chapter · depreciable capital property at its fair ... eligible capital properties ... the tax...
TRANSCRIPT
INCOME TAX IMPLICATIONS OF THE DEATH OF A TAXPAYER
UPDATE
Paul W. Festeryga Stewart McKelvey Stirling Scales
February 16, 1996
INTRODUCTION
In a paper that I presented at the 1988 Continuing Legal Education Conference on estates and
trusts I began my paper as follows:
Tax-planned wills and post-mortem estate planning are not concepts which apply only to wealthy clients. There are steps that may be taken in the preparation of even a 'simple' will and in the administration of a modest estate which may result in relatively substantial tax savings.
That was true in 1988 and it is still true today. A knowledge of potential estate planning measures
is necessary in order to adequately advise a client in the preparation of a will or an executor in the
administration of any estate no matter the size. The purpose of this paper is to touch on certain
income tax aspects of the death of a taxpayer with a particular emphasis on recent developments.
I have attached a Suggested Reading List to assist in understanding the various implications of the
death of a taxpayer in greater detail.
I have assumed for the purposes of this paper that the reader has some basic understanding
of the tax consequences of the death of a taxpayer. However, certain aspects of the basic tax
implications arising on death are discussed briefly in the course of this paper.
The topics to be considered in this paper include:
1. deemed dispositions on death,
2. elections and options available to the executor of an estate,
3. spouse trusts,
4. the elimination of the preferred beneficiary election,
5. 2 I-year deemed disposition rule, and
6. strategies for insurance funded estate planning.
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DEEMED DISPOSITIONS ON DEATH
The death of a taxpayer is a collection point for income tax purposes. Certain items of
income are included in calculating the tax payable for the year of death that may not otherwise be
taxed at that time. Perhaps the most significant tax event on death is the deemed disposition of the
taxpayer's property. The taxpayer is deemed to have disposed of all of the taxpayer's property
immediately before the death and to have reacquired the property at the amount equal to the deemed
proceeds of disposition. The taxpayer is deemed to have disposed of depreciable and non
depreciable capital property at its fair market value as modified by specific provisions of the Income
Tax Act (Canada) (the "Act"). For deaths prior to 1993 only a portion of the value (the mid-point
between UCC and fair market value) was included in the deemed proceeds of disposition. Now the
full amount of the fair market value of the depreciable property is included in determining the recapture, capital gain or terminal loss to the taxpayer arising on death. Therefore, there may be a
disadvantage to holding depreciable property personally rather than through a company.
Eligible capital properties are deemed to be disposed of for proceeds equal to 4/3 of the
cumulative eligible capital. In effect, this allows for a rollover of the goodwill associated with a
taxpayer's sole proprietorship.
Resource properties and land inventory of a deceased taxpayer are dealt with in subsection 70(5.2) and are generally deemed to have been disposed of at fair market value.
Recently, Revenue Canada has advised me that in valuing the shares of a family company
on the death of the taxpayer they would consider a discounted full liquidation approach. However,
in inter vivos intra-family transfers they would only consider the underlying capital gains in the
subject company in calculating fair market value.
ELECTIONS & OPTIONS
Since many items of income are included in the taxpayer's final tax return (the "terminal
return") which would not be included in a normal year there are certain elections and options
available to an executor to reduce the impact of the special rules which apply upon death. The elections include:
1. an election to file separate returns for various sources of income,
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(a) "rights or thinas" t::> ,
(b) certain income from a testamentary trust, and
(c) income from a partnership or proprietorship,
2. an election to claim a deferral of tax payable under subsection 70(2), (5), or (5.2),
3. an election with respect to capital losses in the first year of the estate, and
4. an election under subsection 70(6.2) not to have the automatic rollover provided by
subsection 70(6) apply with respect to property distributed to a spouse or spouse trust.
This list is not intended to be all inclusive. Rather it is intended merely as an example of the range
of elections available to an executor.
