2017-0724301C6 2017 CTF - Q1 - 21 year planning & NR beneficiary

Principal Issues: Can the CRA comment on the tax implications associated with the distribution of property from a discretionary family trust to a Canadian corporation that is wholly owned by a non-resident individual in order to avoid the application of subsection 107(5)?

Position: GAAR likely applicable.

Reasons: The transaction described circumvents the application of subsections 107(5) and 107(2.1).

Author: Panourgias, Marina
Section: 104(4); 107(2); 107(2.1); 107(5); 245

2017 CTF Annual Conference
CRA Roundtable

Question 1:  Distribution of Property by a Canadian Resident Trust to a Canadian Corporation that is Wholly Owned by One or More Non-Residents

A common planning method to avoid the application of the 21-year deemed disposition rule in subsection 104(4) in respect of property with inherent gains held by a Canadian resident discretionary family trust involves the distribution of trust property to a Canadian resident beneficiary on a tax deferred basis pursuant to subsection 107(2) in advance of the trust’s 21st anniversary.  Where the recipient beneficiary is a natural person and subsection 107(2) is applicable, the gains inherent in the distributed property will be deferred until the earlier of the date that the recipient beneficiary disposes of the property or the date of death of the beneficiary (or his or her spouse where a spousal rollover is available).  However, subsection 107(2) is not available in respect of a distribution of property by a trust to a non-resident beneficiary, with the exception of certain properties.  Instead, where property is distributed to a non-resident beneficiary, subsection 107(5) will typically apply and result in the application of subsection 107(2.1) which would deem the property to be distributed to the non-resident beneficiary on a taxable basis.

Consider a situation where the trustees of a Canadian resident discretionary family trust (the “Trust”) are planning to distribute of all or a portion of the Trust’s property (the “Property”) to one or more of its beneficiaries in advance of the Trust’s 21st anniversary.  The Property does not consist of any of the properties described in subparagraphs 128.1(4)(b)(i) to (iii).  The beneficiaries of the Trust that are intended to receive the Trust property are natural persons who have emigrated from Canada and are non-residents of Canada at the relevant time (“NR beneficiaries”).  Instead of distributing the Property to the NR beneficiaries directly, the trustees propose to distribute the Property, on a tax deferred basis pursuant to subsection 107(2), to one or more Canadian companies (“Canco”) that are wholly owned by one or more of the NR beneficiaries, and that are beneficiaries of the Trust.  The result is that the Property will no longer be held by the Trust and as such will not be subject to the 21-year deemed disposition rule. In addition, since the Property will be distributed to one or more Canadian resident corporations, subsection 107(5) should not be applicable and thus the Property will be transferred out of the Trust on a tax-deferred basis pursuant to subsection 107(2).

Does the CRA agree with this conclusion?

CRA Response

The CRA addressed the income tax implications associated with other 21-year deemed disposition planning methods at the 2016 CTF Annual Conference and the 2017 STEP National Conference.  The situations considered at those conferences involved the distribution of property by a Canadian resident discretionary family trust to a Canadian corporation whose shares would be wholly owned by a newly established Canadian resident discretionary family trust.  It was noted that it is the CRA’s view that the situations addressed circumvented the application of the anti-avoidance rule in subsection 104(5.8) in a manner that frustrates the object, spirit and purpose of that provision, the deemed disposition rule in paragraph 104(4)(b) and the scheme of the Act as a whole.  It was also noted that the CRA has significant concerns with these transactions and will consider the application of GAAR where similar transactions are proposed to be put in place unless substantial evidence supporting its non-application is provided.

In respect of the transactions described herein, any capital gains inherent in the Property distributed to Canco may be deferred beyond the 21st anniversary of the Trust and potentially beyond the life of the NR beneficiary or indefinitely.  It is the CRA’s view that the intention of subsection 107(5) is to ensure that Canada maintains the ability to tax capital gains that accrue during the period that property is held by a Canadian resident trust and that the transactions described are not consistent with this intention.  Further, these transactions contravene one of the underlying principles of the taxation of the capital gains regime which is to prevent the indefinite deferral of tax on capital gains and which is supported by subsections 70(5), 104(4) and 107(2). Accordingly, it is the CRA’s view that such transactions circumvent the application of subsections 107(5) and 107(2.1) in a manner that frustrates or defeats the object, spirit or purpose of those provisions, subsections 70(5), 104(4) and 107(2) and the Act as a whole.  The CRA has significant concerns regarding these transactions and will consider the application of GAAR when faced with a similar set of transactions unless substantial evidence supporting its non-application is provided.  In addition to the specific transactions described herein, it is the CRA’s view that GAAR may be applicable in respect of other situations involving the distribution of property from a family trust to a Canadian corporation with one or more non-resident shareholders.

Accordingly, unless substantial evidence supporting the non-application of GAAR is provided, the CRA will not provide any Advance Income Tax Ruling where such structure is proposed to be put in place.

M. Panourgias
2017-072430
November 21, 2017

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