By: Adam Aptowitzer
The Income Tax Act is known for its complexity, but even with that reputation, sometimes the drafters surpass themselves. The provisions enacted from Budget 2014 changing the way Canadians are taxed at death (as opposed to the more usual taxed to death) is a case in point. Given the complexity it was not surprising that certain issues were overlooked; two of which involved donations at death. When these oversights were brought to the attention of the Department of Finance, and they released new amendments to the Income Tax Act on January 15th that were intended to address the problems.
The overhaul of Canada’s taxation at death regime is too complex to detail here, however for the purposes of our discussion it is important to understand that certain types of trusts such as Alter Ego Trusts, Joint Spousal Trusts and Common Law Partner Trusts are deemed to have an end of their taxation year on the death of a beneficiary of the trust.
On the deemed year end (i.e. the date of death), the income of the trust was deemed paid to the beneficiary. It was therefore to be included in the beneficiary’s terminal year tax return. The corollary of this is that the trust, may or may not have any income to report at the calendar year end (after the date of death of the beneficiary).
From the perspective of charitable donations, this could have the effect of stranding donation tax credits of a gift made from the capital of the trust in that period of the calendar year between the death of the beneficiary and December 31st. If the trust does make such a gift (likely because it was directed to do so in the will), the tax credits created could not be used to offset the income tax that would have been in the trust but is payable by the beneficiary’s estate.
To correct this oversight, the Department of Finance proposed a new rule which would allow for gifts by the trust made within 90 days of the calendar year end in which the primary beneficiary of the trust dies, to be carried back to the taxation year deemed ended because of the beneficiary’s death. In plain speak, this means that the trust can allocate the donation tax credits from a gift made within 90 days of December 31st of the year of death to offset tax owing immediately prior to the death of the beneficiary.
Given that the overhaul of the taxation at death system was apparently intended to ensure that trusts and individuals were treated similarly, this amendment would seem to be a reasonable step to take to ensure fair application of the Income Tax Act.
The January 15th proposals also made another change. For this it is important to understand that on the death of a Canadian under the new rules, the estate is entitled to certain preferential tax treatment in the first 36 months after the death of the individual. During that time, if the estate makes a donation the generated tax credits can be allocated either to any of the estate’s taxation years (i.e. within that 36 month period) or the last 2 of the individual’s tax returns.
The new legislative amendments allow for any donations made within 60 months after the individual’s death to be allocated to the 36 month period of the graduated rate estate, or the last 2 taxation years of the individual’s death (of course this may require amending a filed return). The Department of Finance backgrounder also states that the individual’s capital gains exemption would also be extended to these donations.
While Finance’s intentions in proposing these amendments is unclear there may be several motivations. Clearly, these proposals would allow the estate some additional time to sort out litigation and ownership issues of property. But the changes may also be related to an issue raised by STEP Canada which dealt with the donation of non-qualifying securities (NQS) from an estate. By way of background, NQS are typically shares of private companies donated to private foundations and are subject to certain rules to prevent self-dealing. When the donor is alive the anti-avoidance provisions do not apply though if the gift is to an arm’s length public foundation or charitable organization. However, in what must have been an oversight, if the gift is made after the death of the (now former) shareholder the provisions to prevent self-dealing actually apply even if the gift is to a public foundation. (One wonders if the CRA is perhaps worried about zombies).
Part of the self-dealing provisions apply a five year reserve period in which the recipient charity may not issue a receipt for the donated NQS. Similarly, there is a five year reserve period so that the capital gain on donation is not brought into income when they are transferred. If the shares are sold by the charity in that time or they otherwise cease to be non-qualifying securities (i.e.: by way of public offering), the charity may issue the receipt and the donor, or in this case the estate, may use the receipt against its tax owing in the year (which includes the tax on the capital gain then included from the disposition of the shares).
Prior to the January 15th amendments the donation tax credits generated from donations on death could only be used by a GRE or on the individual’s last 2 tax returns. Once the 36 month period after the death of the individual has elapsed the estate can no longer make use of donation tax credits. So imagining for a moment a situation where an individual makes a gift of shares in a private company to say, a public foundation by will and the shares are sold 40 months after the death of the individual, the generated tax credits would have been useless to the estate but there would be an income inclusion as a result of the fact that the reserve period has elapsed.
These new changes effectively allow for the same treatment of NQS by way of gift by will as they do for gifts of such securities by the living. Basically, if the shares cease to be NQS (i.e. by way of sale) between 0 and 60 months after the death of the individual, the tax credits created could be allocated back to that typical 5 year period from 2 years before the date of the death of the individual to 36 months after the date of death of the individual.
These changes are complex and do require consideration and planning by experienced professionals. If you have any questions or concerns on this topic, feel free to contact the author.