The range of options available to an executor is to a great extent dependent upon the
particular will. A will should contain a general clause authorizing the executor to make available
elections at his discretion. Further, the will should contain an exculpatory clause relieving the
executor from liability where he exercises or fails to exercise an election in the bqnajide exercise of his duties.
1. Under subsection 70(2), the executor may report the value of "rights or things" in a separate
return rather than in the terminal return of the deceased taxpayer. "Rights or things" include items
of income which have been earned and are recei vable as at the date of death but which have not been
collected as at that time. Examples of "rights or things" are matured uncashed bond coupons, unpaid
salary and wages or commissions relating to pay periods ending prior to the date of death and
dividends which have been declared but unpaid at the time of death. By contrast, periodic payments
include those payments which were accruing but were not yet due as at the date of death such as
rents, interest, royalties, annuities and remuneration from an office of employment. Periodic
payments are deemed to accrue in equal daily amounts during the period for which the amount is
payable. As a result, even though such an amount is not actually received as at the date of death, subsection 70(1) deems the amounts which have accrued to the date of death to be included in income in the terminal year.
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Under paragraph 104(23)( d), if the deceased taxpayer was an income beneficiary of a trust,
any income paid or payable from the trust after the end of its last completed fiscal period ending
within the calendar year of death may be reported in a separate return.
Business income may also be reported in a separate return if the fiscal period of a business
of which the taxpayer is a proprietor or partner is not on a calendar year basis and the death occurs
after the close of the fiscal period, per subsection 150(4). In the case of a partner's death, a separate
return may be filed only if the death causes the fiscal period of the partnership to end. If there is no
deemed or actual fiscal year end, the deceased's partnership profit for the "stub" period immediately
prior to the death is considered a "right or thing".
Because the separate returns filed under subsection 70(2), 150(4) and 104(23) are considered
to be that of "another person", certain tax credits maybe claimed in each return including the basic
personal tax credit, the age tax credit, the married tax credit, married equivalent tax credit and the
dependant tax credit maybe claimed in each separate return. Subsections 118.93 and 114.2 restrict
the doubling of certain credits and deductions such as tuition fee tax credits, mental or physical
impairment tax credit and the credit for medical expenses.
2. Under subsection 159(5) an executor may file an election in Form T2075 to pay taxes arising
on death by instalments. The executor must furnish security which is acceptable to Revenue Canada.
The security may be in the form of a charge on the property of the deceased taxpayer, a charge on
the property belonging to another person or a guarantee from some other person. A maximum 0 f ten
equal consecutive annual instalments are allowed. Interest is payable from the day the tax would
otherwise have been payable on the balance of tax outstanding at the prescribed rate at the time the
election. Amounts which qualify for instalment payments include "rights or things" included in the
deceased's income regardless of whether the executor has elected to file a separate return for those
items, the tax payable on the deemed disposition of capital property, per subsection 70(5), and the
deemed disposition of resource properties and land inventories, pursuant to subsection 70(5.2).
The first instalment is due on or before the day the tax in respect of those amounts would be
payable if it were not for the election.
3. Pursuant to subsection 164(6) the executor of an estate may elect to have a portion of the net
capital losses realized by the estate in its first taxation year deemed to be a capital loss recognized
by the deceased in his terminal year. The election must be made in respect of capital losses suffered
on a property-by-property basis, but the maximum amount elected cannot exceed the aggregate
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amount by which all capital losses sutTered in the estate's first year exceeds any capital gains
recognized in that year. By deeming the loss to be a capital loss recognized by the deceased it
becomes subject to the same provisions that apply to other capital losses realized in the terminal
year. Proposed amendments relevant to this election are discussed below in respect to insurance
funded estate planning.
