Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: 1. Can a graduated rate estate (GRE) elect under section 216 in respect of a rental property of a deceased taxpayer? 2. Once the estate is administered, can each non-resident beneficiary’s interest in the property be distributed to them pursuant to subsection 107(2)? 3. Will the non-resident beneficiaries be able to elect under section 216?
Position: 1. A GRE can make a section 216 election. 2. Yes, depending on the facts, circumstances and applicable law and assuming the conditions in subsection 107(2) are otherwise met. 3. Based on the current wording of section 216 and assuming the conditions therein are met, the beneficiaries would be able to make a section 216 election.
Reasons: 1. The definition of GRE in subsection 248(1) contemplates both a return of income under Part I filed pursuant to a section 216 election in respect of a Part XIII tax liability and a “regular” Part I return of income. 2. Subsection 107(5) does not apply to the distribution. Assuming the distribution of the rental property to Y and Z is made out of the residue of the Estate and transferred to them in accordance with the provisions of the Will in satisfaction of all or any part of their interests in the capital of the Estate, then subsection 107(2) could apply to allow a tax-deferred rollover on the distribution of the rental properties to Y and Z. 3. Once the beneficiaries each hold beneficial ownership of their interest in the rental property, they could meet the conditions in section 216.
Author: Monteith, Laura
Section: 248(1) graduated rate estate; 216; 107(2), 107(5), 117(2). 3(1) and 33(2) of the Interpretation Act
2020 STEP CRA ROUNDTABLE – November 26, 2020
QUESTION 13. Rental property owned by non-resident estate
In general terms, section 216 sets out rules that allow a non-resident of Canada to elect to file an optional return to be taxed under Part I on the net rental income from real or immovable property or the net income from timber royalties in Canada in lieu of paying Part XIII withholding tax at a rate of 25% (or such reduced rate pursuant to an applicable tax treaty) on the gross amount of such income.
Consider a situation in which a non-resident individual (“Ms. X”) owned a Canadian rental property for several years prior to her death. Ms. X had filed a personal T1 income tax return each year pursuant to the rules in section 216 of the Act. Ms. X’s Will provides that the residue of her estate (“Estate”) is divided equally between her children, Y and Z, both of whom are non-residents. The Estate assets may be distributed in specie. Y and Z are the only capital beneficiaries of the Estate. Ms. X’s Will does not provide for the distribution of income to Y and Z while the rental property is held in the Estate.
The rental property would be considered real or immovable property situated in Canada and depreciable capital property for purposes of the Act. As a result, on Ms. X’s death, she will be deemed to have disposed of the rental property at its then fair market value (“FMV”) and recognize the appropriate capital gains and recaptured depreciation on her terminal T1 income tax return and the return required under section 216, respectively.
The rental property will be transferred to the Estate at the above noted FMV. The executors of the Estate, who are also non-resident wish to designate the Estate as a graduated rate estate (“GRE”) pursuant to the definition in subsection 248(1) of the Act. (footnote 1)
After the executors have administered the Estate and determined the residue, the executors will distribute a 50% interest in the rental property to each of Y and Z.
1. Will the Estate be a GRE?
2. Can the Estate file a T3 trust return under section 216 of the Act?
3. When the Estate distributes the rental property to Y and Z, will the Estate be deemed to dispose of the rental property at its tax cost to the Estate pursuant to subsection 107(2) of the Act?
4. After the Estate distribution, can Y and Z each file a section 216 return on 50% of the income derived from the rental property?
For the purpose of our response, we assume that the Estate and the beneficiaries are not resident in Canada for Canadian income tax purposes, and that section 94 of the Act does not apply to the Estate. (footnote 2) We have further assumed that 1) the Estate does not carry on business in Canada, 2) paragraphs (a) to (d) of the definition of “testamentary trust” under subsection 108(1) do not apply to the Estate, and 3) that the Estate will not use the optional method of payment provided under subsection 216(4).
