2016-0645821C6 2016 STEP - Q11 - Tainting of a Spousal Trust

Principal Issues: Is paragraph 8 of IT305R4 (archived) still valid?

Position: Yes - response provides detail as to context and application.

Reasons: The main purpose of this paragraph is to clarify that for certain purposes of the ITA (i.e. 104(4)) one must reference terms of the trust existing on the date the trust was created.

Author: Kohnen, Phil
Section: 70(5); 70(6) and 104(4)

STEP CRA Roundtable – June 10, 2016

Question 11. - Tainting of a Spousal Trust

Paragraph 8 of archived IT-305R4 – Testamentary Spouse Trusts reads as follows: 

8. Once a trust qualifies as a spouse trust under the terms of subsection 70(6), it remains a spouse trust and is subject to the provisions affecting such trusts (for example, paragraph 104(4)(a)) even if its terms are varied by agreement, legal action or breach of trust. However, these events may cause other provisions of the Act to apply, such as paragraph 104(6)(b) and subsections 106(2) and 107(4). 

At the 2016 Conference for Advanced Life Underwriting (CALU), the CRA was asked to provide its views on paragraph 8 of IT-305R4. Would the CRA share those comments?

CRA Response

In order to understand the relevance of the commentary in paragraph 8 of archived IT-305R4, one must first consider section 70 of the Act. Where a taxpayer dies, as a general rule subsection 70(5) provides that, immediately before the death, the taxpayer is deemed to have disposed of each capital property that was owned at that moment for proceeds equal to the property's fair market value. However, where certain conditions are met, subsection 70(6) allows such property to be transferred to a trust described in paragraph 70(6)(b) on a tax-deferred "rollover" basis. This provision requires, inter alia, that the surviving spouse or common-law partner (the “survivor”) be entitled to receive all of the income of the trust that arises before the survivor’s death, and that no person except the survivor may, before his or her death, receive or otherwise obtain the use of any of the income or capital of the trust.

Subsection 104(4) provides for the deemed dispositions of capital properties held by certain trusts. For a testamentary trust created as a consequence of the death of a taxpayer under which the surviving spouse was exclusively entitled to the income of the trust before his or her death and no other person was entitled before that time to the capital of the trust, the first deemed disposition is determined pursuant to paragraph 104(4)(a).  This first deemed disposition occurs on the day on which the beneficiary spouse or common-law partner dies. This ensures that any accrued gains on properties which could have been deferred at the time of the death of the taxpayer that gave rise to such trusts, are appropriately triggered on the death of the spouse or common-law partner beneficiary.

The wording of subparagraph 104(4)(a)(i) clearly provides for a deemed disposition date that is based on the terms of the trust “at the time it was created”, accordingly, even if the terms of the trust are varied by agreement, legal action, or breach - it is the terms of the trust upon creation that would determine the application of subsection 104(4). In the case of a post-1971 spousal or common-law partner trust, as defined in subsection 248(1), these would be the terms described in subparagraph 104(4)(a)(iii).

The main purpose of paragraph 8 in IT-305R4 (and of the similar comments in the earlier versions of this Bulletin dating back to IT-305), is to clarify that in applying paragraph 104(4)(a), one must look to the terms of the trust at time of creation, such that any subsequent change in the terms of the trust would not invalidate the application of paragraph 104(4)(a). It is worth noting that the wording of subsection 104(4), before its revised wording was introduced by subsection 40(1) of Bill C-22 in 1976, was not as clear in this regard as it is now. Paragraph 5 of IT-305, which was published on April 8, 1976, provided clarity as to our view as to how subsection 104(4) applies; and that has been brought forward, as most recently expressed in paragraph 8 of archived IT-305R4.

CRA has recently begun a project to draft a new income tax folio that will cover much of the information that was contained in archived IT-305R4. We anticipate that the wording in the new folio that will deal with the subject matter previously discussed in paragraph 8 of IT-305R4 will provide clarity, by more closely reflecting the actual wording of subsection 104(4) of the Act.

2016-064582
Phil Kohnen

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