4. Subsection 70(6.2) permits the executor to elect out of the automatic rollover provided by
subsection 70(6) with respect to property distributed to a spouse or spouse trust. This election may
be sued to ensure that a deceased taxpayer has suffIcient capital gains in the year of death to make
full use of avail able capital losses. After the advent of the capital gains exemption this election took
on even greater importance. By electing to suffer the capital gains tax on certain items of property
the executor can ensure that there is sufficient capital gains in the deceased taxpayer's year of death
to fully utilize any capital gains exemption which may be available to the taxpayer upon his death.
This election shall be more fully discussed in that portion of this paper dealing with spouse trusts.
"SPOUSE TRUSTS"
The "spouse trust" is a familiar tax planning tool. Subsection 70(6) provides an automatic
rollover where property is distributed on the death of the taxpayer to his spouse or to a spouse trust.
In order for a trust to constitute a spouse trust, seven conditions must be met:
1. the deceased taxpayer must have been a resident of Canada immediately before his death,
2. the property of the deceased taxpayer must, on or after his death, and as a consequence
thereof, be transferred or distributed to the trust,
3. the trust must be created by the taxpayer's will, per subsection 70(6.1),
4. the trust must be resident in Canada immediately after the time the property vested indefeasibly in the trust,
5. the taxpayer's spouse must be entitled to receive all of the income of the trust during that spouse's lifetime,
6. no other person except the spouse may, before the spouse's death, receive any benefit from
or encroach upon the capital of the trust, and
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7. the subject property must become vested indefeasibly in the spouse trust within 36 months
after the death of the taxpayer.
Boiler-plate wills and vague expressions as to the discretion of the executors may threaten
the integrity of the spouse trust. It has been suggested that a spouse trust may be irretrievably
"tainted" where the corpus of the trust constitutes the residue ofthe estate and where other funds or
beneficiaries are to be maintained out of the residue. One example is the provision for the
maintenance and upkeep of a property out of the residue of an estate where such property is not
included in the spouse trust. If the residue forms the corpus of the spouse trust the will may be
interpreted to require the trustee to use the capital of the trust to maintain the property. Specific
funds or trusts should be provided for bequests or other obligations of the executor that might
otherwise be required to be funded out of the corpus of the spouse trust.
A will may specifically provide for the assets to be distributed to a spouse trust or the
selection may be left to the discretion of the executor. It is suggested that it is more advantageous
to give the executor the discretion to determine which assets are to be distributed to the spouse trust
and those which may be distributed to other beneficiaries or a trust other than a spouse trust. Of
course, the controlling consideration is the intention of the testator.
It may be more advantageous not to receive the benefit of the rollover pursuant to subsection
70( 6) upon the transfer of property to a spouse trust if the deceased taxpayer has insufficient capital
gains in the year of death to fully utilize that taxpayer's available lifetime capital gains exemption.
Otherwise, the taxpayer's capital gains exemption may be lost and the spouse or spouse trust may
have to pay tax on capital gains which might otherwise have been obtained tax free.
There are several methods available to ensure that an adequate amount of capital gains are
incurred by the deceased taxpayer for the purposes of his terminal return in order to make use of his
capital gains exemption and any capital losses which might otherwise be available in the year of
death. These include the use of the election under subsection 70(6.2), the use of a "tainted" spouse
trust pursuant to subsection 70(7) and the use of a "family" or "sprinkling" trust.
As discussed subsection 70(6.2) provides that the legal representative of the taxpayer may
elect, in the return of income of the taxpayer for the year in which the taxpayer died, to have
subsection 70(5) apply to property which would otherwise qualifY for a rollover pursuant to
subsection 70(6). Subsection 70(6.2) is attractive since it permits the executor to deal with the tax
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needs of an estate without interfering with the intention of the testator. The election under
subsection 70(6.2) is deficient because the executor may not elect to realize only a portion of the
capital gains in respect to a particular property.
It is beyond the scope of this paper to fully discuss the benefits and problems associated with
the various means available to avoid the automatic rollover provided by subsection 70(6). Reference
should be made to the articles listed in the Suggested Readings List iffurther discussion of this issue
is desired.
