions does not create a
trust.

2 The lack of a trust document, while not fatal to the creation of a trust, is not ideal. In addition, a
written document is required to transfer some property in trust (such as real property), and in Quebec,
an oral agreement is not sufficient to create a trust.
3 D.W.H. Waters, Law of Trusts in Canada, 2nd ed. (Toronto: Carswell, 1984), indicates at 108: “If tax
avoidance is the object of a transaction, the courts are likely to be particularly concerned with whether
there was an intention to create a trust, or merely a desire to give that appearance.” See Ablan Leon
(1964) Ltd. v. M.N.R. (1976), C.T.C. 506, 76 D.T.C. 6280 (Fed. C.A.).
4 For a discussion of the tax consequences of transfers to settle a trust, see 4.4.

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REVIEW OF TRUST LAW 4.2.1.1

4.2.1.1 Essential Parties to a Trust

The essential parties to the trust are:

• the settlor: contributes the property to the trust. In the case

of an estate, the settlor is the deceased person. A “testator”5 is
a person who makes a Will and a deceased person who dies
with a Will may be referred to as the testator. If the person dies
without a Will, the deceased person may be referred to as the
“intestate,” the term for an individual who dies without a Will.
• the trustee: holds legal title to the trust property. A trustee has
an absolute duty of loyalty or good faith to administer trust
property for the benefit of the beneficiaries in accordance with
the terms of the trust. This duty is called a “fiduciary” duty and
it is the highest duty imposed by law. A trustee includes the
trustee of an estate, but the trustee of an estate may also be
called an “executor,”6 “liquidator,”7 administrator, personal repre-
sentative, or other name that may vary depending on the prov-
ince8 and whether the trustee was appointed under a Will or by
a court, such as would be the case on an intestacy. All execu-
tors are trustees, but not all trustees are executors. The Income
Tax Act often refers to a trustee for an individual, including a
deceased individual, as the “legal representative.”9
• the beneficiary (sometimes referred to as the “object” of the
trust): receives the benefit of the trust. This must be a legal
person, although the law will recognize a trust created for the
benefit of a charitable purpose.10

5 “Testatrix” is the female equivalent, but “testator” will be used here generically.
6 “Executrix” is the female equivalent, but “executor” will be used here generically.
7 In Quebec.
8 In Ontario, for example, the trustee of an estate is called an “estate trustee” with (or without as the case
may be) a Will.
9 Defined in subs. 248(1) to include any trustee, executor, liquidator, or administrator who holds property
in a representative or fiduciary capacity that belongs to or belonged to, or that is held on behalf of,
a taxpayer or a taxpayer’s estate. In this material, “trustee,” “executor,” and “legal representative” are
all used to describe a trustee. “Executor” is generally used to describe the trustee of an estate. “Legal
representative” is used where that term matches the language in the Act.
10 Technically the object of the trust may not be a “party” to the trust, since the beneficiary or object need
not even know of the existence of the trust, or even be in existence at the time of the creation of the
trust, and need take no active role in its creation, whereas the settlor must transfer property and the
trustee must accept the trust.

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4.2.1.2 Chapter 4 – Taxation of Trusts

In most cases, the settlor, trustee, and beneficiary will be different per-
sons, but this is not essential. A settlor may be a trustee or a beneficiary
along with other persons. However, if the settlor is the sole trustee and
sole beneficiary, a trust may not have been created, since no division
of legal and beneficial title to trust property exists in law. The Act does
permit such a situation to be treated as a trust for tax purposes, such
as in the case of an AET. However, where there is unity of title because
the settlor is the sole trustee and beneficiary during the beneficiary’s
lifetime, the “trust” may be a legal fiction from a trust law perspective.

In this material, the words “contributor” or “transferor” are also used in

conjunction with the term “settlor.” Under trust law there is a settlement
of property any time someone contributes property to a trust. However,
it is common to think of the “settlor” as the person who creates the trust
by making the initial settlement of property, even though every person
who contributes property to a trust by way of gift is actually a settlor,
and each contribution actually creates a trust with respect to that prop-
erty. The word “transferor” is also used at times to refer to a person who
contributes or transfers property to a trust, particularly with respect to
the discussion about whether there is a disposition or rollover upon
transfer of property to a trust, and for the purposes of the attribution
rules. This is because many of the rules in the Act refer to the conse-
quences of a “transfer” to a trust, which would include any contribution
by a settlor.

4.2.1.2 The Three Certainties

In order for a trust to be created under trust law, the following three
certainties must be met:

1. Certainty of intention: There must have been an intention on

the part of the transferor to create a trust relationship.
2. Certainty of subject: The property transferred to be held in
trust must be certain.
3. Certainty of object: The beneficiaries must be certain.

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REVIEW OF TRUST LAW 4.2.1.6

4.2.1.3 Certainty of Intention

No particular words are required, and they need not be in writing.11
However, the lack of a written document may make it difficult to prove
the required intention was present, in addition to the practical diffi-
culty that the terms of the trust and provision for successor trustees are
absent. This is one problem associated with informal trusts (see 4.2.5).
The use of the terms “in trust” or “as trustee for” may reveal an inten-
tion to create a trust, but the common-law courts have found that these
words are not conclusive.12

4.2.1.4 Certainty of Subject

First, the property that is to be the subject matter of the trust must be
ascertainable; that is, it must be described in sufficient detail that it can
be identified at the time the trust is created. Second, the portion of the
property each beneficiary is entitled to must be defined or the trust-
ees must be given discretion to make the decision. Generally, as long
as objective standards determine the quantum of the trust property to
which a particular beneficiary is entitled, the latter part of the require-
ment will be satisfied.

4.2.1.5 Certainty of Objects

The beneficiaries do not necessarily have to be specifically identified
as long as it is possible to ascertain who they are. For example, benefi-
ciaries may be referred to by class or group, such as “my children” or
“my issue.” The use of a charitable object is an exception to the require-
ment for certainty of object in the creation of a trust. If the identity of
the charity is uncertain, it does not exist or it ceases to exist, the courts
may substitute another charity as the beneficiary by applying the cy-près
doctrine to permit a distribution to another charitable beneficiary.

4.2.1.6 Property Must Be Transferred to the Trustee

In addition to the three certainties, the transfer of property to the trustee
must be complete in order for the trust to have been created. In legal

11 See footnote 1, however.

12 See, for example, the decision of Garrow J.A. in Re Rispin (1912), 25 O.L.R. 633, 2 D.L.R. 644, affirmed
46 S.C.R. 649, 8 D.L.R. 756, that the term “in trust” was not sufficient and that no trust had been
created.

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4.2.2 Chapter 4 – Taxation of Trusts

terms, there must have been a transfer of property sufficient to split

the ownership of the property into legal and beneficial ownership. The
trustee holds legal ownership (legal title) to the property and the ben-
eficial ownership (equitable title or interest) rests with the beneficiaries.
If the settlor does not own the property, for example, and no legally
enforceable transfer has taken place, a trust has not been created. If
the settlor has merely promised to transfer the property at some future
time, but has not completed the transfer, no trust has been created until
the transfer has been made.

4.2.2 A Trust Acts through Its Trustees

A trust acts through its trustees, who retain the legal ownership of trust prop-
erty, both under trust law and tax law. The proper way for a trust to enter into
any contract or agreement is through the persons who are trustees, acting in
their capacity as trustees. A trust may enter into a contract that is binding on
trust property if the trustees enter into the contract. The appropriate signature is
“John Doe, as trustee of the XYZ Family Trust.” The following is incorrect: “XYZ
Family Trust, Per John Doe Trustee.” Where a trustee has entered into a transac-
tion as trustee, the transaction is legally enforceable against the trustee vis-á-vis
(i.e., with respect to) trust property. Unless a specific personal guarantee is also
given, the trustee will not be personally bound to honour the transaction.

Tax law treats a trust as if it were a legal person, since trusts are taxed as indi-
viduals, and generally the trustee is responsible for preparing returns and pay-
ing any tax liability. However, generally the trustee is only responsible to the
extent of the trust property and has no personal liability13 and no personal inter-
est in the trust property. The Act does impose personal liability on a trustee in
certain circumstances, such as where a distribution is made without a clearance
certificate (see 5.8).

4.2.3 Failure to Create a Trust: The Antle Decision

A recent case illustrates the importance of adhering to trust law principles in the
creation of a trust. In Antle,14 the Tax Court, affirmed by the Federal Court of
Appeal, found that no trust was created, as there were several deficiencies in the

13 Subs. 104(1).
14 Antle v. Canada, 2009 TCC 465, 2010 F.C.A. 280, application for leave to appeal and reconsideration of
leave to appeal to the Supreme Court of Canada dismissed.

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REVIEW OF TRUST LAW 4.2.3

creation of the trust, including a failure to actually transfer property to the trust,
no true intention to create a trust relationship, and uncertainty with respect to
the trust property.

Mr. Antle owned shares of PM. In order to reduce tax payable on the sale of the
company to an arm’s length purchaser, MI, a plan was devised by his advisors
whereby:

• Mr. Antle would settle a spousal trust (qualifying for rollover treat-
ment) with the PM shares,
• the trust would be resident in Barbados with Mr. Truss, a resident
of Barbados, as trustee,
• the trust would sell the shares of PM to Mrs. Antle for a note,
• Mrs. Antle would sell the shares of PM to MI,
• Mrs. Antle would repay the note owing to the trust with the pro-
ceeds of the sale to MI, and
• the trust would distribute all cash from repayment of the note to
Mrs. Antle.

Due to the provisions of the Act permitting a rollover to a spousal trust and
deeming the trust to be resident in Canada (now revised to prevent this “capital
property step-up strategy”) and the provisions of the tax treaty between Canada
and Barbados, this plan, if properly executed, would have avoided the tax on the
capital gain that Mr. Antle would have paid had he sold the shares directly to MI.

The plan failed because the court found that no trust had been created: two of
the three certainties were absent.

First, there was no intention to create a trust based on the circumstances and
the actions of the parties. The trust deed clearly set out the intention to create
a trust, but the document itself was not sufficient evidence in this case of the
intention to create a trust. A trust is not a contract where the parties bargain and
provide consideration to reach a mutually acceptable deal; rather, a trust is a
relationship.

The intention of the parties was subject to scrutiny based on the actions of the
parties, to determine if they were consistent with the establishment of a trust.
Confining the search for certainty of intention to the trust document would be a

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4.2.3 Chapter 4 – Taxation of Trusts

“vacuous inquiry.” Mr. Antle did not even sign the trust document until after the
trustee had signed all the documents committing the trust to the transactions
and distribution to Mrs. Antle. In addition, Mr. Antle had never spoken to Mr.
Truss, the trustee. The following excerpt summarizes the decision on this point:

If Mr. Antle intended any role for Mr. Truss, it may at best have been as
agent in a gift from him to his wife.

I reach the inevitable conclusion that Mr. Antle did not truly intend to
settle shares in trust with Mr. Truss. He simply signed documents on the
advice of his professional advisers with the expectation the result would
avoid tax in Canada. I find that on December 14th, he never intended
to lose control of the shares or the money resulting from the sale. He
knew when he purported to settle the Trust that nothing could or would
derail the steps in the strategy. This is not indicative of an intention to
settle a discretionary trust. Frankly, I have not been convinced Mr. Antle
even fully appreciated the significance of settling a discretionary trust,
beyond an appreciation for the result it might provide. I conclude that
his actions and the surrounding circumstances cannot support a conclu-
sion that signing the Trust Deed, as worded, reflects any true intention
to settle shares in a discretionary trust. I do not find that Mr. Antle is
saved by the language of the Trust Deed itself, no matter how clear it
might be. It does not reflect his intentions.15

Second, the “subject” of the trust (i.e., the PM shares) was uncertain because
Mr. Antle had reserved some undocumented value or rights to himself. This was
demonstrated by his actions subsequent to the sale of PM. He personally sued
and collected damages of $1.38 million from another party in respect of his
rights relating to the ownership of the PM shares arising prior to the alleged
transfer to the trust. Thus, there was an element of ownership in the PM shares
that did not pass to the trust, creating uncertainty of subject matter.

The Tax Court judge also found that, in addition to problems with certainty of
intention and subject, the trust failed because the shares of PM were never actu-
ally transferred to Mr. Truss as trustee so the trust was not properly constituted.

Upon appeal to the Federal Court of Appeal, the decision of the Tax Court was
upheld. The basis for the appeal was that the Tax Court judge made an error of
law in basing his conclusion on circumstances external to the trust deed, which

15 Ibid., paras. 48–49.

4–14
REVIEW OF TRUST LAW 4.2.5

was clear and unambiguous. The decision of the Federal Court was unanimous in
finding that surrounding circumstances, including the conduct of the parties, was
relevant in assessing whether the intention to settle a trust was present, and no
error had been made. Whether or not a trust had been created was to be made on
the facts of the case, as evidenced by the documents and the actions of the parties.

4.2.4 Other Failed Trust Cases

The following are some of the tax cases where the existence of a trust has not
been successfully established:16

• In Kingsdale Securities Co. v. M.N.R.,17 trust documents were signed,

but there was no evidence that the settlors intended to create a
trust, and other necessary steps to create trusts were not executed.
As a result, the court held that the trusts did not exist.
• In Atinco Paper Products Ltd. v. R.,18 an aunt made gifts to her
nephews and there was no evidence she intended that the amounts
be held in trust. Although she signed a trust agreement drawn up
in accordance with her brothers’ (i.e., the trustees’) instructions
after making the gift, she did not transfer any money to the trust’s
bank account after signing the agreement.
• In Ablan Leon (1964) Ltd. v. M.N.R.,19 many deficiencies and incon-
sistencies existed. The documents that did exist to support the cre-
ation of the trusts were inadequate and the purported settlor was a
mere volunteer.

4.2.5 Informal Trusts and “In Trust For” (ITF) Accounts

The tax treatment of an “in trust for” account (ITF, sometimes referred to as an
“informal” trust, where there is no written trust document) is often difficult to
determine because uncertainty exists with respect to the required elements in
the absence of a written document.

16 See also Fraser v. M.N.R. (1991), 91 D.T.C. 5123 (Fed. T.D.), affirmed 95 D.T.C. 5684 (Fed. C.A.); Fletcher
v. M.N.R. (1987), 87 D.T.C. 624 (T.C.C.); Harvey v. R. (1994), 94 D.T.C. 1910 (T.C.C.); and Cole Trusts v.
M.N.R. (1981), 81 D.T.C. 8 (T.R.B.).
17 (1974), 74 D.T.C. 6674 (Fed. C.A.).
18 (1978), 78 D.T.C. 6387 (Fed. C.A.).
19 (1976), 76 D.T.C. 6280 (Fed. C.A.).

4–15
4.2.5 Chapter 4 – Taxation of Trusts

ITFs are accounts opened at a financial institution for the benefit of other per-
sons with no written trust indenture, trust document, or agreement. Often these
are for the benefit of young children or grandchildren, and are started with
small contributions. However, over time they often grow in value as gains and
income accumulate and as additional contributions are made.

As already discussed, the three certainties must exist for a valid trust to be cre-
ated. Where there is no trust document or any written declaration of trust, the
three certainties (i.e., subject, object, and intention) may not be present, particu-
larly that of intention, or may be difficult to prove.

Canada Revenue Agency (CRA) has expressed its view on “in-trust accounts” in
Minister of National Revenue Technical Interpretation 2007–0233761C6. Where
these are set up for minors, CRA suggests that the arrangement may be more in
the nature of agency than a trust.20

Where a trust has not been established because of a lack of formal documenta-
tion, all income (including capital gains) from the ITF account will be taxed in
the hands of the transferor. Even if a trust is found to exist, many tax and legal
problems may arise with respect to ITFs because typically no legal or tax advice
has been obtained upon their creation. These include:

• The beneficiary will be entitled to enforce distribution of his or her

interest upon attaining the age of majority.
• Where the settlor is the sole trustee, which is often the case,
subs. 75(2) will apply, with the result that all income and capital
gains will attribute to the settlor during the lifetime of the settlor,
regardless of the age of the beneficiaries, and no rollover is avail-
able when trust property is distributed to the beneficiary (see 9.3.3,
Loss of Rollover on Distribution of Property from a Trust to a Ben-
eficiary: Subs. 107(4.1)).
• While the creation of the trust has been completed without for-
mality, the legal requirements pertaining to trusts and trustees still
apply. These include the requirement to comply with provincial law
regarding the prudent investor rule, the requirement to account to
beneficiaries and pass accounts, and the obligation to prepare and
file annual income tax returns. In addition, any appropriation of

20 Technical Interpretation 2007–0233761C6.

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BASIC RULES RELATING TO THE TAXATION OF TRUSTS 4.3.1

the trust property by the settlor or trustee in their personal capac-

ity will be a breach of trust.
• Income not paid or payable will be taxed at the highest marginal
rates in the trust unless subs. 75(2) applies.
• The 21-year rule will apply (see 4.8).

Nevertheless, there are examples of cases where undocumented trusts were

upheld by the courts, including the cases of Blum v. Canada21 and Koons v. Qui-
bell.22 In both cases, funds were registered “in trust” with the name of the benefi-
ciary, and the intention to create a trust had been communicated to a third party
who was able to verify that intention.

However, given the potential uncertainty, and the other legal and tax problems
listed above, the obvious conclusion is that if a trust is intended it is best to have
a formal trust document, along with professional advice to ensure the intended
legal and tax consequences are properly explained and the requirements met.

4.3 BASIC RULES RELATING TO THE TAXATION OF TRUSTS

4.3.1 Scheme of Taxation of Trusts under the Act

Section 3 sets out the basic rules for income inclusion under the Act for all tax-
payers. Canadian residents are taxed on their worldwide income.23 Para. 3(a)
includes income from inside or outside Canada from employment, property, and
business. Para. 3(b) includes income from capital gains; notwithstanding that
capital gains are not considered income for trust law purposes, they are included
in income for tax purposes.

Most of the specific rules relating to trusts are contained in Subdivision k of

Division B, Part I, which consists of ss. 104 to 108. While s. 248 contains many
of the definitions in the Act, s. 108 contains many of the definitions relating spe-
cifically to trusts.

21 99 D.T.C. 290 (T.C.C.).

22 (1998), 164 Sask. R. 149 (Sask. Q.B.).
23 Division D of Part I, being ss. 115 and 116, provide special rules for income inclusions of a non-
resident.

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4.3.2 Chapter 4 – Taxation of Trusts

4.3.2 A Trust Is Taxed as an Individual

Subsections 104(1) and 104(2) of the Act provide that:

• a reference to a trust in the Act is to be read as a reference to “the

trustee, executor, administrator, liquidator of a succession, heir or
other legal representative having ownership or control of the trust
property . . . ,” and
• a trust is deemed to be an individual in respect of trust property,
without imposing any personal liability on the trustee or legal rep-
resentative for his or her own income tax.

Under subs. 122(1.1), trusts are not entitled to the personal credits available
to individuals under s. 118, such as the age credit, pension credit, spouse or
common-law partner or equivalent credit, and the basic personal credit.

4.3.3 Residence of a Trust

The Act does not define “residence,” and case law must be examined to provide
guidance with respect to the residence of a trust.

In 2012, the Supreme Court of Canada confirmed that the appropriate test to
determine residence of a trust is the place where central management and con-
trol over the trust property is exercised: St. Michael Trust Corp. v. R24 (known
as Garron). This was a significant change, as previously, as per the decision
in Thibodeau,25 it had been generally accepted by practitioners, and by CRA,
that the residence of a trust was the same as the residence of its trustees. In
Thibodeau, the court determined that the trust was a resident of Bermuda, since
the majority of trustees were residents of Bermuda. The court found that the
central management and control test applicable to corporations was not appli-
cable to trusts, since trust law prohibited trustees from delegating their authority
and decision-making.

24 Garron (Trustee of) v. Canada, 2009 TCC 450, (sub nom. St. Michael Trust Corp. v. Canada) 2010 FCA
309, (sub nom. St. Michael Trust Corp., as Trustee of the Summersby Settlement v. R. (Fundy Settlement))
2012 SCC 14. For the purposes of this discussion, the decision will be referred to as the Garron decision,
as that is the name at the Tax Court, and the name most commonly used by tax practitioners. To add to
the confusion, the Supreme Court of Canada has indexed this case as Fundy Settlement v. Canada and
this is how it is referred to by CRA in Income Tax Folio S6-F1-C1, Residence of a Trust or Estate.
25 Dill v. Canada (sub. nom. Thibodeau Estate (Trustees of) v. Canada) (1978), 78 D.T.C. 6376 (Fed. T.D.).

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BASIC RULES RELATING TO THE TAXATION OF TRUSTS 4.3.3

In Garron, the Tax Court confined the decision in Thibodeau to the particular
facts in that case. Instead, the court ruled that the corporate test for determining
residence (i.e., central management and control) applies to trusts.

The Tax Court found that the trustee, which was apparently resident in Bar-
bados, was selected to provide incidental administrative services and was not
expected to have responsibility for decision-making beyond that. The trustee
had agreed it would defer to the recommendations of Mr. Dunin and Mr. Garron,
two Canadian residents who were principals in the transactions under review
and in which the trust participated. If the trustee did not follow those recom-
mendations, there was a protector who had the power to remove the trustee.
This was an enforcement mechanism that could be exercised by Mr. Dunin, Mr.
Garron, and their respective spouses, who held the power to replace the protec-
tor. Based on these facts, it was found that the residence of the trust was in Can-
ada, where central management and control was exercised, and not in Barbados.
It was stated at para. 157:

As mentioned earlier, I have concluded that the Thibodeau decision is

insufficient authority for me to reject a central management and control
test to determine trust residence. In fact, as I will explain, in my view
there are very good reasons why the judicial test for residence that has
been developed in a corporate context should also apply to trusts.

And further at para. 162:

I conclude, then, that the judge-made test of residence that has been
established for corporations should also apply to trusts, with such modi-
fications as are appropriate. That test is “where the central management
and control actually abides.”

Both the Federal Court of Appeal and the Supreme Court of Canada agreed. The
Supreme Court pointed out that the trustee is not the trust, even though it is
deemed to be so for certain purposes in the Act, and listed the following simi-
larities between corporations and trusts:

1. Both hold assets to be managed.

2. Both involve the acquisition and disposition of assets.
3. Both may require the management of a business.
4. Both require banking and financial arrangements.

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4.3.3.1 Chapter 4 – Taxation of Trusts

5. Both may require the instruction or advice of lawyers, accountants,

and other advisors.
6. Both may distribute income: corporations by way of dividends and
trusts by distributions.

The case summary for the Supreme Court of Canada decision states:

The principal basis for imposing income tax in Canada is residency. As

with corporations, the residence of a trust should be determined by the
principle that a trust resides for the purposes of the Income Tax Act
where its real business is carried on, which is where the central man-
agement and control of the trust actually takes place. The residence of
the trust is not always that of the trustee. It will be so where the trustee
carries out the central management and control of the trust where the
trustee is resident. Here, however, the trusts are resident in Canada,
since the central management and control of the trusts was exercised
by the main beneficiaries in Canada and the trustee’s limited role was
to provide administrative services and it had little or no responsibility
beyond that.

4.3.3.1 CRA’s View: Income Tax Folio S6-F1-C1, Residence of a Trust or

Estate
In Income Tax Folio S6-F1-C1, Residence of a Trust or Estate, CRA adopts
the test of central management and control for residence of a trust as
decided in Garron. The residence of a trust is a question of fact, and the
following analysis, from paras. 1.2 to 1.7 of Income Tax Folio S6-F1-C1,
states:

The residence of a trust in Canada, or in a particular province or terri-

tory within Canada, is a question of fact to be determined according to
the circumstances in each case.

1.1 The Supreme Court of Canada (Fundy Settlement v. Canada, 2012

DTC 5063, 2012 SCC 14) has clarified that residence of a trust will be
determined by the principle that for purposes of the Income Tax Act a
trust resides where its real business is carried on, which is where the
central management and control of the trust actually takes place.

1.2 Usually the management and control of the trust rests with, and
is exercised by, the trustee, executor, liquidator, administrator, heir or

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BASIC RULES RELATING TO THE TAXATION OF TRUSTS 4.3.3.1

other legal representative of the trust. In this Chapter the word trustee is
used to refer to any such person in relation to a trust. In its decision in
Fundy Settlement, the Supreme Court of Canada affirmed the view that
the residence of the trustee does not always determine the residence of
a trust.

1.3 It is not uncommon for more than one trustee to be involved in

exercising the central management and control over a trust. The trust
will reside in the jurisdiction in which the more substantial central man-
agement and control actually takes place.

1.4 In some situations, the facts may indicate that a substantial portion
of the central management and control of the trust rests with someone
other than the trustee, such as the settlor or the beneficiaries of the
trust. Regardless of any contrary provisions in the trust agreement, the
actions of these other persons in respect of the trust must be consid-
ered. It is the jurisdiction in which the central management and control
is factually exercised that will be considered in determining the resi-
dence of the trust.

1.5 For example, when making a determination as to the jurisdiction in

which the central management and control of a trust is exercised, the
CRA will consider any relevant factor, which may include:

• the factual role of a trustee and other persons with respect to

the trust property, including any decision-making limitations
imposed thereon, either directly or indirectly, by any benefi-
ciary, settlor or other relevant person; and

• the ability of a trustee and other persons to select and instruct

trust advisors with respect to the overall management of the
trust.

For this purpose, the CRA will look to any evidentiary support that dem-
onstrates the exercise of decision-making powers and responsibilities
over the trust.

1.6 After an examination of all factors, it may be determined that a trust

is resident in Canada even if another country considers the trust to be
resident in that other country.

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4.3.3.2 Chapter 4 – Taxation of Trusts

4.3.3.2 Residence of a Trust Both in Canada and Outside Canada

It is possible for a trust to be resident in both Canada and in another
country. Where Canada has a tax treaty with the other jurisdiction, tie-
breaker rules may apply to determine the residence of a trust that might
otherwise be resident in each jurisdiction.

A trust resident outside of Canada may be deemed to be a Canadian

resident for tax purposes if it meets the requirements set out under
subs. 94(1) of the Act.26

The province of residence within Canada is determined as at the end of

the trust’s taxation year (i.e., December 31 for inter vivos trusts).

4.3.4 Tax Rates Applicable to Trusts

Inter vivos trusts and testamentary trusts are subject to the highest marginal tax
rates applicable to individuals under subs. 122(1) of the Act, with the exception
of testamentary trusts that are either graduated rate estates (GREs) or qualified
disability trusts (QDTs). These two special testamentary trusts are taxed at the
same graduated or marginal tax rates as individuals. NOTE: Prior to 2016, all
testamentary trusts were entitled to graduated rates (see 4.7.3.1).

4.3.5 Taxation Year

The taxation year is the period for which taxable income must be determined
and returns must be prepared and assessed under the Act as set out in s. 249.
Since individuals have a calendar taxation year, the calendar year is also the tax
year for trusts. However, there are special rules for year-ends for certain trusts.

A graduated rate estate (GRE) may choose any period not exceeding 12 months
from the death of the deceased. Upon the 36-month anniversary of the date of
death, being the last day the trust qualifies as a GRE, a year-end will be triggered
under subs. 249(4.1). There may be two or three tax year-ends in the third cal-
endar year following death: one on the chosen year-end date if it falls before the
anniversary date of death, one on the 36-month anniversary date of death, and
one on December 31 as the trust is then no longer a GRE. As a result, during the

26 These rules are extremely complex and are the subject of ongoing proposed changes. Advice from tax
specialists with specific expertise in the non-resident trust area is imperative in dealing with any non-
resident trust that has a connection to Canada.

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BASIC RULES RELATING TO THE TAXATION OF TRUSTS 4.3.5

time an estate is a GRE, it may have up to four tax year-ends. An example may
be useful.

Assume death is on July 1, 2017, and a January 31 year-end is chosen. The tax
year-ends are January 31, 2018 (7 months), January 31, 2019 (12 months), and
January 31, 2020 (12 months). In 2020, there will also be a year-end on July 1,
being the fourth and last non-calendar year-end for the GRE, and another year-
end on December 31, so there are three year-ends in 2020.

If a November 30 year-end is chosen, the tax year-ends are November 30, 2017 (5
months), November 30, 2018 (12 months), and November 30, 2019 (12 months).
In 2020, there will be two year-ends: July 1, 2020 (6 months), and the first man-
datory calendar tax year-end, December 31, 2020 (6 months), since the trust is
no longer a GRE. The following chart summarizes the year-ends:

Taxation Years for GREs and First Taxation Year After Loss of GRE Status

Tax Year-End Death July 1, 2017; Choice of Death July 1, 2017; Choice of Death July 1, 2017; Choice of
year-end January 31 year-end November 30 year-end July 1
1 Jan. 31, 2018 Nov. 30, 2017 July 1, 2018
2 Jan. 31, 2019 Nov. 30, 2018 July 1, 2019
3 Jan. 31, 2020 Nov. 30, 2019 July 1, 2020
(36 months after death)
4 July 1, 2020 July 1, 2020 Dec. 31, 2020
(36 months after death) (36 months after death) No longer a GRE
5 Dec. 31, 2020 Dec. 31, 2020
No longer a GRE No longer a GRE
NOTE: Three years end in 2020.

An alter ego trust (AET), joint spousal or common-law partner trust ( JPT), and
qualifying spousal or common-law partner trust (QST) will have a deemed year-
end upon the death of: the settlor (in the case of an AET), the last to die of the
settlor and the joint partner (in the case of a JPT), or the spouse (in the case of
a QST).27

See Figure 4.1 for a summary of the tax rates and taxation year of various trusts,
depending on whether they are inter vivos or testamentary.

27 Subs. 104(13.4).

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4.3.6 Chapter 4 – Taxation of Trusts

Figure 4.1: Taxation for Different Types of Trusts

Type of Trust Marginal Trustees Highest Calendar Deemed Year-End

Rates of Tax Choose Marginal Taxation commencing 2016
Taxation Rates of Tax Year
Year
Inter Vivos Trusts
Alter ego trust (AET) x x Death of settlor
Joint spousal or common-law x x Death of survivor of settlor
partner trust (JPT) and spouse/common-law
partner
Inter vivos qualifying spousal and x x Death of spouse/common-
common-law partner trust (QST) law partner
All other inter vivos trusts x x
Testamentary Trusts Pre-2016 Tax Year
Estate x x
Testamentary qualifying spousal x x
and common-law partner
trust (QST)
Testamentary tainted spousal x x
trusts (i.e., no rollover)
Tainted testamentary trust, x x
including estate (i.e., not
testamentary)
Testamentary Trusts Commencing 2016
Graduated rate estate (estate x x 36 months after date of
during first 36 months following death
death)
Qualified disability trust (QDT) x x
Testamentary qualifying spousal x x Death of spouse/common-
and common-law partner law partner
trust (QST)
All other testamentary trusts and x x
estates
“X” indicates what applies.
Note that QSTs may be either testamentary or inter vivos.

4.3.6 Discretion to Tax Multiple Trusts as One

Subsection 104(2) of the Act provides that multiple trusts may be deemed to be
one trust, at the discretion of the Minister of National Revenue. Prior to 2016,
multiple testamentary trusts were used to multiply access to the marginal tax

4–24
BASIC RULES RELATING TO THE TAXATION OF TRUSTS 4.3.71

rates and for non-tax reasons. Since the beginning of 2016, the only trusts that
have access to the marginal or graduated rates of tax are graduated rate estates
(GREs) and qualified disability trusts (QDTs). And only one of each of these
trusts is permitted to claim this status in respect of any deceased individual (in
the case of a GRE) or per disabled beneficiary (in the case of a QDT). There
may be many non-tax reasons, however, to create multiple trusts in one’s Will or
otherwise.

4.3.7 Trust Is a Conduit for Income

The default position is that income (including taxable capital gains) is taxed
inside a trust. However, income can be flowed through a trust to the benefi-
ciary and retain its character for tax purposes. In order for the income to flow
through, the tax rules require that the income be paid or become payable to a
beneficiary in the year. Where these conditions are met, the income:

• will be taxed in the hands of the beneficiary under subs. 104(13),

and
• may be deducted from income of the trust under subs. 104(6).

4.3.71 Income Paid or Payable Included in Income under Subs. 104(13)

Where income is paid or payable to a beneficiary, there is no require-
ment for the beneficiary to actually receive the income from the trust
or for the beneficiary to demand or enforce payment, as long as the
payment is legally enforceable. Subsection 104(24) deems the amount
to be payable if the beneficiary was entitled to enforce payment in the
year. The terms of the trust must be examined to determine if the ben-
eficiary has an absolute right to the income in the year. Income would
be considered payable, if the terms of the trust provide that income is
payable to a beneficiary. Income would also be payable where the terms
of the trust provide that payments of income are discretionary, and the
trustees exercise their discretion to make the income payable in the
year. Income that is paid to a beneficiary in the year also includes pay-
ments made to third parties on behalf of the beneficiary or to reimburse
a person, such as a parent for amounts laid out by them on behalf of the
beneficiary.

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4.3.7.2 Chapter 4 – Taxation of Trusts

4.3.7.2 Deduction from Income by the Trust under Subs. 104(6)

The deduction from trust income under subs. 104(6) is permissive, but
the income inclusion for amounts paid or payable to the beneficiary is
mandatory under subs. 104(13). However, the beneficiary will be tax-
able whether the deduction from income is claimed by the trust or not,
and double tax will result if the trust does not take the deduction in its
tax return under subs. 104(6).

4.3.7.3 Income Payable Where Trust Is Discretionary as to Income

Where the terms of the trust provide discretion with respect to income
distributions, including capital gains, amounts will be deemed paid or
payable where the trustees have exercised their discretion under the
terms of the trust to allocate income to a beneficiary.28 The allocation
must be irrevocable and the beneficiary must have the right to enforce
payment. Generally, in order to be enforceable, the amount of the
income allocated must be determinable, such as a fixed amount or a
fixed percentage, and the beneficiaries must be notified in writing of
their entitlement to the income.

4.3.7.4 Income Paid or Payable by an Estate during the Executor’s Year

CRA acknowledges that, under the common law, payment of income by
the trustees is not enforceable by a beneficiary during the executor’s
year (the first 12 months of an estate). However, CRA will consider the
income payable where the executor’s year corresponds with the taxa-
tion year of the estate and the existence of the executor’s year is the
only reason that income is not payable, unless one or more beneficiaries
object to such treatment.29

For additional details concerning income paid or payable by a trust to a

beneficiary, see 6.1.

28 See IT-286R2 (Archived), Trusts — Amount Payable, para. 5.

29 Ibid., para. 6.

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BASIC RULES RELATING TO THE TAXATION OF TRUSTS 4.3.7.7

4.3.7.5 Exception to Conduit Principle: Income Paid or Payable to a

Beneficiary Is Not Taxed in the Hands of the Beneficiary
The following are exceptions to the above rule that income paid or pay-
able to a beneficiary is taxed in the hands of the beneficiary. Income
will not be taxed in the hands of the beneficiary where:

• The trust designates income to be taxed in the trust to offset losses

taxed in the trust under subss. 104(13.1) or 104(13.2).30
• The attribution rules apply to attribute income to another person.31

4.3.7.6 Exception to Conduit Principle: Income Not Paid or Payable to a

Beneficiary May Be Taxed in the Hands of the Beneficiary
Where income is accumulated in the trust (i.e., not paid or payable to
the beneficiary), it may be taxed in the hands of the beneficiary if any of
the following circumstances apply:

• There is a beneficiary with a disability and a preferred beneficiary

election is made.32
• Income is retained in the trust for a beneficiary under the age of 21
in an “age 40 trust.”33
• Certain taxable benefits defined in subs. 105(1) are conferred on or
received by a beneficiary from the trust.34
• Taxable outlays for upkeep and maintenance of trust property
enjoyed by a beneficiary are made by the trust.35

4.3.7.7 Exception to Conduit Principle: Where Attribution Rules Apply

Income and taxable capital gains (and losses including allowable capi-
tal losses) arising from property transferred to a trust can be taxed in
the hands of the person who made the transfer (the transferor) where
the attribution rules apply. For a discussion of the attribution rules, see

30 See 4.3.9, Election to Have Income Taxed in the Trust under Subss. 104(13.1), 104(13.2), and 104(13.3).
31 See Chapter 9.
32 See 4.10, Preferred Beneficiary Election on Accumulating Income for Disabled Beneficiaries.
33 See 4.7.9, Age 40 Trusts Permit Accumulating Income to Be Taxed to Under-Age-21 Beneficiaries –
Subs. 104(18).
34 Subs. 105(1); see Chapter 6.
35 Subs. 105(2); see Chapter 6.

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4.3.7.8 Chapter 4 – Taxation of Trusts

Chapter 9. If one of the attribution rules applies, income paid or pay-

able to a beneficiary will not be taxable in the hands of the beneficiary.
No election is necessary to obtain this result as the application of the
attribution rules are automatic.

4.3.7.8 Exception to Conduit Principle: Losses Do Not Flow Through to a

Beneficiary
There is no provision in the Act for losses in a trust to be allocated to
a beneficiary. The only situation in which losses of a trust can be used
by another person is where of the attribution rules apply to attribute
income and loss to a transferor of property to the trust (see 4.3.7.7,
Exception to Conduit Principle: Where Attribution Rules Apply). The
only remedy for losses otherwise trapped in a trust is for the trust to
designate income, which is otherwise taxable to a beneficiary, to be
taxed in the trust under subss. 104(13.1) or 104(13.2). These subsections
were added to the Act to permit loss utilization by a trust, and in 2016
with the addition of subs. 104(13.3), these rules are restricted to loss uti-
lization: the designation is invalid if as a result, the trust has any taxable
income in the year.

4.3.8 Trust Is a Conduit for Sources of Income

Where income is taxable in the hands of the beneficiary, the trust may elect to
designate the income to retain its tax character, in which case the tax attributes
of the income will flow through to the beneficiary (in addition to the income
itself), as if the beneficiary had received the income directly from the original
payor or source rather than through the trust. For example, a trust may desig-
nate income to be eligible dividends, non-eligible dividends or capital gains in
the hands of a beneficiary.36

In this material, “allocation” of income refers to the income that the trust deter-
mines and reports as paid or payable to the beneficiary in the year, or otherwise
taxable to the beneficiary in the year. (For example, in a discretionary trust,
amounts of cash paid to a beneficiary might not be “allocated” as income paid
to a beneficiary if the trust decided that the payment was out of capital.) “Des-
ignation” of income refers to the characterization of income already allocated
to a beneficiary by making a designation under the rules discussed below. This

36 Subs. 108(5). See also para. 12(1)(m).

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BASIC RULES RELATING TO THE TAXATION OF TRUSTS 4.3.8.1

language is consistent with the Act, and consistent with the language used in the
T3 Return.

The rules require that the designations of the source of income by the trust must
be reasonable, having regard to all the circumstances. If there is no rule permit-
ting the particular source of the income to flow through the trust and allowing
the trust to re-characterize the income in the hands of the beneficiary, then the
beneficiary will be treated as having received “income from a trust,” which under
the Act is taxed as income from property.

The following are the specific rules that permit designation of the source of
income by a trust.

4.3.8.1 Dividends from Taxable Canadian Corporations

A trust may designate taxable dividends paid by Canadian corporations
to one or more beneficiaries under subs. 104(19). Such dividends are
eligible for the gross-up and dividend tax treatment, if paid to an indi-
vidual or if designated through a trust to a beneficiary who is an indi-
vidual.37 If the designation is made and the beneficiary is a corporation,
the dividend also retains its character as having been received from
another taxable Canadian corporation, and it will be treated as a tax-
free inter-corporate dividend under para. 112(1)(a).38

The designation for dividend income is available where either the

income is payable to the beneficiary, there is a preferred beneficiary
election, or income is allocated to the beneficiary as a benefit from a
trust under subs. 105(1).

Where the trust receives such dividends but does not designate the divi-
dend income to a beneficiary, the trust is subject to the gross-up and
dividend tax credit mechanisms in the same manner as if the dividend
had been received by the individual, and the trust may use the dividend
tax credit to reduce any Part I tax payable.39

37 Para. 82(1)(b) and s. 121.

38 Assuming the recipient corporation is “connected” to the payor corporation, as defined in the Act. The
tax treatment of corporate beneficiaries is not specifically covered in this material.
39 IT-524 (Archived), Trusts — Flow-Through of Taxable Dividends to a Beneficiary — After 1987.

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4.3.8.2 Chapter 4 – Taxation of Trusts

4.3.8.2 Eligible Dividends

Similar to the rule for taxable dividends, a trust may designate an eli-
gible dividend received by it in a taxation year on the share of a taxable
Canadian corporation,40 so that the dividend is treated as an eligible
dividend in the hands of the beneficiary41 and entitled to the enhanced
gross-up and dividend tax credit.

4.3.8.3 Capital Dividends

A trust may designate capital dividends received by a trust in respect of
its beneficiaries.42 The effect of the designation is to preserve the char-
acter of the capital dividend in the beneficiary’s hands, so that it may be
received on a tax-free basis by a Canadian resident beneficiary. Alterna-
tively, where the trust agreement allows, the trust can retain the capital
dividend and allow it to become capital of the trust, to be distributed to
the capital beneficiaries.

4.3.8.4 Net Taxable Capital Gains

A trust resident in Canada throughout a year may allocate all or a part
of its net taxable capital gains for that year to one or more beneficiaries
who are resident in Canada throughout the taxation year of the trust,
under subs. 104(21). The net taxable capital gain of a trust for a year is
the aggregate of its:

• taxable capital gains for the year,

• less allowable capital losses for the year, and
• less any amounts deducted43 in respect of net capital losses from
prior years, or carried back from the three subsequent years.44

Where the designation is made, the beneficiary is deemed to realize a

taxable capital gain from the disposition of property for the purposes of
Part I of the Act. Thus, the beneficiary may offset taxable capital gains
designated by the trust with any allowable capital losses available to the

40 Subs. 104(19).
41 Other than Part XIII.
42 Subs. 104(20).
43 Under para. 111(1)(b).
44 Subs. 104(21.3)

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BASIC RULES RELATING TO THE TAXATION OF TRUSTS 4.3.8.5

beneficiary, either from the current year in calculating net income under
s. 3, or with net capital losses from other years in calculating taxable
income.45 The beneficiary need only have received the taxable portion
of the capital gain in order for the designation of the full amount of the
capital gain to be made. The non-taxable portion forms part of the capi-
tal of the trust unless the trust agreement states otherwise.

4.3.8.5 Lifetime Capital Gains Exemption (LCGE)

NOTE: See STEP Update on Tax Changes in the student resources section of the STEP website to review the
status of tax proposals that would change access to the LCGE through a trust, including any transitional rule
providing for a time-limited election available to trusts.

The capital gains exemption is not available to a trust.46 A claim for the
capital gains deduction can only be made by an individual. However, it
is possible to flow through eligible capital gains from a trust to an indi-
vidual beneficiary so the individual may claim the lifetime capital gains
exemption (LCGE), subject to tax on split income (kiddie tax) if the ben-
eficiary has not turned 17 in the prior year, and the gain is realized on a
non-arm’s length sale of qualifying small business corporation shares.47
For a discussion of the LCGE available to individuals, see 3.3. Tax on
split income is covered in 9.4.

The designation for net taxable capital gains under subs. 104(21) is not
sufficient to make the gain eligible for claiming the beneficiary’s capi-
tal gains deduction under s. 110.6. An additional, separate designation
must also be made under subs. 104(21.2).

The trust may allocate taxable capital gains in any proportion among
a number of beneficiaries.48 However, the designation of taxable capi-
tal gains eligible for the capital gains exemption among beneficiaries
must be in the same proportion as the taxable capital gains designated
under subs. 104(21). Similarly, if a trust has realized net taxable capital
gains from more than one type of property qualifying for the capital

45 Under para. 111(1)(b).

46 Prior to 2016, subs. 110.6(12) permitted a QST to claim the lifetime capital gains exemption on a gain
arising on the death of a spouse to the extent the spouse could have claimed the exemption, and
the trust did not have a cumulative net investment account balance or previously claimed business
investment losses.
47 Subss. 120.4(4) and 120.4(5).
48 Subject to the terms in subs. 104(21).

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4.3.8.6 Chapter 4 – Taxation of Trusts

gains deduction (i.e., qualified farm property, qualified fishing prop-

erty, and qualified small business corporation shares), the designation
of each type of eligible taxable capital gain to beneficiaries must be in
the same proportion as the designation of taxable capital gains to the
beneficiaries.

The amount that can be designated under subs. 104(21.2) as a taxable

capital gain eligible for the capital gains deduction will be reduced by
any balance in the cumulative net investment loss account (CNIL) of the
trust.

4.3.8.6 Foreign Income

Income from foreign sources may be designated to beneficiaries under
subs. 104(22). As a result, the beneficiary may claim any foreign tax
credit available,49 since the amount designated will be deemed to be
foreign source income of the beneficiary, and the foreign tax on the des-
ignated foreign income is deemed to have been paid by the beneficiary
under subs. 104(22.1).50

4.3.9 Election to Have Income Taxed in the Trust under Subss. 104(13.1),
104(13.2), and 104(13.3)

Non-capital losses, net capital losses, and certain tax credits51 do not flow
through to beneficiaries. Where the trust has no income, the tax benefit of these
items is captive in the trust, where they cannot be utilized. This would occur,
for example, where all income of a trust is payable to a beneficiary (in the case
of a QST). Under subss. 104(13.1) and 104(13.2), the trust may retain a portion
of its income for tax purposes as “designated income.” The income designated
is taxed in the trust, not in the beneficiary’s hands, even if paid or payable to
the beneficiary.52 The designation of income not taxable to beneficiaries must
be allocated among beneficiaries according to each beneficiary’s proportionate
share of income from the trust.53 This election may be used to shelter current

49 Under s. 126.
50 The designations must be made on a country-by-country basis where income is from more than one
foreign country.
51 The right to claim the dividend tax credit and any foreign tax credit flows with the designation of the
relevant income.
52 This also applies to income that would otherwise be taxed in the beneficiary’s hands as a benefit from
a trust under s. 105.
53 Otherwise the income will be taxed in both the trust and the beneficiary’s hands.

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TRANSFER OF CAPITAL PROPERTY TO A TRUST 4.4.1

income (including taxable capital gains) with the current year’s losses, or with
non-capital losses and net capital losses from other years where income, includ-
ing gains, is otherwise payable to a beneficiary. Under subs. 104(13.3), if there is
any taxable income in the trust after the designation, the designation is invalid,
ensuring the election can only be used to absorb losses in the trust. The designa-
tion cannot be used to utilize unused non-refundable tax credits otherwise avail-
able to the trust, such as the donation tax credit.

4.4 TRANSFER OF CAPITAL PROPERTY TO A TRUST

Where a settlor transfers property to create a trust, this is done by way of a gift.
A gift is generally treated as a disposition of property at an amount equal to the
fair market value (FMV) of the property, resulting in tax consequences to the
settlor.54 In some cases, however, there may be no immediate tax consequences,
either because the transfer is not considered a disposition or because the dispo-
sition is deemed to take place for proceeds of disposition equal to the tax cost
or adjusted cost base (ACB) of the transferor (i.e., on a rollover basis).

4.4.1 Is It a Disposition?

In creating a trust, the first tax consequence to be examined is the tax treatment
to the person transferring property to the trust; this in turn will affect the cor-
responding tax cost of the property to the trust. A transfer may occur upon the
original contribution of property when the settlor creates the trust or on a sub-
sequent transfer by that person.55

If there is a disposition, a further inquiry must be made as to whether a rollover

applies, that is, are the proceeds of disposition deemed to be equal to the ACB
of the property to the transferor, in which case there is a rollover.

If there is no rollover, the deemed proceeds will usually be the FMV of the prop-
erty, in which case the transfer may be taxable to the transferor, especially if, for
example, there are unrealized capital gains on the property transferred.

Whether the rollover applies or not, the trust will usually be deemed to acquire
the property for a cost amount equal to the proceeds of disposition deemed to
be received by the transferor.

54 Subss. 248(1) and 69(1).

55 Other persons may contribute to trusts in addition to the settlor, and although the specific consequences
are not included here, the treatment may be identical, depending on the trust.

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4.4.1 Chapter 4 – Taxation of Trusts

Generally, any transfer of property to a trust is a disposition: para. (c) of the

definition in subs. 248(1) of “disposition” includes any transfer of property to a
trust. However, there is no disposition in the following situations:

• Transfer with no change in beneficial ownership (excluding

transfers to trusts). There is no “disposition” where there is no
change in beneficial ownership. However, this exception does not
apply where the transfer is to a trust.56 This is an “exception to the
exception” in the definition of “disposition” in the Act.57 So trans-
fers to trusts are still considered dispositions, even if there is no
change in beneficial ownership. For example, a transfer to a trust
for the sole benefit of the settlor may not result in a change in ben-
eficial ownership, but it is a disposition under the Act.
• Transfers to “bare trusts.” A transfer to a “bare trust” is not a dis-
position. A bare trust is generally not considered a trust under the
Act,58 nor is a transfer to a bare trust a disposition.59 For this pur-
pose, a bare trust is an arrangement under which the trust can
reasonably be considered to act as agent for all of the beneficiaries
under the trust for all of the dealings with all of the trust property.60
• Trust-to-trust transfers. Where the transfer to a trust is by another
trust, there is no disposition if:
{ there is no change in beneficial ownership,
{ the transferor trust ceases to exist upon the transfer, and
{ the transferee trust previously held no property, or only prop-
erty of nominal value.61 In this case, an election can be made to
treat the transfer as a disposition.
• Transfer to a self-benefit trust.

56 Paras. (e) and (f) of the definition of “disposition” in subs. 248(1).

57 The Act is like a labyrinth where each rule applies in some cases and not others, and layers of
exceptions abound. The complex net of rules relating to dispositions and transfers to trusts is not
unusual in the Act. The exception to this “exception to the exception” is where the transferor is a trust.
58 See subs. 104(1).
59 Unless the trust has ceased to be a bare trust; see subpara. (b)(v) of the definition of “disposition” in
subs. 248(1).
60 Not defined in the Act, but acts as agent for all beneficiaries in all dealings with trust property as
described in subpara. (b)(v) of the definition of “disposition” in subs. 248(1).
61 Para. (f) of the definition of “disposition” in subs. 248(1).

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TRANSFER OF CAPITAL PROPERTY TO A TRUST 4.4.3

4.4.2 Taxable Dispositions

Where a settlor contributes property to a trust, subpara. 69(1)(b)(ii) deems the

settlor to have disposed of the property transferred for an amount equal to the
FMV of the property at the time of the transfer, and any accrued capital gain or
income gain on the transferred property will be taxed in the hands of the set-
tlor. The trust is also deemed to acquire the property by way of gift at a tax cost
equal to that same value (i.e., the FMV at the time of the transfer).62 This reci-
procity of proceeds of disposition to a transferor and tax cost to the transferee
is, almost without exception, the rule in the Act.63

A transferor cannot avoid the deemed realization at FMV by selling the property
to the trust at a discount from FMV. If there is a disposition to a trust, the ven-
dor will be considered to have received proceeds of disposition equal to FMV if
there is no change of beneficial ownership of the property upon transfer to the
trust,64 or if the vendor is not dealing at arm’s length with the trust.65

Even if there is a capital gain arising on the transfer of property to the trust, the
tax might be deferred or avoided if the transferor may claim any of the following:

• the capital gains exemption,

• net capital loss carryforwards from other years,
• donation credits;
• the principal residence exemption, or
• the capital gain reserve on a sale where receipt of proceeds is
deferred.66

4.4.3 Tax-Deferred Dispositions: Rollover Transfers to Trusts

There are a number of transfers to trusts where there is a disposition, but the
transfer qualifies for rollover treatment (see Figure 4.2), subject to an option in
some cases to elect out of the rollover. In addition, there may or may not be a

62 Under para. 69(1)(c).

63 A non-arm’s length sale of property for inadequate consideration is an exception, whereas gifts provide
reciprocity of tax attributes under paras. 69(1)(a) and (c).
64 Pursuant to subpara. 69(1)(b)(iii) and para. 251(1)(b).
65 Subparas. 69(1)(b)(i) and (iii); and see para. 251(1)(b), which extends the meaning of non-arm’s length
with regard to trusts.
66 Subpara. 40(1)(a)(iii).

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4.5 Chapter 4 – Taxation of Trusts

rollover on distribution of property from the trust to a beneficiary, depending on

the trust. Each of these trusts is discussed in more detail in other sections of this
chapter.

Figure 4.2: Trusts and Rollovers

Disposition on Rollover on Ability to Elect Deemed Disposition

Settlement or Settlement or Out of Rollover on on Death of Life
Type of Trust Transfer Transfer Contribution Tenant
Alter ego (AET)* Yes Yes Yes — property by FMV on death of settlor
property
Joint spousal or Yes Yes Yes — property by FMV on death of last of
common-law partner property settlor and spouse
(JPT)
Qualifying spousal or Yes Yes Yes — property by FMV on death of
common-law partner property spouse
(QST)
Non-qualifying spousal Yes No N/A No deemed disposition
or common-law on death of spouse
partner
Self-benefit trust** Yes Yes Yes — property by FMV on death of
property settlor and property
vests in estate
Lifetime benefit trust No, but income Yes — for RRSP and N/A No
— for registered plan inclusion to deceased RRIF
proceeds unless get rollover
Bare trust No — not considered N/A N/A N/A
a trust for tax purposes

* In addition to the option to elect out of the rollover on transfer of property in settlement of an AET, there is also an election to
opt out of tax treatment as an AET. Such an election is not available for JPTs or QSTs.
** See subs. 73(1) and subpara. 73(1.02)(b)(ii).

4.5 DISTRIBUTION OF CAPITAL PROPERTY FROM A TRUST

This section discusses the tax consequences of distributions of capital property

from a trust. Such distributions may be made during the term of the trust, either
as mandatory or discretionary distributions as a result of a power to encroach on
capital, or upon the termination of the trust when all trust property is distributed.
If capital property of a trust is distributed in kind, there is a deemed disposition,
and the tax treatment of that deemed disposition must be considered; a rollover
may be available. If capital property of a trust is liquidated to make cash distribu-
tions to beneficiaries, there will be no rollover — as there is an actual disposition.

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DISTRIBUTION OF CAPITAL PROPERTY FROM A TRUST 4.5.2

In addition to the tax treatment of dispositions of capital property on distri-

butions from a trust, a personal representative, trustee, or executor must be
aware that personal liability may result if property is distributed to a beneficiary
without a clearance certificate (see 5.8, Liability of the Personal Representative
for Tax and Clearance Certificates) and that there may be additional liability or
requirements resulting from certain distributions to non-residents (see 6.7.6, Dis-
position of Capital Interest in a Trust by Non-Resident Beneficiary and Require-
ment for Certificate of Compliance (S.116 Clearance Certificate)).

4.5.1 Rollover under Subs. 107(2) on Distribution of Trust Property

Generally, a rollover results on the distribution of trust property to a beneficiary.

The general rule, set out in subs. 107(2) of the Act, is that a personal trust can
distribute trust property on a rollover basis to Canadian resident beneficiaries in
satisfaction of all or part of their capital interest in the trust.

No rollover is available when the trust is a “reversionary trust,” or the trust is

otherwise subject to the provisions contained under subs. 75(2).67 A reversion-
ary trust subject to subs. 75(2) is one in which property can be returned to the
settlor or contributor, or a trust where the settlor or contributor retains certain
powers over trust property. The application and tax consequences of subs. 75(2)
are more fully explored later (see Chapter 9). The rule prohibiting a rollover of
property from a reversionary trust terminates on the death of the contributor, so
that distributions from a reversionary trust after the death of the settlor or con-
tributor will take place on a rollover basis.

Where the rollover in subs. 107(2) does not apply, the trust is deemed to have
disposed of the property, and the beneficiary is deemed to have acquired the
property, at an amount equal to the FMV at the time of the distribution.68

4.5.2 Other Tax Consequences of Subs. 107(2) Rollovers

Where a subs. 107(2) rollover applies, the following tax consequences also apply.

• The trust is deemed to receive proceeds of disposition for an

amount equal to the cost amount of the property.

67 Subs. 107(4.1) will apply in respect of any distribution of property by the trust.
68 Subs. 107(2.1).

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4.5.3 Chapter 4 – Taxation of Trusts

• The beneficiary is deemed to have acquired the property for an

amount equal to the proceeds of disposition to the transferor (i.e.,
the cost amount to the trust).69
• The beneficiary is deemed to have disposed of a capital interest in
the trust for proceeds of disposition adjusted under the rules to an
amount that equals the ACB of the interest in the trust, resulting in
a rollover.
• The ACB of the beneficiary’s capital interest is for this purpose
deemed to be an amount equal to the ACB of the distributed prop-
erty, so that no gain arises.70

4.5.3 Election by Trust Out of Rollover on Distribution of Principal Residence

or Other Property: Subs. 107(2.001)

Personal trusts may elect out of the rollover on the distribution of a principal
residence to a beneficiary. As a result of the election, the trust is deemed to have
disposed of and reacquired the residence at FMV immediately before the distri-
bution.71 The trust can use the principal residence exemption to shelter any gain
realized by electing out of the rollover, and the beneficiary will be deemed to
acquire the principal residence at the FMV at the time of the transfer.

Subsection 107(2.001) permits a trust to elect out of the rollover in subs. 107(2)
on the distribution of taxable Canadian property or capital property or inventory
used in a business carried on by the trust. This election may be beneficial to the
trust where there are accrued gains and the trust needs income to utilize losses
trapped in the trust.

4.5.4 Exceptions to the Rollover on Distribution of Trust Property

The tax-deferred rollover does not apply to the following distributions of

property:

• by a QST to anyone other than the spouse if the spouse is alive,72

• by a JPT to a person other than one of the partners while a partner
is alive,

69 Plus certain other amounts, if any, relating to the beneficiary’s cost of the interest in the trust.
70 See the definition of “cost amount” in subs. 108(1) and para. 107(1)(a).
71 Subs. 107(2.01).
72 Such a distribution would be contrary to the terms of a QST.

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Termination of a Trust 4.6

• by an AET to anyone other than the settlor while the settlor is alive,
• by a trust of property to which subs. 75(2) applies, to any person
other than the settlor/contributor or the spouse, former spouse or a
spousal trust of the settlor/contributor while the settlor/contributor
is alive — subs. 107(4.1),
• to a non-resident beneficiary unless the property is Canadian real
estate or certain other property73 not subject to departure tax,74
including real property in Canada, in which case the property will
be subject to Canadian tax on any subsequent disposition by the
non-resident (see 6.7.5, Disposition of Capital Property Distributed
by a Trust to a Non-Resident Beneficiary) — subs. 107(5), or
• to a beneficiary in satisfaction of an income interest in the trust.

4.5.5 Distributions to Non-Resident Beneficiaries

For the tax consequences in respect of distributions by a Canadian resident trust

to a non-resident of Canada, see 6.7.

4.6 TERMINATION OF A TRUST

The timing for the termination of a trust is governed by the terms of the trust.
The duration of a trust will be subject to trust law rules in each province relat-
ing to perpetuities. In addition, the 21-year deemed disposition rule imposes tax
consequences on trusts in existence for periods exceeding 21 years. Trusts may
have mandatory or discretionary termination dates. Where there is discretion,
termination prior to the 21-year anniversary date may be considered to avoid the
tax consequences of the deemed disposition at FMV of all property.

Upon winding up the trust, all property will be distributed according to the
terms of the trust. Generally, distributions of capital property to a beneficiary
in satisfaction of a capital interest in the trust may be made on a rollover basis
(see 4.5, Distribution of Capital Property from a Trust). Distributions of certain
property to non-residents of Canada do not qualify for rollover treatment and
take place at FMV triggering tax in the trust. In addition, there may be compli-
ance or tax consequences to the trust where the trust makes capital distributions
to a non-resident beneficiary as the beneficiary is considered to have disposed

73 Described in para. 128.1(4)(b)(i) to (iii).

74 See subs. 107(5).

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4.7 Chapter 4 – Taxation of Trusts

of a capital interest in the trust. This and other tax consequences of distributions
to non-residents of Canada are discussed later (see 6.7).

In order to wind up a trust, the personal representative must file a final tax
return for the trust. Once the notice of assessment has been issued by CRA for
the final return, the personal representative can apply for a clearance certificate.
Once the clearance certificate has been issued, the personal representative may
distribute trust property without incurring personal liability for tax owing by the
trust, including tax arising from subsequent assessments or reassessments. The
requirement for obtaining a clearance certificate to protect the personal repre-
sentative from personal liability and the potential liability for failure to do so is
discussed in the next chapter (see 5.8). Income earned on property not yet dis-
tributed by the trust after the date of the final return is typically reported in the
hands of the beneficiaries as if it were earned directly.

4.7 TYPES OF TRUSTS FOR TAX PURPOSES

Some of the more common trusts that have unique tax treatment are listed below.
More detailed discussion of some of the more important trusts for tax and estate
planning follows this list. Note that the list is not mutually exclusive. For exam-
ple, all these trusts are personal trusts, and some can only be inter vivos (such
as AETs or JPTs) or only testamentary (such as GREs or QDTs), while others may
be either testamentary or inter vivos (such as QSTs).

• Personal Trust. The trust must not be set up as a commercial

arrangement where the beneficiary pays for his or her interest as
an investor. This material discusses rules pertaining to personal
trusts only — subs. 248(1).
• Inter Vivos Trust. A trust created during the lifetime of the settlor
— subss. 248(1), 108(1).
• Testamentary Trust. A trust created as a consequence of the death
of an individual. Changes effective in 2016 removed the unique tax
attributes of testamentary trusts, save only for GREs and QDTs —
subss. 248(1), 108(1). The unique tax treatment of trusts such as
GREs or QDTs requires these trusts to be testamentary for tax pur-
poses in addition to the other specific requirements. If these trusts
cease to be testamentary for tax purposes, their status as GREs or

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TYPES OF TRUSTS FOR TAX PURPOSES 4.7

QDTs is revoked and they will be treated as inter vivos trusts for
tax purposes.
• Graduated Rate Estate (GRE). A testamentary trust that is the
estate of an individual during the first 36 months following the
date of death. Trusts that are specifically created in the Will of an
individual are not GREs. GREs have special status under the Act,
having unique attributes that were available to all testamentary
trusts prior to 2016. GRE status is very important for tax and estate
planning due to these tax attributes, which include access to the
graduated rates of tax available to an individual and choice of year-
end. In addition, certain rules, such as rules for charitable dona-
tions on death, and the subs. 164(6) carryback of capital losses are
only available if the estate is a GRE — subs. 248(1).
• Alter Ego Trust (AET). A trust for the sole benefit of the settlor
during the settlor’s lifetime where the settlor has attained age 65.
A rollover is available on transfer of property to such a trust.75 See
4.7.7, Alter Ego, Joint Partner, and Common-Law Partner Trusts.
• Joint Spousal or Common-Law Partner Trust ( JPT). This is a
joint form of alter ego trust that permits one Canadian resident
spouse or common-law partner who has attained age 65 to contrib-
ute capital property on a tax-deferred basis to a Canadian resident
trust created primarily for both spouses or common-law partners.
See 4.7.7, Alter Ego, Joint Partner, and Common-Law Partner Trusts.
• Qualifying Spousal or Common-Law Partner Trust (QST). A
trust for the sole benefit of the spouse or common-law partner of
the settlor, during the lifetime of the spouse or common-law part-
ner. To qualify, all the income (income for trust law purposes not
necessarily including capital gains) must be payable to the spouse
during his or her lifetime, and no person other than the spouse
is entitled to the capital of the trust or is eligible for a rollover
on transfers of property to the trust by the settlor spouse. These
trusts can be inter vivos or testamentary. See 4.7.7.5, QST Specific
Requirements, and 10.4, Using the Spousal Rollover and Spousal
Trusts.

75 See 4.7.7.2.

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4.7 Chapter 4 – Taxation of Trusts

• Life Interest Trusts. In trust law, life interest trusts are trusts that
provide exclusively for an individual beneficiary, or a class of indi-
vidual beneficiaries, during the lifetime of such beneficiary or ben-
eficiaries. The beneficiary is called the “life tenant.” When the life
tenant dies, the beneficiaries of the remaining corpus of the trust
are called the “remaindermen.” In tax law, certain defined life inter-
est trusts have special treatment, although the term “life interest
trust” itself has no specific meaning in tax law. Three life interest
trusts in particular are sometimes referred to as “life interest trusts”
in the tax literature, especially when referring to the new rules
introduced in 2016. These three life interest trusts have similar
but not identical terms and tax treatment: alter ego trusts (AETs),
joint partner and common-law partner trusts ( JPTs), and qualify-
ing spousal or common-law partner trusts (QSTs). They will often
be grouped together when discussing their unique but similar tax
treatment. Other life interest trusts include charitable remainder
trusts and lifetime benefit trusts.
• Self-Benefit Trust. A trust for the sole benefit of the settlor and
where the property becomes part of the settlor’s estate on death.
The transfer of property to the trust falls within the definition of a
“qualifying transfer” under subs. 73(1.01) and a rollover is available
under subs. 73(1).76
• Lifetime Benefit Trust. A trust created for the benefit of a mentally
infirm spouse, or mentally infirm child or grandchild who was finan-
cially dependent upon a deceased spouse, parent, or grandparent
immediately before that person’s death — subs. 60.011(2(a). The
Act permits a deferral of tax on transfer of a registered retirement
savings plan (RRSP), registered retirement income fund (RRIF), or a
registered pension plan to such trusts. See 7.8.4 for a discussion of
planning lifetime benefit trusts, qualified trust annuities, and plan-
ning for beneficiaries with disabilities using registered plans.
• Qualified Disability Trust (QDT). These trusts were created
commencing 2016, are testamentary only, and are defined in
subs. 122(3). Along with GREs, they are the only trusts entitled
to the graduated rates of tax. The beneficiary must be specifically

76 A similar type of “tax trust” is one that is created as the result of a “qualifying disposition” as defined
under subs. 107.4(1). Qualifying dispositions are not covered in this material.

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TYPES OF TRUSTS FOR TAX PURPOSES 4.7

named in the Will, be eligible for the disability tax credit, and must
jointly elect with the trustees to have QDT status.
• Reversionary or Revocable Trust. A trust where the settlor may
become entitled to a distribution of capital (otherwise than by
operation of law) such as where the settlor is named as a benefi-
ciary or the settlor retains control over decisions as to who receives
distributions of trust property. Reversion by operation of law may
apply where the trust fails, for example, because all beneficiaries
have died (i.e., failure of trust objects).
• Charitable Remainder Trust. A trust where one person (usually
the settlor if the trust is inter vivos) has a life interest and one or
more charities are the sole beneficiaries upon the death of the life
tenant.
• Bare Trust. In a bare trust arrangement, the trustee’s actions are
subject to the control of the beneficial owner, and the duty of the
trustee is to follow the instructions of the beneficial owner. Bare
trusts are not recognized as trusts for the purposes of the Act.77

Each of the trusts listed above has a tax definition, or sections dealing with
its tax treatment, with the exception of charitable remainder trusts, for which
CRA has published an administrative policy regarding their definition and tax
treatment.

There are many other types of trusts that are used in tax and estate planning
that have specific objectives but may not have specific tax treatment in the Act.
The tax treatment of these types of trusts is not discussed in any great detail in
these materials. They are nevertheless important in tax planning, as the tax con-
sequences must be understood and some of the tax benefits of trusts may apply
notwithstanding that tax planning is not their primary objective; alternatively,
there may be no tax benefit. The following is a list of some types of trusts that
are not dealt with specifically in the Act:

• Discretionary Trust: permits the trustees to decide some aspect of

income or capital distribution, including timing and/or quantum,
and may be used to sprinkle income among multiple beneficiaries
and/or defer vesting of capital.

77 Subs. 104(1).

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4.7.1 Chapter 4 – Taxation of Trusts

• Henson Trust: fully discretionary inter vivos or testamentary trust

to preserve eligibility for provincial disability benefits for a benefi-
ciary with a disability.
• Asset Protection Trust: to preserve wealth from the potential
claims of future creditors of the settlor.
• Spendthrift Trust: to prevent an impecunious beneficiary from
squandering his or her interest.
• Caretaker Trust: to manage finances for a beneficiary who does
not have the skill, interest, or maturity to do so themselves.

The types of trusts in the two lists above are not complete, nor are they mutually
exclusive. For example, a QST is a personal trust, and can be either inter vivos
or testamentary, and may be tax-motivated, may be discretionary with respect to
encroachment on capital, and may also have caretaker objectives.

4.7.1 Personal Trusts

This course covers the taxation of personal trusts. Section 248 of the Act defines
a personal trust as:

• a testamentary trust, or
• an inter vivos trust where no beneficial interest has been acquired
for consideration payable to the trust or a contributor to the trust.

Commercial trusts are not personal trusts, since the “investor” beneficiaries
would have provided consideration for their beneficial interest. There are many
types of trusts that are not personal trusts but still have specific tax treatment
in the Act, such as registered pension plans, mutual funds, and employee profit-
sharing plans; they are not discussed in these materials.78 Most family trusts are
personal trusts, as are estates and trusts created under a Will.

4.7.2 Inter Vivos Trusts

An inter vivos trust that is a personal trust is defined to include any personal trust
other than a testamentary trust.79 However, “inter vivos” is not actually defined
in the Act. It is derived from the Latin root, meaning “during life,” or “between

78 Excluded from the definition of “trust” in subs. 108(1).

79 The result of the definitions of “personal trust” in subs. 248(1)and “inter vivos trust” in subs. 108(1).

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TYPES OF TRUSTS FOR TAX PURPOSES 4.7.3

living persons.” Generally, in trust law an inter vivos trust is a trust settled by a
living person, as opposed to a testamentary trust that is settled as a result of the
death of the settlor. The main tax attributes of an inter vivos trust are:

• taxed at the highest marginal rate for individuals,

• have a calendar taxation year,
• may be subject to alternative minimum tax (AMT), and
• in most cases, the transfer of property in settlement of an inter
vivos trust will take place at FMV.

4.7.3 Testamentary Trusts

The requirements for a testamentary trust are contained in subs. 108(1) and pro-
vide that a testamentary trust is a trust or estate:80

• that arose on or as a consequence of the death of an individual

(the deceased),
• that is created by the deceased, and
• no other person other than the deceased has contributed to the
trust, except by a contribution made on or after the death of the
deceased by another individual as a result of the death of that other
individual.81

An estate is a testamentary trust for tax purposes and it includes an intestate

estate. The following trusts are also considered testamentary trusts:

• a trust created by court order as a result of a claim for dependant

relief against the estate,82
• a trust created under the terms of the Will of the deceased,83

80 For tax purposes, an estate is treated as a trust from its inception, even though in trust law it may not
be considered a trust until trustees are in place and ownership is divided between legal and beneficial
ownership.
81 Special rules apply to trusts created before November 13, 1981, but these will not be covered in this
material.
82 A trust established by court order as the result of a claim against the estate for dependant relief will
be considered a testamentary trust, since the definition in subs. 108(1) includes a trust described in
subs. 248(9.1).
83 Para. 248(9.1)(a).

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4.7.3 Chapter 4 – Taxation of Trusts

• an insurance trust created in a document separate from the Will, if

funded on death with the proceeds of life insurance,
• a trust separate from the estate on death of the annuitant with pro-
ceeds of a registered plan (i.e., an RRSP or RRIF) funded by a ben-
eficiary designation, and
• successive trusts — for example, where a trust for each grandchild
is created in the Will after the death of the surviving spouse who is
the beneficiary of a QST.

Prior to 2016, testamentary trusts were entitled to the same graduated rates of
tax as individuals and could choose their tax year-end. After 2015, only GREs
and QDTs are entitled to the graduated rates, and only GREs may choose their
year. The loss of access to the graduated rates for all other testamentary trusts
has eliminated the use of testamentary trusts to income split between the trust
as a separate taxpayer with its own graduated rates and the beneficiaries of the
trust. However, planning with testamentary trusts created in a Will is still benefi-
cial to achieve tax savings and estate planning objectives, including:

• trusts created for non-tax purposes, usually for protection such as

for a special needs beneficiary, to preserve capital for successive
beneficiaries, to hold a particular asset for special use such as a
residence or family cottage, or to defer direct ownership of prop-
erty until the beneficiary is ready or until the settlor has determined
which beneficiaries are to receive trust property such as in an estate
freeze, or for creditor protection;
• qualifying spousal or common-law partner trusts (QSTs) to provide
for the surviving spouse during lifetime and defer the timing of tax
and distribution to other beneficiaries until the death of the surviv-
ing spouse;
• qualifying disability trusts (QDTs) for a beneficiary with a disabil-
ity, which still have access to the graduated rates;
• discretionary trusts to income split by income “sprinkling” among
a group or class of beneficiaries to access the lower marginal tax
rates (or other tax attributes) of the beneficiaries; and
• as no attribution will apply back to the transferor when the trans-
feror dies, this may create opportunities for inter vivos transfers,
such as to a parent or grandparent, followed by testamentary trust

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TYPES OF TRUSTS FOR TAX PURPOSES 4.7.3.1

planning in the transferee’s Will. Testamentary trusts are not sub-

ject to any of the attribution rules as the settlor is deceased. In
addition, where property was transferred to the deceased during
lifetime, and attribution applied to the transferor, the attribution
stops on the death of the transferee.

4.7.3.1 Graduated Rate Estates (GREs) and Qualified Disability Trusts

(QDTs)
Graduated rate estates (GREs) and qualified disability trusts (QDTs) are
the only testamentary trusts entitled to the graduated rates of tax. Unlike
a GRE, a QDT has a calendar year-end for tax purposes.

A GRE has all the unique attributes that prior to 2016 were enjoyed by
all testamentary trusts. These include being taxed at the same graduated
rates as individuals, not being subject to AMT, not being subject to Part
XII.2 tax, and having a different time for filing a notice of objection to
an assessment.

A “graduated rate estate” is defined in subs. 248(1) as the estate that

arose on and as a consequence of death if it also satisfies the following
requirements:

• during the time within 36 months of death of the individual,

• the estate is at the time a testamentary trust,
• the estate files an estate tax return that includes the social insur-
ance number of the deceased,
• the estate designates itself as the GRE of the individual in its
first T3 return, and
• no other estate so designates itself.

Questions have arisen since the introduction of the GRE relating to the
designation where there are multiple Wills. CRA has confirmed that gen-
erally there is only one estate, even if there is more than one Will (such
as might be the case with multiple Wills for probate fee planning). How-
ever, there could be problems where there are multiple Wills and the
executors are not the same.

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4.7.3.1 Chapter 4 – Taxation of Trusts

A specific testamentary trust created in a Will of an individual is not an

estate, and not a GRE. Questions have also arisen with respect to how
long a GRE might delay setting up testamentary trusts created in the
Will to extend access to the marginal rates by the GRE. This has resulted
in a new practice to include special clauses in Wills that make it clear
that the executors can delay setting up trusts or making income payable
to beneficiaries beyond the traditional executor’s year. Clauses are now
also being used in Wills to direct executors to make the GRE designa-
tion and to administer the estate in a manner to preserve testamentary
status and GRE status.

The status of an estate as a GRE is important for access to the new

donation tax credit rules on death and for post-mortem tax planning
for shares of private corporations. The new donation tax credit rules
for donations made by estates introduced for 2016 and following years
apply only to graduated rate estates. The rule in subs. 164(6) that per-
mits a capital loss carryback to the terminal return is also restricted to
losses realized by a GRE.

A “qualified disability trust” for a taxation year is defined in subs. 122(3)

as a trust that:

• is testamentary at the end of the year,

• elects jointly with one or more beneficiaries to be a QDT in the
year,
• each of electing beneficiaries is an individual specifically named
as a beneficiary by the deceased in the Will,
• each of the electing beneficiaries qualifies for the disability tax
credit in the year, and
• no other trust elects to be a QDT in the year with the same ben-
eficiary or beneficiaries.84

Critics have pointed out that the “only one QDT” rule for any particular
year penalizes arrangements where both parents independently set up
trusts for a disabled child, particularly where the parents are divorced

84 Technically, the definition does not require all beneficiaries to qualify for the disability tax credit, but
special rules claw back the income if another beneficiary benefits from the trust, para. 122(1)(c) and
subs. 122(2).

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TYPES OF TRUSTS FOR TAX PURPOSES 4.7.3.2

or separated and/or the arrangements pre-date the 2016 changes to the

graduated rates.

The introduction of the QDT in conjunction with the loss of graduated

rates for other testamentary trusts permits discretionary testamentary
trusts for disabled individuals (i.e., Henson trusts) to retain income for
the purpose of preserving the beneficiary’s right to income-tested ben-
efits, such as provincial disability benefits, without the “tax penalty” of
being taxed at the highest marginal rate.

4.7.3.2 Loss of Testamentary Status 85

A testamentary trust may cease to qualify if any of the second or third
requirements in the definition above are not satisfied. If a testamen-
tary trust ceases to qualify as a testamentary trust for tax purposes, it
becomes an inter vivos trust for the purposes of the Act. For a GRE, this
means loss of all the special tax attributes described above; for a QDT,
this means loss of the graduated rates.

The following may cause a testamentary trust to lose its testamentary

status:

• Contributions by any living person other than the deceased or

by an inter vivos trust.
• Payment of expenses by a beneficiary on behalf of the trust.86
• Payment of taxes on behalf of the deceased or the estate. Pay-
ment of the income tax of the deceased person in respect of
the terminal return, or any debt of the deceased person or the
estate,87 will disqualify the trust as testamentary. Estate planners
often recommend tax liability clauses in Wills requiring a ben-
eficiary to bear the tax liability arising on death relating to spe-
cific assets of the estate. For example, where some children are
inheriting the family business, those children might be required

85 See Grace Chow and Ian Pryor, Taxation of Trusts and Estates: A Practitioner’s Guide 2017 (Toronto:
Carswell, 2015) at pages 48–50.
86 Technical Interpretation 2002-0154435, Payment of Trust Expenses by Beneficiary (April 17, 2003).
87 See Technical Interpretation 9233787, Election Under 104(13.1) and (13.2) (March 9, 1993), where
the beneficiary of an RRSP paid the tax on the plan owing in the terminal return and the estate lost
testamentary status. Made before the rule in subs. 104(13.3) prevented the election from being used to
result in taxable income in a trust.

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4.7.3.2 Chapter 4 – Taxation of Trusts

in the Will to pay the tax liability arising on death in respect

of the shares in the business corporation. If this is not drafted
skillfully, it could taint the testamentary status of the GRE.88
• Failure to make a distribution of capital that is required under
the terms of the trust.89
• Failure to distribute the estate property to the beneficiaries once
the administration of the estate is completed. If the Will does
not expressly provide that the estate assets continue to be held
in a trust, the trustees have an obligation to facilitate the distri-
bution of the estate capital as soon as they are able to do so.90
This situation is obviously dependent on the facts for the estate.
• Variation of the trust resulting in a new trust. If the trust is
varied in such a manner that there is significant change in the
interests of the capital or income beneficiaries, the variation
may cause the trust to become a new trust and lose its testa-
mentary status.91
• Loans from beneficiaries.92 Where a trust lends money or incurs
a financial obligation to a beneficiary, the status of the trust as
“testamentary” may be lost.93
Post-mortem contributions to a testamentary trust on death of another
individual will not cause the trust to lose its testamentary status. Leaving
property in a Will to a pre-existing testamentary trust will not taint the

88 If the clause is merely an adjustment or “hotchpot” to reduce that beneficiary’s share of the estate, the
testamentary status will be preserved.
89 Technical Interpretation 2000-0172475. See also remarks in the T3 Guide.
90 Subject to the “executor’s year” and any other extenuating circumstances in the administration of the
estate, such as litigation; see Technical Interpretation 9526815, Executor’s Year Passing Beneficial
Ownership of Estate (May 24, 1996).
91 Technical Interpretation 2000-0059795, Testamentary Trust Variation.
92 Subs. 108(d) of the definition “testamentary trust” is an anti-avoidance rule intended to prevent high tax-
rate individuals from lending to testamentary trusts as “income splitting” vehicles. The paragraph provides
that a trust will not receive testamentary status where it incurs a debt or obligation after December 20,
2002, to a “specified party” to pay an amount to, or be guaranteed by, a beneficiary or any other person
or partnership with whom any beneficiary of the trust or estate does not deal at arm’s length.
93 However, certain debts and obligations will not cause a loss of testamentary status. If the indebtedness
arose because of a payment made by a specified party on behalf of the trust or estate, and provided
that the trust or estate fully reimburses the specified party within one year of making the payment, the
indebtedness will not cause a loss of testamentary status. Furthermore, this provision does not apply
to a debt owed to a beneficiary arising on account of an income or capital entitlement payable to the
beneficiary under the terms of the trust, nor to a debt owed to a legal representative on account of fees
for services payable by the estate or trust. See the Department of Finance comfort letter of April 28,
2004, on this point.

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TYPES OF TRUSTS FOR TAX PURPOSES 4.7.4

trust.94 This might be the case, for example, where a parent bequeaths
part of his or her estate to an existing testamentary trust previously cre-
ated by the Will of a deceased grandparent.

Note that even if a testamentary trust loses its status for tax purposes, it
may still be considered a testamentary trust under trust law.

4.7.4 Life Insurance Trusts

A life insurance trust is created with the proceeds of a life insurance policy. The
terms of the trust may be set out in the Will, or may be established in a separate
trust deed outside and apart from the Will. The policyholder must make a ben-
eficiary designation for the insurance proceeds to be paid to the trustees of the
life insurance trust “in trust.”

CRA accepts that life insurance trusts are testamentary trusts.95 However, the fol-
lowing are essential to the testamentary status:

• While the terms of the trust are set out in writing during the life-
time of the policyholder, no settlement of property may take place
during the lifetime of the policyholder; the trust only comes into
existence after death when the life insurance proceeds are trans-
ferred to the trustees.
• The deceased must be the policyholder (i.e., the owner) and the
life-insured.96
• If the trust is established apart from the Will of the policyholder,
the life insurance proceeds will not become part of the estate and
will not be subject to the dispositive provisions of the Will. In some
cases, the insurance trust is established as a separate trust within
the Will document but is drafted in a manner to keep the proceeds
separate from the estate — that is, as an insurance beneficiary des-
ignation to the insurance trustees in trust. The terms are set out
and the language is located at the beginning of the Will document,

94 Para. 108(1)(a) of the definition of “testamentary trust.”

95 Technical Interpretations 9238555 (February 4, 1993) and 2000-0059755 (March 23, 2001).
96 Joint last to die also qualify: see Technical Interpretation 2008-0270421C6 ( July 11, 2008).

