{"id":1561,"date":"2015-11-27T23:15:37","date_gmt":"2015-11-27T23:15:37","guid":{"rendered":"https:\/\/thor.ca\/\/blog\/?p=1561"},"modified":"2025-02-12T13:31:01","modified_gmt":"2025-02-12T21:31:01","slug":"finance-releases-letter-regarding-subsection-10413-4","status":"publish","type":"post","link":"https:\/\/www.thor.ca\/blog\/2015\/11\/finance-releases-letter-regarding-subsection-10413-4\/","title":{"rendered":"Finance Releases Letter Regarding Subsection 104(13.4)"},"content":{"rendered":"

Subsection 104(13.4) of the Income Tax Act<\/em> (the \u201cAct\u201d) will come into effect on January 1, 2016.\u00a0 If not corrected, this provision will have a catastrophic and devastating effect on many estate plans involving alter ego<\/em> trusts, joint spousal and common-law partner trusts, and spousal and common-law partner trusts (collectively \u201cLife Interest Trusts\u201d).<\/p>\n

On November 16, 2015, the Department of Finance (\u201cFinance\u201d) released a comfort letter<\/a> in response to submissions regarding subsection 104(13.4). Finance acknowledged that the provision could lead to \u201cunfair and unintended\u201d results and proposed solutions to correct them.<\/p>\n

There are two main problems with this provision.<\/p>\n

The first problem is that subsection 104(13.4) provides that the tax liability arising from the deemed disposition of certain assets on the death of the last surviving life interest beneficiary (referred to as \u201cLife Interest Beneficiary\u201d) of a Life Interest Trust will be borne by the Life Interest Beneficiary\u2019s estate while the property subject to the deemed disposition will be enjoyed by the beneficiaries of the Life Interest Trust.\u00a0 The potential consequences are illustrated by the following example:<\/p>\n

A testator made a will to give his second wife the family home.\u00a0 The testator also established an alter ego<\/em> trust to provide for his children from his first marriage with an investment portfolio. \u00a0When the testator dies, the alter ego<\/em> trust will be deemed to have disposed of the investment portfolio at fair market value.\u00a0 Pursuant to subsection 104(13.4), all the income from the deemed disposition of the investment portfolio will be reported in the final tax return of the testator and the tax will be borne by the estate.\u00a0 As such, the wife will effectively bear the tax burden of the alter ego<\/em> trust without benefiting from its assets.<\/p><\/blockquote>\n

Subsection 160(1.4) was enacted as an attempt to address the above problem.\u00a0 Under this provision, the estate and the trust will be jointly and severally liable for the tax.\u00a0 The explanatory notes released with the draft legislation stated that the intention is that the Canada Revenue Agency (the \u201cCRA\u201d) will assess the trust for the tax first, notwithstanding that subsection 104(13.4) places the primary tax liability on the estate.\u00a0 This may lead to further complications due to the following:<\/p>\n

(a)\u00a0 notwithstanding the CRA\u2019s assessment, the trustee will probably not have the authority under the trust deed to pay the estate\u2019s tax; and<\/p>\n

(b)\u00a0 it is uncertain whether payment of tax by the Life Interest Trust will affect an estate\u2019s status as a graduated rate estate.<\/p>\n

The second problem is the possible \u201cstranding\u201d of donation tax credits generated from charitable gifts given by a Life Interest Trust.\u00a0 Where paragraph 104(13.4)(b) applies to a trust, it will generally leave the trust with no tax liability against which it can apply the donation tax credits.\u00a0 Furthermore, paragraph 104(13.4)(a) deems the trust\u2019s taxation year to end at the end of the day on which the death occurs, with the result that the donation tax credits from gifts made by the trust after the day of death will only be available for carry-forward and not available in the trust\u2019s taxation year in which the death occurs.\u00a0 The potential consequences are illustrated by the following example:<\/p>\n