One fairly recent development is the expansion of the definition of" spouse" for the purposes
of the Act including spouse and spouse trust rollovers. Effective for 1993 and subsequent years a
spouse now includes a person of the opposite sex who cohabits with the taxpayer in a conjugal
relationship and either:
1. has cohabited with the taxpayer throughout any 12-month period and deemed before the time
in question, or
2. is the other parent of the taxpayer's child (note that your child's in-laws explicitly do not
qualifY under this second part of the definition of "spouse").
THE ELIMINATION OF THE PREFERRED BENEFICIARY ELECTION -WHAT NOW?
Actually, preferred beneficiary elections have not been "eliminated" but merely the
availability of the preferred beneficiary elections have been dramatically reduced. The only persons
who are under a disability as defined for the purposes of subsection 118.3 (1) of the Act may be the
subject of a preferred beneficiary election. This allows the preferred beneficiary election to remain
an important planning technique for estates involving persons under disability. However, for other
beneficiaries an election is not available for taxation years of the trust beginning after 1995.
In order to use the preferred beneficiary election the beneficiary must be entitled to a tax
credit for a mental or physical impairment under subsection 118.3(1) of the Act (or would be so
entitled if there were no deductions claimed for an attendant or care in a nursing home in respect of
the beneficiary).
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The "allocable amount" to such preferred beneficiary is determined under amended
subsection 1 04( 15).
If the trust is a spouse trust and the spouse is alive at the end of the year then an election may
be made with respect to the spouse in regard to the total amount ofthe "accumulating income" for
the year.
In a non-spouse trust situation the allocable amount is determined under paragraphs
1 04(15)(b) and (c). Pursuant to paragraph 1 04(15)(b) each preferred benefIciary is entitled to the
full amount of the trust's accumulating income for the year if that beneficiary's interest in the trust
is not solely contingent on the death of another beneficiary who has a capital interest in the trust but
who does not have an income interest in the trust. Pursuant to paragraph 1 04( 15)( c) in all other cases
not dealt with in paragraphs 1 04( 15)( a) and (b) the preferred beneficiary's share of the accumulating
income of the trust is nil.
In a great percentage of trusts there will therefore be no ability to make a preferred
beneficiary election. However, in preparing a will you should not assume that a preferred beneficiary
election will not be available and language should be included in the will that allows the trustees to
make preferred beneficiary elections as that election is available pursuant to the Act as the Act
applies from time to time.
Subject to the wishes of the testator, it is important to provide flexibility to the trustees in
making elections under the Act. This would include preferred beneficiary elections in whatever form
that they are available in the future. I would not recommend simply dropping references to preferred
beneficiary elections in wills as it is impossible to know at this time whether there would be an
eligible preferred beneftciary of the testamentary trust or whether there may be a beneficial change
to the Act.
F or those trusts that do not have eligible preferred beneficiaries the issue is now how to cope
with the loss of the preferred beneficiary election.
Subsection 104(18) provides some measure of relief. However, subsection 104(18) was
amended as part of the 1995 budget to read as follows with respect to taxation years of trusts that
begin after 1995:
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(18) Trust for minor. Where any part of the amount that, but for subsections (6) and (12), would be the income of a trust for a taxation year throughout which it was resident in Canada has not become payable in the year and was held in trust for an individual
(a) who did not attain 21 years of age before the end of the year, and
(b) whose right to the part of the amount vested at or before the end of the year, did not become vested because of the exercise by any person of, or the failure of any person to exercise, any discretionary power and is not subject to any future condition (other than a condition that the individual survive to an age not exceeding 40 years),
notwithstanding subsection (24), that part of the amount is, for the purposes of subsections (6) and (13), deemed to have become payable to the individual in the year.
It has been suggested in several articles including M. Elena Hoffstein and Peter W. Vair,
"Trusts: Tax and Non-Tax Benefits for Business Interests", Estate Planning - Effective Strategies to
Minimize Tax and Maximize Wealth Transfer (Insight Press, Toronto, 1995) and Wolfe D.
