2019-0799961C6 2019 STEP - Q5 TOSI and Spouse Age 65+

Principal Issues: Application of Paragraph 120.4(1.1)(c) where the “excluded amount” to be relied on is the one for “excluded shares”.

Position: Paragraph 120.4(1.1)(c) may apply in appropriate circumstances.

Reasons: Wording of the provision.

Author: Chong, Henry
Section: Paragraph 120.4(1.1)(c)

2019 STEP CRA Roundtable – June 7, 2019

QUESTION 5. TOSI and the Exclusion for Surviving Spouse/Spouse Age 65+

A specified individual’s income or taxable capital gain for a taxation year will be an excluded amount if the amount would have been an excluded amount in respect of an individual who was, immediately before their death, the specified individual’s spouse or common-law partner, assuming such amount were included in the spouse or common-law partner’s income for that year.

However, there is a question of whether this exemption will apply where the deceased spouse qualified under the “excluded shares” exception based on direct ownership of the shares, and the surviving spouse holds the shares through a holding company or trust.  The issue is whether the surviving spouse’s indirect ownership arrangement needs to be imputed to the deceased in determining whether he or she would have qualified for an exemption from the TOSI rules. 

As well, split income received by a specified individual in a year will be deemed to be an excluded amount if that person’s spouse or common-law partner has attained the age of 65 in the year, and the split income would be an excluded amount if that amount had been received by the spouse or common-law partner in the year.

Again, there may be a question as to whether this exemption will apply where the spouse qualifies for the excluded shares exemption, but the specified individual does not directly own the shares in the corporation.   In effect, does the specified individual’s ownership arrangement impact the application of this deeming rule for purposes of the excluded shares exemption? 

ISSUE

The question raises the issue of how paragraph 120.4(1.1)(c) applies, if at all, to deem an amount to be an excluded amount in respect of a specified individual where the excluded amount to be relied on for purposes of that paragraph is the one for excluded shares.

CRA COMMENTS

The Applicable Law

Subsection 120.4(2) levies an additional tax on the split income of a specified individual except to the extent of such income that is an excluded amount.

A specified individual is defined in subsection 120.4 and includes an individual who is a resident of Canada at the end of the year.

Split income is defined in subsection 120.4(1) and includes income of a specified individual from, or taxable capital gains from the disposition of, shares of a corporation (other than shares of a class listed on a designated stock exchange or shares of the capital stock of a mutual fund corporation). 

Split income is also defined to not include an excluded amount.

Excluded amount is defined in subsection 120.4(1) and includes, under paragraph (g) of the definition, income from, or a taxable capital gain from the disposition of, excluded shares where the individual has attained the age of 24 before the year.

Shares are excluded shares of a specified individual at any time if such shares meet the income/corporate status and ownership requirements described in paragraphs (a) to (c) of the definition of that term in subsection 120.4(1). 

In particular, paragraph (b) of the definition of excluded share requires that the specified individual owns shares of the capital stock of the corporation that immediately before the time

(i) gives the holder thereof 10% or more of the votes that could be cast at an annual meeting of the shareholders of the corporation; and
(ii) have a fair market value of 10% or more of the fair market value of all of the issued and outstanding shares of the capital stock of the corporation.    

A special rule in paragraph 120.4(1.1)(c) deems income or a taxable capital gain that would otherwise be split income of a specified individual to be an excluded amount in respect of the individual for a taxation year where certain requirements are met.

In particular, paragraph 120.4(1.1)(c) deems an amount of split income to be an excluded amount if either:

(i) the following conditions are met:

(A) the amount would be an excluded amount in respect of the specified individual’s spouse or common-law partner for the year, if the amount were included in computing the spouse or common-law partner’s income for the year, and

(B)   the spouse or common-law partner has attained the age of 64 years before the year, or

(ii) the amount would have been an excluded amount in respect of an individual who was, immediately before their death, the specified individual’s spouse or common-law partner, if the amount were included in computing the spouse or common-law partner’s income for their last taxation year (determined as if this section applies in respect of that year);

DISCUSSION

The application of the deeming rule in paragraph 120.4(1.1)(c) can be illustrated through the following hypothetical.