Prior to the time when the estate administration is complete, the executors are generally considered to hold legal and beneficial ownership of the estate property and the estate is still considered to be in existence. It is a question of mixed fact and law as to when beneficial ownership of the estate property is considered to pass to the beneficiaries. The answer would depend on the wording of the Will, all of the facts and circumstances and the applicable law. Accordingly, we are unable to confirm whether the beneficiaries (Y and Z) would hold beneficial ownership prior to the time when the distribution is made by the executors to Y and Z. For the purposes of our response, we have assumed that the Estate would still be considered to be in existence prior to the distribution and that the transfer of beneficial ownership would coincide with the completion of the estate administration and distribution of the rental property from the Estate.
Subsection 216(3) provides that where a section 216 election is made, Part I applies with such modifications as the circumstances require to the payment of tax under section 216. Subsection 122(1) of Part I provides that all trusts, other than a GRE or “qualified disability trust”, pay a flat rate of tax at the top marginal rate.
Questions 1 and 2
A non-resident estate could be a GRE. Neither section 216 nor the definition of a GRE includes any language distinguishing a non-resident estate filing under Part I (T3 Return) on an elective basis pursuant to section 216 in respect of a Part XIII tax liability from a taxpayer who is required to file under Part I in respect of a Part I filing obligation. There is no provision in the Act prohibiting an estate filing under section 216 from qualifying as a GRE.
A non-resident estate could file its return of income under Part I pursuant to a section 216 election by the filing due date set out under section 216 and make the GRE designation in the return. While the Estate is a GRE, the Estate will be taxed at the graduated rates in respect of the net rental income.
Questions 3 and 4
In the taxation year that a non-resident estate disposes of rental property considered “taxable Canadian property”, it must file a separate T3 Return in respect of the disposition as required under section 150. The Estate would have compliance obligations under section 116, which are outside the scope of this question. We refer you to IC72-17R6 Procedures Concerning the Disposition of Taxable Canadian Property by Non-Residents of Canada - Section 116.
Assuming the distribution of the rental property to Y and Z is made out of the residue of the Estate and transferred to Y and Z in accordance with the provisions of the Will in satisfaction of all or any part of their interests in the capital of the Estate, then subsection 107(2) could apply to allow a tax-deferred rollover on the distribution of the rental properties to Y and Z.
Real or immovable property situated in Canada is a property described in subparagraph 128.1(4)(b)(i). Therefore, subsection 107(5) (footnote 3) should not apply to deny the tax-deferred rollover of the rental property to Y and Z and the rental property may be distributed under subsection 107(2) provided the requirements of subsection 107(2) are otherwise satisfied.
It is possible for the assets of an estate to be considered to have vested indefeasibly in and be beneficially owned by the beneficiary of the estate once the estate administration is complete (or sooner in the case of a specific bequest) depending on the particular facts. Ultimately, it is a question of mixed fact and law as to whether the Estate or Y and Z would be considered the beneficial owner of the rental property at a particular time for purposes of making the section 216 election.
Provided that the section 216 requirements are satisfied, from the time they acquire beneficial ownership of the property, Y and Z could elect to file under Part I pursuant to section 216 in respect of their share of income derived from the rental property. Y and Z would each be required to file a Part I return pursuant to section 150 when they dispose of their interest in the rental property. In addition, Y and Z would also be required to file a Part I return pursuant to subsections 216(5) and (6), if the conditions requiring filing pursuant to those provisions are met (e.g., recapture of depreciation).
November 26, 2020
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 Ms. X has a Social Insurance Number (or if she had not been assigned a Social Insurance Number before her death, she has available such other information as is acceptable to the Minister, i.e., a Temporary Tax Number (TTN) or an Individual Tax Number (ITN)).
2 The residence of a trust or estate and the beneficiaries of the estate is a question of fact. For the Estate, we refer you to Income Tax Folio S6-F1-C1, Residence of a Trust or Estate. For the beneficiaries, we refer you to Income Tax Folio S5-F1-C1, Determining an Individual’s Residence Status. Consideration should be given to whether any particular estate could be deemed to be resident in Canada pursuant to section 94.
3 Subsection 107(5) provides that subsection 107(2.1) applies (giving rise to a taxable distribution) and subsection 107(2) does not apply “in respect of a distribution of a property (other than a share of the capital stock of a non-resident-owned investment corporation or property described in any of subparagraphs 128.1(4)(b)(i) to (iii)) by a trust to a non-resident taxpayer (including a partnership other than a Canadian partnership)) in satisfaction of all or part of the taxpayer's capital interest in the trust.”
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