Department of Finance Proposed Technical Amendments - Commentary on CGIR/Capital Dividend Account, Bare Trusts, and Post-Mortem Planning

The Department of Finance released proposed technical amendments yesterday afternoon in conjunction with a news release to move forward with consultations to advance their key budget priorities. You can share your comments to [email protected] by September 11, 2024 (or by an earlier date of September 3, 2024 if your comments relate to the capital gains inclusion rate and lifetime capital gains exemption).

You can read the full releases here: https://fin.canada.ca/drleg-apl/2024/ita-lir-0824-eng.html

These legislative proposals are very broad in coverage and very technical in depth. The below is my read/take on three certain areas of interest so far but, as always, caveats: given how new this is, E&OE and you should consult with your own advisors if seeking advice that may impact you. Happy reading!

Capital Gains Inclusion Rate and Impact on Capital Dividend Account

The government has updated their legislative proposals stemming from the 2024 Federal Budget and is now proposing to amend Section 89 of the Act (which deals with capital dividends) to add subsection 89(1.4) which specifically addresses the 2024 transitional year as it relates to the computation of the Capital Dividend Account at any time.

The proposed amendments will now allow for the accurate determination of the Capital Dividend Account balance at any time and, consequently, for payment from the capital dividend account without taxpayers facing a possible penalty for an unintended excessive capital dividend election.

This deals with the computational nuance that previously existed in the draft Notice of Ways and Means Motion released June 10, 2024 whereby a taxpayer that properly computed the Capital Dividend Account balance prior to June 25, 2024 based on current legislation in effect at the time of computing and paid out a capital dividend in 2024 could have, in certain circumstances, been faced with Part III tax on an inadvertent excessive capital dividend election at a tax rate of 60% of the excess amount absent an election to convert the excessive amount to a taxable dividend. Neither were a good or fair result.

The above was due to the blended inclusion rate that would have been determined at the end of the taxpayer’s fiscal year that straddled June 25, 2024 applying to all transactions during the transitional year regardless of timing of the underlying property disposition, despite the capital dividend account being determined at a particular point in time.

These newly proposed amendments released yesterday afternoon should now mean taxpayers seeking to compute and declare a capital dividend that includes activity in the corporate fiscal year that straddles June 25, 2024 can safely do so. They will not the need to wait until the end of the straddle tax year to quantify a future blended inclusion rate when computing the capital dividend account and instead can compute it accurately based on the timing of the underlying property disposition(s). This is a logical and welcome amendment.

The amendment to deal with the previous nuance is mechanically handled through proposed paragraph (a) of subsection 89(1.4) of the Income Tax Act which states that, despite Section 38, for purposes of computing the capital dividend account of a corporation at any time, this paragraph will now deem the inclusion rate of the taxable capital gain or allowable capital loss from the disposition of any property to coincide with the inclusion rate legislatively in effect at the timing of disposition of the underlying property in the transition year [2024].

Specifically, for purposes of computing the capital dividend account balance at any time, the corporation’s taxable capital gain or allowable capital loss from property dispositions that occurred before June 25th will be deemed to equal one-half (50%) and taxable capital gains or allowable capital losses from property dispositions on or after June 25th will be deemed to equal to two-thirds (66.67%). This now directly correlates to the capital dividend account (50% inclusion before June 25th and 33.33% post June 25th).

There does still appear to be certain calculations that will occur at the end of the transition year by virtue of paragraphs (b) and (c) which deems the corporation to have realized a capital gain and capital loss from the disposition of a property at the end of its transition year equal to the amount determined by certain formulas. These calculations appear to adjust for a difference between the deemed inclusion rate calculated under (a) and the inclusion rate determined at the end of the transition year under Section 38 for purposes of determining the go-forward Capital Dividend Account balance. Given that this impacts the future, it would not impact the computation and payment during the transitional year.

Bare Trusts

The new technical amendments in subsections 104(1) and subsection 150(1.3) impact how trusts are legislatively subjected to an income tax filing requirement.