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4.7.4 Chapter 4 – Taxation of Trusts

before and apart from the standard clause in the Will that transfers
all the property or estate of the deceased to the executors.97
• The transfer of the insurance proceeds to the trustees must be as a
consequence of the death of the policyholder, in keeping with the
definition of a testamentary trust. This is the case where the pro-
ceeds are paid as a result of a beneficiary designation to the trustees.
• A valid trust must be created. The terms of the trust should be set
out in writing prior to the death of the policyholder. Otherwise,
uncertainty with respect to the intention to create a trust or the
objects of the trust may cause the trust to be invalid.

The use of an insurance trust outside and apart from the estate of the life insured
has several advantages:

• Funds are immediately accessible. The proceeds are immediately

available and do not get trapped in the estate during the adminis-
tration period, which could take a year or more.
• Creditor-proofing. The proceeds do not become part of the estate
of the policyholder, so are protected from creditors of the deceased
and the estate.
• Probate fee planning. The proceeds are not subject to probate
fees because they are outside the estate.
• Reduced executor’s fees. Since the insurance is not part of the
estate, executor’s fees may be reduced.

However, if the testator wishes to establish a QST eligible for rollover treatment,
the insurance trust must be established in the Will. Consider, though, whether
the rollover is needed for an insurance trust, since the proceeds do not attract
any tax on the death of the policyholder, and there may be significant benefits to
having a non-QST. These would include:

• No deemed disposition on the death of the surviving spouse.

97 A Saskatchewan case decided that an insurance trust created in a Will was part of the estate subject
to probate fees. Part of the reasoning was that the trustees of the insurance trust were identified as
the “executors,” not as named individuals, and wording that they were receiving the proceeds in their
capacity as trustees and not executors was insufficient to make it a separate trust: Re Carlisle Estate
(2007), 306 Sask.R. 140 (Sask. Q.B.).

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TYPES OF TRUSTS FOR TAX PURPOSES 4.7.5

• The trust may have other beneficiaries in addition to the surviving

spouse.
• Property can be distributed on a rollover basis to other beneficia-
ries during the lifetime of the spouse.

The declaration of the insurance trust should contain the following elements:

• Clearly identify the insurance policy to which it refers.

• State that it is an insurance designation under the relevant provin-
cial legislation governing insurance beneficiary designations.
• Expressly revoke any previous beneficiary designations.
• Identify the trustees specifically by name and avoid merely refer-
ring to them as the “trustees” or “executors” of the estate; even if
they are the same persons, they should be identified separately.98
• State that the insurance trust is to be a trust separate and apart
from the estate.

It is also recommended to ensure that the insurance company does not have a
previous or contradictory designation on file. The insurance company should be
informed of the trust designation and may request a copy of the trust document,
or the Will if the declaration and designation are in the Will.

4.7.5 Self-Benefit Trusts

A self-benefit trust is not actually defined in the Act. However, the term “self-
benefit trust” generally refers to a trust for which:

• There is a rollover upon transfer of property under subs. 73(1).

• The trust is solely for the benefit of the settlor (or settlors if the
property is owned by an individual and his or her spouse or
common-law partner) during their lifetime.99
• The transfer to create the trust results in no change in beneficial
ownership of the property and there is no other interest in the
trust by any other person, even upon the death of the settlor.100

98 Ibid.
99 Subparas. 73(1.01)(c)(ii) or (iii).
100 Subparas. 73(1.02)(b)(ii).

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4.7.6 Chapter 4 – Taxation of Trusts

• The trust does not elect out of the 21-year rule.

A self-benefit trust is similar to an AET or JPT except that the settlor does not
have to be age 65 or older, and any property remaining in the trust after the
death of the settlor is deemed disposed of at FMV and becomes part of the set-
tlor’s estate.

There is no tax benefit to a self-benefit trust since subs. 75(2) would apply to
tax the settlor on all income, including capital gains, during the settlor’s lifetime,
and the property remains in the settlor’s estate on death.

A self-benefit trust may be established as an alternative to a power of attorney

for managing the assets of the settlor. This might be appropriate where the set-
tlor has a medical condition that creates diminished capacity over time, such as
Alzheimer’s disease. Or it may be used as a protective trust to preserve the assets
for the benefit of settlors who lack self-discipline in managing their own finan-
cial affairs.

4.7.6 Lifetime Benefit Trust (LBT)

Lifetime benefit trusts (LBTs) are used to take advantage of certain provisions
of the Act that permit a rollover of proceeds of a registered plan on death of
the plan owner (i.e., annuitant) to a trust for the benefit of a mentally infirm
dependant.

The lifetime benefit trust concept permits trusts created for the benefit of men-
tally101 infirm spouses, children, or grandchildren who were financially depen-
dent upon a deceased spouse, parent, or grandparent immediately before that
person’s death, to defer tax on an RRSP, RRIF, or a registered pension plan.102
Thus, there is a rollover of proceeds of the plan payable to such a trust on the
death of the annuitant of the plan.

4.7.7 Qualifying Life Interest Trusts (QLITs): Alter Ego Trusts (AETs), Joint
Partner Trusts (JPTs), and Qualifying Spousal Trusts (QSTs)

Three types of life interest trusts have special treatment under the Act: the alter
ego trust (AET), joint spousal or common-law partner trust ( JPT), and qualify-
ing spousal or common-law partner trust (QST). In the tax literature, these trusts

101 Physical infirmity is not sufficient.

102 Defined in subs. 60.011(1).

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TYPES OF TRUSTS FOR TAX PURPOSES 4.7.7

are often referred to collectively as “life interest trusts.” A life interest trust can
include any trust where property is held during the lifetime of a beneficiary and
the term is not exclusive to these particular trusts in trust law, even though it
appears that way in the tax literature. The tax planning opportunities for these
trusts is covered at length in other chapters, particularly Chapter 9, Attribution
Rules and Income Splitting, and Chapter 10, Basic Tax Planning for Trusts and
Estates.

For the purposes of this material, the AET, JPT, and QST will sometimes be
referred to as qualifying life interest trusts (QLITs) and the beneficiaries who are
the “life tenants” of QLITs under the Act will be referred to as the “life tenant” or
“life tenants.” The life tenants of a QLIT will be:

• the settlor for an AET,

• the settlor and settlor’s spouse for a JPT, or
• the settlor’s spouse for a QST.

The following is a brief introductory summary of these trusts:

• Alter ego trust (AET) — a trust created by an individual age 65 or

over for the individual’s sole benefit during lifetime.
• Joint spousal or common-law partner trust ( JPT) — the “cou-
ples” version of the AET: a trust created by an individual age 65
or over for the sole benefit of the individual and the spouse or
common-law partner of the individual during their lifetimes.
• Qualifying spousal or common-law partner trust (QST) — a
trust created for the sole benefit of the spouse of the individual
during the lifetime of the individual. This trust is unique among the
QLITs as it can be either inter vivos or, if created in the Will of the
individual, testamentary.
QLITs have the following common tax characteristics and requirements:

• Rollover in with option to elect out: There is a rollover of capital

property transferred by gift, contribution, or settlement to the trust.
{ For inter vivos QLITs, subs. 73(1) provides for the rollover on
“qualifying transfers” defined in subs. 73(1.01). An election is
available to elect out of the rollover for each particular property,

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4.7.7 Chapter 4 – Taxation of Trusts

that is, a property-by-property election to be made by the trans-

feror in the tax return for the year of transfer.
{ For testamentary QSTs, the rollover is in subs. 70(6), and there
is a similar election out of the rollover available on a property-
by-property basis under subs. 70(6.2) to be made by the legal
representative.
• Life tenant(s) taxed on all income: During the lifetime of the
life tenants, the life tenants must be entitled to receive all of the
income of the trust. Income for this purpose means income under
trust law, not under the Act, which does not include capital gains
— subs. 103(3).
• Life tenants must have exclusive rights to income and capi-
tal: During the lifetime of the life tenants, no one other than the
life tenants may receive or otherwise obtain the use of any of the
income or capital of the trust.
• Special tax treatment on death of the last surviving life tenant:
On the death of the last surviving life tenant.
• Deemed disposition of all capital property: There is a deemed
disposition of all capital property owned by the trust for proceeds
of disposition equal to FMV and every 21 years thereafter — sub-
paras. 104(1)(a) and 104(1)(b). All the resulting income from the
deemed disposition will be taxed in the trust, as no deduction from
income is available as a result of subs. 104(6)(b), and this is the
case even if any of the attribution rules applied to the trust, includ-
ing subs. 75(2). There is an exception if the death of the life tenant
was before 2017, in which case the election below is available.
• Deemed tax year-end: There will be a deemed tax year-end (subs.
104(13.4)), although the filing deadline and tax payment due date
will be as for the tax year ending at the end of the calendar year.
• Election for Pre-2017 Death of Life Tenant: If death took place
before 2017, an election is available to tax all the income for the
“stub period” tax year ending on death of the life tenant to treat it
as payable to the life tenant — subpara. 104(13.4)(b.1), with the
result that the income would be taxed in the terminal return of
the life tenant and not the trust. This election might be useful, for
example, if property of the trust were eligible for the LCGE, since

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TYPES OF TRUSTS FOR TAX PURPOSES 4.7.7.1

otherwise there would be no access to the LCGE on the death of

the life tenant. It is regrettable this election is restricted to deaths
before 2017, as it not only allows access to the LCGE but also to
the marginal rates of tax and other tax attributes of the life tenant,
which may be helpful to cushion the effect of the deemed disposi-
tion and other income in the stub-period tax year.103

4.7.7.1 Non-Tax Planning Advantages of Life Interest Trusts

The unique features of AETs and JPTs are that the settlor is a beneficiary
and that the property in the trust never needs to pass through the estate
of the settlor or the estate of the spouse. Thus, the main advantage of
AETs and JPTs is the ability to avoid probate fees or taxes while the set-
tlor maintains all the benefits of direct ownership. The settlor can both
control (if the settlor is a trustee) and enjoy an interest in the property.
Since the settlor may be a capital beneficiary (as well as a mandatory
income beneficiary), such trusts are often completely reversionary; that
is, they can be structured to be revocable.

The main advantage of a QST is the ability to access the spousal rollover
without giving up complete control of the property to the spouse or
relinquishing the right to determine the beneficiaries of the property on
the death of the spouse. Tax on the deemed disposition can be deferred
until the death of the surviving spouse — a particular benefit with testa-
mentary QSTs. Capital can be preserved for other beneficiaries, and this
may be of particular importance when there are children from another
relationship — since on death of the spouse the property will not pass
through the estate of the spouse but will be distributed according to the
terms of the QST.

AETs and JPTs are solely creations of the Act and had no specific exis-
tence in trust law until amendments to the Act introduced them. For
AETs, since the settlor is the sole beneficiary during the settlor’s life-
time, there has been debate among trust lawyers and academics as to
whether or not they are valid trusts. The risk that a valid trust is not
created would be relevant particularly where the settlor is not only the

103 The Department of Finance originally proposed that this would be a requirement for all deaths after
2015: shifting the tax burden to the terminal return of the life tenant in all cases. This led to a huge
outcry from tax and estate professionals, as the tax did not “follow the money.” The result would have
been clearly inappropriate where the beneficiaries of the life tenant’s estate, and those of the life
interest trust, were not identical.

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4.7.7.1 Chapter 4 – Taxation of Trusts

sole beneficiary but also the sole trustee. The argument would be that
the division of ownership of trust property between legal and benefi-
cial title has not taken place, since both are the same person. For this
reason, many lawyers insist that an AET or JPT (particularly where both
spouses contribute, in the case of a JPT) be prepared and executed with
the same clauses and formalities as a Will.

In the absence of other specific tax planning, there is no income tax

advantage to an AET, JPT, or inter vivos QST. Trust income will be taxed
either in the settlor/contributor’s hands or at the top marginal rates in
the trust, which is by definition inter vivos.104 It is not possible to split
income with a spouse using a JPT or an inter vivos QST because of
the attribution rules. There is no tax relief from the deemed disposi-
tion on death as property of the trust is deemed disposed of at FMV
on the death of the settlor or spouse, which is the same as without a
trust (assuming the spousal rollover on the first death of the settlor and
spouse). In addition, if the trust document provides for successive trusts
after the death of the life tenant, then such trusts will not be considered
testamentary because they are not considered to arise as a consequence
of the death of the settlor105 and none of the successive trusts can qual-
ify as a GRE or a QDT.

As stated, the main advantage of AETs and JPTs lies in the ability to pass
property outside one’s estate on death while still benefiting from the
property during the settlor’s lifetime. An inter vivos QST also enables
property to be transferred outside the estate of the settlor or spouse,
although the settlor loses any interest in the property. Property held in
an AET, JPT, or inter vivos QST is no longer owned by the transferor,106
and on the death of the transferor, the property passes outside the estate
of the transferor according to the terms of the trust. This has a number
of non-tax planning advantages for AETs, JPTs, and inter vivos QSTs,
including:

• probate fee savings,

104 And if the settlor is also a trustee, it is very likely that subs. 75(2) will apply.
105 If the estate of the life tenant is the beneficiary, a testamentary trust could be created with the funds in
the Will of the life tenant, although this would likely defeat any probate fee planning.
106 Arguably, if the settlor is the sole trustee, ownership as trustee is only legal ownership, although the
use of another trustee might be helpful.

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TYPES OF TRUSTS FOR TAX PURPOSES 4.7.7.2

• protection from claims by family members,107

• asset protection,
• immediate access to trust property on death, since distribution
is not delayed by the time required to properly administer the
estate,
• avoiding family disputes and delays in respect of the adminis-
tration of the contributor/settlor’s estate,
• privacy, since the existence, terms, and property of the trust
never becomes accessible to the public through the probate
process, and
• alternative vehicle to manage property — instead of a power of
attorney.

4.7.7.2 Tax Disadvantages of Qualifying Life Interest Trusts: AETs, JPTs,

and QSTs
Before any planning is done with QLITs, the following tax disadvan-
tages should be reviewed and considered:

• There is no spousal rollover on the death of the settlor/contributor

to an AET.
• At the time of the death of the last surviving life tenant, all the
income arising from the deemed disposition will be taxed in the
trust at the highest marginal rate even if subs. 75(2) applies to
the trust (since the deemed disposition takes place at the end
of the day). Had the income from the deemed disposition been
taxed in the hands of the deceased life tenant, it would have
been subject to the graduated rates.
• If there are losses trapped in the trust, they may not be flowed
out to the beneficiary. If the attribution rule in subs. 75(2)
applies, as it often does with these trusts where the settlor is a

107 The success of this strategy depends on provincial law relating to family law and dependant relief
claims. This strategy may be helpful in B.C., where a taxpayer wishes to avoid a challenge by family
members under the Wills, Estates and Succession Act, SBC 2009, Chapter 13, under the Variation of
Wills provisions in Division 6.

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4.7.7.3 Chapter 4 – Taxation of Trusts

capital beneficiary or is a trustee of the trust, losses will attri-

bute to the settlor.108
• Timing of charitable bequests can be a challenge with these
trusts. Any donation on the death of the life tenant must be
made to charity no later than the due date of the tax return of
the trust for the year of death of the life tenant. Otherwise, the
donation tax credit will not be available to apply against the
income in the tax year ending with the death of the life tenant,
which will include any gain from the deemed disposition of all
capital on death of the life tenant.
• There may be a mismatch of credits available to reduce the
impact of U.S. estate tax on the death of the life tenant.
• There is no ability on death of the last surviving life tenant to
flow through capital gains eligible for the lifetime capital gains
exemption and it cannot be claimed by the trust.
• T3 returns must be filed annually.

4.7.7.3 AET Specific Requirements

Generally, to be an AET, a trust must satisfy the following conditions:

• At the time of the trust’s creation, the taxpayer creating the trust
was alive and had attained 65 years of age.
• The trust was created after 1999.
• The taxpayer is entitled to receive all the income of the trust
that arises before the taxpayer’s death.
• No person except the taxpayer could, before the taxpayer’s
death, receive or otherwise obtain the use of any of the income
or capital of the trust.

If the above conditions are satisfied, the taxpayer may make transfers
of capital property to the trust on a rollover basis. The conditions for
the AET are almost identical to those for the JPT, except the spouse or
common-law partner is not a beneficiary in the case of an AET.

108 See Chapter 9 for a complete discussion of the attribution rules.

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TYPES OF TRUSTS FOR TAX PURPOSES 4.7.7.4

If the trust meets these requirements, but it is not intended that the AET
rules apply, an election is available to opt out of tax treatment as an AET
under subpara. 104(4)(a)(ii.1). This election is not available for JPTs or
QSTs and should not be confused with the property-by-property elec-
tion to opt out of the rollover of property transferred to an AET. When
this election is made:

• the regular 21-year rule will apply so the first deemed disposi-
tion will be on the 21st anniversary of the creation of the trust,
and every 21 years thereafter,
• there is no deemed disposition on the death of the life tenant
(i.e., the settlor/contributor),
• no rollover is available on transfer of property to the trust (sub-
para. 73(1.02)(c), and
• there is no deemed year-end under subs. 104(13.4) on the death
of the life tenant (i.e., the settlor/contributor).

4.7.7.4 JPT Specific Requirements

Generally, to be a JPT, a trust must satisfy the following conditions:

• At the time of the trust’s creation, the taxpayer creating the trust
(i.e., the person transferring property to the trust by way of
settlement or gift) was alive and had attained 65 years of age.
• The trust was created after 1999.
• The taxpayer or the taxpayer’s spouse (including common-law
partner), or both of them, is entitled to receive all of the income
of the trust that arises before the later of the death of the tax-
payer and the death of the spouse.
• No other person except the taxpayer or the spouse could, before
the later of those deaths, receive or otherwise obtain the use of
any of the income or capital of the trust.

If these conditions are satisfied, the taxpayer may make transfers of cap-
ital property to the trust on a rollover basis, and may elect out of the
rollover on a property-by-property basis. If both spouses create the trust
jointly, and both meet the age 65 requirement, the trust will still satisfy

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4.7.7.5 Chapter 4 – Taxation of Trusts

the definition, and each of them may transfer capital property to the
trust on a rollover basis.109 Unlike AETs, there is no option to elect out
of the tax treatment for JPTs.

4.7.7.5 QST Specific Requirements

A transfer of property to an inter vivos QST is eligible for a rollover
under subs. 73(1). A QST may be inter vivos or testamentary.

An inter vivos QST generally must satisfy both of the following

conditions:110

• The transferor’s spouse or common-law partner must be enti-

tled to receive all the income of the trust that arises before the
death of the spouse or common-law partner.
• During the lifetime of the spouse or common-law partner, no
person except the spouse or common-law partner may receive
or otherwise obtain the use of any of the income or capital of
the trust.

Similarly, a testamentary spousal trust qualifies for the rollover upon the
death of a taxpayer under subs. 70(6) if all of the following criteria are met:

• The trust must be created by the taxpayer’s Will.

• The terms of the trust must provide that:
{ only the spouse or common-law partner is entitled to
receive all the income of the trust that arises before his or
her death, and
{ no person except the spouse or common-law partner may
receive or otherwise obtain the use of any of the capital of
the trust during the lifetime of the spouse or common-law
partner.
• The property must vest indefeasibly in the trust within 36
months after the death of the taxpayer (subject only to exten-
sion by the Minister of Revenue).

109 Technical Interpretation 2001-0099055, Joint Spousal Trust ( January 23, 2002).
110 Subss. 73(1) and (1.01).

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TYPES OF TRUSTS FOR TAX PURPOSES 4.7.8.1

A test for whether an interest has vested indefeasibly was set out in the
Boger Estate case111 by the Federal Court of Appeal:

• the person’s entitled to the interest must be ascertained,

• the interest must be ready to take effect in possession immedi-
ately, subject only to the existence of some prior interest, and
• the interest must not be subject to a condition precedent or a
condition subsequent.

It is possible to elect out of the rollover of any particular property trans-

ferred to an inter vivos QST under subs. 73(1) or a testamentary trust
under subs. 70(6.2). This election is available on a property-by-property
basis without altering the other tax attributes of the QST.

For example, a settlor can transfer property to the trust and elect to
trigger a taxable disposition on some property transferred, but permit
the rollover to apply with respect to the transfer of other property. This
might be the case where an individual wants to realize a capital gain
eligible for the capital gains exemption. He or she could elect out of
the rollover on the number of shares that results in realizing only the
amount of gain that will be sheltered by the exemption, or could elect
on all the property transferred. The election out of the rollover is only
for the transfer of that particular property, and no election is available
to opt out of the other rules relating to the tax treatment of the trust,
such as the deemed disposition on the death of the spouse.112

4.7.8 Trusts for Minor Beneficiaries

4.7.8.1 Legal and Tax Planning Reasons for a Trust

Property held for the benefit of a minor should either be held pursuant
to a provincial order of guardianship or under the terms of an express
written trust. Standard clauses are included in Wills and trusts to ensure
that the interest of any minor is held in trust, at least until the minor
attains the age of majority.

111 Maurice C. Cullity, Catherine A. Brown, and Cindy L. Rajan, Taxation and Estate Planning (Toronto:
Thomson Carswell, 2000) at loose leaf section 2.4.2(2)(b); and Boger Estate v. Minister of National
Revenue, [1991] 2 C.T.C. 168 (F.C.T.D.), affd [1993] 2 C.T.C. 81, 93 D.T.C. 5276 (Fed. C.A.), at [1991] 2
C.T.C. 168 at page 177.
112 The deemed disposition on death of the spouse under para. 104(4)(a) is not altered by electing out of
the rollover on transfer of property into the trust.

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4.7.8.2 Chapter 4 – Taxation of Trusts

For a discussion of the perils of undocumented trusts, see 4.2.6, Infor-

mal Trusts and “In Trust For” (ITF) Accounts. While the reasons for using
trusts for minors are legal, many of the tax planning opportunities avail-
able for minors may fail if there is no trust, or if the trust is not ade-
quately documented and the terms are not specifically designed with
the tax planning objectives in mind. The courts have consistently chided
taxpayers for not “dotting their i’s and crossing their t’s” when it comes
to proper documentation and tax planning, particularly with respect to
the creation and terms of a trust.

The law relating to property and minors is provincial, and regard should
be had to the particular laws of the province that are applicable. The
age of majority varies by province or territory and may be age 18 or
19. Persons who have not attained the age of majority lack legal capac-
ity and cannot enter into contracts in their own name,113 and there are
many difficulties if ownership of property is registered in the name of a
minor directly. Some provinces require property held for minors to be
paid to the provincial public trustee if it is not otherwise held in a for-
mal trust. In addition, the parent or another interested person may have
to apply to a court to be appointed as the legal custodian of the child’s
property if there is no formal trust.

Once the child attains the age of majority, if no written trust document
provides otherwise, the funds of the trust will vest in the child and the
child will be legally entitled to enforce payment to him or her. This is
the effect of the rule in Saunders v. Vautier.114 In a formal trust docu-
ment, this can be avoided by providing for a gift over to another benefi-
ciary (usually issue of the minor) in the event the child does not live to
a certain age, when final distribution is to be permitted.

4.7.8.2 Tax Planning Uses of Trusts for Minors

A trust can provide wealth preservation for a young person during
minority, or after the person attains majority, to defer vesting in posses-
sion until the beneficiary is mature enough to manage money responsi-
bly. This is sometimes referred to as the “red Porsche” provision (i.e., to
ensure that a young person doesn’t spend his or her funds unwisely).

113 With some exceptions, such as for necessities.

114 (1841), 41 E.R. 482. The rule is not applicable in Alberta and Manitoba.

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TYPES OF TRUSTS FOR TAX PURPOSES 4.7.8.3

There is no rollover available for a transfer of property to a trust for a

minor. However, a trust for minor children can provide an opportunity
to income split capital gains. The attribution rules do not attribute capi-
tal gains payable on property held for the benefit of a minor back to
the original transferor of the property.115 Thus, a trust can be set up for
minor children, property transferred to the trust, and subsequent capital
gains on trust property may be taxed in the hands of the minor. This
permits access to the lower marginal tax rates in the hands of the minor,
and can also multiply access to the capital gains deduction available on
qualifying property. The attribution rules will still apply to income other
than capital gains, such as interest, rent, and dividends.

4.7.8.3 Payments to or on Behalf of Minors

A deduction will be available to a trust when a direct payment is made
to a minor beneficiary. Typically, though, payments are not made directly
to the minor beneficiary, but rather are made on their behalf, either to
purchase goods or services for their benefit, or to reimburse the parent
or other family member for incurring expenses on behalf of the minor.
Problems may arise where the trust property returns to the settlor/parent
either directly from the trust or as part of a series of payments where the
parent ends up with the funds.

Payments made to or on behalf of children as beneficiaries cannot be

returned back to parents for the parents’ benefit. However, reimburse-
ments to parents for children’s expenses are acceptable in some circum-
stances (see 6.1.3, Third Party Payments).

From a tax perspective, a payment that will give rise to a deduction in a

trust may be made to a minor by making the payment to a guardian of
the infant, and the trust document will typically specify that payment to
a parent or legal guardian will be a sufficient discharge to a trustee. Pro-
vincial law may affect the right of a parent to receive funds on behalf of
a minor child.116 If one parent is a trustee, it may be better to make the
payment to the other parent to make it clear that a payment has been
made to the child’s guardian.

115 Assuming this is not a reversionary trust to which subs. 75(2) applies; see Chapter 9.
116 In Ontario, for example, parents generally are not the custodians of the child’s property where the
property exceeds $10,000.

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4.7.9 Chapter 4 – Taxation of Trusts

Funds held in a trust are governed by fiduciary duties (a duty of utmost

loyalty to act in the best interests of the beneficiaries) imposed by trust
law and the trust indenture. These duties are in part governed by the
common law and in part codified in the respective Trustee Act of each
province, as well as other provincial statutes relating to children and
guardians. While a trustee has a high duty to protect and act in the
best interest of the beneficiaries of the trust, the trustee also has a wide
latitude, depending on the terms of the trust indenture or Will in ques-
tion, in investing and dealing with the property of the trust. By contrast,
funds that are distributed directly to a minor child are very difficult to
deal with because of the general unenforceability or voidability of con-
tracts made by children, the limited powers of guardians, and the super-
vision of funds of minors by the courts and governmental bodies.

4.7.9 Age 40 Trusts Permit Accumulating Income to Be Taxed to Under-Age-21

Beneficiaries — Subs. 104(18)

A special rule in subs. 104(18) permits income to be taxed in the hands of a

beneficiary who has not attained age 21, even when it is not payable to such
beneficiary. Essentially this rule permits a trust to accumulate income until the
beneficiary attains a specified age, not to exceed age 40, when it must be pay-
able to him or her. This can be very useful for income splitting and tax planning
purposes, since income can be taxed in the hands of a young beneficiary at the
marginal tax rates, but there is no actual requirement to pay out the income
until the child attains age 40. For a discussion of planning with age 40 trusts, see
10.2.2, Using Fixed Interest Age 40 Trusts to Defer Payment of Income Taxed in
the Hands of a Beneficiary Under Age 21.

In order for this rule to apply, the income of the trust arising in any year before
the beneficiary attains age 21 must automatically vest in the hands of the ben-
eficiary without the exercise of any discretion. This is sometimes referred to as
a “fixed interest trust.”117 Legally it is possible for a right to a payment to “vest”
(i.e., the right to the payment is not subject to any condition precedent or condi-
tion subsequent), even though it is not payable until a later time. This is called
an interest “vested but not in possession” in property law. The only condition
permitted under the rule in subs. 104(18) is that the amount may not be pay-
able until the beneficiary attains a specified age, not to exceed age 40. Note that

117 Although it is somewhat of a misnomer since once a particular beneficiary has attained age 21 the
requirement for non-discretionary rights to income for that beneficiary no longer applies.

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TWENTY-ONE-YEAR RULE 4.8.1

the rule applies only to income during the years before the beneficiary turns 21.
Subs. 104(18) requires that:

• the income not be payable in the year,

• the income be held in trust in the year for an individual beneficiary
who is under 21 years of age,
• the trust was resident in Canada throughout the year,
• the right to the income vested in the beneficiary in the year,
• the right to income did not arise through the exercise of any dis-
cretionary power, and
• the only permissible condition on the beneficiary’s entitlement is
that the beneficiary survive to a specified age, not exceeding 40
years.

If these conditions exist, the income is deemed to be payable under subs. 104(18)
and the beneficiary may be taxed on the income with a corresponding deduc-
tion by the trust, notwithstanding that the income is not paid or payable until
the beneficiary attains the specified age.

Accordingly, a fixed interest trust should be considered by those who want to

build up capital that will ultimately be distributed to children on or before the
day they reach the age of 40. The advantage over a discretionary trust in this
regard is the ability to hold funds, possibly contrary to the wishes of the benefi-
ciaries, until they reach a certain age that may be up to 40 years. The standard
discretionary family trust will not satisfy the conditions for this rule, because the
income is subject to the exercise of a discretionary power.

4.8 TWENTY-ONE-YEAR RULE

4.8.1 General Rule

A personal trust is deemed to have disposed of all capital property and land
inventory every 21 years,118 commencing the day that is 21 years after the day
the trust was created, and every 21 years thereafter. Since there was no capital
gains tax prior to 1972, the first deemed disposition is not until the later of 21
years after:

118 Subs. 104(4).

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4.8.2 Chapter 4 – Taxation of Trusts

• the creation of the trust, and

• January 1, 1972.
Accordingly, the first possible deemed disposition under this rule for any trust was
January 1, 1993. Practitioners still occasionally see old trusts that have been in exis-
tence since before 1972 where the deemed disposition under the 21-year rule has
not been reported. These are usually long-term family trusts created under Wills.

Any capital gains resulting from the deemed disposition as a result of this rule
may, if they can be considered “paid or payable” to a beneficiary, be allocated to
a beneficiary and not taxable in the trust.

There are special rules with respect to the 21-year rule relating to qualifying life
interest trusts (AETs, JPTs, and QSTs). Generally, the first deemed disposition
under the rule is deferred until the death of the surviving life tenant (the settlor
in the case of an AET) or until the last to die of the settlor and the beneficiary
(the spouse or common-law partner in the case of a JPT or a QST). In addition,
for this first deemed disposition on death, no allocation of resulting capital gains
to a beneficiary may be made and the gains must be taxed in the trust even if
income of the trust is otherwise payable to a beneficiary.119

4.8.2 The 21-Year Deemed Disposition Rule Is Not a Duration Rule

The 21-year rule is often confused as being a rule against trusts continuing
beyond 21 years. Many trusts do have a termination period that is no longer
than 21 years less at least one day, in order to avoid the 21-year deemed dispo-
sition rule. However, trusts may continue beyond the 21-year period, subject to
the rules against perpetuities and accumulations of income. In fact, many trusts
provide discretion to distribute trust property within the 21-year period so that
the particular property will not be subject to the rule, but the trust may continue
beyond this period. Alternatively, discretion can be given to wind up the trust
within this period, which gives flexibility if there are no advantages to operating
the trust for a continued period.

119 Cl. 104(6)(b)(i)(c).

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TWENTY-ONE-YEAR RULE 4.8.6

4.8.3 The 21-Year Rule Compared with Other Trust Law Rules

The 21-year rule is also sometimes confused with the rule against accumulations,
which prohibits income from being retained by the trust for a certain period.120

4.8.4 Qualifying Spousal and Common-Law Partner Trusts (QSTs)

A different rule applies to spousal trusts eligible for the rollover, including
common-law partner trusts. No deemed disposition takes place during the life-
time of the spouse. Instead, a deemed disposition takes place upon the death of
the spouse or common-law partner, and subsequently a further deemed disposi-
tion takes place every 21 years after the spouse or partner’s death.

4.8.5 Alter Ego and Joint Partner Trusts (AETs and JPTs)

Similar to spousal trusts, there is no deemed realization during the lifetime of

the settlor, or both the settlor and the spouse in the case of a JPT. There is a
deemed realization of trust assets on the death of the settlor of an AET and on
the last-to-die of a JPT, and thereafter every 21 years.

4.8.6 Exception for Interests Vested Indefeasibly

Also note that the 21-year deemed disposition does not occur in a personal trust
under which all interests have vested indefeasibly at the time the deemed disposi-
tion would otherwise occur.121 Essentially, property will vest indefeasibly if the right
to the property is vested in a particular beneficiary who is identified, and the right
to the property is not subject to any condition precedent or condition subsequent.
In this case, a deemed disposition of that beneficiary’s interest would arise at the
time of the death of the beneficiary. Interests will fail to vest indefeasibly, and the
21-year rule will apply, where income interests shift among a pool of beneficiaries
as they die, or a remainder interest in the trust may become effective in the future.

120 In Ontario, 21 years. The rule against accumulation applies only in some provinces.
121 See requirements for “vested indefeasibly” at 4.7.8.

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4.9 Chapter 4 – Taxation of Trusts

Figure 4.3: Application of 21-Year Rule

Type of Trust Timing of Deemed Dispositions

Qualifying spousal or common-law partner trust (QST) On death of surviving spouse and every 21 years thereafter
Tainted spousal trust Every 21 years commencing the later of January 1, 1972, and the
date the trust was created
Alter ego trust (AET) On death of settlor/contributor/beneficiary and every 21 years
thereafter
Joint spousal or common-law partner trust (JPT) On death of last to die of settlor/contributor/beneficiary and spouse
and every 21 years thereafter
Other personal trust Every 21 years commencing the later of January 1, 1972, and the
date the trust was created

4.9 ALTERNATIVE MINIMUM TAX (AMT)

Like individuals, trusts are generally subject to alternative minimum tax (AMT),122
but some exceptions apply. For a general discussion of AMT, see 2.4.3.

For qualifying life interest trusts (a trust that qualifies as a QST, AET, or JPT),
minimum tax does not apply in the year that the first deemed disposition would
take place under the 21-year rule, as shown in Figure 4.3. Essentially this means
there is no minimum tax in the year that the surviving spouse dies in a QST, the
year that the settlor/contributor/beneficiary dies in an AET, and the last of the
settlor/ contributor/beneficiary or spouse in a JPT. In all other taxation years,
minimum tax will apply.

Graduated rate estates are entitled to the same $40,000 annual basic exemption
for AMT available to individuals, but this exemption is not available to other
trusts.

4.10 PREFERRED BENEFICIARY ELECTION ON ACCUMULATING INCOME FOR

DISABLED BENEFICIARIES

The preferred beneficiary election permits a trust to take a deduction for income
accumulated (but not paid or payable) on behalf of a beneficiary who qualifies
as a “preferred beneficiary.”123 The income subject to the election will also be
taxable to the beneficiary. The income may be retained indefinitely in the trust
and never needs to actually be paid to the beneficiary.

122 Ss. 127.5–127.55.

123 Defined in subs. 108(1).

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PREFERRED BENEFICIARY ELECTION ON ACCUMULATING INCOME FOR DISABLED BENEFICIARIES 4.10.1

CRA sets out a full discussion of the requirements for the preferred beneficiary
election for trusts in IT-394R2 (Archived), Preferred Beneficiary Election, dated
June 21, 1999. The definition of “preferred beneficiary” includes an individual
who is the settlor, spouse, former spouse, child, grandchild, or great-grandchild
of the settlor, and who:

• is eligible for the disability tax credit for mental or physical impair-
ment under subs. 118.3(1), or
• attained at least age 18 in the year and
{ was a dependant (as defined in subs. 118(6)) of his or her
spouse or parent or grandparent,
{ was a dependant by reason of mental or physical infirmity, and
{ whose income does not exceed the basic personal amount for
the year, calculated before the income subject to the preferred
beneficiary election.

The preferred beneficiary election can permit the income in an inter vivos trust
to be taxed at the lower marginal rates of the beneficiary rather than at the top
marginal rate of tax in the trust.

Care should be taken to ensure that the notional income attributed to the benefi-
ciary under the preferred beneficiary election will not unwittingly endanger the
beneficiary’s eligibility to income assistance or other assistance programs for the
disabled, including provincial disability benefits or any other benefits that are
subject to an income test. Provincial disability benefit programs must be consid-
ered on a province-by-province basis.

4.10.1 Filing Requirements

The preferred beneficiary election is a joint election whereby the trust and the
preferred beneficiary designate the amount of accumulating income of the trust
to be included in the income of the preferred beneficiary.124 There is a prescribed
form that must be filed no later than 90 days after the trust’s taxation year-end.
Failure to file by the due date may be remedied only in limited circumstances,
and is subject to late-filing penalties.

124 The election is made under subs. 104(14), which provides for the income inclusion to the preferred
beneficiary. The deduction by the trust is provided for in subs. 104(12).

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4.11 Chapter 4 – Taxation of Trusts

4.11 PRINCIPAL RESIDENCE

For a general discussion of the principal residence exemption, see 3.2.8.

4.11.1 Transfer of a Principal Residence to a Trust

An individual may claim the principal residence exemption to shelter the gain on
the transfer to a trust of a qualifying residence since, unless a rollover applies,
the transfer will normally be deemed to take place at FMV.125 If a rollover applies
(on a transfer to a spousal, common-law partner, alter ego, joint spousal, joint
common-law partner or self-benefit trust), the trust is deemed to own the prop-
erty for the same period as the individual prior to the transfer, and the property
will qualify as a principal residence of the trust for those years if it would have
so qualified for the individual transferor.

4.11.2 Use of the Principal Residence Exemption (PRE) by a Trust

A trust can claim the principal residence exemption (PRE) only in respect of any
year in which there is a “specified beneficiary” of the trust for the year. A speci-
fied beneficiary includes a beneficiary of the trust or qualifying family member
of a beneficiary who ordinarily inhabited the residence in the year. A designa-
tion by the trust of any property as a principal residence in the year will extin-
guish the right of all specified beneficiaries of the trust from designating any
other property as their principal residence for the year. These rules ensure that a
trust cannot multiply access to the PRE. However, the rules can apply to reduce
access to the exemption where there are multiple beneficiaries.126

The definition of principal residence for a personal trust in subss. 54(b) and
(c.1) provides that the trust must:127

• Designate the property to be its principal residence for each par-

ticular year of ownership or deemed ownership.
• Specify each person who in the year designated was a “specified
beneficiary,” which is an individual who
{ was beneficially interested in the trust, and

125 Subpara. 69(1)(b)(iii) and para. 69(1)(c) deem the gift or transfer to a trust to be at FMV. See also
Income Tax Folio, S1-F3-C2, Principal Residence, paras. 35–37, dealing with personal trusts.
126 For a comprehensive discussion of the PRE pertaining to trusts, see Chow et al., Taxation of Trusts and
Estates: A Practitioner’s Guide 2015, supra note 97, at pages 219–247.
127 See also Form T1079, Designation of a Property as a Principal Residence by a Personal Trust.

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PRINCIPAL RESIDENCE 4.11.2

{ either ordinarily inhabited the property or whose spouse, for-

mer spouse, or child ordinarily inhabited the property.

The exemption will not be available if any corporation (other than a registered
charity) or partnership is a beneficiary of the trust.128 The availability of the
exemption as between the trust and a specified beneficiary, as defined above, or
certain persons related to a specified beneficiary is mutually exclusive. A desig-
nation of a principal residence for a year by the trust will preclude each speci-
fied beneficiary and related individuals from claiming the exemption on any
property in that year and vice versa. Persons related to the specified beneficiary
include a specified beneficiary’s:

• spouse, unless legally separated throughout the year,

• unmarried child under 18 years of age at the end of the year, and
• mother, father, or unmarried brother or sister under age 18 at the
calendar year-end, if the specified beneficiary is unmarried and
under 18 at the end of the calendar year.
The generous interpretation of what constitutes “ordinarily inhabited” and what
is considered to be a beneficial interest cast a very wide net with respect to the
persons who fit within the definition of a specified beneficiary. Except for the
rule for trusts, this usually works in the taxpayer’s favour, permitting greater
access to the exemption. The reverse is true where a trust holds a residence
and there is more than one beneficiary who uses the property, as very little
“use” is required to satisfy the “ordinarily inhabits” test. This creates the poten-
tial for multiple specified beneficiaries who will all be pre-empted from using
the exemption on any of their own property that would otherwise qualify for
any year the trust makes a designation.

This has an onerous result where there are many specified beneficiaries who
own other residential properties that may qualify, since all such beneficiaries
and their spouses are disentitled from using the exemption on other residences
owned by them for that year.

128 Para. (c.1)(iii) of the definition.

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4.11.3 Chapter 4 – Taxation of Trusts

4.11.3 Proposed Changes to Principal Residence Exemption Rules

NOTE: See STEP Update on Tax Changes in the student resources section of the STEP website to review the status of the
legislation changing the rules for the PRE, which have not as of October 1, 2017, received Royal Assent.

Under proposed changes to the Act, first introduced in 2016, and further amended
in October 2017, not all trusts can designate a property as their principal residence
in respect of particular years that begin after 2016. The definition of principal resi-
dence for a personal trust in para. 54(c.1)(iii.1) provides that only the following
trusts are eligible to designate a property as a principal residence for years that
begin after 2016:

• a qualifying life interest trust (AET, JPT, or QST),

• a qualified disability trust (QDT), or
• an “orphan’s trust.”
For this purpose, an “orphan trust” is a trust settled by a parent of a beneficiary
who has not attained age 18 before the end of the year and whose parents are
not alive at the beginning of the year.

The changes made to the draft legislation in October 2017 removed the require-
ment in the original proposed changes that the terms of the trust specifically pro-
vide the beneficiary with the right to use and enjoyment of the property.

The formula for claiming the PRE is set out in para. 40(2)(b) of the Act. For dis-
positions after October 2, 2016, the “one plus” rule in the formula is only avail-
able for years during which the individual is resident in Canada.

Prior to 2016, CRA had an administrative policy that a disposition of a princi-

pal residence was not required to be reported in an individual’s tax return if the
gain was fully sheltered by the PRE. For the 2016 and following tax years, the
administrative concession is no longer in place: reporting the disposition of a
principal residence and claiming the PRE is now required. Failure to report a
disposition of a principal residence extends the reassessment period indefinitely
under subs. 152(4.01).

4.11.4 Transferring Principal Residence Out of Trust

The general rule for a rollover under subs. 107(2) applies to a distribution by a
trust to a beneficiary. No capital gain is realized by the trust on the distribution

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CHARITABLE DONATION MADE BY TRUSTS AND ESTATES 4.12

of the property in satisfaction of a capital interest, since the proceeds of disposi-

tion are deemed to be the ACB of the property to the trust and the beneficiary is
deemed to have acquired the property for that same amount.

The trust may also elect out of the rollover under subs. 107(2.01). The election
out of the rollover is typically used where the trust has unused losses.

If a trust transfers a principal residence to a capital beneficiary on a tax-deferred

basis, the tax attributes for the period the residence was owned by the trust flow
through to the beneficiary — that is, the beneficiary is deemed to have owned
the residence since the trust last acquired it.129 As a result, the beneficiary may
claim the principal residence exemption for the years owned by the trust, and
must claim it for those years to fully shelter any gain. Given the problems with
the trust using the exemption, as described above (i.e., potentially disqualifying
multiple individuals from using the exemption), and the restrictions regarding
years that begin after 2016, the transfer by the trust on a rollover basis to one
beneficiary and the use of the exemption by that individual upon an arm’s-length
sale may provide better access to the PRE, and will be much more efficient from
a tax perspective where more than one individual is a specified beneficiary as
only the PRE of that beneficiary need be utilized to shelter the gain.

4.12 CHARITABLE DONATION MADE BY TRUSTS AND ESTATES

Charitable giving is an important part of planning in the trust and estate area.
The tax consequences are often assumed to be straightforward. It may be pre-
sumed by those promoting planned giving for their particular cause, or by those
who lack extensive tax expertise, that charitable donations of every kind will
give rise to appropriate tax relief. In reality, this area is a whole specialty on its
own that deserves significant examination. This material only touches on the
most basic issues for trusts.

Just like an individual, a trust is entitled to claim the amount eligible for a dona-
tion tax credit for eligible gifts — that is, a gift made to a qualified donee130 in
the year made or any of the following five taxation years.

There are special rules for charitable gifts made in a Will. The gift is deemed to
be made when the estate actually transfers property to complete the gift. If the

129 Subs. 40(7).

130 Subs. 118.1(3).

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4.12 Chapter 4 – Taxation of Trusts

transfer is made by the GRE, the gift will qualify as an eligible gift for the pur-
poses of generating the donation tax credit in the year made, any prior year of
the GRE, in the year of death, or the immediately preceding death. If the transfer
is made within 60 months of the date of death and the estate would otherwise
be a GRE except for the 36-month requirement for GREs, the same rule applies:
the gift will be an eligible gift in the year made, any prior year of the estate was
a GRE, the year of death, or the year immediately before death.131 In addition,
the usual rule for five-year carryforward will apply.

The same rules and flexibility apply to donations made by transfer of RRSPs,
RRIFs, TFSAs, and life insurance proceeds under new subss. 118.1(5.2) and (5.3).

For the rules for charitable gifts in a Will to apply, the subject of the gift (i.e., the
property transferred by the estate) must be property acquired by the estate on and
as a consequence of the death of the individual or substituted property. Questions
have arisen as to this latter requirement. It seems unlikely, for example, that funds
received by an estate by way of capital dividend would qualify. CRA has already
stated that cash cannot be substituted property for shares. Where life insurance is
used to provide liquidity in an estate, this may be a problem.

For years prior to 2016, gifts in a Will were only available as eligible gifts for the
year of death or the prior year.

For AETs, JPTs, and QSTs, the new deemed year-end on the death of the life ten-
ant introduced for 2016 would disqualify any donation in the terms of the trust
on the death of the life tenant because the donation could not be made within
the same taxation year, and there is no carry back for gifts, except for GREs as
noted above. Accordingly, in part (c)(ii)(C) of the definition of “total charitable
gifts” in subs. 118.1(1), gifts by such trusts can be utilized to generate a donation
tax credit for the stub period year-end created by subs. 104(13.4) if made no later
than the tax return filing date of the stub period year. There is also a require-
ment, similar to that for GREs, that the subject of the gift be property held by the
trust at the time of the death of the life tenant, or substituted property.

The legal nature of a gift is that it is voluntary, and without any consideration. For
this reason, only charitable gifts made by a trust that are discretionary qualify

131 See part (c) of the definition of “total charitable gifts” in subs. 118.1(1) and subs. 118.1(5). Part (c)(i) of
the definition of “total charitable gifts” deals with the year of death and the prior year, (c)(ii)(B) deals
with GREs and estates that would qualify as GREs within 60 months of the date of death, and (c)(ii)(C)
deals with qualifying life interest trusts.

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CHARITABLE DONATION MADE BY TRUSTS AND ESTATES 4.12

for the donation tax credit. Mandatory transfers (i.e., those dictated under the
terms of the trust) do not qualify. An example of a mandatory transfer is where
the trust provides for a capital distribution to a charity and there is no discretion
to be exercised, such as to the amount of such distribution. This may occur in
an AET, or in a QST on the death of the life tenant, where the charity is named
as the residual beneficiary. In such a case, the transfer to the charity would be
regarded as a distribution of capital and not a charitable gift.132 In contrast, a
discretionary gift made by a trustee on behalf of the estate or trust will qualify
for the tax credit. Note that immediate gifts made under the terms of a Will do
not need to be discretionary, but they are not available to the estate since they
are deemed made by the deceased in the year of death and generate a donation
tax credit for the terminal return.

Under the rules in effect prior to 2016, gifts made by Will were deemed to be
gifts made by the deceased during the year of death,133 and therefore generated
a donation tax credit in the terminal return of the deceased, not in the estate.134
There was no need for gifts by Will to be discretionary, and under the new
rules this appears to be the case as a result of the new legislation — see subss.
118.1(4.1) and (5), as gifts by Will are deemed to be gifts of the estate.

If the gift is not payable until after other events have occurred, such as from
a testamentary trust created under the Will, it is not considered a gift by Will,
although there may be two other opportunities to use the donation tax credit
in respect of the gift. If the gift is discretionary, it may qualify for the donation
credit to the estate at the time of the gift. It may also qualify for the donation tax
credit in the terminal return if it is considered a donation to a charitable remain-
der trust.135

The new rules relating to flexibility for donations in respect of death, and for
timing of the donation for AETs, JPTs, and QSTs, do not solve the problem of
whether a gift in a Will or in a trust on the death of a life tenant qualifies for a
gift. Accordingly, such gifts will still need to be discretionary if they are to be
treated by CRA as gifts for the purpose of generating the donation tax.

132 Technical Interpretation 2003-0182905, Gifts of Interest in Alter Ego Trust (December 11, 2003).
133 Subs. 118.1(5).
134 It appears that this rule saves a charitable gift from the residue of an estate, which would be a capital
distribution, from being disqualified.
135 Charitable remainder trusts are not defined in the Act, and their tax treatment is subject to CRA’s
administrative position. Basically, the charity is the sole capital beneficiary subject to an income interest
by an individual who is the life tenant. The gift is available for the donation tax credit at the time of the
transfer to the trust, but the amount is discounted by the actuarial value of the interest of the life tenant.

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4.12.1 Chapter 4 – Taxation of Trusts

For additional discussion, see 7.13.3, Charitable Donations and New Rules for
Deaths after 2015.

4.12.1 Value of Donation Where Gift in Kind of Capital Property in a Will

Where there is a gift in kind of capital property in a Will, the relevant value of
the eligible amount of the gift for determining the tax credit is the FMV at the
date of the transfer of property by the GRE to the beneficiary, which is the time
the actual gift is deemed to take place under subs. 118.1(5). Prior to the 2016
changes, the value was the FMV of the property at the time of death.

4.13 KEY STUDY POINTS

• The tax rules relating to a trust and its beneficiaries apply only if
the arrangement is a trust under trust law. Failure to satisfy the
three certainties will result in very different tax consequences.
• A trust is taxed as an individual, although special rules apply that
differ from those relating to an individual. These include special
rules for some trusts, such as GREs, and deemed disposition for
trusts (the 21-year rule).
• The word “income” in a trust document does not include receipts
that are considered capital receipts in trust law, such as capital
gains.
• Unique tax rules apply to different types of trusts. These include
qualifying life interest trusts (QSTs, AETs, and JPTs), GREs, and
QDTs. The transfer of property to a trust to settle a trust is a gift,
and as such a deemed disposition takes place of any capital prop-
erty settled in the trust for proceeds of disposition equal to FMV.
Exceptions may apply to particular trusts where an automatic roll-
over applies in the absence of an election not to have the rollover
apply.
• A trust is a conduit for tax purposes: income and capital gains can
be flowed through to a beneficiary, and the tax attributes of certain
sources of income will also retain their character in the hands of
the beneficiary. Income and capital gains must be paid or payable
to a beneficiary in order for the income or capital gain to be tax-
able to the beneficiary and deductible by the trust. There are some

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KEY STUDY POINTS 4.13

exceptions to the “paid or payable rule,” including the preferred

beneficiary election and the election to realize income or capital
gains in a trust to absorb losses in the trust. Losses in a trust cannot
be allocated to a beneficiary.
• Distributions of capital property to a trust in satisfaction of a capi-
tal interest in a trust, either during the existence of the trust or
on termination of the trust, result in a deemed disposition of that
capital property on a rollover basis (i.e., at the tax cost of the trust),
unless an election is made for the rollover not to apply. There are
exceptions to the distribution rollover, including where subs. 75(2)
applies, and where the beneficiary is a non-resident of Canada
unless the property is taxable Canadian property.
• Trusts are deemed to dispose of all capital property every 21 years.
Qualifying life interest trusts have their first deemed disposition on
the death of the life tenant, or last surviving life tenant, and every
21 years thereafter. This rule does not apply to life insurance poli-
cies because they are not capital property.
• Trusts are subject to alternative minimum tax (AMT).
• The principal residence exemption (PRE) can be claimed by certain
trusts, including AETs, JPTs, QSTs, QDTs, and orphan trusts. It is
possible for a beneficiary to use his or her PRE to shelter gains on
a residence while it was held by a trust, if the residence is distrib-
uted to the beneficiary on a rollover basis.
• Special rules apply to charitable donations made in a Will and paid
by a GRE, or by an estate within 60 months of death if the estate
would otherwise qualify as a GRE but for the 36-month require-
ment. These rules permit the eligible gift to be claimed for gener-
ating a donation tax credit in the year property was transferred to
complete the gift, any prior year of the estate while it was a GRE,
the year of death, or the year immediately before death. This is in
addition to the rule permitting a five-year carryforward.

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 CHAPTER 5
COMPLETING THE T3 TRUST
OR ESTATE RETURN

LEARNING OBJECTIVES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–5

5.1 REQUIREMENTS TO FILE RETURNS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–5

5.1.1 What Returns Must Be Filed by a Trust? . . . . . . . . . . . . . . . . . . . 5–5

5.1.2 Requirement to File T3 Tax Return and Exception
Where Trust Has Minimal Income . . . . . . . . . . . . . . . . . . . . . . . . 5–6
5.1.3 When Are Returns Required to Be Filed? . . . . . . . . . . . . . . . . . . 5–7
5.1.3.1 Due Date Is 90 Days, NOT Three Months . . . . . . . . 5–7
5.1.3.2 Payment of Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–8
5.1.4 Late-Filing Penalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–8
5.1.5 Who Must File the Returns? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–8
5.2 SPECIFIC MATTERS RELATING TO THE T3 FOR THE FIRST YEAR
OF THE ESTATE OR GRE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–8

5.2.1 Carryback of Losses to the Terminal Return — GREs . . . . . . 5–8

5.2.2 Tax Year-End for Trusts and Graduated Rate Estates (GREs) . . . 5–9
5.2.3 Final Tax Year of a Trust or Estate . . . . . . . . . . . . . . . . . . . . . . . 5–10
5.2.4 File a Copy of the Will . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–11
5.2.5 Income of a Trust or Estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–11
5.3 INFORMATION REQUIRED IN THE T3 RETURN . . . . . . . . . . . . . . . . . 5–11

5.3.1 Residence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–11

5.3.2 Type of Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–12
5.3.3 Other Required Information — Questions . . . . . . . . . . . . . . 5–12
5.3.3.1 Question 2: Required Payments of Income
to Beneficiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–12
5.3.3.2 Question 3: Distributions of Assets Other
than Cash to a Beneficiary . . . . . . . . . . . . . . . . . . . 5–13

5–1
 5.3.3.3 Question 5: Lifetime Beneficiary Death in
the Year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–13
5.3.3.4 Question 6: Borrowing from or Incurring a
Debt to a Non-Arm’s Length Person . . . . . . . . . . 5–14
5.3.3.5 Question 7: Change in Ownership of Capital
or Income Interest in the Trust . . . . . . . . . . . . . . . 5–14
5.3.3.6 Question 8: Holding Shares in a Private
Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–14
5.4 DETERMINING AND REPORTING NET INCOME ON THE T3 . . . . 5–15

5.4.1 Taxable Capital Gains and Allowable Capital Losses . . . . . 5–15

5.4.2 Dividends from Taxable Canadian Corporations . . . . . . . . 5–15
5.4.3 Foreign Investment Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–16
5.4.4 Other Investment Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–16
5.4.5 Income from a Business, Farming, Fishing, and Rental
Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–16
5.4.6 Reporting Deemed Dispositions: Gains or Losses . . . . . . . 5–17
5.4.7 Other Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–17
5.4.8 Post-Mortem Income from an Unmatured Registered
Retirement Savings Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–17
5.4.9 Deductions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–17
5.4.9.1 Interest Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–18
5.4.9.2 Carrying Charges for Investments . . . . . . . . . . . . 5–18
5.5 DESIGNATIONS AND ALLOCATIONS TO BENEFICIARIES IN
COMPUTING NET INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–18

5.5.1 Allocations to Beneficiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–19

5.5.1.1 Election to Tax Trust for Amounts Taxable to
Beneficiary to Absorb Losses in the Trust . . . . . 5–19
5.5.2 Designating the Type of Income Receipt to the
Beneficiary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–20
5.5.3 T3 Summary and T3 Slips . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–21
5.5.4 NR4 Slips and NR4 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–21

5–2
5.6 DETERMINING TAXABLE INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–22

5.6.1 Non-Capital Losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–22

5.6.2 Net Capital Losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–22
5.6.3 Special Capital Loss Carryback to the Terminal Return
in the First T3 of a Graduated Rate Estate . . . . . . . . . . . . . . . 5–23
5.6.4 Claiming Losses Carried Forward from Prior Years . . . . . . . 5–23
5.6.5 No Capital Gains Deduction for a Trust and Problems
with Deemed Dispositions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–23
5.7 TAX CONSEQUENCES WHERE THERE ARE NON-RESIDENT
BENEFICIARIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–24

5.7.1 Part XII.2 Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–24

5.7.2 Withholding Tax on Amounts Paid or Credited to Non-
Residents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–26
5.7.3 Certificates of Compliance for Capital Distributions to
a Non-Resident . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–26
5.8 LIABILITY OF THE PERSONAL REPRESENTATIVE FOR TAX AND
CLEARANCE CERTIFICATES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–26

5.9 KEY STUDY POINTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5–28

5–3
 Chapter 5
Completing the T3 Trust
or Estate Return

Learning Objectives
Knowledge Objectives:
• Know the requirements to file and complete the T3 Trust Income Tax and
Information Return.

Skills Objectives:
• Explain the requirement for a trust and estate tax return.
• Describe and explain the contents of the T3 Trust Income Tax and Information
Return.

5.1 REQUIREMENTS TO FILE RETURNS

Chapter 11 contains details for the filing of tax returns and other compliance
matters that are not repeated here. For example, see 11.2, Requirement to File
Returns and Pay Tax Owing.

5.1.1 What Returns Must Be Filed by a Trust?

Trusts file tax returns annually just like individuals. However, instead of the
T1 General Income Tax and Benefit Return required to be filed by individuals,
trusts file a T3 Trust Income Tax and Information Return (T3 Return). There is
an annual T3 Trust Guide (Form T4013) that is helpful in providing assistance
in completing the T3 Return. The T3 Return has a number of schedules that are
referred to throughout this chapter.

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5.1.2 Chapter 5 – Completing the T3 Trust or Estate Return

The T3 is both an income tax return, which calculates income and tax payable,
and an information return, which reports amounts allocated and designated to
beneficiaries. Where income is allocated to resident beneficiaries, the following
information returns must also be filed:

• T3 Summary: Summary of Trust Income Allocations and Designa-

tions and
• T3 Slips: Statement of Trust Income Allocation and Designations
{ A T3 Slip must be issued for each beneficiary of a trust to whom
income is allocated. The beneficiary is required to file the T3
Slips with his or her individual T1 Return for the year.

Similarly, if income is allocated or designated to a non-resident of Canada, the

trust must prepare and file non-resident information returns, which show the
allocation or designation to each non-resident beneficiary:

• NR4 Summary: Return of Amounts Paid or Credited to Non-

Residents of Canada and
• NR4 Slips: Statement of Amounts Paid or Credited to Non-Residents
of Canada.

In summary, a trust is required to file a T3 Summary and T3 Slips for its resi-
dent beneficiaries and an NR4 Summary and NR4 Slips for its non-resident
beneficiaries.

5.1.2 Requirement to File T3 Tax Return and Exception Where Trust Has
Minimal Income

For the requirements to file tax returns and the exceptions in the Act, see 11.2.
In addition to the requirements listed there, a trust must file a tax return if it
holds any property subject to the rule in subs. 75(2).

Where the trust has income of no more than $500, CRA has an administrative
policy not to require a T3 Return for a year in which the trust receives from the
trust property any income, gain, or profit that is allocated to one or more benefi-
ciaries and the trust does not have:

• total income from all sources of more than $500,

• income of more than $100 allocated to any single beneficiary,

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REQUIREMENTS TO FILE RETURNS 5.1.3.1

• made a distribution of capital to one or more beneficiaries, or

• allocated any portion of the income to a non-resident beneficiary.1

5.1.3 When Are Returns Required to Be Filed?

Trusts, including estates, are required to file a T3 Return annually. The T3 Return
and related forms are due 90 days after the year-end of the trust or estate.2 For
inter vivos trusts, this means that the annual T3 Return is due on March 31 of the
following year, or March 30 if the year is a leap year. For graduated rate estates
(GREs), the return deadline can vary, as the year-end is chosen by the execu-
tors (so long as the first year-end does not exceed 12 months ( i.e., no later than
the first anniversary of the death of the individual).3 If a GRE loses its status as
a GRE, it becomes an inter vivos trust for tax purposes, and a year-end will be
triggered immediately before the change of status. The resulting inter vivos trust
will then have a December 31 year-end.

For qualifying life interest trusts (i.e., AETs, JPTs, and QSTs) that all have a
deemed year-end on the death of the life tenant or last surviving life tenant (in
the case of a JPT), the due date for filing the T3 Return and paying tax for that
“stub period” is based on the calendar year.4

Failure to file the T3 Return on time may result in interest and penalties being
assessed if the trust has tax payable. The filing deadline for the T3 Summary, T3
Slips, NR4 Summary, and NR4 Slips is identical to that of the T3 Return.

5.1.3.1 Due Date Is 90 Days, NOT Three Months

Note that the deadline is not the same as three months following year-
end. Practitioners sometimes get caught with graduated rate estates on
this point. The deadline is 90 days from the trust or estate’s year-end,
not three months, which is usually 91 or more days. This almost always
falls short of the three-month period after the year-end of an estate,
as long as one of the months does not include February, the shortest
month of the year.

1 See the T3 Trust Guide under “Who Should File.”

2 Para. 150(1)(c).
3 Para. 104(23)(a).
4 Para. 104(13.4)(c).

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5.1.3.2 Chapter 5 – Completing the T3 Trust or Estate Return

If the filing due date falls on a Saturday, Sunday, or statutory holiday,

CRA will generally consider the return to be filed on time if it is deliv-
ered on, or postmarked by, the first working day after the filing due
date.

5.1.3.2 Payment of Tax

Payment of tax is also due on the due date of the T3 Return.

5.1.4 Late-Filing Penalties

Late filing penalties are covered in detail at 11.6. In addition to late-filing pen-
alties for the T3 Return, there are penalties for each late-filed T3 slip and each
late-filed NR4 slip.

5.1.5 Who Must File the Returns?

It is the responsibility of the trustees (including executors or administrators

appointed to manage an intestate estate) to prepare and file the T3 Return. How-
ever, a trustee is not liable personally to pay the tax liability of a trust unless
distributions have been made without a proper clearance certificate.5 In practice,
the actual preparation of the return is often done by an accountant. However, the
responsibility for the accuracy and filing remains with the trustee. The trustee
must sign the return and certify that the return and all attached documents are
correct, complete, and fully disclose the trust’s income from all sources.

5.2 SPECIFIC MATTERS RELATING TO THE T3 FOR THE FIRST YEAR OF THE
ESTATE OR GRE

5.2.1 Carryback of Losses to the Terminal Return — GREs

In the first taxation year of the estate that is a GRE, the personal representative
may elect to apply losses incurred in that first year to the final T1 tax return of
the deceased for the year in which the person died, called the terminal return.
See Chapter 7 for preparation of the terminal return. This election is made under
subs. 164(6) of the Act for capital losses and terminal losses, and under subs.
164(6.1) for losses from employment and employee stock options. There is no
specific form for this election. Instead, a letter must be attached to the T3 Return

5 See subss. 104(1) and 159(3).

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SPECIFIC MATTERS RELATING TO THE T3 FOR THE FIRST YEAR OF THE ESTATE OR GRE 5.2.2

containing details of the election.6 This election can be made by resident and
non-resident estates or trusts.

The trust may not claim any loss on which the election has been made. How-
ever, dispositions of estate property must still be reported on Schedule 1.

The post-mortem tax planning associated with this loss carryback rule is dis-
cussed later (see Chapter 8).

5.2.2 Tax Year-End for Trusts and Graduated Rate Estates (GREs)

Generally, trusts have a calendar year-end for tax purposes. In addition to the
calendar year-end, qualifying life interest trusts (AETs, JPTs, and QSTs) have a
deemed year-end on the death of the last surviving life tenant.

Graduated rate estates (GREs) are the only trusts entitled to choose a non-calendar
tax year-end. In the first return for an estate that is a GRE, the personal representa-
tives (i.e., the executors or, where there is an intestate estate, the administrators)
must choose the estate’s year-end for tax purposes. This can be any time after the
date of the deceased’s death, but no later than the date of the first anniversary of
the death. Choosing a year-end includes some of the factors discussed below:

• The opportunity for a beneficiary to defer payment of tax. An

individual beneficiary must include income received from the trust
from the taxation year of the trust year that ended in the calendar
year. There can be a deferral of taxation for individual beneficiaries
where the tax year-end of the trust ends early in the calendar year.
For example, if the trust year-end is January 31, 2018, the individ-
ual will report income from the trust for the 12-month period from
February 2017 to January 2018 in his or her 2018 T1 Return, which
is not due until April 30, 2019. However, the requirement to make
instalment payments of tax may reduce this benefit, although CRA
normally does not require instalments for the first taxation year in
which instalment payments were required under the Act.
• The calendar year may be more convenient. Most reporting of
investment income by financial institutions is on a calendar-year
basis. Having a year-end that has stub periods in two different cal-
endar years can make preparing returns more difficult, as each

6 See Regulation 1000 and the T3 Trust Guide 2008 under “Estate Elections” at page 24.

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5.2.3 Chapter 5 – Completing the T3 Trust or Estate Return

source of income has to be split into two parts for both calendar
years bridged by the trust year-end. In addition, CRA forms and
returns for the calendar year may not be available at the time the
trust return is ready, and there may be delays in assessing the laws
that are in process, which is more likely to occur in the middle of
the calendar year.
• Some foreign jurisdictions, such as the United States, require
that a resident report income from an estate or trust (even for-
eign) based on what was earned to the end of the calendar
year. This may be so even if the estate or trust does not have a cal-
endar year-end. In these cases, a calendar year-end may be a more
convenient choice.
• Loss carryback to the terminal return from losses in the first
year of a GRE. In the first tax year of an estate that is a GRE,
subss. 164(6) and 164(6.1) provide for an election to carry back
losses incurred during that first year to the terminal return of the
deceased. It may be advantageous for the GRE to delay the estate’s
tax year-end as long as possible to take advantage of this rule.
NOTE: This rule might be critical for post-mortem tax planning,
where the deceased owned shares in a Canadian-controlled private
corporation (CCPC). This planning involves a redemption of the
shares, that is, a sale of the shares back to the issuing corporation,
resulting in a deemed dividend. The deemed dividend triggers a
capital loss that can be utilized in the year of death if the election
is available. Extending the first year may provide the time needed
to obtain tax advice and to complete and implement such planning.

5.2.3 Final Tax Year of a Trust or Estate

A GRE must file its final T3 Return and pay any tax owing 90 days after wind-
up. The final tax year for a GRE will end on the date of the final distribution
of the assets. For all other trusts, the final T3 Return and tax payable is due 90
days after the trust’s tax year-end, although it is possible to file before the trust
year-end.7

7 See the T3 Trust Guide under “Final Return.”

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INFORMATION REQUIRED IN THE T3 RETURN 5.3.1

5.2.4 File a Copy of the Will

If this is the first year of the estate, a copy of the Will should be filed with CRA.
Similarly, in the first year of filing for a trust, the trust deed or agreement should
be filed.

5.2.5 Income of a Trust or Estate

The income of a trust is computed in the same manner as it is for an individual.

Section 3 of the Act requires income from sources both inside and outside Can-
ada from employment, business, and property to be included in the calculation
of income. In this material, the focus will be on income from property,8 as this is
the most common form of income for personal trusts and trusts used in tax and
estate planning.

The main differences between individual returns (i.e., T1 Returns) and T3

Returns are as noted below:

• A trust is not entitled to the personal tax credits.

• The reporting period may be different from the calendar year for
GREs.
• A T3 Return is due 90 days from year-end (not April 30 of the fol-
lowing calendar year).
• A trust must report the income designated or allocated to
beneficiaries.
• Income designated or allocated to beneficiaries is deductible by the
trust from its income.

5.3 INFORMATION REQUIRED IN THE T3 RETURN

5.3.1 Residence

This material assumes that the trust is a resident of Canada.9 For a detailed
description of the residence of a trust, see 4.3.3. In 2012, the Supreme Court of
Canada confirmed that the place where central management and control over
trust property is exercised, rather than the residence of the trustee(s), is the

8 Trusts do not receive employment income as a general rule, and the calculation of income from a
business is beyond the scope of this material.
9 And assumes the trust is not a “deemed resident” under the Act.

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5.3.2 Chapter 5 – Completing the T3 Trust or Estate Return

appropriate test to determine residence of a trust: St. Michael Trust Corp. v. R.10
(Garron Family Trust). The province of residence is the trust’s residence on the
last day of its year-end. The province of residence will determine the provincial
taxes payable. Where the trustee is a trust company, the province of residence
will be determined by the location of the branch office of the company that is
administering the trust.11 If the trust is carrying on a business through a perma-
nent establishment in another province, territory, or country, it must calculate
the source of income from each such jurisdiction and will have to calculate the
provincial tax accordingly.

5.3.2 Type of Trust

The type of trust must be identified by code number as listed in the T3 Trust
Guide. Graduated rate estates and qualified disability trusts are specifically
shown on the T3 Return. There is a code for each type of inter vivos trust, includ-
ing AETs, JPTs, and inter vivos QSTs, and for each type of testamentary trust,
including GREs, QDTs, testamentary QSTs, and lifetime benefit trusts.

5.3.3 Other Required Information — Questions

On page 2 of the T3 Return, certain questions must be answered. The ones rel-
evant for this material are discussed below.

5.3.3.1 Question 2: Required Payments of Income to Beneficiaries

Does the Will, trust document, or court order require the payment of
trust income earned in the current year to beneficiaries? If yes, complete
Schedule 9.

This question will identify amounts that are payable (and therefore tax-
able) to the beneficiaries for whom T3 Slips must be prepared. In addi-
tion, these amounts will be deductible by the trust.

10 Garron (Trustee of) v. Canada, 2009 TCC 450, (sub nom. St. Michael Trust Corp. v. Canada) 2010
FCA 309, (sub nom. St. Michael Trust Corp., as Trustee of the Summersby Settlement v. Her Majesty
the Queen (Fundy Settlement)) 2012 SCC 14. For the purposes of this discussion, the decision will be
referred to as the Garron decision, as that is the name at the Tax Court, and the name most commonly
used by tax practitioners.
11 Income Tax Folio S6-F1-C1, Residence of a Trust or Estate.

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INFORMATION REQUIRED IN THE T3 RETURN 5.3.3.3

5.3.3.2 Question 3: Distributions of Assets Other than Cash to a

Beneficiary
Did the trust distribute assets other than cash to a beneficiary during the
tax year? If yes, attach a note giving a complete description of the prop-
erty, the name and address of the beneficiary to whom the property was
distributed, and the date the property was distributed. If the beneficiary
is an individual, provide the beneficiary’s social insurance number.

This refers to distributions in specie or in kind where property other

than cash is distributed. Depending on the type of trust, the set-up of
the trust, the property being distributed, the beneficiary, and the nature
of the distribution, such distributions may take place on a rollover basis
(in this case, sometimes called a “rollout” rather than a rollover), or may
trigger a disposition of capital property at fair market value.

A distribution to the spouse beneficiary of a qualifying spousal trust will

generally take place on a rollout basis. Distributions to a non-resident
trigger deemed dispositions at fair market value of any capital property,
and may also require the trust to withhold Canadian tax, or obtain a cer-
tificate of compliance, more commonly called a “clearance certificate.”12
For a detailed discussion of the tax consequences of distributions to a
non-resident, see 6.7.

Where the distribution in kind is in respect of a beneficiary’s capital

interest in the trust, a statement must be provided, including the follow-
ing additional information about the distributed property:

• name and address of the recipient,

• description of the property,
• fair market value on the day distributed, and
• cost amount on the day distributed.

5.3.3.3 Question 5: Lifetime Beneficiary Death in the Year

Did the lifetime beneficiary under the trust die in the year? If yes, pro-
vide the date of death (see the guide for details).

12 A clearance certificate under s. 116 is required upon a deemed sale to the non-resident of his or her
capital interest in the trust.

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5.3.3.4 Chapter 5 – Completing the T3 Trust or Estate Return

This question deals with AETs, JPTs, and QSTs. It identifies those trusts
that have a deemed disposition on the death of the life tenant and a
deemed tax year.

5.3.3.4 Question 6: Borrowing from or Incurring a Debt to a Non-Arm’s

Length Person
Did the trust borrow money, or incur a debt, in a non-arm’s length trans-
action? If yes, state the year, and, if during this tax year, attach a note
showing the amount of the loan, the lender’s name, and the lender’s
relationship to the beneficiaries.

This question may determine whether a trust created on death no lon-

ger qualifies as a testamentary trust for tax purposes (and therefore does
not qualify as a GRE either).

5.3.3.5 Question 7: Change in Ownership of Capital or Income Interest in

the Trust
For any trust (other than a unit trust), did the ownership of capital or
income interests change since 1984? If yes, enter the year, and, if during
this tax year, attach a note showing the changes.

The purpose of this question is to determine whether there has been a

disposition of a capital interest or income interest in a trust that may be
taxable in the hands of the transferor and/or the trust. Distributing trust
property to the beneficiaries is not a change in ownership for the pur-
poses of this question.

5.3.3.6 Question 8: Holding Shares in a Private Corporation

Does the trust hold shares in a private corporation? If yes, and the trust
is a personal trust, attach a note giving details of the corporation, includ-
ing name, business number, and the number of shares held.

This question could identify a trust that has beneficiaries who may be
subject to tax on split income (kiddie tax).

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DETERMINING AND REPORTING NET INCOME ON THE T3 5.4.2

5.4 DETERMINING AND REPORTING NET INCOME ON THE T3

A trust must calculate its income from all sources in the same manner as an
individual. Deductions are permitted from income in calculating net income,
and additional deductions may be taken from net income to calculate taxable
income. The last deductions in calculating net income are the amounts allocated
and designated to beneficiaries.

Income of a trust that is subject to the attribution rules will be taxed according
to those rules and not under the rules otherwise applicable to beneficiaries. For
a discussion of the attribution rules, see Chapter 9. In this chapter, it is sufficient
to know that income of the trust attributed to another person under the attribu-
tion rules must be reported in the trust in the same way as other distributions
and allocations of income are reported. A T3 Slip is to be prepared for attributed
income in the name of the person to whom the income is attributed. The fact
that trust income is reported to a person under the attribution rules must be
noted in Part A of Schedule 9.

5.4.1 Taxable Capital Gains and Allowable Capital Losses

Taxable capital gains and allowable capital losses of the trust are reported on
Schedule 1. If there is a net capital loss, it cannot be deducted from other income
of the trust, but may be carried back to prior years (three years back) or forward
to any subsequent year to offset taxable capital gains in those years. Losses can-
not be allocated to beneficiaries. In the first taxation year of a graduated rate
estate, an election is available to permit net capital losses to be carried back to
the terminal return of the deceased taxpayer to offset income from any source in
that final year.13

5.4.2 Dividends from Taxable Canadian Corporations

The actual amount of dividends received is entered on Schedule 8. Dividends

from taxable Canadian corporations are subject to the gross-up and dividend tax
credit mechanisms. The actual dividend plus the gross-up is the taxable dividend
(i.e., the amount that is included in income). The federal dividend tax credit is
a portion of the gross up and it more than compensates an individual taxpayer
for the additional tax payable on the gross up included in income. The gross-
up and dividend tax credit amounts vary with the taxation year, and whether

13 Subs. 164(6).

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5.4.3 Chapter 5 – Completing the T3 Trust or Estate Return

the dividend is an eligible dividend or other dividend received from a taxable

Canadian corporation. These are entered on Schedule 8 and may be taken from
the T3 Slip or T5 Slip provided by the dividend payor, which reports the divi-
dends received. These slips must be prepared by the payor corporation and
must include the actual amount of the dividend, the taxable dividend, and the
dividend tax credit for both regular dividends and eligible dividends.

Dividends may be deemed to be received as a result of certain transactions

involving the shares of a corporation, including a repurchase of shares by the
corporation or redemption of shares initiated by the shareholder. A dividend is
deemed to be received equal to the actual proceeds less the paid-up capital of
the share. These dividends must also be reported.

Dividends paid out of a corporation’s capital dividend account (i.e., capital divi-
dends) are not included, as they are received tax-free by the recipient.

5.4.3 Foreign Investment Income

The gross amount of foreign income (including any tax withheld at source by the
non-resident payor) must be reported in Canadian dollars. The average exchange
rate published by CRA for that currency for the year may be used.

5.4.4 Other Investment Income

Other investment income includes any income not already reported, such as
bond interest, bank interest, and mortgage interest. Interest on tax refunds
received in the year must also be reported.

5.4.5 Income from a Business, Farming, Fishing, and Rental Income

The gross and net income or loss from a business, from farming or fishing, and
from rentals must be reported in calculating total income. Losses from these
sources are deductible against the other income in the trust. If the trust is a
member of a partnership, the trust’s share of partnership net income or loss
must be reported. Special rules apply to a trust carrying on a business with a tax
year-end other than December 31. There are a number of rules that must be fol-
lowed in calculating income from a business, farming, fishing, or rentals that are
beyond the scope of this course.

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DETERMINING AND REPORTING NET INCOME ON THE T3 5.4.9

5.4.6 Reporting Deemed Dispositions: Gains or Losses

If the trust has deemed dispositions in the year as a result of the 21-year rule,
or on the death of the life tenant for an AET, JPT, or QST, any gain or loss must
be reported, and Form T1055, Summary of Deemed Dispositions, must be com-
pleted. The deemed disposition of property every 21 years for trusts is discussed
in detail earlier (see 4.8). The trust will be deemed to have disposed of all capital
property, including depreciable property of a prescribed class, land inventory,
and foreign resource properties, at the end of the deemed disposition day for
an amount equal to the property’s fair market value, and to have reacquired
the property for that same amount. If the trust has depreciable capital property,
recapture of capital cost allowance may also result.

5.4.7 Other Income

Other income, such as royalties, commissions, Canada or Quebec Pension Plan

death benefits, and retiring allowances, also must be reported.

5.4.8 Post-Mortem Income from an Unmatured Registered Retirement Savings

Plan

Generally, the fair market value of registered plans at the date of death of the
annuitant is included in the terminal return. There is an exception if the pro-
ceeds of the plan qualify as a “refund of premiums” for a registered retirement
savings plan (RRSP), or as a “designated benefit” in the case of a registered
retirement income fund (RRIF). In those cases, the proceeds may be taxed in the
hands of a qualified beneficiary (i.e., a spouse, common-law partner, or child or
grandchild who was financially dependent on the deceased), and in most cases
a rollover is available (see 7.8 for full details relating to the taxation of registered
plans on death). However, the income earned from an unmatured RRSP for the
period subsequent to death where no living person is entitled to receive the
RRSP proceeds may be taxable to the estate. Such post-mortem income will be
reported on a T4RSP slip and must be reported by the estate.

5.4.9 Deductions

A trust is permitted the same deductions as an individual in computing net

income. Both interest expense and carrying charges for investments are deduct-
ible, as discussed below. Expenses incurred for the purpose of earning income

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5.4.9.1 Chapter 5 – Completing the T3 Trust or Estate Return

from a business or property also are deductible, but a detailed analysis of such
deductions is not included here.

5.4.9.1 Interest Expense

Interest on borrowed money is deductible to the extent it was borrowed
for the purpose of earning income. For example, if an estate is hold-
ing real estate that was rented out by the deceased, the interest on any
mortgage on the property (assuming it was deductible by the deceased
as incurred for the purpose of earning income from the rental property)
will be deductible by the trust in computing income from that property.

Interest paid to earn income from a business or property is not reported

on Schedule 8, but rather on the appropriate forms for computing
income from a property or business: Form T2124, Statement of Business
Activities, or Form T776, Statement of Real Estate Rentals.

5.4.9.2 Carrying Charges for Investments

The following expenses are deductible in computing income from
investments and are included in Schedule 8:

• management fees,
• investment counsel fees,
• custodial costs of holding securities, and
• accounting fees in respect of investments.

Any of these expenses incurred in respect of foreign investments must

be shown separately, and must be deducted from the income from each
foreign country.

5.5 DESIGNATIONS AND ALLOCATIONS TO BENEFICIARIES IN COMPUTING

NET INCOME

The last deductions in calculating net income of the trust are the amounts allo-
cated and designated to beneficiaries. These are reported in the T3 Return on
Schedule 9.

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DESIGNATIONS AND ALLOCATIONS TO BENEFICIARIES IN COMPUTING NET INCOME 5.5.1.1

5.5.1 Allocations to Beneficiaries

Income allocated to beneficiaries and deductible to the trust is to be reported on

Schedule 9.14 This includes the following:

• amounts paid or payable to a beneficiary,

• amounts deemed payable to an individual under age 21 from an
“age 40 trust,”15
• amounts subject to a preferred beneficiary election,16 and
• benefits for maintenance and upkeep of a property for the benefit
of a life tenant under subsection 105(2).17

The total of these amounts must be entered on Line A of the T3 Return. The trust
may elect to reduce the amount to be included in the income of the beneficiaries
as a group, and only the amounts remaining after the election will be allocated
as taxable to the beneficiaries. The reduction is entered on Line B of the T3
Return.

Once the amount of income allocated to beneficiaries (net of the reduction from
the election) is determined, the trust may designate the amounts allocated to
retain their character. In this way, the beneficiaries can take advantage of deduc-
tions or credits that relate directly to the type of income received by the trust.
Amounts allocated to the beneficiaries are deductible to the trust.