Assume A is the deceased spouse or common-law partner of a specified individual (the “Specified Individual”), and owned shares of Canco, a taxable Canadian corporation that is a private corporation, that were excluded shares of A, as that term is defined in subsection 120.4(1), throughout A’s last taxation year before death.  The Specified Individual is a beneficiary of a Canadian resident trust that owns a class of shares of Canco.  A and the Specified Individual are residents of Canada.  Canco carries on a business that was a related business of A and is a related business of the Specified Individual.  The Canco shares owned by the trust were acquired during A’s lifetime and were not acquired for the benefit of the Specified Individual as a consequence of A’s death.  Canco pays a dividend (the “Dividend”) to the trust which is then distributed by the trust to the Specified Individual.  By reason of subsections 104(13) and (19) and subparagraph (a)(i) of the definition of split income in subsection 120.4(1), the income (i.e. the Dividend) of the Specified Individual will be split income of the Specified Individual unless it is an excluded amount.  In the circumstances, the Dividend will not be an excluded amount as income from excluded shares of the Specified Individual because the Specified Individual does not meet the ownership requirement in paragraph (b) of the definition as the Specified Individual does not directly own any shares of Canco.  For purposes of this discussion, we have also assumed that the Dividend would not otherwise be an excluded amount of the Specified Individual under any other category of excluded amount listed in the definition in subsection 120.4(1). 

Based on the foregoing, the Dividend will be split income of the Specified Individual unless it is deemed to be an excluded amount under subparagraph 120.4(1.1)(c)(ii) because the amount of the Dividend would have been an excluded amount if it had been included in computing A’s income for A’s last taxation year in the circumstances described in that subparagraph. 

In general, for purposes of determining whether an amount would have been an excluded amount in respect of the deceased spouse or common-law partner (the “Spouse”) of a specified individual under subparagraph 120.4(1.1)(c)(ii) if the amount had been included in the Spouse’s  income, consideration should be given to all of such Spouse’s relevant facts and circumstances in the applicable taxation year, including in the case of determining whether an amount is an excluded amount because it is income from excluded shares, any shares of a corporation owned by such Spouse.

Thus, in our view, the ownership requirement in paragraph (b) of the definition of excluded shares for purposes of paragraph 120.4(1.1)(c) is based on the actual ownership of the shares of the dividend payor by the Spouse of the specified individual in the relevant year or taxation year described in subparagraphs 120.4(1.1)(c)(i) and (ii).

Based on the foregoing, subparagraph 120.4(1.1)(c)(ii) will then apply to the hypothetical as follows. The subparagraph will deem the Dividend to be an excluded amount of the Specified Individual if the amount would have been an excluded amount of A if the Dividend had been notionally included in computing A’s income in A’s last taxation year before death.  In our circumstances, the excluded amount that is being relied on for A is the one for income from excluded shares.  Whether the amount of the Dividend would have been income from excluded shares of A should take into consideration the following:  (1) A owned shares of Canco throughout A’s last taxation year before death; (2) such shares met the requirements for being excluded shares under subsection 120.4(1) during that period; and (3) we will consider the amount of the Dividend that was notionally included in computing A’s income for purposes of subparagraph 120.4(1.1)(c)(ii) to be income from such shares.  Based on the foregoing, the amount of the Dividend would have been an excluded amount in respect of A if the amount had been included in computing A’s income in A’s last taxation year as income from excluded shares.  Accordingly, the Dividend should be deemed to be an excluded amount in respect of the Specified Individual under subparagraph 120.4(1.1)(c)(ii).

A similar analysis would apply for purposes of subparagraph 120.4(1.1)(c)(i) where the spouse or common-law partner is age 65 or over in the applicable year.

The foregoing is intended to illustrate a general approach to applying paragraph 120.4(1.1)(c) in the context of excluded shares to a relatively straightforward set of circumstances involving a basic and common share ownership structure.  It is unclear whether the same approach could apply in the case of more complex structures, including structures involving holding corporations. In those cases, taxpayers should consider seeking confirmation of whether this general approach would apply to their particular fact situation.  As well, the GAAR may apply where artificial transactions are undertaken to achieve a similar but inappropriate result.

Finally, note that while the foregoing discussion has been limited to the excluded amount for income from excluded shares, the deeming rule in paragraph 120.4(1.1)(c) could also generally apply based on one or more of the other categories of excluded amount listed in the definition of that term in subsection 120.4(1) which should be considered in any fact circumstance.

Henry Chong
2019-079996

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