Newly amended subsection 150(1.3) will deem certain trusts to be express trusts for purposes of Section 150 of the Income Tax Act and Section 204.2 of the Income Tax Regulations.

Paragraphs 150(1.3)(a) through (c) deem an express trust to include any arrangement in which one or more persons have legal ownership of property that is held for the use of, or benefit of one or more persons or partnerships and the legal owner can reasonably be considered to act as agent for the persons or partnerships who have the use of, or benefit of, the property.

The above essentially describes bare trust arrangements. Absent a permitted exception, these bare trusts would have to file an income tax return under the requirements of subsection 150(1) of the Income Tax Act.

There appears to now be two general exceptions:

One

Subsection 150(1.31) will provide for an exception for certain deemed trust arrangements for a taxation year. There is a specific list of exceptions included in this subsection, but the most common ones are likely to be covered in paragraphs (a) through (c) of subsection 150(1.31) which appears to essentially except an arrangement with respect to those who are on legal title of a property that is real property that would be the principal residence (as defined in section 54) of one or more legal owners and all the legal owners are individuals that are related persons. This will likely be welcome news for those who own a primary home and have adult child or parent on legal title.

Two

Subsection 150(1.1) also allows for exceptions to the information return filing requirement under subsection 150(1) by reference to subsection 150(1.2). 150(1.2) outlines a number of exceptions, but specifically the new legislative amendments target paragraphs 150(1.2)(b) and (c).

(b) will exempt an express trust if it holds assets with a total fair market value not exceeding $50,000 throughout the year;

(b.1) will exempt if each trustee is an individual, each beneficiary is an individual and is related to each trustee, and the total fair market value of the property of the trust does not exceed $250,000 throughout the year and the only assets held by the trust throughout the year are one or more of essentially money, a GIC issued by a Canadian bank or trust company, or publicly listed marketable securities [see paragraph for full list].

This will likely be welcome news for those who have financial accounts holding money, GICs, or marketable securities with less than $250,000 where there is another related individual on legal title who does not have beneficial ownership of the account. This planning was very common for estate administration purposes.

The modifications to paragraph (c) will likely be a welcome change for professionals who may have to maintain trust accounts pursuant to rules of professional conduct or the laws of Canada or a province. This proposed paragraph provides an exemption provided the trust is not maintained as a separate trust for a particular client or clients, or the only assets held by the trust throughout the year are money with a value that does not exceed $250,000.

Post-Mortem Planning under 164(6)

Prior to these proposed legislative amendments, there was a short window of time in which the executor of an estate had to implement post-mortem planning under subsection 164(6) which previously allowed for the carryback of a capital loss incurred by the estate within its first taxation year to the terminal return of the decedent taxpayer to offset a capital gain. The new proposed legislative amendments for subsection 164(6) now reference the first three taxation years of the estate, which is now in line with the definition of a graduated rate estate.

This is a welcome change to provide more time to eliminate the double taxation that can otherwise occur absent this planning being executed on a timely basis. To illustrate a common example of this type of planning: Under subsection 70(5), to the extent shares are not left to a surviving spouse under the automatic spousal rollover provisions contained in 70(6), a deemed disposition of shares of a Canadian controlled private corporation would occur immediately before passing at fair market value and a capital gain could result that is reportable on the decedent’s terminal tax return.

Those same shares would then have a step up in cost base to the estate since tax was paid on the terminal return of the decedent, but if those shares are subsequently redeemed from the taxpayer’s estate, a taxable deemed dividend to the estate would result under subsection 84(3). The estate would simultaneously realize a capital loss on the redemption due to the mechanics of the proceeds of disposition being modified for calculation purposes. The end result is that the estate may pay tax on the deemed dividend (to the extent it does not elect partial CDA treatment of the resulting deemed dividend if insurance was in place) ?and is left with a capital loss that may not be useable if the window of timing is missed under 164(6).

That capital loss could only be carried back to the terminal return to offset the capital gain under 164(6) if done within the first taxation year which would not leave a lot of time for planning and execution upon the death of a shareholder. Three years is a much more reasonable window of time to deal with these complex matters.

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