5.5.1.1 Election to Tax Trust for Amounts Taxable to Beneficiary to

Absorb Losses in the Trust
A trust may elect to retain the income in the trust for tax purposes in
order to absorb losses in the trust. The election to retain income in the
trust is made under subs. 104(13.2) for capital gains and a separate elec-
tion is made under subs. 104(13.1) for other income. The result of this
election is:

14 Benefits conferred by a trust on any person, including persons not beneficiaries, as described in subs.
105(1), are not deductible by the trust and are not reported on Schedule 9. See 4.5.4, Exceptions to the
Rollover on Distribution of Trust Property.
15 See 4.5.4, Exceptions to the Rollover on Distribution of Trust Property.
16 Described in subss. 104(12) and (14); see 4.10, Preferred Beneficiary Election on Accumulating Income
for Disabled Beneficiaries.
17 See 6.3, Income in the Form of Outlays for Upkeep of Trust Property.

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5.5.2 Chapter 5 – Completing the T3 Trust or Estate Return

• The income or gain is deemed not to have been paid or payable

to the beneficiary.
• No amount is deductible by the trust in respect of such amount.
• The income or gain will not be taxed in the beneficiary’s hands.

The trust must make this election in order for the income not to be
included in the hands of the beneficiary. The trust cannot merely fail to
take the deduction under subs. 104(13).

Subsection 104(13.3) provides that this election is invalid if after taking

the election the trust’s taxable income is greater than nil. Effectively,
this limits the use of the election to adding income or capital gains back
into the trust to be absorbed by losses carried forward from other years.
Losses cannot be flowed through a trust to its beneficiaries. Losses
incurred in a year where there is no other income to utilize them may
be deducted in other years under the loss carryforward and carryback
rules. Leaving income in the trust to utilize losses from other years may
be appropriate. The trustee may use this election to designate income to
the trust:

• in a year when the trust has taxable income and a non-capital

loss carryforward, or
• in a year when the trust has taxable capital gains and a net capi-
tal loss carryforward.

5.5.2 Designating the Type of Income Receipt to the Beneficiary

Once the amounts to be allocated to each beneficiary have been established, and
any election has been taken to reduce such allocations, the trust may designate
specific types of income to be received by the beneficiary in Part B of Schedule
9 of the return. The following specific types of income may be allocated:

• net taxable capital gains,

• certain lump-sum pension income,
• taxable dividends and eligible taxable dividends from Canadian
corporations,
• foreign income,
• pension income that qualifies for the pension income amount,

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DESIGNATIONS AND ALLOCATIONS TO BENEFICIARIES IN COMPUTING NET INCOME 5.5.4

• pension income that qualifies for an eligible annuity for a minor

beneficiary, and
• retiring allowances that qualify for a rollover to a registered plan.

The types of income allocated and designated to beneficiaries are reported on

Schedule 9 separately for non-resident beneficiaries, and for any amounts allo-
cated and designated pursuant to a preferred beneficiary election. Part A of
Schedule 9 requires a statement to be submitted if income has not been allo-
cated equally to each beneficiary.

The amount, if any, designated under subs. 105(1) as a benefit from a trust that
is taxable to a beneficiary and not deductible by the trust should not be reported
on Schedule 9.

5.5.3 T3 Summary and T3 Slips

The trustee must also prepare the T3 Slip, Statement of Trust Income Allocations
and Designations, for each resident beneficiary, including a preferred benefi-
ciary, who has had income allocated and designated in the year. The T3 Slip will
show the amounts of income from each source (i.e., each type of income) that
has been allocated and designated to that beneficiary. The T3 Slips and the T3
Summary must be submitted with the T3 Return and are due at the same time as
the T3 Return. Two copies of the T3 Slip must be sent to the beneficiary and one
retained for the trust’s records. The T3 Slips for any trust with a December 31
year-end will be due in time for an individual beneficiary to report the income
in his or her T1 Return for the prior year, which is due on April 30.

Along with the T3 Slips, the trustee must prepare the T3 Summary, Summary of
Trust Income Allocations and Designations, even if there is only one beneficiary.
This form records the total of the more common amounts reported on all related
slips.

5.5.4 NR4 Slips and NR4 Summary

If the trust paid or credited, or was deemed to pay or credit, income to non-
resident beneficiaries, these must be reported on Schedule 9. In addition, the
trustee must prepare an NR4 Slip, Statement of Amounts Paid or Credited to
Non-Residents of Canada, for each non-resident, and an NR4 Summary, Return
of Amounts Paid or Credited to Non-Residents of Canada, in respect of these

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5.6 Chapter 5 – Completing the T3 Trust or Estate Return

amounts. This requirement is similar to the requirement for the T3 Slips and T3
Summary. Detailed information regarding the NR4 Slips and NR4 Summary can
be found in Guide T4061, NR4 — Non-Resident Tax Withholding, Remitting, and
Reporting.

5.6 DETERMINING TAXABLE INCOME

The net income of the trust is the amount calculated after the deduction of
amounts allocated to beneficiaries, plus the gross-up amount of dividends not
allocated to beneficiaries. This is the final adjustment in calculating net income.

After net income is determined, there are several additional deductions available
to calculate taxable income. Taxable income is the final amount upon which the
trust’s tax liability can be calculated, according to the rates of tax applicable to
the trust. The deductions in arriving at taxable income include losses carried for-
ward from other years and the capital gains deduction in the year of death of the
spouse beneficiary of a spousal or common-law partner trust.

5.6.1 Non-Capital Losses

In preparing the T3 for a particular taxation year, any unused non-capital losses
of the 20 prior taxation years may be carried forward to reduce the income of the
trust from any source. For losses incurred in a year that ended before March 23,
2004, the carryforward period is seven years. For losses incurred in years ending
from March 23, 2004, to December 31, 2005, the carryforward period is 10 years.
For non-capital losses that qualify as business investment losses, the carryfor-
ward is 10 years. After the 10-year period, these can continue to be carried for-
ward as regular non-capital losses.

Non-capital losses can also be carried back to reduce income of the three taxa-
tion years prior to the year in which the loss occurred. If the trust allocated all
income to beneficiaries in prior taxation years, the income allocation cannot be
adjusted to permit the use of the non-capital loss carryback, and the non-capital
loss will have to be used, if at all, in the subsequent taxation years of the trust.

5.6.2 Net Capital Losses

Unused net capital losses of other taxation years can only be deducted against
taxable capital gains. Net capital losses of any prior year may be used to offset
taxable capital gains in the trust’s particular taxation year.

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DETERMINING TAXABLE INCOME 5.6.5

Net capital losses can also be carried back to reduce taxable capital gains of the
trust for the three taxation years prior to the year in which the loss occurred.
If the trust allocated all taxable capital gains to beneficiaries in prior taxation
years, it is possible to reduce the taxable capital gains payable to beneficiaries in
that prior year, providing the total amount of income allocated to beneficiaries
in those prior years does not change.

5.6.3 Special Capital Loss Carryback to the Terminal Return in the First T3 of a
Graduated Rate Estate

In the first year of a graduated rate estate (GRE), the GRE may carry back any
net capital loss to the terminal return of the deceased. This is done by making
an election under subs. 164(6) of the Act in the T3 Return for the first year of the
GRE and filing the request for the loss carryback within the due date for filing
the T3 Return.18 This election is very important in estate planning to reduce the
overall tax impact of death, so ensuring the GRE status for an estate and filing
the return for the first taxation year and the election on or before the due date
are both critical to the availability of this planning strategy. Significant taxable
capital gains are often triggered in the terminal return as a result of the deemed
disposition on death. In addition, there are a number of post-mortem planning
strategies that trigger capital losses in the estate. These may involve redemption
or repurchase of shares of a private or closely held corporation owned by the
deceased (see Chapter 8 for discussion).

5.6.4 Claiming Losses Carried Forward from Prior Years

To claim losses of prior years, the trust must file a continuity statement of the loss
balances of other years, including the year the loss was incurred, the amounts
applied in previous years, and the balance remaining at the beginning of the
current year. A chart is provided for the statement of net capital losses in Guide
T4037, Capital Gains.

5.6.5 No Capital Gains Deduction for a Trust and Problems with Deemed
Dispositions

A trust cannot take the capital gains deduction. This may be a difficulty where
there is a deemed disposition and a capital gain on property qualifying for the
lifetime capital gains exemption (LCGE). If the gain cannot be allocated to a

18 The election and due date are prescribed under Regulation 1000.

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5.7 Chapter 5 – Completing the T3 Trust or Estate Return

beneficiary, there is a loss of access to the LCGE. This may occur where the
21-year rule applies and there is no power to encroach on capital for the benefit
of the beneficiary.19 It also applies in the case of AETs, JPTs, and QSTs on the
death of the last surviving life tenant.

Prior to 2016, a qualifying spousal trust (QST) could access the unused capital
gains deduction of the beneficiary spouse and could be utilized by the trust in the
taxation year of the trust in which the spouse died.20 This is no longer available.

5.7 TAX CONSEQUENCES WHERE THERE ARE NON-RESIDENT

BENEFICIARIES

Schedule 10 is to be completed if the trust is allocating income to non-resident

beneficiaries. There are two parts to Schedule 10.

• Part XII.2 Tax. A special tax that is payable by a trust, other than a
GRE, on certain amounts paid to non-resident beneficiaries (called
“designated beneficiaries” under the rules for this tax).
• Withholding Tax. The trustee(s) may be required to withhold and
remit certain amounts of tax from payments made, or deemed to
be made, to non-resident beneficiaries.

5.7.1 Part XII.2 Tax

Part XII.2 of the Act, consisting of ss. 210 to 210.3, imposes an additional tax on
certain amounts (called “designated income”) payable to non-resident beneficia-
ries (called “designated beneficiaries”).

All trusts except graduated rate estates are required to pay a 36% flat tax on
“designated income” payable to a “designated beneficiary.” Essentially, a desig-
nated beneficiary is a beneficiary who is a non-resident of Canada. The amounts
subject to this tax include:21

• taxable capital gains from taxable Canadian property,22

• income from real property in Canada,
• income from businesses carried on in Canada,

19 CRA may specifically require that deemed capital gains be payable as well.
20 Under subs. 110.6(12).
21 Subs. 210.2(2) includes a complete list.
22 Defined in subs. 248(1).

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TAX CONSEQUENCES WHERE THERE ARE NON-RESIDENT BENEFICIARIES 5.7.1

• income from timber resource properties, and

• income from Canadian resource properties.

For the purpose of Part XII.2 tax, these income amounts subject to the tax are
called “specified income” on Schedule 10.

The sale of taxable Canadian property by a non-resident of Canada is not gener-

ally treaty-exempt. Thus, these provisions attempt to force the payment of tax
by the non-resident person on certain receipts by taxing the payor (i.e., the
trust). The tax is not payable by a GRE. Part XII.2 tax is deductible in calculating
income for Part I tax.

A portion of Part XII.2 is available as a refundable tax credit to resident benefi-

ciaries, called “eligible beneficiaries.” Essentially, a deduction can be taken for
the tax that represents the amount of tax allocated to non-resident beneficiaries.
The deduction is calculated as the amount equal to the portion of the tax that
the income allocated to non-resident beneficiaries bears to the income allocated
to all beneficiaries. The remainder of the tax, after the deduction of the non-
refundable portion, is calculated on Schedule 10 and carried onto Schedule 9 in
Column 1 in respect of Canadian beneficiaries.

Example: The income of the trust consists of $21,000 of taxable capital gains in
respect of the sale of taxable Canadian property. There are three beneficiaries
who share equally in the gains, and one of them is a non-resident of Canada. The
Part XII.2 tax would be 36% of $21,000, or $7,560. The amount of the reduction
is the portion of the tax multiplied by the income allocated to the non-resident
divided by the income allocated to all beneficiaries:

$7,560 x ($7,000 ÷ $21,000) = $7,560 x 1/3 = $2,520

This amount is deducted from the Part XII.2 tax to determine the amount of the
refundable tax credit, being $7,560 – $2,520 = $5,040. This is the amount of the
refundable tax credit, and it should also be entered on Schedule 9 and allocated
to each particular resident beneficiary on the respective T3 Slip.

The portion of the tax representing the amount not available for refund (i.e., the
amount of the reduction) is in effect the amount allocated to the non-resident
beneficiary. This amount is taken as a deduction from income paid or credited to
non-residents on which withholding tax is calculated in Part B of Schedule 10.
In the example above, this amount is $2,520.

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5.7.2 Chapter 5 – Completing the T3 Trust or Estate Return

5.7.2 Withholding Tax on Amounts Paid or Credited to Non-Residents

Income subject to withholding tax under Part XIII of the Act and the tax pay-
able on such amounts are reported on Part B of Schedule 10. In calculating the
amount subject to non-resident withholding tax under Part XIII, there is a deduc-
tion available for any Part XII.2 tax on income paid or payable to non-residents,
as calculated in Part B of Schedule 10 and discussed above. The amount of tax
payable depends on the income paid to particular beneficiaries according to the
rate of tax which may be applicable under any tax treaty between Canada and
the country in which that particular beneficiary resides. The amount of tax must
match the amount calculated in the NR4 Summary and the related NR4 slips. See
also 6.7.2, Withholding Tax on Income Paid or Credited to Non-Residents.

5.7.3 Certificates of Compliance for Capital Distributions to a Non-Resident

Where capital property is distributed to a beneficiary, there is also a disposi-

tion by the beneficiary of the capital interest in the trust by the beneficiary.
See 6.7.6, Disposition of Capital Interest in a Trust by Non-Resident Beneficiary
and Requirement for Certificate of Compliance (S. 116 Clearance Certificate).

5.8 LIABILITY OF THE PERSONAL REPRESENTATIVE FOR TAX AND

CLEARANCE CERTIFICATES

A trustee or any person who is a “legal representative”23 is jointly and severally

liable, along with the taxpayer, to pay any tax, file any return, or perform any
other requirement under the Act that is the responsibility of the taxpayer he or
she represents. This liability is limited to the extent of the property controlled by
the legal representative.24

An executor, trustee, or any personal representative will be personally liable for

any unpaid income tax and interest on unpaid tax of the trust or estate (includ-
ing unpaid tax of the deceased person) where a distribution of trust property is
made without a clearance certificate. For example, if the executor of an estate
distributes property to a beneficiary under the terms of the Will, he or she will
be personally responsible to pay any unpaid tax liability owing in respect of the
deceased’s terminal return.

23 Defined in subs. 248(1) to include any trustee, executor, liquidator, or administrator who holds property
in a representative or fiduciary capacity that belongs to or belonged to, or that is held on behalf of, a
taxpayer or a taxpayer’s estate.
24 Subs. 159(1). See also 11.10, Joint and Several Liability under the Act.

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LIABILITY OF THE PERSONAL REPRESENTATIVE FOR TAX AND CLEARANCE CERTIFICATES 5.8

Personal liability is limited to the value of the property that was actually distrib-
uted.25 The liability extends to any assessment of tax in respect of the taxpayer
for the period up to the time of distribution, including amounts subsequently
assessed for this period. For the purpose of determining personal liability, a dis-
tribution includes the appropriation of property by the personal representative.26
A payment of income to a beneficiary under a continuing trust is not a distribu-
tion for the purposes of these rules.27

Personal liability for distributions can be avoided if a clearance certificate is

obtained before any distribution is made. The requirement to obtain a clear-
ance certificate is set out in subs. 159(2) of the Act. Information Circular 82-6R7,
Clearance Certificate, sets out CRA’s administrative policy regarding the issu-
ance of clearance certificates. A clearance certificate is obtained by filing Form
TX19 and including all information required. The certificate will not be issued
until all returns are filed, assessments of tax made and all amounts paid for prior
periods. In lieu of payment, the Minister may accept security for unpaid taxes.

Timing difficulties can arise with respect to distributions and clearance certif-
icates, since all tax must be assessed and paid before the certificate can be
issued, and the distribution itself may trigger tax. To some extent, this problem
is dealt with by choosing a distribution date prior to obtaining a certificate, and
preparing a return and making the application for the certificate as if the distri-
bution was actually made on that proposed date, even though the distribution
actually takes place after issuing the certificate. CRA’s administrative position is
to treat the trust or estate as having been wound up on the date indicated on
the final tax return and on the Form TX19, as long as the remaining property is
distributed shortly after the clearance certificate is issued. CRA will assist on a
case-by-case basis where there is difficulty, such as when income is earned after
the chosen distribution date and before the actual distribution. In some cases
such income can be reported by the beneficiaries.

Once the clearance certificate is issued, the distribution proposed in the applica-
tion may be made without incurring personal liability on the part of the personal
representative. The clearance certificate only covers the property controlled by
the personal representative up until the distribution date proposed in the appli-
cation. Once the clearance certificate is obtained and the distribution is made,

25 Subs. 159(3).
26 Subs. 159(3).
27 Subs. 159(3.1).

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5.9 Chapter 5 – Completing the T3 Trust or Estate Return

a further certificate is required for any additional distributions. This may be rel-
evant, for example, where additional property comes under the control of the
legal representative.

A clearance certificate operates only to protect the legal representative from per-
sonal liability. It does not prevent subsequent audit, assessment, or reassessment
of tax of the trust or the deceased taxpayer by the Minister, subject to the require-
ment that reassessments be made within the normal statutory time period under
the Act. If the estate is reassessed, it is possible that the Minister could take steps
to seize the assets distributed to the beneficiaries. For this reason, it is usually rec-
ommended that the executors warn the beneficiaries of this possibility.

5.9 KEY STUDY POINTS

• A trust files a T3 Trust Income Tax and Information Return (T3

Return). An estate may not have to file a T3 Return if it is fully dis-
tributed in the first year and the beneficiaries report all the income.
There are other exceptions to the requirement to file a T3 Return.
• There are penalties for late filing a T3 Return and each T3 Slip.
There are also penalties for late filing a Non-Resident Return (for
income paid to a non-resident of Canada) and for each NR4 Slip,
although CRA may apply reduced penalties.
• An estate that is a GRE is entitled to special rules regarding year-
end, rates of tax, the election available under subs. 164(6) in the
first year, and Part X.II.2 tax.
• There are special rules for charitable donations made by a GRE
or a trust that was a GRE in the last 60 months. These rules are
detailed in Chapter 4.
• Making distributions from a trust without a clearance certificate can
result in personal liability for the trustee to the extent of the lessor
of the amount distributed and tax owing at the time of the distri-
bution (even if subsequently assessed or reassessed for the time
period at or before the distribution). The beneficiaries are jointly
and severally liable for the trustee’s personal liability.

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 CHAPTER 6
TAXATION OF BENEFICIARIES

LEARNING OBJECTIVES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–3

6.1 TAXATION OF INCOME TO A BENEFICIARY . . . . . . . . . . . . . . . . . . . . . 6–3

6.1.1 Allocation of the Nature of the Amount Paid or Payable . . . 6–4

6.1.2 Determining the Income of a Beneficiary for Amounts
Paid or Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–6
6.1.3 Third Party Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–7
6.1.4 Documenting Amounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . 6–8
6.1.5 Steps to Take to Make Income Payable by a Trust . . . . . . . . . 6–9
6.1.6 Income Not Payable during Executor’s Year . . . . . . . . . . . . . . . 6–9
6.2 BENEFITS CONFERRED BY A TRUST . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–9

6.3 INCOME IN THE FORM OF OUTLAYS FOR UPKEEP OF TRUST

PROPERTY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–10

6.4 FLOW-THROUGH OF SOURCE OF INCOME TO A BENEFICIARY 6–11

6.4.1 Designation of Taxable Dividends . . . . . . . . . . . . . . . . . . . . . . 6–12

6.4.2 Designation of Capital Gains . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–12
6.4.3 The Capital Gains Deduction: Qualifying Farm
Property, Qualifying Fishing Property, or Shares in a
Qualified Small Business Corporation (QSBC) . . . . . . . . . . . 6–13
6.4.4 No Flow-Through for Losses . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–14
6.4.5 Phantom Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–14
6.4.6 Designation of Capital Dividends . . . . . . . . . . . . . . . . . . . . . . 6–15
6.5 COST OF CAPITAL PROPERTY RECEIVED FROM A TRUST . . . . . 6–15

6.6 DISPOSITIONS BY A BENEFICIARY OF AN INCOME INTEREST

OR A CAPITAL INTEREST IN A TRUST . . . . . . . . . . . . . . . . . . . . . . . . . . 6–15

6.6.1 Disposition of an Income Interest in a Trust to a Third

Party . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–16

6–1
 6.6.2 Disposition of a Capital Interest in a Trust . . . . . . . . . . . . . . . 6–17
6.6.2.1 Disposition to a Third Party . . . . . . . . . . . . . . . . . . 6–17
6.6.2.2 Disposition of a Capital Interest upon
Distribution from the Trust . . . . . . . . . . . . . . . . . . . 6–18
6.7 DISTRIBUTIONS TO NON-RESIDENT BENEFICIARIES . . . . . . . . . . 6–19

6.7.1 Income Distributions to Non-Resident Beneficiaries:

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–19
6.7.2 Withholding Tax on Income Paid or Credited to Non-
Residents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–19
6.7.3 Part XII.2 Tax on Designated Income . . . . . . . . . . . . . . . . . . . 6–20
6.7.4 Distributions to Non-Resident Beneficiaries in
Satisfaction of a Capital Interest in a Trust: Summary . . . . 6–22
6.7.5 Disposition of Capital Property Distributed by a Trust
to a Non-Resident Beneficiary . . . . . . . . . . . . . . . . . . . . . . . . . 6–22
6.7.6 Disposition of Capital Interest in a Trust by
Non-Resident Beneficiary and Requirement for
Certificate of Compliance (S. 116 Clearance Certificate) . . . 6–23
6.7.7 Relief from Requirement for Certificate of Compliance
Where Disposition of Capital Interest in the Trust Is
Treaty-Exempt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–24
6.8 KEY STUDY POINTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–25

6–2
 Chapter 6
Taxation of Beneficiaries

Learning Objectives
Knowledge Objectives:
• Understand how beneficiaries of trusts and estates are taxed.

Skills Objectives:
• Explain how beneficiaries of trusts and estates are taxed.

6.1 TAXATION OF INCOME TO A BENEFICIARY

This chapter covers the taxation of a beneficiary in respect of income and capital
gains earned in a trust, and the disposition by a beneficiary of his or her inter-
est in the trust, including an income interest and a capital interest in a trust. To
some extent this chapter repeats the rules discussed earlier (see Chapter 4), but
it approaches the rules more specifically from the perspective of the beneficiary.
Section 6.7 will look at the rules for both trusts and beneficiaries with respect to
distributions to non-resident beneficiaries.

Income of a trust is taxable to the beneficiary (providing no election is made

otherwise under subss. 104(13.1) or (13.2)) (and deductible by the trust under
subs. 104(6)) in each of the following circumstances:

• income is paid to the beneficiary — subs. 104(13),

• income is payable to the beneficiary, even if not actually paid to
the beneficiary — subs. 104(13),

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6.1.1 Chapter 6 – Taxation of Beneficiaries

• income is retained in a trust, but a preferred beneficiary election is

made — subs. 104(14),
• a benefit is received from a trust under subs. 105(1) (in fact, any
person who receives a benefit from a trust will be taxable pursuant
to this subsection, not just a beneficiary), and
• an amount is paid for upkeep and maintenance of trust property —
subs. 105(2).

Income paid or payable to a beneficiary is taxable to the beneficiary under

subs. 104(13) whether or not the trust deducts the payment under subs. 104(6).
The income inclusion to the beneficiary and the deduction of that income by the
trust are not always concurrent. In Brown,1 a beneficiary of a trust argued he
should not be taxable on income received from the trust because the trust made
no deduction from its income in respect of the payment. The Federal Court
affirmed the assessment of the taxpayer — since the income was payable to him
it was taxable whether or not the trust deducted it. In addition, as discussed
later in this chapter, under subs. 105(1) certain benefits conferred on a person
by a trust may be taxable to the person who benefitted from them, even though
there is no corresponding deduction available to the trust.

A trust can allocate payments made to a beneficiary as income and report this
in the T3 Return. Once income is allocated to a beneficiary, the trust may then
designate the income as being from a particular source. The allocation will make
the amount taxable in a beneficiary’s hands, the designation will characterize
the type of income receipt, so that the amount flows through to the beneficiary,
retaining its specific tax attributes from the original source of income received by
the trust. For example, dividends from taxable Canadian corporations received
by a trust and paid to an individual beneficiary will be eligible for the gross-up
and dividend tax credit system as if received directly from the corporation.

6.1.1 Allocation of the Nature of the Amount Paid or Payable

Where amounts are paid to a beneficiary, it is up to the trust to determine

whether the amount is paid out of capital or income, to determine whether to
allocate the amount paid as income (including capital gains for this purpose) to
the beneficiary for tax purposes, and to further designate the tax character of
the income distributed.

1 Brown v. R., [1979] C.T.C. 476, [1980] 2 F.C. 356, 79 D.T.C. 5421, [1980] 2 F.C. 356 (Fed. T.D.).

6–4
TAXATION OF INCOME TO A BENEFICIARY 6.1.1

The amounts paid to a beneficiary by a trust may be out of income or out of

capital from a trust law perspective, keeping in mind that the term “income” in a
trust does not normally include capital gains unless there is a specific clause in
the trust to this effect. Generally, if income is not paid to a beneficiary in a year,
under trust law it is added to the capital of the trust and in future years may be
distributed as a tax-free capital distribution.

In determining the nature of any distribution, the characterization will first be

restricted by the terms of the trust. For example, a beneficiary may or may not
be entitled to distributions of capital. Such distributions may be mandatory, or
discretionary. If a distribution is made to a beneficiary who is not a capital ben-
eficiary of the trust, the trust cannot designate the distribution as a capital gain.

Similarly, if a beneficiary is not an income beneficiary under the terms of the

trust, but is entitled only to capital payments from the trust, a distribution cannot
be allocated as an income payment other than one that is designated as a capital
gain, since in trust law income does not include a capital gain. This would pro-
hibit the trust from designating a payment to such a beneficiary as a payment
of regular income such as interest income, or taxable eligible dividends. Canada
Revenue Agency (CRA) takes the view that the trustee of a discretionary trust
can generally decide whether an allocation relates to capital or income for a year
where both income and capital exist, but this assumes the beneficiary has both a
right to income and a right to capital.2

Where the terms of the trust provide that payments of income are mandatory,
the income of the trust will be taxable to the beneficiary and deductible by the
trust.3 This would be the case, for instance, in respect of a qualifying spousal
trust (QST, inter vivos or testamentary), where by definition, in order to qualify
for rollover treatment under subss. 70(6) or 73(1), all of the income must be
payable to the spouse or common-law partner in order for the trust to be con-
sidered a QST (a spousal trust that qualifies for the rollover on a transfer to the
trust). The general rule would apply to permit a “flow-through” of the income
and the tax characterization of income from the original source as earned by the
trust, and tax such income in the hands of the beneficiary.4

2 CRA Views Doc. No. 2003-0051731I7.

3 Subs. 104(13) requires the beneficiary to include income “payable” by a trust in income, and
para. 104(6)(b) provides a discretionary deduction by the trust.
4 See Chapter 4.

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6.1.2 Chapter 6 – Taxation of Beneficiaries

Many factors determine whether an amount is payable for the purposes of the
Act. Where the terms of the trust require payment of income to the beneficiary
(i.e., payment of income is mandatory), this is sufficient to make income pay-
able. However, where the payment of income or capital to a beneficiary is dis-
cretionary, the determination is more difficult.

6.1.2 Determining the Income of a Beneficiary for Amounts Paid or Payable

Amounts of income will be taxable to the beneficiary where paid or payable to

the beneficiary. Under subs. 104(24), amounts will be deemed payable where
the beneficiary may enforce payment.5

The first step in determining whether income is “payable” to a beneficiary is to

examine the terms of the trust. Does the trust document require a mandatory
distribution, such as would be the case for a distribution of income from a quali-
fying spousal trust, or is the trustee permitted to make discretionary payments
of income to beneficiaries, such as would be the case for a discretionary family
trust? For a discussion of mandatory and discretionary payments of income by
a trust, see 4.3.7.3. If payments are discretionary, they will not be payable until
the discretion is exercised. The amounts may not be considered payable unless
documented.

IT-286R2 (Archived), Trusts — Amount Payable contains CRA’s views on amounts

of income considered payable to a beneficiary. Under subs. 104(24), an “amount
payable in a taxation year” is defined to include amounts paid and amounts pay-
able where the person to whom the amount was payable is entitled in the year
to enforce payment. Where a payment can be enforced only by virtue of a right
of a beneficiary to wind up the trust, CRA takes the position that the amount is
not payable until such right is exercised by the beneficiary and in fact causes the
trust to be wound up. Where an amount can only be distributed at the discre-
tion of the trustee, no amount is payable until the trustee’s discretion has been
exercised.

The question as to whether income is payable, and the amount of income pay-
able to a beneficiary (as compared with an amount payable, which is discussed
in IT-286R2 noted above) is discussed in IT-342R (Archived), Trusts — Income
Payable to Beneficiaries.

5 For an extensive discussion of this area, see Maurice C. Cullity, Catherine A. Brown, and Cindy L. Rajan,
Taxation and Estate Planning (Toronto: Thomson Carswell, 2000) at looseleaf s. 3.3.3(1), Amounts
Payable to Beneficiaries.

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TAXATION OF INCOME TO A BENEFICIARY 6.1.3

6.1.3 Third Party Payments

Where payments are made on behalf of a beneficiary to third parties, the issue
arises as to whether CRA will consider such payments to have been paid or
payable to the beneficiary for the purposes of the deduction from income by
the trust under subs. 104(6) and the income inclusion for the beneficiary under
subs. 104(13).

In the case of Langer Family Trust v. M.N.R.,6 the Tax Court of Canada held that
payments not made directly to minor beneficiaries, but made to the parent as
reimbursements of personal and living expenses for the minor children, were
not considered paid or payable to the beneficiaries.

CRA’s administrative position may be more lenient than might be determined

under the Langer decision, provided proper documentation and other require-
ments are satisfied. CRA issued its position in response to the Langer case in
Payments Made by a Trust for the Benefit of a Minor Beneficiary, Technical News
No. 11 (Archived, September 30, 1997), which states in part:

The trustee of a discretionary trust may decide to allocate trust income

for the benefit of a beneficiary who is a minor by making a payment to
a third party or to the parent as a reimbursement for an expenditure.
Alternatively, the parent may seek the trustee’s agreement to make such
a payment and, at the same time, provide direction to pay the amount to
the appropriate person (i.e., the third party or the parent). The Depart-
ment will consider such a payment to be deductible from the trust’s
income as an amount paid to the child in the year (pursuant to subsec-
tion 104(6)) and included in the child’s income in the year (pursuant to
subsection 104(13)) where:

(a) The trustee exercised his or her discretion pursuant to the terms
of the trust indenture or will to make the amount of the trust’s
income payable to the child in the year before the payment was
made

(b) The trustee initiated the steps to make the payment, the trustee
notified the parent of the exercise of the discretion and the
parent directed the trustee to pay the amount to the appropri-
ate person before the payment was made; or the payment was
made pursuant to the parent’s request and direction, the parent

6 Langer Family Trust v. M.N.R, [1992] 1 C.T.C. 219, 92 D.T.C. (T.C.C.).

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6.1.4 Chapter 6 – Taxation of Beneficiaries

was advised of the exercise of discretion and payment of the

amount either before or after the payment was made, and

(c) It is reasonable to consider that the payment was made in

respect of an expenditure for the child’s benefit; i.e., amounts
paid for the support, maintenance, care, education, enjoyment
and advancement of the child, including the child’s necessaries
of life.

The above comments assume that the attribution rules do not apply.
Where the actions taken by the trustee and parent described in (a) and
(b) above are not evidenced in writing, the trustee and parent should be
prepared to provide other satisfactory evidence that the requirements
were met. Records kept by the trustee to support that a payment was
made in respect of an expenditure for the child’s benefit should include
the receipt issued by the third party, or where the parent was reim-
bursed for the expenditure, the receipt obtained by the parent for that
expenditure.

Good record keeping backed up by relevant documentation, such as invoices,

receipts, and bank statements, is particularly necessary in order to satisfy CRA’s
requirements with respect to third party payments. Poor record keeping and fail-
ure to provide proper documentation were some of the persuasive factors in the
decision in Langer.

For adult beneficiaries, CRA also stated:

With respect to indirect payments, where an amount of income is not

paid directly to the individual so entitled, but is paid to another person
for the benefit of the individual pursuant to the individual’s direction or
concurrence, that amount will be included in the individual’s income.7

6.1.4 Documenting Amounts Payable

Where the trust is discretionary, it is important for the trust to document the
exercise of the trustee’s discretion and creation of an enforceable obligation to
make the payment to the beneficiary. One method is to issue a demand promis-
sory note or cheque payable to the beneficiary. However, the exercise of discre-
tion by the trustee to issue the note must not be revocable, nor should there

7 Technical News No. 11 (Archived, September 30, 1997).

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BENEFITS CONFERRED BY A TRUST 6.2

be any condition or postponement attached to the right of the beneficiary to

enforce payment of the note.8

6.1.5 Steps to Take to Make Income Payable by a Trust

Where income is to be made payable in a discretionary trust, the exercise of the

trustee’s discretion should:

• be recorded in writing,
• identify the beneficiary to whom the income is being made payable,
• set out the amount of income or express the interest of the benefi-
ciary as a fixed portion of income,
• state that the exercise of discretion is not revocable by the trustees
and is enforceable by the beneficiary,
• be signed by the trustees before the year-end of the trust, and
• be delivered to the beneficiary, or if a minor, the legal guardian.

As stated above, delivery of an unconditional demand promissory note may be

considered payment by CRA.

6.1.6 Income Not Payable during Executor’s Year

See the discussion at 4.3.7.4, Income Paid or Payable by an Estate during the
Executor’s Year.

6.2 BENEFITS CONFERRED BY A TRUST

Under subss. 105(1) and 105(2), certain benefits or advantages from a trust
may be taxable to a beneficiary (or any person under subs. 105(1)) without any
amount being paid or payable to such beneficiary or person.

A taxpayer must include in income the value of any benefit received from a trust
except to the extent that the benefit is in respect of maintenance of property oth-
erwise taxed under subs. 105(2).9 The language in subs. 105(1) is very broad; the
term “benefit” is not defined or otherwise clarified, nor are the tax consequences

8 Supra, note 6, at pp. 3-21 to 3-22.

9 Or any amount subject to a deduction in adjusted cost base (ACB) of the interest in the trust under
para. 53(2)(h).

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6.3 Chapter 6 – Taxation of Beneficiaries

limited to a beneficiary of the trust. Any person who receives a benefit from the
trust will be taxable.

CRA’s administrative position is that the use of personal-use property (such as

a residence occupied as the person’s home) owned by the trust is not a ben-
efit.10 However, the property must qualify under the definition of “personal use
property” in s. 54 in order to qualify for this administrative concession. If the
property is not used for personal use (i.e., for some purpose other than personal
use and enjoyment such as a rental property), there will be a benefit. Where
a benefit is conferred, the amount would be based on the fair market value of
the benefit. For example, if real property of a trust is used by a taxpayer in the
course of carrying on a business, the value of the benefit would be the fair mar-
ket value of renting a comparable property less the amount, if any, paid by the
user of the property.

Taxation of any benefit under subs. 105(1) is a potentially onerous result, since
there is no deduction from trust income for such amount, notwithstanding the
corresponding income inclusion.

In Cooper v. M.N.R.11 a trust created for the purpose of buying a home for the
taxpayer granted an interest-free loan payable on demand and secured by a
mortgage on the home purchased. The taxpayer was assessed for a benefit under
subs. 105(1) on the interest-free loan. The loan was held not to be a benefit and
therefore not taxable.

6.3 INCOME IN THE FORM OF OUTLAYS FOR UPKEEP OF TRUST PROPERTY

Under subs. 105(2), amounts paid by a trust out of the income of the trust for
the upkeep, maintenance, or taxes of or in respect of property required “under
the terms of the trust arrangement” to be maintained for the use by a life ten-
ant or beneficiary are to be included in the income of such person. The amount
included in income is such part of the amount paid as is “reasonable in the
circumstances.”

Unlike the non-deductible benefit under subs. 105(1), the trust may deduct the
amount included (under subs. 105(2)) in the income of the beneficiary from trust

10 Technical Interpretation 2003-0047727, Right of Use — Deemed Trust (December 17, 2003). See also
Technical Interpretation 9618885, Third Party Payments and Rent Free Use of Trust Property (September
22, 1997).
11 Cooper v. M.N.R., [1989] 1 C.T.C. 66, 88 D.T.C. 6525 (Fed. T.D.).

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FLOW-THROUGH OF SOURCE OF INCOME TO A BENEFICIARY 6.4

income, under para. 104(6)(b). In addition, only a beneficiary of the trust or life
tenant of the property can be assessed under this rule, and only payments out of
income, not capital, are subject to the rule. This rule, where it applies, in effect
deems income payments made to a third party to be taxable in the hands of the
beneficiary or life tenant who benefited from the payment. However, if payments
are out of capital, the benefit rule under subs. 105(1) may apply. Accordingly, if
there is a choice, such payments should be made out of income so that the trust
is entitled to the deduction.

Where the trust is not required to maintain the property under the terms of the
trust, and the payment made out of income for maintenance or upkeep is discre-
tionary, the provision may not apply. However, if “under the terms of the trust
arrangement” includes payments made pursuant to the exercise of the trustee’s
discretion to make such payments, it may be included under subs. 105(2). Again,
it may be better to treat the amount as required to be paid under subs. 105(2) if
it might otherwise be assessed as income with no deduction by the trust under
subs. 105(1).

6.4 FLOW-THROUGH OF SOURCE OF INCOME TO A BENEFICIARY

Income from a trust is considered to be income from property that is an interest

in a trust, unless the trust is able to designate the income from a particular, spe-
cific source under a specific provision of the Act.12

The following types of income may retain their character in the hands of a ben-
eficiary if specifically designated by the trust:

• taxable dividends from Canadian corporations, including eligible

and non-eligible dividends,13
• capital gains,14
• capital gains eligible for the capital gains deduction,15
• capital dividends,16 and
• foreign source income.17

12 Subs. 108(5).
13 Subs. 104(19).
14 Subs. 104(21).
15 Subss. 104(21) and (21.2).
16 Subs. 104(20).
17 Subs. 104(22).

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6.4.1 Chapter 6 – Taxation of Beneficiaries

6.4.1 Designation of Taxable Dividends

The benefit of allocating taxable dividends to an individual beneficiary is access

to the dividend tax credit. However, if dividends are not allocated, the trust may
also use the dividend tax credit. The dividend tax credit operates to reduce the
rate of tax on the amount received as a dividend even after taking into account
the taxable dividend (i.e., the actual dividend plus the gross-up) that is included
in the recipient’s income. This may be of particular benefit where the individual
beneficiary has no other sources of income.

This designation is available in respect of income allocated to a beneficiary

under subs. 104(13) and also with respect to amounts designated as a preferred
beneficiary election under subs. 104(14). Where designated, the dividends retain
their “flow-through” nature for the purposes of the dividend gross-up and divi-
dend tax credit for individuals. The flow-through provisions apply to eligible
dividends and other or “non-eligible” taxable dividends.

6.4.2 Designation of Capital Gains

An estate or trust can only make a designation of net taxable capital gains to a
beneficiary if it is reasonable to consider that the amount designated forms part
of the beneficiary’s income.18

CRA sets out an extensive commentary in Interpretation Bulletin IT-381R3

(Archived), Trusts — Capital Gains and Losses and the Flow-Through of Tax-
able Capital Gains to Beneficiaries. The effect of this designation is that the
beneficiary may treat the amount designated as a taxable capital gain and may
offset the gain against allowable capital losses.19 In addition, the taxable capital
gain may be offset by net capital losses of other years. An additional designa-
tion is necessary for the gain to be eligible for the capital gains deduction under
s. 110.6.

In determining whether an amount of capital gain can be allocated and des-

ignated to a beneficiary, the beneficiary need only receive, or have an amount
payable equal to, the taxable portion of the capital gain.

Capital gains on deemed dispositions cannot always be flowed through to ben-

eficiaries. For further discussion, see 6.4.5, Phantom Income.

18 Para. 104(21)(a).
19 Under s. 3.

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FLOW-THROUGH OF SOURCE OF INCOME TO A BENEFICIARY 6.4.3

6.4.3 The Capital Gains Deduction: Qualifying Farm Property, Qualifying

Fishing Property, or Shares in a Qualified Small Business Corporation
(QSBC)

Capital gains eligible for the lifetime capital gains exemption may be flowed
through to an individual beneficiary, who may then use the exemption to shel-
ter any tax on the gains.20 A trust is not entitled to the capital gains exemption.
The trust must designate the amount as a taxable capital gain both under subs.
104(21) and as an amount of eligible taxable capital gain under subs. 104(21.2)
in order for the beneficiary to claim the exemption. The amount designated will
be limited by any balance in the cumulative net investment loss (CNIL) account
in the trust.

The formulas contained in subs. 104(21.2) are very complex. Essentially, the
designation of eligible taxable capital gains to each beneficiary must be in the
same proportion as the designation of the total amount of taxable capital gains
designated to each beneficiary under subs. 104(21). In addition, the eligible tax-
able capital gain from each type of property (farming property, fishing property,
or shares of a qualifying small business) must be designated separately.

For example, if the designation of all taxable capital gains under subs. 104(21) is
in equal amounts to each beneficiary, then the eligible taxable capital gains must
be designated in equal amounts to each beneficiary.

In making the designation under subs. 104(21) among a number of beneficia-

ries, which in turn will determine the amount each beneficiary may receive that
is eligible for the capital gains exemption, the trustees might take into account
the ability of each beneficiary to benefit from the capital gains exemption. For
example, the use of the exemption may be limited if the beneficiary:

• has a CNIL balance,

• claimed an allowable business investment loss,
• already used some or all of his or her lifetime exemption, or
• has unused net capital loss carryforwards.

Also, non-resident beneficiaries will not be able to claim the capital gains exemp-
tion. The terms of the trust will dictate to what extent payments of capital may
be made to beneficiaries, and in what proportions. For example, taxable capital

20 For additional details on the lifetime capital gains exemption, see 4.3.8.5 and 3.3.

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6.4.4 Chapter 6 – Taxation of Beneficiaries

gains cannot be allocated to a beneficiary who is entitled only to trust “income”

under trust law. Where there is flexibility under the trust document, the tax
advantage of designating eligible taxable capital gains is a factor to be consid-
ered. The trustees will also have to ensure that they are not failing to maintain
an even hand among beneficiaries in making such allocations and designations.

6.4.4 No Flow-Through for Losses

Unless subs. 75(2) applies to the trust,21 or one of the other attribution rules
applies, there is no provision to flow through losses from the trust to any other
person, and losses are “trapped” in the trust. Loss utilization by trusts may be
accomplished through an election under subss. 104(13.1) or 104(13.2) (see 4.3.9).

6.4.5 Phantom Income

Phantom income refers to income from a deemed disposition or realization of

income under the Act where there is no actual receipt of funds. For example, any
taxable capital gains resulting from the deemed disposition arising as a result of
the application of the 21-year rule is phantom income. There is an issue as to
when such income can be deducted by the trust, since there is no actual income
receipt to pay or make payable to a beneficiary. CRA is of the view that phantom
income is not income for trust law purposes, and that the ability to allocate such
income to a beneficiary depends on whether under the terms of the trust the
amount is either paid or payable, or whether the trustee has sufficient discre-
tion to make such amount payable.22 Generally, therefore, there must be a right
to encroach on capital to make such amount payable. CRA has also suggested in
an earlier document that the terms of the trust must be specific so as to permit
the discretion or to make payable an amount equivalent to the deemed income.23

Phantom income may be made taxable in the hands of a preferred beneficiary if

the appropriate designation is made.

The deduction of income by a trust from certain deemed dispositions is prohib-

ited under para.104(6)(b). In the event such income is also payable to a benefi-
ciary under the terms of the trust, there will be double tax as the election under
subss. 104(13.1) or 104(13.2) is only available to absorb losses in the trust. Under

21 Applicable where property may return to the settlor or the settlor retains control over trust property.
See 9.3, Attribution Back to Settlor/Contributor Where Property Held in Trust: Subs. 75(2).
22 CRA Document No. 2004-0069951C6, June 21, 2004.
23 CRA Document No. 9429175, March 30, 1995.

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DISPOSITIONS BY A BENEFICIARY OF AN INCOME INTEREST OR A CAPITAL INTEREST IN A TRUST 6.6

subs. 104(6), the deemed income from the following dispositions is not eligible
for deduction by the trust:

• deemed disposition on the death of the spouse of a QST,

• deemed disposition on the death of the settlor/contributor of an
alter ego trust (AET), or
• deemed disposition on the death of the last to die of the settlor/
contributor of a joint spousal or common-law partner trust ( JPT) or
his or her spouse.

6.4.6 Designation of Capital Dividends

Where a trust receives tax-free capital dividends, they may be designated as tax-
free dividends in the hands of a beneficiary under subs. 104(20). Capital dividends
paid by a trust to a non-resident are subject to withholding tax.

6.5 COST OF CAPITAL PROPERTY RECEIVED FROM A TRUST

Generally, the rules operate with symmetry where property is transferred from
a trust. On the distribution of property from a trust to a beneficiary, there is a
disposition by the trust for deemed proceeds of disposition. Depending on the
rules applicable, the deemed proceeds of disposition may be equal to the trust’s
tax cost — that is, the distribution is on a rollover basis24 or equal to the fair
market value of the property at the time of transfer.25 The beneficiary is gener-
ally deemed to have acquired the property from the trust for an amount equal
to the same amount as the deemed proceeds of disposition to the trust on the
transfer. Similar symmetry operates on transfers of property to the trust by way
of settlement or gift.

6.6 DISPOSITIONS BY A BENEFICIARY OF AN INCOME INTEREST OR A

CAPITAL INTEREST IN A TRUST

A right to receive a distribution from a trust (whether income or capital) is con-

sidered property of the person holding the right, usually the beneficiary. When
the trust makes the distribution, the beneficiary is considered to have made

24 A rollover is provided for in subs. 107(2).

25 Where subs. 107(2.1) applies, as in subs. 107(4.1) where there is a distribution from a reversionary
trust subject to the attribution rule in subs. 75(2), or a distribution of certain property to a non-resident
beneficiary.

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6.6.1 Chapter 6 – Taxation of Beneficiaries

a disposition of the right to receive the distribution. Similarly, if a beneficiary

transfers the right to the distribution to a third party, this can result in a taxable
event for the beneficiary/transferor.

Dispositions of income interests (only to third parties) are given ordinary income
treatment (i.e., an inclusion of income), whereas dispositions of capital inter-
ests are treated on capital account, resulting in potential capital gains or capital
losses.

6.6.1 Disposition of an Income Interest in a Trust to a Third Party

An income interest is defined in subs. 108(1) as a right of a beneficiary to receive

income from a personal trust (see the example below.) The right can be immedi-
ate or future, absolute or contingent, and can be to receive all or any portion of
income of the trust. The disposition of an income interest to a third party by a
beneficiary will result in an income inclusion to the beneficiary equal to the pro-
ceeds of disposition less the cost to the beneficiary of the income interest in the
trust.26 In most cases, the cost of an income interest in a personal trust will be
nil, so that the entire amount of the proceeds will be included in income. Where
the interest is disposed of to a person with whom the transferor does not deal
at arm’s length, the proceeds will be deemed to be the fair market value of the
interest, but the cost of the interest to the purchaser will not be adjusted.27 The
following is an example:

Paula is an income beneficiary of her grandmother’s estate and is entitled to dividends on fixed-income preferred shares
held by the trust in the amount of $15,000, payable at the beginning of each calendar year. In August, Paula assigns her
income interest in the trust for the amount payable to her next January 1 to her brother, Sam, for $12,000, in order to pay
her tuition fees to medical school. Paula’s cost of the income interest in the estate is nil, and her proceeds are deemed to be
fair market value of the interest or $15,000 (adjusted to $15,000 under subpara. 69(1)(b)(i) since she does not deal with
Sam at arm’s length and assuming the value of the interest is $15,000).
Paula will have an income inclusion of $15,000 in the current year in respect of the disposition of the income interest in
the trust. She will not be entitled to any flow-through treatment in respect of the income inclusion (i.e., she will be denied
access to the gross-up and dividend tax credit on the dividend).

26 Subs. 106(2).
27 Subpara. 69(1)(b)(i).

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DISPOSITIONS BY A BENEFICIARY OF AN INCOME INTEREST OR A CAPITAL INTEREST IN A TRUST 6.6.2.1

A distribution of property to a beneficiary by the trust in satisfaction of an income

interest will not result in a disposition that creates an income inclusion to the
beneficiary under this rule.28 However, the distribution of capital property to an
income beneficiary in satisfaction of an income interest will trigger a disposition
by the trust of that property for an amount equal to the fair market value of the
property.29 Since most distributions of capital property to a beneficiary in satis-
faction of a capital interest in a trust are made on a tax-deferred rollover basis, it
may be a preferred strategy to distribute cash or in-kind distributions of capital
property on which there is minimal accrued gains in respect of income interests.

6.6.2 Disposition of a Capital Interest in a Trust

A capital interest in a trust includes all rights as a beneficiary under the trust,
including a right to enforce payment of an amount by the trust to a beneficiary,
but does not include an income interest in the trust.30

6.6.2.1 Disposition to a Third Party

The disposition of a capital interest in a trust to a third party may result
in a capital gain or loss (see below for an example).31 The gain will be
equal to the proceeds of disposition less the greater of the adjusted cost
base of the capital interest and its cost amount. In most cases, the rules
provide that the adjusted cost of the capital interest in a personal trust
will be nil,32 unless the interest has been purchased from a beneficiary.
The cost amount of the capital interest as defined in subs. 108(1) is the
particular beneficiary’s proportionate share of the cost amount of trust
property less liabilities. In effect, this permits the beneficiary to benefit
from the cost of property held by the trust: the cost to the beneficiary
in calculating any gain is “bumped up” by the cost amount in the trust,33
thereby reducing the gain subject to tax. The following is an example:

28 See the exclusion in para. 106(2)(a) if subs. 106(3) applies.

29 Subs. 106(3).
30 Subs. 108(1).
31 Subs. 107(1).
32 Subs. 107(1.1).
33 Certain stop-loss rules may apply where an individual has received capital dividends from a trust
under subs. 104(20).

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6.6.2.2 Chapter 6 – Taxation of Beneficiaries

Yolanda sells her capital interest in a family trust in which she is currently the sole remaining beneficiary.
The purchaser, Joe (an unrelated person), buys the interest for $25,000. The property in the trust consists of
securities with a value of $30,000 and a cost amount to the trust of $16,000. Her gain is calculated as follows:

Proceeds of Disposition $25,000

Less: greater of:
ACB of capital interest in the trust 0
Cost amount of property in trust $16,000 $16,000
Capital gain to Yolanda $9,000

6.6.2.2 Disposition of a Capital Interest upon Distribution from the Trust

A distribution of capital from a trust to a beneficiary in satisfaction of
the beneficiary’s capital interest in the trust is a disposition for both the
trust34 of the property distributed and by the beneficiary of the benefi-
ciary’s capital interest in the trust.35 As previously discussed, the trust’s
disposition may take place on a rollover basis, or at an amount equal to
fair market value. In most cases, the beneficiary’s deemed disposition of
the capital interest in the trust will take place on a rollover basis.36

Where the property is distributed on a rollover basis, the beneficiary’s

cost of the property distributed will be equal to the trust’s cost of the
property.37 However, if the beneficiary has an adjusted cost base in the
capital interest in the trust, a bump-up is available to increase the cost
of the property distributed by the excess of the adjusted cost base of the
capital interest over the cost amount of the property to the beneficiary
(i.e., the cost of the property to the trust).

In the above example involving Yolanda, Joe is now a beneficiary of

the trust.38 If the trust winds up and distributes the same securities
now worth $30,000, the rules in para. 107(2)(b) would provide a cost
amount of the property to Joe of $16,000 plus the difference between
his adjusted cost base of the capital interest in the trust, and the cost of

34 Para. (c) of the definition of “disposition” in s. 248.

35 Ibid., para. (d).
36 There are a number of rules deeming the cost of the capital interest in the trust in subs. 108(1) and the
proceeds of disposition of the capital interest in para. 107(2)(c) to be the same amounts.
37 Para. 107(2)(b).
38 See the extended meaning of “beneficiary” in subs. 108(1), which includes a person beneficially
interested in the trust. Joe, as an assignee of a beneficiary, arguably qualifies as a beneficiary.

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DISTRIBUTIONS TO NON-RESIDENT BENEFICIARIES 6.7.2

the property to the trust ($25,000 – $16,000 = $9,000), with the result
that Joe’s cost of the securities would be deemed to be $25,000 (i.e., the
amount he actually paid for his capital interest in the trust).

6.7 DISTRIBUTIONS TO NON-RESIDENT BENEFICIARIES

Distributions to a beneficiary under the terms of a trust are either in respect of

an income interest in a trust or a capital interest in a trust. Payments to a ben-
eficiary in respect of an income interest in the trust will be treated as income to
the beneficiary. If capital property is transferred to a beneficiary in satisfaction
of either an income or capital interest in the trust, there will be a disposition of
that property by the trust for tax purposes. As has already been discussed (see
4.5.1), distributions of capital property to a beneficiary in satisfaction of a capital
interest in a trust are subject to the rollover provisions in subs. 107(2).

This section will discuss the special rules that apply to trust distributions of
income or capital to non-resident beneficiaries (i.e., the taxation of non-resident
beneficiaries and the tax consequences to a trust of having non-resident ben-
eficiaries). Note that the Canadian tax system attempts to collect tax in respect
of non-residents on Canadian-source income by imposing obligations and tax
liability on the Canadian payor; in addition to withholding tax, a Canadian trust
with non-resident beneficiaries may also be required to pay Part XII.2 tax, or
obtain a certificate of compliance (clearance certificate).

6.7.1 Income Distributions to Non-Resident Beneficiaries: Summary

When income is distributed to a non-resident beneficiary:

• there is a requirement for the trust to withhold and remit withhold-

ing tax under Part XIII of the Act and
• Part XII.2 tax may apply on certain income and taxable capital
gains of taxable Canadian property if designated to non-residents.

6.7.2 Withholding Tax on Income Paid or Credited to Non-Residents

Payments to non-residents of Canada may be subject to withholding tax under

Part XIII of the Act. Paragraph 212(1)(c) levies a 25% tax on income paid,
credited,39 or payable by a trust to a non-resident beneficiary. Under subs. 215(1),

39 See subs. 212(1) preamble.

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6.7.3 Chapter 6 – Taxation of Beneficiaries

the trust is required to withhold the non-resident tax of 25% of the gross amount
of any income distribution paid or credited to a non-resident,40 notwithstanding
any law or any agreement to the contrary, and to submit with the remittance a
statement in prescribed form. The remittance should be remitted on or before
the 15th of the month following the month that payment is paid or credited for
it to be considered remitted in a timely manner.

The 25% rate imposed under Part XIII may be subject to reduction under any tax
treaty Canada has with the country in which the non-resident of Canada resides.
In addition to applying to income distributed from the trust, this withholding tax
is also payable on distributions of capital dividends (i.e., dividends paid out of a
corporation’s capital dividend account), which would otherwise be non-taxable
to a Canadian resident recipient.

Income paid or payable to a non-resident beneficiary by a trust is considered

to be income from a trust and not from any other source.41 The income does
not retain its tax character in the hands of a non-resident beneficiary, even if
the income is otherwise eligible to be designated for flow-through treatment.
Consequently, the reduced treaty rates of withholding tax imposed on particular
sources of income (such as dividends, rents, or royalties) are not available when
the income is received by a non-resident beneficiary through a trust. Rather, the
reduced treaty withholding rate relating to income from a trust will apply.

In calculating the amount subject to non-resident withholding tax under Part

XIII, there is a deduction available for any Part XII.2 tax on income paid or pay-
able to non-residents, discussed above.

See 5.7, Tax Consequences Where There Are Non-Resident Beneficiaries, and
11.4, Requirements to Withhold and Remit and Penalties for Failure, for a discus-
sion of the compliance requirements of payments to non-residents by a trust.

6.7.3 Part XII.2 Tax on Designated Income

Part XII.2 Tax42 is a tax payable only by trusts. The combination of Part XII.2
tax and the withholding tax under Part XIII is intended to result in the same
tax liability on certain Canadian-source income and gains that would arise if the

40 Pursuant to paras. 212(1)(c) and 214(3)(f) and subs. 212(11).

41 Subs. 212(11).
42 Ss. 210 to 210.3.

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DISTRIBUTIONS TO NON-RESIDENT BENEFICIARIES 6.7.3

non-resident earned such amounts directly rather than through a trust. All trusts
are subject to this tax after 2015.

The tax is payable if:

• there is as a non-resident beneficiary (called a “designated benefi-

ciary”) and
• the trust has “designated income” (defined below) that is paid or
payable to beneficiaries.

The tax is 36% of “designated income,”43 which comprises the following:

• taxable capital gains from disposition of taxable Canadian

property,44 including real property in Canada,
• income from real property in Canada,
• income from businesses carried on in Canada,
• income from timber resource properties, and
• income from Canadian resource properties.

The portion of the tax on income designated to resident beneficiaries (called

“eligible beneficiaries”) creates a refundable tax credit to resident beneficiaries.

Example of the Application of Part XII.2 Tax

The income of the trust consists of $21,000 of taxable capital gains in respect of the sale of taxable Canadian property. There
are three beneficiaries who share equally in the gains, and one of them is a non-resident of Canada. The Part XII.2 tax would be:
Part XII.2 Tax = 36% of $21,000 = $7,560
The amount of the refundable credit is the portion of the tax allocated to the resident beneficiaries:
Refundable Credit: Part XII.2 Tax 2/3 = $7,560 x 2/3 = $5,040
Portion not refunded: $7,560 minus $5,040 = $2,520

The portion of the tax representing
$2,520 in the example, is in effect
resident beneficiary. This amount is
credited to non-residents on which
Schedule 10 in the T3 trust return.
the amount not available for refund, being
36% of the amount allocated to the non-
taken as a deduction from income paid or
withholding tax is calculated in Part B of

43 Called “specified income” on Schedule 10 and in the T3 Trust Guide.

44 Defined in subs. 248(1).

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6.7.4 Chapter 6 – Taxation of Beneficiaries

The taxation of non-resident beneficiaries is discussed below, but see also 4.5.5,
Distributions to Non-Resident Beneficiaries, and 5.7, Tax Consequences Where
There Are Non-Resident Beneficiaries. In addition, IT-465R (Archived), Non-Resi-
dent Beneficiaries of Trusts, sets out some of the rules in detail.

6.7.4 Distributions to Non-Resident Beneficiaries in Satisfaction of a Capital

Interest in a Trust: Summary

Where a trust distributes property to a non-resident beneficiary in satisfaction of

a capital interest in a trust:

• there is a disposition of any capital property distributed by the

trust that may or may not be on a rollover basis (see below) and
• there is a disposition by the non-resident beneficiary of that benefi-
ciary’s capital interest that may result in the trust being required to
pay a 25% tax on the value of any property distributed if the non-
resident has not obtained a certificate of compliance under s. 116
of the Act (formerly called a “section 116 clearance certificate”).

6.7.5 Disposition of Capital Property Distributed by a Trust to a Non-Resident

Beneficiary

Under subs. 107(5), a distribution by a trust of capital property to a non-resident

beneficiary in satisfaction of all or part of the beneficiary’s capital interest in
the trust is not eligible for the rollover in subs. 107(2). The trust is deemed to
have disposed of the property distributed at its fair market value, and the non-
resident beneficiary is deemed to acquire the property for that same amount
under subs. 107(2.1). However, there are exceptions. Distributions of the follow-
ing properties are eligible for rollover treatment when distributed by a trust to a
non-resident beneficiary:

• shares of a non-resident-owned investment corporation,

• real property situated in Canada,
• Canadian resource property and timber resource property, and
• certain property used in a business carried on through a perma-
nent establishment in Canada.

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DISTRIBUTIONS TO NON-RESIDENT BENEFICIARIES 6.7.6

6.7.6 Disposition of Capital Interest in a Trust by Non-Resident Beneficiary and

Requirement for Certificate of Compliance (S. 116 Clearance Certificate)

When property is distributed to a non-resident beneficiary in satisfaction of a

capital interest in the trust, in addition to a disposition of the property distrib-
uted by the trust, the non-resident beneficiary, as vendor, is deemed to have
disposed of the capital interest in the trust to the resident Canadian trust, as pur-
chaser. If the capital interest in the trust is considered taxable Canadian prop-
erty, the disposition by the non-resident is subject to the requirements under
s. 116 of the Act for dispositions by non-residents of Canada.

The definition of taxable Canadian property (TCP) in subs. 248(1) includes a

capital interest in a trust only if, at the time of the disposition or at any time
within the prior 60 months, more than 50% of the fair market value of the inter-
est in the trust was derived directly or indirectly from:

• real property situated in Canada,

• Canadian resource properties,
• timber resource properties, and
• options in respect of the above.

Where the capital interest in the trust is TCP, the non-resident is required to
obtain a certificate of compliance45 from CRA in respect of the distribution. In
the application for the certificate of compliance, the non-resident must report
the “sale” of a capital interest in the trust and pay a tax equal to a 25% tax of the
fair market value of the capital interest in the trust. The amount of tax may be
reduced in some circumstances, but this is dependent on the information pro-
vided on the application form.46

The 25% tax is payable by the non-resident under subs. 116(4), but under
subs. 116(5) the purchaser (the trust) is liable for the tax if the property being
distributed by the trust in satisfaction of a capital interest in the trust is trans-
ferred without the compliance certificate. This forces the trust to police the non-
resident’s compliance with the obligation to obtain the certificate of compliance
and pay the tax. Effectively the trust may be forced to “withhold” the liability
prior to making the distribution.

45 Formerly called a “section 116 clearance certificate” and commonly still referred to this way.
46 See Form T2062, Request by a Non-Resident of Canada for a Certificate of Compliance Related to the
Disposition of Taxable Canadian Property.

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6.7.7 Chapter 6 – Taxation of Beneficiaries

The requirement to obtain the certificate of compliance does not differ with
the type of property distributed and may apply even to cash distributions made
to a non-resident in respect of a capital interest. The test is whether the non-
beneficiary’s capital interest in the trust falls within the definition of taxable
capital property. This could be a danger area for a trustee who may be unaware
of the tax liability in the absence of obtaining the certificate of compliance,
and provides a further reason to obtain a clearance certificate to protect the
trustee from personal liability before making any distributions to beneficiaries.
The requirement to obtain a “certificate of compliance” where there is a distribu-
tion to a non-resident beneficiary should not be confused with the requirement
to obtain a “clearance certificate” for any estate distributions under subs. 159(2).

Where the property transferred to the non-resident beneficiary is subject to

departure tax, the requirement to withhold or obtain the s. 116 certificate of
compliance does not apply. “Departure tax” is the tax payable arising from the
deemed disposition of property that is imposed under the Act when the owner
becomes a non-resident of Canada.47

6.7.7 Relief from Requirement for Certificate of Compliance Where Disposition

of Capital Interest in the Trust Is Treaty-Exempt

If the interest in the trust is taxable Canadian property, relief from the require-
ment to obtain a certificate of compliance may still be available under subss.
116(5.01) to (5.02). These new rules protect the Canadian purchaser from liabil-
ity where the disposition by the non-resident would be treaty-protected. The
trust must make a reasonable inquiry and conclude that the non-resident is a
resident of a country that has a treaty with Canada and that the property distrib-
uted would be treaty-protected. In addition, the trust must provide notice to the
Minister within 30 days of the distribution, with detailed information.48 Provided
that these conditions are met, the requirement to withhold and remit Part XIII
taxes will be waived.49

47 See para. 128.1(4)(b).

48 See Form T2062C, Notification of an Acquisition of Treaty-protected Property from a Non-resident Vendor.
49 It is not entirely clear what reasonable inquiry is required. However, the required notice contained in
Form T2062C states: “The purchaser must take prudent measures to confirm the vendor’s country of
residence for treaty purposes. Generally, the CRA will accept that the purchaser has made reasonable
inquiry if Part D is completed by the vendor or an equivalent declaration is obtained from the vendor.”

6–24
KEY STUDY POINTS 6.8

6.8 KEY STUDY POINTS

• A beneficiary is taxable on income paid or payable by a trust to

that beneficiary. The only exception is when the trust makes an
election to have the receipt taxed in the trust to absorb losses in
the trust.
• A trust should document its decisions to make income payable,
and where it is not actually paid, unless the payment is enforce-
able by the beneficiary, the amount is not deductible by the trust or
included in the income of the beneficiary. Payments allocated and
designated to beneficiaries must be consistent with the terms of the
trust.
• Certain sources of income retain their tax character when received
by a beneficiary if the trust has allocated and designated the
amount to the beneficiary in the T3 Return.
• A beneficiary may be taxable on dispositions of the right to a dis-
tribution from a trust, if made to a third party, whether a right to a
capital or interest distribution.
• Distributions of income to a non-resident beneficiary are subject to
non-resident withholding tax.
• A beneficiary is considered to have made a disposition of a capital
interest in the trust when the trust distributes an amount to the
beneficiary in satisfaction of a capital interest in a trust. For non-
resident beneficiaries, capital distributions can trigger certain com-
pliance provisions of the Act, if the trust held real property situated
in Canada within five years of the distribution. This can result in
an obligation of the beneficiary and the trust to obtain a s. 116 cer-
tificate of compliance or clearance certificate. This obligation can
arise even in the case of cash distributions to a non-resident.
• Distributions from a trust of capital property take place on a roll-
over basis, and the beneficiary will take capital property at the
tax cost of the trust. The rollover is not available for distributions
of capital property to a non-resident, with some exceptions, most
notably real property situated in Canada.

6–25
 CHAPTER 7
TAXATION OF DECEASED INDIVIDUALS AND THE
TERMINAL RETURN

LEARNING OBJECTIVES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–5

7.1 INTRODUCTION TO TAXATION ON DEATH . . . . . . . . . . . . . . . . . . . . . 7–5

7.2 NECESSARY AND ELECTIVE RETURNS FOR DECEASED

PERSON . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–7

7.3 DUE DATE FOR FILING RETURNS FOR A DECEASED PERSON

FOR THE YEAR OF DEATH AND PRIOR YEARS . . . . . . . . . . . . . . . . . . 7–8

7.4 PAYMENT OF TAX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–10

7.5 LIABILITY FOR PAYMENT OF TAXES AND CLEARANCE

CERTIFICATE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–10

7.6 PREPARATION OF THE T1 RETURN OR FINAL RETURN FOR

THE YEAR OF DEATH . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–11

7.7 INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–11

7.7.1 Periodic Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–11

7.7.2 Employment Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–12
7.7.3 Death Benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–12
7.7.4 Old Age Security Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–12
7.7.5 Canada Pension Plan and Quebec Pension Plan
(CPP and QPP) Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–13
7.7.6 CPP or QPP Death Benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–13
7.7.7 Other Pension Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–13
7.7.8 Employment Insurance Benefits . . . . . . . . . . . . . . . . . . . . . . . 7–13
7.7.9 Investment Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–13
7.7.9.1 Reserves in the Year of Death . . . . . . . . . . . . . . . . 7–13

7–1
7.8 RRSPS AND RRIFS ON THE DEATH OF THE ANNUITANT . . . . . . . 7–14

7.8.1 General Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–14

7.8.2 Value of Plan at Death Included in Deceased’s Final
Return . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–15
7.8.2.1 Exception from General Rule Where Matured
RRSP Paid to Spouse . . . . . . . . . . . . . . . . . . . . . . . . . 7–16
7.8.3 Discretionary Election to “Tax Shift” a Refund of
Premiums from the Terminal Return to the Recipient . . . 7–16
7.8.3.1 Financially Dependent — Subs. 146(1.1) . . . . . 7–18
7.8.3.2 Discussion of Discretionary Nature of the
Final Return and the Rollover for Refund of
Premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–18
7.8.3.3 Joint Election to Include Amount of Plan in
the Income of a Qualified Beneficiary . . . . . . . . 7–19
7.8.4 Rollovers Available for Refund of Premiums . . . . . . . . . . . . 7–19
7.8.4.1 Options for Able Child Under Age 18 . . . . . . . . . 7–20
7.8.4.2 Options for a Spouse, or Child/Grandchild
Financially Dependent by Reason of Physical
or Mental Infirmity . . . . . . . . . . . . . . . . . . . . . . . . . . 7–20
7.8.4.3 Trust Options for Mentally Infirm Spouse
or Child: Lifetime Benefit Trusts (LBTs) and
Qualified Trust Annuities (QTAs) . . . . . . . . . . . . . . 7–21
7.8.5 Taxation of Beneficiary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–22
7.8.6 Payment of Tax Liability for RRSPs and RRIFs . . . . . . . . . . . . 7–22
7.8.7 Contributions to RRSP after Death . . . . . . . . . . . . . . . . . . . . . 7–23
7.8.8 Losses in a Registered Plan after Death . . . . . . . . . . . . . . . . . 7–23
7.9 OTHER REGISTERED PLANS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–24

7.9.1 Tax-Free Savings Accounts (TFSAs) . . . . . . . . . . . . . . . . . . . . . 7–24

7.9.2 Registered Education Savings Plans (RESPs) . . . . . . . . . . . . 7–24
7.9.3 Registered Disability Savings Plan (RDSPs) . . . . . . . . . . . . . 7–25

7–2
7.10 DEEMED DISPOSITIONS AT DEATH . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–25

7.10.1 Land Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–25

7.10.2 Capital Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–25
7.10.3 Depreciable Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–26
7.10.4 Personal Use Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–27
7.10.5 Principal Residence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–27
7.10.6 Jointly Held Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–28
7.10.7 Partnership Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–30
7.10.8 Rollovers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–30
7.10.9 Lifetime Capital Gains Exemption (LCGE) . . . . . . . . . . . . . . . 7–31
7.11 DEDUCTIONS FROM NET INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–31

7.12 NET CAPITAL LOSSES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–32

7.12.1 Net Capital Losses in the Year of Death . . . . . . . . . . . . . . . . . 7–32

7.12.2 Net Capital Losses Carried Forward to the Year of
Death . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–32
7.13 NON-REFUNDABLE TAX CREDITS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–33

7.13.1 Personal Amounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–33

7.13.2 Medical Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–33
7.13.3 Charitable Donations on Death . . . . . . . . . . . . . . . . . . . . . . . . 7–33
7.14 ALTERNATIVE MINIMUM TAX (AMT) . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–35

7.15 RIGHTS OR THINGS RETURNS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–35

7.16 KEY STUDY POINTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7–36

7–3
 Chapter 7
Taxation of Deceased Individuals
and the Terminal Return

Learning Objectives
Knowledge Objectives:
• Understand the rules arising on death, including the requirements to file and
complete the tax return for the year of death.

Skills Objectives:
• Explain how individuals are taxed on death.
• Describe and explain the contents of the tax returns for the year of death.

7.1 INTRODUCTION TO TAXATION ON DEATH

Death is a taxable event under the Act, and any obligations of the deceased to
pay tax or file returns in existence at the time of death continue and become the
responsibility of the personal representatives. The main provisions dealing with
taxation on death are contained in s. 70 of the Act, but many other provisions
of the Act have special rules relating to the death of a taxpayer. Death creates a
year-end for tax purposes, and a T1 Return for income of the deceased for the
period from January 1 to the day of death must be filed by the personal repre-
sentatives. This final tax return is also called the “terminal return.”

7–5
7.1 Chapter 7 – Taxation of Deceased Individuals and the Terminal Return

The following are the basic rules for taxation in the year of death:

• Amounts due or accruing due to the day of death are to be included

in the final return.1
• An election is available to file a separate tax return for any “rights
and things” of the deceased at the time of death.2
• All capital property, land inventory, and resource property of the
deceased is deemed disposed of for an amount equal to fair market
value immediately before the death.3 Many exceptions exist, and a
number of rollovers are available.
• The value of all registered retirement savings plans (RRSPs) and
registered retirement income funds (RRIFs) at the time of death is
included in income of the deceased. There is an exception where
the proceeds of the plan qualify as a “refund of premiums,” in
which case options are available to tax the amount in the final
return or in the hands of a qualifying beneficiary who may also be
entitled to a rollover upon a transfer to his or her own registered
plan.
• Payments from RRSPs and RRIFs are not subject to withholding
tax on death unless paid to a non-resident beneficiary, resulting in
potential problems because “the tax does not follow the money.”
• Capital losses may be deducted against all sources of income in the
year of death and the immediately preceding year.
• Minimum tax is not applicable in the year of death.
• The limit for using the charitable donation tax credit is increased to
100% of income in the year of death; any unused charitable dona-
tions in the year of death may be carried back one year and the
100% limit is also available for the year prior to death.
• There are special rules for charitable gifts in a Will: there is flex-
ibility, and the donation tax credit may be used by the graduated
rate estate (GRE) of the deceased, in the final return, or that of the
prior year.

1 Subs. 70(1).
2 Subs. 70(2).
3 Subss. 70(5) and (5.2).

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NECESSARY AND ELECTIVE RETURNS FOR DECEASED PERSON 7.2

7.2 NECESSARY AND ELECTIVE RETURNS FOR DECEASED PERSON

The legal representative is responsible for filing returns for the year of death and
any other returns for years prior to death not filed by the deceased.4 See 11.2
for more details about the requirement to file returns and due dates. The volun-
tary disclosure procedure may be available to minimize penalties for delinquent
returns of prior years.5 Filing outstanding personal returns, as well as any estate
returns required, and paying tax and interest owing on all these returns will be
required before any clearance certificate can be issued for the estate. Any distri-
bution of property from the estate by the personal representative without first
obtaining a clearance certificate will result in personal liability for unpaid taxes
and interest (see 7.4, Payment of Tax, and 7.5, Liability for Payment of Taxes and
Clearance Certificate).

A final T1 tax return must be filed for the year of death to report the income due
and accruing due to the day of death.

In addition to the required final return, the personal representative may elect to
file additional separate tax returns for income that would otherwise be reported
in the final return as if the deceased person were “another person.”6 The follow-
ing additional returns may be available:

• the rights or things return (see 7.15),

• a return for income of the deceased received from a GRE having a
tax year-end in the calendar year of death but prior to the date of
death, and
• a return for income from a partnership or sole proprietorship
where the fiscal year of the business ends in the calendar year but
prior to the date of death.

A GRE may choose a year-end other than the calendar year. An individual reports
income from a GRE arising in the taxation year of the GRE that ends in the cal-
endar year. Where the date of death is after the year-end of the GRE, a separate
return may be filed for the “stub period” between the year-end of the trust and
the date of death.7

4 Subparas. 150(1)(b) and (d).

5 Information Circular 00-1R2.
6 See IT-326R3 (Archived), Return of Deceased Persons as “Another Person.”
7 Para. 104(23)(d).

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7.3 Chapter 7 – Taxation of Deceased Individuals and the Terminal Return

Where certain grandfathering rules apply, a separate return may be filed for the
income of a business for the period from the end of the fiscal period in the cal-
endar year of death until the date of death.8 This may apply where the deceased
was a partner in a business or the sole proprietor of a business and grandfather-
ing provisions permit a non-calendar year-end. The due date for this return is
the same as for the terminal return. Most partnerships and sole proprietors have
a December 31 fiscal year-end due to requirements to report income on a calen-
dar basis, and the opportunity to file this additional return seldom arises.9

There are a number of advantages to filing these optional returns. The marginal
rates of tax apply to each of these returns and the terminal return, providing the
opportunity for income splitting. There may also be an opportunity to double up
on certain personal tax credits. The following amounts may be claimed in the
final return and in each optional return in full:

• basic personal amount,

• age amount,
• spouse or common-law partner amount,
• amount for an eligible dependant,
• amount for infirm dependants age 18 or older, and
• caregiver amount.

Where the personal representative does not elect to file any optional returns, the
income must be reported in the final return.

7.3 DUE DATE FOR FILING RETURNS FOR A DECEASED PERSON FOR THE
YEAR OF DEATH AND PRIOR YEARS

The due date for filing the final T1 Return and the optional returns for the year
of death, other than the rights or things return, is set out under paras. 150(1)(b)
and (d) as the later of:

• six months after the date of death, and

• April 30 of the year following death.

8 Subs. 150(4).
9 This situation is limited to the situation where the sole proprietor or the members of a partnership
have made an election under subs. 249.1(4) to retain an off-calendar fiscal year-end.

7–8
DUE DATE FOR FILING RETURNS FOR A DECEASED PERSON FOR THE YEAR OF DEATH AND PRIOR YEARS 7.3

However, if the deceased or the spouse or common-law partner of the deceased

was carrying on a business (see example), the due date for the final return will be:

• June 15 of the year following death, or

• six months after the date of death if death occurred after
December 15.

Example: Due Dates for the T1 Final Return

John and Janette were in a serious car accident on October 15, 2017. Janette died immediately, and John passed away three
weeks later on November 6. The due dates for their terminal returns are April 30, 2018, for Janette and May 6, 2018, for
John.
If John or Janette were carrying on a business at the time of death — either as a member of a partnership or as a sole
proprietor — the due date for both terminal returns would be June 15, 2018.

The due date for filing a rights or things return, and the deadline for making an
election to file a rights or things return, is the later of one year from the date of
death or 90 days after the mailing of any notice of assessment in respect of the
tax for the year of death.

Where a tainted testamentary spousal trust is created in the Will of the deceased,
the due date for the final return is extended until 18 months following the date
of death.10 However, the due date for tax payable is not extended.

Where death occurs early in the calendar year, the personal representative may
file the terminal tax return before the due date, but the assessment of the return
may be based on the tax legislation applicable to the prior taxation year. A reas-
sessment can be issued at a later time, applying the applicable legislation, at
the request of the legal representative. It may also be necessary to use the prior
year’s forms in preparing the return, as the current year’s forms are usually not
available until January of the following year.

There is an extension for filing the T1 Return for the year prior to death if death
takes place before the due date for filing the return in the current year. The T1
Return for the prior year is extended until the later of the time it was otherwise
due and six months after the date of death, under para. 150(1)(b). For example, if
death occurred on February 15, 2017, the regular T1 Return for 2016 would be due
on August 15, 2017. The final T1 Return for 2017 would be due on April 30, 2018.

10 See subs. 70(7) and para. 70(7)(b).

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7.4 Chapter 7 – Taxation of Deceased Individuals and the Terminal Return

7.4 PAYMENT OF TAX

Payment of tax for the year of death is due on April 30 of the following year if
death occurs before November 1. If death occurs after October 31, tax is payable
six months after the date of death. This is the due date for the payment of tax in
respect of the final T1 Return and any optional returns, including the rights or
things return, notwithstanding the fact that the filing due date for the return may
be later in some cases.

An election is available under subs. 159(5) to defer the payment of tax owing
from the deemed disposition of capital property, and in respect of rights or
things whether reported in a separate return or in the final return. However, a
prepayment is required of interest owing on the unpaid tax at the prescribed
rate to the date of the deferred payment. The prepayment must be made at the
time the election to defer the tax is made.11 Canada Revenue Agency (CRA) will
only grant the extension if security for the amount owing is provided. The terms
and conditions of the security must be acceptable to CRA in order for the exten-
sion to be available,12 and may include a charge on the property of the deceased
or a letter of guarantee from a bank. The maximum extension period is equal
annual instalments over 10 years.

Due dates for filing returns and payment of tax for a deceased individual are
also summarized in Chapter 11.

7.5 LIABILITY FOR PAYMENT OF TAXES AND CLEARANCE CERTIFICATE

The personal representative is responsible for payment of taxes for the year of
death arising from the final or any other returns, and for any unpaid taxes and
interest owing by the deceased at the time of death. The latter liability includes
amounts owing for any taxation years prior to the date of death, including tax,
interest, and penalties not assessed at the time of death — as may be the case
for unfiled returns or returns filed but not assessed. Interest will continue to run
on any unpaid amounts until fully paid.

Personal liability of the personal representative is limited to the value of prop-

erty in the possession and control of the personal representative in that capacity,
and will only arise if such property is distributed without obtaining a clearance
certificate. For complete details regarding clearance certificates, see 5.8.

11 Subs. 159(7).
12 Subs. 159(5); see also Form T2075.

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INCOME 7.7.1

7.6 PREPARATION OF THE T1 RETURN OR FINAL RETURN FOR THE YEAR OF

DEATH

Subsection 70(1) requires a return to be filed for the year of death for the period
from January 1 to the date of death. The name of the taxpayer should be “The
Estate of the Late” followed by the deceased’s name, and the date of death must
be provided. In addition to the specific rules for including income in the year of
death, the normal rules for taxation of an individual generally apply. (For infor-
mation on the taxation of individuals and capital gains, see Chapters 2 and 3.)

CRA publishes a guide for each taxation year, T4011, Preparing Returns for
Deceased Persons, providing detailed information regarding the preparation of
the final return.

7.7 INCOME

Income received prior to death in the calendar year of death is normally included
in the final return, in the same manner as it would be included in a regular T1
Return, along with any income accrued to the date of death.

7.7.1 Periodic Payments

Under subs. 70(1), the amount of any income from periodic payments due after
death in respect of the period of time up to the day of death must be included
in the final return. These include periodic payments in respect of interest, rent,
royalties, annuities, and salary or wages or any other periodic payments to the
extent the amount relates to the period prior to death. If the amount was receiv-
able but unpaid at the time of death, the amount may be reported in the rights
or things return (see the following example).

The amount of the periodic payment is deemed to accrue in equal daily amounts
up to the date of death. Where a periodic payment is due after the date of death,
and the accrued portion is required to be included in the final return, the other
portion of the payment should be reported in the T3 Return for the first year of
the estate.

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7.7.2 Chapter 7 – Taxation of Deceased Individuals and the Terminal Return

Example

Vesna held a mortgage with semi-annual payments due on June 30 and December 31 each year. The amount of interest
included in each payment in 2017 was $2,400. Vesna died on July 31, 2017. The $2,400 interest she received from the June
payment must be included in the final return. In addition, the accrued but unpaid amount of interest for the December
payment also must be included. This would be calculated as $2,400 times the number of days in July divided by the number
of days from July 1 to December 31 ($2,400 x (31/184)) or $404.35.
The June payment would be a right or thing if payment was outstanding at the time of death. It could be included in the
final return or, at the option of the personal representative, in a rights or things return.

