Backgrounder: Legislative Proposals Relating to Income Taxation of Certain Trusts and Estates
The legislative proposals accompanying this release propose amendments to the income tax rules for certain trusts and estates and their beneficiaries. Below are brief explanations of several key elements of the proposed amendments.
Trust loss restriction events
The income tax rules contain restrictions on when losses incurred by a taxpayer may be recognized and used to offset the taxpayer’s own income. Losses realized by a taxpayer generally remain with that taxpayer for income tax purposes but may be carried forward or back to offset taxable income in other years within certain limits.
The ability of a corporation or trust to carry over its losses (and other tax attributes) may be constrained, under the loss restriction event rules, where the corporation or trust is subject to a significant change in ownership. For trusts, this typically involves cases where a beneficiary, or group of beneficiaries, acquires more than 50% of the beneficial interests in a trust. However, a trust that is an investment fund is not subject to a loss restriction event if certain conditions are met.
The legislative proposals would modify the application of the trust loss restriction event rules to investment funds and other trusts, including by:
- Ensuring that the investment fund definition applies in a manner that generally permits funds to establish whether they are in compliance with the definition without the need to track on an ongoing basis the valuations of entities in which they invest, while also introducing anti-avoidance rules to prevent trusts that directly or indirectly carry on a business from inappropriately claiming status as an investment fund;
- Clarifying that an investment fund is not subject to a loss restriction event solely because of a redemption of its issued units; and
- Expanding the list of trust tax filing obligations for which deferred filing is permitted where the trust is subject to a loss restriction event.
Donations made by an individual to a registered Canadian charity or other qualified donee are eligible for a Charitable Donation Tax Credit (CDTC). Subject to certain limits, a CDTC in respect of the eligible amount of the donation may be applied against the individual’s income tax otherwise payable. The eligible amount is generally the fair market value of the donated property at the time that the donation is made (subject to any reduction required under the income tax rules). The individual may claim a CDTC for the year in which the donation is made or for any of the five following years.
Trusts (including estates) are subject to the same rules for their donations. However, additional rules facilitate the tax treatment of donations made by the estate of an individual who dies after 2015. These rules, which apply to donations made by the individual’s estate while it is the individual’s graduated rate estate, permit the estate to allocate the available donation among any of: the taxation year of the estate in which the donation is made; an earlier taxation year of the estate; or the last two taxation years of the individual. In addition, if the property donated by the individual’s graduated rate estate is a publicly-listed security, or a unit of a mutual fund, that was owned by the individual immediately before the death, the capital gains on the property arising on the individual’s death are exempt from income tax. An individual’s estate may qualify as the individual’s graduated rate estate for only the first 36 months after the individual’s death.
The legislative proposals would modify the application of the above rules for donations made by an individual’s graduated rate estate by extending the rules to apply to donations made by the graduated rate estate, after it ceases to have that status because of expiry of the 36-month period, for up to 60 months after the individual’s death. Donations made by an individual’s former graduated rate estate would be eligible to be allocated among any of: the taxation year of the estate in which the donation is made or the last two taxation years of the individual. The individual’s year-of-death capital gains exemption would also be extended to these donations.
Spousal and common-law partner (and similar) trusts
The tax rules permit an individual to transfer, on a tax-deferred basis, capital property to a trust the primary beneficiary of which is the individual’s spouse or common-law partner. These trusts, and certain similar trusts, are subject to a deemed recognition of capital gains (and certain other income amounts) on the death of the trust’s primary beneficiary (i.e., the spouse or common-law partner beneficiary). For deaths before 2016, these income amounts are taxed in the trust. For deaths after 2015, these amounts are instead recognized as income in the hands of the primary beneficiary, although the trust would generally be assessed by the Canada Revenue Agency as though the trust were liable in the first instance for any resulting tax arising in the primary beneficiary’s final tax return.
The legislative proposals would modify the above tax treatment of spousal and common-law partner trusts and similar trusts, for deaths after 2015, by:
- Subject to the election described below, taxing in the trust the income deemed to be recognized in the trust on the death of the primary beneficiary;
- Permitting a testamentary spousal or common-law partner trust (that arose on and as a consequence of a death before 2017) to jointly elect with the graduated rate estate of the trust’s primary beneficiary to have taxed in the primary beneficiary’s final tax return the income of the trust for its taxation year in which the primary beneficiary dies; and
- For purposes of computing the trust’s Charitable Donation Tax Credit in respect of a donation made by the trust within 90 days after the end of the calendar year in which the primary beneficiary dies, permitting the trust to allocate the donation to the trust’s taxation year in which the primary beneficiary dies.