2024-1003611C6 STEP 2024 – Q7 - AET and Subsection 75(2)

Principal Issues: Whether a particular AET is subject to subsection 75(2).

Position: General comments provided.

Reasons: See below.

Author: Robinson, Katie
Section: 73(1.01), 73(1.02), 75(2)

2024 STEP CRA Roundtable – June 4, 2024

QUESTION 7. Alter Ego Trusts and Subsection 75(2)

Can the CRA confirm whether subsection 75(2) of the Income Tax Act (the “Act”) (footnote 1) will apply to an alter ego trust (“AET”) that meets all of the conditions of subparagraph 73(1.01)(c)(ii) and subsection 73(1.02) with the following attributes:

- The AET is settled by an individual (the “Settlor”).

- There are three trustees of the trust, one of which is the Settlor, and the trust indenture requires that all decisions be made by a majority vote of the three trustees.

- The trust indenture provides that no capital distributions, including any capital gains, can be made from the trust while the Settlor is alive.

- The trust indenture provides for income and capital distributions that are to be made to various beneficiaries after the death of the Settlor, but does not include any provision that grants the Settlor a power to direct these future distributions.

CRA Response

Pursuant to subsection 73(1), an individual (other than a trust) can transfer capital property on a tax-deferred basis, where certain conditions are met. In order for subsection 73(1) to apply, the following conditions must be met:

1. at the time of the transfer of property, both the transferor of the property and the transferee must be resident in Canada;

2. the transferor must not elect out of the rollover rule; and

3. subsection 73(1.01) must apply in respect of the transfer (a “qualifying transfer”).

Subsection 73(1.01) provides that, subject to the requirements of subsection 73(1.02), qualifying transfers include, inter alia, transfers to a trust, created by the individual transferring the property, that meet the requirements of subparagraph 73(1.01)(c)(ii), such that the individual is entitled to receive all the income of the trust arising before the individual’s death and no person except that individual may receive or otherwise obtain the use of any of the income or capital of the trust before that individual’s death.

Subsection 73(1.02) imposes additional conditions that must be met in order for a trust to meet the requirements of subparagraph 73(1.01)(c)(ii). Generally, in this situation:

- the trust must be created after 1999;

- the individual must be at least 65 years of age at the time the trust is created; and

- the trust does not make an election under subparagraph 104(4)(a)(ii.1).

A trust described in subparagraph 73(1.01)(c)(ii) that meets all of the relevant conditions outlined above will be an AET as defined in subsection 248(1). You have asked us to confirm whether subsection 75(2) will apply to a particular AET with the above-noted attributes.

Subsection 75(2) is an attribution rule applicable in respect of trusts factually resident in Canada and created since 1934. The rule generally applies where property is held by such a trust on condition that:

a) the property, or property substituted for it, may revert to the person from whom it was directly or indirectly received, or pass to persons determined by that person subsequent to the creation of the trust, or

b) during the existence of the person, the property may be disposed of only with the person’s consent or in accordance with the person’s direction.

When either of these conditions is met, any income or loss from or taxable capital gain or allowable capital loss in respect of the property, or property substituted for it, is attributable to that person while resident in Canada. Accordingly, any amounts attributable are determined in respect of a particular property, or property substituted for that property. It is a question of fact as to whether property is held by a trust under the conditions described in either paragraph 75(2)(a) or (b).

The fact that a trust will only qualify as an AET if the settlor is entitled to all the income of the trust that arises before his or her death, as required by subparagraph 73(1.01)(c)(ii), does not necessarily mean that the property contributed by the settlor, or property substituted for it, can possibly revert to the settlor.

In this particular case, the trust indenture provides that no capital distributions, including any capital gains, can be made from the trust while the Settlor is alive. For this particular AET, the Settlor does not appear to have a capital interest in the trust. However, where, for example, the settlor of an AET has a capital interest in the trust, subsection 75(2) will generally apply during the period in which the settlor is resident in Canada.

Additionally, in this particular case, there are three trustees, one of which is the Settlor. The trust indenture requires that all decisions be made by a majority vote of the three trustees and the trust indenture does not include any provision that grants the Settlor a power to direct the future distributions. The fact that the Settlor is one of three trustees, acting in their fiduciary capacity to decide issues by majority will not normally, in and by itself, give rise to the application of subsection 75(2).

However, subsection 75(2) could still apply where the terms and conditions of a trust expressly require the settlor’s consent or direction with respect to any decision made by the trustees. This could include the situation where decisions are made by a majority of trustees provided that the trustee-settlor is one of that majority.

As noted above, it is a question of fact as to whether property is held by a trust under the conditions described in either paragraph 75(2)(a) or (b). Thus, a determination of whether these conditions are met in respect of any particular property can only be made on a case-by-case basis following a review of all the facts and circumstances surrounding a particular situation, including a review of the complete trust indenture.

Katie Robinson
2024-100361

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 Unless otherwise expressly stated, every statutory reference herein is a reference to the relevant provision of the Act.

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