7.7.2 Employment Income

Employment income received from January 1 to the date of death is included in

the final return. In addition, income from the end of the last pay period to the
date of death — even if received after death — is taxable to the deceased and
included in the final return, or may be eligible for the rights or things return, as
discussed below (see 7.15). Some amounts in respect of employment should be
reported in the T3 Return13 or, if a death benefit, in the return of the beneficiary.

7.7.3 Death Benefit

An employer may pay a death benefit: an amount in respect of the employ-

ee’s death in recognition of the employee’s service. The term “death benefit”
is defined under subs. 248(1), and this definition exempts the first $10,000 of
any such payment from income. Under subpara. 56(1)(a)(iii), a death benefit
(i.e., the amount in excess of $10,000) is included in the income of the recipi-
ent. Accordingly, this amount is not included in the final return of the deceased
and may be included in the income of the estate, the spouse of the deceased, or
other recipient .

7.7.4 Old Age Security Payments

Payments received before death are included in the final return. Any payment
for the month in which the individual died may be reported either in the final
return or a rights or things return.

13 These are listed in Chart 2 of Guide T4011, Preparing Returns for Deceased Persons.

7–12
INCOME 7.7.9.1

7.7.5 Canada Pension Plan and Quebec Pension Plan (CPP and QPP) Payments

Regular payments received before death must be included in the final return.
Payments for the month in which the individual died may be reported in the
final return or in a rights or things return. The Canada Pension Plan (CPP) and
Quebec Pension Plan (QPP) death benefit is not included in the final return.

7.7.6 CPP or QPP Death Benefit

This amount will be reported either in the return of the recipient beneficiary
or in the estate return. Where the deceased had no heirs and there is no other
property in the estate, the death benefit will not be taxable if received by an
arm’s-length person who paid the deceased’s funeral expenses (to the extent of
such funeral expenses).

7.7.7 Other Pension Payments

Any pension payments, superannuation payments, and annuity payments from

a registered retirement income fund (RRIF) or life income fund (LIF) received
from January 1 to the date of death must be included in the final return.

7.7.8 Employment Insurance Benefits

Employment Insurance benefits received from January 1 to the date of death

must be included in the final return. These amounts are subject to repayment in
the same manner as for any live individual.

7.7.9 Investment Income

Investment income received from January 1 to the date of death must be

included in the final return. Investment income payable but not received before
the date of death must also be included in the final return. Amounts of invest-
ment income accruing prior to death but payable after death are taxable to the
deceased, and may be reported in the final return (see also 7.7.1, Periodic Pay-
ments, and 7.15, Rights or Things Returns).

7.7.9.1 Reserves in the Year of Death

Under s. 72, many of the reserves normally available to reduce income
are not available in the year of death. For example, the reserve for capi-
tal gains where the payment of proceeds of disposition is deferred is not

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7.8 Chapter 7 – Taxation of Deceased Individuals and the Terminal Return

available in the year of death, unless the receivable passes to the surviv-
ing spouse or common-law partner or a qualifying spousal trust (QST).14

7.8 RRSPS AND RRIFS ON THE DEATH OF THE ANNUITANT

7.8.1 General Overview

Registered retirement plans and their tax consequences are an important part
of estate planning. Other than the family home, retirement plans in the form of
RRSPs or RRIFs may form the most significant financial asset of individuals age
60 and over.

An individual may make contributions to an RRSP based on 18% of earned

income of the prior year. The year in which the individual turns 71 is the last
year the individual can contribute to his or her own RRSP. The owner of the
plan, called the “annuitant,” is the sole beneficiary of the plan during the owner’s
lifetime. Any unused contributions may be carried forward, creating accumulated
“contribution room.” Catch-up contributions are often made as the mortgage is
paid off and retirement approaches.

In addition, an individual may contribute to the RRSP of a spouse, called a spou-

sal plan. In the case of a spousal plan, the beneficiary and annuitant is the
spouse of the contributor. Contributions to a spousal plan may be made, even
if the contributor is older than 71, until the year in which the spouse turns 71.
The contribution room is depleted by contributions both to one’s own plan and
a spousal plan. Withdrawals by the annuitant from a spousal plan can be attrib-
uted back to the contributor if made within three years of the contribution.

No later than the year in which the individual turns 71, an RRSP must be con-
verted either into a “matured” RRSP or an RRIF. Failure to do so will result in
the inclusion of the value of the plan in the annuitant’s income in the year the
individual turns 71.

Most individuals will choose the RRIF option for an RRSP as they approach age
72, as matured RRSPs are uncommon. The options for “matured” RRSPs are lim-
ited to annuities, which have no flexibility regarding withdrawals, and typically
have less favourable returns over time compared with an RRIF. RRIFs permit
the same investment options as RRSPs, the main differences between RRIFs and
RRSPs being that for RRIFs there can be no contributions (other than transfers

14 See subs. 72(2).

7–14
RRSPS AND RRIFS ON THE DEATH OF THE ANNUITANT 7.8.2

from other plans) and there are mandatory minimum annual withdrawals calcu-
lated as an increasing percentage of the plan balance to a maximum of 20% at
age 95.

On death of the owner (the “annuitant”) of a registered retirement plan, the

fair market value of the plan at death is included in the income of the terminal
return, unless the proceeds qualify as a refund of premiums for an RRSP or as
a designated benefit for an RRIF because they are paid to a qualified benefi-
ciary. These still may be taxed in the terminal return, but there are two addi-
tional options: a refund of premiums or designated benefit may also be taxed
in the hands of the qualified beneficiary if an election is made or the qualified
beneficiary can access a rollover where the refund of premiums or designated
benefit is transferred to his or her own registered retirement plan. As a further
exception, there are different rules for matured RRSPs and a successor annuitant
under an RRIF.

A payment from a registered plan upon death of the annuitant is not subject to
withholding tax.15 This differs from withdrawals from retirement plans during
lifetime, leading to incorrect assumptions that the tax will follow the money if
the annuitant names a beneficiary of the plan. The estate will bear the tax bur-
den (in respect of the liability arising from the income inclusions in the terminal
return) unless a qualified beneficiary receives the proceeds and an election is
made. In theory, the beneficiary can “take the money and run,” except that CRA
has the option of collecting from the recipient if the tax is not paid by the estate.
Even in that case, the beneficiary could look to the estate for reimbursement
where the primary liability is that of the estate.

The provisions in the Act for RRSPs and RRIFs are very similar, particularly with
respect to taxation on death and the options available, although some of the ter-
minology is different.

7.8.2 Value of Plan at Death Included in Deceased’s Final Return

The general rule for RRSPs and RRIFs is that the fair market value of all prop-
erty in an RRSP or RRIF is deemed to be received by the deceased annuitant
at the time of death and is included in the final return of the deceased — see
subss. 146(8), 146(8.8), and 146.3(6). The amount is automatically included in
the final return, even where the proceeds qualify as a refund of premiums or

15 Unless the recipient is a non-resident of Canada.

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7.8.2.1 Chapter 7 – Taxation of Deceased Individuals and the Terminal Return

a designated benefit, in which case a discretionary election may be made to

reduce the income inclusion in the final return. The only exceptions to the “auto-
matic without election” inclusion in the final return are for a matured RRSP paid
to a surviving spouse (where the amounts are taxed in the hands of the spouse)
or the automatic rollover of an RRIF where the spouse is named as the successor
annuitant. Income earned after the date of death from a registered plan is not
taxed in the final return.

7.8.2.1 Exception from General Rule Where Matured RRSP Paid to

Spouse
The amount of any matured RRSP paid to the annuitant’s surviving
spouse or common-law partner as a result of death is automatically
included in the income of the spouse, no amount is included in the
deceased’s final return, and this amount is not a refund of premiums.16
The surviving spouse will step into the place of the deceased annuitant,
and the continuing annuity payments will be taxable to the surviving
recipient spouse as successor annuitant. A joint election by the personal
representative and the spouse is available to achieve the same result
where the matured RRSP is paid to the estate.17 If there is no surviving
spouse or common-law partner who is a beneficiary, para. 146(2)(c.2)
requires that the annuity be commuted and a lump-sum payment will
be included in the final return. As a practical matter, matured RRSPs are
seldom seen, and financial institutions report that matured RRSPs are
rare if not extinct. Taxpayers typically choose to re-invest an RRSP on a
rollover basis into an RRIF upon attaining age 71 instead of converting
to an annuity in a matured RRSP.

7.8.3 Discretionary Election to “Tax Shift” a Refund of Premiums from the

Terminal Return to the Recipient

Plan proceeds paid to the surviving spouse, or child or grandchild of the

deceased who was financially dependent on the deceased annuitant, may qualify
as a refund of premiums (RRSP) or a designated benefit (RRIF). The personal
representative may elect to deduct any amount of a refund of premiums or a
designated benefit (defined below) from the amount required to be included
in the final return of a deceased annuitant. The election is available under ss.

16 Subpara. 146(8.8)(b).
17 Subs. 146(8.91).

7–16
RRSPS AND RRIFS ON THE DEATH OF THE ANNUITANT 7.8.3

146(8.9) and 146.3(6.2). The election, in effect, shifts the income inclusion and
the tax burden from the final return of the deceased to the recipient surviving
spouse, or child or grandchild, each of whom in all but one case18 are in turn
entitled to a rollover of the amount of the election by making a contribution to
his or own registered retirement plan.

Essentially the rules for a refund of premiums and a designated benefit for an
RRIF are the same, and to some extent the definition of “designated benefit”
piggybacks on the rules for a refund of premiums.

A “refund of premiums” or “designated benefit” refers to the amount of proceeds

of the RRSP or RRIF that a particular beneficiary (for convenience referred to
here sometimes as a “qualified beneficiary”) becomes entitled to as a result of
the death of the annuitant, and is defined in subss. 146(1) and 146.3(1) to mean
any amount paid from an RRSP or RRIF to:

• a spouse or common-law partner where the annuitant died before

the maturity of the plan19 or
• a child or grandchild of the annuitant who was at the time of death
financially dependent on the annuitant for support.

Where the qualified beneficiary is the direct beneficiary of the plan, and the
plan proceeds are paid directly to the qualified beneficiary, the election may be
made solely by the personal representative. Where the plan proceeds are paid to
the estate, the election must be made jointly by the personal representative and
the qualified beneficiary.

To the extent that the relevant election is made, there is a deduction in the ter-
minal return from the plan proceeds, and the income is included instead in the
hands of the qualified beneficiary listed above.

A rollover is available for each qualified beneficiary listed above except where
the child or grandchild is older than 18 and not infirm. The rules provide that a
child or grandchild financially dependent on the annuitant may only rollover a
refund of premiums to an annuity fully payable to age 18 unless dependent by
reason of mental or physical infirmity. As a result, there can be a “tax shift” for a
refund of premiums paid but there are no rollover options.

18 No rollover is available for a dependent child 18 or older who is not infirm.

19 If the plan is matured, there is no refund of premiums, but the spouse as successor annuitant is
automatically taxed on the annuity.

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7.8.3.1 Chapter 7 – Taxation of Deceased Individuals and the Terminal Return

7.8.3.1 Financially Dependent — Subs. 146(1.1)

Under subs. 146(1.1), a child or grandchild is assumed not to be finan-
cially dependent on the annuitant if the income of the child or grandchild
for the year preceding the year of death exceeded the basic personal
amount, unless it is otherwise established. For the purposes of the spe-
cial rules relating to a child or grandchild who was financially dependent
because of mental or physical infirmity, the income limit for determining
financial dependence is the total amount of the basic personal amount
and the disability amount.

7.8.3.2 Discussion of Discretionary Nature of the Final Return and the

Rollover for Refund of Premiums
The deduction from the final return for RRSPs and RRIFs is discretion-
ary, even where the qualified spouse, child, or grandchild is named as
a beneficiary. There is a commonly held misconception that a refund of
premiums or designated benefit is automatically taxed in the hands of a
named beneficiary. This leads to an incorrect conclusion that the benefi-
ciary must contribute the proceeds to his or her own plan in order not to
be subject to tax personally. When the surviving spouse visits the bank
or other financial institution to discuss the accounts of the deceased,
typically the spouse, as the named beneficiary of the plan, is advised to
do an immediate transfer of any RRSP or RRIF to the spouse’s own plan
without any awareness of, or attention to, the options available. If the
spouse carries out the transfer, CRA will automatically assume the per-
sonal representative has taken the deduction from the final return. This
may not be in the best interests of the spouse. The spouse may not be a
beneficiary of the estate, or may be only one of several beneficiaries, in
which case if the income is taxed in the final return, the spouse will not
bear the entire cost of the tax.

A beneficiary may be too quick to exercise the right to the rollover by

contributing to the beneficiary’s own plan. The beneficiary may prefer
to receive the proceeds tax-free and let the estate pay the tax, especially
if there are other beneficiaries of the estate. Keep in mind that no mat-
ter who the recipient of the payment is, whether the estate or a named
beneficiary, there is no withholding tax on the payment of an RRSP or
RRIF on death.

7–18
RRSPS AND RRIFS ON THE DEATH OF THE ANNUITANT 7.8.4

The income inclusion in the hands of the qualified beneficiary is the

decision of the personal representative, except where the plan proceeds
are paid to the estate and the decision is that of the personal represen-
tative and the qualified beneficiary since a joint election must be made.

If the qualified beneficiary contributes the refund of premiums to his

or her own plan, the deduction from the final return may be treated by
CRA as having been made whether or not the legal representative actu-
ally filed for the deduction.

See IT-500R (Archived), Registered Retirement Savings Plans — Death of

an Annuitant, and Fact Sheet RC4177(E), Death of an RRSP Annuitant
or PRPP Member. These publications make it clear that the opportunity
to reduce the amount in the final return is optional on the part of the
legal representative and may be exercised in order to ensure that the
least amount of tax is payable.

7.8.3.3 Joint Election to Include Amount of Plan in the Income of a

Qualified Beneficiary
The election to deduct a refund of premiums or a designated benefit
from income in the final return is available not only when the qualified
beneficiary is a named beneficiary of the plan but also where the estate
is the plan beneficiary and a qualified beneficiary is a beneficiary under
the deceased’s Will. In this latter case, the election must be made jointly
by the personal representative and the qualified beneficiary. The elec-
tion is provided for under subs. 146(8.1) in the case of a refund of pre-
miums and under para. 146.3(1)(a) in the case of a designated benefit.

A similar joint election by the personal representative and the spouse

is available under subs. 146(8.91) in the case of a matured RRSP paid
to the legal representative for the benefit of the annuitant’s surviving
spouse. Where the election is made, the amount is taxable in the hands
of the spouse.

7.8.4 Rollovers Available for Refund of Premiums

A rollover is available where a refund of premiums is used by the beneficiary to

make a contribution to his or her own plan. The rollover is available under para.
60(l) for contributions made in the year the amount would have been included in

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7.8.4.1 Chapter 7 – Taxation of Deceased Individuals and the Terminal Return

the hands of the qualified beneficiaries or within 60 days after the end of that year.
The amount of the refund of premiums is technically included in the beneficiary’s
return and then there is a deduction for the contribution to the registered plan:

• by a spouse — cl. 60(l)(v)(A),

• by a child or grandchild who was financially dependent on the
annuitant by reason of physical or mental infirmity — cl. 60(l)(v)(B),
and
• by a child or grandchild under the age of 18 who was financially
dependent on the annuitant — cl. 60(l)(v)(B.1).

Note that a rollover of premiums is not available where the refund of premi-
ums is paid to an adult financially dependent child or grandchild (i.e., who has
attained age 18) who is not infirm. Only the “tax shift” is available in this case.

7.8.4.1 Options for Able Child Under Age 18

For a financially dependent child or grandchild who has not attained
age 18 and is not infirm, a rollover is available if the refund of premi-
ums is used to purchase an annuity with the following terms:

• the child or grandchild must be the only beneficiary,

• the term of the annuity cannot exceed 18 years minus the age
of the child or grandchild at the time of its acquisition, and
• the annuity must be acquired in the year the refund of premiums
is received, or within 60 days of the end of the year of receipt.

A rollover is also available, under para. 60(l), for this type of annuity
for a child or grandchild who is financially dependent on the deceased
annuitant by reason of physical or mental infirmity.

7.8.4.2 Options for a Spouse, or Child/Grandchild Financially Dependent

by Reason of Physical or Mental Infirmity
Under para. 60(l), a beneficiary who is a spouse or common-law part-
ner of the deceased, or a child or grandchild of the deceased who was
financially dependent on the deceased at the time of death by reason of
physical or mental infirmity, has the option to:

7–20
RRSPS AND RRIFS ON THE DEATH OF THE ANNUITANT 7.8.4.3

• make a contribution to an RRSP under which the qualified ben-

eficiary is the annuitant,
• purchase an annuity for a term equal to 90 minus the age in
years of the qualifying beneficiary, or
• purchase an RRIF under which the qualified beneficiary is the
annuitant.

Under para. 60(m), a rollover is also available to the child or grandchild’s

registered disability savings plan (RDSP) where the child or grandchild
is financially dependent on the deceased annuitant by reason of physi-
cal or mental infirmity.20

7.8.4.3 Trust Options for Mentally Infirm Spouse or Child: Lifetime

Benefit Trusts (LBTs) and Qualified Trust Annuities (QTAs)
Certain disabled beneficiaries of an RRSP may defer the payment of tax
on a refund of premiums by transferring the refund of premiums on a
rollover basis to a lifetime benefit trust (LBT), where the LBT purchases
a qualified trust annuity (QTA). The QTA must be for the life of a benefi-
ciary for a fixed term equal to 90 years minus the taxpayer’s age at the
time the annuity is acquired. If the taxpayer dies during the guarantee
period where there is a fixed term, the payment on the death of the tax-
payer must be commuted into a single payment.

A “lifetime benefit trust” is defined under para. 60.011(1)(a) as a trust in

respect of the taxpayer and the estate of the deceased if:

• immediately before the death of the deceased individual, the

taxpayer was either:
{ a mentally infirm spouse or common-law partner of the
deceased or
{ a child or grandchild of the deceased who was dependent
on the deceased because of mental infirmity, and

20 S. 60.02 and Form RC 4625, Rollover to a Registered Disability Savings Plan (RDSP) under Paragraph
60(m).

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7.8.5 Chapter 7 – Taxation of Deceased Individuals and the Terminal Return

• the trust is a personal trust under which:

{ during the lifetime of the taxpayer no person other than the
taxpayer may receive or obtain the use of any income and
capital of the trust and
{ the trustees are empowered to pay amounts from the trust to
the taxpayer and when making such decisions are required
to consider the needs of the taxpayer, including the taxpay-
er’s comfort, care, and maintenance.
In order for the rollover to be available, the LBT must purchase a QTA
and the beneficiary must file an election in his or her tax return for the
year in which the amount would have otherwise been deductible under
para. 60(l). A “qualified trust annuity” is defined under subs. 60.011(2).

7.8.5 Taxation of Beneficiary

Where a beneficiary receives a refund of premiums or a designated benefit and

the legal representative reduces the amount included in the final return, the ben-
eficiary will be taxable on the amount, unless he or she makes contributions quali-
fying for the rollover (see 7.8.3, Rollovers Available for Refund of Premiums).

7.8.6 Payment of Tax Liability for RRSPs and RRIFs

Amounts may be paid from an RRSP or RRIF to a named beneficiary without any
direct involvement of the personal representative. Nevertheless, the estate has
the liability for the income inclusion under subs. 146(8.8), and there is no option
to reduce the amount of the inclusion unless the proceeds qualify as a refund of
premiums or a designated benefit.

A personal representative may distribute funds to beneficiaries without a clear-

ance certificate, only to find out later that the estate was liable for tax on plan
proceeds paid to a beneficiary without the personal representative’s knowledge.
This makes the application and the obtaining of a clearance certificate even
more critical to protect the personal representative from personal liability.

A beneficiary of an RRSP or RRIF is jointly and severally liable along with the
estate for any tax liability arising as a result of the inclusion of the plan proceeds.
The joint and several liability is imposed under subs. 160.2(1) and 160.2(2) and
extends to the estate where the estate is named as beneficiary or is the default

7–22
RRSPS AND RRIFS ON THE DEATH OF THE ANNUITANT 7.8.8

beneficiary under the plan. Joint and several liability does not extend to the ben-
eficiary of the estate who receives the proceeds of the RRSP or RRIF from the
estate.

There is no withholding tax on the payment of plan proceeds to a beneficiary

under the Act, a fact that is often overlooked by annuitants and their advisors.
Determining the effect of the tax liability for a registered plan upon death is a
key component of structuring the estate plan. Failure to properly understand the
options, and the primary liability imposed under the Act to the estate (i.e., in the
final return) — even where there is a named beneficiary — can result in unex-
pected consequences and can foil the planned distribution on death. Conflict
may exist where the plan beneficiaries are not identical to the residual benefi-
ciaries of the estate in the Will. Any liability of the estate for the tax in the final
return will reduce the inheritance of the residual beneficiaries under the Will,
resulting in a potential windfall to the plan beneficiaries.

7.8.7 Contributions to RRSP after Death

Unused RRSP contribution room cannot be used to contribute to the deceased

person’s RRSP after death. However, the legal representative can contribute any
amount of the unused contribution room of the deceased to the RRSP of a sur-
viving spouse or common-law partner, either in the year of death or during the
60 days after the end of that year. While there is no tax rule that requires it,
from a trust law perspective, such a contribution should be specifically autho-
rized in the Will or receive the appropriate consents to protect the personal
representative.

7.8.8 Losses in a Registered Plan after Death

Losses in the value of an RRSP or RRIF may be deducted in the final return of
the deceased to provide relief where there is a decrease in the fair market value
of an unmatured RRSP or RRIF between the date of death and the date of final
distribution of the plan proceeds to the beneficiary or the estate.21 The deduc-
tion is available if the final payment is made before the end of the year that fol-
lows the year of death of the annuitant. However, on a case-by-case basis, CRA
may permit the loss where the payment is delayed.

21 Subs. 146(8.92) for RRSP and subs. 146.3(6.3) for RRIF.

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7.9 Chapter 7 – Taxation of Deceased Individuals and the Terminal Return

7.9 OTHER REGISTERED PLANS

7.9.1 Tax-Free Savings Accounts (TFSAs)

There are no tax consequences to the deceased holder and no reporting is

required in the terminal return.

Contributions by an individual to a tax-free savings account (TFSA) are tax-

sheltered both while in the plan and upon withdrawal from the plan. The con-
tribution limit is set each year, and is cumulative since 2009 when TFSAs were
first introduced. The limit is $5,000 for each year from 2009 to 2012, $5,500 for
2013 and 2014, $10,000 in 2015, and $5,500 in 2016 and 2017, for cumulative
contribution room as of 2017 of $52,000. Although contributions are not deduct-
ible, these plans are very attractive because the income earned in the plan on
the contributions is not only earned tax-free in the plan but is tax-free when
withdrawn from the plan. In addition, a spousal rollover is available on death.
Provincial law permits designations of beneficiaries for TFSAs, as for RRSPs and
RRIFs.

Unless there is a successor holder, a TFSA ceases to be a TFSA on death of the

holder, and any income earned after the date of death of the holder will be tax-
able to the beneficiary of the TFSA. Earnings up until the time of death remain
exempt from tax. If the spouse or common-law partner of the holder becomes
the successor holder of the TFSA, he or she will continue to enjoy the tax-free
status of the account until the end of the exempt period, being the calendar year
following the year in which the holder dies. The surviving spouse may contrib-
ute the TFSA to his or her own TFSA within the exempt period as an exempt
contribution, in which case the exempt status will continue.

Under the Act, the surviving spouse may become the successor holder if the
spouse is designated as the successor holder in the TFSA contract, named as the
beneficiary of the TFSA in the Will of the holder, or is the sole beneficiary under
the Will.

7.9.2 Registered Education Savings Plans (RESPs)

There are no tax consequences to the deceased subscriber and no reporting is

required in the terminal return.

A registered education savings plan (RESP) belongs to the subscriber, and on

death the contributions are the property of the estate of any sole subscriber

7–24
DEEMED DISPOSITIONS AT DEATH 7.10.2

and subject to the terms of his or her Will. On the death of the last surviving
joint subscriber, the RESP becomes an asset of the estate of the last to die, and
is subject to the terms of his or her Will. It is possible to appoint a successor
subscriber, in which case the plan need not be collapsed on the death of the
subscriber.

7.9.3 Registered Disability Savings Plan (RDSPs)

Where the beneficiary of a registered disability savings plan (RDSP) dies, the
RDSP must be closed by the end of the calendar year following the year of
death. There may be a requirement to repay government bonds and grants, and
any remainder will be paid to the estate of the beneficiary. Any taxable portion
of a disability assistance payment must be included in the income of the benefi-
ciary’s estate in the year the payment is made.

7.10 DEEMED DISPOSITIONS AT DEATH

In addition to the inclusion in respect of RRSPs and RRIFs, an individual is

deemed to have disposed of capital property and land inventory on death.22

7.10.1 Land Inventory

Under para. 70(5.2)(c), there is a deemed disposition at fair market value of any
land that is part of an inventory of a business. Where there is a gain on land
inventory, this would result in business income23 to be taxed in the final return
of the deceased. There is a spousal rollover where the inventory passes to the
surviving spouse or common-law partner or a qualifying spousal trust. Gener-
ally, land inventory includes land held for resale or on speculation, as opposed
to land held for the purpose of earning rental income or for use as a business
location. Land inventory is not a right or thing.

7.10.2 Capital Property

A deceased is deemed to have disposed of each capital property owned at

the date of death immediately before death, for proceeds of disposition equal
to the fair market value (FMV) at the time of the deemed disposition, under
para. 70(5)(a). This rule applies to both depreciable and non-depreciable capital

22 The deemed disposition of eligible capital property and resource property is beyond the scope of this
material.
23 Subs. 23(1).

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7.10.3 Chapter 7 – Taxation of Deceased Individuals and the Terminal Return

property. Under para. 70(5)(b), the estate is deemed to have acquired all capital
property at the same amount. The result of the deemed disposition of all capital
property on death is that all accrued capital gains and losses and all terminal
losses and recapture on depreciable capital property of the deceased up to the
time of death are realized on death.

The tax cost of the capital properties deemed to be disposed of on death is

identical to the rules for other dispositions during lifetime. This would include
adjustments in the costs of property acquired before 1972, usually to the V-Day
value (being the value as at December 31, 1971). See 3.2.2, Adjusted Cost Base.

7.10.3 Depreciable Property

Capital cost allowance cannot be claimed in the final return, since technically the
deceased does not own any depreciable property at the time of death because of
the deemed disposition of all capital property immediately before death (see the
following example).

Where the FMV of the depreciable property in the class exceeds the undepre-
ciable capital cost (UCC) of the class:

• a capital gain will be realized, to the extent that the FMV exceeds
the adjusted cost base (ACB) of the class and
• a recapture of previously claimed capital cost allowance will be an
income inclusion in the final return equal to the amount by which
the lesser of the FMV and the ACB of the class exceeds the UCC.

Where the FMV of the property is less than the UCC of the class, a terminal loss
is created equal to the amount of the UCC less the FMV of the property in the
class. This terminal loss may be claimed in the final return against the taxpayer’s
income from the business or property, and may create a loss from that source
available to reduce income from other sources. In addition to the following
example, see 2.2.2.5, Income from a Trust, and 2.2.3.1, Capital Cost Allowance
and Terminal Loss, for a detailed discussion of the rules relating to capital cost
allowance on depreciable property, disposition of depreciable property, recap-
ture, and a terminal loss.

7–26
DEEMED DISPOSITIONS AT DEATH 7.10.5

Example: Taxpayer Dies Owning Depreciable Property

Amar dies, owning depreciable property of a particular class with the following attributes:
ACB $175,000
UCC $100,000
If the value of the property at death is $200,000, Amar will have a capital gain of $25,000 and a recapture of capital cost
allowance of $75,000.
If the fair market value of the property at the date of death is $130,000, Amar will have recapture of capital cost allowance
equal to $30,000.
If the fair market value of the property at the time of death is $50,000, Amar will have a terminal loss of $50,000.

Special rules apply if the deceased owned both land and building at the date of
death. In such a case, subs. 13(21.1) provides for reallocation of the proceeds of
disposition between the land and the building so that any terminal loss on the
building will be applied to reduce the capital gain on the land.

7.10.4 Personal Use Property

Personal use property is capital property, and gains are to be included in the
final return subject to the $1,000 minimum (see 3.5.3). Losses from personal use
property, including any residence of the deceased, are deemed to be nil and are
not included as capital losses in the final return. This rule would apply to the
loss on a principal residence.

The same rules for listed personal property in the year of death or the disposi-
tion immediately before death apply as for inter vivos dispositions (see 3.5.4).

7.10.5 Principal Residence

Under the Act, any real property owned by the deceased, including residences, is
considered capital property and is deemed disposed of at FMV immediately before
death.24 The principal residence exemption may be claimed in respect of gains on
residences owned by the deceased at the date of death (see 3.2.8). Any loss on a
principal residence would be deemed to be nil as a loss on personal use property.

Where more than one residence is owned by the deceased, it will be advanta-
geous for the estate to claim the principal residence exemption on the property
that has the greatest gain per year, since the principal residence exemption is

24 Assuming that real property is not held as inventory or in the course of an adventure in the nature of trade.

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7.10.6 Chapter 7 – Taxation of Deceased Individuals and the Terminal Return

limited to one residence for each year in which the property was owned and it
is a year-by-year designation. Because of the “one plus” in the formula for deter-
mining the principal residence exemption, the election should be made for each
principal residence owned by the taxpayer for at least one year. Such designa-
tion will maximize the use of the principal residence exemption on multiple
properties, without reducing the exemption available for years during which
other property was held.

7.10.6 Jointly Held Property

In provinces other than Quebec, property may be held jointly with a right of
survivorship. This form of ownership is often described as a “joint tenancy” in
the case of real property, or simply as “jointly with a right of survivorship” in the
case of other types of jointly held property. Where property is held jointly with
another person with the right of survivorship, on the death of one of the joint
owners the property passes by operation of law to the surviving joint owner.
The property will not pass through the estate of the deceased owner or be sub-
ject to the terms of the Will of the deceased owner unless the deceased owner is
the last surviving joint owner of the property.

On the death of a joint tenant, there is a deemed disposition of the interest in

the jointly held property held by the deceased, even where there are surviving
owners to whom ownership passes by right of survivorship outside the estate.
The tax does not “follow the money,” similar to the situation where the proceeds
of a registered plan pass outside the estate but the personal representative is
still responsible for reporting the income arising on death as a result of death in
the terminal return, even though the personal representative may not have had
control of the property or knowledge of the passing of the property outside the
estate.

It is a common misconception that property held jointly with a right of survivor-

ship passes outside the estate without any income tax consequences. This confu-
sion arises because of the probate fee planning strategies under which property
passing outside the estate is not included in the estate of the deceased for the
purposes of calculating probate fees. Property may also be held jointly without
a right of survivorship. Where real property is involved, this is usually described
as a tenancy in common or may be described as jointly held without a right of
survivorship. Where the deceased was a tenant in common, the portion of the
property attributed to the deceased tenant in common will be an asset of the

7–28
DEEMED DISPOSITIONS AT DEATH 7.10.6

estate, and will pass under the terms of the Will of the deceased. In addition,
the disposition of the deceased owner’s share must be included in the terminal
return.

Where property is held jointly, either with a right of survivorship as joint ten-
ants or without a right of survivorship as tenants in common, it will be assumed
that the joint owner’s share is equal to the value of the property divided by the
number of joint owners immediately prior to death, unless there is an agree-
ment in writing or some other evidence that the joint owners hold in unequal
shares. Unequal shares are not permitted for joint ownership with a right of
survivorship.

Two recent cases decided by the Supreme Court of Canada25 may have altered
the long-established rules relating to joint ownership. The effect of these deci-
sions is currently being debated by the legal community and the Estates Bar.
However, it appears that it may be possible to create a situation where, although
property is registered in joint names, the actual arrangement may be more in the
nature of an agency arrangement or a bare trust whereby:

• during the lifetime of the original owner, that owner has the ben-
efit of the whole of the property and the other registered owner
does not have a beneficial interest in the property and
• upon the death of the original owner, the original owner’s interest
ceases and the other joint owner becomes entitled to the property.

From a planning perspective, this type of arrangement may not be recommended

because of its uncertainty. However, in reporting the income in the final return
of a deceased person who was a joint owner, inquiries should be made as to
whether or not such a bare trust or agency arrangement existed. If the arrange-
ment was a bare trust arrangement, then the entire capital gain on the property
(not just a proportionate share) would be taxable to the estate.

Where a surviving joint owner subsequently dies, the ACB of the joint own-
er’s share will be adjusted by the FMV of the previously deceased joint owner,
according to the surviving but now deceased joint owner’s proportionate share
(see the following example).

25 See Pecore v. Pecore, [2007] S.C.J. No. 17 (S.C.C.) and Madsen Estate v. Saylor, [2007] S.C.J. No. 18
(S.C.C.).

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7.10.7 Chapter 7 – Taxation of Deceased Individuals and the Terminal Return

Example

A and B were unmarried sisters with no children who held title to a cottage jointly with a right of survivorship. They inherited
the property from their mother when the value was $140,000. Their ACB was therefore $70,000 each.
B died at a time when the value of the cottage was $200,000. B will have a capital gain of $30,000. The surviving sister, A,
will have a cost base in the entire property of $170,000, made up of her original $70,000 on the inheritance from her mother
plus $100,000 for the FMV of B’s share.

7.10.7 Partnership Interest

A member of a partnership has a partnership interest that is capital property,

and this capital property is subject to the deemed disposition of all capital prop-
erty on death at FMV. There is a spousal rollover available where property passes
to a surviving spouse or common-law partner or qualifying spousal trust under
subs. 70(6). Special rules apply to a disposition of a partnership interest, which
are not discussed here.

7.10.8 Rollovers

A number of rollovers are available with respect to capital property, similar to

those available for inter vivos transfers. These include:

• property that passes directly to the surviving spouse or common-

law partner, through the Will, on an intestacy or as the surviving
joint tenant,
• property passing to a qualified spousal trust (QST), and
• farm property eligible for the intergenerational rollover.

For a more detailed discussion of these rollovers, see 3.4.

Where a spousal trust is contained in the Will and the rollover is not avail-
able because of requirement to pay testamentary debts,26 it may be possible to
“untaint” the spousal trust so that it qualifies for the rollover on death. (For fur-
ther discussion, see 8.4, Post-Mortem Planning with Spousal Trusts.) In addition,
the filing deadline for the final return may be extended to provide the personal
representative with an opportunity to have time to untaint the spousal trust (see
7.4, Payment of Tax).

26 See 3.4.3, Transfers to a Spouse or Qualifying Spousal Testamentary Trust as a Consequence of Death.

7–30
DEDUCTIONS FROM NET INCOME 7.11

7.10.9 Lifetime Capital Gains Exemption (LCGE)

The last opportunity to claim the lifetime capital gains exemption (LCGE) of the
deceased occurs in the year of death. The LCGE cannot be transferred to the
estate or any beneficiary. The LCGE is available to an individual to shelter capital
gains on qualifying property for an aggregate lifetime limit. Property eligible for
the LCGE includes:

• qualifying shares of a small business corporation,

• qualified farm property, and
• qualified fishing property.

For additional details, see 3.3.

Where the deceased has unused capital gains exemption available and the roll-
over to a spouse or a QST applies, consideration may be given to triggering
additional gains at the date of death to utilize the exemption to shelter the gain
from tax and increase or “bump up” the tax cost of the property received by the
beneficiary. In this way, the LCGE of the deceased is crystallized in the increased
ACB of the property transferred to the beneficiary. The election is a property-by-
property election at FMV, that is, a “fractional” rollover on a particular property
is not available. The entire capital gain on each particular property subject to
the election will be triggered, and it is not possible to elect an amount between
the ACB and FMV. However, it is possible to manipulate the amount of the gain
triggered by electing out of the rollover on some of the assets or shares but not
others.

For additional details regarding this strategy, see 8.2, Elections Relating to Taxa-
tion of the Deceased in the Year of Death.

7.11 DEDUCTIONS FROM NET INCOME

The aggregate of certain deductions that may be claimed on all the income tax
returns, including the optional returns, for the year of death may not exceed the
amount deductible if only one return had been filed.27 For a general discussion
of deductions from net income, see 2.2.3.

27 Under s.114.2.

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7.12 Chapter 7 – Taxation of Deceased Individuals and the Terminal Return

7.12 NET CAPITAL LOSSES

7.12.1 Net Capital Losses in the Year of Death

Capital losses in the year of death may be carried back and applied against capi-
tal gains for the three preceding taxation years from the year of death by filing
Form T1A, Request for Loss Carryback, in the same manner as any individual
taxpayer.

Net capital losses in the year of death (taxable capital losses less allowable capi-
tal gains) may be applied to reduce income from any source in the year of death
or the taxation year immediately preceding death.

The amount of net capital loss available to be used against any source of income
in the year of death or immediately preceding year is reduced by the amount of
any capital gains deduction (i.e., the half amount of the LCGE) claimed by the
deceased. In addition, the carryback of a net capital loss in the normal way to
any of the immediately three preceding taxation years to reduce taxable capital
gains may reduce the capital gains deduction available to be claimed in the ter-
minal return.

Capital losses on property held by the deceased incurred in the first tax year of
the estate may be carried back to the final return under subs. 164(6). See 5.6.3,
Special Capital Loss Carryback to the Terminal Return in the First T3 of a Gradu-
ated Rate Estate, and 8.7.1, Capital Loss Planning: Using Subs. 164(6) to Carry
Back a Capital Loss on a Redemption of Shares to the Terminal Return.

7.12.2 Net Capital Losses Carried Forward to the Year of Death

Net capital losses may be carried forward indefinitely (see 3.5). In the year of
death, any unused net capital losses from prior years may be used to offset
income from any source for that year or for the immediately preceding taxation
year. Claiming a net capital loss against income from other sources in the year
before the year of death requires completion of Form T1-ADJ, T1 Adjustment
Request, and a reduction in the capital gains deductions for that year may result.

7–32
NON-REFUNDABLE TAX CREDITS 7.13.3

7.13 NON-REFUNDABLE TAX CREDITS

7.13.1 Personal Amounts

The full amount of the tax credits based on the personal amounts may be claimed
in the final return and in each of the optional returns in full. These include the
following non-refundable credits:

• basic personal amount,

• age amount,
• spouse or common-law partner amount,
• amount for an eligible dependant,
• amount for infirm dependants under age 18 or older,
• pension income amount,
• caregiver amount,
• disability amount for self, and
• disability amount transferred from a dependant.

7.13.2 Medical Expenses

A non-refundable credit based on medical expenses may be claimed in the year

of death. These are limited to the lower of the basic exemption for the year and
3% of the net income of all returns in the year of death. The expenses can be for
any 24-month period that includes the date of death, providing they have not
been claimed on any other return.

7.13.3 Charitable Donations on Death

In calculating the charitable donation tax credit in the final return, the following
amounts will qualify as eligible gifts:

• gifts to a qualified donee made by the deceased or his or her com-

mon-law partner before the date of death, and
• gifts to a qualified donee in the Will and paid by transfer of prop-
erty by the graduated rate estate (GRE) of the deceased or within

7–33
7.13.3 Chapter 7 – Taxation of Deceased Individuals and the Terminal Return

60 months of the date of death where the estate would otherwise

qualify as a GRE but for the 36-month requirement.28

A charitable donation tax credit may also be claimed in respect of a direct distri-
bution of proceeds to a qualified charity from an RRSP or RRIF or life insurance
policy, where the charity has been named as a beneficiary as the result of a ben-
eficiary designation.

Any donation amounts not claimed for the period five years before the year
of death may also be claimed in the year of death. Charitable donations made
during lifetime cannot be carried forward from the deceased to the estate. The
amount of the eligible gifts to generate the donation tax credit in the final return
and all optional returns is increased from 75% to 100% of net income. The
increased limit is also available for the year immediately prior to death if after
claiming all the eligible gifts available for the year of death amounts still remain.

There are special rules for donations of shares of publicly traded corporations.29
A gift of capital property generally triggers a deemed sale for proceeds of dis-
position equal to the fair market value of the property. However, for shares of
publicly traded corporations (including publicly listed flow-through shares), the
inclusion rate for gains is reduced from 50% to zero. Accordingly, no capital gain
will be taxed on a charitable gift of such property. A savings may be available
where a donation in a Will can be satisfied with such property, either because
the Will specifically provides a donation “in kind” or the terms of the Will permit
bequests to be satisfied with an “in kind” transfer of property.

The donation tax credit available in the final return for gifts on death is also avail-
able in other years. Where the donation is paid by the GRE within 36 months or
under the 60-month “extension period” for payment of donations on death, the
personal representative has flexibility to allocate the donation among the year
the donation was paid and other years. See 4.12, Charitable Donation Made by
Trusts and Estates. The same flexibility is available to donations of RRSPs, RRIFs,
TFSAs, and life insurance under new subss. 118.1(5.2) and (5.3).

28 Subss. 118.1(4.1) and (5).

29 There are also special rules for donations of Canadian cultural property, and ecologically sensitive
land, but these are not discussed here.

7–34
RIGHTS OR THINGS RETURNS 7.15

7.14 ALTERNATIVE MINIMUM TAX (AMT)

There is no minimum tax in the year of death.30 Minimum tax credits from prior
years may be used to reduce the tax payable in the terminal return. Any mini-
mum tax credit in excess of the tax payable in the terminal return is not refund-
able. Minimum tax carryovers do not apply to the rights and things return, or
any other returns filed for the year of death, other than the terminal return.31

7.15 RIGHTS OR THINGS RETURNS

The personal representative may elect to file a separate return for “rights or things”
of the deceased person as at the date of death.32 Rights or things are amounts that:

• have been earned prior to death,

• are unpaid at the time of death,
• are payable at the time of death, and
• would have been included in income of the deceased when
received.33

The amounts qualifying as rights or things are relatively limited, and include:

• dividends declared but unpaid,

• unpaid commissions,
• salary and wages unpaid at the date of death that are payable in
respect of pay periods ending prior to death,
• an unpaid bonus declared prior to death that was legally
enforceable,
• unpaid employment insurance benefits,
• Canada Pension Plan and Old Age Security benefits,
• uncashed matured bond coupons,
• unused vacation leave credits, and
• inventory of a farmer who reports income on a cash basis.

30 S. 127.55.
31 Subs. 120.2(4).
32 Subs. 70(2). See also IT-326R3 (Archived), Return of Deceased Persons as “Another Person.”
33 See IT-212R3 (Archived), Income of Deceased Persons — Rights or Things.

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7.16 Chapter 7 – Taxation of Deceased Individuals and the Terminal Return

Rights or things do not include capital property or an interest in a life insurance

policy. The accrued portion of any periodic payment is not considered a right or
thing, and must be included in the final return.34

The due date for filing a rights or things return, and the deadline for making an
election to file a rights or things return, is the later of one year from the date of
death or 90 days after the mailing of any notice of assessment in respect of the
tax for the year of death.

Any amounts in respect of rights or things that have been transferred to a ben-
eficiary prior to the expiration of the time for making an election to file a rights
or things return will be included in the income of the recipient beneficiary, and
may not be reported in the separate rights or things return.35

7.16 KEY STUDY POINTS

• A final return must be filed by the personal representative of a

deceased individual for the year of death for the period from Janu-
ary 1 to the date of death. In addition to a regular T1 Return for
this period, other returns, such as a rights and things return, may
be available.
• A personal representative should obtain a clearance certificate in
order to avoid personal liability. Liability is limited to the lesser
of the amounts distributed from the estate and any unpaid tax,
interest, or penalties owing by the estate (which includes amounts
owing but unpaid by the deceased) at the time of the distribution.
The amount owing at the time of distribution could be determined
at a subsequent time, such as upon a reassessment or in respect of
liabilities subsequently determined.
• The FMV at death of any RRSP and RRIF is included in the ter-
minal return of the deceased annuitant, subject to a number of
exceptions. Where the proceeds of the plan qualify as a refund
of premiums (RRIF) or a designated benefit (RRIF), an election is
available to reduce the income inclusion in the terminal return and
tax the amount instead in the hands of the recipient. The recipient
of a refund of premiums or a designated benefit may in most cases

34 Pursuant to subs. 70(1).

35 Subs. 70(3).

7–36
KEY STUDY POINTS 7.16

reduce the tax on such amounts by making a contribution to his or

her own plan.
• The payout on death from an RRSP or RRIF is not subject to with-
holding tax. This can create problems in an estate plan, or the
administration of the estate, as the tax does not necessarily “fol-
low the money.” The general rule is that the estate pays the tax
because of the inclusion in the final return of the deceased annui-
tant. The personal representative may be caught unaware of the lia-
bility where there is a designated beneficiary and the plan is paid
outside the estate. And a beneficiary may “double dip” by receiving
plan proceeds tax-free in addition to his or her entitlement under
the Will.
• There is a deemed disposition on death of all capital property and
land inventory owned by the deceased on death. A spousal rollover
may apply. Special rules also apply to a principal residence and
property that qualifies for the LCGE. It may be appropriate to elect
out of rollover provisions to fully exhaust unused tax credits or
losses of the deceased.
• There are special rules relating to capital losses on death. Allow-
able capital losses and unused net capital loss carryforwards of
prior year are available to reduce all sources of income in the year
of death. Where such losses have reduced taxable income in the
year of death to nil, any balance is available to reduce all sources
of income in the immediately preceding year.
• There is a special rule under subs. 164(6) for using capital losses
realized in the first year of the estate in the terminal return.

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 CHAPTER 8
POSTMORTEM TAX PLANNING

LEARNING OBJECTIVES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–3

8.1 INTRODUCTION TO POST-MORTEM TAX PLANNING . . . . . . . . . . . 8–3

8.2 ELECTIONS RELATING TO TAXATION OF THE DECEASED IN

THE YEAR OF DEATH . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–4

8.2.1 Reducing Income in the Year of Death . . . . . . . . . . . . . . . . . . . 8–6

8.2.2 Increasing Income in the Year of Death . . . . . . . . . . . . . . . . . . . 8–7
8.2.2.1 Electing Out of a Rollover to Increase the
ACB of Property Passing to the Estate or a
Beneficiary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–7
8.2.2.2 Using Up Losses Available to the Deceased
in the Year of Death . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–8
8.2.2.3 Using Minimum Tax Credits from Prior Years . . . . 8–8
8.2.2.4 Taking Full Advantage of Charitable
Donations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–8
8.2.2.5 Utilizing the Lower Marginal Tax Rates in the
Terminal Return . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–8
8.2.3 Electing Out of a Rollover . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–9
8.3 LOSS UTILIZATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–11

8.3.1 Use of Capital Losses in Year of Death and Immediately

Prior Year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–11
8.3.2 Losses Carried Back from the Estate (Graduated Rate
Estate) under Subs. 164(6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–12
8.4 POST-MORTEM PLANNING WITH SPOUSAL TRUSTS . . . . . . . . . . 8–13

8.4.1 Allocating Assets between a QST and a Tainted QST or

Non-QST . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–13
8.4.2 Curing a Tainted Spousal Trust Where Tainted in
Respect of Testamentary Debts . . . . . . . . . . . . . . . . . . . . . . . . 8–14
8.4.3 Curing a Tainted Spousal Trust by Disclaimer . . . . . . . . . . . 8–14

8–1
 8.4.4 Curing a Spousal Trust by Variation of Trust or
Rectification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–14
8.5 TAX ATTRIBUTES OF PROPERTY AND DISTRIBUTIONS OF
PROPERTY IN SPECIE (IN KIND) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–15

8.6 TAX ATTRIBUTES OF PROPERTY AND DIVIDING ASSETS

BETWEEN A SPOUSE AND OTHER BENEFICIARIES . . . . . . . . . . . . 8–16

8.7 MITIGATING THE DOUBLE TAX ON SHARES OF PRIVATE

CORPORATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–16

8.7.1 Capital Loss Planning: Using Subs. 164(6) to Carry

Back a Capital Loss on a Redemption of Shares to the
Terminal Return . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–20
8.7.2 The “Pipeline” Strategy: Transfer to a Holding Company
Where Assets in the Corporation Already Have a High
Cost Base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–24
8.7.3 Using Para. 88(1)(d) to “Bump Up” the Cost of Non-
Depreciable Capital Property . . . . . . . . . . . . . . . . . . . . . . . . . . 8–27
8.7.4 Evaluating the Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–28
8.8 KEY STUDY POINTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8–29

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 Chapter 8
Post-Mortem Tax Planning

Learning Objectives
Knowledge Objectives:
• Understand basic post-mortem tax planning concepts.

Skills Objectives:
• Explain basic post-mortem tax planning concepts.

8.1 INTRODUCTION TO POST-MORTEM TAX PLANNING

NOTE: Proposals first introduced in July 2017 would significantly change post-mortem tax planning where the deceased
is a shareholder of a Canadian-controlled private corporation (CPC). The Department of Finance altered its proposals in
October and December of 2017, but a state of uncertainty exists with respect to post-mortem planning with shares of a
CCPC. Students should check the STEP website in the student resources section for updates.

Significant tax liability occurs in the year of death of an individual, mainly due
to the additional income created by the capital gain on the deemed disposi-
tion of capital property at fair market value (FMV) and the inclusion in income
of the value of all registered retirement savings plans (RRSPs) and registered
retirement income funds (RRIFs). The balloon income inclusion in the terminal
return of the deceased can push taxable income up into a higher or even the
highest marginal tax bracket, if the individual was not already in that bracket.
The impact of the additional income will be greater where the individual dies
later in the calendar year, after a large portion of regular annual income, such
as employment and investment income, has already been earned. Where the
individual dies without a spouse or common-law partner, no spousal rollover is

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8.2 Chapter 8 – Post-Mortem Tax Planning

available, so the tax in the year of death may well be a greater amount than for
any other year during the lifetime of the individual.

This chapter will examine the elections and strategies available to minimize tax
in the terminal year when administering the estate. It will also look at tax plan-
ning strategies that the personal representative may consider to minimize the tax
burden on the estate and the beneficiaries.

Death is a taxable event, and when the deceased holds shares in a private cor-
poration, post-mortem tax planning strategies are available to reduce the double
tax that is inherent in owning assets through a corporation. This chapter will
serve as an introduction to the post-mortem strategies for the estate of a share-
holder of a private corporation, specifically a CCPC. A detailed discussion is
beyond the scope of this material, as a thorough understanding of the taxation
of corporations and their shareholders would be required. An introduction to
basic taxation of corporations and their shareholders is included at 2.5, and stu-
dents are urged to review this section in order to understand some of the corpo-
rate tax concepts not specifically explained in this chapter.

8.2 ELECTIONS RELATING TO TAXATION OF THE DECEASED IN THE YEAR OF

DEATH

Many elections are available in respect of the income in the year of death to be
reported in the terminal return. Many of these elections have been discussed in
other chapters, and not all of them are unique to the terminal return. The per-
sonal representative has an obligation to seek tax advice and to utilize the elec-
tions or strategies available to preserve as much of the estate as possible for the
benefit of the beneficiaries.

The following elections or options are available in the year of death:

• election out of the spousal rollover for property transferred to a

spouse, common-law partner, or a qualifying spousal trust (QST)
where there is an unrealized gain or loss, or potential recapture or
terminal loss in respect of depreciable property:
{ under subs. 70(6.2) for rollover of capital property, including
depreciable property, and

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ELECTIONS RELATING TO TAXATION OF THE DECEASED IN THE YEAR OF DEATH 8.2

{ under para. 70(5.2)(c) for resource property,1

• election out of the intergenerational rollover of farm property and
fishing property under subss. 70(9.01) and (9.21),
• elections to take reserves where a receivable passes to a spouse,
common-law partner, or QST under subs. 72(2),
• joint election to reduce income from a matured RRSP where the
spouse is a beneficiary under the Will or an intestacy under subs.
146(8.91),
• election to reduce income in the year of death by taking a deduc-
tion for a refund of premiums for an RRSP or a designated benefit
of a RRIF where a qualified beneficiary is named as a beneficiary
under subss. 146(8.9) and 146.3(6.2),
• joint election to reduce income in the year of death by taking a
deduction for a refund of premiums for an RRSP where a qualified
beneficiary is a beneficiary under the Will or an intestacy under
subs. 146(8.1),
• claim for the capital gains deduction on qualifying property under
s. 110.6,
• claim for the donation tax credit under subs. 118.1(5), or commenc-
ing in 2016 claim for donations made by a graduated rate estate
(GRE),
• options as to whether a charitable gift made in the Will (when
completed by transfer of property by the GRE of the deceased) will
be claimed in the estate, the year of death or the year immediately
prior to death,
• distribution in kind of appreciated capital property to satisfy a char-
itable gift in the Will and designate an amount to be the proceeds
of disposition and the amount of the gift under subs. 118.1(6),
• distribution in kind of appreciated publicly listed securities to sat-
isfy a charitable gift in the Will to exclude any capital gain from
income under subs. 38(a.1),

1 Neither subs. 70(5.2) or any other provision of the Act provides for an election out of the spousal
rollover for land inventory.

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8.2.1 Chapter 8 – Post-Mortem Tax Planning

• using the medical expense tax credit for any 24-month period up
to and including the day of death under subs. 118.2(1),
• option to transfer rights or things to a beneficiary and shift the tax
liability to the beneficiary under subs. 70(3),
• filing a separate return for rights and things under subs. 70(2),
• filing a separate return for stub period sole proprietorship or part-
nership income,
• filing a separate return for stub period income from a GRE,
• use of principal residence exemption and allocation between prop-
erties where there is a second residence,
• loss utilization in the year of death (and preceding year), and
• election to carry back capital losses or a terminal loss from the first
year of the GRE under subs. 164(6).

In addition to tax planning in the year of death, the personal representative has
a responsibility to appreciate and take into account the tax consequences of the
following:

• income of the estate in the year immediately after death,

• income of the estate during administration,
• distribution of assets to trusts created in the Will,
• any ongoing trusts created in the Will, and
• distribution of assets to beneficiaries.

8.2.1 Reducing Income in the Year of Death

Careful use of the rollovers, exemptions, and elections available can significantly
reduce the tax burden in the year of death. However, reducing the income to
zero and having no tax liability in the year of death is not the whole story. Losses
in the year of death, loss carryforwards, any remaining lifetime capital gains
exemption (LCGE), the dividend tax credit, unused deductions such as oil and
gas deduction pools, and personal tax credits do not carry over into the estate
— they are either utilized in the return of the deceased or lost. In addition, the
graduated rates of tax may be available to reduce tax in the year of death.

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ELECTIONS RELATING TO TAXATION OF THE DECEASED IN THE YEAR OF DEATH 8.2.2.1

Typically, on the death of the first spouse, there is a rollover to the surviving
spouse of all assets, including non-registered investments; the home; second
residence, if any; and all registered plans. Taking full advantage of the spousal
rollover may not be the best strategy in all cases. For example, if the deceased
had unused net capital losses from prior years, they are fully deductible against
income in the year of death. An amount from the registered plan could be left
to be taxed in the year of death to absorb such losses and eliminate the tax the
surviving spouse’s estate will pay on the final distribution from the RRSP or
RRIF. An election to deduct some but not all of the refund of premiums or des-
ignated benefits of an RRSP or RRIF is available even if the spouse is the named
beneficiary.

Also, there may be property that qualifies for the LCGE. Failure to use the LCGE
in favour of the spousal rollover wastes the LCGE available in the terminal return
and exposes the surviving spouse to a potentially greater tax liability in the
future.

8.2.2 Increasing Income in the Year of Death

The benefit from decreasing income or tax payable in the year of death is obvi-
ous: to reduce tax payable on death. However, the advantages of increasing
income in the year of death, or otherwise increasing tax payable in the year of
death, may not be readily apparent. In some cases, the objective may be to uti-
lize losses, exemptions, or other credits that would otherwise expire. In other
cases, the tax payable for the year of death may be offset or be less than the
potential future tax liability of the estate or a beneficiary. The following para-
graphs summarize some of these potential advantages.

8.2.2.1 Electing Out of a Rollover to Increase the ACB of Property

Passing to the Estate or a Beneficiary
Rollovers on death are available for property passing to a spouse or
a QST, or for intergenerational transfers of interests in farm or fish-
ing properties. The spousal rollover is available in respect of capital
property, including depreciable property under subs. 70(6.2) and for
resource property and land inventory under subs. 70(5.2). Where there
is an accrued gain, an election out of the rollover will deem the disposi-
tion on death to take place at an amount equal to FMV, or at the elected
amount in the case of farm or fishing property or resource property.

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8.2.2.2 Chapter 8 – Post-Mortem Tax Planning

There is a corresponding adjustment in the adjusted cost base (ACB)

or tax cost of the property in the hands of the estate, or in the hands
of the beneficiary if the property is distributed in kind. The increase in
ACB will shelter gain on a future disposition by the beneficiary, and in
the case of depreciable property will increase the undepreciated capital
cost (UCC) upon which the annual deduction for capital cost allowance
(CCA) is calculated.

8.2.2.2 Using Up Losses Available to the Deceased in the Year of Death

Net capital losses are available to offset income from any source in the
year of death and, if necessary, the immediately preceding year. Non-
capital losses may also be present. See 8.3, Loss Utilization.

8.2.2.3 Using Minimum Tax Credits from Prior Years

While there is no minimum tax in the year of death, pursuant to
s. 127.55, an individual may have unused minimum tax credits from
years in which minimum tax was payable. If the income tax payable in
the terminal return exceeds the minimum tax amount in the year, the
credit may be utilized. Minimum tax does not apply to any of the elec-
tive returns, and as a result the minimum tax credits are only available
in the terminal return and not in any of the elective returns.

8.2.2.4 Taking Full Advantage of Charitable Donations

Charitable gifts made in the Will are deemed to be made by the GRE
when property is transferred to complete the gift. The availability of the
donation tax credit is flexible. For details, see 7.13.3, Charitable Dona-
tions on Death.

8.2.2.5 Utilizing the Lower Marginal Tax Rates in the Terminal Return
There may be little or no income in the year of death if the individual
dies very early in the calendar year, or if there is little or no income
from other sources. For example, if the individual dies in early January,
or if the taxpayer had little income during the year, the only income
for the year of death may be that arising from the deemed disposition
of capital property. It may be tax-efficient to trigger some gains on the
property held at death in order to permit the income or capital gain to

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ELECTIONS RELATING TO TAXATION OF THE DECEASED IN THE YEAR OF DEATH 8.2.3

be taxed at the lower marginal rates of tax in the terminal return. The
benefit of the lower rate and the increase in the tax cost of the property
to the estate must be measured against the loss of deferral of the tax
until a sale of the property by the estate or the beneficiary.

8.2.3 Electing Out of a Rollover

Most rollovers, such as the spousal rollover, are automatic if the conditions set
out in the Act are met, but often it is possible to elect out of a rollover. The elec-
tions out of the rollover may be on a full FMV basis, or may permit the legal rep-
resentative to choose the amount of the deemed proceeds of disposition from
within a range of values.

The election out of the spousal rollover for capital property is provided for under
subs. 70(6.2). This election is on a FMV basis (i.e., on a property-by-property
basis). Once the election is made in respect of a particular property, the deemed
disposition on the elected property automatically takes place at FMV. As a result,
it is possible to include part but not all of the income or gain on capital on death
only where there are multiple properties. By careful selection of the properties to
be included in the election (election on only one or more of a number of proper-
ties), the personal representative may be able to manipulate the amount of income
or gain to be included in the year of death and determine which properties will
have a bump in basis to pass along to the estate or the beneficiary.

By contrast, the following elections out of a rollover can be at the amount cho-
sen by the legal representative, so that, in effect, partial rollovers are available
on any particular property:

• election out of the spousal rollover on resource property under

para. 70(5.2)(b),
• election out of the intergenerational rollover of farm or fishing
property under subs. 70(9.01), or
• election out of the intergenerational rollover of shares of a family
farm or family fishing corporation under subs. 70(9.21).

There are specified limits within which these elections must be made to prevent
gains or losses from being realized artificially. The legal representative may elect
any amount between the FMV and the ACB of the property. In the case of depre-
ciable property, the election may be made between the FMV of the property and

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8.2.3 Chapter 8 – Post-Mortem Tax Planning

the lessor of the ACB and the proportionate UCC of the property based on the
cost of the property as a fraction of the cost of all property in the class.

There is no election out of the spousal rollover for land inventory under
para. 76(5.2)(b).

If the property is passing to a QST, the election out of the rollover will not avoid
the deemed disposition on the death of the surviving spouse or common-law
partner (see examples below). This can be a significant problem if the rollover is
not needed on death, and there may be significant capital gains on the death of
the surviving spouse. This might be the case, for example, if the surviving spouse
is not likely to survive for another 21 years and the rollover is not needed. If a
QST is created in the Will, but the tax treatment of a QST is not desirable, the
personal representative could delay the administration of the estate so the prop-
erty does not vest in the spousal trust within the required 36-month period. The
rollover would be denied, but there would also be no deemed disposition on the
death of the surviving spouse.

Example: Brad and Precious

Deemed Disposition on Death of Surviving Spouse and Insurance

Brad died in 1991, leaving a large estate, including an insurance policy of $500,000. His Will created a qualifying spousal
trust (QST) for Precious, his wife, to be funded with the life insurance proceeds. Precious died in 2010, when the insurance
trust, mainly consisting of stocks and bonds, was worth $1.1 million, with $450,000 in unrealized capital gains. There will be
a deemed disposition on Precious’s death and capital gains will be taxed.
Had the insurance proceeds been payable into a trust that was not a QST, no deemed disposition would take place on Precious’s
death, and under subs. 107(2) the stocks and bonds could be transferred to the residual beneficiaries without triggering any
additional tax in the insurance trust. This would have been the case, for example, if the insurance trust had been created in a
separate “executory” trust document outside the Will since a QST must be created under the terms of the Will.
In this case, Precious died before the 21st anniversary of Brad’s death. If the trust was not a QST, the 21-year rule would have
applied if Precious was still alive on the 21st anniversary date of death.

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LOSS UTILIZATION 8.3.1

Example: Petra and Ian

Election under Subs. 70(6.2) Out of the Spousal Rollover to Utilize the Lifetime Capital Gains Exemption

Petra and Ian were married for 32 years when Petra died, her Will stipulating that everything be left to Ian. She and Ian each
owned a 50% interest in UR Covered Ltd., a CCPC that manufactures custom window coverings, bedding, and upholstery at
its facility in Brandon, Manitoba. At the time of Petra’s death, the business was worth $2 million, the ACB of the shares was
nominal, and the LCGE would shelter maximum amount of capital gains of $750,000. Ian’s accountant suggested using the
LCGE in Petra’s final tax return in order to “bump up the basis,” or increase the tax cost — the ACB — of Ian’s shares and
shelter some of his capital gain on a subsequent disposition of the shares.
However, the gain on Petra’s shares was $1 million and the maximum LCGE available was $750,000. Petra and Ian each
owned 100 shares of UR Covered, so Ian, as the personal representative, filed an election under subs. 76(6.2) to elect out of
the spousal rollover under subs. 70(6) on 75 shares of UR, permitting the rollover to automatically apply to the remaining
25 shares, on which there was an accrued gain of $250,000. (NOTE: The exemption refers to the amount of gain that can be
sheltered, whereas the deduction refers to the portion of taxable capital gain that can be reduced. The maximum LCGE in
this example is $750,000; the maximum capital gains deduction is $375,000.)
After the distribution from the estate, Ian’s ownership of UR Covered has increased to 200 shares, with an ACB of $750,000
(assuming his original cost was nominal).
If only one share had been issued to Petra, the election would have applied to the entire share, resulting in immediate tax
on the remaining $250,000, since a partial election on a particular property is not provided for in the Act. For this reason, it
is advisable to issue multiple treasury shares on incorporation of a small business, or subsequently create them by a simple
stock split.

8.3 LOSS UTILIZATION

Losses cannot be transferred from the deceased to the estate or a beneficiary. If

the losses are not used in the year of death, they will expire. Consequently, it is
desirable to make maximum use of any losses available in the year of death.

8.3.1 Use of Capital Losses in Year of Death and Immediately Prior Year

In the year of death and the prior year, the general restriction on use of capital
losses to offset capital gains is lifted (see the following example). Under subs.
111(2), allowable capital losses realized, including those deemed to be realized,
in the year of death and net capital losses from other years may be deducted
against any source of income (not just taxable capital gains) in the year of death.
If income from the year of death is reduced to nil and losses remain, the losses
are fully available to be carried back to reduce income from any source in the
immediately preceding year. This provides a unique opportunity. Since net capi-
tal losses carry forward indefinitely during lifetime, they may be available from
as far back as 1972, when taxation of capital gains was first introduced into the

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8.3.2 Chapter 8 – Post-Mortem Tax Planning

Canadian tax system. The use of capital losses on death may be affected by pre-
viously claimed LCGE, and details are beyond the scope of these materials.

Example: Ration Crash

Using Net Capital Loss Carryforwards in the Year of Death

Ration Crash was a geology professor at Simon Fraser University. He and his wife, Sandra, had a home in Burnaby and
a timeshare in Whistler. In February 1997, just after a college reunion with some of his former classmates (who had
experienced excellent returns from investments in the resource sector), Ration made a one-time foray into the stock market
with an $80,000 purchase of shares of Bre-X Minerals. Bre-X claimed to have found a huge gold deposit in the remote jungles
of Indonesia and was the “darling child” of the TSX in 1996 and early 1997. In March 1997, rumours that there was no real gold
reserve shocked the investment world, and by June, when the extent of the fraud had been revealed, the stock collapsed.
Ration vowed never to invest in equities again and returned to investing in only guaranteed investments. In 2010, Ration died
and his widow, Sandra, relayed this story to the lawyer she consulted regarding Ration’s estate. Immediately the lawyer asked
for documentation so the loss could be claimed in Ration’s terminal return. The net capital loss carryforward of $40,000 had
never been claimed, since Ration had never had any taxable capital gains against which to claim them. The loss could be fully
utilized in the year of death to offset Ration’s pension income earned before he died. Since Ration never reported the capital loss
in his return, it may still be possible to claim the loss, providing CRA is presented with the appropriate documentation.
In the event the net capital loss exceeded income for the year of death, Sandra could consider not using the spousal rollover on
Ration’s RRIF or electing out of the rollover on the Whistler property.

8.3.2 Losses Carried Back from the Estate (Graduated Rate Estate) under
Subs. 164(6)
It is also possible to carry a capital or terminal loss realized in the first taxation
year of the GRE of the deceased back to the year of death to be claimed in the
terminal return. The loss carried back is available only in the terminal return2
and, unlike other losses in the year of death, cannot be carried back to the year
before death. It may be appropriate to recognize losses in the first year of the
estate by an actual sale of property. Another strategy may be to distribute prop-
erty on which there is a loss subsequent to death to a beneficiary at FMV to
trigger the loss in the GRE. Note that early distributions from the GRE may be
a concern, as it is likely too early to obtain a clearance certificate. The personal
representative should be cautious if this strategy is recommended, and might
require a personal indemnity from the beneficiary.

The loss carryback available under subs. 164(6) is an important option in post-
mortem planning with respect to shares of a private corporation, as discussed at
8.7.1, Capital Loss Planning: Using Subs. 164(6) to Carry Back a Capital Loss on
a Redemption of Shares to the Terminal Return. It is imperative that the personal

2 Para. 164(6)(f).

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POST-MORTEM PLANNING WITH SPOUSAL TRUSTS 8.4.1

representative obtain tax advice as early as possible in order to take advantage

of the planning opportunities this election provides, since the loss must be real-
ized in the first year of the estate. The opportunity might be lost, for example, if
the personal representative selected an early year-end for the estate before such
planning is undertaken, or if some event occurs that causes the estate to lose its
status as a GRE.

Any loss carried back under subs. 164(6) will erode the capital gains deduction
taken on qualified property in the terminal return, and care should be taken to
ensure the desired tax benefit is available.

The election under subs. 164(6) must be filed in accordance with the require-
ments of Regulation 1000. The election must be filed no later than the later of
the deadline for filing the terminal return and the deadline for filing the T3
Return for the first year of the estate.

8.4 POST-MORTEM PLANNING WITH SPOUSAL TRUSTS

8.4.1 Allocating Assets between a QST and a Tainted QST or Non-QST

Even though the personal representative may elect out of the rollover on prop-
erty passing to a QST, the deemed disposition on death of the surviving spouse
will still take place on all assets in a QST. In anticipation of this problem, or for
non-tax reasons, the Will may contain two trusts with the spouse as a beneficiary
— one that qualifies for the rollover (i.e., a QST) and one that does not (i.e., a
non-QST). For example, the trust that does not qualify may name the children
of the deceased as income or capital beneficiaries during the lifetime of the sur-
viving spouse, or may be artificially tainted by providing that a named charity
receives a nominal amount, say $100, each year. These are just examples, but
either of these terms in the trust would disqualify the trust from the rollover
treatment.

The tax advantage is the fact that the property in the non-QST will not be sub-
ject to the deemed disposition on death of the surviving spouse; however, the
21-year deemed disposition rule will start to run from the death of the first
spouse. If the surviving spouse outlives his or her spouse by 21 years or more,
the trustees may consider a number of strategies to avoid the 21-year rule,
including a tax-free distribution of assets to one or more beneficiaries prior to
the deemed disposition.

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8.4.2 Chapter 8 – Post-Mortem Tax Planning

Typically, the executors will be given the discretion to allocate assets to one trust
or another. In administering the estate, the tax consequences of funding these
two trusts must be considered. Assets on which there is little or no capital gain
may be transferred to the non-QST, since the rollover is not needed.

8.4.2 Curing a Tainted Spousal Trust Where Tainted in Respect of Testamentary

Debts

Where the Will requires the spousal trust to pay testamentary debts, the trust
does not qualify as a QST. However, it is possible to cure this problem in order
to “untaint” the spousal trust, making it a QST for tax purposes.

Under subs. 70(7), the executors may make an election to trigger a deemed
disposition on selected property of the trust with a value at least equal to the
testamentary debts of the deceased, thereby curing the defect and permitting
the trust to qualify for the rollover and tax treatment as a QST. Since 1972 when
taxation of capital gains was first introduced, drafting practices have changed so
that today it is rare to see a spousal trust in a Will with wording that requires
this relief to qualify for the rollover.

8.4.3 Curing a Tainted Spousal Trust by Disclaimer

Where under the terms of the trust a person other than the surviving spouse
has rights to income or capital of the trust, the trust will not satisfy the require-
ments for the rollover under subs. 70(6). A disclaimer by the beneficiary will
not untaint the trust because the terms of the trust remain unchanged and the
terms still do not meet the requirements of the rollover (see 3.4.3, Transfers to
a Spouse or Qualifying Spousal Testamentary Trust as a Consequence of Death).

8.4.4 Curing a Spousal Trust by Variation of Trust or Rectification

Canada Revenue Agency (CRA) has taken the position that it is not possible to
cure a tainted spousal trust by making an application under provincial law to
vary the terms of the trust. However, it may be possible to untaint the trust, if
not with a variation, then with a court order rectifying the terms of the trust so
that they are considered to be amended ab initio, that is, from the time the trust
was created. A detailed discussion of the equitable doctrine of rectification and
its use to cure tax problems is beyond the scope of this material. It is available
in limited circumstances, usually to fix drafting mistakes in documents where

8–14
TAX ATTRIBUTES OF PROPERTY AND DISTRIBUTIONS OF PROPERTY IN SPECIE (IN KIND) 8.5

the form of the documents did not accurately reflect the intention. However, it
should be investigated in the appropriate situation. To be effective for tax pur-
poses, CRA must be a party to any court proceedings, or there is a risk that CRA
will not recognize the order for tax purposes.

8.5 TAX ATTRIBUTES OF PROPERTY AND DISTRIBUTIONS OF PROPERTY IN

SPECIE (IN KIND)

Where all property in the estate is liquidated and the distribution is in assets
consisting of cash, it is simple to divide the estate property between beneficia-
ries. For example, assume the residual clause in the Will leaves the estate equally
to two children. If the estate has cash of $600,000, a $300,000 distribution to
each beneficiary may be made. However, the division of property into shares for
beneficiaries is not so clear where property is distributed in kind (see examples
below). A division of property among beneficiaries based on FMV alone may
not be fair if the cost of the property for tax purposes is not equal to the FMV. If
there has been a significant change in the value of the property from the time of
death to the time of distribution, valuation problems can arise. The potential tax
liability may affect the true value of the property distributed. One solution is to
divide each property equally between the beneficiaries, although this is seldom
practical.

Examples: Distributions in Kind with Estate Worth $600,000 at Time of Distribution and 50/50 Split

Example One:

Assume there is $300,000 cash and a cottage worth $300,000, with a cost base to the estate of $225,000. Should the
beneficiary who is to receive the cottage be topped up with some additional cash to account for the latent tax liability
associated with the cost base being less than FMV?

Example Two:

Assume there is $300,000 cash and securities worth $300,000, with a cost base to the estate of $400,000. Should the
beneficiary receiving the cash get topped up to compensate for the higher cost base in the securities that may shelter future
gains?

Another factor to consider when making distributions in kind is the use of the
election out of the rollover on a distribution. This can be of help to equalize the
tax attributes of property distributed but may only be a partial solution. If this
triggers a prepayment of tax (i.e., electing to trigger a gain), it may be better to
allow for the tax attributes in determining the value for division. And electing

8–15
8.6 Chapter 8 – Post-Mortem Tax Planning

to trigger losses may be a waste if capital losses cannot be used by the estate
(i.e., if there are no capital gains in the estate, and the first year of the estate
has already passed and no carryback is available under subs. 164(6)). In addi-
tion, the election out of the rollover is on a property-by-property basis, making a
specific result difficult (e.g., a “match” of gains and losses may not be possible).

8.6 TAX ATTRIBUTES OF PROPERTY AND DIVIDING ASSETS BETWEEN A

SPOUSE AND OTHER BENEFICIARIES

Where property of the estate is to be divided between a spouse or QST and

other beneficiaries, issues arise with respect to the use of the spousal rollover.

For example, assume the residue of the estate is to be divided equally between
a spouse and a child. If there are two assets worth $200,000 each and one has
a FMV at death of $150,000 and the other has a FMV of $200,000, it would
seem most tax-efficient to distribute the property with the unrealized gain to the
spouse. However, this overlooks the fact that the spouse would be receiving an
asset that has a latent tax liability, whereas the child is receiving an asset with
an ACB equal to the full FMV. In order to be fair to both beneficiaries, it may be
necessary to increase the distribution to the spouse.

Is it reasonable to discount the value of assets passing to a spouse or QST by the

latent tax liability? The amount of the discount to be applied, if any, will be at
the discretion of the personal representatives. Some of the factors in determin-
ing whether to apply a discount, and the amount, might include:

• the tax situation of the spouse,

• the likelihood that the property will be sold,
• the timing of any future sale, and
• the life expectancy of the spouse.

8.7 MITIGATING THE DOUBLE TAX ON SHARES OF PRIVATE CORPORATIONS

Where the deceased owned shares of a corporation, there is a potential for dou-
ble or even triple taxation: first, to the deceased in the terminal return upon a
deemed disposition of shares; second, when the corporation sells the property
of the corporation or distributes it to a shareholder, there will be tax on the dis-
position of the property; and third, the corporate distribution may be taxable to
the shareholder.

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MITIGATING THE DOUBLE TAX ON SHARES OF PRIVATE CORPORATIONS 8.7

An understanding of the taxation of dividends at 2.2.1.4 and 2.2.1.7 and the

basic taxation of corporations and their shareholders at 2.5 is assumed in this
section of the material. The taxation of CCPCs is designed to achieve “integra-
tion” between the corporation and the shareholder with respect to income. The
concept of integration is that the tax on income is the same whether earned by
the individual shareholder directly or through a CCPC. In general, the rules do
not result in perfect integration to the same extent, if at all, with respect to a
return of the corporately held property to the individual shareholder.

Post-mortem tax planning for private corporations is aimed at reducing or elimi-

nating the aggregate of:

• the tax on death in the terminal return on the deemed disposition

of shares,
• the tax in the corporation on the disposition of assets in the corpo-
ration, and
• the tax on distribution of property held by the corporation to the
shareholder.

The tax in the terminal return will arise on any gain from the deemed disposi-
tion of the shares for deemed proceeds of disposition equal to FMV. The estate
will be deemed to have an ACB of the shares for an amount stepped up to the
FMV at the time of death. However, in the absence of specific “bump” plan-
ning discussed below, there is no corresponding step-up in the cost basis of
the underlying assets held in the corporation. Tax will be payable when the
corporation sells the underlying assets, and tax will be payable once again by
the shareholder when the proceeds of sale of the property are distributed to an
individual shareholder. In some cases, the corporately held property will not be
sold to a third party but distributed as a dividend in kind to the shareholder. The
tax consequences are the same, as either transaction results in a disposition for
tax purposes.

Corporate distribution of assets from the corporation to a shareholder subse-

quent to death will be subject to taxation in the same manner as other corpo-
rate distributions (i.e., in the form of dividends, and return of paid-up capital
(PUC), repayment of loan, remuneration, or other taxable benefit). Of these
options, only a return of PUC or payment of a capital dividend is free from tax.
A full description and explanation of the taxation of corporate distributions is
beyond the scope of this material, but it will be referred to where necessary to

8–17
8.7 Chapter 8 – Post-Mortem Tax Planning

understand the concepts essential to the discussion of post-mortem tax plan-

ning. The distribution by the corporation to the shareholder is usually by way of
dividend. The tax impact of the dividend can be reduced in some circumstances
if the corporation has a capital dividend account (CDA), refundable dividend tax
on hand (RDTOH), or a general rate income pool (GRIP), which would enable
the corporation to pay eligible dividends. These corporate tax accounts are more
fully discussed at 2.5.

Case Study: Investco

Double Tax on Death

NOTE: The following case study includes the facts provided here and in Figure 8.1 (p. 8-19), Figure 8.2 (p. 8-23), and Figure
8.4 (p. 8-25).
Assume Roberta dies owning shares of Investco worth $1,000,000. The value of the shares is the same as the underlying
property of Investco, being a portfolio of securities with an aggregate FMV of $1,000,000 and an ACB of $600,000. Note
that CRA does not permit any discount in the FMV of shares of a corporation to take into account the inherent tax liability
in the assets held by the corporation or the tax payable on distribution of corporate assets to the shareholder. There will be
capital gains tax on Roberta’s death in the final T1 for the year of death as a result of the deemed disposition of the shares
of Investco on death. If the property of Investco is distributed, either as a dividend in kind or upon sale of the portfolio
shares, there will be tax at the corporate level and tax again upon the distribution of property from the corporation to the
shareholder, be it the estate or by an individual beneficiary. Figure 8.1 on the next page shows the tax at each level from
the terminal return to the final distribution of all corporate property to the estate or an individual shareholder. With no tax
planning, the rate of tax to distribute corporate assets to the estate, given the assumptions, is 63%.

There are several strategies to reduce the potential double tax created on death
in respect of corporate holdings and to permit a tax-efficient distribution of
corporate property. They are the capital loss strategy under subs. 164(6), the
pipeline strategy, and the “bump” strategy. An overview of them is given below
with a very simple example. The rules pertaining to this type of tax planning
are extremely complex and will not be explained in detail. The recognition of
the need for post-mortem planning and a general understanding of the plan-
ning opportunities is the most a non-tax professional can expect to reasonably
appreciate. While it is prudent to obtain tax advice wherever tax consequences
will occur, it is particularly important that specific tax advice be obtained where
an interest in a private company was held by the deceased at the time of death,
even if the spousal rollover or the capital gains exemption may be available to
fully offset the tax in the year of death. The personal representative should seek
such advice promptly after death as at least one of the available strategies —
capital loss planning under subs. 164(6) — must be completed within the first
taxation year of the estate.

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MITIGATING THE DOUBLE TAX ON SHARES OF PRIVATE CORPORATIONS 8.7

Figure 8.1: Investco — Tax on Death and Distribution

No Planning — TAX 63%

Assumptions:
1. FMV shares of Investco = FMV Property in Investco $ 1,000,000
2. ACB and PUC of shares held by deceased nil
3. ACB of portfolio shares held by Investco $ 600,000
4. Tax in Final T1 and Estate is at top marginal rate
Tax in T1 Final Return Tax
FMV shares of Investco $ 1,000,000
ACB shares of Investco $ —
Capital Gain $ 1,000,000
Taxable Capital Gain $ 500,000
Tax on Death in Final T1 at 50% 50% $ 250,000 $ 250,000
Tax in Investco on Sale of Portfolio Shares
FMV portfolio shares $ 1,000,000
ACB portfolio shares $ 600,000
Capital Gain $ 400,000
Taxable Capital Gain $ 200,000
Tax in Investco of 49% 49% $ 98,000
Capital Dividend Account $ 200,000
Refundable Dividend Tax on Hand (RDTOH) 30.67% $ 61,340
Corporate Tax after refund of RDTOH $ 36,660 $ 36,660
Investco Distributes Dividend to Estate
Cash available to distribute
FMV $ 1,000,000
Less Corporate Tax $ 98,000
Plus RDTOH $ 61,340
Dividend paid to estate $ 963,340
Capital Dividend $ 200,000
Regular Dividend $ 763,340
Tax on Regular Dividend at 45%* 45% $ 343,503 $ 343,503
Total Tax: Final T1, Investco, Estate 63% $ 630,163
*After Gross-Up and Dividend Tax Credit

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8.7.1 Chapter 8 – Post-Mortem Tax Planning

The following is a very general description of strategies that may be available to

reduce the impact of double tax on private corporation holdings at death. Not
all the rules or potential tax issues associated with these strategies are identified
and, as already indicated, the advice of a tax professional is vital.

8.7.1 Capital Loss Planning: Using Subs. 164(6) to Carry Back a Capital Loss on
a Redemption of Shares to the Terminal Return

A redemption or repurchase by the issuing corporation of the shares at FMV in

the first taxation year of the GRE will produce the following tax consequences:

• a dividend on the shares will be deemed to be received by the GRE

equal to the FMV of the shares less the PUC or stated capital,
• the estate will be deemed to sell the shares for proceeds of dis-
position equal to the FMV of the shares less the above deemed
dividend,3
• the deemed disposition of the shares will result in a capital loss
equal to the difference between the FMV of the shares on death4
(which is the ACB to the GRE) and the PUC (which is the deemed
proceeds of disposition),
• the personal representative may file an election under subs. 164(6)
to carry the capital loss back to the terminal return5 (subject to a
stop-loss rule relating to the capital dividend account (CDA)) and
use it to reduce income or capital gains in the year of death only,
and
• if property other than cash is used by the corporation to redeem or
repurchase the shares, there will be a deemed disposition at FMV
of those assets, within the corporation, creating a corporate tax
liability and additions to the corporation’s surplus accounts (i.e.,
CDA, RDTOH, and general rate income pool (GRIP)).

