2016-0642811E5 attribution rules - spouses

Principal Issues: Whether the attribution rules apply in a particular situation.

Position: Question of fact. General comments provided.

Reasons: Attribution rules related to spouses found in ss 73(1), 74.1(1), 74.2(1), 74.5(2), 74.5(11).

Author: Teow, Christina
Section: 73(1), 74.5(11), 74.1(1), 74.2(1), 74.5(2), 82(2), 74.5(11), 20(1)(c)

XXXXXXXXXX                                                                                                          2016-064281
                                                                                                                                  C. Teow
June 29, 2016

Dear XXXXXXXXXX:

Re: Attribution Rules - Spouses

This is in response to your correspondence of April 11, 2016, wherein you requested our views on the income tax implications pertaining to the attribution rules in the Income Tax Act (the “Act”) related to spouses.

In your letter, you describe a scenario in which an individual had owned and sold shares of a Canadian-controlled private corporation that are “qualified small business corporation shares,” as defined in subsection 110.6(1) of the Act. The capital gain arising on the disposition of shares qualified for the capital gains exemption. The proceeds from the sale of the shares were placed in a non-registered joint investment account with the individual’s spouse for the purpose of acquiring and holding financial instruments such as bonds and mutual funds. It is your view that all capital gains and other income earned in the joint account that is reported by the spouse would be attributed back to the individual unless a prescribed loan is made from the individual to his or her spouse. You ask a series of specific questions related to the avoidance of the attribution rules in the Act.

Written confirmations of the tax implications inherent in particular transactions are provided by this Directorate where the transactions are proposed and are the subject matter of an advance income tax ruling submitted in the manner set out in Information Circular 70-6R7, “Advance Income Tax Rulings”, dated May 17, 2016.  This Information Circular and other Canada Revenue Agency (“CRA”) publications can be accessed on the internet at http://www.cra-arc.gc.ca/formspubs/menu-e.html.  Where a particular transaction has already been completed, a review of the relevant facts and circumstances surrounding the situation would be required.  Such review would normally be conducted by the applicable Tax Services Office (“TSO”) during the course of an income tax audit which, if undertaken, would be carried out after the particular taxpayer has prepared and filed its income tax return for the year.

Our Comments

The Act contains a comprehensive set of rules intended to prevent an individual and the individual’s spouse from splitting income from property so as to reduce the total amount of tax payable on that income. Except where fair market value consideration is paid by the spouse or the parties are living separate and apart by reason of a breakdown of their marriage, income earned and capital gains and losses realized on property transferred or loaned from an individual to the individual’s spouse (and on property substituted for that property) are generally deemed to be the income, gains or losses of the taxpayer and not of the individual’s spouse.

Subsection 73(1) of the Act provides that where an individual transfers capital property to his or her spouse and both are resident in Canada at the time of the transfer, the particular property transferred shall be deemed to have been disposed of for proceeds equal to the adjusted cost base of the property immediately before the transfer and to have been acquired by the individual's spouse for an amount equal to those proceeds. However, the transferor may elect out of the provisions of subsection 73(1) of the Act.

If the transferor does not elect out of the provisions of subsection 73(1) of the Act, he or she is not required to report any capital gains resulting from the sale of the property to their spouse. However, pursuant to subsections 74.1(1) and 74.2(1) of the Act and subject to subsection 74.5(11) of the Act, any dividends or other income from the property after the sale to the spouse, will be deemed to be the transferor's income, and any capital gains or losses realized on the subsequent disposition of the property will be deemed to be the transferor's capital gains or losses. In this regard, income from property would generally be income after deducting those expenses that are deductible in computing income from that particular property. Finally, subsection 82(2) of the Act provides that where a dividend is included in the transferor's income because of the attribution rules, the dividend is deemed to have been received by the transferor. This will enable the transferor to claim the dividend tax credit.

In circumstances where one spouse purchases property using funds which are provided solely from the assets or earnings of the other spouse (the "Contributing Spouse"), the Contributing Spouse is considered to have transferred property to the other spouse. It is our view that the attribution rules would apply to property transferred by the Contributing Spouse to the other spouse. As a consequence, any income earned and capital gains or losses realized on the investments by the other spouse from the property transferred by the Contributing Spouse would generally be deemed to be income, gains or losses of the Contributing Spouse and would therefore not be considered to be income of the other spouse. Generally, subsection 74.5(2) provides that if a Contributing Spouse loaned funds to his or her spouse and charged interest on the loan at a rate equal to or greater than the lesser of the prescribed rate that was in effect at the time the loan was made, and the rate, that would, having regard to all the circumstances, have been agreed on, at the time the loan was made, between parties dealing with each other at arm’s length, subsections 74.1(1) and (2) and section 74.2 would not apply to any income, gain or loss derived in a particular taxation year from the property acquired with the loaned funds.

It should be noted that it is a question of fact as to whether attribution applies to any particular situation and the issue can only be decided on a case-by-case review of all the pertinent information. The resolution of this question from the perspective of the taxpayer or the spouse would require an analysis of all of the pertinent facts surrounding the acquisition of the portfolio of income producing investments.  You may wish to refer to Interpretation Bulletin IT-511R, Interspousal and Certain Other Transfers and Loans of Property, for additional information on the application of the attribution rules.

We would also like to mention that, in our view, the anti-avoidance rules of subsection 74.5(11) or section 245 of the Act may have application where it can be shown that the primary purpose, or one of the main purposes, of the transactions was to reduce the tax liability of the taxpayer or the spouse.  This, of course, could not be determined until there was a thorough review of the facts in an actual situation.

Interest Expense

You have asked whether interest expense paid by an individual to his or her spouse on a loan would be deductible. Subparagraph 20(1)(c)(i) of the Act provides that interest expense on borrowed money is deductible only if certain conditions are met. The interest paid in the year or payable in respect of the year (depending on the method regularly followed by the individual in computing the individual’s income) must be pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy). The amount deductible under subparagraph 20(1)(c)(i) is the lesser of the amount paid or payable as interest, as described above, or a reasonable amount.

The situation described in your correspondence appears to be more in the nature of a request for tax planning advice. The CRA does not offer tax planning advice and consequently we are unable to provide any comments regarding the particular situation described.

We trust that these comments will be of assistance.

Yours truly,

G. Moore
For Director
Partnerships and Corporate Financing Section
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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