(From the January 2021 Edition of eFORUM)
By Kevin Wark
Every year the Canada Revenue Agency (CRA) participates in various “CRA Roundtables,” which are organized by national organizations that represent different taxpayer interests. CRA officials typically appear at an organization’s annual general meeting and respond to a number of questions collected from its members. These roundtable sessions offer an excellent opportunity for the CRA to gain a better understanding of specific taxpayer issues and concerns, and in turn, for members of these organizations to obtain responses to questions of importance to their practices/clients.
Due to COVID-19, the CRA Roundtables held by such organizations as the Conference for Advanced Life Underwriting (CALU), the Society for Estate and Tax Practitioners (STEP), and the Canadian Tax Foundation (CTF) had to be rescheduled as virtual events in 2020. Despite this change in format, these sessions continued the beneficial exchange of information and provided greater clarity on the tax consequences of certain planning arrangements. Below are two CRA responses provided at the recent CTF Roundtable, one of which is positive and another that is not so positive, from a taxpayer perspective.
Life Interest Trusts and Personal-Use Property
The Income Tax Act contains certain beneficial tax rules for “life interest trusts,” which includes alter ego, joint partner, and spouse trusts. The settlor may transfer capital property into a life interest trust on a rollover basis. As well, the 21-year deemed disposition rule does not initially apply to these types of trusts. Instead, the deemed disposition of trust property (at fair market value) takes place upon the death of the life interest beneficiary (or the surviving joint life interest beneficiary).
To meet the requirements of a life interest trust, only the settlor (and/or the settlor’s spouse depending on the type of trust) can be entitled to receive all of the income that may arise while the settlor (and/or spouse) is alive, and the settlor (and/or spouse) is the only person who can receive or have the use of any income or capital of the trust during his or her lifetime.
One question posed to the CRA at the CTF Roundtable concerns whether a taxable benefit would be assessed to the beneficiary of a life interest trust in the circumstances where the trust owns a “personal-use property,” such as a cottage or home, and that property is used by the beneficiary or other family members. The CRA confirmed that its earlier interpretations, which related to trusts in general, would also apply to life interest trusts. Thus, a taxable benefit would not be assessed for the rent-free use of such property. Notwithstanding this position, the CRA indicated that a taxable benefit may be assessed to the extent the trust is responsible for the expenses relating to the upkeep, maintenance, or taxes for such properties.
However, the CRA went on to state that if the personal-use property is used by anyone other than the life interest beneficiary, the status of the trust as a life interest trust could be lost. For example, if the child of the life interest beneficiary was living in a cottage or home owned by the trust, this could taint the trust and trigger unexpected tax results. The views of the CRA should be taken into account where the settlor is contemplating the transfer of personal-use property such as a cottage to a life interest trust, particularly if such property may be used by someone other than the life interest beneficiary.
Refinancing Prescribed Rate Loans
Most advisors are aware of the benefits of prescribed rate loans to avoid the income attribution rules in the Income Tax Act, as such loans permit income splitting within a family group. For example, assume a parent (paying tax at a 45% rate) lends $20,000 to a child (paying tax at 20% rate) at the current prescribed rate of 1%. The child invests that money and earns $1,000 in the calendar year. Assuming the child pays the interest to the parent within 30 days after the end of the calendar year, the parent will include $200 in income and the child will pay tax on the net income of $800. The tax savings achieved from arranging this loan is $200 ($1,000 x 45% – ($200 x 45% + $800 x 20%)).
It is important to note that the prescribed interest rate on a loan (established by a formula under the Income Tax Act) is fixed and will not change if the prescribed interest rate changes in the future. With the prescribed rate currently at 1%, now is a particularly good time to implement a prescribed rate loan. On the other hand, if a loan was put in place when prescribed rates were higher, it is not possible for the borrower and lender to simply agree on the lower prescribed rate or use the new loan to repay the old loan. The loan itself must be repaid by the borrower from another source of capital, typically by selling the investments acquired with the original loan. This will often result in the triggering of any capital gains that have accumulated on that source of capital.
At the CTF Roundtable, the CRA was asked to consider a situation where a prescribed rate loan for $100,000 (at 2% interest) was advanced to a spouse and this amount was invested in securities that have grown in value to $200,000. The spouse wants to repay the current loan and take out a new loan for $100,000 at the current prescribed rate of 1%. The CRA was asked whether the spouse could liquidate half the securities to repay the loan, and thereafter, continue to avoid the income attribution rules. The CRA confirmed that it was permissible to only sell sufficient investments to repay the original loan. This is a beneficial interpretation, as in this example the spouse can avoid paying tax on half the accumulated investment gains, and possibly avoid being put into a higher tax bracket to access the lower prescribed rate.
As can be seen from these CRA responses, the CRA Roundtables are an important annual event for the tax planning community and help create greater certainty — good and bad — for various tax planning strategies.
Kevin Wark, LLB, CLU, TEP, is the author of the bestselling consumer book The Essential Canadian Guide to Estate Planning (2nd Ed.) and the newly released The Essential Canadian Guide to Life Insurance Transfers (available on Amazon.ca, Kobo, and Kindle).