3 The proceeds of disposition on the deemed sale of the shares on the redemption is reduced by the
amount of the dividend under subs. 54(j) of the definition of proceeds of disposition.
4 This also assumes the value on redemption is the same as the FMV on death.
5 For the requirements, see 5.6.3, Special Capital Loss Carryback to the Terminal Return in the First T3 of
a Graduated Rate Estate.

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MITIGATING THE DOUBLE TAX ON SHARES OF PRIVATE CORPORATIONS 8.7.1

The following example is from 2.5.11, Sale of Shares and Redemption of Shares:

Example

Assume shares are being redeemed to the corporation for $1,000, with a PUC of $100 and an ACB (cost) of $500. There is a
deemed dividend of $900 ($1,000 sale price less PUC of $100). There is a capital loss of $400 (proceeds of disposition are $100
– $1,000 less $900 – and ACB is $500). The deemed dividend will be subject to the same gross-up and dividend tax credit
mechanism as other dividends if the corporation is a taxable Canadian corporation and the shareholder is an individual.

Essentially, this strategy converts capital gains on death into a dividend received
by the GRE in its first taxation year. The tax impact of the dividend received by
the GRE may be reduced by a number of factors.

• Up to 50% of the dividends can be capital dividends6 if there is a

capital dividend account (CDA). The dividend may trigger a refund
of refundable dividend tax on hand (RDTOH) in the corporation.
• The dividends may be eligible dividends if there is a general rate
income pool (GRIP) balance.
• The above three corporate accounts (CDA, RDTOH, and GRIP) may
result from pre-existing balances in the relevant surplus accounts,
and additional CDA and RDTOH may be generated as a result of
the sale of property of the corporation to pay the dividend or the
deemed disposition of property of the corporation distributed as a
dividend in kind. In addition, CDA can be generated by the receipt
of life insurance proceeds by the corporation on the death of the
shareholder.
• The dividend may be allocated to beneficiaries, thereby deferring
the tax payable to the beneficiaries’ tax-due dates and, possibly,
permitting significant tax reductions where beneficiaries are not in
the higher marginal tax brackets.

The capital loss strategy has some limitations, which include:

• The estate must qualify as a GRE, which includes the requirement

to be a testamentary trust. If there is any concern that the estate is
“tainted,” subs. 164(6) is not available. This might be a concern if
the Will imposes debts of the estate on a beneficiary. A requirement
in the Will for a beneficiary to pay the tax arising on death of the

6 Subs. 112(3.2) is subject to a greater amount if April 26, 1995, grandfathering applies.

8–21
8.7.1 Chapter 8 – Post-Mortem Tax Planning

shareholder would result in the estate being a non-testamentary

trust for tax purposes.
• The loss must be incurred during the first taxation year of the
GRE. The short timing requirement allows little time to permit the
personal representative to finalize a post-mortem plan, including
obtaining full information about estate assets, obtaining valuations,
and considering all the planning opportunities.
• If there is limited or no CDA, RDTOH, and/or GRIP, the tax on
the deemed dividend will exceed the tax otherwise payable on the
capital gain on death, which increases the cost of planning since
the dividend will be taxed at higher rates than a capital gain, and
the dividend may be greater than the amount of the capital gain if
PUC is greater than ACB.

Figure 8.2 on the next page shows the same fact situation with Investco as Fig-
ure 8.1, except the capital loss strategy under subs. 164(6) has been utilized. In
this particular situation, the loss strategy has reduced the tax from 63% in Fig-
ure 8.1 with no planning to 40%. If using the capital loss strategy, the deemed
dividend on redemption would be the full $1,000,000 with no capital dividend
and no refundable tax. So a tax on the capital gain on the shares of Investco
of $1,000,000 has been exchanged for tax on a deemed dividend of the full
$1,000,000 (assuming PUC were also nominal). The cost of distributing the assets
of the corporation would be the difference between the rate of tax on a capital
gain and the rate of tax on the deemed dividend on the redemption. Currently,
the top rate on dividends is higher in every province: the rates fluctuate by prov-
ince, and over time, but currently the top rate of tax on dividends exceeds that
on capital gains by 6.45% to more than 15.87% for eligible dividends, and from
16.87% to 20.54% for other dividends. So, for example, the cost of the capital
loss planning with the bump in the example, paying eligible dividends, would
be an additional 12.58% in Ontario for an additional $125,800. (See Figure 8.3
on p. 8-24 for the rate spreads by province.).

Pipeline planning avoids conversion of capital gains into dividends and exposure
to the resulting higher rate. See 8.7.2, The “Pipeline” Strategy: Transfer to a Hold-
ing Company Where Assets in the Corporation Already Have a High Cost Base.

8–22
MITIGATING THE DOUBLE TAX ON SHARES OF PRIVATE CORPORATIONS 8.7.1

Figure 8.2: Investco — Tax on Death and Distribution

Capital Loss Planning, subs. 164(6) — Tax 40%

Assumptions:
1. FMV shares of Holdco and Property in Holdco $ 1,000,000
2. ACB of shares held by deceased nil
3. ACB of property held by Holdco $ 600,000
4. Tax in Final T1 and Beneficiary is at top marginal rate
Tax in T1 Final Return Tax
FMV $ 1,000,000
ACB $ —
Capital Gain $ 1,000,000
Taxable Capital Gain $ 500,000
Tax on Death in Final T1 at 50% 50% $ 250,000
Less subs. 164(6) Carryback $ 250,000
$ — $ —
Tax When Corporation Sells Shares
FMV $ 1,000,000
ACB $ 600,000
Capital Gain $ 400,000
Taxable Capital Gain $ 200,000
Tax in Holdco of 49% 49% $ 98,000
Capital Dividend Account $ 200,000
Refundable Dividend Tax on Hand (RDTOH) 30.67% $ 61,340
Corporate Tax after refund of RDTOH $ 36,660 $ 36,660
Dividend: Investco Distributes Funds to Beneficiary
Deemed Dividend
FMV Investco $ 1,000,000
PUC $ —
Deemed Dividend $ 1,000,000
Less Capital Dividend $ 200,000
Regular Dividend $ 800,000
Tax on Regular Dividend at 45%* 45% $ 360,000 $ 360,000

Total Tax: Investco and Estate 40% $ 396,660

$ 8
*After Gross-Up and Dividend Tax Credit

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8.7.2 Chapter 8 – Post-Mortem Tax Planning

Figure 8.3: Rate Spread between Capital Gains and Dividends by Province 2017*

Eligible
Eligible Dividends Rate Other Dividends
Province Capital Gains Dividends Increase Other Dividends Rate Increase
Alberta 24.00% 31.71% 7.71% 41.240% 17.24%
BC 23.85% 31.30% 7.45% 40.950% 17.10%
Manitoba 25.20% 37.78% 12.58% 45.740% 20.54%
New Brunswick 26.65% 33.51% 6.86% 46.350% 19.70%
Newfoundland 26.75% 42.62% 15.87% 43.620% 16.87%
Nova Scotia 27.00% 41.58% 14.58% 46.970% 19.97%
Ontario 26.76% 39.34% 12.58% 45.300% 18.54%
PEI 26.69% 34.22% 7.53% 43.870% 17.18%
Quebec 26.75% 39.83% 13.08% 43.840% 17.09%
Saskatchewan 23.88% 30.33% 6.45% 39.620% 15.74%
*Rates are constantly changing at federal and provincial levels.

The capital loss strategy of share redemption and loss carryback to reduce the tax
on capital gains on death can also be used on the death of the life tenant in an
AET, JPT, or QST. However, the rules operate differently. The loss carryback under
subs. 164(6) applies only to GREs. An AET, JPT, or QST can carry the loss back to
reduce capital gains on the death of the life tenant by using the regular loss carry-
back rules for net capital losses applicable to individuals, which permit a three-year
carryback.7 In order to take advantage of the loss carryback, the AET, JPT, or QST
document must be drafted to permit a continuation of the existence of the trust
after the death of the life tenant.8 In addition, the exception in subs. 40(3.61) to the
“affiliated” stop-loss rule in subs. 40(3.6) for a loss carried back under subs. 164(6)
is not applicable to such trusts. Accordingly, care must be taken to ensure that the
trust and the corporation are not affiliated9 after the redemption. Details of the
“affiliated” stop-loss rule are complex and are not covered in this text.

8.7.2 The “Pipeline” Strategy: Transfer to a Holding Company Where Assets in

the Corporation Already Have a High Cost Base

This strategy involves the distribution of assets of a corporation tax-free to the

extent there is already cost basis in the underlying assets. The shares of Opco

7 Note that the death of the life tenant triggers a tax year-end.
8 Without specific continuation language in the trust deed, CRA takes the position that the trust terminates
on the death of the life tenant and any subsequent loss is that of the beneficiaries of the trust.
9 Subs. 251.1(1).

8–24
MITIGATING THE DOUBLE TAX ON SHARES OF PRIVATE CORPORATIONS 8.7.2

(the shares held by the estate) are sold to Holdco for a promissory note. Opco
may distribute its high-cost properties to Holdco as a tax-free intercorporate
dividend and Holdco may distribute the assets in repayment of the note. The
pipeline strategy is often combined with the bump strategy discussed at 8.7.3 to
increase the tax cost of non-depreciable capital property such as shares or land
that is capital property.

Figure 8.4 illustrates the use of the pipeline strategy with or without the bump. In this
particular example, the total tax is 25% with the bump, or 35% if there is no bump.

Figure 8.4: Investco — Tax on Death and Distribution

Pipeline with Bump OR without Bump

Tax with Bump 25%; Tax without Bump 35%
Tax in T1 Final Return Tax
FMV shares of Investco $ 1,000,000
ACB shares of Investco $ —
Capital Gain $ 1,000,000
Taxable Capital Gain $ 500,000
Tax on Death in Final T1 at 50% 50% $ 250,000 $ 250,000
Tax in Estate upon Sale of Investco to Holdco
FMV shares of Investco $ 1,000,000
ACB shares of Investco (FMV on death) $ 1,000,000
Capital Gain nil
Holdco Pays Promissory Note by Selling/Distributing Portfolio Shares
Disposition on portfolio shares distributed
FMV portfolio shares $ 1,000,000
ACB portfolio shares (bumped under para. 88(1)(d)) $ 1,000,000
Capital Gain nil
Dividend paid to estate by Holdco nil
Total Tax with Bump: Final T1 25% $ 250,000
Additional Tax If No Bump:
Disposition on portfolio shares distributed
FMV portfolio shares $ 1,000,000
ACB portfolio shares (bumped under para. 88(1)(d)) $ 600,000
Capital Gain $ 400,000
Taxable Capital Gain $ 200,000
Tax in Holdco of 49% 49% $ 98,000 $ 98,000
UNUSED: Capital Dividend Account $ 200,000
UNUSED: Refundable Dividend Tax on Hand (RDTOH) 30.67% $ 61,340
Total Tax If No Bump: Final T1, Investco 35% $ 348,000

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8.7.2 Chapter 8 – Post-Mortem Tax Planning

If there is no tax on liquidation of the property distributed to the estate, the

pipeline strategy may be effective to distribute assets of the corporation with no
additional tax to the estate, so the only tax payable is the tax on the capital gain
in the final return on the gain on the shares.

There are a number of disadvantages to the pipeline strategy:

• Cost: The strategy is relatively simple, but it is more costly to imple-

ment than the capital loss strategy using subs. 164(6).
• Wasted CDA and RDTOH: The pipeline is most effective to dis-
tribute cash or other property that already has a high tax cost. If
there are accrued gains on assets, the CDA and the RDTOH cannot
be utilized in the pipeline and they are “wasted” unless the corpo-
ration continues and they can be used in the future.
• LGCE: Where the LCGE has been claimed on the shares by the
deceased or a non-arm’s length person, or the ACB of the shares
reflects the value as at December 31, 1971 (V-Day value), s. 84.1
may apply to convert the proceeds into a dividend, and the pipe-
line strategy will not be appropriate.
• Timing: Subsection 84(2) provides for a deemed dividend on dis-
tribution of property on the winding up of a corporation. CRA has
expressed views that this provision could apply to trigger a taxable
dividend in a pipeline transaction, or even in the course of a wind-
ing up involving a para. 88(1)(d) “bump” (see 8.7.2). CRA’s posi-
tion may be consistent with the MacDonald decision of the Federal
Court of Appeal.10 However, tax practitioners are currently debating
the extent to which CRA’s view is supportable and the effect of
the MacDonald case. CRA has issued a number of rulings on the
subject, and it appears that it will be necessary to wait one to two
years after death before utilizing the pipeline strategy in order to
reduce the risk that CRA will apply subs. 84(2) to the transaction.
• Exposure to change in rules: In July 2017, the Department of
Finance announced proposed changes, including a change to
s. 84.1, which would have halted pipeline planning by converting
gains to dividends. That proposal was abandoned, but there is con-
cern in the tax community that this retreat is a temporary reprieve

10 2013 FCA 110.

8–26
MITIGATING THE DOUBLE TAX ON SHARES OF PRIVATE CORPORATIONS 8.7.3

and that the Department of Finance will soon introduce new pro-
posals to limit the pipeline strategy.

8.7.3 Using Para. 88(1)(d) to “Bump Up” the Cost of Non-Depreciable Capital
Property

Under this strategy, the shares of the corporation held by the deceased (Opco)
are sold to a holding company (Holdco) at FMV in exchange for a promissory
note. Opco is subsequently wound up on a tax-free basis, transferring all the
assets to Holdco. The promissory note may be repaid either immediately or at a
later time to the estate or a beneficiary. Below are the tax consequences:

• The sale of Opco to Holdco does not trigger any gain to the estate
since it has an ACB equal to the FMV on death (assuming there has
been no increase in value after the date of death).
• Winding up Opco and distributing all property to Holdco would be
done on a tax-free basis as Opco is a wholly owned subsidiary.
• The personal representative may elect to use the excess of the
FMV of the Opco shares, less the ACB of all property in Opco, to
increase (or “bump”) the tax cost of any non-depreciable capital
property that is transferred to Holdco on the winding up. Non-
depreciable capital property includes land that is capital property
(i.e., not land inventory) and portfolio shares or shares in another
corporation. This increase in ACB will reduce the corporate tax on
a future sale or distribution of these assets.
• The repayment of the promissory note, to the estate or to the ben-
eficiary, is without tax consequences.

The bump strategy can be used in isolation, or in conjunction with either the
subs. 164(6) capital loss strategy or most commonly with the pipeline strategy.

Figure 8.4 illustrates the tax payable in our example, substituting Investco for
Opco. The bump works well in this example as the property of Investco consists
of securities — that is, portfolio shares. Since securities are non-capital prop-
erty, the bump strategy can be used to increase the cost of the shares to the
FMV of the shares held by the estate — that is, up to $1,000,000. The securities
could then be distributed to the estate as a dividend in kind (or sold to gener-
ate cash) with no tax consequences to Holdco or the estate, and both Holdco

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8.7.4 Chapter 8 – Post-Mortem Tax Planning

and Investco could be wound up. The tax is reduced to 25%, being the tax in the
terminal return, and the assets of the corporation have been distributed to the
estate without any additional tax. In the event the bump strategy is not available,
the rate of tax in this situation is 35%, still a saving over no planning or capital
loss planning.

8.7.4 Evaluating the Strategies

Post-mortem tax planning for shares of private corporations requires a high level
of tax expertise. Each situation is unique. Not every situation will be appropriate
for any or all of these strategies. Determining which one is most cost-effective
and appropriate is partly a number-crunching task in which variations of each
strategy, or a combination of them, is calculated. Other factors include the nature
of the business, the nature of the assets in the corporation, whether there is a
business that will continue, and whether family members will continue the busi-
ness or sell to third parties.

The fact situation with Investco analyzed in Figures 8.1, 8.2, and 8.4 is simple,
and in practice the analysis will be more difficult.

The use of life insurance to fund buy–sell agreements between shareholders of

an incorporated business is a common practice. The agreement typically requires
that the life insurance be used to fund the purchase of the deceased sharehold-
er’s interest. Complex calculations would be done to determine how the capital
dividend account could be used to reduce the tax if the capital loss strategy is
used. It is the use of life insurance that typically creates a CDA large enough to
make the capital dividend stop-loss rule relevant. Since only half the deemed
dividend can be a capital dividend (unless grandfathered), often only half the
deemed dividend is declared as a capital dividend, reserving the remaining CDA
to shelter tax on future dividends to be paid to the surviving shareholder. In
practice, this is referred to as the 50% solution. The availability of the LCGE on
the shares may also significantly change the post-mortem plan.

The above is only one example of a more complicated post-mortem planning sit-
uation. Assistance from a tax professional is recommended where the deceased
owned shares in a private corporation.

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KEY STUDY POINTS 8.8

8.8 KEY STUDY POINTS

• Post-mortem tax planning includes strategies to reduce tax on

death and tax in the estate or in the hands of the beneficiaries.
• Post-mortem tax planning is often overlooked. There are many tax
saving opportunities available, some of which may not be readily
recognized by the non-tax professional as they provide a deferral
of tax or reduce tax liability of beneficiaries in the future.
• Tax credits, loss carryforwards, and the LCGE are just some exam-
ples of tax benefits that do not carry over from the deceased to
the estate. Consequently, it is sometimes beneficial to intentionally
increase income in the year of death to fully utilize these amounts
and reduce tax in the future. Realizing income from an RRSP or
RRIF in the year of death instead of using a rollover will reduce or
eliminate the tax to the beneficiary in future. Similarly, electing out
of a rollover on capital property will step up or bump the ACB of
the capital property distributed to a beneficiary, providing shelter
from capital gains in the future.
• Capital losses receive special treatment in the year of death and can
be used to reduce any source of income. If income in the year of
death is fully exhausted, they can be carried back to reduce income
from any source in the year immediately prior to death.
• It is important to understand that GRE status as subs. 164(6) capital
loss planning is only available to a GRE.
• The rules for charitable gifts in a Will provide great flexibility.
• Post-mortem tax planning for estates owning shares of private cor-
porations should be referred to a tax professional. The tax strate-
gies are complex but may result in significant savings when taking
into consideration not only the tax on death in the terminal return
but also the potential tax on the property held by the corporation
and the potential tax on distributions to the shareholder.

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 CHAPTER 9
ATTRIBUTION RULES AND
INCOME SPLITTING

LEARNING OBJECTIVES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–3

9.1 BASIC CONCEPTS OF ATTRIBUTION AND INCOME SPLITTING . . . . 9–3

9.2 INCOME ATTRIBUTION ON TRANSFERS AND LOANS FOR

THE BENEFIT OF A SPOUSE OR RELATED PERSON UNDER
AGE 18 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–5

9.2.1 Transfer or Loan to Spouse: Spousal Attribution Rule

for Income and Capital Gains under Subss. 74.1(1) and
74.2(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–5
9.2.2 Transfer or Loan to Related Person Under Age 18:
“Children’s” Attribution Rule for Income under
Subs. 74.1(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–6
9.2.3 Transfers to a Trust: Trust Attribution Rule under
Subs. 74.3(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–6
9.2.4 Transfers to a Corporation: Corporate Attribution Rule:
S. 74.4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–8
9.2.5 Non-Arm’s Length Loans with Intent to Reduce Tax:
Subs. 56(4.1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–9
9.2.6 Attribution Rules and Substituted Property . . . . . . . . . . . . 9–11
9.2.7 Back-to-Back Transactions and Guarantees of Purchase
Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–11
9.2.8 Artificial Transactions: Using the Attribution Rules to
Reduce Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–12
9.3 ATTRIBUTION BACK TO SETTLOR/CONTRIBUTOR WHERE
PROPERTY HELD IN TRUST: SUBS. 75(2) . . . . . . . . . . . . . . . . . . . . . . . 9–12

9.3.1 Consequences of Reversion: Subpara. 75(2)(a)(i) . . . . . . . . 9–14

9.3.2 Control by the Settlor/Contributor: The Right to
Determine Beneficiaries or to Consent to Disposition of
Trust Property: Subpara. 75(2)(a)(ii) and Para. 75(2)(b) . . . . 9–16

9–1
 9.3.3 Loss of Rollover on Distribution of Property from a
Trust to a Beneficiary: Subs. 107(4.1) . . . . . . . . . . . . . . . . . . . 9–18
9.3.4 Application of Subss. 75(2) and 107(4.1) to an Alter
Ego Trust (AET) and Joint Partner or Common-Law
Partner Trust (JPT) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–19
9.3.5 Unique Features of the Attribution Rule under Subs.
75(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–19
9.4 TAX ON SPLIT INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–20

9.4.1 Tax Penalty on Dividends: Combatting the Dividend

Tax Credit Advantage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–20
9.5 EXCEPTIONS TO ATTRIBUTION RULES . . . . . . . . . . . . . . . . . . . . . . . . 9–24

9.5.1 Transfers for Fair Market Value and Loans for Value . . . . . 9–24
9.5.2 Spouse or Common-Law Partner Living Separate and
Apart . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–24
9.5.3 No Attribution on Income Earned on Attributed
Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–24
9.6 SOME BASIC INCOME-SPLITTING TECHNIQUES . . . . . . . . . . . . . . . 9–25

9.6.1 Spouse in Lower Tax Bracket Invests Earnings or

Inheritance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–25
9.6.2 Spousal RRSP Contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–26
9.6.3 Asset Swaps and Transfers for Value . . . . . . . . . . . . . . . . . . . . 9–26
9.6.4 Loans at Prescribed Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–26
9.6.5 Capital Gains with Minor Children . . . . . . . . . . . . . . . . . . . . . 9–27
9.6.6 Income Splitting with Corporations and Businesses:
Salary to Employees, Officers, and Directors . . . . . . . . . . . . 9–28
9.6.7 Multiplying Access to the Lifetime Capital Gains
Exemption (LCGE) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–28
9.7 EXAMINING BLAIR’S INHERITANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–28

9.8 KEY STUDY POINTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9–30

9–2
 Chapter 9
Attribution Rules and
Income Splitting

Learning Objectives
Knowledge Objectives:
• Understand the attribution rules and income-splitting concepts.

Skills Objectives:
• Identify situations where the attribution rules apply.
• Recognize and explain income-splitting opportunities.

9.1 BASIC CONCEPTS OF ATTRIBUTION AND INCOME SPLITTING

NOTE: See note under 9.4, Tax on Split Income, regarding changes first proposed in 2017 that would seriously impact
income splitting with a private corporation.

Generally, the attribution rules prevent an individual from inappropriate “income

splitting” where an individual transfers property to another individual so that the
income from the property may be taxed at a lower rate because the transferee
is in a lower marginal tax bracket. In situations where shifting income from one
person to another is seen as abusive, the attribution rules will “attribute” income
back to the original owner of the property. A number of elements in the rules
will assist to determine whether or not a particular transfer or transaction might
be subject to one or more of the attribution rules.

9–3
9.1 Chapter 9 – Attribution Rules and Income Splitting

• The relationship between the parties is relevant, since income split-

ting is generally done to achieve tax savings within the family as an
economic unit.
• If a direct transfer would attract an attribution rule, it is likely
that the rule (or another attribution rule) will apply if the transfer
takes place indirectly, through a series of transactions, or through
another entity such as a trust or corporation.
• Where attribution applies to property transferred, it will also apply
to any substituted property, including property subsequently sub-
stituted for substituted property.
The attribution rules generally apply to transactions or transfers, whether direct,
indirect, or through another entity, by an individual to:

• the spouse or common-law partner of the individual or

• an individual related to the individual who has not attained age 18
in the year.
There are three additional rules that apply in other circumstances and do not
necessarily involve transfers to a spouse or related minor.

1. A settlor/contributor attribution rule applies to transfers to a trust

where property is held on certain terms under which it can return
to, or be controlled by, the settlor/contributor, no matter who the
beneficiaries are.
2. An anti-avoidance attribution rule applies (where the other attri-
bution rules do not), where there is a non-arm’s length loan to a
related person with a purpose to reduce tax.
3. An attribution rule applies where payments meant for the tax-
payer are redirected at the taxpayer’s request or consent to another
person,1 sometimes referred to as “indirect payments.” This rule
may apply, for example, where a corporation provides a benefit to
a family member of a controlling shareholder.
Transfers of property that may attract the attribution rules include a gift, sale, or
loan, although exceptions do exist (see 9.5).

1 Subs. 56(2) is not specifically discussed in this material.

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INCOME ATTRIBUTION ON TRANSFERS AND LOANS FOR THE BENEFIT OF A SPOUSE OR RELATED PERSON UNDER AGE 18 9.2.1

Generally, the attribution rules apply only during the time that the transferor is a
resident of Canada, and attribution ceases on the death of the transferor.

Example: Application of Attribution Rules – Blair’s Inheritance

Blair inherited $750,000 from his father. Blair’s income from his position as a senior executive is $270,000 per annum, and
with investment income he is already in the top marginal tax bracket. Any investment income from his inheritance will be
taxed at the top marginal rates. Blair gives his wife, Angie, $200,000 to invest on her own and sets up a discretionary trust
for his three children, ages 10, 12, and 23, with himself and Angie as trustees. He settles the trust with $300,000 of his
inheritance and lends the remaining $250,000 without interest to his mother so she can live on the investment income.

Without the attribution rules, Blair would have effectively transferred or shifted
all the investment income from his inheritance to other family members. In fact,
upon application of the attribution rules, almost all the income from the inheri-
tance, including capital gains and losses, and in some cases income losses, will
be attributed back to Blair. The application of the rules to these transactions and
possible alternate planning that does not attract the attribution rules are exam-
ined later in this chapter (see 9.7, Examining Blair’s Inheritance).

There are a number of exceptions to the attribution rules, and these are the
foundation for legitimate income splitting that is not prevented by the attribution
rules. Further details of these exceptions follow, but in summary they include:

• transfers for fair market value, provided the transferor has not guar-
anteed any purchase loan or provided generous financing terms
(i.e., loans at commercial rates or at the prescribed rate with inter-
est paid within 30 days of the end of the calendar year) and
• capital gains splitting with related children under age 18.

9.2 INCOME ATTRIBUTION ON TRANSFERS AND LOANS FOR THE BENEFIT

OF A SPOUSE OR RELATED PERSON UNDER AGE 18

9.2.1 Transfer or Loan to Spouse: Spousal Attribution Rule for Income and
Capital Gains under Subss. 74.1(1) and 74.2(1)

Under subs. 74.1(1), the income or loss and, under subs. 74.2(1), the capital gain
or capital loss from any property transferred or loaned by an individual is attrib-
uted back to the transferor where the transfer or loan:

• takes place directly, indirectly by means of a trust, or by any other

means “whatever” and

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9.2.2 Chapter 9 – Attribution Rules and Income Splitting

• is to or for the benefit of the transferor’s spouse or common-

law partner or a person who becomes the transferor’s spouse or
common-law partner.

The transfer of a right to receive benefits under the Canada Pension Plan (CPP),
or a comparable provincial plan such as the Quebec Pension Plan (QPP), and
contributions to a spousal registered retirement savings plan (RRSP)2 are not
subject to the spousal income attribution rule in subs. 74.1(1).

9.2.2 Transfer or Loan to Related Person Under Age 18: “Children’s” Attribution
Rule for Income under Subs. 74.1(2)

Under subs. 74.1(2), the income or loss from any property transferred or loaned
by an individual is attributed back to the transferor where the transfer or loan:

• takes place directly, indirectly by means of a trust, or by any other

means “whatever” and
• is to or for the benefit of a person who will not attain the age of 18
years in the year and who:
{ does not deal at arm’s length with the transferor or
{ is a niece or nephew of the transferor.

This rule applies to attribution of “income” for trust law purposes, but not for
capital gains. Capital gains or losses realized by related children or nieces or
nephews under age 18 are not subject to attribution.3 The amount of any tax on
split income that is required to be taxed in the hands of a person under age 18
will not be subject to the attribution rule in subs. 74.1(2).4

9.2.3 Transfers to a Trust: Trust Attribution Rule under Subs. 74.3(1)

Subsection 74.3(1) clarifies that the attribution rules described above for direct
or indirect transfers or loans to a spouse or related person under age 18 (i.e., the
rules in subss. 74.1(1), 74.1(2), and 74.2(1)) apply to the income and the capital

2 Subs. 74.5(12), although there is another rule not discussed in these materials that attributes
withdrawals from a spousal RRSP back to the contributor in certain circumstances.
3 Except for certain farm or fishing property, see s. 75.1.
4 Subs. 74.5(13).

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INCOME ATTRIBUTION ON TRANSFERS AND LOANS FOR THE BENEFIT OF A SPOUSE OR RELATED PERSON UNDER AGE 18 9.2.3

gain5 from any property transferred or loaned by an individual to a trust for the
benefit of a spouse or related person under age 18. This trust attribution rule
applies to attribute to the individual transferor any income or capital gain from
property transferred by the individual to a trust where:

• the transfer takes place directly, indirectly by means of a trust, or

by any other means “whatever,”
• a “designated person” of the transferor is beneficially interested in
the trust, and
• a “designated person” receives, or is deemed to receive, income or
a capital gain from the trust.

“Designated person” is defined for the purposes of this rule — that is, the “trust
attribution rule” in subs. 74.3(1) — and the corporate attribution rule described
below as a person who is:

• the spouse or common-law partner of the individual,

• a person under 18 years of age and with whom the individual does
not deal at arm’s length, or
• a niece or nephew of the individual who is under 18 years of age.

This trust attribution rule makes it clear that only income received or deemed
to be received by a person who at the time is a designated person is attributed
back to the transferor. Income or gains accumulating in the trust are not subject
to this attribution rule. For example, if an inter vivos trust is settled by a parent
for the parent’s children who are under age 18, interest income earned in the
trust would only be subject to attribution back to the parent if paid or payable
to the children. Note that in this case, if the parent was not already taxed at the
highest graduated rate, it might be better to make payments to or on behalf of
the children to allow the attribution rule to apply so the income is not subjected
to the highest rate of tax in the inter vivos trust.

Note that this attribution rule for transfers to trusts is not really a separate attri-
bution rule. It simply clarifies the amount of income (in the case of a spouse or
related person under 18) or gain (in the case of a spouse) that is to be attributed

5 Note that losses that are attributed under the direct transfer rules are not attributed under the trust
attribution rule, since losses in a trust cannot be flowed through to beneficiaries (the only exception
being where the attribution rule in subs. 75(2) applies).

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9.2.4 Chapter 9 – Attribution Rules and Income Splitting

under subss. 74.1(1), 74.1(2), and 74.2(1), discussed above, where a transfer or
loan is made to a trust.

9.2.4 Transfers to a Corporation: Corporate Attribution Rule: S. 74.4

Section 74.4 contains a further attribution rule regarding loans or transfers of

property to a corporation by an individual. Under subs. 74.4(2), there will be
income attributed to an individual who loans or transfers property to a corpora-
tion where:

• the transfer or loan takes place directly, indirectly by means of a

trust, or by any other means “whatever,”
• one of the main purposes of the transfer or loan may reasonably
be considered to benefit a person who is a designated person in
respect of the individual, and
• the benefit to the designated person may be received directly, indi-
rectly, by means of a trust, or by any other means “whatever.”

This rule is particularly harsh, as the amount to be attributed to the transferor is

fixed and bears no relation to income actually earned or distributed. The amount
of income to be attributed to the individual under this rule is based on the value
of the property transferred or loaned to the corporation, and is calculated as the
prescribed rate of interest on such amount. The amount attributed is reduced by
any interest actually received by the transferor and by 5/4 of any taxable divi-
dends on shares received as part of the transfer and 5/4 of any split income (i.e.,
income subject to tax on split income — see 9.4) taxed in the hand of a child or
niece or nephew under age 18, where that split income was part of the benefit
intended by the transferor.

Example: Corporate Attribution Rule

Jasper transfers 100 common shares of Soda Pop Top Ltd. (SPT) to Holdco Ltd. in exchange for fixed value preference shares
with fair market value (FMV) of the shares transferred in the course of an estate freeze. The rule in s. 74.4 will apply on the
FMV of the shares of SPT exchanged or transferred in the course of the freeze, except during any time SPT qualifies as a small
business corporation, or where there are no longer any designated persons who are beneficiaries.

As the above example illustrates, this rule may be triggered where an exchange
of shares is made to a corporation in the course of an estate freeze. To avoid
the rule, it is common to provide a provision in the trust document preventing

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INCOME ATTRIBUTION ON TRANSFERS AND LOANS FOR THE BENEFIT OF A SPOUSE OR RELATED PERSON UNDER AGE 18 9.2.5

distributions to persons falling within the definition of a designated person.

However, the rule does not apply to transfers of property to a small business
corporation6 (SBC), and for this reason the provisions restricting distributions
to designated persons will not be required if the corporation is expected to
remain an SBC. In the event the corporation ceases to be an SBC, the corporate
attribution rule in s. 74.4 will apply until the corporation regains SBC status.
See 10.7.11, Avoiding the Corporate Attribution Rule, for more details regarding
planning.

9.2.5 Non-Arm’s Length Loans with Intent to Reduce Tax: Subs. 56(4.1)

In general, the attribution rules do not apply to transfers to family members

who were not either a spouse, a common-law partner, or persons related to the
transferor who are under the age of 18. So, for example, it is generally possible
to transfer money to an adult child who invests the funds with no attribution of
the investment income back to the parent. However, where the purpose of the
loan is to reduce tax, a further anti-avoidance attribution rule contained in subs.
56(4.1) may apply even if the other attribution rules do not. This rule applies
where the loan is to any person with whom the lender is not dealing at arm’s
length.

The Act contains rules to determine whether persons deal at arm’s length.
Subsection 251(1) provides that:

• “related persons” are deemed not to deal with each other at arm’s
length and
• whether unrelated persons deal with each other at arm’s length is
a question of fact.

So both related and unrelated persons may be non-arm’s length, but related per-
sons are always non-arm’s length. “Related persons” include persons connected
by a blood relationship, marriage, common-law partnership, or adoption.

As a result of these and other rules in the Act, an individual and the following
persons do not deal at arm’s length:

• a spouse or common-law partner of the individual,

• a child or parent or a more remote descendant or ascendant,

6 See 3.4.6.

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9.2.5 Chapter 9 – Attribution Rules and Income Splitting

• brothers and sisters of the individual,

• the spouse or common-law partner of the individual’s brother or
sister,
• a child or parent or more remote descendant or ascendant of the
individual’s spouse or common-law partner,
• corporations controlled by the individual or persons related to the
individual, and
• adopted children or siblings, of the individual and his or her
spouse.

There are two components that must exist in order for this attribution rule to
apply:

1. the loan must be to a non-arm’s length person, and

2. it can be reasonably considered that one of the main reasons for
making the loan was to reduce or avoid tax by causing income
from the transferred property to be included in the income of the
non-arm’s length recipient or, in the case of a trust, the non-arm’s
length person who was beneficially interested in the trust.7

This rule applies to loans to a trust where a person who does not deal at arm’s
length with the transferor is beneficially interested in the trust. So, for example,
this rule would apply where an individual lends property to a trust and the par-
ent of the individual is a beneficiary of the trust, if the intent was to reduce tax
by including the income in the parent’s hands.

Similar to the other attribution rules, this attribution rule also applies only where
the lender is resident in Canada throughout the year.

The income will be attributed to the lender only to the extent that the other
attribution rules in subss. 74.1(1), 74.1(2), and 75(2) do not apply.

Where the lender is a trust, the rule may also apply, although there are addi-
tional details not discussed here.

Only income from the property or substituted property — not losses or capital
gains or capital losses — will be attributed under this rule. Under subs. 56(4.2),

7 A beneficial interest in a trust is defined in subs. 248(25).

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INCOME ATTRIBUTION ON TRANSFERS AND LOANS FOR THE BENEFIT OF A SPOUSE OR RELATED PERSON UNDER AGE 18 9.2.7

the rule will not apply where interest is charged at the prescribed rate (provided
for in Regulation 4301), in effect at the time the loan is made, or where the
loan is made on commercial terms similar to the exemption contained in subs.
74.5(2).

Under subs. 56(4.2), where an interest-bearing loan is at the prescribed rate, this
attribution rule will be avoided as long as interest (at the prescribed or commer-
cial rates noted above) is paid in respect of every year and no later than 30 days
after the end of the preceding taxation year. A common problem is to assume
the deadline is the last day of January (i.e., January 31 of the following year).
This is incorrect — the deadline is January 30, and as with the other attribution
rules where prescribed rate loans are being used to achieve income splitting,
if the deadline is missed by even one day, the loan will forever be offside and
income attribution will apply until the loan is repaid, even if interest is paid on
time in future years.

9.2.6 Attribution Rules and Substituted Property

The attribution rules apply to transfers of property or loans. Each attribution rule
also extends to property substituted for transferred property, including property
purchased with loan proceeds. “Substituted property” is given a very broad defi-
nition in subs. 248(5) and includes not only original substitutions but subsequent
substitutions. For example, where cash is transferred to a trust and the trust pur-
chases capital property, the capital property will be considered substituted prop-
erty. If the property is then subsequently disposed of and the proceeds used to
purchase additional property, that property will also be substituted property and
any income from it will be subject to the attribution rule.

9.2.7 Back-to-Back Transactions and Guarantees of Purchase Debt

Subsection 74.5(6) prevents back-to-back loans or transfers from being used to

avoid the attribution rules. This rule ensures that the attribution rules will apply
where property is loaned or transferred by an individual to another person,
directly or indirectly, on condition that the other person in turn make a loan or
transfer property to or for the benefit of a person to whom attribution would
otherwise apply, such as a spouse or common-law partner, related child, or niece
or nephew under age 18. This includes transfers to a trust or a corporation other
than an SBC.

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9.2.8 Chapter 9 – Attribution Rules and Income Splitting

Example: Back-to-Back Transfers on Condition of Attribution

John and Joe are brothers who each just inherited $425,000 from their parents. Joe gives $425,000 to John to settle a trust
for his children, and John gives Joe $200,000 to settle a trust for the benefit of Joe’s wife, Jennie. If Joe made the transfer on
condition that John would settle the trust and vice versa, attribution would apply. The back-to-back rule would clearly apply,
but possibly this transaction might also be caught under the “directly, indirectly, or in any manner whatever” language of
the attribution rules.

Similarly, subs. 74.5(7) ensures that a guarantee or financial assistance by the

transferor to repay a loan on a purchased property, or to repay a loan for value,
cannot be used to avoid the application of the attribution rules.

Example: Financial Assistance and Attribution

Beth purchases shares of a holding company for $750,000 cash from her husband, Anton, and Anton uses his lifetime
capital gains deduction to shelter the capital gain triggered when he elects out of the rollover under subs. 73(1). Normally
attribution would not apply. However, if Beth borrows the purchase funds from the bank, the attribution rules will apply if
Anton guarantees Beth’s loan. Similarly, if Anton makes an interest-free loan to Beth for the purchase, attribution will apply.

9.2.8 Artificial Transactions: Using the Attribution Rules to Reduce Income

Subsection 74.5(11) provides that the attribution rules do not apply where it
may reasonably be concluded that one of the main reasons for a transfer or loan
was to reduce tax that would otherwise be payable on income or gains from the
property transferred.

Example: Attribution Rule Abuse — Result Is No Attribution

Sabina has no income, but her husband, Bill, has a high salary and is in the top marginal tax rate. Bill borrows $1.5 million
to invest and Sabina guarantees the loan, signing a collateral mortgage on their home. Bill and Sabina expect that the
attribution rule relating to financial assistance in subs. 74.5(7) will apply to attribute income to her. If one of the main
reasons to make the guarantee was to reduce Bill’s income, attribution will not apply, and the income will be taxed in Bill’s
hands.

9.3 ATTRIBUTION BACK TO SETTLOR/CONTRIBUTOR WHERE PROPERTY

HELD IN TRUST: SUBS. 75(2)

A special attribution rule applies where the settlor or contributor to a trust

retains certain rights over trust property, or has a right to determine the benefi-
ciaries of the property. The rights must arise as a result of the terms of the trust.

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ATTRIBUTION BACK TO SETTLOR/CONTRIBUTOR WHERE PROPERTY HELD IN TRUST: SUBS. 75(2) 9.3

Subsection 75(2) will apply to attribute any income or losses and any capital
gains or capital losses from the property held in the trust to the transferor. In
addition, no rollover or “rollout” of trust property is available on a distribu-
tion to a beneficiary in satisfaction of a capital interest in a trust if subs. 75(2)
ever applied to the trust. The rule will apply in any one of the following three
situations:

1. Reversion to Settlor/Contributor: where property can revert to

the settlor/contributor other than by operation of law — that is, the
trust fails and property reverts to the settlor. This would be the case
if there is a right to encroach on capital for the settlor or the trust
is revocable.
2. Settlor/Contributor Determines Beneficiaries: where the settlor/
contributor can determine who receives property after the creation
of the trust.
3. Settlor/Contributor Controls Dispositions: where property
cannot be disposed of without settlor/contributor’s consent or
direction.
Specifically, subs. 75(2) of the Act provides:

75(2) Where, by a trust created in any manner whatever since 1934,

property is held on condition

(a) that it or property substituted therefore may

(i) revert to the person from whom the property or property for
which it was substituted was directly or indirectly received (in
this section referred to as “the person”), or

(ii) pass to persons to be determined by the person at a time subse-

quent to the creation of the trust, or

(b) that, during the existence of the person, the property shall not be
disposed of, except with the person’s consent or in accordance with
the person’s direction,

any income or loss from the property or from property substituted for
the property, and any taxable gain or allowable capital loss from the
disposition of the property or a property substituted for the property,
shall, during the existence of the person while the person is resident
in Canada, be deemed to be income or a loss, as the case may be, or a
capital gain or allowable capital loss, as the case may be, of the person.

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9.3.1 Chapter 9 – Attribution Rules and Income Splitting

Where subs. 75(2) applies to a trust, a T3 Return should be filed (and income
allocated on T3 Slips) even if all the income is attributed.8

Subsection 75(2) will not apply during any time that the transferor or contribu-
tor is a non-resident of Canada, or after the death of the transferor or contribu-
tor. For this reason, subs. 75(2) never applies to a testamentary trust.

9.3.1 Consequences of Reversion: Subpara. 75(2)(a)(i)

When, under the terms of the trust, property can revert back to the person who
transferred it to the trust, the attribution rule in subs. 75(2) will apply. Such
trusts are called “reversionary trusts,” or sometimes “revocable trusts.” “Rever-
sion” refers to the fact that property of the trust can “revert” or be paid back to
the contributor or settlor. It includes situations where the settlor retains rights or
has future rights to the capital property in the trust no matter how remote.

The attribution rule applies to all income from a particular property, even where
the settlor has limited rights to the particular property. Consider the situation
where an individual transfers an apartment block to a trust but retains the poten-
tial right to use one suite. Canada Revenue Agency (CRA) has expressed the opin-
ion that in such a case, the potential right to use the one suite is a capital interest
in the trust that may offend the rule against reversion in subpara. 75(2)(a)(i),
with the result that income from the entire property, not just the particular suite,
will attribute to the settlor.9

The rule will apply only if the reversion takes place under the terms of the trust.
So, for example, where the reversion takes place by operation of law due to
failure of the objects of the trust, such as the death of all beneficiaries, the rule
will not apply. Similarly, if there is a genuine loan to the trust and the loan is
repaid pursuant to the terms of the loan agreement, the rule will not apply, since
the repayment is not made under the terms of the trust but under the contract
between the lender and the borrower.10

The rule may not apply to the right of a settlor or contributor to receive income,
as opposed to capital, from the trust. This seems to make sense, as generally it
is also thought that a settlor/contributor can exercise discretion with respect to

8 See T3 Trust Guide under “Who Should File.”

9 See Technical Interpretation 2002-0118255, June 10, 2002.
10 Although other attribution rules could apply. See Howson v. R. (2006), TCC 644, where a genuine loan
was not subject to subs. 75(2).

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ATTRIBUTION BACK TO SETTLOR/CONTRIBUTOR WHERE PROPERTY HELD IN TRUST: SUBS. 75(2) 9.3.1

distributions of income to beneficiaries without invoking the rule under subpara.

75(2)(a)(ii) relating to determining beneficiaries. However, most trusts avoid per-
mitting such rights to the settlor/contributor out of an abundance of caution for
fear CRA may attempt to apply subs. 75(2) in such circumstances.

As a result of Sommerer,11 the reversionary rule in subpara. 75(2)(a)(i) does not

apply to property transferred to a trust by a capital beneficiary as a vendor for
proceeds equal to fair market value, since the rule was only intended to apply
to transfers by a settlor or contributor to the trust. In Sommerer, the trust was a
non-resident of Canada, and the capital beneficiary who sold the property to the
trust was a resident Canadian. The courts held that subs. 75(2) did not apply to
the sale to the trust.

Changes introduced in the 2013 Federal Budget have remedied the result of this
decision from CRA’s perspective. Transfers by Canadian beneficiaries to non-
resident trusts whether by gift, sale, or loan of any kind will result in such trusts
being deemed to be resident in Canada. The current rule in subs. 75(2) remains
unchanged with respect to Canadian resident trusts, but it now applies only to
trusts actually resident in Canada (excluding non-resident trusts deemed to be
resident in Canada).

The use of the word “may” in para. 75(2)(a) indicates that the possibility of
reversion back to the settlor or contributor (or the right to determine the benefi-
ciary) will include a potential right, or one that is subject to certain conditions.
This rule will apply wherever the settlor or contributor is a capital beneficiary of
a trust, or even a potential beneficiary, and will apply whether the possibility of
property returning to the settlor/contributor is absolute or contingent. For exam-
ple, many trusts will provide for remote or alternate beneficiaries in the event
the intended beneficiaries of the trust fail to survive the distribution date. Care
must be taken to make sure the settlor/contributor is not a potential beneficiary
under such circumstances, however unlikely. Most trusts have an “anti-reversion”
clause that specifically prohibits reversion of the property of the trust back to
the settlor in any circumstances. Or, if the trust provides that the property of the
trust will revert to the transferor in the event the trustees do not make a distri-
bution from the trust, or if they do not distribute the property of the trust to the
beneficiaries within a certain time period, the rule will apply.

11 Sommerer v. R. (2011), 2011 D.T.C. 5126, affirmed by F.C.A. Justice Sharlow.

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9.3.2 Chapter 9 – Attribution Rules and Income Splitting

Where the right is a reversion right, the rule may apply whether property was
directly or indirectly transferred to the trust.

Example: Indirect Transfer Resulting in Subs. 75(2)

Assume that a parent gifts property to a child. A number of years later, the child transfers the property to an inter vivos
family trust in which the child and his or her spouse and children and grandchildren are beneficiaries and the parent is a
contingent residual beneficiary. Subsection 75(2) would apply to attribute all income and loss, and all capital gains and
losses, from the property or any substitute property to the parent.

Out of an abundance of caution, some advisors recommend including a clause

in the trust document that prevents property from being sold back to the set-
tlor. This should be carefully considered; it may not be necessary, since the sale
would not take place under the terms of the trust, and in some circumstances, the
settlor may want the option to purchase the property back. In addition, where
a trust is a shareholder of a corporate beneficiary, and theoretically dividends
could be distributed back to the corporation as beneficiary, it may be appropri-
ate to restrict the possibility of property reverting to anyone from whom it was
received (except by operation of law such as where the trust fails).

9.3.2 Control by the Settlor/Contributor: The Right to Determine Beneficiaries

or to Consent to Disposition of Trust Property: Subpara. 75(2)(a)(ii) and
Para. 75(2)(b)

The rule applies where the settlor/contributor has control over who receives
trust property, or the disposition of trust property, specifically where:

• the settlor or contributor has the right to determine the persons

who receive property of the trust, after the creation of the trust
(subpara.75(2)(a)(ii)) or
• property cannot be disposed of without the settlor/contributor’s
consent or in accordance with the settlor/contributor’s direction
(para. 75(2)(b)).

Typically, the settlor/contributor will have these rights where the settlor/con-
tributor is a sole or co-trustee of the trust. If the settlor/contributor is the sole
trustee, the rule will apply, assuming the trustee has the discretion either to dis-
pose of property or to decide who is to receive property either during the term
of the trust or upon distribution to a beneficiary. The discretion to dispose of
property includes the right to sell trust property during the term of the trust. The

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ATTRIBUTION BACK TO SETTLOR/CONTRIBUTOR WHERE PROPERTY HELD IN TRUST: SUBS. 75(2) 9.3.2

discretion to decide who is to receive property is present if there is a discretion

to encroach on capital, or the final distribution to beneficiaries is discretionary,
because the settlor/contributor, as sole trustee, would have the right to deter-
mine to whom property passes. In each of these cases, subs. 75(2) will apply,
either under subpara. 75(2)(a)(ii) or para. 75(2)(b), respectively.

These two rights may also cause subs. 75(2) to apply where the settlor/
contributor is a co-trustee. Trustees are required to make all decisions unani-
mously, in the absence of any provision to the contrary in the trust document.
As a co-trustee the settlor or contributor would, in effect, have a veto power over
decisions of the trustees. However, if there was a requirement for at least three
trustees at all times, and a provision permitting a majority of trustees to make
decisions, and no requirement that the settlor or contributor be a member of
that majority, the settlor or contributor may be a trustee without the application
of subs. 75(2). The right to make decisions to distribute or dispose of property
(see para. 75(2)(b)) should be suspended during any time there are less than
three trustees, in the event the settlor/contributor is a trustee. Even where three
trustees are named with a majority clause that does not require the transferor or
contributor to be a member of the majority, a contingent right to control trust
property or distributions may exist in the event that a co-trustee resigns. In this
event, it is recommended that the trust document provide that any rights that
otherwise attract the application of subs. 75(2), such as a right to sell property
or make a discretionary distribution to beneficiaries, should be suspended until
the number of trustees is restored to three.

If a settlor is found to be acting as agent for another person in settling the trust,
say the founder of the business, and the founder is the sole trustee (or control-
ling trustee) or beneficiary of the trust, then there may be a risk of subs. 75(2)
applying to attribute income to the founder. This may be a concern where the
founder’s accountant or lawyer is used to settle the family trust. A provision that
requires the settled property, or any property substituted therefore, to be held
for the duration of the trust and distributed on dissolution under a fixed for-
mula — for instance, equally between the beneficiaries other than the founder—
could be used to reduce such a risk

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9.3.3 Chapter 9 – Attribution Rules and Income Splitting

Example: Application of Subs. 75(2) to Substituted Property

Raymond is the sole trustee of a family trust he settled for the education of his minor grandchildren. He transfers a building
to the trust at a time when the value of the building is $80,000. Subsequently, the trust sells the building for $100,000. If
subs. 75(2) applies to the trust, as it would if the trust were a discretionary trust with respect to distributions of capital,
the $20,000 of capital gains will be attributed back to him. Generally, capital gains do not attribute back to the transferor
where the transfer is to or for the benefit of minors. However, this does not prevent attribution under subs. 75(2). If the trust
invests the proceeds in a stock portfolio, any investment income and any capital gains and losses realized on the shares in
the portfolio will also be attributed back to Raymond.12

9.3.3 Loss of Rollover on Distribution of Property from a Trust to a Beneficiary:

Subs. 107(4.1)

If subs. 75(2) ever applied to a trust, subs. 107(4.1) states that the rollover in
respect of a distribution of trust property to a beneficiary provided for in subs.
107(2) does not apply to distributions of capital property to a beneficiary in satis-
faction of a capital interest in the trust. This is a potentially onerous consequence
of the application of subs. 75(2) to a trust. It applies to all distributions of trust
property, not just the property transferred by the particular settlor/contributor
who retained the rights described under subs. 75(2). The only exceptions to subs.
107(4.1) are:

• distributions after the death of the settlor/contributor and

• distributions to the settlor/contributor and his or her spouse or
common-law partner.

In some circumstances, the application of the attribution rule in subs. 75(2) can
be cured by having the offending provisions of the trust document amended,
either pursuant to a permission to amend the trust document contained in the
document itself or pursuant to variation of trust legislation in the province. How-
ever, the ability of the trust to distribute property to a beneficiary on a tax-free
basis cannot be cured in this manner.

The loss of the rollover on distribution of trust property can pose problems in
avoiding the application of the 21-year rule. Typically, a distribution to a benefi-
ciary before the anniversary date or other date when the 21-year rule will apply
will avoid the deemed disposition at fair market value (FMV). This is not an
effective strategy if subs. 107(4.1) applies to deny the rollover on the disposition.

12 See para. 7 of IT-369R (Archived), A ribu on of Trust Income to Se lor.

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ATTRIBUTION BACK TO SETTLOR/CONTRIBUTOR WHERE PROPERTY HELD IN TRUST: SUBS. 75(2) 9.3.5

9.3.4 Application of Subss. 75(2) and 107(4.1) to an Alter Ego Trust (AET) and
Joint Partner or Common-Law Partner Trust (JPT)

The terms of an alter ego trust (AET) or joint partner (or common-law partner)
trust ( JPT) must provide that the settlor be an income beneficiary and that all
the income be payable to the settlor or, in the case of his or her spouse, to the
settlor and his or her spouse during their lifetime. Subs. 75(2) will generally
apply to AETs and JPTs where:

• the settlor/contributor has a right to distributions of capital,

• the settlor/contributor has control over dispositions of property in
the trust, or
• the settlor has control over distributions of income sufficient to
exclude a beneficiary (including the settlor/contributor or the
spouse or common-law partner) from distributions altogether.

The last two rights may exist where the settlor/contributor is a sole trustee, or in
certain circumstances a co-trustee. The companion rule in subs. 107(4.1) (deny-
ing the rollover on distribution of property from the trust where subs. 75(2)
applies) does not apply to distributions to the settlor/contributor or his or her
spouse or common-law partner.

The application of subs. 75(2) to AETs and JPTs is not usually a problem since
the attribution of income back to the settlor is incompatible with the planning
objectives associated with the use of these trusts, and in the absence of the appli-
cation of subs. 75(2) the settlor (or in some circumstances the spouse) would be
taxed on the income in any event.

9.3.5 Unique Features of the Attribution Rule under Subs. 75(2)

This rule is one to be wary of in trust practice, as it often inadvertently applies,

even where the purpose of the trust is for non-tax purposes. This makes the rule
exceptionally dangerous, as tax advisors are not always involved in reviewing
the terms of trusts that are not tax-motivated. The rule applies whether or not
the transfer is made at fair market value and regardless of the identity of the
beneficiaries. In addition to attribution with respect to the particular property
transferred, as noted above, all distributions of capital property to beneficiaries
will take place at fair market value as long as the settlor/contributor is alive and
resident in Canada.

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9.4 Chapter 9 – Attribution Rules and Income Splitting

The rule can apply to settlements made for the support and maintenance of chil-
dren upon a breakdown of a marriage or common-law relationship.

The rule can also apply to subsequent transfers to a trust many years after an
initial transfer by an individual (see example).

Like the other attribution rules, it no longer applies after the death of the settlor
or “transferor.” In the case of subs. 75(2), however, this means that not only the
attribution of income and capital gains and losses ceases, but also the rollover of
property from the trust on a distribution of capital property in satisfaction of a
capital interest in a trust is restored.

Unique Feature of Attribution Rules — Example of Subsequent Transfer

Raj established a charitable foundation organized as a corporation by transferring $5 million to the charity. Ten years later,
Raj wants to ensure that his brother and his children continue to have a role in determining the charitable beneficiaries and
that the funds in the charitable corporation are donated to a charitable trust. The trust sets out that Raj is the sole trustee
during his lifetime, and that his brother and children will be successor trustees. There is a possibility that subs. 75(2) could
apply because a trust vehicle is now used for the charity and the original funds came from Raj, who is now the sole trustee of
a discretionary trust. If so, any income and capital gain or loss of the charitable trust will be attributed back to Raj, and under
subs. 107(4.1) any distributions of property from the trust will take place at FMV, with any deemed capital gain or loss also
being attributed back to Raj.

9.4 TAX ON SPLIT INCOME

NOTE: Proposals first announced on July 18, 2017, were made to extend the tax on split income (TOSI). Check the STEP
website in the student resources section for updates as to the status of these and other changes. These proposals, if adopted,
would expand the TOSI to adults and tax dividends from private corporations and gain on the disposition of shares on
private corporations at the top marginal rate of tax. In future, income splitting with a family business will be subject to a
reasonableness test under the TOSI rules. The question will be whether the recipient of corporate-sourced income (whether
dividends or capital gains) was sufficiently “active” in the business, had sufficient financial risk, or made a sufficient non-
monetary contribution to the business so that the receipt was “reasonable.” If not, the dividends and any taxable capital gain
will be subject to the highest graduated rate. Because the capital gain is deemed not to be a capital gain, the lifetime capital
gains exemption will also not be available. And income from reinvested income will also be “tainted.”

9.4.1 Tax Penalty on Dividends: Combatting the Dividend Tax Credit

Advantage

The mechanism of the dividend tax credit has made it very desirable to use
taxable dividends to divert income to other family members who have little or
no other sources of income. Significant taxable dividends may be received by
an individual who has no other income without paying any tax, subject to the

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TAX ON SPLIT INCOME 9.4.1

application of the alternative minimum tax (AMT). The thresholds at which tax
will be payable differ for federal and provincial income tax and are discussed
fully at 2.2.1.4, Dividends from Taxable Canadian Corporations. In 2017, if eli-
gible dividends were the only source of income for an individual, approximately
$50,000 before gross up could be received before paying federal income tax. The
value of dividends that can be sheltered from tax varies considerably from prov-
ince to province and from year to year as changes are made to the amount of
gross-up and dividend tax credit and federal and provincial tax rates are altered.
For example, the amount will be less for regular dividends, as the dividend tax
credit is lower and the effective tax rate is higher than for eligible dividends.

The dividend tax credit operates to provide this advantage because the tax
credit reduces tax on a dollar-for-dollar basis and therefore may shelter a greater
amount of income from the dividend or from other sources for those in the
lower marginal tax brackets.

At one time, it was common practice for a private corporation to be set up with
shares held in a family trust with minor children and other family members as
discretionary beneficiaries. Dividend income could be distributed on a discre-
tionary basis (called “sprinkling”) to beneficiaries with little or no sources of
income, such as children under the age of 18. Dividends could be allocated for
tax purposes to minor beneficiaries, if paid or payable to them. Often this was
done, and the payments were used for discretionary payments on behalf of the
child — that is, expenses not considered the responsibility of the parents to pro-
vide the necessities of life. Such payments might be made for school fees, vaca-
tion trips, private lessons, sports training, and the like. In addition, if an “age 40
trust”13 was set up, no income had to be paid to or on behalf of the minor ben-
eficiary until a later time that, under the terms of the trust, could not exceed the
time at which the child turned 40 years of age.

The use of a corporate vehicle to distribute dividends to the hands of minor

beneficiaries or others in the low marginal tax brackets, where they were subject
to little or no payment of tax, has been seen as an abuse by the Department of
Finance. As a result of perceived abuses, the tax on split income (TOSI) rules
were introduced by adding s. 120.4 to the Act applicable to 2000 and subse-
quent years. The TOSI rules imposed a new tax on “split income.” Split income
includes dividends from private corporations received by an individual who is

13 See 4.7.9, Age 40 Trusts Permit Accumulating Income to Be Taxed to Under-Age-21 Beneficiaries –
Subs. 104(18).

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9.4.1 Chapter 9 – Attribution Rules and Income Splitting

under age 18. The tax ensures that such dividends are subject to the highest
graduated rate of tax in the hands of an individual under age 18 — thus, the
TOSI was referred to informally as the kiddie tax.

The rule imposes tax on “split income” at the highest federal rate, 29%, appli-
cable to dividends received by “specified individuals” (defined below — those
who have not attained age 18 during the taxation year) and the provinces have
followed suit. Split income includes:

• taxable dividends from private corporations,

• loans and shareholder benefits from private corporations,
• certain income from a partnership where a person who is related
to the recipient performs services for the partnership,
• taxable dividends on private corporations received through or
deemed to be taxable to the individual through a trust,
• income from providing property (e.g., interest) or services to a
business carried on by a related person or certain corporations in
which related persons had an interest,
• capital gains realized by, or included in the income of, a related
person under age 18 from a disposition of shares of a private cor-
poration to a person who does not deal at arm’s length with that
related person,14 and
• income from a partnership or trust derived from business or a
rental property where a person related to the specified individual
is actively engaged on a regular basis in the activities of the part-
nership or trust to earn the income, or in the case of a partnership,
has a direct or indirect interest in the partnership.15

The TOSI applies to the receipt of these dividends and partnership income, trust
income, or capital gains where the person is a specified individual. “Specified
individual” is defined in subs. 120.4(1) as a person:

14 Added by the 2011 Federal Budget applicable to capital gains realized on or after March 22, 2011, and
applies if dividends from the shares sold in a non-arm’s length transaction would have been subject to
TOSI. This would apply to prevent utilization of the capital gains exemption by under-age beneficiaries
of family trusts where the sale is a non-arm’s length transaction.
15 As proposed in the 2014 Federal Budget.

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TAX ON SPLIT INCOME 9.4.1

• who has not attained age 17 years before the year (i.e., will not be
18 or older at the end of the year),
• who was a Canadian resident throughout the year, and
• who has a parent resident in Canada at any time in the year.

Unlike the other attribution rules (other than subs. 75(2)), there is no specific
relationship requirement (i.e., there is no requirement that the minor be a child
or grandchild of a person related to the corporation or partnership). There is
also no exemption for persons under the age of 18 who may actually work in
the business.

Where a trust receives taxable dividends from a private corporation and allo-
cates them and designates them to a beneficiary who has not attained age 18 in
the year, the split income rules will apply.

The split income rules do not apply if:

• the income is from property inherited by the beneficiary from any

person and during the year he or she studies full-time in a post-
secondary educational institution or qualifies for the disability
amount,
• the income is from property the beneficiary inherits from a parent,
• the beneficiary was a non-resident of Canada at any time in the
year, or
• neither of the beneficiary’s parents lived in Canada at any time in
the year.

If the tax on split income rules applies, any attribution rules that may apply
to the same income will not; thus, a double penalty is not imposed (see 9.2.2,
Transfer or Loan to Related Person Under Age 18: “Children’s” Attribution Rule
for Income under Subs. 74.1(2)).

In preparing the trust T3 Return, split income must be shown on Schedule 9 and
a T3 Slip issued to the minor beneficiary. There is also a requirement to advise
the beneficiary in writing that he or she must complete Form T1206, Tax on Split
Income.

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9.5 Chapter 9 – Attribution Rules and Income Splitting

Under subs. 160(1.2), a parent of a specified individual may be jointly and sever-
ally liable for the tax on split income where the parent is involved in the busi-
ness carried on by the partnership or corporation or is a shareholder of the
corporation.

9.5 EXCEPTIONS TO ATTRIBUTION RULES

9.5.1 Transfers for Fair Market Value and Loans for Value

The attribution rules in ss. 74.1 and 74.2, for transfers or loans to a spouse, per-
son under 18, or to a trust for the benefit of such persons, do not apply where:

• the transfer takes place at fair market value — and in the case of
a transfer to a spouse or spousal trusts the transferor elects under
subs. 73(1) out of the spousal rollover (subs. 74.5(1)) and
• any loan is subject to interest charged at a rate no less than the
prescribed rate at the time of the loan and such interest is paid no
later than 30 days after the calendar year for the particular year
and every preceding year (subs. 74.5(2) — see 9.6.4, Loans at Pre-
scribed Rates) or the loan is otherwise made at arm’s length (i.e.,
market or commercial) rates.

9.5.2 Spouse or Common-Law Partner Living Separate and Apart

Subsections 74.5(3) and 74.5(4) provide that the attribution rules in subss.
74.1(1), 74.1(2), and s. 74.4 do not apply during any time the individual’s spouse
or common-law partner is living separate and apart because of a breakdown of
the marriage or common-law partnership. However, where the attribution is in
respect of a capital gain or loss attributed to a spouse under subs. 74.1(2), this
exception will apply only if the spouse or common-law partner and the indi-
vidual transferor file a joint election.

9.5.3 No Attribution on Income Earned on Attributed Income

Where income is subject to the attribution rules, there is no additional attribu-

tion on the re-invested income that was subject to attribution.

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SOME BASIC INCOME-SPLITTING TECHNIQUES 9.6.1

9.6 SOME BASIC INCOME-SPLITTING TECHNIQUES

Effective income splitting must avoid the attribution rules. The following is a list
of exceptions or opportunities for income splitting:

• loans at the prescribed rate at the time of the loan,

• sales for fair market value consideration,
• income on income, also known as second generation income,
• using a non-resident transferor, in which case there is no attribution,
• gifts to trusts for adult children (assuming subs. 75(2) does not apply),
• gifts to any adult, related or unrelated, other than a spouse (i.e.,
parents, siblings, etc.) or trusts for such person (assuming subs.
75(2) does not apply), and
• gifts to trusts to earn gains made paid or payable by the trusts to or
for the benefit of related persons under 18 years of age.

Many of the income-splitting techniques involve the use of trusts either because
the trust is an essential part of the tax strategy, such as income sprinkling with
a discretionary trust to access the lower marginal tax rates of family members
with limited income; or for non-tax objectives, such to maintain a degree of con-
trol over the property and income distributions generated, such as a discretionary
family trust for income sprinkling. In the case of minor beneficiaries, trusts may
be the most convenient way, if not the only way, to hold legal title to property on
their behalf without inviting the jurisdiction of the public trustee or other statutory
public official in the particular province.

9.6.1 Spouse in Lower Tax Bracket Invests Earnings or Inheritance

Where one spouse is in the highest marginal tax bracket, it will be tax-effective
to maximize the capital of the lower-income spouse to generate investment
income. The capital must not be subject to the attribution rules.

Where the lower-income spouse has employment income, the family living
expenses, including mortgage payments, should be paid by the other spouse
and the earnings of the lower-income spouse kept segregated and invested.

If the lower-income spouse inherits funds, these should be used to invest and
generate investment income not subject to attribution. The investments of the

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9.6.2 Chapter 9 – Attribution Rules and Income Splitting

higher-income spouse could be used to make any changes in lifestyle as a result

of the inheritance.

9.6.2 Spousal RRSP Contributions

An individual may contribute to the RRSP of a spouse or common-law partner

subject to the contribution deduction limit of the individual (not the spouse).
This may be advantageous where it is anticipated that the other spouse will
be taxed at a lower tax rate during retirement years. There is no attribution in
respect of the contribution, although if the spouse makes withdrawals from the
plan at a time when spousal contributions have been made in the current or
either of the two previous calendar years, the withdrawals will be attributed to
the contributor, to the extent of the value of the contributions in the current or
either of the two prior calendar years.

9.6.3 Asset Swaps and Transfers for Value

If the lower-income spouse owns an asset that is not income-producing, and it

does not have a significant gain, it may be possible to convert the asset into an
income-earning investment by a sale to the other spouse if the election out of
the spousal rollover is made.

For example, if a low-income spouse inherits an asset that does not produce
income, it can be sold at FMV to the other spouse. If they elect out of the roll-
over under subs. 73(1), then the lower-income spouse can invest the proceeds
without attribution of income back to the other spouse.

Asset Swap to Income Split between Spouses

Marion inherits the family cabin from her mother’s estate worth $250,000. She can sell the cabin to Sam, her husband, for
$250,000 and invest the proceeds. Marion should have an adjusted cost base (ACB) equal to the FMV of the cabin at the
time her mother died, and if the FMV has not increased she will have no capital gain on the sale. Note that if Sam transfers
investments worth $250,000 to pay for the cabin, he will have to elect out of the spousal rollover on that disposition also.

9.6.4 Loans at Prescribed Rates

Making a loan to a spouse, spousal trust, or trust for minor children at the pre-
scribed rate of interest can be an effective income-splitting technique where the
pre-tax rate of return on the loan exceeds the prescribed interest rate. Because
of the decline in interest rates and rates of return in recent years, many of the

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SOME BASIC INCOME-SPLITTING TECHNIQUES 9.6.5

previous loans set up to income split no longer operate effectively. However,

when interest rates are expected to increase, it is a good planning strategy to
initiate income-splitting loans or restructure old ones.16 The prescribed rate of
return is fixed permanently at the time the loan is made, provided interest pay-
ments are made as required. Consequently, if rates of return increase in future
years, the gap between the income earned on the borrowed funds and the pre-
scribed rate will increase, further increasing the amount of income not subject to
attribution.

Example: Loan for Value

Bob lends $500,000 to Max, his same-sex partner, in year one when the prescribed rate is 2%. Over the next eight years, the
rate of return averages 4.5%. The difference between the income and the interest paid to Bob at the fixed prescribed rate
(which is deductible from Max’s income and included in Bob’s income) is taxed in Max’s return without attribution to Bob.
Also, Bob can pay Max’s tax liability each year without any additional attribution. In this way, Max can re-invest the pre-tax
net income to increase the capital fund and maximize income not subject to attribution in future years.

9.6.5 Capital Gains with Minor Children

As we have seen, the only attribution of capital gains is with respect to a person
who is a spouse or common-law partner. This leaves the door open to income
split capital gains between a parent, grandparent, or other family member and
children of any age, including minor children.

A family trust can be established with all the children and other issue of an
individual as discretionary beneficiaries. There will be attribution of interest,
dividends, or other income from property to the extent that any distributions are
made to or for the benefit of a related child or niece or nephew under age 18.
However, there will be no attribution of any capital gains or losses. It is strongly
recommended that a trust be established to hold the property for a minor rather
than gifting the funds outright. From a tax planning perspective, this is desirable
in order to permit discretion to allocate income and gains among a number of
beneficiaries as is appropriate in any given year. This can be very effective to
multiply access to the lifetime capital gains exemption.

For example, a discretionary family trust may have income and capital gains. If
some children are 18 or older in the year, income can be allocated to them and
capital gains can be allocated to the children under age 18. Also, the amount of

16 A back-to-back transaction should be avoided where a loan at the current prescribed rate is being put
in place and a previous loan is being retired.

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9.6.6 Chapter 9 – Attribution Rules and Income Splitting

income allocated to each child can correspond to the payments for each child’s
expenses to be made by the trust on behalf of the child, such as school fees and
other expenses.

For a discussion of a trust for minors to income split, see 10.2.2, Using Fixed
Interest Age 40 Trusts to Defer Payment of Income Taxed in the Hands of a Ben-
eficiary Under Age 21.

9.6.6 Income Splitting with Corporations and Businesses: Salary to Employees,

Officers, and Directors

The payment of a salary to an employee by an individual is not subject to the

attribution rules under subs. 74.5(12). Similarly, a payment of deductible sal-
ary to a spouse, a common-law partner, or children under 18 by a corporation
where the individual is a sole or major shareholder would not attract attribution,
providing the compensation is reasonable for the services provided.17 Generally,
officers and directors of corporations may receive a salary for their services.

9.6.7 Multiplying Access to the Lifetime Capital Gains Exemption (LCGE)

Where capital gains can be shifted to other family members, there is a potential
for multiplying access to the lifetime capital gains exemption (LCGE). The LCGE
is available only to individuals, and each individual has a maximum lifetime
exemption subject to future indexing for inflation. For a more detailed discus-
sion of the exemption, see 3.3, and for details on multiplying the use of the
exemption among family members, see Chapter 10. This is a form of income
splitting that does not rely on the difference in marginal tax rates. The exemp-
tion is available to shelter gains on a qualifying small business corporation and
certain interests in family farm and fishing properties.

9.7 EXAMINING BLAIR’S INHERITANCE

In the introduction to this chapter, we looked at Blair and his inheritance. It is

repeated here.

17 Assuming that there were services provided and the expense was not unreasonable.

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EXAMINING BLAIR’S INHERITANCE 9.7

Example: Application of Attribution Rules: Blair’s Inheritance

Blair inherited $750,000 from his father. Blair’s income from his position as a senior executive is $270,000 per annum, and
with investment income he is already in the top marginal tax bracket. Any investment income from his inheritance will be
taxed at the top marginal rates. Blair gives his wife, Angie, $200,000 to invest on her own and sets up a discretionary trust
for his three children, ages 10, 12, and 23, with himself and Angie as trustees. He settles the trust with $300,000 of his
inheritance and lends the remaining $250,000 without interest to his mother so she can live on the investment income.

Here is a summary of the attribution rules that apply to Blair’s situation.

• The gift to Angie, Blair’s wife, will attract attribution of income

and loss under subs. 74.1(1) and capital gains or loss under
subs. 74.2(1).
• The gift to the trust for his children will cause the income and loss
and any capital gain or capital loss to fully attribute to Blair under
subs. 75(2) because he and Angie are the trustees of the trust, and
he is in a position as co-trustee to choose beneficiaries and must
consent to the sale of property.
• Even if subs. 75(2) did not apply — for example, if Blair were
not a trustee of the discretionary trust — the income or loss from
trust property (although not capital gain or loss) paid or payable
to his 10- and 12-year-old children would attribute to him under
subs. 74.1(2).
• The interest-free loan to his mother may attract attribution under
subs. 56(4.1) if one of the main reasons for the loan was to reduce
tax.

If Blair had sought tax advice, he may have taken the steps noted below:

• Made a prescribed rate loan to Angie and paid her tax liability on
the net income she reported from the income. Blair would have
to report the interest paid by Angie in his return, but Angie could
deduct it from the amount included in her income. Over time,
the pre-tax net income can be reinvested by Angie, increasing the
amount of income not subject to attribution. Angie needs to pay
interest by January 30 each year.
• Blair can set up a discretionary family trust with three trustees,
of which he is one, where a majority of trustees may make any

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9.8 Chapter 9 – Attribution Rules and Income Splitting

decision and with no requirement that he be a member of the

majority, and providing that no decisions regarding discretionary
distributions or disposition of property may be made unless there
are at least three trustees.
• The trust can allocate capital gains to the 10- and 12-year-olds and
other income to the 23-year-old. And Blair could make a prescribed
loan to the trust to allow other income to be taxed to the 10- and
12-year-olds.
• Blair can gift the funds to his mother, and she can leave a bequest
to Blair in her Will to recognize his financial assistance. Alterna-
tively, Blair can set up a trust for his mother, with similar trustee
provisions as for the discretionary family trust described above,
with a gift over to his children or wife on her death. Blair cannot
be a contingent beneficiary, though, or subs. 75(2) would apply.

9.8 KEY STUDY POINTS

• The attribution rules shift the tax burden back to a transferor of

property so that the income otherwise taxable in the recipient’s
hands is taxed back or “attributed” back to the original owner of
the property.
• The attribution rules generally apply to transfers to a spouse, child
under 18, or to a trust where the transferor retains some rights to
the property. The rules are comprehensive and include direct and
indirect transfers, including those made to a trust for the benefit of
a spouse or child under age 18. Additional rules apply to low-rate
loans to a non-arm’s length person where the purpose is to reduce
tax, transfers to corporations where the spouse or child under 18 is
a direct or indirect beneficiary, and a special tax on “split income”
with respect to dividends from private corporations.
• The “settlor/contributor” attribution rule in subs. 75(2) can apply in
any of three separate situations, not just to a reversionary trust. If
the capital can ever revert to the settlor or if the settlor can deter-
mine who is to receive capital or has control over the disposition
of property held by the trust, the rule will apply. The relationship
of the settlor to the beneficiaries is of no significance, and no pay-
ments need to be made to beneficiaries of the trust. In addition, if

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KEY STUDY POINTS 9.8

the rule ever applied to the trust, it is tainted as long as the settlor
is alive or a resident of Canada. Lastly, no rollover or rollout of
property distributed from the trust to a beneficiary is available.
• The attribution rules only apply as long as the transferor is alive or
is a resident of Canada.
• There is no attribution of capital gains for children under age 18.
• There are exceptions to the attribution rules. Transfers for FMV and
prescribed rate loans are two examples. Tax planning to income
split by stick handling around and through the attribution rules
requires meticulous attention to detail and a solid understanding of
the applicable provisions of the Act.
• Trusts can be structured to avoid the corporate attribution rule and
the application of the settlor/contributor attribution rule in subs.
75(2).
• Income splitting generally requires sufficient capital to generate
enough income to make the exercise worthwhile in terms of cost
of professional advice, set-up, additional compliance costs (i.e., tax
return filing, reporting to tax CRA), and complexity. In addition, the
individual must want to benefit other family members with pre-tax
or tax-reduced dollars. If the individual does not want to “share the
wealth” to save tax, income splitting, at least during lifetime, is not
appropriate.

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 CHAPTER 10
BASIC TAX PLANNING FOR
TRUSTS AND ESTATES

LEARNING OBJECTIVES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–5

10.1 INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–5

10.1.1 Identifying Opportunities and Problems in

Tax Planning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–6
10.1.2 Tax Planning Strategies: A Summary . . . . . . . . . . . . . . . . . . . 10–8
10.1.3 Tax Deferral: Taking Advantage of Rollovers to
Defer Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–9
10.1.4 Tax Reduction: Taking Advantage of the Exceptions to
the Attribution Rules to Income Split . . . . . . . . . . . . . . . . . . . 10–9
10.1.5 Tax Elimination: Optimizing the Benefit of
Exemptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–10
10.2 USING TRUSTS FOR INCOME SPLITTING . . . . . . . . . . . . . . . . . . . . . 10–10
10.2.1 Benefits of Using Trusts for Income Splitting . . . . . . . . . . . 10–10
10.2.2 Using Fixed Interest Age 40 Trusts to Defer Payment
of Income Taxed in the Hands of a Beneficiary Under
Age 21 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–11
10.3 PLANNING OPTIONS FOR FUNDING EDUCATIONAL
EXPENSES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–14

10.3.1 Separate Accounts and Informal Trusts . . . . . . . . . . . . . . . . 10–14

10.3.2 Using an RESP for Educational Expenses for Children
and Grandchildren . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–14
10.3.3 Trust for Education for Children or Grandchildren . . . . . . 10–15
10.4 USING THE SPOUSAL ROLLOVER AND SPOUSAL TRUSTS . . . 10–17

10.4.1 Requirements for the Spousal Rollover to a QST:

Practice Tips and Traps and Drafting Details . . . . . . . . . . . 10–18
10.4.1.1 Spouse Must Be Entitled to Receive All the
Income: Limits Offside and Onside . . . . . . . . . . 10–18

10–1
 10.4.1.2 Remarriage Clause . . . . . . . . . . . . . . . . . . . . . . . . . 10–19
10.4.1.3 Even-Handed Rule . . . . . . . . . . . . . . . . . . . . . . . . . . 10–19
10.4.1.4 Testamentary QST Must Be in the Will . . . . . . . 10–19
10.4.1.5 Right to Lend at Less than FMV Rates Can
Taint QST . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–20
10.4.2 Is the Rollover Needed or Wanted? Using Two Trusts:
A QST and a Non-QST . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–20
10.4.3 Including a Right to Encroach on Capital . . . . . . . . . . . . . . 10–21
10.4.4 Drafting a Spouse Trust to Defer Tax on Particular
Assets Such as a Family Business . . . . . . . . . . . . . . . . . . . . . . 10–21
10.4.5 Other Tips for Drafting a Spouse Trust . . . . . . . . . . . . . . . . . 10–22
10.4.6 The Missing Rollover for Spousal Trusts:
Registered Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–23
10.5 USING GRES AND OTHER TESTAMENTARY TRUSTS TO INCOME
SPLIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–23

10.5.1 Income Splitting with GREs . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–23

10.5.2 Testamentary Family Trusts: Tax Savings for Children
and Their Families . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–25
10.6 TAX PLANNING FOR DISABLED BENEFICIARIES . . . . . . . . . . . . . . 10–26

10.7 ESTATE FREEZING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–28

10.7.1 Introduction to Estate Freezing . . . . . . . . . . . . . . . . . . . . . . . 10–28

10.7.2 Gifting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–29
10.7.3 Conveying the Remainder Interest in Real Property . . . . 10–29
10.7.4 Using the Corporate Structure for an Estate Freeze . . . . 10–30
10.7.4.1 Fractional Ownership and Control of
Distributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–30
10.7.4.2 Custom Design the Attributes of Ownership . 10–30
10.7.5 The Classic Estate Freeze . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–31
10.7.6 Rollover for Freeze . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–33
10.7.7 Share Attributes and the Corporate Freeze . . . . . . . . . . . . 10–33
10.7.7.1 Freeze Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–34

10–2
 10.7.7.2 Voting Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–35
10.7.7.3 Growth Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–36
10.7.8 Freezing and the Capital Gains Exemption . . . . . . . . . . . . 10–36
10.7.8.1 Crystallization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–36
10.7.8.2 Purification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–36
10.7.8.3 Multiplying Access to the Capital Gains
Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–37
10.7.9 Cautions Regarding Paid-Up Capital and Non-Share
Consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–37
10.7.10 Funding a Trust and Avoiding the Attribution Rules
with a Loan to Subscribe for Treasury Shares . . . . . . . . . . 10–38
10.7.11 Avoiding the Corporate Attribution Rule . . . . . . . . . . . . . . 10–38
10.7.12 Using a Trust to Hold the Growth Shares in an Estate
Freeze . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–39
10.7.13 Use of a Trust in an Estate Freeze and the Settlor
Attribution Rule in Subs. 75(2) . . . . . . . . . . . . . . . . . . . . . . . . 10–40
10.7.14 Freeze with a Bail Out, or Gel . . . . . . . . . . . . . . . . . . . . . . . . . . 10–40
10.7.15 Other Types of Freeze Transactions . . . . . . . . . . . . . . . . . . . . 10–41
10.7.15.1 Partial Freeze . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–41
10.7.15.2 Melt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–41
10.7.15.3 Thaw . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–41
10.7.15.4 Refreeze . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–42
10.7.15.5 Refreeze at Lower Value . . . . . . . . . . . . . . . . . . . . 10–42
10.7.15.6 Reverse Freeze . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–42
10.7.16 To Freeze or Not to Freeze . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–42
10.7.17 Example of Tax and Estate Planning for a CCPC
(Canadian-Controlled Private Corporation) . . . . . . . . . . . . 10–43
10.8 KEY STUDY POINTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10–47

10–3
 Chapter 10
Basic Tax Planning for
Trusts and Estates

Learning Objectives
Knowledge Objectives:
• Understand basic concepts of tax planning through trusts and estates.