Goodman, "The Elimination of the Preferred Beneficiary Election Requires New Coping Methods",
Goodman on Estate Planning, Vol. 4, No.2, p. 179 that s. 104(18) may be effectively used in a
discretionary trust to allow income to be taxed in the hands of the beneficiaries. However, the draft
legislation implementing the 1995 federal budget appears to have been issued after these articles had
been written. The proposed amendments to subsection 1 04( 18) set forth in the notice of ways and
means motion dated December 12, 199 5 (reproduced above) at paragraph 1 04( 18)( c) appears to
prevent the use of subsection 1 04( 18) where the right has vested as the result of an exercise by any
person, or the failure of any person to exercise, any discretionary power. In interpreting this
provision Revenue Canada's comments on old subsection 104(15) relating to the calculation of the
allocable amount for a preferred beneficiary are relevant. Revenue Canada has stated that wherever
there is a discretionary power to encroach upon capital in favour of any beneficiary then the rights
of all beneficiaries are subject to the exercise by any person of, or the failure of any person to
exercise, any discretionary power (Revenue Canada Technical Interpretation 9223425 - Capital Gain
Designation, dated February 10, 1993 and 9228225 - Preferred Beneficiary, dated February 24,
1993). Therefore, subsection 1 04( 18), as amended, may not apply where there is a discretion with
respect to the income or capital of a trust.
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One idea to overcome the preferred beneficiary election problem is to have the trust actually
distribute income to a beneficiary or in the case of a minor to the beneficiary's guardian. With
respect to minors it is important to include a power allowing the trustees to distribute income or
capital that is to be distributed to minors to the minor's guardian or parents. This assists in protecting
the trustees. The problem with an outright distribution to a benefIciary is that the beneficiary may
not be, in the estimate of the trustees, capable of handling the funds. The distributed income may
be "loaned" back to the trust at interest, subject to the various attribution rules contained in the Act
creating an income source for the beneficiary and, hopefully, an interest deduction to the trust. It is
unlikely that a trust would be able to deduct interest paid on a promissory note issued as payment
of a distribution based upon the Supreme Court of Canada decision in Bronfman Trust v. The Queen
(1987),87 D.T.C. 5059.
Distributions to guardians or parent may expose the parent or guardian to the claims of a
disgruntled child if the funds are not used by the parent or guardian in an appropriate manner.
I believe that we will see many different plans developed and discussed in articles and at
conferences and in income tax journals over the next year of so and I am sure that we will see a great
deal of ingenuity on the part of tax planners.
21 - YEAR DEEMED DISPOSITION RULE
The 1995 federal budget also eliminated the deferral of the 2 I-year deemed disposition rule
involving exempt beneficiaries. The repeal of the election is to be effective January 1, 1999 and will
apply to trusts that have previously elected to defer the deemed disposition as well as those which
do not reach their deemed disposition date prior to 1999. In my view the deferral rules were
hopelessly complex but in some instances quite useful. Nevertheless we now find ourselves in the
same position that we were prior to the proposal of the exempt beneficiary rules in 1991.
One issue that has plagued the wind up of many a discretionary trust prior to the deemed
disposition date is a limited power of encroachment. An example of a limited power would be as follows:
... but the trustees may at any time and from time to time pay to or apply for the benefit of the Beneficiary such sum or sums of the capital of the Fund as the Trustees in their discretion consider desirable, in addition to the net income, for the support, maintenance, or education of the Beneficiary; ...
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This discretion may not be sufficient to allow the trustees to distribute the entire corpus of
the trust and wind-up the trust prior to the 21-year deemed disposition date. Such a distribution to
capital beneficiaries would generally result in a tax-free rollover.
An example of a broadly worded clause is as follows:
... together with so much of the capital as my executors in their discretion deem necessary or advisable to or for the benefit of the Beneficiary ...