An alter-ego<\/em> trust was established to provide for the settlor\u2019s children and make a substantial donation to a charity after the settlor\u2019s death. \u00a0It was intended that the donation tax credits from the donation made by the trust will offset the tax from the deemed disposition of certain trust assets on the settlor\u2019s death.\u00a0 However, under paragraph 104(13.4)(b), the income from the deemed disposition will be included in the final tax return of the settlor and the tax will be borne by the settlor\u2019s estate. \u00a0The donation tax credits cannot be used to offset the estate\u2019s tax liability and would go unused unless the trust earned sufficient income.<\/p><\/blockquote>\n

Life Interest Trusts can be critical to protecting charitable donations from wills-variation claims.\u00a0 If not corrected, subsection 104(13.4) will effectively deny the benefit of donation tax credits where the donation is made by a Life Interest Trust as part of an estate plan.\u00a0 As a further consequence, subsection 104(13.4) will affect the use of Life Interest Trusts to protect a testator\u2019s testamentary wishes in the context of a second marriage.\u00a0 The use of Life Interest Trusts is especially common in British Columbia where the adult children from the testator\u2019s first marriage have the ability to challenge a will on the ground that it does not make adequate provision for them based on economic and moral considerations.\u00a0 If not corrected, the enacted subsection 104(13.4) will undoubtedly cause problems for many estate plans involving Life Interest Trusts.<\/p>\n

In response to these concerns, Finance is considering amending paragraph 104(13.4)(b) so that it does not apply to a trust unless the trust and estate jointly elect to have the paragraph apply.\u00a0 If such amendment is enacted, the tax liability from the deemed disposition of the trust property will by default remain in the trust.\u00a0 To further address the problem of donation tax credits, Finance is also considering making amendments to allocate the amount of donations made by the trust after the day of the Life Interest Beneficiary\u2019s death but before the end of the calendar year to the trust\u2019s taxation year in which the death occurs.\u00a0 (Although not addressed in Finance\u2019s letter, in order to give full credit for charitable donations, it would be generally necessary to remove the 75%-of-income limit on charitable donations made by Life Interest Trusts, as there is no such limit for donations made under a will.\u00a0 Finance has done nothing and recommends nothing with respect this long-standing problem.)<\/p>\n

It is good news that Finance is sympathetic to the concerns regarding subsection 104(13.4).\u00a0 Given the severity of the problems, the amending legislation is expected to be on its way.<\/p>\n","protected":false},"excerpt":{"rendered":"

Subsection 104(13.4) of the Income Tax Act<\/em> (the \u201cAct\u201d) will come into effect on January 1, 2016.\u00a0 If not corrected, this provision will have a catastrophic and devastating effect on many estate plans involving alter ego<\/em> trusts, joint spousal and…<\/p>\n","protected":false},"author":19,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[52],"tags":[],"class_list":["post-1561","post","type-post","status-publish","format-standard","hentry","category-tax-blog-general"],"_links":{"self":[{"href":"https:\/\/www.thor.ca\/blog\/wp-json\/wp\/v2\/posts\/1561","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.thor.ca\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.thor.ca\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.thor.ca\/blog\/wp-json\/wp\/v2\/users\/19"}],"replies":[{"embeddable":true,"href":"https:\/\/www.thor.ca\/blog\/wp-json\/wp\/v2\/comments?post=1561"}],"version-history":[{"count":1,"href":"https:\/\/www.thor.ca\/blog\/wp-json\/wp\/v2\/posts\/1561\/revisions"}],"predecessor-version":[{"id":2690,"href":"https:\/\/www.thor.ca\/blog\/wp-json\/wp\/v2\/posts\/1561\/revisions\/2690"}],"wp:attachment":[{"href":"https:\/\/www.thor.ca\/blog\/wp-json\/wp\/v2\/media?parent=1561"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.thor.ca\/blog\/wp-json\/wp\/v2\/categories?post=1561"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.thor.ca\/blog\/wp-json\/wp\/v2\/tags?post=1561"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}