Skills Objectives:
• Recognize basic trust and estate tax planning opportunities.
• Identify key tax planning strategies.

10.1 INTRODUCTION

This chapter will serve as an introduction to tax-motivated estate and trust plan-
ning. When engaging in trust and estate planning, it is imperative to keep the
objectives in sight, and be aware that while the client may not always distin-
guish between tax-motivated planning and planning motivated by other consid-
erations, the advisor must do so. Chapter 9 discusses tax planning to avoid the
attribution rules, and those planning techniques are not repeated here. Conse-
quently, this chapter has a greater focus on the tax aspects of estate planning.

Tax and estate planning is not a topic that can be adequately addressed in one
chapter. This chapter identifies and discusses some of the more common tax
and estate planning strategies in varying degrees of detail. The intention is to
provide an introduction to some of the opportunities and to some of the details
of particular strategies such as estate freezing and spousal trusts. The subject

10–5
10.1.1 Chapter 10 – Basic Tax Planning for Trusts and Estates

matter is by necessity selective, and this chapter should not be relied upon as
providing complete information about all the opportunities or strategies avail-
able. Nor does it include a discussion of all the possible rules and exceptions
that may apply to the particular strategies discussed.1

NOTE: See STEP Update on Tax Changes in the student resources section of the STEP website to review the status of tax
proposals first introduced in 2017. These proposals would make sweeping changes. These include expansion of the tax
on split income (TOSI) to adult family members where there is income or capital gains derived from private corporations,
and restrictions on access to the lifetime capital gains exemption (LCGE). These changes will impact planning for business
succession, and many of the estate and tax planning strategies to avoid, reduce, or defer tax discussed in this chapter may
be affected or eliminated.

10.1.1 Identifying Opportunities and Problems in Tax Planning

Where planning is not tax-motivated, a client’s non-tax objectives should always

be considered in the light of potential tax consequences, and the plan should
be structured in such a way as to attract the minimum amount of tax. Neverthe-
less, the tax tail should not wag the dog, and the advisor must be able to assist
the client in navigating the various objectives and weighing the tax and non-tax
benefits of various strategies so that the ultimate solution fits the client’s overall
objectives.

Tax-motivated planning requires meticulous preparation and execution. The

courts have been consistently unsympathetic where the taxpayer’s intentions
were not carried out with the precision necessary to adhere to the tax and legal
requirements needed to achieve the intended result. The generalist should be
aware of tax planning opportunities and be able to identify situations that may
benefit from specialized tax planning. In some cases, the generalist may be able
to spot tax problems of which the client is blissfully unaware. A referral to a pro-
fessional with tax expertise is often advisable, and the generalist should avoid
the temptation to offer “armchair” tax advice where the client is reluctant to seek
the expertise recommended.

Most tax planning requires a degree of wealth to justify the cost. In general
terms, the wealthier the client, the more tax planning opportunities may be
available. Income splitting, for example, requires significant capital to generate

1 For example, no discussion is included about the hazards of s. 84.1 or the general anti-avoidance rule
(GAAR).

10–6
INTRODUCTION 10.1.1

sufficient income to make the savings on lower tax rates justify the cost and
complexity of the planning and the income-splitting structure.

In determining a client’s wealth and identifying income-splitting opportunities,

the advisor should consider the client’s potential inheritance from parents and
other family members. If the client is of modest means, but stands to inherit sig-
nificant wealth, the estate plan may include “floating” trusts (trusts that can be
funded with varying amounts at the discretion of the executor) or other tax plan-
ning devices in anticipation of the inheritance to provide flexibility for either a
modest or more sizeable estate. In addition, there may be planning opportuni-
ties available with respect to an inheritance yet to be received by the client from
a wealthy relative. Parents may create income-splitting and income-sprinkling
family trusts for a child’s inheritance, for example, and such planning is free of
the attribution rules.

Life insurance may also provide the funds to income split for a client of even
modest means. For example, if a married couple takes out life insurance to pro-
vide financial security for a family with young children, income splitting with a
discretionary testamentary trust funded by life insurance may be of much greater
assistance to a client of modest means where the annual tax savings of income
splitting with children may make a difference in the lifestyle of the surviving
spouse and the children. Income can be “sprinkled” from the trust to the spouse,
and for the benefit of children in a manner that takes optimal advantage of the
graduated rates. Note that any income not paid or payable by the testamentary
trust will be taxed in the trust at the highest graduated rates.

Where the client is already providing financial assistance to other family mem-
bers, tax planning may reduce the cost of such assistance. Most advisors readily
recognize opportunities for income splitting among children and grandchildren,
but parents may also be the beneficiaries of financial assistance. A parental trust
can fund the parents’ living and health-care expenses without attribution if struc-
tured properly, and the income on the capital will be taxed at lower rates in the
hands of the parent as beneficiary.

Where potential tax problems are identified, the client should also be referred
to a professional with tax expertise. The most dangerous client may be the one
who “knows a little about tax planning” from his or her own research or experi-
ence with other family situations, such as being the executor of his or her par-
ents’ estate. Self-help in matters involving tax planning is an invitation for failure.

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10.1.2 Chapter 10 – Basic Tax Planning for Trusts and Estates

There are so many rules and exceptions and exceptions within exceptions in tax
planning that no universal planning or blanket strategies can be recommended
for any particular situation without a review by a tax specialist.

10.1.2 Tax Planning Strategies: A Summary

Broadly speaking, tax planning seeks to reduce, defer, or eliminate tax liability.

• Deferral of Tax: Tax advisors are fond of the saying “a tax dollar
deferred is a tax dollar saved.” Only in rare cases does a tax plan-
ning strategy ever involve prepayment of tax today to save tax at
a later date. An example might be early withdrawals from a regis-
tered plan, either to reduce the high rate of tax on the lump sum
inclusion on death or in low-income years to “use up” the lower
graduated rates. A rollover is an example of a deferral of tax — the
transferor avoids the tax, but the recipient will pay the tax even-
tually. Rollovers are discussed in detail throughout this text and
include transfers of capital property to a spouse, spousal trust, cer-
tain trusts, corporations, or to a child or grandchild in the case of
farm or fishing property.
• Reduction of Tax: Planning that takes advantage of the lower mar-
ginal rates of tax for individuals, GREs, or QDTs are examples of a
reduction of tax. Since income is taxed at lower rates than it would
be in the hands of another taxpayer who is subject to the high-
est graduated rate, the overall tax “bill” for the income is reduced.
Income-splitting or income-sprinkling strategies all result in a
reduction of tax. Where the dividend advantage reduces the tax
on the dividends to nil because of the gross-up and dividend tax
credit mechanism, income splitting may reduce the tax to nil, but in
theory, income is still taxable.
• Elimination of Tax: The principal residence exemption (PRE) and
the lifetime capital gains exemption (LCGE) are examples of strate-
gies that provide a complete elimination of tax on the particular
receipt or portion of capital gain that is sheltered.

A more detailed discussion of particular tax planning strategies includes those

discussed below.

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INTRODUCTION 10.1.4

10.1.3 Tax Deferral: Taking Advantage of Rollovers to Defer Tax

There are many opportunities to defer tax with the use of rollovers. A tax-
planned estate should anticipate the use of these rollovers and be structured to
optimize their availability and use where appropriate. These include:

• spousal rollover on transfer of capital and other property to a

spouse or qualifying spousal trust (QST),
• spousal rollover for registered retirement savings plans (RRSPs)
and registered retirement income funds (RRIFs),
• rollover of RRSPs and RRIFs for financially dependent child or
grandchild under 18, or over 18 if also mentally or physically infirm,
• rollover of RRSPs and RRIFs to a trust for a mentally infirm spouse
or mentally infirm child or grandchild,
• rollover of property to certain trusts, including alter ego trusts
(AETs) and joint partner trusts ( JPTs),
• rollover of property to a beneficiary on distribution from a trust,
• intergenerational rollover for transfer of interests in farm or fishing
property, and
• transfer of property to a corporation in exchange for shares.

10.1.4 Tax Reduction: Taking Advantage of the Exceptions to the Attribution

Rules to Income Split

Income splitting is a common strategy in tax planning, and trusts are commonly
used to optimize the income-splitting opportunities among multiple family mem-
bers and to control the use and ultimate distribution of the capital that funds the
income. Care must be taken, however, to minimize the application of the attri-
bution rules. See Chapter 9 for details of the attribution rules and exceptions.
In the estate planning context, the attribution rules do not apply because the
“transferor” is deceased, and many tax planning strategies for income splitting
rely on the use of testamentary trusts. The following is a summary of some of
the income-splitting opportunities:

• loans at the prescribed rates,

• transfers for fair market value (FMV),

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10.1.5 Chapter 10 – Basic Tax Planning for Trusts and Estates

• capital gains splitting with children under age 18,

• income splitting with adult family members other than a spouse,
and
• income sprinkling among family members with discretionary testa-
mentary trusts.

10.1.5 Tax Elimination: Optimizing the Benefit of Exemptions

Tax planning includes devising strategies to maximize the use of tax exemp-
tions. These include:

• the principal residence exemption (PRE),

• the capital gains exemption on qualifying small business corpora-
tion shares (QSBCS), and
• the capital gains exemption on interests in farm or fishing
properties.

10.2 USING TRUSTS FOR INCOME SPLITTING

10.2.1 Benefits of Using Trusts for Income Splitting

An inter vivos or testamentary discretionary trust is commonly used to income

split with children and other family members of the transferor. The benefits of
these trusts include those listed below:

• The trust provides a legal vehicle to hold property for individuals

who are minors.
• The trust enables the property to be managed and controlled by
the trustees, not the beneficiaries.
• Distribution and allocation of income, capital gains, and other capi-
tal are at the discretion of the trustee, providing flexibility with
respect to wealth transfer and deferral until the beneficiaries are
mature.
• Discretion to allocate income and capital gains can be designed to
achieve the optimal tax result among a number of beneficiaries.
• Capital gains can be allocated to children under age 18 with no
attribution (inter vivos trusts).

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USING TRUSTS FOR INCOME SPLITTING 10.2.2

• Income other than capital gains can be allocated to beneficiaries

who have attained age 18 without attribution (inter vivos trusts).
• Actual distribution of allocated income, including capital gains, can
be deferred until the beneficiary attains age 40.
• The trust may facilitate multiple access to the lifetime capital gains
exemption (LCGE).2
• Testamentary trusts can be used to sprinkle income to low tax-rate
beneficiaries without the application of the attribution rules.

10.2.2 Using Fixed Interest Age 40 Trusts to Defer Payment of Income Taxed in
the Hands of a Beneficiary Under Age 21

The attribution rules do not apply to capital gains received or otherwise taxed in
the hands of a related person (or niece or nephew) under 18 years of age. Con-
sequently, creating a trust to income split capital gains with minor children is a
popular tax planning strategy. For more details about trusts for minor beneficia-
ries, see the discussion at 4.7.8.

If income is paid or payable to a beneficiary, it may be deducted by the trust and

included in the income of the beneficiary. As attractive as the income-splitting
benefits are, it is not always desirable to make payments to or on behalf of
minor beneficiaries, or even young adults, particularly if the amounts are signifi-
cant (such as may be the case where taxable capital gains are allocated to utilize
the LCGE).

The benefit of income splitting without distributions to beneficiaries under age

21 can be achieved if the requirements of subs. 104(18) are satisfied (see 4.7.9).
Amounts of income may be accumulated in the trust but deemed payable and
deductible from trust income under subs. 104(18) in respect of beneficiaries
under age 21. Except for the preferred beneficiary election, which is available
in respect of disabled beneficiaries, this provision is the only method by which
income and capital gains taxed in the hands of a beneficiary may be accumu-
lated in a trust for a beneficiary without the amount being paid or made imme-
diately payable to the beneficiary. The main benefit for an inter vivos trust is for
allocation of capital gains, since the attribution rules apply to other sources of
income where the beneficiary is a related child under the age of 18.

2 Note that the 2017 proposed changes may limit access to the LCGE through a trust, although the
Department of Finance appears to have backpedalled on this particular proposal.

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10.2.2 Chapter 10 – Basic Tax Planning for Trusts and Estates

In summary, the requirements for accumulating income to be allocated by the

trust and taxed in the hands of any beneficiary who has not attained age 21 in
the year are:

• the income must not be payable to the beneficiary in the year

(since there is no need for the rule in this case),
• the beneficiary’s right to the income must vest by the end of the
year,
• the vesting of the right to income cannot be as a result of any dis-
cretionary power, and
• the only condition respecting payment of income is that the benefi-
ciary survives to an age not exceeding age 40.

The question of whether or not the interest in the income vests is not the same
as the requirement for a QST where the interest must “vest indefeasibly,” since
the vesting can be subject to divestiture if the beneficiary does not attain an age
not exceeding 40. The requirement that the individual beneficiary survive to an
age not exceeding age 40 is a permitted condition precedent, and it is the only
condition that can divest the beneficiary of the right to payment.

In Technical Interpretation 9807495, dated March 12, 1999, and Technical Inter-
pretation 9901375, dated January 12, 1999, Canada Revenue Agency (CRA) made
identical statements that in order for the interest of a beneficiary to be “vested”
within the meaning of subs. 104(18):

. . . the individual must have an immediate fixed right of present or

future possession. It would mean that all individuals who are to have
an interest in the trust are in existence and ascertained, the size of their
interest is ascertained and any conditions precedent are satisfied.

These two documents make it clear that in the year the income is earned, the
interest of each specific beneficiary must be identified, and that subs. 104(18)
will not apply if the income is to be distributed among beneficiaries who are
identified at a later time. There can be discretion as to the timing of the payment
to a beneficiary, as long as this discretion does not affect the share of a ben-
eficiary. The following examples of rights to income of the trust will be within
subs. 104(18):

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USING TRUSTS FOR INCOME SPLITTING 10.2.2

• to my grandchildren who have not attained age 21 years in the

year in equal shares and
• to all my children alive in the year in equal shares.

The following would not qualify:

• to my nieces and nephews who are alive when the youngest of

them attains age 24.

Drafting trust terms that comply with subs. 104(18) can be difficult, as it is easy
to inadvertently create interests that are not ascertainable as to the beneficiary
or the size of the interest. The following clause permits discretion with respect
to the allocation of a fixed share among beneficiaries who have attained age 21.
Care must be taken with this type of distribution to ensure that the portion to be
allocated to beneficiaries under the age of 21 is fixed, and it follows that the por-
tion available for other beneficiaries is fixed also, but the division of that latter
portion may be discretionary:

The income shall be divided into the number of equal shares each year
that is equal to the number of the beneficiaries who are then alive. One
such equal part shall be set aside for the benefit of each beneficiary
who has not attained age 21 in the year. The remaining shares may be
divided among any one or more of the beneficiaries who have attained
the age of at least 21 in the year, in such portions as my trustees in their
absolute discretion decide, and not necessarily in equal shares, and may
be to one or more such beneficiaries to the exclusion of others.

Generally with these trusts, the payment of the income and capital gains to
any individual beneficiary is deferred until a year in which the beneficiary has
attained at least age 21 and no later than the year in which the beneficiary
attains age 40. In addition, the distribution of income can be completely discre-
tionary in any year in which all beneficiaries of the trust have attained age 21.
Where not all beneficiaries have attained age 18, there can be discretion with
respect to amounts of income paid or payable to beneficiaries who have attained
age 21, but the division of income between the discretionary portion for such
beneficiaries and the portion for beneficiaries who have not attained age 21 in
the year must be fixed.

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10.3 Chapter 10 – Basic Tax Planning for Trusts and Estates

10.3 PLANNING OPTIONS FOR FUNDING EDUCATIONAL EXPENSES

Parents or grandparents often want to set aside a fund to finance their chil-
dren’s or grandchildren’s post-secondary education. This could be done through
a segregated savings account, an informal trust account with a financial institu-
tion (ITF, or in trust for account), registered education savings plan (RESP), or a
formal trust. Each strategy has different legal and tax consequences, and varies
with respect to cost and complexity. The appropriate vehicle will depend on the
legal and tax implications, the amount of funds available, the parents’ or grand-
parents’ priorities, and their tolerance for complexity.

10.3.1 Separate Accounts and Informal Trusts

Separate savings or investment accounts provide no tax benefits and may not
satisfy the grandparents’ objective of irrevocably transferring the funds for the
benefit of the grandchildren. The funds and investments will be included in the
grandparents’ estate and subject to provincial probate fees and capital gains tax
on death. However, this may be an appropriate strategy for very small amounts,
and for clients who are not sophisticated or prefer simplicity over all else. At
the very least, the disposition of the account, or the appointment of a successor
trustee or account holder, should be included in the Will.

ITFs have many problems relating to the failure to obtain tax and legal advice.
These include attribution of all income and capital gains because of the appli-
cation of subs. 75(2), where the parent or grandparent funds and controls the
account and the vesting of the child’s right to distribution upon attaining the age
of majority. Planning is often ignored at the outset because the initial amounts
are small, but problems become more serious if continued contributions and
growth in the value of the investments cause the fund to grow substantially. A
formal trust prepared in accordance with tax and legal advice is preferable.

10.3.2 Using an RESP for Educational Expenses for Children and Grandchildren

An RESP operates as a tax-deferred vehicle to provide for the education of young

family members. Up to $50,000 may be contributed for each eligible child, and
the earnings will accumulate tax-free in the plan without any attribution to the
subscriber or contributor to the plan.

An RESP may be appropriate if the intended contributions are within the limits
for these plans and no other person has set up an RESP for the child. An RESP

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PLANNING OPTIONS FOR FUNDING EDUCATIONAL EXPENSES 10.3.3

provides no deduction for contributions, but the earnings in the plan accumulate
tax-free until paid out to the child for educational expenses as educational assis-
tance payments (EAPs) — when the student is enrolled full-time in a qualifying
educational program at a post-secondary educational institution or part-time in
a specified educational program. In addition, a government grant (the Canadian
Education Savings Grant, or CESG) is available. The grant is 20% of annual con-
tributions made to all eligible RESPs for a qualifying beneficiary, with an annual
maximum of $500 in respect of each beneficiary ($1,000 if there is unused grant
room from a previous year), and a lifetime limit of $7,200 per beneficiary. While
there is no annual limit to the amount of contribution, an annual contribution
of $2,500 will maximize the amount of the CESG. The CESG is increased for
low-income families to 30% or 40% of the first $500 of contributions, depending
upon income level.

Children of low-income families may also be entitled to receive the Canada

Learning Bond (CLB). The government will contribute $500 to the child’s RESP
in the first year of eligibility (plus $25 in the year in which the plan is opened in
order to cover any administration fees) and $100 per year thereafter to a maxi-
mum of $2,000. There are no matching requirements; that is, no contributions
need to be made to the RESP to receive the CLB.

Contributions may be withdrawn by the subscriber at any time, and are not the
property of the beneficiary of the plan (unless and until the subscriber chooses
to give the contributions to the beneficiary). The term “beneficiary” is simply
used to determine who can receive EAPs and for calculating entitlements to
CESGs and CLBs.

10.3.3 Trust for Education for Children or Grandchildren

A family trust may be set up to fund educational expenses. Typically, such trusts
include the following terms:

• Settlor/Contributor. The settlor and contributor is typically a par-

ent or grandparent. The trust may be created by the donation of a
gold coin or some other property intended to preserve the subject
of the trust, plus additional contributions to fund the capital of the
trust.
• Trustees. The trustees may be the parent or parents of the children
where the grandparent is the settlor/contributor. Where the settlor/

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10.3.3 Chapter 10 – Basic Tax Planning for Trusts and Estates

contributor is a trustee, care must be taken to avoid the application

of subs. 75(2).3
• Beneficiaries. Beneficiaries are usually defined by class, such as
“my grandchildren” or “the issue of my children A, B, and C.” In
some cases, separate trusts may be set up for the issue of each
child, but this potentially limits flexibility with respect to distribu-
tions and may add to the cost of implementation and maintaining
the trust.
• Rights to Income and Capital. Distributions of income and capital
are at the discretion of the trustees as to the portion to be distrib-
uted. The amount of income to be distributed in any year is usually
stated as “the whole or any part,” and the discretion to encroach on
capital is usually included. The amount to be distributed to each
beneficiary is also discretionary, providing flexibility to make distri-
butions to any one or more to the exclusion of others.
• Duration. Duration usually allows for the wind-up of the trust
within 21 years to avoid the 21-year rule, and may be at a time
when the youngest or oldest member of a class attains a certain
age. For example, “upon my youngest grandchild then alive attain-
ing age 24.” Perpetuity rules for the relevant province must be
considered.
• Distribution. The distribution among beneficiaries upon termina-
tion of the trust may be at the discretion of the trustees, or by some
formula, such as “to my grandchildren then alive in equal shares
per capita” or “to my issue in equal shares per stirpes.” If there
is discretion, there should be a default provision in the event the
trustees fail to exercise the discretion.

The benefit of having multiple beneficiaries is flexibility. Funds can be dispersed

as needed to beneficiaries who are in private school or pursuing post-secondary
education. As individual beneficiaries attain age 18, dividends and other invest-
ment income can be allocated to them without attribution, reserving capital gains
allocations for younger beneficiaries. There is no maximum amount that can be
contributed to the trust, and the distributions and allocations among beneficia-
ries can be completely discretionary. This flexibility allows for income-splitting
opportunities.

3 See 9.3.

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USING THE SPOUSAL ROLLOVER AND SPOUSAL TRUSTS 10.4

However, one of the drawbacks of the trust may be an inability by the parents
to take the money back at a later date. One solution to this problem may be to
simply lend money to the trust so that the beneficiaries only become entitled
to the income and growth on those funds. However, the loan would have to be
structured to avoid the attribution rules, and these requirements may reduce the
amount of the tax benefit from income splitting.

10.4 USING THE SPOUSAL ROLLOVER AND SPOUSAL TRUSTS

The spousal rollover is available on transfers to inter vivos and testamentary

spousal trusts. Even if a testamentary trust is tainted and the rollover is not avail-
able, the trust may still qualify as a testamentary trust for tax purposes. Most of
the tax planning with spousal trusts involves testamentary spousal trusts as part
of an estate plan.

With the elimination of the graduated rates for testamentary trusts, testamentary
spousal trusts can no longer reduce tax by income splitting between the spouse
and the spousal trust. However, there are still many reasons an individual may
want to provide a trust for a surviving spouse. Non-tax objectives may include
providing financial security for a surviving partner who may not be able or will-
ing to manage the inheritance on his or her own. This is becoming more com-
mon as men and women live longer and cognitive abilities or health decline.
Another important use of a spousal trust is to preserve capital for other benefi-
ciaries, particularly in a second marriage situation where there are children or
other family members from a previous relationship.

From a tax perspective, the purpose and advantage of a spousal trust is the roll-
over. Tax on capital gains on property transferred to a spousal trust under the
Will of the testator will be deferred until the death of the surviving spouse or
when the property is actually sold to a third party. This is of particular impor-
tance where there is a family business and family members are inheriting the
business. In such a case, there may be little or no liquidity on death of the owner
to pay the tax on the shares held in the corporation carrying on the business.
So a deferral of the tax liability until the death of the surviving spouse provides
more time to plan for payment. Where an estate freeze has already been done,
the amount of gain has been fixed, and the amount of taxes can be quantified
and payment can be funded with joint last-to-die life insurance on the lives of
both spouses at considerably less cost than on the life of one person alone. The
spouse trust may also serve to isolate the spouse from control or management of

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10.4.1 Chapter 10 – Basic Tax Planning for Trusts and Estates

the business; this may be an objective if the spouse has had no involvement in
the business and the testator wants the children who will be the successor own-
ers to run the business without interference from the surviving spouse.

10.4.1 Requirements for the Spousal Rollover to a QST: Practice Tips and Traps
and Drafting Details

If clients want their assets to roll over to the surviving spouse on a tax-deferred
basis, they must adhere to the requirements for a QST. In practice, the specific
requirements may be overlooked. Here is a list of some tips to ensure the roll-
over is available, along with some additional tips and traps for drafting the spou-
sal trust:

10.4.1.1 Spouse Must Be Entitled to Receive All the Income: Limits Offside
and Onside
Certain limits to the income entitlement of the spouse will put the trust
offside. For example, a clause that provides the spouse receive “as much
income as is required to maintain my spouse in the manner to which
my spouse was accustomed during our marriage together” is not permit-
ted, since the spouse must be entitled to all the income. However, the
Act does not require capital gains or other receipts that are considered
capital to be payable to the spouse.

The requirement to pay all income to the spouse can be limited by

including a clause in the trust that specifically carves out the require-
ment to pay capital gains, capital dividends, or any capital receipt. Tech-
nically, a specific clause is not necessary, since at common law the word
“income” does not include such capital receipts, and it is the common-
law interpretation of the word “income” that would prevail in a trust
document. However, it is a good practice to include such a clause in the
trust first to avoid any ambiguity and second to draw the trustees’ atten-
tion to this point. That way they cannot mistakenly believe there is an
obligation to distribute any amounts that would be taxable as income
even if technically the amounts are capital. An additional requirement
that such capital receipts be accumulated will not taint the trust.

Sometimes a specific clause may include capital gains and other capi-
tal receipts that are income for tax purposes in the requirement to pay
income. Such a clause should be used only where this is specifically

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USING THE SPOUSAL ROLLOVER AND SPOUSAL TRUSTS 10.4.1.4

what is intended. Usually it is better to provide maximum flexibility and

permit discretion to encroach on capital to distribute such amounts.

10.4.1.2 Remarriage Clause

A prohibition on distributions of income to the spouse in the event of
remarriage or cohabitation in a conjugal relationship would prevent the
spousal rollover on the transfer to the spouse or QST. However, it is per-
missible to prohibit distributions of capital, including capital gains, in
the event of remarriage, as long as no other person is entitled to capital
during the lifetime of the spouse.

10.4.1.3 Even-Handed Rule

Another clause that might be permitted in the event of remarriage of the
surviving spouse is a clause detailing the manner in which the trustees
maintain an even hand between the life tenant and the remainderman
(i.e., the residual or ultimate capital beneficiaries after the death of the
spouse). Often there is a specific clause with respect to the even-handed
rule in a spousal trust that permits the trustees to favour the spouse in
exercising their discretion, even to the detriment of the residual benefi-
ciaries. This clause could be designed so that it no longer applies in the
event of remarriage, and may even work in reverse, so that in the event
of remarriage the even-handed rule is not to be applied and the trustees
may favour the residual beneficiaries over the spouse.

Any reversal of the even-handed rule to prefer a beneficiary other than

the spouse must not impair the right of the spouse to receive all the
income of the trust, or permit any other person to receive, use, or enjoy
the trust capital during the spouse’s lifetime. However, the investment
policy of the trustees could favour long-term capital appreciation over
generating current income in the trust.4

10.4.1.4 Testamentary QST Must Be in the Will

A trust only need arise on death in order to be treated as a testamentary
trust. An insurance trust funded by the proceeds of life insurance on the
death of the insured will be considered testamentary, whether the terms

4 There is a risk that CRA might find this offensive, but as long as some income is provided to the
spouse this risk is minimized.

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10.4.1.5 Chapter 10 – Basic Tax Planning for Trusts and Estates

of the trust are contained in the Will or in a separate trust document.

However, if the terms of the trust are not in the Will, the trust will not
be a QST, as it will fail to satisfy the requirement in para. 70(6)(b) that
the trust be created by the taxpayer’s Will.

10.4.1.5 Right to Lend at Less than FMV Rates Can Taint QST
One of the requirements of the rollover to a trust is that no person
except the spouse (including common-law partner) may receive or oth-
erwise obtain the use of any of the trust’s income or capital during the
lifetime of the surviving spouse. CRA has for some years taken the posi-
tion that where the trustees have the discretion to make loans, this could
put the trust offside of the requirement that the capital be reserved for
the spouse. CRA has also taken the position that the ability or require-
ment to pay the premiums under a life insurance policy offends the roll-
over requirement. Consequently, it has become the practice to include
a limit on the trustees’ powers to the effect that notwithstanding any
other powers set out in the trust, the trustees may not exercise their
discretion or do any act that would cause the trust not to qualify for the
spousal rollover.

10.4.2 Is the Rollover Needed or Wanted? Using Two Trusts: A QST and a Non-QST

One disadvantage of the spousal rollover in the case of a QST is the deemed dis-
position on the death of the spouse under subs. 104(4). The deemed disposition
applies to all property in the QST whether or not there was an election out of
the rollover under subs. 73(1) for an inter vivos QST or subs. 70(6.2) for a testa-
mentary QST. This may not be advantageous for property on which there is no
unrealized gain when transferred, such as liquid assets or insurance proceeds,
especially where the life expectancy of the surviving spouse may fall short of
the first deemed disposition under the 21-year rule that applies if the rollover
does not.

In order to provide flexibility with respect to the obligatory deemed disposition

on death for a QST, it may be appropriate to create two spousal trusts: one that
qualifies for the rollover and one that does not. The executor can be given the
discretion with respect to the allocation of property between the trusts.5 The

5 CRA may not consider such discretion offensive; see IT-305R4 (Archived), Establishment of
Testamentary Conjugal Trusts, at para. 7.

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USING THE SPOUSAL ROLLOVER AND SPOUSAL TRUSTS 10.4.4

property to be allocated to the tainted trust could include cash and other liq-
uid assets, including life insurance proceeds, for which no rollover is required,
along with other property on which there may be a loss or minimal capital
gains. Where there are capital losses, additional property can be allocated to the
tainted spousal trust and the losses can be used to offset the capital gains.

There also may be non-tax reasons for including a tainted spousal trust. The
testator may wish to include children or other family members as beneficiaries
during the lifetime of the surviving spouse, or may wish to impose a remarriage
clause, for example. Including other family members as beneficiaries can also
create additional income-splitting opportunities.

10.4.3 Including a Right to Encroach on Capital

A right to encroach on capital for the surviving spouse is optional, and will not
affect the rollover as long as it can only be exercised for the benefit of the sur-
viving spouse. In general, it is recommended that maximum flexibility be built
into any tax planning, and including a power to encroach on capital is usually a
wise strategy to permit allocation of capital gains to the surviving spouse. This
may be particularly beneficial if the capital gains exemption may be available on
the sale of trust property, since a trust cannot claim the exemption. The entire
taxable capital gain can be allocated to the spouse for tax purposes, even if only
the taxable portion is made payable and distributed.

10.4.4 Drafting a Spouse Trust to Defer Tax on Particular Assets Such as a Family
Business

The spousal trust may be set up only to “park” assets until the death of the
spouse in order to defer tax on those assets for as long as possible. There may
be a pure deferral objective with little or no need to provide for the surviving
spouse from the capital of the trust. For example, consider a scenario where
a business owner intends to leave his operating company to his children but
wishes to defer the tax on the transfer as long as possible. It may not be appro-
priate for the spouse to become an owner of the business, for any number of rea-
sons. The business owner may not want the business to pass under the spouse’s
Will, as the spouse would then be able to control who ultimately inherits the
business and the owner wants to ensure that the children will inherit the busi-
ness. This may be particularly important in cases where the children are from a

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10.4.5 Chapter 10 – Basic Tax Planning for Trusts and Estates

previous marriage, there is concern that the spouse may remarry, or the spouse
has no business or financial acumen or no interest in the business.

Typically, the business owner will indicate the desire to leave the business out-
right to the children. However, the imposition of an intervening spousal trust can
provide a deferral in the payment of tax on the deemed disposition on death.
Where this is the sole purpose of the trust, there should be as many restrictions
on the right of the spouse to income and capital as may be permitted without
tainting the trust and disqualifying it for the rollover. The children can be the
sole trustees of the trust, and can use their power as trustees to elect themselves
as the directors of the corporation and manage the business. However, the chil-
dren cannot operate the corporation to the detriment of the spouse, and must
balance their fiduciary obligation as trustees with their duty to the corporation
as directors. If potential conflict erupts between the spouse and the children
(which may be quite possible in the case of a second marriage or pre-existing
conflict), the strategy of using the spousal trust purely for deferral of tax should
be carefully reviewed in light of the problems litigation or family conflict may
cause.

10.4.5 Other Tips for Drafting a Spouse Trust

The surviving spouse can be a trustee of the spousal trust. It is not usually
appropriate for the spouse to be the sole trustee, for non-tax purposes. But
even from a tax perspective, this is not recommended, especially if there is a
liberal right to encroach on capital or if the right to encroach on capital is abso-
lute — that is, even to the entirety of the trust. The problem is whether there is
a valid trust, especially if the spouse is entitled to encroach on capital, thereby
potentially defeating the interest of the other capital beneficiaries whose interest
arises only after the death of the spouse. Under trust law principles, a valid trust
may not be created if the beneficiary and the trustee is the same person and no
other person has an interest in the trust. Additional trustees should be included
so that CRA will not challenge the existence of the spousal trust and deny the
rollover or so that other parties will not attempt to “bust the trust.” For exam-
ple, the trustees could be the surviving spouse along with two children, with a
majority clause requiring the spouse to be a member of the majority. In addition,
there must be a trustee after the death of the surviving spouse to administer and
distribute any funds remaining in the trust.

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USING GRES AND OTHER TESTAMENTARY TRUSTS TO INCOME SPLIT 10.5.1

When a spousal trust is used, there is a risk that the surviving spouse may have
a right to make a claim against the estate under provincial law. Such a claim may
be for division of property under the provincial family law regime or for sup-
port under dependant relief legislation. It may be possible to reduce this risk by
entering into a marriage contract. A surviving spouse may wish to make such a
claim, for example, even if the entire estate is held in the spousal trust, preferring
an outright interest in the capital of the estate rather than a trust arrangement.

10.4.6 The Missing Rollover for Spousal Trusts: Registered Plans

Except where the spouse suffers from mental infirmity, it is not possible to use
a trust as a vehicle to hold the proceeds of registered plans and utilize the spou-
sal rollover of their proceeds. Where the registered plan is payable to a spousal
trust, the only option (in the absence of mental infirmity) is to use the power to
encroach on capital of the trust to contribute to a spousal plan. If this is done,
the spouse will own the plan and it will be beyond the control or ownership of
the spousal trust. This is a problem often incurred in trying to plan for couples
who have children from a previous relationship where there is a desire to use
the rollover but also a desire to lock in a gift over to the children of the first
marriage for any amounts remaining on the death of the surviving spouse. The
Department of Finance has been approached by the Canadian Bar Association to
consider amendments to the Act to permit such a rollover; however, it does not
appear that Finance is willing to make such a change.

10.5 USING GRES AND OTHER TESTAMENTARY TRUSTS TO INCOME SPLIT

10.5.1 Income Splitting with GREs

Graduated rate estates (GREs) are entitled to the graduated rates of tax. Thus,
it is possible to income split between a GRE and the beneficiaries of the estate.
This opportunity is limited by a number of factors.

The first is the 36-month time period. A GRE is like Cinderella. The 36-month
anniversary of the death of the testator is “midnight.” On the 36-month anni-
versary date, the GRE turns into an ordinary trust and loses all its special tax
attributes. A year-end is triggered, and the estate commences being taxed at the
top marginal rate of tax in the same manner as an inter vivos trust or other testa-
mentary trusts. So any opportunity to income split between the beneficiaries of
an estate and a GRE is limited to 36 months.

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10.5.1 Chapter 10 – Basic Tax Planning for Trusts and Estates

The second limitation is the concern that income earned by the estate after the
executor’s year may be considered payable to the beneficiaries of the estate. If
so, no income can be taxed in the estate at its graduated rates. It is generally
accepted in estate law that an estate is not required to pay beneficiaries any
amounts during the first year of administration, as the assets and liabilities are
still being uncovered and the financial status of the estate is unknown. After the
executor’s year, beneficiaries may be able to enforce payment of income earned
by the estate. Trust companies who act as corporate executor usually consider
that income is payable to a residual beneficiary after this one-year period. It is
a rule of thumb, as there is no actual rule in the Act or in any provincial statute
in Canada that makes this law. Since the introduction of GREs in 2016, lawyers
have started including clauses in Wills to permit the executor to delay distribu-
tions and payments of income to beneficiaries for up to 36 months following
death. Such clauses also permit payments made to beneficiaries to be allocated
as paid from “capital” rather than income at the discretion of the executor.6 This
is to make it clear that amounts of income in the form of capital gains are not
“payable” to beneficiaries unless the executors chose to make them payable. In
theory, this permits flexibility to have income taxed in the estate at the gradu-
ated rates. Whether CRA will challenge such planning is speculation.

A third limitation, similar to the second, is that only an estate is a GRE. A testa-
mentary trust created in the Will, even if set up within the 36-month period, is
not a GRE and is not entitled to the graduated rates. It may be difficult to delay
establishing a testamentary trust just to maintain GRE status.

A fourth limitation is that it is no longer possible to pay income to a beneficiary

and elect to have it taxed in the GRE to take advantage of the marginal rates
in the GRE. Prior to 2016, it was possible to shift the tax inclusion of amounts
paid or payable by a testamentary trust to a beneficiary back to the trust to
gain access to the trust’s graduated rates. However, the election under subss.
104(13.1) and 104(13.2) is now limited by subs. 104(13.3) to the situation where
losses are trapped in the trust or estate and after the election the trust will still
have no taxable income.

It may be possible to reduce this risk by entering into a marriage contract.

6 Payments from capital need not be from capital gains and thus are non-taxable to a beneficiary.

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USING GRES AND OTHER TESTAMENTARY TRUSTS TO INCOME SPLIT 10.5.2

10.5.2 Testamentary Family Trusts: Tax Savings for Children and Their Families

The use of a testamentary discretionary family trust with multiple beneficia-

ries permits income to be sprinkled among low tax-rate beneficiaries to achieve
income splitting among many beneficiaries. Unlike income splitting with a dis-
cretionary inter vivos trust, there is no need to plan around the attribution rules.
In addition, it is easier to fund an income-splitting trust through the estate with
an inheritance than through lifetime gifts, as capital is no longer required to
maintain the settlor’s/testator’s needs.

Discretionary testamentary trusts can achieve tax savings for children and their
families through income sprinkling. Assume, for example, that the child of the
testator is taxed at or close to the highest graduated rate of tax. If a testamen-
tary trust is funded with some of the inheritance that the child would otherwise
receive directly, it may be possible to reduce the overall tax bill within the fam-
ily by having some of the income earned on the inheritance in the trust taxed
in the hands of the child’s other family members (such as spouse, child, etc.)
who are in the lower tax brackets. Income from the trust can be paid or made
payable to beneficiaries who are not taxed at the highest graduated rate — that
is, income sprinkling. Family members who have little or no income from other
sources will pay less tax than those whose earnings or income place them in
the top marginal tax bracket. Children, grandchildren, and each of their spouses
or partners could be included as discretionary beneficiaries to maximize the
benefits of income sprinkling. The income-splitting benefits of a testamentary
trust cannot be created post-mortem if the child or other beneficiary inherits the
funds directly. The trust must be set up in the Will. If the child or other benefi-
ciary inherits the property directly and then attempts to set up the trust with the
inheritance, the trust will be an inter vivos trust resulting in the application of
the attribution rules, including subs. 75(2).

Where the testator would like to use a discretionary family testamentary trust for
income sprinkling, but is not certain it will be appropriate at the time of death,
a “floating” trust may be used. The testator may not be certain, for example, that
the size of the estate will merit such planning or may want to permit the execu-
tors to decide whether such trust planning is appropriate for each particular
child’s circumstances. The trust is created in the Will with a small amount of
money, perhaps $1,000, along with such additional amounts to be determined at
the discretion of the trustee, and a liberal right to encroach on up to the entire
capital (so that the $1,000 can be paid out to terminate the trust). In order not

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10.6 Chapter 10 – Basic Tax Planning for Trusts and Estates

to infringe the rule that prohibits delegation of a testamentary power, it may

be advisable to limit the discretion in some way, such as providing a maximum
amount or maximum portion of the estate that can be allocated to the trust.

10.6 TAX PLANNING FOR DISABLED BENEFICIARIES

The objective of planning for disabled beneficiaries is typically not tax-motivated.

The primary objective is to provide financial security for an individual who,
because of a disability, may be financially dependent and/or incapable of man-
aging property. A secondary objective, relevant in some jurisdictions in Canada,7
may be to preserve the right to income-tested and asset-tested government dis-
ability benefits through the use of a discretionary inter vivos or discretionary tes-
tamentary trust often called a Henson trust, which refers to the case that made
such trusts effective.8

The Act accommodates planning for disabled beneficiaries and contains rules
that permit such planning to be tax-neutral or, in some cases, provides conces-
sions not available in any other circumstances. These include:

• rollovers and tax deferral for RRSPs and RRIFs passing to disabled
beneficiaries;
• the registered disability savings plan (RDSP), which provides for a
tax-deferred savings plan for a disabled beneficiary and is consid-
ered an exempt asset for federal, provincial, and territorial govern-
ment benefits;
• the lifetime benefit trust available for RRSP and RRIF proceeds
passing to a mentally disabled beneficiary, including qualified trust
annuities;
• the preferred beneficiary election for inter vivos trusts for a dis-
abled beneficiary, and
• access to the graduated rates of tax for a testamentary trust for the
benefit of a disabled beneficiary, where the trust meets the require-
ments of a qualified disability trust.

7 Henson trusts are not effective in Alberta. They are effective in Ontario. They may or may not be
effective in other provinces.
8 The Minister of Community & Social Services v Henson, [1987] OJ No 1121, aff’d [1989] OJ No 2093
(1989) 36 ETR 192 (Ont C.A.).

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TAX PLANNING FOR DISABLED BENEFICIARIES 10.6

Rollovers are available for a refund of premiums (in the case of an RRSP) or
designated benefits (in the case of an RRIF) payable to a disabled beneficiary.
Details of the requirements, and the options available, are discussed at 7.8.4.2,
Options for a Spouse, or Child/Grandchild Financially Dependent by Reason of
Physical or Mental Infirmity. RDSPs are discussed at 7.9.3.

The lifetime benefit trust provides for a trust arrangement for refunds of pre-
miums in respect of RRSPs and RRIFs payable to a disabled beneficiary who
is mentally infirm. The trust must purchase a qualified trust annuity, and the
detailed requirements are at 7.8.4.3, Trust Options for Mentally Infirm Spouse or
Child: Lifetime Benefit Trusts (LBTs) and Qualified Trust Annuities (QTAs).

The preferred beneficiary election, discussed in detail at 4.10, permits income

not paid or payable to a disabled beneficiary to be taxed in the hands of a dis-
abled beneficiary. Other than an age 40 trust, this is the only situation where
income can be accumulated in a trust but be taxable to the beneficiary. The elec-
tion provides access to the graduated rates of the disabled beneficiary without
any actual payment to the beneficiary. Without the preferred beneficiary elec-
tion, income in the inter vivos trust would be taxed at the highest marginal rate.
The election is not available to testamentary trusts, but it is not needed, as a
qualified disability trust (QDT) is entitled to the graduated rates of tax.

A QDT is the only trust other than a GRE that has access to the graduated rates
of tax. A QDT must qualify as a testamentary trust; the detailed requirements
are discussed at 4.7.3.1. Both the preferred beneficiary election and the QDT
facilitate accessing the graduated rates of tax where income is not actually made
payable to a disabled beneficiary. The non-tax objectives of trust planning for
disabled beneficiaries are not penalized by the tax system by imposing higher
rates of tax. The non-tax objectives include financial protection for a beneficiary
who cannot (because of incapacity) or should not (because of poor judgement
or lack of financial skills) be handling money and the preservation of the right
to receive provincial disability benefits.

The tax planning strategies for disabled individuals should be examined in the
light of the particular circumstances and the non-tax objectives. The use of trusts
for a disabled beneficiary may provide income-splitting opportunities, especially
in the case of an inter vivos trust where the beneficiary is over the age of 18.
Asset protection and preservation of capital is often an objective, but not in every
case. If the beneficiary suffers from mental infirmity, additional trust options are

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10.7 Chapter 10 – Basic Tax Planning for Trusts and Estates

available with respect to registered plans. In determining whether to set up an

inter vivos or testamentary QDT, the impact of the 21-year rule should be con-
sidered. In addition, if the sole purpose of the trust is to protect the individual’s
entitlement to provincial disability benefits, it may be appropriate to provide for
termination of the trust once eligibility for benefits has ended due to the age of
the beneficiary.

Common requirements for the preferred tax treatment for disabled beneficiaries
may include:

• a specific relationship between the taxpayer (the RRSP or RRIF

annuitant, or the settlor of the trust or deceased) and the disabled
beneficiary,
• entitlement to the disability tax credit, and
• financial dependence on the taxpayer.

Each rule has its own particular requirements, and any planning for disabled
beneficiaries should include tax advice.

10.7 ESTATE FREEZING

10.7.1 Introduction to Estate Freezing

Estate freezing is one of the most common estate tax planning strategies. Typi-
cally, an estate freeze involves a corporate reorganization of a privately held
business, but the strategy encompasses many other types of planning.

The concept of an estate freeze is simple. The value of the future growth is
transferred from the original owner (usually the parents) to the heirs (usually
the children or grandchildren). The current value of an individual’s “estate” (i.e.,
their personal wealth) is fixed or frozen so that any increase in value between
the time of the “freeze” and death is transferred on a tax-free basis during life-
time to the persons who would otherwise inherit the property on death. Since
Canada taxes capital gains on death through the income tax system, and many
of the provinces have a mini “wealth tax” in the form of probate fees, significant
savings can be achieved if wealth can be shifted to heirs outside the system of
taxation on death.

In addition to income tax and probate fee savings on death, an estate freeze is
often used to shift wealth to other family members to achieve income splitting

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ESTATE FREEZING 10.7.3

over time. An estate freeze is a tax-effective way to transfer wealth to family

members without attracting the attribution rules, and without triggering capital
gains that would otherwise apply to a gift or sale of property.

A further objective of an estate freeze is for parents to witness their children

benefitting from wealth transfer instead of waiting until death. Where the prop-
erty subject to a freeze is a family business, an estate freeze provides an incen-
tive for children to contribute to the success of the business, since the value of
growth will accrue to them.

The key to an estate freeze is that only the value of the future growth is trans-
ferred. Even if a deemed disposition did occur in the course of an estate freeze,
the present value of future growth is not considered to have any value for tax
purposes, providing the interest that is held by the heirs or family members is
designed in accordance with guidelines acceptable to CRA.

10.7.2 Gifting

The simplest form of an estate freeze is a gift. It may not be an estate freeze in
the classic sense, since the donor does not retain the current value of the prop-
erty. However, it does reduce the value of the estate and on death avoids both
probate fees and capital gains tax on post-gift growth in value. However, one
must question the value of saving taxes to preserve wealth on the one hand and
giving wealth away on the other. There are several specific disadvantages.

• The transferor gives up the value of the property.

• The transferor loses control of the property.
• The attribution rules may apply.
• A deemed disposition at fair market value may trigger tax on any
unrealized capital gain at the time of making the gift, instead of
deferring the gain until the time of death.

Other more complex estate-freezing strategies avoid all or most of these

drawbacks.

10.7.3 Conveying the Remainder Interest in Real Property

Another estate freeze strategy is to transfer property while reserving a life inter-
est either directly or through a trust. This is commonly done with personal real

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10.7.4 Chapter 10 – Basic Tax Planning for Trusts and Estates

estate that is intended to be enjoyed for generations, such as the family cottage
where the current owner still wants to retain the present value, control, and use
of the property. This may be done, for example, by transferring the property to
one’s self for life with the intended recipient receiving the remainder interest.

Alternatively, the entire property could be transferred with a lease back to the
donor for life. The advantage of this strategy is that the donor retains control
and use of the property during lifetime. In addition, the attribution rules are not
an issue where the property is personal use property and/or the transferees are
children or more remote issue, so that future capital gains are not subject to attri-
bution on a subsequent sale. Under s. 43.1 of the Act, any transaction whereby
the title to real estate is divided into a life interest and a remainder interest, with
the owner retaining the life interest, is treated as a disposition of the entire prop-
erty at FMV and a rollover to the surviving owner on death. Consequently, any
unrealized capital gains at the time of the conveyance of the remainder interest
will be taxable to the donor, but a freeze for the purpose of capital gains tax is
achieved. Where the real property is eligible, the principal residence exemption
may be used to shelter the gain at the time of the conveyance.

10.7.4 Using the Corporate Structure for an Estate Freeze

The corporate structure is the most common vehicle for an estate freeze. Fre-
quently a corporation is in place already, and the freeze involves fixing the value
of pre-existing shares of a corporation. Whether this is the case or not, the use
of a corporation to hold property in the course of an estate freeze has a number
of advantages.

10.7.4.1 Fractional Ownership and Control of Distributions

The use of a corporation permits multiple owners who may have the
same or different ownership rights. Separate classes of shares may be
issued to separate beneficiaries to control the flow of profits or other
types of distribution to the shareholders, since dividends may be
declared on one class of shares and not another.

10.7.4.2 Custom Design the Attributes of Ownership

The use of different classes of shares can customize the attributes of
ownership to a great degree. For example, separate classes of shares
can be designed to isolate:

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ESTATE FREEZING 10.7.5

• future growth — in the form of newly issued common shares

from treasury,
• voting control — in the form of low-value shares with super-
voting rights, and
• current fixed value — in the form of preference shares.

Typically, the owner retains control of the assets or business through

voting shares and retains the wealth at the time the freeze takes place
through ownership of the fixed-value preferred shares.

If one of the purposes of the freeze is to multiply access to the capital

gains exemption, but the owner does not wish to transfer any value
that is not necessary to maximize this saving, the beneficiary of the
freeze can receive shares that have a maximum value. For example, spe-
cial shares could be designed to appreciate in value but to a maximum
value of the current amount of the lifetime capital gains exemption.

10.7.5 The Classic Estate Freeze

In the classic estate freeze, the owner of the property (the freezor) exchanges
the property for fixed-value preference shares (freeze shares) designed to main-
tain a fixed value equal to (and no more nor less than) the value of the property
at the time of the freeze. Common shares that initially have no value (since the
value of the corporation is entirely represented by the freeze shares) are issued
from treasury and are held directly or through a trust for the benefit of other
family members who would otherwise inherit the property, usually the children
and other issue of the freezor. Sometimes the spouse is also included as part of
the freeze where the corporation is a small business corporation (SBC) and there
is a desire to split income and provide access to the capital gains exemption.9

9 The inclusion of the spouse is otherwise not beneficial because of the corporate attribution rule (see
10.7.11).

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10.7.5 Chapter 10 – Basic Tax Planning for Trusts and Estates

Figure 10.1: Simple Estate Freeze — Before

Figure 10.1 shows a simple estate freeze of a corporation before the estate freeze.
Before the freeze, the owner owns all of the shares of the corporation. After the
freeze (see Figure 10.2), the share capital of the corporation is divided into com-
mon shares issued to the family trust, fixed-value preference shares held by the
freezor, and a separate class of super-voting shares also held by the freezor.

Figure 10.2: Simple Estate Freeze — After

In order to preserve the continuity of the management and control of the busi-
ness, there is typically a shareholder agreement executed between all persons
who are shareholders after the freeze, in addition to the family trust. These two
safeguards, the trust and the shareholder agreement, are not necessary from a
tax perspective, but the non-tax benefits are imperative, and often a business
owner or any potential freezor may be reluctant to consider a freeze without
such protection. They should always be presented as important options to the

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ESTATE FREEZING 10.7.7

freezor when an estate freeze is contemplated, as often the benefits are seen
only in hindsight.

In reality, a freeze is seldom, if ever, as simple as is illustrated here. There may

be multiple corporations in the business group, multiple shareholders, and inter-
ests already held by pre-existing family trusts. The freeze itself may take place
at the level beneath a holding corporation instead of at the level of individual
share ownership, especially if there are arm’s length owners of the business or
there are multiple corporations or businesses and it is only intended to freeze
some but not all of them.

The strategy to implement the freeze may be “internal,” as illustrated where

shares of an existing corporation are reorganized within the same corporation,
or “external,” whereby a new corporation (Newco) is created and the existing
shares are transferred to Newco in exchange for shares of Newco. A trust may
or may not be used, or there may be multiple trusts. However, the corporate
freeze is structured, the concepts are the same—growth shares are issued from
treasury, and the existing owner freezes the value of his or her interest in the
corporation.

10.7.6 Rollover for Freeze

The conversion of shares into freeze shares is almost always done on a rollover
basis under any number of provisions of the Act. Details will not be discussed
here, but these include a s. 85 rollover, a s. 86 reorganization of capital, a con-
version of shares under s. 51, or an amalgamation rollover under s. 87 of the Act.
The conversion or transfer to freeze shares may be done on a taxable basis or
partially taxable basis if the owner wishes to trigger a gain and utilize the capital
gains exemption to shelter it by increasing the cost basis of the freeze shares,
thereby “crystallizing” the capital gains exemption.

10.7.7 Share Attributes and the Corporate Freeze

The attributes of the shares created or taken back in an estate freeze are criti-
cal to the effectiveness of the freeze and avoiding undue tax consequences to
the freezor. If, for example, the value of the shares and any non-share consider-
ation taken back by the freezor is less than the value of the original property or
shares, an immediate shareholder benefit may be taxable to the freezor under

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10.7.7.1 Chapter 10 – Basic Tax Planning for Trusts and Estates

s. 15 of the Act, or other undue tax consequences may occur.10 On the other
hand, if the non-share consideration and the value of the preference shares (i.e.,
the freeze shares) is more than the value of the original property or shares, the
intended freeze will not take place. This could be particularly onerous if it were
determined that the so-called freeze shares actually continued to grow in value,
thereby completely negating the freeze.

10.7.7.1 Freeze Shares

The freeze shares should have the following attributes to ensure the
value is fixed.

• Retractable. They can be sold back to the corporation at the

option of the holder.
• Redeemable. The corporation may repurchase the shares at its
option.
• Redemption amount equal to the fixed value. The price for
the shares on retraction or redemption is equal to the amount of
the fixed value. In some cases, this amount may be subject to a
price adjustment clause in the event of a reassessment by CRA,
but to be effective there must have been a reasonable effort to
ascertain the FMV of the original property or shares and set the
original redemption amount accordingly.11
• Dividend rate. The shares should have rights to reasonable
dividends (to ensure value), but the annual dividend should be
subject to a maximum amount and such dividends should be
non-cumulative12 (to ensure no growth).

10 Excess value not taken back by the freezor may be taxable under any number of provisions, including
para. 85(1)(e.2), subs. 56(2), s. 246, or subs. 245(2) — GAAR, in addition to subs. 15(1).
11 See Guilder News Co. (1963) Ltd. v. M.N.R., 73 D.T.C. 5048 (Fed. C.A.), where a price adjustment clause
was not effective; and Miko Leung and Sit Wa Leung v. M.N.R., 92 D.T.C. 1090 (T.C.C.), where it was.
CRA’s requirement in Income Tax Folio S4-F3-C1 to disclose price adjustment clauses or agreements is
usually ignored by practitioners.
12 Cumulative or non-cumulative dividends are relevant only when there is a fixed dividend for the year,
or a range within which the amount of the dividend may be declared within the year. “Non-cumulative
dividends” means if the dividend is not declared in a particular year, the right of the corporation to
declare dividends in respect of that year is extinguished. If dividends are cumulative, the potential
right to the dividends (i.e., for them to be declared and paid) continues in subsequent years.

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ESTATE FREEZING 10.7.7.2

• Preference as to distribution. The class of freeze shares

should rank first as to the redemption amount on a dissolution
or winding up.
• Non-impairment clause. No distributions to other classes of
shareholders — including dividends, redemptions, or return of
capital — may be made if the value of the freeze shares may
decline below the redemption amount as a result.
• Voting. Voting rights may be included, or may be concentrated
in another class of super-voting or “thin” voting shares.

10.7.7.2 Voting Shares

Often a separate class of low-value super-voting shares is created to
permit the freezor to hold control of the corporation in a class of shares
separate from the freeze shares. This might be particularly useful to
maintain control of the corporation if the freezor started to redeem the
freeze shares to access funds from the corporation. It is also sometimes
useful to permit a future transfer of control to one of the children with-
out disturbing a more equal distribution of the value. A statement by
CRA in Income Tax Technical News No. 38 (Archived, September 22,
2008), raised the issue as to whether CRA would put a premium value
on control in respect of shares that carried voting control. However, a
2009 statement confirms that:

. . . in the context of an estate freeze of a Canadian-con-

trolled private corporation, where a freezor, as part of the
estate freeze, keeps controlling non-participating preference
shares in order to protect his economic interest in the cor-
poration, CRA generally accepts not to take into account any
premium that could be attributable to such shares . . .13

There is authoritative case law that maintains no premium in value

should be attributed to controlling shares, but there is still some con-
cern among more conservative tax practitioners that a control premium
is possible14 or at least that CRA will take the position that a premium is
appropriate in some circumstances.

13 B.C. Tax Conference, September 22, 2009; see David Louis, Tax and Family Business Succession
Planning, 3rd ed. (Toronto: CCH, 2009), at para. 227 and its Addendum.
14 David Louis, Implementing Estate Freezes, 2nd ed. (Toronto: CCH, 2006) at pp. 211–212.

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10.7.7.3 Chapter 10 – Basic Tax Planning for Trusts and Estates

Super-voting shares may carry more than one vote each, typically are
non-participating (not entitled to dividends), and are issued, retractable,
and redeemable for a nominal amount, such as $1.00.

10.7.7.3 Growth Shares

The growth shares are typically garden-variety common shares and may
or may not be entitled to vote. The right to dividends, and distribution
on winding up, will be unlimited in amount but always subject to the
rights of the holders of other classes of shares, and no distribution may
be made that would impair the rights or value of the fixed-value prefer-
ence shares (i.e., the freeze shares). Often several classes of common
shares will be issued to facilitate flexibility in distributing dividends,
particularly if the growth shares will not be held by a trust or are held
by multiple trusts.

10.7.8 Freezing and the Capital Gains Exemption

A freeze is an excellent time to do some companion tax planning.

10.7.8.1 Crystallization
A crystallization is a transaction whereby a taxable disposition of quali-
fying small business corporation shares (QSBCS) is triggered to use the
capital gains exemption to shelter the gain and increase the tax cost of
the shares. A crystallization locks in the use of the capital gains exemp-
tion. This may be helpful as part of an estate freeze, especially if there
is concern15 that the shares of the corporation may not qualify as QSBCS
in the future. Since the cost of a reorganization is already being incurred
and appraisals are needed to properly estimate values, the additional
cost of a crystallization as compared with the benefit is minimal.

10.7.8.2 Purification
A purification is a reorganization whereby the assets of a corporation
are rebalanced so that the shares of the corporation qualify as QSBC
shares prior to a crystallization transaction.

15 In the past, crystallizations were also routinely done to protect against the possible repeal of the
capital gains exemption. However, Finance has consistently given reassurances that a repeal with no
warning is unlikely, and that if there were to be a repeal, ample grandfathering would be provided.

10–36
ESTATE FREEZING 10.7.9

10.7.8.3 Multiplying Access to the Capital Gains Exemption

A freeze almost always accommodates the possibility of additional
access to the capital gains exemption by the family members who will
own or have an interest in the growth shares of the corporation. Where
the shares qualify as QSBCS, or may qualify in the future, this is another
benefit of a freeze; and where the business is sold before the death of
the owner, this may be the only benefit actually realized, since the tax
savings on death will no longer be possible. However, the initial value
of the growth shares is nil, so there must be an increase in the value of
the corporation after the freeze in order for there to be any value and
gain on the growth shares. For this reason, an estate freeze completed
immediately before a sale will not be effective to multiply access to the
exemption.

10.7.9 Cautions Regarding Paid-Up Capital and Non-Share Consideration

In the course of an estate freeze, or any corporate reorganization for that matter,
care must be taken to avoid undue tax consequences that may result if either of
the following occurs:

• the paid-up capital of a corporation or of the particular received

shares increases or
• the transferor of property or shares receives non-share consider-
ation such as cash or debt, or property with a value in excess of
the lessor of the ACB (which may be adjusted by certain factors,
including the use of the capital gains exemption) and the paid-up
capital of transferred shares, if any.

Paid-up capital for the purpose of these rules is not necessarily stated capital on
the financial statements; it is a tax concept and could be less than stated capital
for corporate law or accounting purposes. The details of these avoidance rules
are well beyond the scope of the material here. However, it is important to rec-
ognize that many more complex tax rules may apply even to a simple estate
freeze, and advice from a tax professional is imperative.

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10.7.10 Chapter 10 – Basic Tax Planning for Trusts and Estates

10.7.10 Funding a Trust and Avoiding the Attribution Rules with a Loan to
Subscribe for Treasury Shares

The attribution rules apply to transfers of property for the benefit of certain per-
sons where the transfer is direct, indirect, or through a trust. The future growth
of the corporation is represented in a corporate estate freeze by issuing new
common shares from treasury that will be owned directly or through a trust by
the children. These shares can be acquired in such a way as to avoid the attribu-
tion rules.

One method of funding a trust with shares of a private corporation is to use a

loan for fair market value from a financial institution, arm’s-length person, fam-
ily friend, or relative where the funds are used to subscribe for treasury shares.
The subscription price for these shares is always nominal. The loan may be for
as little as $1.00 and it can be repaid in full with interest at the prescribed rate
with dividends paid on the shares. This method will avoid the application of the
attribution rules in ss. 74.1, 74.2, and 74.3 (i.e., the attribution rules relating to
transfers or loans made directly, indirectly, or through a trust). Great care must
be taken in preparing the documentation for this loan and in ensuring that the
lender is not just an agent for a family member to whom the attribution rules
would otherwise apply.

10.7.11 Avoiding the Corporate Attribution Rule

The corporate attribution rule in s. 74.4 may be avoided if the corporation qual-
ifies and will continue to qualify as an SBC.16 The corporate attribution rule
imposes taxation on deemed interest income at the prescribed interest rate
where there is a transfer to a corporation and a spouse, or related person (or
niece or nephew) under the age of 18,17 is a specified shareholder18 and may
benefit as a result. This is exactly what occurs in an estate freeze: there is a trans-
fer when the freezor exchanges existing shares for fixed-value shares, whether
the freeze is accomplished by a transfer of assets to a corporation, or an internal
or external freeze of existing shares; and the purpose of a freeze is to transfer
the future growth to others who as a group will own all or most of the new com-
mon shares.

16 See 9.2.4.
17 “Designated persons” under the rule.
18 “Specified shareholder” is defined in subs. 248(a) to include any shareholder who owns, directly or
indirectly, 10% or more of any class of shares in the corporation or a related corporation.

10–38
ESTATE FREEZING 10.7.12

In the event the corporation is not an SBC, or there is concern that it may
not continue to be, the freeze can be structured through a trust that contains a
restriction on distributions in accordance with the exception to the corporate
attribution rule in subs. 74.4(4). This is an important exception to the corpo-
rate attribution rule because of the potential severity of the rule. Unlike other
attribution rules, the corporate attribution rule taxes the transferor on deemed
annual income, whether or not any income is actually earned, and even if earned
whether or not it is allocated, paid, or otherwise accrued for the benefit of the
designated person. In addition, it can be risky to depend on the SBC exception
to the rule, as values of the assets in the corporation can fluctuate, causing the
corporation to go “offside” the definition. For example, if surplus cash accumu-
lates and is used to purchase passive investments, the 90% test for the definition
of SBC may not be met and the corporate attribution rule will apply until the
value of the assets changes to meet the 90% test.

The exception in subs. 74.4(4) requires that the interest of any designated per-
son be held in a trust, and under the terms of the trust no designated person
may receive or otherwise obtain the use of any of the trust’s income or capital
while being a designated person in respect of the freezor. These terms would
prohibit the spouse of the freezor from having the right to receive any income
or capital of the trust during the freezor’s lifetime. However, children (and other
related persons and nieces and nephews under age 18) are not prohibited from
receiving rights to income or capital once they attain age 18.

10.7.12 Using a Trust to Hold the Growth Shares in an Estate Freeze

A trust is frequently used to hold the growth shares issued in the course of an
estate freeze. A trust is required if the exception to the corporate attribution rule
in subs. 74.4(4) is being relied upon. Using a trust to hold the shares permits
flexibility in the allocation of income and capital gains in order to optimize the
potential income-splitting benefits, including multiplying the access to the capi-
tal gains exemption.

In the context of an estate freeze where the capital of the trust can be substan-
tial, the benefit of deferring distribution to the beneficiaries may be paramount.
If an existing business is the subject of the freeze, the owner may not know
which of the children should become future owners or how the business should
be apportioned among them. In addition, the children may not be ready to run
the business as owners, and the current owner, the freezor, may not be willing

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10.7.13 Chapter 10 – Basic Tax Planning for Trusts and Estates

to relinquish the degree of control and ownership that a direct transfer to the
children would entail.

10.7.13 Use of a Trust in an Estate Freeze and the Settlor Attribution Rule in
Subs. 75(2)

Where a trust is used to hold the growth shares in an estate freeze, caution must
be exercised in avoiding the application of subs. 75(2).19 The effect of subs. 75(2)
could be disastrous. During the lifetime of the settlor/contributor or person con-
trolling the sale of trust property or distribution of income, there is:

• attribution of income and capital gains realized in the trust during

the time the settlor/contributor or person controlling the sale of
trust property or distribution of income is resident in Canada and
• a deemed disposition at FMV of property distributed in kind to a
beneficiary.

Where subs. 75(2) applies and the person to whom attribution applies lives for
21 years after the creation of the trust, the deemed disposition rule would apply
to the trust. There is no way to cushion the impact of the 21-year rule because
there is no rollover under subs. 107(2) of property distributed to a beneficiary.

It is usually possible to structure the acquisition of the growth shares by the

trust to avoid the application of subs. 75(2) by using a loan with interest paid
at prescribed rates. Where there is no transfer to the trust by the freezor, the
freezor may be a trustee and a potential beneficiary of the trust (where a “gel” is
preferred, see 10.7.14 for discussion). However, out of an abundance of caution,
it is a common practice to include terms in the trust that require that at any time
the freezor is a trustee there must be three trustees at all times, with a majority
clause. This precaution will not prevent the application of subs. 75(2) if it other-
wise applies and the freezor is a discretionary beneficiary of the trust.

10.7.14 Freeze with a Bail Out, or Gel

A “gel” is a freeze that provides the opportunity for the growth shares to revert
back to the freezor. The most common method of achieving this is to have the
freezor as a discretionary beneficiary (along with other family members) of the
trust that holds the growth shares. A freeze that contains a gel may be very

19 See 9.3.

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ESTATE FREEZING 10.7.15.3

attractive, as it potentially permits the freezor to have the benefits of the freeze
or unwind it with impunity. CRA has indicated it would not apply the general
anti-avoidance rule to such a structure in and by itself.20 However, extreme cau-
tion must be taken to avoid the application of subs. 75(2) if the freezor is a
beneficiary of the trust, and this may not always be easy to do with complete
confidence. Many practitioners take a conservative approach and prefer not to
include a gel in a freeze, whereas for others it is common practice.21

10.7.15 Other Types of Freeze Transactions

A number of different types of freezes, as well as transactions for unwinding or

reversing freezes, exist.

10.7.15.1 Partial Freeze

The freezor participates in the growth of the corporation along with the
other family members. The tax benefit on death is not as great since the
freezor’s interest in the corporation will continue to increase in value,
albeit at a lesser pace than before the freeze.

10.7.15.2 Melt
The value of the corporation after the freeze is kept at the freeze value
or reduced back to the freeze value by making payments to the freezor,
either by way of dividends to the extent these are permitted on the
freeze shares or by providing taxable benefits, salary, or bonus pay-
ments to the freezor.

10.7.15.3 Thaw
In a thaw, the effect of the freeze is unwound. This can be done by
the freezor or the corporation repurchasing the growth shares, both of
which are taxable events. If the growth shares qualify for the capital
gains exemption, this may be a possible tax-exempt form of thaw where
the shares are repurchased by the freezor (not a repurchase by the cor-
poration). However, the transaction must take place at fair market value

20 Question 22, 1990 Revenue Canada Round Table at the Annual Tax Conference of the Canadian Tax
Foundation.
21 See David Louis, Implementing Estate Freezes, 2nd ed., supra note 14, at pp. 164–166.

10–41
10.7.15.4 Chapter 10 – Basic Tax Planning for Trusts and Estates

and the freezor will be out of pocket. A preferred transaction to the

thaw is a refreeze.

10.7.15.4 Refreeze
The growth shares are exchanged for fixed-value shares in a second-
stage freeze. Where the shares are held by a trust, there could be a
problem with respect to the trustees breaching their fiduciary duty to
the beneficiaries if the future growth of the shares is relinquished in
favour of another person (typically the freezor).

10.7.15.5 Refreeze at Lower Value

Where the value of the corporation drops below the redemption value
of the freeze shares, a refreeze may be considered to further limit the
tax on the freezor’s death or on a subsequent sale. CRA generally takes
the view that a refreeze at a lower value is acceptable tax planning,
providing the decrease in assets is not the result of stripping corporate
assets.22

10.7.15.6 Reverse Freeze

In a reverse freeze, instead of transferring assets or shares to a corpora-
tion, an existing corporation transfers assets to a new corporation. This
is a variation of a freeze, or may also be used to effect a refreeze or
freeze at a lower value.

10.7.16 To Freeze or Not to Freeze

An estate freeze saves taxes on the death of the freezor, but the advantages and
disadvantages must be carefully considered by the client before such a complex
planning strategy is implemented. A number of questions are appropriate.

Is the potential freezor old enough and rich enough? The future growth is trans-
ferred in an estate freeze. If the freezor is young, it may be too soon to forego
the benefit of sharing in the growth of the business, especially where the freezor
will continue to be the driving force in the business for many years to come.
The freezor must also be content that the other assets and the existing value of
the business will be sufficient to finance his or her needs and lifestyle for the

22 See, for example, TI 2003-0046823, dated January 28, 2003.

10–42
ESTATE FREEZING 10.7.17

remainder of his or her lifetime. If there is uncertainty with respect to financial

security, the freeze may not be appropriate. A partial freeze may be the answer
if a total freeze is premature. In addition, an income can be received from divi-
dends on the preferred shares; however, this may not be secure, as it will depend
on the continuing profitability of the business.

Is there a possibility that the business will be sold at arm’s length during the
freezor’s lifetime? There is no tax benefit on death if the business is sold during
the lifetime of the freezor. A sale to an arm’s-length party may be significantly
more difficult if the freezor has brought in other family members as sharehold-
ers, who all have their own agenda and negotiating stance in the course of con-
ducting the arm’s length sale. The use of a trust to hold the growth shares and a
shareholder agreement can provide a measure of protection in such a case.

If there is an arm’s length sale, will the freeze multiply access to the capital
gains exemption?

10.7.17 Example of Tax and Estate Planning for a CCPC (Canadian-Controlled

Private Corporation)

Brenda and her sister, Vivian, founded Cookies Galore Ltd. 20 years ago and are
60/40 owners (see Figure 10.3). The company has grown into a franchise opera-
tion with retail outlets selling baked goods and confections across Atlantic Can-
ada. Brenda and Vivian both want to do an estate freeze and bring their children
and any grandchildren on as shareholders so they can multiply access to the
capital gains exemption in the event of a sale and provide financial assistance
to their children and grandchildren with after-tax dollars. Vivian also wants to
include her husband, Alberto, as a discretionary beneficiary to be able to supple-
ment his retirement income with dividends and provide access to the capital
gains exemption.

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10.7.17 Chapter 10 – Basic Tax Planning for Trusts and Estates

Figure 10.3: Reorganization of Cookies Galore Ltd. — Before

Brenda Vivian

60% 40%

Cookies Galore Ltd.

worth $10 million

Solution (see Figure 10.4)

• Brenda and Vivian can each settle a discretionary trust for their
spouse, children, and other issue and any spouse of their children
or other issue.23 Alternatively, the trust can be settled by a family
friend or more distant relative. Each trust can be settled with a gold
coin or other property that is retained in a safety deposit box, so
that its existence and identity can be maintained throughout the
duration of the trust.
• An estate freeze may be carried out whereby Vivian and Brenda
transfer their existing shares to separate holding corporations
(Holdcos) in exchange for fixed-value preference shares.
• Vivian and Brenda may also take back a separate class of “thin
voting shares” to maintain control of Cookies Galore Ltd. indepen-
dently from their individual Holdcos.24
• The separate Holdcos will enable tax-free intercorporate dividends
to be paid by Cookies Galore to each Holdco, and provide Vivian
and Brenda with flexibility to decide how to accumulate or distrib-
ute such dividends independently.
• Brenda and Vivian may or may not crystallize their capital gains
exemption in the course of the freeze.

23 Including the spouse, and the spouse of any children or issue, provides maximum potential and
flexibility in future, but this depends on the client’s comfort level.
24 This could be done any number of ways, such as a preliminary reorganization of Cookies Galore Ltd.
before the transfer of shares to the Holdcos, a stock dividend, or a share subscription.

10–44
ESTATE FREEZING 10.7.17

• A financial institution, another family member, or a family friend

can make a loan at prescribed rates of $10 to each of the trusts, and
the trusts in turn will subscribe for common shares in the respec-
tive Holdcos.
• If there is concern that Cookies Galore may not be a small business
corporation or may not qualify in the future, a restriction in the
trust on distributions of income and capital to designated persons
(the spouse during the lifetime of the freezor and any related per-
son, niece or nephew under age 18) should be included in order
to ensure the corporate attribution rule in s. 74.4 will not apply. If
the corporate attribution rule is not an issue, the use of a trust is
optional from a tax perspective but is still imperative for legal rea-
sons if the beneficiaries are minors.
• Allocations to Alberto from Vivian’s family trust may be subject
to the corporate attribution rule during Vivian’s lifetime if Cook-
ies Galore is not a small business corporation (SBC) and the small
business deduction (SBD) exception does not apply. The inclusion
of the clause restricting distributions to Alberto will preclude spou-
sal income splitting and access to the capital gains exemption by
Alberto. If there is a pre-existing holding corporation in place, the
freeze may be accomplished by that holding company reorganizing
the share ownership of Cookies Galore by imposing another hold-
ing corporation, or other reorganization. In such a case, the “trans-
fer” will not be by the freezor, and the corporate attribution rule
in s. 74.4 may not apply, depending on how the holding company
was set up in the past.
• A shareholder agreement will be entered into with all parties to pro-
tect Vivian and Brenda and the separate interests of the trusts and
their beneficiaries. At the very least, Brenda and Vivian should have
the option to repurchase the common shares from the Holdcos at
FMV, and there should be rights that permit Brenda and Vivian to
sell all the shares of Cookies Galore or the entire corporate group
in the event of an arm’s length sale. A buy–sell agreement between
Brenda and her trust and Vivian and her trust may also be included.
• The tax on split income (TOSI) will apply to any dividends from
the Holdcos allocated by the trust to beneficiaries under age 18.

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10.7.17 Chapter 10 – Basic Tax Planning for Trusts and Estates

• Dividends from the Holdcos may be paid to the trusts and allo-
cated to children or nieces or nephews who are 18 or older, and to
other adult family members (other than a spouse or common-law
partner) such as parents or brothers or sisters, to income split. If a
holding company is made a beneficiary of the trust, then passive
assets may be flowed out to the holding company on a regular
basis to ensure that the operating company is kept “pure” for the
$800,000 capital gains exemption yet still be able to continue to
defer the shareholder level of tax.
• The plan multiplies access to the capital gains exemption for all ben-
eficiaries if the corporate attribution rule does not apply because of
the SBC exemption, or to beneficiaries other than spouses who are at
least 18 years of age if the rule does apply. In order for there to be any
gain on the common shares held by the trusts, the value of Cookies
Galore must increase over the value at the time of the freeze.

Figure 10.4: Reorganization of Cookies Galore Ltd. — After

Brenda Vivian

60% 40%
Supervoting Supervoting

Brenda Vivian
Family Trust Family Trust
$6 million $4 million
Preference Preference
common common

Brenda Vivian
Holdco Holdco

60% common 40% common

Cookies Galore Ltd.

worth $10 million

10–46
KEY STUDY POINTS 10.8

10.8 KEY STUDY POINTS

• Tax planning strategies generally do at least one of three things:

they defer, reduce, or eliminate tax. Rollovers defer tax, income
splitting reduces tax, and the principal residence exemption (PRE)
and the lifetime capital gains exemption (LCGE) eliminate tax.
Tax planning includes inter vivos planning and estate planning. In
some cases, non-tax objectives drive the planning, but tax expertise
is required to ensure there are not adverse tax consequences or
to exploit the tax planning opportunities created from the non-tax
planning.
• Spousal trusts can be very effective to achieve non-tax objectives,
such as providing for the surviving spouse but using the trust to
preserve an inheritance for other beneficiaries. Spousal trusts are
often used in a second marriage situation or for couples with no
children so that each partner can have different beneficiaries after
the death of the survivor. Without a trust, there is no certainty that
the property of the spouse or partner who dies first will be left to
the intended beneficiaries when the surviving spouse or partner
dies, since the survivor, if capable, is always free to make a new
Will. Trusts are a preferred option to will contracts or mutual wills,
which have many legal problems not discussed in the text. In most
cases, it will be very important to design the spousal trust to also
have the tax benefit of the spousal rollover.
• Spousal trusts are used to provide a rollover for assets that are
to pass ultimately to other beneficiaries (i.e., “preserve capital”),
without the risk that the surviving spouse will disrupt the plan of
distribution.
• Common tax mistakes in spousal trust planning include:
{ making payment of income discretionary or subject to termina-
tion such as upon remarriage,
{ including payments to another beneficiary during the lifetime
of the trust,
{ failure to recognize the benefit of a QST and a non-QST to pro-
vide flexibility, and

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10.8 Chapter 10 – Basic Tax Planning for Trusts and Estates

{ failing to limit the standard trust powers to lend or other stan-

dard powers that CRA may interpret as permitting a person
other than the spouse to obtain, use, or enjoy the capital of the
trust.
• Estate planning may require not only estate planning expertise but
also tax expertise. An estate plan should be designed to meet the
non-tax objectives and minimize tax on death by accessing the tax
planning strategies that are available. The estate planner should
have “tax radar” — that is, be able to recognize where and when
tax issues or opportunities are relevant and access the appropriate
tax expertise.
• More planning opportunities are available with testamentary trusts
since none of the attribution rules apply. Discretionary testamen-
tary trusts can provide excellent opportunities to distribute, or
“sprinkle,” income to family members of the deceased who have
limited sources of income to utilize their marginal rates of tax.
Beneficiaries may include minors who have no source of income,
young adults who are completing their post-secondary education
and have not entered the workforce full-time, low-income parents,
non-working adult family members, and the spouse or partner of
a beneficiary. Sufficient capital is necessary to generate enough
income to make the income splitting effective.
• Inter vivos trusts are often set up for children or grandchildren to
income split or to provide for educational expenses. The attribution
rules may not be a barrier to such planning if the main objective is
to save for post-secondary education or for a time when the benefi-
ciary attains age 18. However, such trusts still need to be set up in
such a way to:
{ avoid subs. 75(2) if there is ever to be a tax benefit and to
access the rollover on distribution of property and
{ avoid the risk that a valid trust may not have been established.
• Inter vivos trusts can be set up without attribution of capital gains
made paid or payable to related children under age 18.
• Business succession has many tax planning aspects. Where the
business is being transferred within the family, the tax burden
on death is a significant problem. If the business is sold to third

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KEY STUDY POINTS 10.8

parties, the proceeds can be used to provide liquidity for the estate
and to pay the taxes. But the transfer to family members generates
no proceeds to pay the tax. However, the tax on death of the busi-
ness owner can be reduced, deferred, eliminated, and funded with
good tax planning during lifetime, skillful use of life insurance, and
tax-motivated post-mortem planning. The tax planning strategies
include estate freezing to reduce tax on death and obtain a tax-
free transfer of future growth to family members, maximizing and
multiplying access to the capital gains exemption, income splitting
among family members with dividends from the corporation carry-
ing on the business, and utilizing the spousal rollover to defer tax
on death for as long as possible. None of these strategies is without
complex tax rules that could deny the benefits intended or, worse,
accelerate or increase the liability. Don’t try this at home, unless it
is also your occupation when you are at the office.
• Many tax planning strategies accompany an estate freeze by a busi-
ness owner. A discretionary trust is often used in conjunction with
an estate freeze to achieve tax and non-tax objectives, including
income splitting with dividends (avoiding TOSI), multiplying access
to the LCGE, delaying the distribution of growth of the business
until the beneficiaries are ready or to give the business owner time
to decide how it will be distributed to family members. A crystal-
lization is utilized with the LCGE to “bump up” the cost of shares
at a time when they qualify for the LCGE. A purification is used to
restructure the assets of a corporation so the shares qualify for the
LCGE, and usually precedes a crystallization.
• Common traps in estate and trust planning include:
{ failure to understand subs. 75(2) for inter vivos trusts,
{ tax on split income (TOSI),
{ extracting cash in excess of paid-up capital as part of a
crystallization,
{ failure to use or correctly implement the spousal rollover,
{ undertaking a freeze before the business owner is ready or
where it is not appropriate,
{ exposure to the corporate attribution rule in an estate freeze,

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10.8 Chapter 10 – Basic Tax Planning for Trusts and Estates

{ failing to inquire as to whether the client or any family mem-

bers may be subject to tax in another jurisdiction, particularly if
there are any U.S. citizens or U.S. residents who will be share-
holders or beneficiaries,
{ creating complexity that the individual or the individual’s fam-
ily members will either subvert or resent, and
{ failure to appreciate the compliance requirements of the plan-
ning strategies or to honour them.