Naturally, the wishes of the testator are paramount, however the testator should make his
decision based upon full knowledge of the potential adverse tax consequences of adopting a limited
power of encroachment where the trust does not otherwise terminate prior to the 21-year deemed
disposition date.
For a review of the income tax consequences of a variation of trust I refer you to the article
by William Innes and Joel T. Cuperfain, "Variations of Trusts: An Analysis of the Effects of
Variations of Trusts Under the Provisions of the Income Tax Act", 43 Canadian Tax Journal 16.
INSURANCE FUNDED ESTATE PLANNING
Another significant change arising out of the 1995 federal budget is the limitation placed
upon the losses that may be generated on capital dividends in an estate.
A common planning technique devised to minimize and fund the tax consequences of the
deemed disposition arising on death involves the use of corporate-owned insurance.
A simple example would be as follows:
1. Mr. A owns all of the preferred shares of Aco and all common shares are held by his adult children.
2. The preferred shares (obtained by Mr. A on a freeze of Aco have a high redemption value
[$100,000] and a low paid-up capital and adjusted cost base [$1 D.
3. Aco holds an insurance policy payable on Mr. Ns death with a payout of $1 00,000.
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In our simple example Mr. A has now died leaving the preferred shares to his children
(therefore no spousal rollover). The insurance proceeds (less the cost of the policy as determined
by the Act) flows into the capital dividend account of Aco and is received tax-free by Aco That
capital dividend account may be utilized to create a loss and to provide funds to the estate to pay the
tax liability arising upon Mr. A's death by using the following plan:
1. Aco redeems the preferred shares held by the estate for $1 00,000 declaring a capital dividend
payable on the redemption of $99,999 (redemption price minus the paid-up capital).
2. The $99,999 will be received as a tax -free capital dividend by the estate. The payment ofthe
dividend, whether a capital dividend or otherwise, reduces the proceeds of disposition of the shares
for capital gains purposes. Since the cost of the shares is $100,000 resulting from a deemed
disposition on the death of Mr. A the estate now has a $99,999 loss.
3. Pursuant to subsection 164(6) the loss generated in the first year of the estate may be applied
against the gain earned by the deceased pursuant to the deemed disposition on death. This eliminates
the capital gain in our scenario and provides liquidity to the estate.
Even in this simple example there are a number of issues that arise. The primary concern
under the present rules is whether a loss will be denied on the redemption of the preferred shares
pursuant to the stop-loss rules in subsection 85(4) and proposed subsection 40(3.3).
These rules would deny the loss where the estate controls Aco directly or indirectly in any
manner whatever immediately after the redemption. Recently Revenue Canada has suggested that
an estate may be considered to control a company where the executors hold the controlling shares
in their own capacity. In our example iftwo ofthe children were executors then the estate might be
considered to control Aco immediately following the redemption. I believe that Revenue Canada
is incorrect, however, in estate planning the ideal is to keep income tax risks to an absolute
minimum. Therefore, another alternative has been suggested to deal with the uncertainty in Revenue Canada's position on control.
The stop-loss rules (old subsection 85(4) and new subsection 40(3.3)) do not apply on a
winding-up. Therefore, the following plan has been devised to access the capital loss:
1. All the facts are as above however prior to the redemption the estate transfers the shares of
Aco to Newco (a newly incorporated company) in exchange for shares of New co having a low paid-
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up capital and high cost base (note that it may be necessary to use a s. 85 election on this transfer as
insurance proceeds in Aco will not be included in the valuation of the shares of Aco on the deemed
disposition pursuant to subsection 70(5) [see subsection 70(5.3)] however, the insurance proceeds
will be included in valuing the company in other dispositions).
2. The preferred shares of Aco are redeemed by Aco flowing the capital dividend account up
to Newco (subsection 89(1)).
3. Newco is then wound up pursuant to subsection 88(2) into the estate creating a deemed
dividend which is treated as a capital dividend on the winding-up. The loss is therefore realized on
the shares of New co but the stop-loss rules do not apply.