10–50
 CHAPTER 11
ADMINISTRATION AND ENFORCEMENT

LEARNING OBJECTIVES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–3

11.1 COMPLIANCE AND ENFORCEMENT UNDER THE ACT . . . . . . . . . 11–3

11.2 REQUIREMENT TO FILE RETURNS AND PAY TAX OWING . . . . . . 11–4

11.3 REQUIREMENT TO PAY INSTALMENTS . . . . . . . . . . . . . . . . . . . . . . . . 11–6

11.4 REQUIREMENTS TO WITHHOLD AND REMIT AND PENALTIES

FOR FAILURE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–6

11.5 INTEREST . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–7

11.6 PENALTIES FOR FILING LATE TAX RETURNS AND

INFORMATION RETURNS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–8

11.7 ASSESSMENTS AND REASSESSMENTS OF TAX . . . . . . . . . . . . . . . . 11–9

11.8 ENFORCEMENT POWERS: AUDITS, DEMANDS FOR

INFORMATION, AND SEARCH WARRANTS . . . . . . . . . . . . . . . . . . . . 11–9

11.9 COLLECTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–11

11.10 JOINT AND SEVERAL LIABILITY UNDER THE ACT . . . . . . . . . . . . 11–11

11.11 CLEARANCE CERTIFICATES AND CERTIFICATES OF

COMPLIANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–12

11.12 NOTICES OF OBJECTION, APPEALS, REASSESSMENTS, AND

TAX LITIGATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–12

11.13 DEDUCTIONS FROM INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–14

11.14 OFFENCES UNDER THE ACT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–14

11.15 SOLICITOR AND CLIENT PRIVILEGE . . . . . . . . . . . . . . . . . . . . . . . . . . 11–15

11–1
11.16 RELIEF FROM INTEREST AND PENALTIES . . . . . . . . . . . . . . . . . . . . 11–15

11.16.1 Voluntary Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–16

11.16.2 Taxpayer Relief under the Fairness Provisions . . . . . . . . . . 11–17
11.16.3 U.S. Taxpayer Relief . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–18
11.17 TAX AVOIDANCE AND EVASION AND ETHICAL ISSUES FOR
THE ADVISOR . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–18

11.18 KEY STUDY POINTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11–20

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 Chapter 11
Administration and Enforcement

Learning Objectives
Knowledge Objectives:
• Know how the tax system is administered and enforced.

Skills Objectives:
• Explain Canada Revenue Agency’s administrative role and powers to enforce
the income tax system.
• Appreciate the nature of tax avoidance and tax evasion and the difference.

11.1 COMPLIANCE AND ENFORCEMENT UNDER THE ACT

Tax policy and the development of income tax law in Canada are the respon-
sibility of the Department of Finance. Once tax law has been enacted, it is the
responsibility of Canada Revenue Agency (CRA) to administer the Canadian
income tax system.

This chapter covers the law in the Act relating to the administration and enforce-
ment of the rules in the Act and the details of CRA’s role in this process, which
includes assessment, audit, collection, enforcement, and appeals. Also covered is
a brief overview of the appeals process as dealt with by the courts.

Division I — Returns, Assessments, Payments and Appeals, of Part I of the Act (ss.
150 to 168), deals with the requirement to file returns; assessment of taxes, inter-
est, and penalties by CRA; payment of taxes, interest, and penalties; and appeals
to CRA from assessments or reassessments. As previously discussed, the trustees,

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11.2 Chapter 11 – Administration and Enforcement

executors, or personal representatives have the responsibility for trust and estate
compliance under the Act, including filing the returns of deceased persons for
the year of death and any prior years, without personal liability (see 5.8, Liability
of the Personal Representative for Tax and Clearance Certificates).

Division J — Appeals to the Tax Court of Canada and the Federal Court of
Appeal, of Part I of the Act (ss. 169 to 180), deals with appeals to the courts.

Part XV of the Act (ss. 221 to 244) contains the provisions that permit CRA to
administer and enforce the Act. These include CRA’s power to conduct audits;
demand information; obtain and carry out search warrants; collect taxes by gar-
nishment and seizure; apply relief from penalties and interest; accept late filed,
amended, or revoked elections; and prosecute taxpayers for offences.

11.2 REQUIREMENT TO FILE RETURNS AND PAY TAX OWING

Section 150 of the Act requires every Canadian resident, including corporations,
trusts, and individuals, to file an annual tax return “without notice or demand”1
(see Figure 11.1 for summary). The Canadian income tax system is a self-assessing
system, and every person is required not only to file an annual return but also to
report all sources of income and other information contained in the relevant tax
return prescribed for that type of taxpayer and to estimate the tax payable in the
return.2

However, unless a demand to file a return is made by CRA under subs. 150(2),
an individual, including a trust, is not required to file a return unless:

• tax is payable under Part I or

• there is a taxable capital gain or a disposition of capital property.

Administratively, CRA may waive the requirement to file returns in certain cir-
cumstances as well. For policies regarding T3 Returns, see 5.1.2, Requirement to
File T3 Tax Return and Exception Where Trust Has Minimal Income.

The balance of taxes owing for the year must be paid no later than the due date
of the return for trusts and estates. For deceased persons, the payment due date
for the year of death is April 30 of the following year, or six months after death
if death took place in November or December.

1 S. 150.
2 S. 151.

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REQUIREMENT TO FILE RETURNS AND PAY TAX OWING 11.2

Figure 11.1: Tax Returns — Filing and Paying

DECEASED INDIVIDUALS Due Date of Return Balance Due Date (date tax
payable)
Description of Taxpayer
Deceased Individual year of death Later of: Later of:
April 30 of following year or April 30 of following year or
Six months after death (i.e., if died in Six months after death (i.e., if died in
Nov. or Dec.) Nov. or Dec.)
Deceased Individual year of death Later of: Later of:
where deceased (or their spouse or
June 15 of following year or April 30 of following year or
common-law partner) was carrying on
business as partner or sole proprietor Six months after death (i.e., if died after Six months after death (i.e., if death in
Dec. 15) Nov. or Dec.)
Deceased Individual, for year prior to Extension to later of time return April 30 of year of death
death where death before prior year’s otherwise due and six months after
return due death

TRUSTS AND ESTATES Due Date of Return and Date Tax

Description of Taxpayer
Qualifying life interest trust: AET, JPT,
QST, in stub period year of deemed
disposition on death of life tenant
Graduated rate estate
Testamentary trust and estate until
2016
Inter vivos trust, testamentary trust, and
estate after 2015
Payable
90 days after December 31 of the year of
that deemed disposition
90 days after chosen year-end
90 days after chosen year-end
90 days after December 31 (March 31 or
March 30 if leap year)

A qualified disability trust (QDT), like a graduated rate estate (GRE), is entitled
to the graduated rates of tax. However, it has a calendar year-end, and files
returns and pays tax on this basis for all tax years.

In addition, the due date for filing a rights or things return, and the deadline for
making an election to file a rights or things return, is the later of one year from
the date of death or 90 days after the mailing of any notice of assessment in
respect of the tax for the year of death.

Under subs. 150(2), CRA has the power to demand that a taxpayer file a return if
it has not been filed as required. If a demand to file has been issued, late filing
and other penalties may be doubled.

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11.3 Chapter 11 – Administration and Enforcement

The requirements for filing returns and payment of taxes for trusts and estates
have also been discussed earlier in this course (see 5.1, Requirements to File
Returns).

The requirements for filing returns and payment of taxes for deceased persons
are discussed further (see 7.3, Due Date for Filing Returns for a Deceased Per-
son for the Year of Death and Prior Years, and 7.4, Payment of Tax).

11.3 REQUIREMENT TO PAY INSTALMENTS

Under subs. 156(1), an individual (including a trust) is required to pay quarterly

instalments of tax for the current year if the net tax owing for the year or either
of the two prior years is more than $3,000 (or $1,800 for residents of Quebec).3
GREs are exempt from the instalment requirement. As an administrative practice,
CRA does not assess trusts for penalties or interest for failure to make instalment
payments, although this may be under review and subject to change.4 In addi-
tion to interest owing on unpaid instalments, additional penalties may be pay-
able where the interest on all instalments payable for the year exceeds $1,000.5

11.4 REQUIREMENTS TO WITHHOLD AND REMIT AND PENALTIES FOR

FAILURE

There are a number of requirements to withhold income tax and other amounts
from payments made by an estate to another person.

There is a requirement to withhold tax on payments of income made to a non-

resident person, sometimes called “non-resident withholding tax.” The amount
may be required under Part XIII of the Act (ss. 212 to 218.1) and subject to
reduction or elimination under any tax treaty Canada has entered into with the
country where the non-resident resides (see 5.7.2, Withholding Tax on Amounts
Paid or Credited to Non-Residents, and 6.7.2, Withholding Tax on Income Paid
or Credited to Non-Residents).

Executor compensation is considered income from an office or employment

by CRA, unless the executor reports the compensation as income from a busi-
ness. For example, a lawyer or accountant who acts as executor for a deceased
client will include the compensation in business income. A family member or

3 Subs. 156.1(2).
4 See, for example, the T3 Trust Guide 2016 under “Tax Instalments.”
5 S. 163.1.

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INTEREST 11.5

friend will be treated as earning income from an office or employment, and such
income is subject to withholding and deductions. Executor compensation that is
employment income must be reported by the estate on a T4 slip, and income tax
and employee contributions to the Canada Pension Plan (CPP) must be withheld
from the payment of compensation. The amounts required to be withheld, along
with the employer portion of the CPP, must be remitted by the estate to CRA.
Before the remittance is made, the estate must apply to CRA for a business num-
ber (BN) and register for a payroll program account. CRA may refuse to issue a
clearance certificate unless the estate has obtained a business number and made
the appropriate remittances and returns for income tax and CPP.

Failure to withhold income tax and CPP from executor compensation is subject
to a penalty of 10% of the amount that should have been withheld, with a 20%
penalty for additional failures in the same calendar year.6

Where any amounts have been withheld under the Act, there are late remittance
penalties. These apply to both non-resident and employer withholding require-
ments. CRA may assess a penalty of 3% if the amount is one to three days late;
5% if it is four or five days late; 7% if it is six or seven days late; and 10% if it is
more than seven days late.

11.5 INTEREST

Interest is payable at the prescribed rate on unpaid instalments of tax (if

required), tax not paid by the balance due date, and on any unpaid penalties
and is compounded daily. The prescribed rate is reset quarterly under a formula
based on the equivalent yield on Government of Canada Treasury bills.7 Where
a refund of tax, interest, or penalties is owing by CRA, interest is payable and
such amounts are included in the taxpayer’s income in the year of receipt. For
amounts owing by a taxpayer, the prescribed rate is 4% above the equivalent
yield. For interest payable to a taxpayer, the prescribed rate is 2% above the
equivalent yield and such interest only becomes payable 45 days after the filing
date for the relevant taxation year.

6 If the additional failures were made knowingly or under circumstances of gross negligence.
7 Subss. 161(1) and (2) and Regulation 4301.

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11.6 Chapter 11 – Administration and Enforcement

11.6 PENALTIES FOR FILING LATE TAX RETURNS AND INFORMATION

RETURNS

A penalty is levied for the late filing of income tax returns equal to 5% of the
unpaid tax owing plus 1% for every full month the return is filed late, not exceed-
ing 12 months.8 Increased late-filing penalties may apply in the amount of 10%
of the unpaid tax and 2% per month for every full month the return is late for up
to 20 months where:9

• a demand to file a return has been made by CRA, and

• there is a repeated late filing within three years (i.e., a return was
filed late for any one or more of the previous three taxation years).

There are late-filing penalties for information returns. Each T3 Slip and each
NR4 Slip is considered a separate information return for the purposes of cal-
culating the information return late-filing penalty. The amount of the penalty is
based on the number of each “type” of information return late-filed. T3 Slips and
NR4 Slips are each different types of information returns for this purpose. The
penalties provided for in the Act10 are as follows:

Legislated late-filing penalties — Minimum $100 or

Number slips filed late Penalty per day 100-day maximum Maximum penalty — based on 100 days
1 to 50 $10 $1,000
51 to 500 $15 $1,500
501 to 2,500 $25 $2,500
2,501 to 10,000 $50 $5,000
10,001 or more $75 $7,500

However, CRA has an administrative policy that may reduce the penalty “that we
assess so it is fair and reasonable for small business.”11 This policy may apply to
NR4 Slips but does not apply to late-filed T3 Slips. The reduced penalty, if avail-
able, is a flat $100 for 1 to 5 late-filed slips, $5 per day for 6 to 10, or $10 per day
for 11 to 50. The daily penalty remains subject to a 100-day maximum, and the
minimum penalty remains at $100.

8 Subs. 162(1).
9 Subs. 162(2).
10 Under Regulation 205(3), the penalties under subs. 162(7.01) apply rather than that under subs. 162(7).
11 See CRA’s stated policy on the CRA website “Penalty for failure to file an information return by the due
date” under “Relieving administrative policy.”

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ENFORCEMENT POWERS: AUDITS, DEMANDS FOR INFORMATION, AND SEARCH WARRANTS 11.8

The combination of penalties, daily compound interest on unpaid tax, instal-

ments of tax, and penalties can result in substantial costs for failure to file returns
on time and pay tax when due.

11.7 ASSESSMENTS AND REASSESSMENTS OF TAX

CRA is responsible for assessing tax returns for amounts of tax payable, as well
as penalties and interest under the Act, by issuing a notice of assessment.12 In
addition, CRA may reassess an individual or a trust at any time within three years
of the date of mailing of the original notice of assessment.13 Additional reassess-
ments of interest, tax, and penalties may be made within this time period.

The limitation period for assessments and reassessments does not apply where:

• there is a misrepresentation attributable to neglect, carelessness, or

wilful default by the taxpayer or the person filing the return,
• the taxpayer or the person filing the return has committed any
fraud in filing the return or supplying any information under the
Act, or
• a waiver of the normal reassessment period has been filed.

Reassessments may be made under these rules whether or not a clearance cer-
tificate has been issued. The clearance certificate merely protects the trustee,
executor, or personal representative from personal liability.14

11.8 ENFORCEMENT POWERS: AUDITS, DEMANDS FOR INFORMATION, AND

SEARCH WARRANTS

CRA has the right to conduct a review of a taxpayer’s affairs for the purpose of
administering the Act.15 Specifically CRA may, through an authorized person:

• inspect, audit, or examine books and records of the taxpayer or of

any other person,
• examine inventory,

12 Subss. 152(1) and (2).

13 Subss. 152(3.1) and (4).
14 See 5.8, Liability of the Personal Representative for Tax and Clearance Certificates.
15 S. 231.1.

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11.8 Chapter 11 – Administration and Enforcement

• enter any premises where property or books or records are kept,

and
• require the taxpayer and any other person on the premises to assist
and answer questions relating to the administration of the Act.

In addition, a warrant may be issued to enter a residence to conduct an audit if

there are reasonable and probable grounds to believe that entry will be refused.

CRA may:

• Demand any person provide information and production of any

document by issuing a notice. Such demand may be for the pur-
pose of administering the Act, including collection, and for infor-
mation exchange with any country with which Canada has a tax
treaty.16
• Demand that a resident of Canada produces any “foreign-based
information or document,” which is defined to mean any infor-
mation or document that is available or located outside Canada
that may be relevant to the administration of the Act, including
collection.17
• Obtain an order for a search warrant to enter and search any build-
ing or place where CRA can convince a judge that there are reason-
able and probable grounds to believe that an offence under the
Act has been committed and that evidence of such offence may be
located in such building or place.18 In the conduct of a search war-
rant, documents or other items that afford possible evidence of the
commission of an offence may be seized.

To catch taxpayers who “cheat” by hiding assets in offshore accounts, the 2013
Federal Budget introduced the Offshore Tax Informant Program to give finan-
cial rewards to individuals who report Canadians with offshore accounts. This
program is part of “The Stop International Tax Evasion Program” launched on
January 15, 2014. While it demonstrates the government’s intention to increase
revenue by enforcement and collection, it coincides with significant CRA budget
cuts — calling into question the ability for CRA to effectively enforce the Act.

16 S. 231.2.
17 S. 231.6.
18 S. 231.3.

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JOINT AND SEVERAL LIABILITY UNDER THE ACT 11.10

11.9 COLLECTION

CRA has numerous collection powers under the Act. A simple procedure for col-
lection is provided for under s. 223. First, amounts of tax, interest, or penalties
or any amount payable under the Act, or under the provincial tax system (except
Quebec), are certified by the Minister as being payable by the taxpayer-debtor.
Once the certificate is registered in Federal Court, it has the effect of a judgment
for the debt payable, and proceedings may then be taken by way of execution to
enforce payment. Under ss. 224 to 226, CRA may enforce payment by:

• garnishment of salary, advances, or other amount due to a taxpayer,

• seizure of goods and chattels, or
• special immediate request for payment where a taxpayer is about
to leave Canada.

Other than for corporations, the right to enforce payment is suspended if a tax-
payer has an outstanding notice of objection or appeal regarding the matter,
unless the Minister can show that the delay would jeopardize the collection of
any amount ultimately owing. However, interest will continue to accrue dur-
ing the period of suspension on any unpaid amounts determined to be owing
once the objection or appeal has been resolved. The 2013 Federal Budget made
a change requiring 50% of the tax interest and penalties to be paid where the
assessment of a charitable donation tax shelter is under objection or appeal.

In certain cases, the right of garnishment for amounts under the Act takes prior-
ity over secured creditors.19

11.10 JOINT AND SEVERAL LIABILITY UNDER THE ACT

There are a number of situations under the Act in which a third party may be
jointly and severally liable for the amounts payable by a taxpayer.

• Rights to collect against transferees of property under s. 160 where

a tax debtor has transferred property to a non-arm’s length person
for inadequate consideration (cannot exceed the value of the prop-
erty transferred less the consideration paid by the transferee).
• Rights to collect against a transferee of property under s. 160 where
the attribution rules apply to the transfer.

19 Subss. 224(1.2) and 224(1.3).

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11.11 Chapter 11 – Administration and Enforcement

• Rights to collect against a parent of a child subject to the tax on

split income under subs. 160(1.2).
• Rights against a trustee, executor, or personal representative who has
distributed property without a clearance certificate under subs. 159(3).
• Rights against a beneficiary or recipient of registered retirement
savings plan (RRSP) or registered retirement income fund (RRIF)
proceeds where the estate has failed to pay the tax owing in respect
of the proceeds under subss. 160.2(1) and (2).

If CRA assesses a third party under one of the above circumstances, there is a
right of recovery against the taxpayer who has the primary tax liability. In the
case of a trust or estate, the third party has a right of recovery as against the
property of the trust or the estate.

11.11 CLEARANCE CERTIFICATES AND CERTIFICATES OF COMPLIANCE

The requirement and procedure for obtaining clearance certificates for an estate
or trust have been discussed earlier (see 5.8, Liability of the Personal Represen-
tative for Tax and Clearance Certificates).

The requirement and procedure for obtaining a certificate of compliance (or “sec-
tion 116 certificate”) has also been discussed (see 6.7.6, Disposition of Capital
Interest in a Trust by Non-Resident Beneficiary and Requirement for Certificate of
Compliance (S. 116 Clearance Certificate)).

11.12 NOTICES OF OBJECTION, APPEALS, REASSESSMENTS, AND TAX

LITIGATION

A taxpayer may appeal an assessment or reassessment by filing a notice of

objection in writing setting out the reasons for the objection and all the relevant
facts.20 For all trusts except GREs, the due date for the notice of objection is 90
days from the date of mailing of the notice of assessment or reassessment. For
individuals and GREs, the due date is one year after the filing deadline for the
return for the year under objection, or 90 days after the date of mailing of the
notice of assessment or reassessment, whichever is later. Assume, for example,
that a GRE is reassessed for the taxation year ending on January 31, 2017, on
December 1, 2017. The deadline for filing a notice of objection would be May 1,

20 Subs. 165(1).

11–12
NOTICES OF OBJECTION, APPEALS, REASSESSMENTS, AND TAX LITIGATION 11.12

2018. This is the later of the filing deadline for the 2017 tax year — 90 days after
January 31, 2018, being May 1, 2018, or 90 days after the notice of reassessment
being March 1, 2018 — subs. 165(1).

The preparation of notice of objection may be done by the taxpayer or other

professional on behalf of the taxpayer, such as an accountant or a lawyer. How-
ever, it may be advisable to have a lawyer prepare the notice of objection, par-
ticularly if there is a possibility that the matter may ultimately be appealed to the
Tax Court of Canada or beyond.

The appeals division of CRA will contact the taxpayer or the taxpayer’s represen-
tative to review and discuss the notice of objection. If the time for making a reas-
sessment within the normal period is drawing near, CRA may request a waiver
from the taxpayer, and this may also be requested in the course of an audit. If
the matter cannot be resolved at the CRA appeals level, CRA will confirm the
assessment or reassessment and the taxpayer has the option of further appeal
to the Tax Court of Canada. A taxpayer may also bypass the appeals division of
CRA and move the matter directly to the Tax Court of Canada if CRA does not
deal with an objection within 90 days.

At the Tax Court of Canada, there is an informal procedure for amounts in dispute
of $25,000 or less. The rules are less strict, and a taxpayer may be represented by
another person who does not need to be a lawyer. For other court proceedings,
a taxpayer can be represented only by a lawyer, unless self-represented. Appeals
from a decision of the Tax Court of Canada may be made to the Federal Court
of Appeal, and a further appeal is available, with leave, to the Supreme Court of
Canada.

Appeals to the Tax Court of Canada qualify as an informal procedure, as opposed

to the “general” procedure, if the total amounts at issue do not exceed $25,000.
At the informal hearing, a taxpayer may be represented by an agent who need
not be qualified as a lawyer, and some of the technical rules of evidence are
relaxed. In any other court proceedings, the taxpayer must be represented by a
lawyer unless the taxpayer chooses to be self-represented.

In some cases, a taxpayer may get relief from a tax problem by making an
application to the court to seek rectification of a document. Rectification is an
equitable remedy that can be granted by the courts in limited circumstances
where the documents implementing a transaction do not reflect accurately the
intention of the parties. In tax cases, one may be successful in accomplishing

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11.13 Chapter 11 – Administration and Enforcement

a retroactive amendment to fix a mistake in a document, such as a trust agree-

ment, where unintended tax consequences would otherwise apply. CRA must be
a party to any such application, and the court will not generally grant the order
if CRA objects. Even if the court does not require CRA’s consent, CRA may not
recognize any court-ordered relief if CRA was not made a party to the applica-
tion. CRA generally requires evidence that there was a genuine mistake with
respect to the intention of the parties and may require evidence to satisfy itself
that the tax consequences were not those resulting from the document. Recti-
fication most frequently is sought in tax matters usually to avoid a negligence
claim against professional advisors. (Also see comments at 10.1.1., Identifying
Opportunities and Problems in Tax Planning.)

11.13 DEDUCTIONS FROM INCOME

The cost of preparing a notice of objection or other further appeal under the Act
is deductible from income.21 The amount of any interest, penalties, or late-filing
penalties is not deductible.

11.14 OFFENCES UNDER THE ACT

The provisions of the Act dealing with offences are contained in ss. 238 and 239
of the Act. These offences are more of a criminal nature, sometimes referred to
as “quasi-criminal,” have more onerous penalties, and are subject to a different
standard of proof. Under s. 238, failure to comply with any provision of the Act
is subject to a fine of between $1,000 and $25,000 and imprisonment for up to
12 months.

Under s. 239, a person who has:

• made or participated in making false or deceptive statements,

• destroyed or otherwise tampered with books of account or records
for the purpose of evading tax,
• made or participated in making false entries in books of accounts
or records, or
• wilfully or in any manner evaded or attempted to evade compli-
ance with the Act or payment of tax

21 Para. 60(o).

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RELIEF FROM INTEREST AND PENALTIES 11.16

is guilty of an offence and is subject to a fine of 50% to 200% of the tax sought
to be evaded and to a sentence of imprisonment for up to two years.

These offences are prosecuted by the Department of Justice on behalf of the Min-
ister of National Revenue (the ministry of the federal government under which
CRA functions). Unlike other provisions of the Act, the onus is on the Minister to
prove, beyond a reasonable doubt, the facts necessary for a conviction. In other
proceedings under the Act, the Minister’s assertions or assumptions of fact relied
upon in assessing a taxpayer are assumed to be true, and it is up to the taxpayer
to show, on a balance of probabilities, that the assertions or facts are not correct.

11.15 SOLICITOR AND CLIENT PRIVILEGE

A lawyer is entitled to claim solicitor and client privilege with respect to any
request by CRA for disclosure of information or documents.22 This privilege does
not extend to accountants or other advisors. For example, in Tower v. M.N.R.,23
the Federal Court of Appeal ruled that a CRA auditor can require written answers
to questions and production of documents by the taxpayer’s accountant.

11.16 RELIEF FROM INTEREST AND PENALTIES

Subsection 220(3.1) of the Act provides CRA with the discretion to waive or
reduce all or a portion of interest and/or penalties payable by a taxpayer under
the Act. While subs. 220(3.1) of the Act makes it clear that CRA has complete
discretion with respect to whether it will grant relief in a particular situation,
limited levels of review are available. There is no relief from the liability to pay
income tax under this provision, only interest and penalties.

The application for relief must be made within 10 years from the end of the cal-
endar year in which the tax relief is being requested ended. This 10-year limita-
tion period has been softened as a result of the Federal Court of Appeal decision
in Bozzer v. R.,24 where it was determined that relief may be granted for interest
in respect of years before this 10-year period to the extent it accrued during the
10-year period.

22 S. 232.
23 Tower v. M.N.R., [2003] F.C.J. No. 1153 (Fed. C.A.).
24 2011 FCA 186.

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11.16.1 Chapter 11 – Administration and Enforcement

Under subs. 220(3.1), CRA has two programs for relief — voluntary disclosure
(see 11.16.1) and the taxpayer relief application (fairness) (see 11.16.2). These
are discussed separately below.

Prior to death, individuals often have a period of physical illness or diminished

emotional or mental capacity. It is not unusual in administering an estate to dis-
cover that there was a problem with the deceased’s income tax reporting and
payment in years prior to death. It is appropriate for the personal representa-
tive to consider the voluntary disclosure procedure to clear up any outstanding
tax issues, as a clearance certificate does not prevent a subsequent assessment
on the part of CRA. Alternatively, a taxpayer relief (fairness) application may
be appropriate where the taxpayer was already being audited prior to death or
there are outstanding unpaid assessments and extraordinary circumstances are
present.

11.16.1 Voluntary Disclosure

CRA has a policy not to levy criminal or civil penalties on a taxpayer who volun-
tarily discloses incorrect or missing and overdue tax filings.25 CRA may also pro-
vide relief from interest under the voluntary disclosure program, but it is their
stated policy to limit interest relief in the case of voluntary disclosure to interest
arising in respect of assessments for years or reporting periods preceding the
three most recent years of returns required to be filed.

CRA’s administrative policy as to when relief is to be granted under the volun-

tary disclosure program is outlined in Information Circular IC00-IR5, and for
applications commencing March 1, 2018, Information Circular IC00-1R6 applies.
The requirements for a voluntary disclosure application are:

• it must be truly voluntary,

• disclosure of information to CRA must be accurate and complete,
• it must involve the potential application of penalties, and
• it must include information that is at least one year late.

Both ICs provide a detailed explanation of what constitutes a “voluntary” disclo-

sure, but in general, if the taxpayer becomes aware of any audit, investigation,

25 Similar policies have been adopted by CRA for other taxes, including GST/HST, excise tax, and excise
duty.

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RELIEF FROM INTEREST AND PENALTIES 11.16.2

or other enforcement action by CRA, or CRA has started any inquiry, audit, or
enforcement action, the disclosure will be too late.

CRA’s policy is that if the application for voluntary disclosure is accepted, then
no penalties will be charged and partial interest relief may be available, and full
relief from penalties is available for any taxation year that ends in the previous
10 years before the calendar year in which the application for relief is filed and
interest may be reduced for the same periods. For applications received on or
after March 1, 2018, full relief will be available in some but not all circumstances.

The new policy outlined in IC00-1R6 is more restricted and has additional
requirements. There are restrictions as to who is eligible and the relief available.
There is a “two track” system: the General Program and the Limited Program.
Full relief will still be available for the prior 10-year period if the taxpayer quali-
fies for the General Program. The Limited Program may provide reduced relief
for those whose failure to comply has a less innocent nature — i.e., beyond
absentmindedness — and factors will include large dollar amounts, offshore
income, multiple years of non-compliance, and sophisticated taxpayers. All tax-
payers must pay the tax estimated to be owing with their application. The name
of the advisor who assisted with the subject matter of the application is to be
included with the application, and CRA requires that the taxpayer and the advi-
sor make full disclosure of all documents, records, and information as requested.

11.16.2 Taxpayer Relief under the Fairness Provisions

In addition to an application for voluntary disclosure, CRA has another pro-

cess for taxpayer relief or interest and penalties, called taxpayer relief or a “fair-
ness application.” CRA relies on the same statutory authority in subs. 220(3.1) to
provide relief from interest and penalties in response to a fairness application.
Accordingly, the relief that is available is the same, which includes all penalties
and all interest arising and accruing for the 10-year period prior to the applica-
tion. However, the administrative policy and process differs.

In both cases, CRA has discretion as to whether or not relief is to be granted

and how much relief to grant. The most significant difference is that unlike the
voluntary disclosure, the fairness measures do not require the taxpayer to come
forward voluntarily. A fairness application could be made, even where the assess-
ment for which penalties and interest relief is sought resulted from an audit or
other investigation.

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11.16.3 Chapter 11 – Administration and Enforcement

CRA’s policy with respect to a fairness application is set out in Information Cir-
cular IC00-1. Relief may be granted where the following factors may justify, at
CRA’s discretion, the taxpayer’s inability to satisfy a tax obligation or require-
ment at issue:

• extraordinary circumstances,
• actions of CRA, or
• inability to pay or financial hardship.

For example, a serious illness or serious emotional or mental distress resulting

from death of a family member might be an acceptable extraordinary circum-
stance leading to CRA granting relief. Financial hardship may include situations
where the payment of interest and/or penalties would result in prolonged inabil-
ity to provide the basic necessities of life or make it impossible for the taxpayer
to actually repay the outstanding tax owing. However, CRA will also take into
account whether there is a history of non-compliance, and whether the taxpayer
was negligent or careless in complying with the Act under the self-assessment
system.

11.16.3 U.S. Taxpayer Relief

There are also special U.S. tax procedures that may reduce the risk of an execu-
tor’s or fiduciary’s personal liability for the “short-sightedness” of the deceased
with respect to U.S. reporting and tax obligations. This may assist the personal
representative of an estate of a U.S. citizen who has failed to file U.S. income tax
returns.

11.17 TAX AVOIDANCE AND EVASION AND ETHICAL ISSUES FOR THE
ADVISOR

Generally, a taxpayer is entitled to order his or her affairs in a manner that attracts
the least tax. This was originally enshrined in the House of Lords decision from
England in the case of the Duke of Westminster,26 where it was stated that:

Every man is entitled if he can to order his affairs so as that the tax
attaching under the appropriate Act is less than it otherwise would be

26 I.R.C. v. Westminster (Duke), [1936] A.C. 1 (H.L.).

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TAX AVOIDANCE AND EVASION AND ETHICAL ISSUES FOR THE ADVISOR 11.17

. . . however inappreciative the Commissioners of Inland Revenue or his

fellow taxpayers may be of his ingenuity.27

However, the law of interpretation of tax legislation and the introduction in Can-
ada of the general anti-avoidance rule (GAAR) have eroded this principle, and at
present the “health of the Duke” is said to be failing if not in a coma. Case law
makes it very clear that in Canada a taxpayer may not circumvent the obligation
to pay tax by sham transactions, artificial transactions, or by schemes that run
contrary to the “object and spirit” of the Act as a whole.28

Legitimate strategies to minimize income tax liability, referred to as tax avoid-

ance, are considered appropriate for taxpayers and their advisors to investigate
and implement. Where there is a grey area of interpretation, the taxpayer may
be entitled to the benefit of doubt in taking a filing position, in the preparation
of a tax return, and the reporting of income. However, this practice must not be
a manifestation of the propensity to play the “audit lottery,” where questionable
planning is not fully disclosed in the tax return in the full knowledge that it will
not stand up to the scrutiny of CRA if it comes to light.

An example of a tax avoidance strategy, estate freezing, may be a case in point.

The strategy clearly is an attempt to defer tax and shift the burden of the tax on
future growth to the business owner’s heirs at some time in the future. However,
the strategy has been accepted by taxpayers and CRA as acceptable tax plan-
ning. In the U.S., by contrast, estate freezing is considered inappropriate and is
not recognized as legitimate tax planning.

On the other hand, when planning goes beyond legitimate interpretation of the
Act and case law and includes strategies that clearly offend or ignore the Act’s
rules, the taxpayer risks being accused of tax evasion. Tax evasion is a criminal
offence under the Act.

The line between aggressive tax planning (i.e., legitimate tax avoidance) and
tax evasion is not always clear, but it is one that professionals who specialize
in taxation should understand. Professionals may find they have legitimate dif-
ferences of opinion as to where the line should be drawn, and how particular
matters should be handled. There is no “whistle-blowing” obligation in the Act,
and the duty of maintaining client confidentiality is universal to tax and other

27 Ibid., at 19.
28 As the pre-GAAR case of Stubart Investments Ltd. v. R., [1984] S.C.J. No. 25 (S.C.C.) demonstrates.

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11.18 Chapter 11 – Administration and Enforcement

advisors. However, solicitor-client privilege only extends to lawyers. The work of

other advisors may also fall under solicitor-client privilege if they were engaged
by lawyers.

It is clear that the advisor can neither knowingly participate in, nor acquiesce
with respect to, a misrepresentation or omission for the purpose of evading tax,
nor willingly participate in assisting a client to engage in tax evasion. Advising
on positions that the CRA may ultimately disagree with or to which the GAAR
may successfully be applied (where there are legitimate differences of opinion),
however, will not result in penalties to an advisor.

The offences under the Act include not only overt acts but also acts of omission
and acquiescing in acts of evasion or omission. This may extend the possibility
of prosecution to the taxpayer’s advisors. In addition, there are two civil penal-
ties, non-criminal in nature, for third parties such as tax preparers, advisors, tax
shelter promoters, and valuators who cause or assist others in misrepresenting
their tax owing.29

A professional advisor also must adhere to the code of conduct that governs
his or her profession. If an advisor has concern that there is a problem relating
to improper conduct under the Act, he or she may consider withdrawing his or
her services, or refer the client to another professional for the matter under con-
cern. Solicitor-client privilege does not apply to communications between the
taxpayer and non-lawyer professionals. For this reason, it may be appropriate
to refer any matter concerning compliance, avoidance, or evasion, or any matter
that may incur penalties or be an offence under the Act to a lawyer.

11.18 KEY STUDY POINTS

• Failure to file returns on time can result in interest and penalties.

Interest will accrue and compound daily on unpaid tax and unpaid
penalties.
• Tax avoidance that involves strategies to reduce, eliminate, or defer
payment of tax as a result of the application of the provisions of
the Act and its interpretation is considered legitimate tax planning,
even if aggressive.

29 See s. 163.2 and IC01-1.

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KEY STUDY POINTS 11.18

• Tax evasion involves non-payment of taxes by wilfully conducting

one’s affairs in defiance of the application of the Act. Strategies
may include those designed to deceive, misrepresent, or conceal
income. The Act contains criminal-style offences that apply to tax
evasion with substantial monetary penalties and imprisonment.
The level of proof for such offences is beyond a reasonable doubt
and the onus of proof is on the Crown.
• CRA has enforcement powers under the Act that include rights to
audit and to compel disclosure, and collection powers that include
garnishment and seizure of property for payment of amounts
owing under the Act. Where criminal activity is alleged, powers are
greater and include obtaining warrants for search and seizure.
• A clearance certificate is required to protect an executor or trustee
from personal liability for taxes interest and penalties to the extent
of the value of property distributed.
• A transferee of property may become liable for the transferor’s lia-
bility under the Act if the transfer was not at fair market value and
the transferor and transferee were not dealing at arm’s length.
• Relief from interest and penalties may be available from CRA on a
discretionary basis under the Taxpayer Relief (Fairness) Program
and the Voluntary Disclosures Program.

11–21
 CHAPTER 12
FOREIGN JURISDICTION TAX ISSUES

LEARNING OBJECTIVES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–5

12.1 INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–5

12.2 U.S. ESTATE TAX FOR CANADIAN RESIDENTS WHO ARE

NON-RESIDENT ALIENS OF THE U.S. (NRAS) . . . . . . . . . . . . . . . . . . 12–6

12.2.1 The Two-Question Test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–6

12.2.2 Definition of U.S.-Situs Property . . . . . . . . . . . . . . . . . . . . . . . . 12–7
12.2.3 Definition of Worldwide Estate . . . . . . . . . . . . . . . . . . . . . . . . . 12–8
12.2.4 Requirement to File U.S. Estate Tax Return and Treaty
Relief for NRAs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–8
12.2.5 The Unified Credit and the Exemption Amount . . . . . . . . . 12–9
12.2.6 The Marital Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–10
12.2.7 Canadian Foreign Tax Credit . . . . . . . . . . . . . . . . . . . . . . . . . . 12–11
12.2.8 Example of U.S. Estate Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–11
12.2.9 Common Errors and Misconceptions about U.S. Estate
Tax for Canadians . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–12
12.2.9.1 The Value of U.S. Real Property Subject
to U.S. Estate Tax Is Net of Any Mortgage
against the Property . . . . . . . . . . . . . . . . . . . . . . . . 12–12
12.2.9.2 Property Held in a Personal Holding
Company Is Not Subject to U.S. Estate Tax . . . 12–13
12.2.9.3 Property Should Be Held in Joint Names to
Avoid U.S. Estate Tax on the First Death . . . . . . 12–13
12.2.9.4 If the U.S. Portfolio Is with a Canadian
Investment Dealer, the U.S. Securities Are
Exempt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–14
12.2.10 U.S. Estate Tax Planning for Residents of Canada Who
Are Not U.S. Citizens . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–14
12.2.10.1 Make Lifetime Gifts of U.S.-Situs Assets . . . . . . 12–14

12–1
 12.2.10.2 Gift by Will of U.S.-Situs Property to a U.S.
Charity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–14
12.2.10.3 Hold U.S. Securities in a Canadian
Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–15
12.2.10.4 Hold U.S. Investments through Canadian
Mutual Funds or Canadian Exchange Traded
Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–15
12.2.10.5 Taking Full Advantage of the Unified Credit
as Between Husband and Wife . . . . . . . . . . . . . . 12–15
12.2.10.6 Use Spousal Trusts in Both Wills of Husband
and Wife . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–16
12.2.10.7 Use a Qualifying Domestic Trust (Q-DOT) for
Assets Passing to a Surviving Spouse . . . . . . . . 12–16
12.2.10.8 Life Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–17
12.3 U.S. ESTATE TAX FOR U.S. CITIZENS LIVING IN CANADA . . . . . 12–17

12.3.1 U.S. Tax System Based on Citizenship: U.S. Citizens and

U.S. Persons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–17
12.3.2 Application of the Canada-U.S. Tax Convention (1980)
to U.S. Persons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–18
12.3.3 Calculation of U.S. Estate Tax for U.S. Persons . . . . . . . . . . 12–18
12.3.4 Requirement to File U.S. Income Tax Returns . . . . . . . . . . 12–18
12.3.5 Requirement to File a U.S. Estate Tax Return . . . . . . . . . . . 12–18
12.3.6 Other Reporting Requirements . . . . . . . . . . . . . . . . . . . . . . . 12–19
12.4 U.S. GIFT TAX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–19

12.4.1 U.S. Gift Tax for Donors Who Are NRAs (Non-Resident
Aliens — i.e., Not U.S. Persons) . . . . . . . . . . . . . . . . . . . . . . . . 12–19
12.4.2 U.S. Gift Tax for Donors Who Are U.S. Persons . . . . . . . . . . 12–20
12.5 TAXATION OF CANADIANS IN OTHER JURISDICTIONS ON
GIFTS AND INHERITANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–21

12.5.1 Gifts or Inheritances Received by Canadians . . . . . . . . . . . 12–21

12.5.2 Foreign Income Tax, Inheritance Taxes, and
Domestic Fees and Duties on Property Located
Outside Canada . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–21

12–2
12.6 OFFSHORE TRUST PLANNING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–22

12.6.1 Immigration Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–22

12.6.2 Inheritance Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–22
12.6.3 Foreign Trusts Deemed Resident in Canada . . . . . . . . . . . 12–23
12.7 ANNUAL FOREIGN REPORTING REQUIREMENTS . . . . . . . . . . . . 12–23

12.8 KEY STUDY POINTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12–23

12–3
12–4
 Chapter 12
Foreign Jurisdiction Tax Issues

Learning Objectives
Knowledge Objectives:
• Understand how tax laws of other jurisdictions may apply to estates of
Canadians.
• Understand when U.S. gift tax may apply.

Skills Objectives:
• Identify U.S. estate and gift tax issues.
• Appreciate how tax laws of other countries apply to Canadians.

12.1 INTRODUCTION

Throughout this material, it has been assumed, except where specifically stated,
that all parties to a transaction and all trusts are resident in Canada. In this chap-
ter, the potential impact of U.S. estate tax and gift tax on residents of Canada
will be examined for the purpose of issue identification. There is a brief discus-
sion regarding taxation of property located outside Canada in other jurisdictions.
There is also a brief discussion of offshore tax planning for the purposes of
identifying planning opportunities. The taxation of non-resident trusts is beyond
the scope of this material.

Tax and estate planning for a Canadian resident cannot be carried out without
an awareness of the possible exposure to U.S. estate and gift tax. Canadians
invest in U.S.-situs property that is subject to U.S. estate and gift tax. Americans

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12.2 Chapter 12 – Foreign Jurisdiction Tax Issues

move to Canada, often even becoming Canadian citizens, but may still be subject
to U.S. estate and gift tax (and U.S. income tax).

NOTE: The U.S. estate tax exemption amount (see Figure 12.2) and the U.S. gift tax exclusion amount (see Figure 12.4) are
indexed annually. You are responsible for accessing the STEP student resource materials to inform yourself of the amounts
applicable in the current calendar year. The student tutorial for the May exam in each year will include the updated amounts,
and/or the amounts will be included in an update available in the student resources section of the STEP website.

12.2 U.S. ESTATE TAX FOR CANADIAN RESIDENTS WHO ARE NON-RESIDENT
ALIENS OF THE U.S. (NRAS)

A resident of Canada who is a non-resident alien (NRA) of the U.S. may be sub-
ject to U.S. estate tax on U.S.-situs property with a total value over $60,000US if
the value of the worldwide estate is over certain limits.1 Other factors that affect
potential exposure to U.S. estate tax include the year of death and the extent
to which U.S.-situs property is inherited by a spouse or qualifying spousal trust
(QST). A Canadian resident may also be subject to gift tax on gifts of U.S.-situs
property. A non-resident alien is essentially an individual who is not a U.S. citi-
zen, and not a U.S. resident nor an individual whose domicile is the U.S. (for
discussion, see 12.3.1).

12.2.1 The Two-Question Test

The following two quick questions will determine whether a Canadian-resident

NRA faces potential exposure to U.S. estate tax and is required to file a U.S.
estate tax return:

1. Does the value of U.S.-situs property exceed $60,000US? If yes, pro-

ceed to question 2.
2. Does the value of the worldwide estate exceed the exemption
amount in effect for deaths in that year? If not, no U.S. estate tax
is payable, although there may still be an obligation to file a U.S.
estate tax return depending on the answer to question 1.

If the answer to question 1 is yes (U.S.-situs property has a value over $60,000US),
the estate has an obligation to file a U.S. estate tax return. However, the U.S.
estate tax credits available under the Canada-U.S. Treaty will be sufficient to

1 Throughout this chapter, unless otherwise specified, a reference to an “NRA” will refer to a Canadian
resident who is not a “U.S. person” — i.e., not a U.S. citizen, or not taxed as a U.S. person under U.S.
tax law.

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U.S. ESTATE TAX FOR CANADIAN RESIDENTS WHO ARE NON-RESIDENT ALIENS OF THE U.S. (NRAS) 12.2.2

eliminate any U.S. estate tax liability unless the answer to question 2 is also yes
(see 12.2.4).

If the answer to both questions is yes, further inquiry by a specialist in U.S. taxa-
tion is warranted since, in addition to the requirement to file a U.S. estate tax
return, U.S. estate tax may be payable.

Before these questions can be answered, the value of U.S.-situs property and
worldwide estate must be determined. See Figure 12.2, U.S. Estate Tax Exemp-
tion Amount and Unified Credit ($US), for the value of the exemption amount.
For deaths in 2017, the exemption amount is $5,490,000.

12.2.2 Definition of U.S.-Situs Property

U.S.-situs property subject to U.S. estate tax for NRAs includes:

• U.S. real estate, including condominiums, co-operatives, and time

shares;
• household goods and other property normally located in the U.S.,
including furniture, artwork, cars, and boats;
• U.S.-issued stocks, mutual fund units, and money market units;
• U.S. pension plans; and
• debt issued by U.S. persons or entities, or debt secured against
U.S.-situs property, such as vendor takeback mortgages on sales of
U.S. real estate.

U.S. law includes “look through” rules for some trusts. These rules apply to
property held in an alter ego trust, a registered retirement savings plan (RRSP),
a registered retirement income fund (RRIF), or a tax-free savings account (TFSA).

Property not considered U.S.-situs property includes:

• American depository receipts, since the underlying security is not

issued by a U.S. entity,
• securities listed in U.S. dollars but issued by a non-U.S. entity,
• Canadian mutual funds and Canadian exchange traded funds
(ETFs) that hold U.S. securities,
• most U.S. bonds,

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12.2.3 Chapter 12 – Foreign Jurisdiction Tax Issues

• U.S. Treasury bills and U.S. certificates of deposit, and

• U.S. bank accounts.

12.2.3 Definition of Worldwide Estate

The value of the worldwide estate will determine whether the estate is exempt
from U.S. estate tax, and if it is not, the value is also relevant in calculating
the amount of the pro-rated unified credit that NRAs are entitled to under the
Canada-U.S. Tax Treaty. “Worldwide estate” includes all U.S.-situs property as
defined above, plus all other property owned by the deceased, wherever situ-
ated, whether it passes through the estate or outside the estate by way of joint
ownership or beneficiary designation. It includes life insurance if the deceased
was the owner of the policy (determined by such things as the right to name a
beneficiary and the person who pays the premiums) or the insurance is paid to
the deceased’s estate. It also includes RRSPs, RRIFs, and TFSAs.

Property held in trust for an individual in an alter ego trust (AET), joint spou-
sal or common-law partner trust ( JPT), bare trust, revocable trust, and any trust
where the beneficiary has a general power of appointment will also be included.
The power of appointment may catch certain spousal trusts where the spouse is
also a trustee and there is no restriction on the appointment of capital.

12.2.4 Requirement to File U.S. Estate Tax Return and Treaty Relief for NRAs

Even if the value of U.S.-situs property is over $60,000US, there may be no U.S.
estate tax in some cases, based on the applicable exemption amount and the
credits described below. However, once the value of U.S.-situs property is over
the $60,000US threshold, a U.S. estate tax return is required, whether or not U.S.
estate tax is payable. The deadline is nine months following the date of death,
although it is possible to file for an extension. It may also be necessary to obtain
proof of Internal Revenue Service (IRS) clearance in order to have U.S.-situs
property transferred into the name of the executor, personal representative, or
a beneficiary. This could be required by the land registry authorities for real
property, a transfer agent for publicly traded shares, or a purchaser of U.S.-situs
property.

Under the Canada-U.S. Convention with Respect to Taxes on Income and on

Capital (less formally called the Canada-U.S. Tax Convention (1980), or the
Canada-U.S. Tax Treaty), a number of tax reductions are available for NRAs. This

12–8
U.S. ESTATE TAX FOR CANADIAN RESIDENTS WHO ARE NON-RESIDENT ALIENS OF THE U.S. (NRAS) 12.2.5

includes the exemption in the two-question test discussed earlier (see 12.2.1),
the pro-rated unified tax credit, the marital credit, and the Canadian foreign
tax credit available to reduce Canadian tax in the Canadian final return of the
deceased. None of these reductions in U.S. estate tax or Canadian income tax is
available if no U.S. estate tax return is filed on behalf of the deceased. Since in
many cases the estate will have no additional tax liability as a result of the ben-
efits under the treaty, it is extremely important that the U.S. estate tax return is
filed to claim these benefits. Executors should be aware of the potential liability
(possibly personal liability) that the loss of treaty benefits could cause if they fail
to file a U.S. estate tax return.

12.2.5 The Unified Credit and the Exemption Amount

The unified credit is a tax credit that reduces U.S. estate tax for all U.S. per-
sons. The exemption amount determines the amount of the unified credit and
is indexed annually. The amount of the unified credit available will completely
offset the tax on the exemption amount. So, for example, in 2017, an estate
of $5,490,000US actually has U.S. estate tax of $2,141,800US before the uni-
fied credit (see Figure 12.1), but the unified credit is exactly this amount —
$2,141,800US — providing a complete reduction of tax on estates with a value
up to $5,490,000US for deaths in 2017.

Figure 12.1: U.S. Estate Tax Exemption Amount and Unified Credit ($US)

Unified Credit (tax on

Year of Death Exemption Amount exemption amount) Top Rate
2015 $5,430,000 $2,117,800 40%
2016 $5,450,000 $2,125,800 40%
2017 $5,490,000 $2,141,800 40%

NRAs are entitled to a portion of the unified credit. The estate tax is first calcu-
lated by applying the rates (see Figure 12.2) to the value of U.S.-situs property.
The portion of the unified credit for the year available (see Figure 12.2) must
then be calculated to determine the U.S. estate tax liability, if any. The portion
available is the same proportion as the value of U.S.-situs property to the value
of worldwide property. For example, if the value of U.S.-situs property is 10% of
the value of worldwide property, 10% of the unified credit is available. Note that
although only a portion of the unified credit is available to NRAs, the pro-rated
amount will always completely offset the tax on estates with a worldwide value

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12.2.6 Chapter 12 – Foreign Jurisdiction Tax Issues

equal to or less than the exemption amount, no matter what the value of the
U.S.-situs property.

Figure 12.2: U.S. Estate Tax Rate Table ($US)

Property Value Estate Tax on First Amount Tax Rate 0n Balance

$60,000 $13,000 26%
$80,000 $18,200 28%
$100,000 $23,800 30%
$150,000 $38,800 32%
$250,000 $70,800 34%
$500,000 $155,800 35%
$750,000 $248,300 39%
$1,000,000 $345,800 40%

Under the changes introduced in December 2010, any unused exemption amount
(which generates the unified credit) is “portable” to the surviving spouse upon
his or her death. However, this portability of the exemption amount between
spouses is only available where both spouses are U.S. persons. So a married cou-
ple living in Canada will not have access to this benefit unless both the parties
to the marriage are U.S. persons. For Canadian married couples, special plan-
ning may be necessary to ensure the couple can “double up” on the exemption
amount.

12.2.6 The Marital Credit

The marital credit is available if the U.S.-situs property is inherited by the spouse
of the deceased, either directly or through a QST. The marital credit is equal to,
and in addition to, the portion of the unified credit available, assuming all U.S.-
situs property is inherited by the spouse or QST. If the spouse inherits less than
all the U.S. property, the amount of the marital credit may be less than the por-
tion of the unified credit available. As a result of the marital credit, on the first
death the value of the estate that is fully exempt can be almost twice as much as
the exemption amount for U.S. estate tax. However, on the death of the surviv-
ing spouse, only the exemption amount will be available to shelter the tax. For
example, based on the rules in effect for deaths in 2017, if the surviving spouse
inherits all U.S.-situs property, the combination of the unified credit and marital
credit will ensure that an estate with a value of almost $10,980,000US will be
exempt from tax on the first death. If there is no surviving spouse, an estate with
a value of $5,490,000US will be exempt.

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U.S. ESTATE TAX FOR CANADIAN RESIDENTS WHO ARE NON-RESIDENT ALIENS OF THE U.S. (NRAS) 12.2.8

For Canadian individuals, common-law relationships, including same-sex rela-

tionships, may be recognized for the purposes of U.S. estate and gift tax laws
where they are recognized under Canadian law. This may be more liberal than
the U.S. domestic situation where common-law and same-sex relationships are
not as likely to be recognized. However, note that in 2013, the U.S. Supreme
Court in United States v. Windsor2 held that same-sex married couples are enti-
tled to the same tax benefits, including estate tax credits, as heterosexual mar-
ried couples, and in 2015 same-sex marriage was recognized.

12.2.7 Canadian Foreign Tax Credit

If U.S. estate tax is payable even after the portions of the unified credit and mari-
tal credit are calculated, additional relief is available in the form of a Canadian
foreign tax credit in respect of the U.S. estate tax paid. The Canadian foreign tax
credit would be claimed in the Canadian final return of the deceased. This tax
credit is not available under domestic law in Canada, only under the Canada-U.S.
Tax Treaty. The credit is only available to offset the Canadian tax on U.S. source
income, including capital gains, from property that is subject to U.S. estate tax.
For example, U.S. source income for this purpose would include capital gains
arising on death from the deemed disposition of U.S.-situs property. The Cana-
dian tax on such gains can be offset by the U.S. estate tax payable.

12.2.8 Example of U.S. Estate Tax

Max died in 2017 with an estate of $8,000,000US. Max is a Canadian resident

who is an NRA of the U.S. and has a condominium in Hawaii worth $2,000,000.
Max has no spouse and his children are his sole beneficiaries.

Two-Question Test

1. Is the total value of U.S.-situs property over $60,000US? Yes,

continue.
2. Is the value of worldwide property over the exemption amount of
$5,490,000US for deaths in 2017? Yes, continue.

Since the answer to question 1 is yes, a U.S. estate tax return must be filed. Since
the answer to question 2 is also yes, further investigation by a U.S. tax expert is
warranted.

2 570 U.S. (2013) (Docket No. 12-307).

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12.2.9 Chapter 12 – Foreign Jurisdiction Tax Issues

Max’s legal representatives must file a U.S. estate tax return, both as a matter
of U.S. tax law and also in order to be able to transfer legal title of the condo-
minium property. Also, filing a U.S. estate tax return will ensure access to the
pro-rated unified credit and marital credit available under the treaty. See Figure
12.3 for a simplified calculation of the U.S. estate tax liability.

Figure 12.3: U.S. Estate Tax Liability

Determine U.S.-situs property $2,000,000US

Determine worldwide property $8,000,000US
U.S. estate tax on $2,000,000US from Figure 12.2 $345,800 + $400,000 = $745,800
Unified credit for year from Figure 12.1 for 2017 $2,141,800US
U.S.-situs property/worldwide property 2,000,000 /8,000,000 = .25
Portion of unified credit available .25 X $2,141,800US $535,450
U.S. Estate Tax $745,800 – 535,450 = $210,350

Since the U.S.-situs property was worth 25% of Max’s worldwide estate, the por-
tion of the unified credit permitted under the treaty is 25%. If Max were married
and his wife inherited the property, an additional marital credit equal to the
portion of unified credit available of $535,450 would reduce tax payable to nil.
However, U.S. estate tax may be payable on the death of the wife, since the mari-
tal credit will not be available.

If a capital gain was reported on the property in the deceased’s Canadian termi-
nal return, the U.S. estate tax would be available in Canada to reduce the Cana-
dian income tax on the capital gain.

12.2.9 Common Errors and Misconceptions about U.S. Estate Tax for Canadians

12.2.9.1 The Value of U.S. Real Property Subject to U.S. Estate Tax Is Net
of Any Mortgage against the Property
This is false. Only the value of any non-recourse debt may be deducted
directly from the value of U.S.-situs property. “Non-recourse debt” is an
obligation that is enforceable only against the property pledged as secu-
rity, and the owner cannot be forced to pay the debt personally from
other resources.

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U.S. ESTATE TAX FOR CANADIAN RESIDENTS WHO ARE NON-RESIDENT ALIENS OF THE U.S. (NRAS) 12.2.9.3

12.2.9.2 Property Held in a Personal Holding Company Is Not Subject to

U.S. Estate Tax
This is partly true. If property is held in a Canadian corporation, any
U.S.-situs property in the corporation will not generally be subject to
U.S. estate tax. (Note that there are exceptions: for example, if the cor-
poration is structured solely to avoid U.S. estate tax to the point that is
considered a sham, it may be subject to U.S. anti-avoidance rules that
would look through the corporation.) The use of a corporation to hold
U.S. securities can be effective to reduce the exposure to U.S. estate tax.
However, this structure can result in double tax in Canada on the death
of the shareholder unless further post-mortem planning is done.

Since 2005, purchasing U.S. real estate in a “single-use personal holding

corporation” for the purposes of avoiding U.S. estate tax has not been an
option. Prior to 2005, this was a common method used to hold personal-
use real estate such as a Florida condominium or Arizona property. CRA
had a lenient administrative policy with respect to the shareholder ben-
efit rules that made this method of holding U.S. recreational property
popular for Canadians. Although this strategy is no longer available for
new transactions, arrangements that were in place prior to January 1,
2005, are grandfathered.

12.2.9.3 Property Should Be Held in Joint Names to Avoid U.S. Estate Tax
on the First Death
This is false. If property is held jointly with a right of survivorship, it will
be assumed that 100% of the property was owned by the joint owner
upon death, unless the contrary can be proven to the IRS, assuming
both joint owners are NRAs. This is particularly onerous, since the prop-
erty will also be included 100% in the estate of the surviving spouse and
potentially subject to U.S. estate tax in full a second time. If property is
held without a right of survivorship (e.g., as tenants in common and not
as joint tenants), only the deceased person’s share will be counted in
determining the value of U.S.-situs property and the value of the world-
wide estate.

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12.2.9.4 Chapter 12 – Foreign Jurisdiction Tax Issues

12.2.9.4 If the U.S. Portfolio Is with a Canadian Investment Dealer, the

U.S. Securities Are Exempt
This is false. It is the identity or residence of the issuer, not the loca-
tion of the account, that determines whether the securities are U.S.-situs
property.

12.2.10 U.S. Estate Tax Planning for Residents of Canada Who Are Not U.S.
Citizens

A number of strategies are available to reduce U.S. estate tax for residents of
Canada. A U.S. professional should always be consulted regarding any tax plan-
ning strategies to reduce U.S. estate tax. The U.S. gift tax rules, Canadian and
U.S. income tax rules, the effect of the treaty, and the estate planning objectives
of the client must all be considered before commencing any U.S. estate planning
implementation. This typically requires input from both U.S. and Canadian advi-
sors, ideally all of whom specialize in cross-border planning.

There are also planning techniques available to U.S. citizens who are resident in
Canada. However, these are not specifically included here.

12.2.10.1 Make Lifetime Gifts of U.S.-Situs Assets

If the value of U.S.-situs assets is reduced, so is the U.S. estate tax liabil-
ity. Gifts of U.S.-situs property may be made annually to any recipient
with a value not exceeding the annual gift tax exclusion amount, being
$14,000US for 2017 or $149,000US for 2017 for gifts to a spouse who is
not a U.S. person. Over time a substantial reduction of U.S.-situs prop-
erty can be made in this manner as the limit is per recipient and both a
husband and wife may make such gifts (i.e., $28,000US to each recipi-
ent in 2016 and 2017, for total gifts of $56,000US in a two-year period).
Property gifted to a spouse will still be subject to U.S. estate tax on the
death of the spouse.

12.2.10.2 Gift by Will of U.S.-Situs Property to a U.S. Charity

U.S.-situs assets donated on death to a U.S. charity will be deducted
from both the U.S.-situs assets and the U.S. taxable estate.

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U.S. ESTATE TAX FOR CANADIAN RESIDENTS WHO ARE NON-RESIDENT ALIENS OF THE U.S. (NRAS) 12.2.10.5

12.2.10.3 Hold U.S. Securities in a Canadian Corporation

The shares of a Canadian corporation holding U.S. securities will not be
considered U.S.-situs property. Caution should be exercised if an exist-
ing U.S. portfolio is transferred into a Canadian corporation for the sole
purpose of U.S. estate tax avoidance, as a U.S. anti-avoidance rule may
apply. For reasons discussed in the study materials (and subject to U.S.-
situs property acquired before January 1, 2005, under arrangements that
are grandfathered), a corporation should no longer be used to hold per-
sonal use U.S.-situs real estate.

12.2.10.4 Hold U.S. Investments through Canadian Mutual Funds or

Canadian Exchange Traded Funds
Generally, Canadian mutual funds and Canadian exchange traded funds
(ETFs) will not be considered U.S.-situs property even if the fund invests
in U.S. securities.

12.2.10.5 Taking Full Advantage of the Unified Credit as Between Husband

and Wife
Canadian individuals are entitled to a portion of the unified estate tax
credit. Where possible, a husband and wife can hold property to maxi-
mize the use of the available credit on the death of each spouse. This,
combined with the use of spousal trusts (see 12.2.11.6, Use Spousal
Trusts in Both Wills of Husband and Wife) can significantly reduce the
exposure to U.S. estate tax of a married couple. Note that special rules
apply to jointly held property, and generally for U.S. estate tax planning
purposes it is better not to hold property jointly with a right of survi-
vorship. Transferring U.S.-situs property from one spouse to another to
implement this strategy may attract U.S. gift tax (except for intangible
U.S.-situs property), or could result in problems with mismatching of
U.S. tax with the Canadian foreign tax credit because of the Canadian
attribution rules. On sale of the property or on death, U.S. tax will be
a liability of the owner, whereas Canadian tax will be a liability of the
other spouse. As a result, if there is an accrued gain on the property,
this can result in a mismatch and no foreign tax credit will be available
to offset the Canadian tax on the gain.

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12.2.10.6 Chapter 12 – Foreign Jurisdiction Tax Issues

12.2.10.6 Use Spousal Trusts in Both Wills of Husband and Wife

The use of “criss-cross” spousal trusts in both Wills of a husband and
wife, where each provides a spousal trust for the benefit of the surviv-
ing spouse, may reduce the potential U.S. estate tax on the death of the
surviving spouse although these must be properly structured to achieve
the U.S. objectives. In addition, such trusts are usually designed to bene-
fit from the spousal rollover under Canadian rules. The spousal trust can
reduce the U.S. taxable estate of the surviving spouse because assets in
the spousal trust are not included in the surviving spouse’s estate for
U.S. estate tax purposes. U.S. investments could be used to fund such a
trust, and this would have the result of significantly reducing U.S. estate
tax on the death of the survivor. A restriction on discretion to distribute
capital, other than realized capital gains, from the trust to the surviv-
ing spouse may be necessary in order to ensure the trust assets are
excluded from the estate of the surviving spouse for U.S. purposes. In
some cases, the right to encroach on capital must be subject to what are
referred to as “HEMS” purposes. “HEMS” stands for health, education,
maintenance, and support. The U.S. rules are very strict in this area, and
U.S. counsel must review the Wills.

In order to use this strategy, assets must be held separately as between

husband and wife (and not jointly with a right of survivorship) so they
will form part of the estate of the first to die. The trust can be a qualify-
ing spousal trust for Canadian tax purposes so that the rollover is avail-
able if during lifetime of the surviving spouse all net income is payable
to the surviving spouse and no one other than the surviving spouse is
entitled to the capital of the trust.

12.2.10.7 Use a Qualifying Domestic Trust (Q-DOT) for Assets Passing to a

Surviving Spouse
Where assets are bequeathed to a qualifying domestic trust (Q-DOT),
an NRA of the U.S. can use the marital deduction (in lieu of the marital
credit) to eliminate U.S. estate tax on assets passing to the trust on the
first death. However, this strategy results in a deferral rather than a tax
saving as all assets in the trust will be taxed either on distribution dur-
ing lifetime of the surviving spouse or on the death of the surviving
spouse. U.S. rules set out the terms for a spousal trust to qualify as a
Q-DOT. Among other requirements, the trust must have a U.S. trustee.

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U.S. ESTATE TAX FOR U.S. CITIZENS LIVING IN CANADA 12.3.1

12.2.10.8 Life Insurance

Life insurance can be used to fund the U.S. estate tax liability in appro-
priate circumstances. Life insurance issued on the life of the Canadian
individual will not be U.S.-situs property even if the policy is issued by
a U.S. entity. In addition, the value of the death benefit can be excluded
from the worldwide estate if the deceased did not own the policy. For
this reason, it may be advantageous to transfer ownership of the life
insurance to a trust or other person to avoid reducing the amount of
estate unified credit and marital credit.

12.3 U.S. ESTATE TAX FOR U.S. CITIZENS LIVING IN CANADA

12.3.1 U.S. Tax System Based on Citizenship: U.S. Citizens and U.S. Persons

The U.S. tax system is unique in that it is based on citizenship. This means U.S.
citizens are taxed under the U.S. tax system, including income tax and estate
and gift tax, no matter where they are resident and no matter what their source
of income. Essentially U.S. citizens and other U.S. persons (see below) are taxed
on their worldwide income and all gifts made during lifetime, and on death
are taxed on their worldwide property, no matter where they are resident. U.S.
residents are subject to the same rules as U.S. citizens. For this purpose, a “U.S.
resident” is any person who is domiciled in the U.S. “Domicile” is a legal concept
that is similar to residence, but it refers to a person’s place of intended perma-
nent residence rather than their current place of residence. It generally requires
physical presence in the U.S. with an intention to remain, and generally includes
green card holders even if they are not physically present in the U.S. For U.S.
estate and gift tax purposes, a person may be domiciled in the U.S. and consid-
ered a U.S. resident if he or she:

• has a valid U.S. green card (immigration card) that has not been
surrendered, regardless of country of residence,
• currently resides in the U.S. and intends to reside in the U.S. on a
permanent basis, or
• does not currently reside in the U.S. but intends to reside in the
U.S. on a permanent basis sometime in the future.

For the purposes of this discussion, the term “U.S. person” will include U.S. citi-
zens and persons considered U.S. residents as defined above.

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12.3.2 Chapter 12 – Foreign Jurisdiction Tax Issues

12.3.2 Application of the Canada-U.S. Tax Convention (1980) to U.S. Persons

The application of the Canada-U.S. Tax Convention (1980), commonly called the
Canada-U.S. Tax Treaty, to U.S. persons who are resident in Canada is unique,
and such persons may not be entitled to the same relief under the treaty as other
residents of Canada. For example, many U.S. advisors take the view that a U.S.
person is not entitled to the marital credit for U.S. estate tax under the Canada-
U.S. Tax Treaty.

12.3.3 Calculation of U.S. Estate Tax for U.S. Persons

U.S. persons will not be subject to U.S. estate tax if the value of the worldwide
estate does not exceed the exemption amount (net of lifetime gifts in excess of
the gift tax annual exclusion amount) because of the unified credit.

U.S. persons are subject to tax on the value of the worldwide estate (see Figure
12.2) and are entitled to the full amount of the unified credit for the year of
death (see Figure 12.1), resulting in the applicable exemption amount for U.S.
estate tax. There is no marital credit available. Instead, a full “marital deduction”
is available for all amounts transferred to a spouse who is a U.S. citizen or to
certain qualifying spousal trusts.

12.3.4 Requirement to File U.S. Income Tax Returns

The U.S. income tax treatment of U.S. persons is well beyond the scope of this
material and is only highlighted here. A U.S. person is required to file annual
U.S. income tax returns each year regardless of country of residence. U.S. per-
sons who are not resident in the U.S. may be entitled to a foreign earned income
exclusion — an “expatriate” deduction from U.S. income. Foreign tax credits are
generally provided to avoid double taxation. For example, a foreign tax credit
for U.S. income tax paid by a Canadian resident may be available to reduce
Canadian tax on U.S. source income.

12.3.5 Requirement to File a U.S. Estate Tax Return

The personal representatives must file a U.S. estate tax return for the estate of a
deceased U.S. person and must pay any tax owing. The executors may become
personally liable for failure to pay U.S. estate tax. Under the Canada-U.S. Tax
Treaty, the U.S. can use the powers under the Canadian tax system (i.e., the

12–18
U.S. GIFT TAX 12.4.1

powers under the Canadian Income Tax Act and CRA) to carry out collection of
unpaid U.S. estate tax owing by U.S. persons or their estates.

12.3.6 Other Reporting Requirements

U.S. persons who receive assets from an estate may become responsible for any
U.S. estate tax that has not been paid. In addition, a U.S. person must report the
receipt of property from a foreign resident, including a foreign estate, to the IRS.
No tax is payable, but the information and identity of the deceased person must
be reported to the IRS.

12.4 U.S. GIFT TAX

In addition to U.S. estate tax on death, the U.S. imposes gift tax on lifetime gifts.
The tax is imposed on the donor. Unlike U.S. estate tax, there is no relief for U.S.
gift tax under the Canada-U.S. Tax Treaty. The gift tax discussion applies to any
NRA of the U.S. whether resident in Canada or not.

12.4.1 U.S. Gift Tax for Donors Who Are NRAs (Non-Resident Aliens — i.e., Not
U.S. Persons)

For NRAs, only gifts of U.S.-situs property are subject to U.S. gift tax. The U.S.-
situs property subject to U.S. gift tax is identical to the property subject to U.S.
estate tax for NRAs, except that intangible property is excluded under U.S.
domestic law. This means that for NRAs, U.S. stocks and bonds are not subject to
U.S. gift tax, even though they are subject to U.S. estate tax. So, for example, a
gift of U.S. securities is not subject to U.S. gift tax.

NRAs will be subject to gift tax on any amount gifted to a person in excess of
the annual gift tax exclusion amount. The annual exclusion amounts for gifts are
indexed each year for inflation (see Figure 12.4).

Figure 12.4: U.S. Gift Tax: Annual Exclusion Amount

To NRA Spouse or Spouse

Year of Gift who is not a US Person To each other individual
2015 $147,000 $14,000
2016 $148,000 $14,000
2017 $149,000 $14,000

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12.4.2 Chapter 12 – Foreign Jurisdiction Tax Issues

NRAs may make annual U.S. tax-free gifts of U.S.-situs property to any number
of individual recipients for amounts not exceeding the annual gift tax exclusion
amount. For gifts in 2017, this amount is $14,000US per recipient, or $149,000US
for gifts to a spouse who is an NRA. Gifts between common-law or same-sex
partners may not be entitled to the spousal exclusion amount under U.S. gift tax
rules but would be eligible for the $14,000US annual gift tax exclusion amount
for gifts to other recipients. However, under the 2012 U.S. Supreme Court deci-
sion in Windsor, same-sex married spouses must be treated identically to other
married couples.

For individuals who are not U.S. persons, gifts of U.S.-situs property cannot be
sheltered by the U.S. estate tax unified credit,3 and there is no other relief pro-
vided under the treaty. This contrasts with U.S. persons who can shelter lifetime
gifts in excess of the annual gift tax exclusion by using the unified credit. The
U.S. estate tax return includes a requirement to report lifetime gifts of U.S.-situs
property, and because the unified credit may not be used to shelter the U.S. gift
tax for gifts by non-U.S. persons, the requirement to file a U.S. estate tax return
may prove very onerous even if no U.S. estate tax is payable.

12.4.2 U.S. Gift Tax for Donors Who Are U.S. Persons

U.S. persons are subject to gift tax on gifts of all property, including intangible
property. Gifts to the husband or wife of an individual are 100% exempt in the
same way the marital deduction exempts the inheritance of a spouse from U.S.
estate tax, providing the spouse is recognized as a spouse for U.S. purposes
(i.e., legally married or recognized under local law) and the spouse is also a U.S.
person.

Where U.S. persons are resident in Canada, caution must be exercised in trans-
ferring assets between husband and wife where one is a U.S. person and the
other is not. Canadian couples generally pass ownership of property back and
forth between themselves or in and out of joint accounts without any Cana-
dian tax consequences, as the rollover rules and attribution rules apply to pre-
serve the pre-existing tax attributes and reporting of income and capital gains
on the property. However, this is not the case for U.S. purposes where a U.S.
person transfers property to a spouse who is not a U.S. person. Such trans-
fers, if done by way of gift (without consideration), or with inadequate financial

3 This is only available to shelter taxable gifts made by U.S persons, as discussed below.

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TAXATION OF CANADIANS IN OTHER JURISDICTIONS ON GIFTS AND INHERITANCE 12.5.2

consideration, are subject to U.S. gift tax if over the annual exemption amount
for gifts to a spouse ($149,000US in 2017).

Lifetime gifts by U.S. persons that are not sheltered by the annual gift tax exclu-
sion amount can be sheltered by the unified credit available under the U.S. estate
tax rules. The use of the unified credit to shelter lifetime gifts will reduce the
unified credit available on death. It is not available to shelter non-exempt life-
time gifts by non-U.S. persons.

U.S. persons who receive gifts from an NRA or non-U.S. person are subject to
U.S. information disclosure reporting if they receive gifts in excess of $100,000
in the aggregate in any year.

12.5 TAXATION OF CANADIANS IN OTHER JURISDICTIONS ON GIFTS AND

INHERITANCE

12.5.1 Gifts or Inheritances Received by Canadians

Under most legal and tax systems, a beneficiary is not subject to taxation on a
gift or inheritance. It is more practical to tax the estate in the case of death, or
the donor in the case of the gift, as death and transfers of property are gener-
ally reportable events under most income and estate and gift tax regimes. As
a result, a Canadian beneficiary will seldom be responsible for taxes or other
duties owing on a gift or inheritance received from a donor or an estate residing
in another country.

12.5.2 Foreign Income Tax, Inheritance Taxes, and Domestic Fees and Duties on
Property Located Outside Canada

If a Canadian has property located outside Canada, it may be prudent to inquire

regarding possible income tax (including capital gains) and inheritance taxes or
other duties that may be imposed by the other jurisdiction on the death of the
Canadian owner. If any such foreign duties or inheritance taxes exist, they gen-
erally will apply only to real property (or immoveable property) located in that
jurisdiction, either as a result of domestic law or as a result of treaty protection
as discussed below.

In making preliminary inquiries, it may be helpful to consult the STEP Year-

book, which contains summaries of income and inheritance taxes for many
jurisdictions.

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12.6 Chapter 12 – Foreign Jurisdiction Tax Issues

Canada has income tax treaties with most countries that are members of the
Organisation for Economic Co-operation and Development (OECD). These trea-
ties are generally based on the OECD model that exempts capital gains on mov-
able property owned by a non-resident of a particular country. If capital gains
tax is imposed on real property located in another country upon the death of
the owner, the tax paid to the foreign jurisdiction will generally be available for
a foreign tax credit in Canada to reduce the income tax payable in respect of any
capital gain in Canada on that property. The only Canadian treaty that provides
some level of relief for inheritance tax is the Canada-U.S. treaty, as discussed ear-
lier in this chapter.

12.6 OFFSHORE TRUST PLANNING

The details of offshore trust planning are beyond the scope of this material. The
taxation of non-resident trusts in Canada is extremely complex and has been the
subject of constant revision and proposed reform. The non-tax specialist should
always refer clients to an expert when these issues arise.

It is appropriate nonetheless to be alert to some of the opportunities that may

warrant specialized advice. Offshore trusts may be appropriate in the following
situations if properly structured.

12.6.1 Immigration Trusts

An individual who has not been resident in Canada for more than 60 months
may settle an offshore immigration trust for the benefit of other family members,
and may shelter income and capital gains from tax in Canada for up to five years
(60 months). The creation of an effective immigration trust is very technical and
should always be implemented with the assistance of a specialist in this area.

12.6.2 Inheritance Trusts

A non-resident of Canada who has never been resident in Canada may set up
an offshore trust to hold the inheritance of a Canadian beneficiary. This must be
done before the non-resident has died, as part of his or her estate plan. The trust
is created during the lifetime of the non-resident or under the terms of his or her
Will. After the death of the non-resident, income or capital gains earned in the
trust that are not payable or distributed to the Canadian beneficiary will not be
taxed in Canada. Once income and capital gains are accumulated in the trust, in

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KEY STUDY POINTS 12.8

years subsequent to the year they were earned, they may be paid tax-free to the
Canadian beneficiary as distributions of capital.

12.6.3 Foreign Trusts Deemed Resident in Canada

There are situations where a non-resident can inadvertently create a trust that is
deemed to be resident in Canada under Canadian tax law. Section 94 of the Act
can catch innocent mistakes. While this is referred to briefly in an earlier section
of the book (see 4.3.3, Residence of a Trust), the topic is generally beyond the
scope of this material.

12.7 ANNUAL FOREIGN REPORTING REQUIREMENTS

Canadian residents are required to report certain interests in respect of foreign

property:

• ownership of certain foreign property where the value based on

cost amount exceeds $100,000 in Canadian dollars in the year,
under s. 233.3 (T1135),
• the transfer or loan of property to a non-resident trust, under
s. 233.2 (Form T1141), and
• the receipt of a distribution or loan from a non-resident trust, under
s. 233.6 (Form T1142).

To comply with these reporting requirements, the forms must be filed, generally
no later than the filing due date of the income tax return for the relevant taxa-
tion year. These reporting requirements are designed to permit CRA to review
transactions involving non-resident investments and interests in non-resident
entities. The filing requirements do not require any payment of tax, although
high penalties exist for late filing and failure to file.

12.8 KEY STUDY POINTS

• Estates of Canadian residents may be subject to estate taxes in

another country based on citizenship or the location (situs) of their
property. Treaty relief may be available.
• Non-resident aliens of the U.S. are subject to U.S. estate and gift tax
on U.S.-situs property. For gift tax purposes, U.S. property excludes
intangible property.

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12.8 Chapter 12 – Foreign Jurisdiction Tax Issues

• Estates of Canadian non-resident aliens of the U.S. are entitled to

reduce the liability for U.S. estate tax by claiming benefits under
the Canada-U.S. Tax Treaty. These include access to a portion of the
unified credit and the marital credit. If a U.S. estate tax return is not
filed, these benefits may be denied. The treaty also provides for tax
relief in Canada by way of a foreign tax credit for U.S. estate tax.
• U.S. persons resident in Canada are taxed in the U.S. on worldwide
income during lifetime, and on death their worldwide estates are
subject to U.S. estate tax.
• U.S. persons are subject to U.S. gift tax on gifts of any property but
can shelter gifts with the unified credit.
• A married couple resident in Canada where only one is a U.S. per-
son is subject to unique U.S. rules for gifts and estates that require
professional advice.
• Failure to make inquiries regarding U.S. citizenship, or investigat-
ing the possibility that an individual resident in Canada might be
a U.S. person, could result in inappropriate advice and expose the
advisor to liability.
• Cross-border tax planning is the field of specialists; and once issues
are identified, sound practice dictates involving cross-border exper-
tise both in Canada and the foreign jurisdiction.
• Offshore trust planning is complex and expensive. The opportuni-
ties do not match the cocktail talk, and specialized advice is critical.

12–24
 TABLE 1 — TABLE OF LEGISLATION

Act Section Number References in Text

2 2 2.1.4
3 3 1.10.1, 2.1.4, 2.2, 2.2.2.1, 3.1.1, 3.1.4, 3.2.1., 4.1,
4.3.1, 4.3.8.4, 5.2.5, 6.4.2
3(a) 4.3.1
3(b) 4.3.1
5 5(1) 2.2.2.2
9-37 9-37 2.2.1
12 12(1)(c) 2.2.1.2
12(1)(m) 2.2.2.5, 4.3.8
13 13(21.1) 7.10.3
15 15, 15(1) 10.7.7
20 20(11) 2.2.1.7
20(12) 2.2.1.7
23 23(1) 7.10.1
38 38 2.5.8
38(a.1) 8.2
38-55 38-55 3.2
39 39(1)(c) 3.5.2
39(4) 3.1.3.3
40 40(1) 3.2.1
40(1)(a)(iii) 4.4.2
40(2)(b) 4.11.3
40(3.6) 8.7.1
40(3.61) 8.7.1
40(7) 4.11.4
43 43.1 10.7.3
50 50(1) 3.5.2
51 51 10.7.6
53 53(2)(h) 6.2
54 54 2.5.11, 3.2, 3.2.2, 3.2.8, 3.5.1, 3.5.3, 6.2
54(b) 4.11.2
54(c.1) 4.11.2
54(c.1)(iii.1) 4.11.3
54(j) “proceeds of disposition” 8.7.1
56 56(1)(a)(iii) 7.7.3
56(2) 9.1, 10.7.7
56(4.1) 9.2.5, 9.7
56(4.2) 9.2.5
60 60(o) 11.13
60(l) 7.8.4, 7.8.4.1, 7.8.4.2, 7.8.4.3
60(l)(v)(A) 7.8.4

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Table of Legislation

Act Section Number References in Text

60(l)(v)(B) 7.8.4
60(l)(v)(B.1) 7.8.4
60(m) 7.8.4.2
60.011(1) 4.7.6
60.011(1)(a) 7.8.4.3
60.011(2) 7.8.4.3
60.011(2)(a) 4.7
60.02 7.8.4.2
69 69(1) 4.4
69(1)(a) 4.4.2
69(1)(b)(i) 4.4.2, 6.6.1
69(1)(b)(ii) 4.4.2
69(1)(b)(iii) 4.4.2, 4.11.2
69(1)(c) 4.4.2, 4.11.2
70 70 7.1
70(1) 7.1, 7.6, 7.7.1, 7.15
70(2) 7.1, 7.15, 8.2
70(3) 7.15, 8.2
70(5) 7.1
70(5)(a) 7.10.2
70(5)(b) 7.10.2
70(5.2) 7.1, 8.2, 8.2.2.1
70(5.2)(b) 8.2.3
70(5.2)(c) 8.2, 7.10.1
70(6) 3.4.3, 3.4.4, 4.7.7, 4.7.7.5, 6.1.1, 7.10.7, 8.2.3, 8.4.3
70(6)(b) 10.4.1.4
70(6.2) 4.7.7, 4.7.7.5, 8.2, 8.2.2.1, 8.2.3, 10.4.2
70(7) 7.3, 8.4.2
70(7)(b) 7.3
70(9) 3.4.5
70(9.01) 8.2, 8.2.3
70(9.21) 8.2, 8.2.3
70(10) 3.4.5
72 72 7.7.9.1
72(2) 7.7.9.1, 8.2
73 73(1) 3.4.2, 3.4.4, 4.4.3, 4.7, 4.7.5, 4.7.7, 4.7.7.5, 6.1.1,
9.2.7, 9.5.1, 9.6.3, 10.4.2
73(1.01) 3.4.2, 4.7, 4.7.7, 4.7.7.5
73(1.01)(c)(ii) 4.7.5
73(1.01)(c)(iii) 4.7.5
73(1.02)(b)(ii) 4.4.3, 4.7.5
73(1.02)(c) 4.7.7.3
73(3) 3.4.5
73(6) 3.4.5

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 Table of Legislation

Act Section Number References in Text

74 74.1 9.5.1, 10.7.10
74.1(1) 9.2.1, 9.2.3, 9.2.5, 9.5.2, 9.7
74.1(2) 9.2.2, 9.2.3, 9.2.5, 9.5.2, 9.7
74.2 9.5.1, 10.7.10
74.2(1) 9.2.1, 9.2.3, 9.7
74.3 10.7.10
74.3(1) 9.2.3
74.4 9.2.4, 9.5.2, 10.7.11, 10.7.17
74.4(2) 9.2.4
74.4(4) 10.7.11, 10.7.12
74.5(1) 9.5.1
74.5(2) 9.2.5, 9.5.1
74.5(3) 9.5.2
74.5(4) 9.5.2
74.5(6) 9.2.7
74.5(7) 9.2.7, 9.2.8
74.5(11) 9.2.8
74.5(12) 9.2.1, 9.6.6
74.5(13) 9.2.2
75 75(2) 1.9, 3.4.7, 4.2.5, 4.5.1, 4.5.4, 4.7.5, 4.7.7.1, 4.7.7.2,
4.7.8.2, 4.13, 5.1.2, 6.4.4, 6.5, 9.2.3, 9.2.5, 9.3,
9.3.1, 9.3.2, 9.3.3, 9.3.4, 9.3.5, 9.4.1, 9.6, 9.7, 9.8,
10.3.1, 10.3.3, 10.5.2, 10.7.13, 10.7.14, 10.8
75(2)(a) 9.3.1
75(2)(a)(i) 9.3.1
75(2)(a)(ii) 9.3.1, 9.3.2
75(2)(b) 9.3.2
75.1 9.2.2
76 76(5.2)(b) 8.2.3
76(6.2) 8.2.3
82 82(1)(a)(i) 2.2.1.4
82(1)(a)(ii) 2.2.1.4
82(1)(b) 4.3.8.1
82(1)(b)(i) 2.2.1.4
82(1)(b)(ii) 2.2.1.4
84 84(2) 2.5.11, 8.7.2
84(3) 2.5.11
84.1 8.7.2, 10.1
85 85 1.10.3, 3.4.6, 10.7.6
85(1)(e.2) 10.7.7
85.1 3.4.6
86 86 3.4.6, 10.7.6
87 87 10.7.6
88 88(1)(d) 8.7.2, 8.7.3

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Table of Legislation

Act Section Number References in Text

89 89(1) 3.3.2.2
94 94 12.6.3
94(1) 4.3.3.2
103 103(3) 4.7.7
104 104(1) 4.1, 4.2.2, 4.3.2, 4.4.1, 4.7, 5.1.5
104(1)(a) 4.7.7
104(1)(b) 4.7.7
104(2) 4.3.2, 4.3.6,
104(4) 4.8.1, 10.4.2
104(4)(a) 4.7.7.5
104(4)(a)(ii.I) 4.7.7.3
104(5.8) 5.3.3.8
104(6) 4.3.7, 4.3.7.2, 6.1, 6.1.3, 6.4.5
104(6)(b) 4.7.7, 6.1.1, 6.3, 6.4.5
104(6)(b)(i)(c) 4.8.2
104(12) 4.10.1, 5.5.1
104(13) 4.3.7, 4.3.7.1, 4.3.7.2, 5.5.1.1, 6.1, 6.1.1, 6.1.3, 6.4.1
104(13.1) 4.3.7.5, 4.3.7.8, 4.3.9, 5.5.1.1, 6.1, 6.4.4, 6.4.5, 10.5
104(13.2) 4.3.7.5, 4.3.7.8, 4.3.9, 5.5.1.1, 6.1, 6.4.4, 6.4.5, 10.5
104(13.3) 4.3.7.8, 4.3.9, 4.7.3.2, 5.5.1.1, 10.5
104(13.4) 4.3.5, 4.7.7, 4.7.7.3, 4.12
104(13.4)(b.1) 4.7.7
104(13.4)(c) 5.1.3
104(14) 4.10.1, 5.5.1, 6.1, 6.4.1
104(18) 4.7.9, 10.2.2
104(19) 4.3.8.1, 4.3.8.2, 6.4
104(20) 4.3.8.3, 6.4, 6.4.6, 6.6.2.1
104(21) 4.3.8.4, 4.3.8.5, 6.4, 6.4.3
104(21)(a) 6.4.2
104(21.2) 4.3.8.5, 6.4, 6.4.3
104(21.3) 4.3.8.4
104(22) 4.3.8.6, 6.4
104(22.1) 4.3.8.6
104(23)(a) 5.1.3
104(23)(d) 7.2
104(23)(e) 11.3
104(24) 4.3.7.1, 6.1.2
105 105 4.3.9
105(1) 4.3.7.6, 4.3.8.1, 5.5.1, 5.5.2, 6.1, 6.2, 6.3
105(2) 4.3.7.6, 5.5.1, 6.1, 6.2, 6.3
106 106(2) 6.6.1
106(3) 6.6.1
107 107(1) 6.6.2.1
107(1)(a) 4.5.2

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 Table of Legislation

Act Section Number References in Text

107(1.1) 6.6.2.1
107(2) 4.5.1, 4.5.2, 4.5.3, 4.5.4, 4.11.4, 6.5, 6.7, 6.7.5,
8.2.3, 9.3.3, 10.7.13
107(2)(b) 6.6.2.2
107(2)(c) 6.6.2.2
107(2.001) 4.5.3
107(2.01) 4.5.3, 4.5.4, 4.11.4
107(2.1) 4.5.1, 4.5.4, 6.5, 6.7.5
107(4.1) 4.5.1, 4.5.4., 6.5, 9.3.3, 9.3.4
107(5) 4.5.4, 6.7.5
107.4(1) 4.7
108 108 4.3.1, 4.7.2
108(1) “beneficiary” 6.6.2.2
108(1) “cost amount” 4.5.2
108(1) “inter vivos trust” 4.7.2
108(1) “preferred beneficiary” 4.10
108(1) 4.7, 4.7.3, 6.6.1, 6.6.2, 6.6.2.1, 6.6.2.2
108(1) “trusts 4.7.1
108(1)(a) “testamentary trust” 4.7.3.2
108(5) 4.3.8, 6.4
108(d) 4.7.3.2
110 110.6 3.2, 3.3.1, 3.3.2.1, 4.3.8.5, 6.4.2, 8.2
110.6(1) 3.3.3
110.6(1.3) 3.3.3
110.6(1.3)(c) 1.3.2.4
110.6(2.2) 3.3.3
110.6(12) 4.3.8.5, 5.6.5
110.6(14)(g) 3.3.2.5
111 111(1)(a) 2.3.1
111(1)(b) 3.5.5, 4.3.8.4
111(2) 8.3.1
112 112 2.2.1.4, 2.5.6, 2.5.9
112(1)(a) 4.3.8.1
112(3.2) 1.3.2.4, 8.7.1
114 114.2 7.11
116 116 5.3.3.2, 6.7.4, 6.7.6, 6.8, 11.11
116(4) 6.7.6
116(5) 6.7.6
116(5.01)-(5.02) 6.7.7
117 117 2.4.1, 4.3.4
117(2) 2.4
118 118 4.3.2
118(6) 4.10
118.1(1)(c)(i)-(ii) “total charitable gifts” 4.12

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Table of Legislation

Act Section Number References in Text

118.1(3) 4.12
118.1(4.1) 4.12, 7.13.3
118.1(5) 4.12, 4.12.1, 7.13.3, 8.2
118.1 (5.2) 4.12, 7.13.3
118.1(5.3) 4.12, 7.13.3
118.1(6) 8.2
118.2(1) 8.2
118.3(1) 4.10
120 120.2(4) 7.14
120.4 9.4.1
120.4(1) 9.4.1
120.4(4) 4.3.8.5
120.4(5) 4.3.8.5
121 121 2.2.1.4, 4.3.8.1
122 122(1) 4.3.4
122(1)(c) 4.7.3.1
122(1.1) 4.3.2
122(2) 4.7.3.1
122(3) 4.7, 4.7.3.1
123 123(1)(a) 2.5.6
123.4 2.5.6
124 124(1) 2.5.6
125 125(2) 2.5.6
125(3) 2.5.6
125(4) 2.5.6
125(7) 3.3.2.2
126 126 4.3.8.6
126(1) 2.2.1.8
126(2) 2.2.1.8
127 127.5-127.55 2.4.3, 4.9
127.55 7.14, 8.2.2.3
128 128.1(4)(b)(i)-(iii) 4.5.4, 6.7.6
146 146(1) 7.8.3
146(1.1) 7.8.3.1
146(2)(c.2) 7.8.2.1
146(8) 7.8.2
146(8.1) 7.8.3.3, 8.2
146(8.8) 7.8.2, 7.8.6
146(8.8)(b) 7.8.2.1
146(8.9) 7.8.3, 8.2
146(8.91) 7.8.2.1, 7.8.3.3, 8.2
146(8.92) 7.8.8
146.3(1) 7.8.3
146.3(1)(a) 7.8.3.3

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 Table of Legislation

Act Section Number References in Text

146.3(6) 7.8.2
146.3(6.2) 7.8.3, 8.2
146.3(6.3) 7.8.8
150 150 11.2
150(1)(b) 7.2, 7.3
150(1)(c) 5.1.3
150(1)(d) 7.2, 7.3
150(2) 11.2
150(4) 7.2
151 151 11.2
152 152(1) 11.7
152(2) 11.7
152(3.1) 11.7
152(4) 11.7
152(4.01) 4.11.3
156 156(1) 11.3
156.1(2) 11.3
159 159(1) 5.8
159(2) 5.8, 6.7.6
159(3) 5.1.5, 5.8, 11.10
159(3.1) 5.8
159(5) 3.2.7, 7.4
159(7) 7.4
160 160 11.10
160(1.2) 9.4.1, 11.10
160.2(1) 7.8.6, 11.10
160.2(2) 7.8.6, 11.10
161 161(1) 11.5
161(2) 11.5
162 162(1) 11.6
162(2) 11.6
162(7) 11.6
162(7.01) 11.6
163 163.1 11.3
163.2 11.17
164 164(6) 1.3.2.4, 4.7, 4.7.3.1, 5.2.1, 5.2.2, 5.4.1, 5.6.3, 5.9,
7.12.1, 7.16, 8.2, 8.3.2, 8.5, 8.7, 8.7.1, 8.7.2, 8.7.3,
8.8
164(6)(f) 8.3.2
164(6.1) 5.2.1, 5.2.2
165 165(1) 11.12
210 210–210.3 5.7.1, 6.7.3
210.2(2) 5.7.1
212 212(1) 6.7.2

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Table of Legislation

Act Section Number References in Text

212(1)(c) 6.7.2
212(11) 6.7.2
214 214(3)(f) 6.7.2
215 215(1) 6.7.2
220 220(3.1) 11.16, 11.16.2
223 223 11.9
224 224–226 11.9
224(1.2) 11.9
224(1.3) 11.9
231 231.1 11.8
231.2 11.8
231.3 11.8
231.6 11.8
232 232 11.15
233 233.2 12.7
233.3 12.7
233.6 12.7
238 238 11.14
239 239 11.14
245 245(2) – GAAR 10.7.7
246 246 10.7.7
248 248 4.3.1, 4.7.1, 6.7.6
248(a) “specified shareholder” 10.7.11
248(1) 4.4, 4.7
248(1) “common-law partner” 2.1.5
248(1) “death benefit” 7.7.3
248(1) “disposition” 3.2.4, 4.4.1, 6.6.2.2
248(1) “graduated rate estate” 4.7.3.1
248(1) “legal representative” 4.2.1.1, 5.8
248(1) “personal trust” 4.7.2
248(1) “small business corporation” 3.3.2.3
248(1) “taxable Canadian property” 5.7.1, 6.7.3, 6.7.6
248(5) 9.2.6
248(9.1) 3.4.3, 4.7.3
248(9.1)(a) 4.7.3
248(23.1) 3.4.3
248(25) 9.2.5
249 249 4.3.5
249.1(4) 7.2
249(4.1) 4.3.5
251 251(1) 9.2.5
251(1)(b) 4.4.2
251(1)(b)–(f) 3.5.1
251.1(1) 3.5.1, 8.7.1

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 Table of Legislation

Act Section Number References in Text

252(1) 3.4.5
Part I Part I 1.4, 4.3.8.1, 4.3.8.4
Part I, Division B, subdivision c 3.2
Part I, Division B, subdivision k 4.3.1
Part I, Division D 4.3.1
Part I, Division E.1 2.4.3
Part I, Division I 11.1
Part I, Division J 11.2
Part IV Part IV 2.2.1.4
Part XII.2 Part XII.2 4.7.3.1, 5.7, 5.7.1, 5.7.2, 5.9, 6.7, 6.7.1, 6.7.2, 6.7.3
Part XIII Part XIII 1.5.3, 4.3.8.2, 5.7.2, 6.7.1, 6.7.2, 6.7.3, 6.7.7, 11.4
Part XV Part XV 11.1

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Table of Legislation

Regulations Under the Income Tax Act

Reg. 1000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.2.1, 5.6.3
Reg. 4301 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.2.5, 11.5
Regs. Part XI ............................................ 1.5.1
Regs. Part XLIII .......................................... 1.5.1

Other Statutes
Constitution Act, 1867 (formerly the British North America Act,
1867) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2.1, 4.2.3
Income War Tax Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2.2
Magna Carta . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1.1, 1.1.3
Wills, Estates and Succession Act (B.C.) . . . . . . . . . . . . . . . . . . . . . . . . 4.7.7.1
Canada-U.S. Tax Convention (1980) . . . . . . . . . . . . . . . . . . . . . 12.2.4, 12.3.2

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 TABLE II — TABLE OF CRA PUBLICATION REFERENCES

DOCUMENT TEXT SECTION

Forms
NR4 Slip, Statement of Amounts Paid or Credited to Non-Residents of
Canada . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.1.1, 5.5.4
NR4SUM, Return of Amounts Paid or Credited to Non-Residents of
Canada . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.1.1, 5.5.4
RC 4625, Rollover to a Registered Disability Savings Plan (RDSP) under
Paragraph 60(m) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.8.4.2
T1-ADJ, T1 Adjustment Request . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.12.2
T1A, Request for Loss Carryback . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.12.1
T1, General Income Tax and Benefit Return
(5001–R to 5012-R) . . . . . . . . . . . . . . . . . . . . . . 5.1.1, 7.1-7.4, 7.6, 7.7, 7.16
T3, Trust Income Tax and Information Return
(T3 Return) . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.3.8, 5, 5.3.3, 6.7.3, 9.3, 9.4.1
T3, Statement of Trust Income Allocations and Designations
(Slip) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.1.1, 5.3.3.1, 5.5.3, 9.3
T3SUM, Summary of Trust Income Allocations and Designations . . . 5.1.1, 5.5.3
T657, Calculation of Capital Gains Deduction . . . . . . . . . . . . . . . . . . . . 3.3.1
T776, Statement of Real Estate Rentals . . . . . . . . . . . . . . . . . . . . . . . . . 5.4.9.1
T1055, Summary of Deemed Dispositions ....................... 5.4.6
T1079, Designation of a Property as a Principal Residence by a Personal
Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.11.2
T1135, Foreign Income Verification Statement . . . . . . . . . . . . . . . . . . . . . 12.7
T1141, Information Return in Respect of Transfers or Loans to a Non-
Resident Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12.7
T1142, Information Return in Respect of Distributions from and
Indebtedness to a Non-Resident Trust . . . . . . . . . . . . . . . . . . . . . . . . . . 12.7
T1206, Tax on Split Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.4.1
T2017, Summary of Reserves on Dispositions of Capital Property . . . . . . 3.2.7
T2062, Request by a Non-Resident of Canada for a Certificate of
Compliance Related to the Disposition of Taxable Canadian Property . . . 6.7.6
T2062C, Notification of an Acquisition of Treaty-protected Property from
a Non-Resident Vendor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.7.7

TCRA–1
Table of CRA Publication References

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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.4
T2091(IND), Designation of a Property as a Principal Residence by an
Individual (Other Than a Personal Trust) . . . . . . . . . . . . . . . . . . . . . 3.2.8
T2091(IND)-WS, Principal Residence Worksheet .................. 3.2.8
T2124, Statement of Business Activities or Professional Activities . . . . . 5.4.9.1
T5003, Statement of Tax Shelter Information . . . . . . . . . . . . . . . . . . . . 3 App.
TX19, Asking for a Clearance Certificate . . . . . . . . . . . . . . . . . . . . . . . . . . 5.8

Guides
RC4060, Farming Income and the AgriStability and AgriInvest Programs
Guide . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 App.
RC4408, Farming Income and the AgriStability and AgriInvest Programs
Harmonized Guide . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 App.
T1 Guide, General Income Tax and Benefit Guide . . . . . . . . . . . . . . . . . 2.1.2
T4003, Farming and Fishing Income . . . . . . . . . . . . . . . . . . . . . . . . . . 3 App.
T4011, Preparing Returns for Deceased Persons . . . . . . . . . . . . . . . . 7.6, 7.7.2
T4013, T3 Trust Guide . . . . . . . . . . . . . . . . 1.6.3, 5.1.1, 5.1.2, 5.2.1, 6.7.3, 9.3
T4037, Capital Gains Guide . . . . . . . . . . . . . . . . . . . . . . . 3.1.1, 3 App., 5.6.4
T4061, NR4 – Non-Resident Tax Withholding, Remitting, and Reporting . . . 5.5.4
T4068, Guide for the Partnership Information Return (T5013 Forms) . . . 3 App.

Information Circulars
IC00-IR5, Voluntary Disclosures Program (IC00-IR6 as of
March 1, 2018) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.2, 11.16.1
IC01-1, Third-Party Civil Penalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11.17
IC82-6R7, Clearance Certificate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.8

Interpretation Bulletins (Archived)

IT-212R3 (Archived), Income of Deceased Persons – Rights or Things . . . . 7.15
IT-218R (Archived), Profit, Capital Gains and Losses from the Sale of Real
Estate, Including Farmland and Inherited Land and Conversion of Real
Estate from Capital Property to Inventory and Vice Versa . . . . . . 3.1.3, 3.1.3.1
IT-268R4 (Archived), Inter Vivos Transfer of Farm Property to Child ... 3.4.5
IT-286R2 (Archived), Trusts – Amount Payable . . . . . . . . 4.3.7.3, 4.3.7.4, 6.1.2
IT-305R4 (Archived), Establishment of Testamentary Conjugal Trusts . . . 10.4.2

TCRA–2
 Table of CRA Publication References

IT-326R3 (Archived), Return of Deceased Persons as

“Another Person” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.2, 7.15
IT-342R (Archived), Trusts – Income Payable to Beneficiaries . . . . . . . . . 6.1.2
IT-349R3 (Archived), Intergenerational Transfers of Farm Property on
Death . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4.5
IT-369R (Archived), Attribution of Trust Income to Settlor . . . . . . . . . . . 9.3.2
IT-381R3 (Archived), Trusts – Capital Gains and Losses and the Flow-
Through of Taxable Capital Gains to Beneficiaries . . . . . . . . . . . . . . . . . 6.4.2
IT-394R2 (Archived), Preferred Beneficiary Election . . . . . . . . . . . . . . . . . 4.10
IT-456R (Archived), Capital Property – Some Adjustments to Cost Base . . . 3 App.
IT-459 (Archived), Adventure or Concern in the Nature of Trade . . . . . . . 3.1.3
IT-465R(Archived), Non-Resident Beneficiaries of Trusts ............ 6.7.3
IT-479R (Archived), Transactions in Securities . . . . . . . . . . . . . . 3.1.3, 3.1.3.2
IT-500R, Registered Retirement Savings Plans – Death of an Annuitant . . . 7.8.3.2
IT-524 (Archived), Trusts – Flow-Through of Taxable Dividends to a
Beneficiary – After 1987 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.3.8.1

Tax Folios
S1-F3-C2, Principal Residence . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2.8, 4.11.1
S4-F3-C1, Price Adjustment Clauses . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.7.7.1
S5-F1-C1, Determining an Individual’s Residence Status . . . . . . . . . . . . . . 2.1.4
S1-F5-C1, Related Persons and Dealing at Arm’s Length . . . . . . . . . . . . 3 App.
S6-F1-C1, Residence of a Trust or Estate . . . . . . . . . . . . . . . . . . . . 4.3.3.1, 5.3.1

Technical Interpretations
9233787, Election Under 104(13.1) and (13.2) (March 9, 1993) . . . . . . 4.7.3.2
9238555, Establishing Testamentary Trusts Separate from a Will with Life
Insurance (February 4, 1993) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.7.4
9429175, Capital Gains Election – Property in Trust (March 30, 1995) . . . . 6.4.5
9526815, Executor’s Year Passing Beneficial Ownership of Estate (May 24,
1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.7.3.2
9618885, Third Party Payments and Rent Free Use of Trust Property
(September 22, 1997) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.2
9807495, Trusts For Minors (March 12, 1999) . . . . . . . . . . . . . . . . . . . . 10.2.2
9901375, Trust For Minors ( January 12, 1999) . . . . . . . . . . . . . . . . . . . . 10.2.2
2000-0059755, Trust Receiving Property From an Alter Ego Trust (March
23, 2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.7.4

TCRA–3
Table of CRA Publication References

2000-0059795, Testamentary Trust Variation . . . . . . . . . . . . . . . . . . . . 4.7.3.2

2001-0099055, Joint Spousal Trust ( January 23, 2002) . . . . . . . . . . . . . 4.7.7.4
2002-0118255, Application of 75(2) ( June 10, 2002) ............... 9.3.1
2002-0154435, Payment of Trust Expenses by Beneficiary
(April 17, 2003) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.7.3.2
2002-0172475, Administration of Estates . . . . . . . . . . . . . . . . . . . . . . . 4.7.3.2
2003-0046823, Reverse Estate Freeze ( January 28, 2003) . . . . . . . . . . 10.7.15.5
2003-0047727, Right of Use – Deemed Trust (December 17, 2003) . . . . . . . . 6.2
2003-0051731I7, Distributions from a Non-Resident Trust (April 15,
2004) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.1.1
2003-0182905, Gifts of Interest in Alter Ego Trust (December 11, 2003) . . . . 4.12
2004-0069951C6, Phantom Income ( June 21, 2004) . . . . . . . . . . . . . . . . 6.4.5
2007-0233761C6, In Trust Accounts ( June 8, 2007) . . . . . . . . . . . . . . . . 4.2.5
2008-0270421C6, Joint Last-to-Die Policy ( June 11, 2008) . . . . . . . . . . . . 4.7.4
2009-0345781E5, Proposed amendment to section 40(3.1) ( January 20,
2010) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.6.7

Other Documents
Information Sheet RC4177(E), Death of an RRSP Annuitant . . . . . . . . . 7.8.3.2
ITAR 26 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.5.2, 3.2.2
Pamphlet P113, Gifts and Income Tax . . . . . . . . . . . . . . . . . . . . . . . . . . 3 App.
Technical News No. 11 (Archived, September 30, 1997) . . . . . . . . . . . . . . 6.1.3
Technical News No. 38 (Archived, September 22, 2008) . . . . . . . . . . . 10.7.7.2
Technical News No. 44 (Archived, April 14, 2011) . . . . . . . . . . . . . . . . . 1.3.2.3

TCRA–4
 TABLE III — TABLE OF CASES

Ablan Leon (1964) Ltd. v. M.N.R. (1976), C.T.C. 506, 76 D.T.C. 6280
(Fed. C.A.) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2, 4.2.4
Antle v. Canada, 2009 TCC 465, 2010 F.C.A. 280, leave to appeal to SCC
dismissed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2.3
Atinco Paper Products Ltd. v. The Queen (1978), 78 D.T.C. 6387 (Fed. C.A.) . . . . 4.2.4
Blum v. Canada 99 D.T.C. 290 (T.C.C.) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2.5
Boger Estate v. Minister of National Revenue, [1991] 2 C.T.C. 168 (Fed. T.D.),
affd [1993] 2 C.T.C. 81, 93 D.T.C. 5276 (Fed. C.A.) . . . . . . . . . . . . . . . . . . . . . 4.7.7
Bozzer v. R., 2011 FCA 186 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11.16
Brown v. R., [1979] C.T.C. 476, [1980] 2 F.C. 356, 79 D.T.C. 5421 (Fed. T.D.) . . . . . . 6.1
Carlisle Estate, Re (2007), 306 Sask.R. 140 (Sask. Q.B.) . . . . . . . . . . . . . . . . . . . 4.7.4
Cole Trusts v. M.N.R. (1981), 81 D.T.C. 8 (T.R.B.) . . . . . . . . . . . . . . . . . . . . . . . 4.2.4
Cooper v. M.N.R., [1989] 1 C.T.C. 66, 88 D.T.C. 6525 (Fed. T.D.) . . . . . . . . . . . . . . . 6.2
Dill v. Canada (alt. nom. Thibodeau Estate (Trustees of) v. Canada) (1978), 78
D.T.C. 6376 (Fed. T.D.) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.3.3
Edwards v. R., 2012 FCA 330 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.3.2.3
Eurig Estate (Re), [1998] 2 S.C.R. 565 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1.5
Fletcher v. M.N.R. (1987), 87 D.T.C. 624 (T.C.C.) . . . . . . . . . . . . . . . . . . . . . . . . 4.2.4
Fraser v. M.N.R. (1991), 91 D.T.C. 5123 (Fed. T.D.), affd 95 D.T.C. 5684 (Fed.
C.A.) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2.4
Fundy Settlement v. Canada: see Garron (Trustee of), infra. Garron (Trustee of)
v. Canada, 2009 TCC 450 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.3.3, 4.3.3.1, 5.3.1
Guilder News Co. (1963) Ltd. et al. v. M.N.R., 73 D.T.C. 5048 (Fed. C.A.) . . . . 10.7.7.1
Harvey v. The Queen (1994), 94 D.T.C. 1910 (T.C.C.) .................... 4.2.4
Howson v. The Queen, 2006 TCC 644 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.3.1
I.R.C. v. Westminster (Duke), [1936] A.C. 1 (H.L.) . . . . . . . . . . . . . . . . . . . . . . . 11.17
Kingsdale Securities Co. v. M.N.R. (1974), 74 D.T.C. 6674 (Fed. C.A.) . . . . . . . . . 4.2.4
Koons v. Quibell (1998), 164 Sask. R. 149 (Sask. Q.B.) . . . . . . . . . . . . . . . . . . . . 4.2.5
Langer Family Trust v. M.N.R, [1992] 1 C.T.C. 219, 92 D.T.C. (T.C.C.) . . . . . . . . . 6.1.3
Leblanc v. Canada, 2006 TCC 680 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2
MacDonald, 2013 FCA 110 ....................................... 8.7.2
Madsen Estate v. Saylor, [2007] S.C.J. No. 18 (S.C.C.) . . . . . . . . . . . . . . . . . . . . . 7.10.6

TC–1
Table of Cases

Miko Leung and Sit Wa Leung v. M.N.R., 92 D.T.C. 1090 (T.C.C.) . . . . . . . . . . 10.7.7.1
Pecore v. Pecore, [2007] S.C.J. No. 17 (S.C.C.) . . . . . . . . . . . . . . . . . . . . . . . . . . 7.10.6
Regal Heights Ltd. v. M.N.R., [1960] S.C.R. 902 (S.C.C.) . . . . . . . . . . . . . . . . . . 3.1.3.1
Rispin, Re (1912), 25 O.L.R. 633, 2 D.L.R. 644, affd 46 S.C.R. 649, 8 D.L.R. 756 . . . . 4.2.1.3
Saunders v. Vautier (1841), 41 E.R. 482 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.7.8
Sommerer v. R. (2011), 2011 D.T.C. 5126, affirmed by F.C.A. Justice Sharlow . . . 9.3.1
St. Michael Trust Corp. v. R.: see Garron (Trustee of), supra.
Stubart Investments Ltd. v. The Queen, [1984] S.C.J. No. 25 (S.C.C.) . . . . . . . . 11.17
The Minister of Community & Social Services v. Henson, [1987] OJ No 1121, aff’d
[1989] OJ No 2093 (1989) 36 ETR 192 (Ont C.A.) . . . . . . . . . . . . . . . . . . . . . . 10.6
Thibodeau Estate (Trustees of) v. Canada): see Dill v. Canada, supra.
Tower v. M.N.R., [2003] F.C.J. No. 1153 (Fed. C.A.) . . . . . . . . . . . . . . . . . . . . . . . 11.15
United States v. Windsor, 570 U.S. (2013) (Docket No. 12-307) . . . . . . . . . . . . . 12.2.6

TC–2
 GLOSSARY

Adjusted cost base (ACB) of capital property is its original purchase price plus any costs
incurred to acquire the property, plus the cost of any capital improvements. Special rules
apply to property acquired before 1972. The Act provides for additional adjustments to
ACB in subs. 53(1) and (2), but these are beyond the scope of this material.

Affiliated person is defined in subs. 251.1(1) to include both an individual and his/her
spouse or common-law partner, as well as individuals, corporations, and partnerships
that are connected with each other in specific ways.

Allowable business investment loss (ABIL) means one-half of a business investment

loss defined in para. 39(1)(c) as the loss incurred on the disposition of shares of an SBC
(small business corporation) or the disposition of a loan to an SBC. For purposes of
claiming an ABIL, a corporation qualifies as an SBC if it was an SBC at any time in the 12
months before the loss was incurred. ABILs are not restricted to offsetting capital gains,
but may be deducted from all sources of income.

Alter ego trust (AET). A trust for the sole benefit of the settlor during the settlor’s
lifetime where the settlor has attained age 65. Transfers of property to an AET take place
on a rollover basis, but there is a deemed disposition on the death of the settlor.

Asset protection trust. A trust to preserve wealth from the potential claims of future
creditors of the settlor.

Bare trusts refer to an agency relationship or other arrangement where the “trustee’s”
power to deal with property is limited and under the control of the beneficial owner.
Bare trusts are not really trusts either legally or for tax purposes. The Act specifically
excludes “an arrangement under which the trustee can reasonably be considered to act
as agent for all the beneficiaries under the trust with respect to all dealings with all of
the trust’s property” from treatment as a trust under subs. 104(1), and transfers to such a
“trust” are not dispositions under the definition of disposition in subs. 248(1).

Canadian-controlled private corporation (CCPC) is defined in subs. 125(7) as a private

corporation (i.e., not listed on a stock exchange) that is incorporated in Canada or
resident in Canada, and is not controlled by non-residents or publicly traded corporations
or a combination of non-residents and public corporations.

Capital gain. The amount realized when there is a disposition of capital property for
proceeds of disposition in excess of the taxpayer’s adjusted cost base for the property.

Capital gains deduction refers to the rules used in calculating the deduction from the
amount of taxable capital gains to be included in income.

G–1
Glossary

Capital gains exemption means the amount of capital gain (i.e., the gross capital gain,
not taxable capital gain) sheltered under the lifetime capital gains exemption rules in
s. 110.6.

Capital loss. The amount lost when the proceeds of disposition of capital property and
costs of disposition are less than the taxpayer’s adjusted cost base of the property.

Caretaker trust. A trust created to manage finances for a beneficiary who does not have
the skill, interest, or maturity to do so themselves.

Certificate of compliance. A certificate issued under s. 116 in respect of a sale of

certain property by a non-resident. These were traditionally referred to as “clearance
certificates,” but CRA has recently asked that requests for such certificates use the term
“certificate of compliance” to avoid internal confusion in CRA with requests for clearance
certificates for other estate distributions under subs. 159(2).

Charitable remainder trusts are trusts where the charity’s interest in the capital of the
trust is subject to a life interest.

Clearance certificate. A certificate pre-approving certain estate distributions under subs.

159(2) of the Act.

Common-law partner is defined in subs. 248(1) to include a person who co-habits in a

conjugal relationship with the taxpayer either for a continuous period of one year or for
any period of time while raising a child together. It includes same-sex partners who are
not legally married.

Designated person is defined for the purposes of the trust attribution rules and the
corporate attribution rule in subss. 74.3(2) and 74.5(5) to include a person who is: the
spouse or common-law partner of the individual; a person under 18 years of age and
with whom the individual does not deal at arm’s length; or a niece or nephew of the
individual who is under 18 years of age.

Deemed disposition. Many sections of the Act treat a taxpayer as having disposed
of property for proceeds of disposition equal to a certain amount, even if the actual
proceeds are a different amount, or if there is no actual transfer of property or no actual
receipt of proceeds. For example, under s. 70, there is a deemed disposition on death
of an individual of all capital property at proceeds equal to fair market value, and s. 69
deems proceeds of disposition to be received whenever property is transferred by way
of gift. The deeming provision usually has a corresponding provision that deems the
property to have been acquired, or reacquired where there is no change in ownership,
for the same amount as the deemed proceeds. Wherever proceeds of disposition are
deemed to be received there is a disposition.

Discretionary trust permits the trustees to decide some aspect of income or capital
distribution, including timing and/or quantum, and may be used to sprinkle income
among multiple beneficiaries and/or defer vesting of capital. There may also be discretion
as to the final distribution of trust property upon dissolution of the trust.

G–2
 Glossary

Disposition is defined in s. 248 to include any transaction entitling a taxpayer to

proceeds of disposition, and includes the cancellation or redemption of a bond, note,
debenture, or share.

Eligible dividend. A dividend paid by a CCPC or a deposit insurance corporation that

has been designated in writing at the time it is paid as an eligible dividend entitling the
recipient to claim an enhanced dividend tax credit. A corporation resident in Canada that
is not a Canadian-controlled private corporation or a deposit insurance corporation can
also sometimes pay eligible dividends, but in more limited circumstances.

Estate freeze. An estate planning technique whereby the value of future growth is
transferred from the original owner (usually the parents) to the heirs (usually the children
or grandchildren). The current value of an individual’s “estate” (i.e., their personal wealth)
is fixed or frozen so that any increase in value between the time of the “freeze” and death
is transferred on a tax-free basis during lifetime to the persons who would otherwise
inherit the property on death.

Executor’s year. Under trust law, this means the first 12 months of an estate. Traditionally,
beneficiaries cannot enforce payment of income during the executor’s year.

Grandfathering refers to transitional provisions that provide relief from the adverse
effect of income tax amendments. These transitional rules often shelter certain taxpayers
from the changes in respect of transactions that take place before a certain date.

Henson trust. A discretionary trust created for the benefit of a disabled person in order
to preserve eligibility for provincial disability benefits.

Income splitting. The practice of distributing income in a manner that it will be taxable
in the hands of one or more taxpayers who are taxed at the marginal rates of tax, with
the intention that the overall tax burden on the income will be at less than the top
marginal rate. Typically, this is done within families so that family members in lower tax
brackets will receive the benefit of wealth transferred directly or indirectly from another
family member who is taxed at the top marginal rate.

Inter vivos trusts are referred to in the Act and in various definitions, but are not
specifically defined in the Act. In trust law, an inter vivos trust is one created during the
settlor’s lifetime (from the Latin “among the living”). A testamentary trust that has lost its
testamentary status for tax purposes is taxed as an inter vivos trust. Inter vivos trusts are
included in the definition of personal trusts.

Intestate means “without a Will” and may refer to a person who dies without a Will
or without a valid Will. The estate of such a person is referred to as an intestate estate.
Similarly, an “intestacy” is said to occur when a person dies without a Will.

G–3
Glossary

Joint spousal or common-law partner trust ( JPT) is a joint form of alter ego trust that
permits one Canadian resident spouse or common-law partner who is over 64 years old
to contribute capital property on a tax-deferred basis to a Canadian resident trust created
for the sole benefit of the settlor and the spouse or common-law partner during their
lifetime.

Legal representative. A trustee, executor, or any personal representative of a deceased

person.

Life insurance trust. A trust created with the proceeds of a life insurance policy. The
terms of the trust may be set out in the Will, or may be established in a separate
trust deed outside and apart from the Will. The policyholder must make a beneficiary
designation for the insurance proceeds to be paid to the trustees of the life insurance
trust “in trust.” CRA accepts that life insurance trusts are testamentary trusts, subject to
certain conditions.

Lifetime benefit trusts are trusts created for the benefit of mentally infirm spouses,
children or grandchildren who were financially dependent upon a deceased spouse,
parent, or grandparent immediately before that person’s death. The Act permits a deferral
of tax on an RRSP, RRIF, or a registered pension plan.

Listed personal property is a specific subset of personal use property that includes
works of art, rare books, jewellery, stamps, and coins. Losses from listed personal
property may offset gains from listed personal property.

Net income, as provided in s. 3, means the taxpayer’s income from all sources inside and
outside Canada from each office, employment, business and property, plus the amount
by which the taxpayer’s taxable capital gains for the year exceeds the allowable capital
losses for the year, less certain deductions permitted in computing net income.

Personal trust is defined in s. 248 as a testamentary trust, or an inter vivos trust where
no beneficial interest has been acquired for consideration payable to the trust or a
contributor to the trust. The trust must not be set up as a commercial arrangement where
the beneficiary pays for his or her interest as an investor.

Personal use property is any property used by the taxpayer, or a person related to the
taxpayer, for personal use or enjoyment. Where the taxpayer is a trust, property owned
by the trust but used by a beneficiary of the trust, or any person related to a beneficiary,
for personal use or enjoyment will be personal use property. Losses from personal use
property are not deductible unless the property is listed personal property.

Phantom income refers to income from a deemed disposition or realization of income

under the Act where there is no actual receipt of funds.

Prescribed means it is contained in the regulations to the Income Tax Act.

G–4
 Glossary

Principal residence, as defined in s. 54, includes a housing unit and a share in a co-
op housing corporation. The property must be ordinarily inhabited by the taxpayer, the
taxpayer’s child, or the taxpayer’s current or former spouse or common-law partner.

Qualified farm property is defined in subs. 110.6(1) as real and immovable property
owned by an individual and used in carrying on the business of farming in Canada by
the property’s owner or the owner’s spouse, common-law partner, children or parents;
where the owner is a personal trust, a capital or income beneficiary of the trust; a family
farm corporation or partnership; shares of a family farm corporation owned by the
individual, the individual’s spouse or common-law partner; an interest in a family farm
partnership owned by the individual, the individual’s spouse or common-law partner;
and certain eligible capital property.

Qualified fishing property is defined as real or immovable property or a fishing vessel

that is used principally in carrying on the business of fishing in Canada.

Qualified small business corporation share (QSBCS), as defined in s. 110.6, means a

share that meets three tests: (1) the 24-month holding period test, which requires that
the shares cannot be held by anyone other than the individual or a related person during
the 24-month period prior to disposition; (2) the 50% test, which requires that more than
50% of the fair market value of the assets of the corporation must be used in an active
business carried on primarily in Canada throughout the 24-month holding period; and
(3) the 90% test, which requires that the shares be shares of a small business corporation
(SBC) at the time of disposition.

Qualified spousal trust (QST). A trust that qualifies for the spousal rollover, being a
trust, either inter vivos or testamentary, for the sole benefit of the settlor’s spouse or
common-law partner, that is, the spouse or common-law partner is entitled to receive
all the income of the trust that arises before the death of the spouse or common-law
partner, and where no one except the spouse or common-law partner may receive or
otherwise obtain the use of any of the income or capital of the trust during the lifetime
of the spouse or common-law partner.

Reversionary or revocable trusts are trusts where the trust property can revert to the
settlor or, under certain tax rules, the disposition or distribution of trust property is
controlled by the settlor. These trusts are subject to the attribution rule in subs. 75(2)
and cannot distribute trust property on a rollover (or rollout) basis during the lifetime
of the contributor or settlor.

Rights or things are amounts that have been earned prior to death and are payable
but remain unpaid at the time of death, and that would have been included in the
deceased’s income when received. This includes dividends declared but unpaid; unpaid
commissions; salary and wages unpaid at the date of death that are payable in respect
of pay periods ending prior to death; an unpaid bonus declared prior to death that was
legally enforceable; unpaid employment insurance benefits; Canada Pension Plan and
Old Age Security benefits; uncashed matured bond coupons; unused vacation leave
credits; and inventory of a farmer who reports income on a cash basis.

G–5
Glossary

Rollover. A disposition that is deemed to take place for proceeds of disposition equal
to the tax cost or adjusted cost base (ACB) of the transferor. A rollover has the effect of
deferring payment of tax.

Self-benefit trust. A trust for the sole benefit of the settlor and where the property
becomes part of the settlor’s estate on death. A self-benefit trust is similar to an alter ego
trust (AET) or joint spousal and common-law partner trust ( JPT) except that the settlor
does not have to be age 65 or older.

Settlor is a person who contributes the property to a trust. In the case of an estate, the
settlor is the deceased person. “Contributor” or “transferor” are also used in conjunction
with the term “settlor.” Under trust law there is a settlement of property any time someone
contributes property to a trust. However, it is common to think of the “settlor” as the
person who creates the trust by making the initial settlement of property, even though
every person who contributes property to a trust by way of gift is actually a settlor. The
word “transferor” is also used at times to refer to a person who contributes or transfers
property to a trust, particularly with respect to the discussion about whether there is a
disposition or rollover upon transfer of property to a trust, and for the purposes of the
attribution rules. Many of the rules in the Act refer to the consequences of a “transfer” to
a trust, which would include any contribution by a settlor.

Small business corporation (SBC) is a Canadian-controlled private corporation (CCPC)

where all or substantially all (90%) of the fair market value of the corporation’s assets
were used principally in an active business carried on primarily in Canada, or where all
or substantially all of the FMV of the assets consisted of shares or debt of other small
business corporations connected with the corporation, or a combination of the two.

Spendthrift trust: A trust created to prevent an impecunious beneficiary from

squandering his or her interest.

Spouse is not defined in the Act, but it is generally accepted that it means persons who
are legally married, including same-sex partners who are legally married.

Superficial loss is defined in section 54 as a loss from the disposition of particular

property where during the period that begins 30 days before and ends 30 days after
the disposition, thetaxpayer or an affiliated person acquires the same or an identical
property, and the taxpayer or an affiliated person owns the same property or an identical
property at the end of the 30-day period.

Tainted spousal trust. A trust created in the Will of the deceased whose terms do not
conform to all the conditions for the spousal rollover in subs. 70(6). In some cases, it
may be possible to cure the problem in order to “untaint” the spousal trust and make it
a QST for tax purposes.

Tainted testamentary trust. A testamentary trust that has lost its testamentary status
under the Act.

G–6
 Glossary

Taxable income. The amount of income that the tax rates are applied to in order to
determine tax payable. Taxable income is calculated by reducing net income by the
permitted deductions from taxable income, which include non-capital losses of other
years, net capital losses of other years, and the capital gains deduction.

Taxation year. The period for which returns must be prepared and assessed under the
Act. Individuals and inter vivos trusts have a calendar taxation year. Under subs. 104(23),
a testamentary trust may choose any period not exceeding 12 months from the death of
the deceased. Once the year end of a testamentary trust has been chosen, it may not be
changed without consent of the Minister.

Terminal return. The final tax return of the deceased for the year in which the person
died.

Testamentary trusts are trusts created as a consequence of the death of an individual,

often in a Will. They receive special tax treatment under the Act that can be revoked in
certain circumstances, in which case the trust will be treated as an inter vivos trust for
tax purposes.

Testator is a person who makes a Will, and a deceased person who dies with a Will. If
the person dies without a Will, the deceased person may be referred to as the “intestate,”
the term for an individual who dies without a Will.

Trustee is the person who holds legal title to the trust property. A trustee includes
the trustee of an estate, but the trustee of an estate may also be called an “executor”
or “liquidator,” or other name. The name used varies depending on the province and
depending on whether the trustee was appointed under a Will or by a court, such as
would be the case on an intestacy. All executors are trustees, but not all trustees are
executors. The Income Tax Act often refers to a trustee for an individual as the “legal
representative.”

21-Year Rule is the rule under which a personal trust is deemed to have disposed of
all capital property and land inventory every 21 years. There are some exceptions for
certain types of trusts, such as AETs, JPTs, and spousal or common-law partner trusts.

Valuation Day (V-Day) is December 31, 1971, and is the day on which capital property
owned by individuals before 1972 may be valued for the purposes of determining
adjusted cost base.

Worldwide estate, for U.S. estate tax purposes, includes all U.S. property plus all other
property owned by the deceased, wherever situate, whether it passes through the estate
or outside the estate by way of joint ownership or beneficiary designation. It includes
life insurance if the deceased was the owner of the policy or the insurance is paid to the
deceased’s estate. It also includes RRSPs and RRIFs.

Worldwide income means income from all sources, whether located in Canada or
otherwise.

G–7
 SELECT BIBLIOGRAPHY AND SUGGESTED READING

NOTE: Entries with an asterisk (*) are particularly helpful.

Belo Gomes, Nancy, Jones-Foster, Luann, and Corupe, Paul. Tax Planning for You and
Your Family 2018. Toronto: Carswell, 2017.

Brown, Catherine A. Taxation and Estate Planning. Toronto: Carswell, 1996.

* Chow, Grace, and Cadesky, Michael. Taxation at Death: A Practitioner’s Guide 2016.
Toronto: Carswell, 2016.

* Chow, Grace, and Pryor, Ian. Taxation of Trusts and Estates: A Practitioner’s Guide
2018. Toronto: Carswell, 2016.

Duncan, Garry. When I Die: Financial Planning for Life and Death, 2018. Toronto:
Carswell, 2017.

Edgar, Tim, Cockfield, Arthur, and O’Brien, Martha. Materials on Canadian Income
Tax, 15th ed. Toronto: Carswell, 2015.

Li, Jinyan, Magee, Joanne, and Wilkie, Scott. Principles of Canadian Income Tax Law,
9th ed. Toronto: Carswell, 2017.

Louis, David. Implementing Estate Freezes, 3rd ed. Toronto: Wolters Kluwer Canada
Ltd./CCH, 2011.

Magee, Joanne. Insight into Canadian Income Tax 2017-2018. Toronto: Carswell, 2017.

* Prior, Pam, Hanson, Suzanne I.R., and Doody, Shaun M. Death of a Taxpayer, 11th
ed. Toronto: Wolters Kluwer Canada Ltd./CCH, 2016.

* Roth, Elie, Youdan, Tim, Anderson, Chris, and Brown, Kim. Canadian Taxation of
Trusts. Toronto: Canadian Tax Foundation, 2016.

Todary, Michael J. Tax Guide for Investment Advisors, 2018 Edition. Toronto: Carswell,
2017.

B–1
 SUBJECT INDEX

21-year deemed disposition rule definition, 4.7

generally, 2.1.6, 4.8.2 income definition, 4.7.7
T3 return reporting, 5.4.6 requirements, 4.7.7.3
rollover
21-year rule, 4.8 election out, 4.7.7
tax characteristics, 4.7.7
Accountants, 1.8 21-year rule, 4.8.5

Accounting – matching principle, Alternative minimum tax (AMT), 2.1.6,

1.10.3 2.4.3, 4.9, 7.14

Acquisition – deemed – definition, AMT income, 2.4.3, 9.4.1

3 App
Annuity – taxation, 7.8.3
Adjusted cost base (ACB)
definition, 3 App Anti-avoidance rules, 9.2.7, 9.2.8
generally, 3.2.2
identical properties, 3.2.3 Arm’s length transaction – definition,
increasing by electing out of rollover, 3 App
8.2.2.1
private corporate shares – increasing, Asset protection trust – definition, 4.7
8.7.2
shares, 2.2.1.7 Asset swap, 9.6.3

Advance Rulings, 1.6.5 Attribution

AET, 9.3.4
Advantage – definition, 3 App anti-avoidance rules, 9.2.7, 9.2.8
artificial transactions, 9.3.9
Age 40 trust avoiding, 9.6
income splitting, 10.2.2 control of trust by settlor, 9.3.2
retained income for beneficiary under co-trustee, 9.3.2
age 21, 4.3.7.6, 4.7.9 definition, 1.10.3
dividend tax credit – kiddie tax, 9.4.1
Allocation of income: see Beneficiary – effect on flow-through of income from
allocation. trust, 4.3.7.7
exceptions, 9.5
Allowable business investment loss generally, 9.1
(ABIL), 3.5.2 income from property, 9.3.1
JPT, 9.3.4
Alter ego trust (AET) kiddie tax, 9.4.1
advantages, 4.7.7 loans and guarantees, 9.2.7
attribution, 9.3.4 non-arm’s length loans, 9.2.5
death of beneficiary/settlor, 4.7.7, of trust property back to settlor, 9.3
4.7.7.3, 4.8.1 re-invested income, no additional, 9.5.3
deemed disposition on death, 4.7.7, reversion of trust property, 9.3.1
4.7.7.3, 4.8.1

I–1
Subject Index
s. 75(2), 9.3.5
substituted property, 9.2.6
testamentary trusts
unique attributes, 4.7.3.1
transfer for FMV, 9.5.1
transfer or loan to related person
under age 18, 9.2.2
transfer or loan to spouse, 9.2.1
where spouses separated, 9.5.2
transfers to and from trusts, 3.4.7,
9.2.3, 9.3.3, 10.7.13
in estate freeze, 10.7.13
transfer to corporation, 9.2.4, 10.7.11
Bare trust – definition, 4.7
Beneficiary
allocation of income, 6.1.1
allocation of net taxable capital gains,
4.3.8.4
allocations – computing net income,
5.5.1
child or grandchild
educational expenses, 10.3
financially dependent, 7.8.4, 7.8.7
infirm, 7.8.4
testamentary family trust, 10.5.2
death – AET or QST, 4.7.7
disabled
lifetime benefit trust, 4.7.6, 7.8.5
preferred beneficiary election,
4.3.7.6, 4.10
tax planning, 10.6
disposition of capital interest in trust,
6.6.2
disposition of income interest in trust,
6.6.1
even-handed rule – spouse vs. other
beneficiaries, 8.6
financially dependent – rollover of
RRSP or RRIF, 7.8
grandchild: see beneficiary – child or
grandchild
liability for unpaid tax, 11.10
maintenance of trust property –
amounts taxed as income to
beneficiary, 6.3
minor, 4.7.8
non-resident
capital gains exemption, 6.4.3
I–2
distribution of trust property to, 6.7
distribution of income to, 6.7.1
distributions to, 6.7
NR4 slip, 5.1.1, 5.5.4
NR4 summary, 5.1.1. 5.5.4
tax consequences, 5.7
withholding tax, 5.7.2, 6.7.2
receipt of benefits from trust, 6.2
receipt of capital dividends, 6.4.6
receipt of capital property from trust –
cost, 6.5
receipt of property from trust –
attribution, 9.3.3
receipt of RRSP or RRIF refund of
premiums, 7.8.6, 7.8.7
taxation of income, 6.1
third-party payments on beneficiary’s
behalf, 6.1.3, 6.3
under age 21, 4.3.7.6
use of trust property, 6.2
Benefits – taxable – receipt by
beneficiary from trust, 4.3.7.6, 6.2,
6.3
Blair’s inheritance, 9.1, 9.7
Business – definition, 1.10.1
Business income, 1.10.1, 2.2.2.3
deceased’s, 7.2
reporting on T3 return, 5.4.5
vs. employment income, 1.10.1
Canada Pension Plan (CPP) – payments
received after death, 7.7.5
Canada Revenue Agency (CRA)
advance rulings, 1.6.5
discretion – multiple trusts taxed as
one, 4.3.6
guides, 1.6.3
publications, 1.6, 1.7
Canada-U.S. Tax Convention: see U.S.
tax treaty.
Canadian-controlled private
corporation (CCPC) definition,
3.3.2.2, 3 App
dividends, 2.2.1.5
 Subject Index

CanLII, 1.7 QSBCS, 6.4.3

qualifying farm or fishing property,
Canadian non-resident aliens of U.S. 6.4.3
(NRAs), 12.2, 12.4.1 spousal trust – year of death – T3
return, 5.6.5
Canadian non-resident – taxation of,
1.3.3.2 Capital gains exemption, 2.1.6, 3.2.1,
3.3.1, 7.10.9
Canadian resident allocation to beneficiaries, 4.3.8.5
definition, 2.1.4 designation, 4.3.8.5
taxation of, 1.3.3.1 income splitting, 9.6.7
multiplying access, 9.6.7, 10.7.8
Canadian securities: see Securities – non-resident beneficiary, 6.4.3
Canadian. use by beneficiary, 6.4.3

Capital cost allowance (CCA) Capital loss

definition, 1.10.2, 3 App
in terminal return, 7.10.3
recapture – definition, 3 App
rental property, 2.2.1.9
terminal loss – definition, 3 App
Capital disposition
reserve, 3.2.7
Capital dividend – designation to
beneficiary, 6.4.6
Capital gain
as income, 2.2.2.1
calculation, 3.2.1
deferral – rollover to spousal trust,
10.4.4
definition, 1.10.2, 3.1.1, 3.2, 3 App
designation to beneficiary, 6.4.2, 6.4.3
history, 3.1.2
inclusion rate, 3.1.2
definition, 3 App
income splitting with minor children,
9.6.5
lifetime exemption: see Capital gains
exemption
net taxable – allocation to beneficiary,
4.3.8.4
T3 return reporting, 5.4.1
taxable – definition, 3 App
unique characteristics, 3.1.1
vs. income, 1.10.2
Capital gains deduction, 1.8.2.2, 3.3.1
allowable, 3 App
allowable business investment loss
(ABIL), 3.5.2
calculation, 3.2.1
carryback, 3.5.5, 5.6.3
carryback from first year of estate to
terminal return, 8.3.2
carry forward – T3 return, 5.6.4, 7.12.2
definition, 3.2, 3 App
in year of death, 3.5.7, 7.12.1, 8.3.1
listed personal property, 3.5.4
personal use property, 3.5.3
share redemption, 2.2.1.7, 8.7.1
superficial loss, 3.5.1
T3 return reporting, 5.4.1, 5.6.3
Capital property
deemed disposition on death, 7.10.2,
7.10.6
definition, 1.10.2, 3 App
distribution from a trust, 4.5
distribution to beneficiary – cost, 6.5
eligible – definition, 3 App
partnership interest, 7.10.7
rollovers upon death, 7.10.8
Capital receipts vs. income, 3.1.3
designation, 6.1.1
Caretaker trust – definition, 4.7
Carryback of losses to terminal return,
5.2.1

I–3
Subject Index
Carrying charges, 2.2.3.2
Certificate of compliance, 11.11
Charitable donation
by deceased, 7.13.3, 8.2.2.4
by estate, 4.12, 8.2.2.4
by trust, 4.12
discretionary vs. mandatory, 4.12
Charitable remainder trust – definition,
4.7
Clearance certificate, 5.8, 7.2, 7.5,
11.10
Comfort letters–Department of
Finance, 1.6.7
Commercial trusts, 4.7.1
Common-law partner – definition,
2.1.5, 3 App
Conduit principle, 4.3.7
attribution, 4.3.7.7
exceptions, 4.3.7.5, 4.3.7.6, 4.3.7.7,
4.3.7.8
losses, 4.3.7.8
Corporation
eligible active business corporation –
definition, 3 App
eligible small business corporation –
definition, 3 App
estate freezing with, 10.7.4
private shares
bump up of non-depreciable capital
property, 8.7.2
capital loss carryback, 8.7.1
mitigating double tax, 8.7
transfer to holding company, 8.7.3
winding up, 8.7.3
reorganization – rollover, 3.4.6
rollover to, 3.4.6
small business (SBC)
allowable business investment loss
(ABIL), 3.5.2
definition, 3.3.2.3, 3 App
I–4
Creation of trust, 4.2.1
certainty of intention, 4.2.1.3
certainty of objects, 4.2.1.5
certainty of subject, 4.2.1.4
essential parties, 4.2.1.1
failure, 4.2.4, 4.2.5
three certainties, 4.2.1.2
transfer of property, 4.2.1.6
Crystallization – estate freeze, 10.7.8
Cumulative net investment loss (CNIL),
3.3.1
Death benefit, 7.7.3, 7.7.6
Deduction – definition, 1.10.3
Deemed cost, 3 App
Deemed disposition, 3.2.5
capital property, 7.10.2
definition, 3 App
distribution to non-resident beneficiary,
6.7
inventory, 7.10.1
personal use property, 7.10.4
principal residence, 7.10.5
under 21-year rule – T3 return
reporting, 5.4.6
upon death, 7.10
Deemed proceeds
phantom income, 6.4.5
transfer to trust – FMV, 4.4.2
Delinquent returns, 7.2
Depreciable property – definition,
1.10.2, 3 App
Discretionary trust
amounts payable to beneficiary, 6.1.5
discretionary trust – definition, 4.7
Disposition
deemed proceeds, 4.4.2
definition, 3 App
deferred proceeds, 3.2.7
definition, 3.2.4, 3 App
expenses, 3.2.6

proceeds, 3.2.4
definition, 3 App
transfer of property to trust, 4.4.1,
4.4.2, 4.4.3
Distributions to non-resident
beneficiaries: see Non-resident
beneficiaries.
Dividends, 2.2.1.4
capital – designation, 4.3.8.3, 6.4.6
eligible, 2.2.1.5
designation, 2.2.1.5, 4.3.8.2
gross-up, 2.2.1.4, 2.2.1.5
non-eligible, 2.2.1.4
taxable Canadian corporations – T3
return reporting, 5.4.2
taxable – designation, 2.2.1.4, 4.3.8.1,
6.4.1
tax credit, 2.2.1.4
Dividend tax credit, 2.2.1.4, 2.2.1.5
attribution – kiddie tax, 9.4.1
Donation Tax Credit, 2.4.2
Educational expense trusts, 10.3
Eligible active business corporation –
definition, 3 App
Eligible amount of the gift – definition,
3 App
Eligible capital property – definition,
3 App
Eligible dividends: see Dividends –
eligible.
Eligible small business corporation –
definition, 3 App
Employment income, 2.2.2.2
received after death, 7.7.2
Employment Insurance benefits –
received after death, 7.7.8
Enforcement powers, 11.8
I–5
Subject Index
Estate
distribution in specie (in kind), 8.5
distribution – T3 return due date, 5.2.3
executor’s year, 4.3.7.4
filing copy of Will with CRA, 5.2.4
first T3 return, 5.2
payment to beneficiary, 4.3.7.4
residence, 4.3.3.1
tax advice, 1.8.1
year-end, 5.2.2
Estate freeze, 10.7
capital gains exemption, 10.7.8
classic, 10.7.5
crystallization, 10.7.8
gel, 10.7.14
life interest in real property, 10.7.3
melt, 10.7.15.2
non-share consideration, 10.7.9
partial freeze, 10.7.15.1
pros and cons, 10.7.16
PUC of shares, 10.7.9
refreeze, 10.7.15.4, 10.7.15.5
reverse freeze, 10.7.15.6
thaw, 10.7.15.3
using corporation, 10.7.4
using trust to hold corporate shares,
10.7.12, 10.7.13
vs. gift, 10.7.2
Excepted gift – definition, 3 App
Executor – personal liability, 7.5
Exemptions – tax planning strategies,
22.3
Fair market value (FMV) – definition,
3 App
Family trusts, 10.5.2
Farm property – rollover, 3.4.5
Financially dependent, 7.8.3.1, 7.8.4.2
Fishing property – rollover, 3.4.5
Fixed interest trust, 4.7.9, 10.2.2
Foreign currency – receipts, 3.2.5
Subject Index
Foreign income
conversion, 2.2.1.8
designation to beneficiaries, 4.3.8.6
T3 return reporting, 5.4.3
Foreign investments – income, 2.2.1.8
Foreign property – duty to report, 12.7
Foreign tax
advice, 1.8.3
foreign property owned by Canadians,
12.5.2
gifts and inheritances by Canadians,
12.5.1
income tax, 12.5.2
Foreign trust – deemed residence in
Canada, 12.6.3
Freeze, 1.8.2.1. See also Estate freeze.
Gifts
charitable
by estate, 4.12
by trust, 4.12
eligible amount – definition, 3 App
excepted – definition, 3 App
in kind of capital property, 4.12.1
taxation – in Canada, 2.2
to trust – rollover, 4.4
vs. estate freeze, 10.7.2
graduated rate estate (GRE), 4.7,
4.7.3.1, 5.2, 5.2.2, 10.5, 10.5.1
Grandfathering, 1.3.2.4, 1.5.2
Henson trust – definition, 4.7, 10.6
Immigration trust – offshore trust,
12.6.1
Inclusion rate: see Capital gain –
inclusion rate.
Inheritance trust – offshore trust,
12.6.2
I–6
Income
accumulation – taxation in hands of
beneficiary, 4.3.7.6
after death
death benefit, 7.7.3, 7.7.6
employment income, 7.7.2
Employment Insurance benefits, 7.7.8
investment income, 7.7.9
Old Age Security, 7.7.4
periodic payments, 7.7.1
pension payments, 7.7.5, 7.7.7
business, 1.10.1
T3 return reporting, 5.4.5
calculation – deductions to trust, 5.4.9
definition, 1.10.1, 3.1.4
definition for AETs, JPTs, QSTs, 4.7.7
designation, 4.3.8, 4.3.8.9, 5.5.2, 6.1.1
distribution to non-resident beneficiary,
6.7.1
election to retain in trust, 5.5.1.1
farming or fishing – T3 return
reporting, 5.4.5
from employment – definition, 1.10.1
from property, 2.2.1
definition, 1.10.1
increasing in year of death, 8.2.2
investment
carrying charge deductions, 5.4.9.2
received after death, 7.7.9
reporting on T3 return, 5.4.4
net, 2.1.4
payable to beneficiary, 6.1.2
payment by estate, 4.3.7.4
payment by trust, 4.3.7.1
flow-through, 4.3.7
phantom, 6.4.5
reducing in year of death, 8.2.1 rental –
T3 return, 5.4.5
reserves – in year of death, 7.7.10
retained for beneficiary under age 21,
4.3.7.6
source – flow-through to beneficiary,
4.3.8, 6.4
taxable – calculation, 5.6
taxable to beneficiary, 6.1
trust or estate vs. individual, 5.2.5
vs. capital receipts, 3.1.3
 Subject Index

Income splitting Interest expense, 2.2.3.2, 5.4.9.1

capital gains exemption, 9.6.7
definition, 1.10.3 Interest income, 2.2.1.2
designated income, 4.3.8.9 deductions, 2.2.1.3
dividend tax credit effect, 2.2.1.4
family testamentary trust, 10.5.2 Interpretation Bulletins (IT Bulletins),
fixed interest age 40 trust, 10.2.2 1.6.1
graduated rate estates (GREs), 10.5,
10.5.1 In trust for accounts, 4.2.6, 10.3.1
tax planning strategies, 10.1.4, 10.2
techniques, 9.6, 10.2 Inventory
testamentary trusts, 10.5 deemed disposition on death, 7.10.1
using trusts, 10.2 definition, 1.10.2
with business, 9.6.6
with minor children, 9.6.5, 10.2.2 Joint accounts, 2.2.1.1

Income sprinkling: see Income Joint spousal or common-law partner

splitting. trust ( JPT)
advantages, 4.7.7
Income Tax Act – organization, 1.4 attribution, 9.3.4
death of survivor, 4.7.7, 4.7.7.4, 4.8.1
Income Tax Application Rules (ITARs), deemed disposition on death, 4.7.7,
1.5.2 4.7.7.4, 4.8.1
definition, 4.7
Income Tax Folios (ITFs), 1.6.1, 1.6.6. income definition, 4.7.7
requirements, 4.7.7.4
Income Tax Technical News (ITTNs), rollover
1.6.6 election out, 4.7.7
tax characteristics, 4.7.7
Indefeasible vesting of interest, 4.8.6 21-year rule, 4.8.5

Individual – taxation – vs. trust, 2.1.6 Jointly held property, 7.10.6

Informal trust, 4.2.6, 10.3.1 Kiddie tax, 9.4.1

dividend tax credit – combatting, 9.4.1
Information Circulars (ICs), 1.6.2 penalty on dividends, 9.4.1

Inheritance – taxation – in Canada, 2.2 Late filing penalties, 11.6

Interest: see Relief, from interest and Lawyers, 1.8

penalties.
Life insurance trusts, 4.7.4
Inter vivos trust
definition, 4.7 Life interest in real property, 10.7.3
T3 filing requirements, 5.1.3
tax attributes, 4.7.2 Lifetime benefit trust
tax rates, 4.3.4, 4.3.5 definition, 4.7.6
taxation year, 4.3.5 rollover of refund of RRSP premiums,
7.8.4.3
uses, 4.7.6

I–7
Subject Index
Lifetime capital gains exemption: see
Capital gains exemption.
Listed personal property
definition, 3.5.4, 3 App
loss, 3.5.4
Litigation, 11.12
Loans and guarantees
at prescribed rate, 9.6.4
attribution, 9.2.7
Losses
after death – RRSPs and RRIFs, 7.8.8
flow-through from trust to beneficiary,
2.1.6, 4.3.7.8, 6.4.4
Loss utilization, 8.3
Lottery winnings – taxation, 2.2
Marital status – effect on tax, 2.1.5
Matching – definition, 1.10.3
Medical expenses – tax credit, 7.13.2
Mutual funds, 2.2.1.6
Net adjusted taxable income for
minimum tax (AMT Income), 2.4.3
Net capital loss, 3.5.6
carry forward, 7.12.2
definition, 3.5.5, 3 App
in year of death, 7.12.1, 8.2.2.2
T3 return, 5.6.2
Net income
allocations to beneficiaries, 5.5.1
calculation, 2.2
deductions, 2.2.3
income from a trust, 2.2.2.5
Non-arm’s length
loans – attribution, 9.2.5
related vs unrelated persons, 9.2.5
transaction – definition, 3 App
I–8
Non-capital loss, 2.3.1, 3.5.5
T3 return, 5.6.1
Non-qualifying real property: see Real
property – non-qualifying.
Non-qualifying securities: see
Securities – non-qualifying.
Non-refundable personal tax credits,
2.1.6, 7.13
Non-resident beneficiaries
certificate of compliance requirement,
6.7.6
relief from, 6.7.7
designated income, tax on, 6.7.3
disposition of capital interest, 6.7.6
disposition of capital property, 6.7.5
distribution in satisfaction of a capital
interest, 6.7.4
income distributions to, 6.7.1
withholding tax credited to, 6.7.2
withholding tax on Income paid to,
6.7.2
treaty-exempt, 6.7.7
Non-resident trust – duty to report
transactions, 12.7
NR4 slip, 5.1.1, 5.5.4
NR4 summary, 5.1.1, 5.5.4
Offshore Tax Informant Program, 11.8
Offshore trust, 12.6
deemed residence in Canada, 12.6.3
immigration trust, 12.6.1
inheritance trust, 12.6.2
Old Age Security – payments received
after death, 7.7.4
Outlays and expenses – definition,
3 App
Paid-up capital (PUC) – shares, 2.2.1.7,
8.7
in estate freeze, 10.7.9
 Subject Index

Payment of tax, 7.4 transfer by trust, 4.11.4

transfer to trust, 4.11.1
Penalties: see Relief, from interest and
penalties. Probate fee – legality, 1.1.5

Pension plan – income from, 2.2.2.4. Proceeds of disposition: see

7.7.7 Disposition – proceeds.

Personal representative: see Trustees; Progressive tax, 1.10.3

Executor.
Purification – QSBCS – estate freeze,
Personal trust 10.7.8
definition, 4.7, 4.7.1
21-year rule, 4.8.1, 4.8.6 Qualified beneficiary – refund of RRSP
premiums, 7.8.3.3
Personal use property
deemed disposition on death, 7.10.4 Qualified donee – definition, 2.4.2,
definition, 3.5.3, 3 App 3 App
loss, 3.5.3
use by beneficiary, 6.2 Qualified farm property or fishing
property
Phantom income: see Income – capital gains deduction, 6.4.3
phantom. definition, 3.3.3, 3 App

Pipeline strategy: see Corporation, Qualified small business corporation

private shares.
Post-mortem tax planning, 8.1
electing out of rollover to increase
ACB, 8.2.2.1
increasing income in year of death,
8.2.2
reducing income in year of death, 8.2.1
share (QSBCS)
capital gains deduction, 6.4.3
crystallization, 10.7.8
definition, 3.3.2.1, 3 App
estate freezing, 10.7.7, 10.7.8
purification, 10.7.8
relieving provision on death, 3.3.2.5
24-month holding test, 3.3.2.4

Preferred shares – interest expense on Qualified trust annuities, 7.8.4

purchase, 2.2.3.2
Qualifying property – capital gains
Prescribed security: see Security – exemption, 3.3.1
prescribed.
Qualifying spousal or common-law
Principal residence partner trust (QST)
deemed disposition on death, 7.10.5 allocation of assets with non-QST and
definition, 3.2.8 tainted spousal trust, 8.4.1
distribution to beneficiary – rollover – death of beneficiary or spouse, 4.7.7,
election out, 4.5.3 4.7.7.5, 4.8.1
exemption, 2.1.6, 3.2.8 deemed disposition on death, 4.7.7,
formula, 3.2.8 4.7.7.5, 4.8.1
use by trust, 4.11.2 definition, 3.4.4, 4.7
ordinarily inhabited – definition, 4.11.2 income definition, 4.7.7
proposed changes, 4.11.3 requirements, 4.7.7.5, 10.4.1

I–9
Subject Index

rollover, 4.7.7, 10.4, 10.4.1 transfer to trust, 3.4.7, 4.4.3

election out, 4.7.7 value for terminal return, 7.8.1
pros and cons, 10.4.2
Real property
Quebec Pension Plan (QPP) – capital vs. income, 3.1.3.1
payments received after death, 7.7.5 definition, 3 App
life interest, 10.7.3
RDSP – taxation of deceased, 7.9.3 non-qualifying – definition, 3 App

RESP Recapture – definition, 3 App

as trust for children or grandchildren,
10.3.2 Registered disability savings plan: see
taxation of deceased, 7.9.2 RDSP.

RRIF, 4.7.8, 7.8.7 Registered education savings plan: see

beneficiary, 2.2.3.4 RESP.
designated benefit, 5.4.8
losses after death, 7.8.8 Registered plans
refund of premiums – taxation of contributions, 2.2.3.4
beneficiary, 7.8.1, 7.8.5, 7.8.6 spousal rollover, 10.4.6
value for terminal return, 7.8.1
Registered retirement income fund:
RRSP, 4.7.8, 7.8.2, 7.8.3 see RRIF.
beneficiary, 2.2.3.4
contributions, 2.2.3.4 Registered retirement savings plan:
financially dependent child or see RRSP.
grandchild, 7.8.4.1
infirm child or grandchild, 7.8.4.2 Regressive tax, 1.10.3
losses after death, 7.8.8
matured – taxation, 7.8.3 Regulations, 1.5.1
payment to financially dependent child
or grandchild, 7.8.4.2 Relief, from interest and penalties,
post-mortem income – T3 return 11.16
reporting, 5.4.8 fairness application, 11.16.2
refund of premiums, 5.4.8, 7.8.3 U.S. taxpayer relief, 11.16.3
qualified beneficiary, 7.8.3.3 voluntary disclosure, 11.16.1
qualified trust annuities, 7.8.4.3
Rental property
rollover –financially dependent child
capital cost allowance, 2.2.1.9
or grandchild, 7.8.4.2
expenses, 2.2.1.9
taxation of beneficiary, 7.8.1, 7.8.5
income, 2.2.1.9
rollover, 7.8.3
loss, 2.2.1.9
spousal
pros and cons, 10.4.2
Reserve on capital disposition
registered plans, 10.4.6
proceeds, 3.2.7
upon death – electing out of, 8.2.1
testamentary trust, 3.4.3, 10.4 Residence
spousal contributions, 9.6.2 estate, 4.3.3.1
tax planning strategies, 10.1.3 foreign trust – deemed residence in
transfer from trust, 3.4.7 Canada, 12.6.3
transfer to corporation, 3.4.6 province of, 2.1.4

I–10
 Subject Index

trust, 4.3.3, 4.3.3.2 Shares

tiebreaker, 4.3.3.2 capital dividend account (CDA), 8.7
dividend tax credit – attribution –
Reversion of property, consequences, kiddie tax, 9.4.1
9.3.1 exchange, 3.4.6
in estate freeze, 10.7.7
Reversionary or revocable trust – private corporations – double taxation,
definition, 4.7 8.7
redemption
Rights or things capital loss carryback, 8.7.1
definition, 7.15 deemed dividend, 2.2.1.7
return, 7.15 rollover, 3.4.6
in estate freeze, 10.7.6, 10.7.7
Rollover
capital gains deferral, 10.4.4 Small business corporation (SBC): see
concepts, 3.4.1 Corporation – small business.
corporate shares – in estate freeze,
10.7.6 Solicitor and client privilege, 11.15
definition, 1.10.3
distribution of trust property to Spendthrift trust – definition, 4.7
beneficiary, 4.5.1, 4.5.2
attribution, 9.3.3 Spousal trust
election out, 4.5.3 allocation of assets, 8.4.1
exceptions, 4.5.4 capital gains deduction – year of death
electing out, 8.2.3 – T3 return, 5.6.5
to increase ACB, 8.2.2.1 drafting, 10.4.4, 10.4.5
farm or fishing property, 3.4.5 qualified – definition, 3.4.4
qualifying transfers, 3.4.2 right to encroach on capital, 10.4.3
QST, 4.7.7.5, 10.4.1 rollover
electing out, 4.7.7 capital gains deferral, 10.4.4
pros and cons, 10.4.2 registered plans, 10.4.6
21-year rule, 4.8.1, 4.8.4
Securities tainted
Canadian definition, 3 App curing, 8.4.2, 8.4.3, 8.4.4
election to treat on capital account, definition, 3.4.4
3.1.3.3 loan at less than FMV, 10.4.1.4
income vs. capital, 3.1.3.2 rectifying, 8.4.4
non-qualifying – definition, 3 App tax planning with, 3.4.4
prescribed – definition, 3 App testamentary
income splitting, 10.5
Self-benefit trust rollover, 3.4.3
definition, 4.7, 4.7.5
tax treatment, 4.7.5 Spouse – definition, 2.1.5, 3 App

Settlor Substantially all – definition, 4.3.6

attribution of income back to, 9.3.1
attribution of trust property back to, Superficial loss, 3.5.1
9.3
control over trust – attribution, 9.3.2 T3 return, 5.1.1
death of – AET or JPT, 4.7.7 business income, 5.4.5

I–11
Subject Index

capital gains and losses, 5.4.1 depreciable property, 7.10.3

capital gains deduction – spousal trust elective returns, 7.2
– year of death, 5.6.5 income after death, 7.7
designation of income type to net capital loss
beneficiary, 5.5.2 carry forward, 7.12.2
dividends from taxable Canadian in year of death, 7.12.1
corporations, 5.4.2 non-refundable tax credits, 7.13
due date, 5.1.3 post-mortem tax planning: see Post-
where estate substantially mortem tax planning.
distributed, 5.2.3 reducing income in year of death, 8.2.1
election to retain income in trust, RDSP, 7.9.3
5.5.1.1 RESP, 7.9.2
electronic filing, 5.1.4 rights or things return, 7.15
farming income, 5.4.5 RRSPs and RRIFs, 7.8
filing requirements, 5.1.3 summary, 7.1
first year of estate, 5.2 TFSA, 7.9.1
fishing income, 5.4.5 terminal return, 7.2. 7.6
information required due date, 7.3
questions, 5.3.3 tax rates, 8.2.2.5
residence, 5.3.1
type of trust, 5.3.2 Taxation of trusts
net income, 5.4 as individuals, 4.3.2
post-mortem income from an multiple trusts taxed as one, 4.3.6
unmatured RRSP, 5.4.8 scheme of Act, 4.3.1
rental income, 5.4.5 vs. individuals, 2.1.6
reporting foreign income, 5.4.3
reporting investment income, 5.4.4 Taxation relief: see Relief.
taxable income, 5.6
Taxation year
T3 slip, 2.2.2.5, 5.1.1, 5.5.3 definition, 4.3.5
net income, 5.4 inter vivos trusts, 4.3.5
testamentary trusts, 4.3.5
T3 summary, 5.1.1, 5.5.3
Tax attributes of property
Taxable benefits: see Benefits – taxable. distribution in specie (in kind), 8.5
spouse vs. other beneficiaries, 8.6
Taxable capital gain: see Capital gain –
taxable. Tax credit, 2.4.2
definition, 1.10.3
Taxable income, 2.3 minimum – from earlier years, 8.2.2.3
non-refundable, 2.4.2
Tax advice – foreign, 1.8.3 in year of death, 7.13
medical expenses, 7.13.2
Taxation of deceased personal amounts, 7.13.1
annuity, 7.8.3
capital cost allowance, 7.10.3 Tax expenditures – definition, 1.10.3
capital loss – carryback from first year
of estate to terminal return, 8.3.2 Tax-free savings account (TFSA) –
charitable donations, 7.13.3 taxation of deceased, 7.9.1
deemed disposition upon death, 7.10

I–12
 Subject Index

Tax law Tax return

case law, 1.5.5 filing deadline, 2.1.6, 11.2
federal, 1.3.4 late filing – penalties, 11.6
history, 1.2.2 requirement to file, 11.2
Income Tax Act – organization, 1.4
legislative process, 1.3.2 Tax treaties, 1.5.3, 2.1.4
OECD Model Tax Convention, 1.5.4
powers to impose, 1.2.1 Technical Interpretations, 1.6.4
provincial, 1.3.4
purposes, 1.2.3 Terminal loss – definition, 3 App
sources, 1.3.1, 1.5, 1.6, 1.7
vs. trust law, differences, 4.1 Terminal return, 7.2, 7.6. See also
Taxation of deceased.
Tax payments deduction for RRSPs and RRIFs, 7.8.7
calculation, 2.4 due date, 7.3
due date, 11.2 value of RRSPs and RRIFs, 7.8
instalments, 11.3
interest, 11.5 Termination of a trust, 4.6
requirement to make, 11.2
Testamentary trusts
Tax preparation software, 2.1.2 definition, 4.7
income splitting, 10.5
Tax procedure loss of testamentary status, 4.7.3.2
appeals, 11.12 requirements, 4.7.3
assessments, 11.7 T3 filing requirements, 5.1.3, 5.1.5
audits, 11.8 tax attributes, 4.7.3.1
certificate of compliance, 11.11 tax rates, 4.3.4, 4.3.5
clearance certificate, 11.11 taxation year, 4.3.5
filing deadlines, 11.2 unique attributes, 4.7.3.1
late filing – penalties, 11.6
litigation, 11.12 Transfers from trusts – rollover, 3.4.7
notices of objection, 11.12
offences under Act, 11.14 Transfers to trusts
payment due dates, 11.3 disposition, 4.4.1
reassessments, 11.7, 11.12 rollover, 3.4.7, 4.4, 4.4.3
rectification of mistake, 11.12
Trust as a legal person, 4.2.2
tax avoidance, 11.17
tax evasion, 11.7, 11.17
Trustees
unpaid tax
duty to file T3 return, 5.1.4
collection, 11.9
exercise of discretion – record-keeping,
joint and several liability, 11.9
6.1.2, 6.1.4, 6.1.5
voluntary disclosure, 7.2, 11.16.1
fiduciary duties – minor beneficiary,
4.7.8.3
Tax professionals, 1.8
joint and several liability, 5.8, 11.10
Tax rates liability to pay tax, 5.1.4
individuals, 2.4.1 personal liability, 5.1.4, 5.8, 7.5
terminal return, 8.2.2.5 settlor – control over trust – attribution,
trusts, 4.3.4, 4.3.5 9.3.2
websites, 2.4.1

I–13
Subject Index
Trust income
designation to be taxed in trust, 4.3.7.5
flow-through of income, 4.3.7
taxation in hands of beneficiary, 4.3.7.6
Trust law
history, 4.2.3
vs. tax law, differences, 4.1
Trust losses – flow-through, 6.4.4
Trust payments
to beneficiary
allocation of income source, 6.1.1
amounts payable, 6.1.2, 6.1.4
deduction, 4.3.7.2
designation of income, 6.1.1
discretionary, 4.3.7.3, 6.1.2, 6.1.5
from capital, 6.1.1
income, 4.3.7.1
non-resident beneficiary, 6.7
to or on behalf of minor, 4.7.8.3
to third party on behalf of beneficiary,
6.1.3
Trust property
distribution to beneficiary – rollover,
4.5.1, 4.5.2
attribution, 9.3.3
election out, 4.5.3
exceptions, 4.5.4
distribution to non-resident beneficiary,
6.7
maintenance – outlays taxed in hands
of beneficiary, 4.3.7.6, 6.3
reversion, 9.3.1
right to encroach on capital, 10.4.3
transfer, 4.2.1.6
attribution back to settlor, 9.3
to beneficiary – cost, 6.5
Trust tax return, 5.1.1
filing requirements, 5.1.3
trust tax return – minimal income
exception, 5.1.2
Types of trust for tax purposes, 4.7
I–14
Undepreciated capital cost (UCC) –
definition, 3 App
U.S. estate and gift tax, 12.1
annual exclusion amount, 12.2.5
application to Canadian non-resident
aliens of U.S. (NRAs), 12.2
Canadian foreign tax credit, 12.2.7
definition of U.S. property, 12.2.2
definition of worldwide estate, 12.2.3
estate planning for Canadian NRAs,
12.2.10
strategies to reduce U.S.
tax,12.2.10.1 to 12.2.10.8
gift tax
Canadian NRAs, 12.4.1
U.S. persons, 12.4.2
marital credit, 12.2.6
misconceptions, 12.2.9
requirement to file return, 12.2.4
tax rates, 12.2.5
treaty relief, 12.2.4
U.S. citizens living in Canada, 12.3
reporting requirements, 12.3.6
requirement to file return, 12.3.4,
12.3.5
tax calculation, 12.3.3
U.S. person – definition, 12.3.1
unified credit, 12.2.5
U.S. taxation system – 1.3.3.1
U.S. tax treaty, 12.2.4
application to U.S. persons, 12.3.2
Vesting – definition, 4.7.9
Worldwide estate – definition – U.S.
estate and gift tax, 12.2.3
Year-end, 2.1.6
estate, 5.2.2
individuals, 2.1.6
inter vivos trusts, 2.1.6
stub period, 7.2
testamentary trusts, 2.1.6, 7.2