The general anti-avoidance rule, s. 245 of the Act, must be considered a risk in this scenario.
However, since estate planning has been viewed as being, to a certain extent, sheltered from the
general anti-avoidance rule, see Information Circular 88-2, arguably GAAR should not apply to this
plan.
I would however note that Revenue Canada has issued a technical interpretation dated
March 24, 1995 that suggests that GAAR may be applied where the estate has distributed the
controlling shares to the beneficiaries prior to the redemption creating the capital loss. In that
scenario the estate assuming that the executors do not control the corporation in their own right,
would not control the corporation immediately following the redemption. Revenue considered that
the timing of distribution might be subject to GAAR. The likely result of the application ofGAAR
would be the denial of the capital loss.
In addition to the adjustments to the stop-loss rules (a complete discussion of which is
beyond the scope of this paper) the amendments first proposed on April 26, 1995 reduce the loss that
may be created using a capital dividend. As a result of a strong lobby by the insurance industry the
Department of Finance proposed changes to the draft legislation which were issued December 14,
1995.
Generally, the proposed amendments to the draft legislation would allow 1/4 of the loss that
would otherwise have been realized by the use of the capital dividends. The rules do not cause the
capital dividend to be taxed it merely reduces the benefit of the insurance-funded plan by reducing
the loss that may be generated by use of the capital dividends.
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The grandfathering rules are somewhat complex and are very important in that a number of
insurance funded plans that are presently in place may be grandfathered and therefore have access
to 100% of the capital loss generated by the use of the capital dividends if action is taken prior to
December 31, 1996. The modified grandfathering proposals contained in the December 14. 1995
draft proposal will allow the full capital loss to be utilized where:
1. the disposition occurs after April 26, 1995 pursuant to an agreement in writing entered into
before April 27, 1995;
2. the disposition is made to the corporation after the individual's death (or where the individual
is a testamentary or inter vivos spouse trust, after the death of the beneficiary spouse) pursuant to an
agreement in writing entered into before 1997 if on April 26, 1995 the corporation was a beneficiary
of a life insurance policy on the life of the individual or, where the individual is a spouse trust, on
the life of the beneficiary spouse; and it is reasonable to conclude that the shares were acquired with
the proceeds of the policy; or
3. the disposition occurs after the individual's death or, where the individual is a testamentary
or inter vivos spouse trust, after the death ofthe beneficiary spouse and before 1997.
The key grand fathering provision is in paragraph number 2. Often there will be no written
agreement with respect to the use of the life insurance proceeds and capital dividend account and this
grand fathering provision allows until December 31, 1996 to put that agreement in place. The
problem with the current grandfathering proposal it that it does not allow for the wind-up alternative
discussed above as the disposition by the estate to create the capital loss is not on a redemption to
the corporation (in our example Aco) but on a winding-up (in our example on a winding-up of Newco).
I understand that representations are being made to the Department of Finance by the
insurance industry and by various interested taxpayers to make further adjustments in the grandfathering provisions.
Whether the entire capital loss is allowed under the grandfathering rules or only 1/4 of the
loss is allowed the control (directly or indirectly in any manner whatever - de facto control) is still
a concern. In order to address this question consideration should be given to:
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1. Ensuring that the executors are persons other than persons who own the controlling shares
(following a redemption) or will receive the controlling shares from the estate;
2. The estate should consider distributing the balance of the shares of the subject corporation
owned by the estate prior to completing the redemption that will create the capital loss (Revenue
Canada has said that GAAR might apply);
3. The shares held by the testator that are voting shares (often these are nominal value voting
preferred shares) may be bequeathed outside the estate to a specific person who is not an executor
or the voting privileges on the shares may cease on the death ofthe testator. In either event this may
keep control of the estate out of the estate.
Revenue Canada's position and the law with respect to the control of a corporation should
be reviewed prior to the implementation of any plan involving the utilization of a capital loss created
by way of redemption or winding-up.