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ESTATE PLANNING AND SUCCESSION:SELECTED TAX ISSUES

These materials were. prepared by Beaty Beaubier of Priel Stevenson Hood & Thornton law firmSaskatoon, Saskatchewan for the Saskatchewan Legal Education Society Inc. seminar, Estate &Succession Litigation; November 2002. .

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TABLE OF CONTENTS

I. INTRODUCTION 1

II. GENERAL RULES 1A. INCOME TAX CONSEQUENCES RESULTING FROM THE DEATH OF AN INDIVIDUAL 2

1. Deemed Disposition at Fair Market Value 22. Tax Rollovers to a Surviving Spouse or Common-Law Partner 23. Rollovers to Children 3

B. PROBATE LEVIES 5C. GOODS AND SERVICES TAX 6

1. Effect of the Individual's Death 62. Distribution of Estate Property 7

III. SELECTED TAX ISSUES 8A. AVOIDING PROBATE LEVIES - SOME PITFALLS 8

I. Taxpayer Dies Owning an RRSP - Who Pays the Income Tax? 92. Estate Property and Loss Carrybacks 10

B. RE-WRITING THE WILL : 121. Varying Testamentary Gifts 13

(a) Disclaimers, Releases and Surrenders 13(b) Dependants' Relief Legislation 16(c) Matrimonial Property Legislation 16

2. Varying and/or Winding Up Testamentary Trusts 17(a) "Income Interests" and "Capital Interests" in Trusts 17(b) Disposing of Income Interests in Trusts 17(c) Disposing of Capital Interests in Trusts 18(d) Varying a Testamentary Trust. 19(e) Winding Up a Testamentary Trust. 21

C. CLEARANCE CERTIFICATES 23

IV. CONCLUSION 24

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ESTATE PLANNING AND SUCCESSION: SELECTED TAX ISSUES

I. INTRODUCTION

Lawyers face several challenges when advising clients on estate planning and estate

administration Issues. Separate and apart from the general laws that affect Wills and

testamentary dispositions, lawyers must also be cognizant of the tax rules that may apply at any

given stage of an estate plan or an estate administration. Lawyers and their clients face

additional complications when administering an estate which has been named as a party to a

lawsuit. Lawsuits against estates may arise for several different reasons, including claims by

creditors such as the Canada Customs and Revenue Agency (the "CCRA") in respect of tax

debts, and claims by disappointed beneficiaries for a greater share of estate property.

This paper is not intended to be a comprehensive identification of all of the different tax rules

that are relevant to estate planning and estate administration. Rather, the paper identifies a few

different tax issues that, in recent years, have caused problems for some lawyers (and

accountants) when advising clients in estate-related matters. Some of the tax issues identified

are relevant to the construction of the estate plan; others are relevant to the administration of the

estate.

II. GENERAL RULES

In order to understand the tax issues that can cause problems for lawyers when they are advising

clients with respect to estate planning or estate administration matters, it is first necessary to have

a general understanding of the tax rules that can apply in respect of the death of an individual.

This part of the paper provides a general description of those rules.

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A. INCOME TAX CONSEQUENCES RESULTING FROM THE DEATH OF AN

INDIVIDUAL

1. Deemed Disposition at Fair Market Value

Pursuant to Subsection 70(5) of the Income Tax Act (Canada)!, when an individual dies, the

individual is deemed to have, immediately before death, disposed of all of his or her capital

property for proceeds of disposition equal to the fair market value ("FMV") thereof. Other rules

in the Act provide for similar income tax consequences with respect to other types of property in

the event of an individual's death (e.g. rules dealing with the deemed disposition at FMV of land

inventories and resource properties2, and the deemed "collapse" or payment out of all property in

unmatured RRSp'S3, RRIF's4 and NISA Fund No.2 accounts5). Generally speaking, the estate,

identified by the executor or administrator, receives the deceased individual's property at a tax

cost equal to the deemed proceeds of disposition of that property that arise immediately before

the individual's death.

2. Tax Rollovers to a Surviving Spouse or Common-Law Partner

The most significant exceptions to the "deemed disposition at FMV" rules referred to above are

found in those provisions of the Act which provide for a "rollover" to a spouse or common-law

partner who is a resident of Canada.6 A spouse, with respect of an individual, is another

individual of the opposite sex who is a party to a voidable or void marriage with that individual.7

A common-law partner, with respect to an individual, is another individual, whether of the same

sex or the opposite sex, who cohabits at the particular time in a conjugal relationship with the

individual and:

1 R.S.C. 1985, c. 1 (5th Supp.), as amended (herein referred to as the "Act"). Unless otherwise stated, statutoryreferences in this paper are to the Act.2 Subsection 70(5.2).3 Subsection 146(8.8).4 Subsection 146.3(6).5 Subsection 70(5.4).6 Subsection 70(6) - Capital Property; Subsection 70(6.1) - NISA Fund No.2; Paragraph 70(5.2)(b) - LandInventories and Resource Properties; Subsections 146(8.8) and (8.9) - RRSP's; Subsections 146.3(6.1), (5) and(6.11) and Paragraphs 60(l)(iii) and (v)(B. 1) - RRIF's.7 Subsection 252(3).

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• Has so cohabited with the individual for a continuous period of at least one year; or

• Is a parent of a child of whom the individual is also a parent.8

Under a "rollover" provision, there is no deemed disposition of the property at FMV. Rather, the

property is transferred to the surviving spouse or common-law partner (or in some circumstances

to a trust for that person) at its tax cost. The result is that no income tax will generally result

where a rollover rule applies.

Another significant exception to the "deemed disposition at FMV" rules is found in those

provisions of the Act which provide for a rollover to a trust for a spouse or common-law partner

(hereinafter a "spousal trust,,).9 A "spousal trust" is a trust resident in Canada created by the

taxpayer's Will immediately after property vests indefeasibly in it and under which the

taxpayer's spouse or common-law partner is entitled to receive all of the income of the trust

arising before the death of the spouse or common-law partner. No person except the spouse or

common-law partner may receive or otherwise obtain the use of any of the income or capital of

the trust before the death of such spouse or common-law partner. It should be noted that not all

types of property which are eligible for a rollover to a spouse or common-law partner are eligible

for a rollover to a spousal trust. For example, a taxpayer's interest in RRSP's or RRIF's is

eligible for a rollover to a spouse or common-law partner, but is not eligible for a rollover to a

spousal trust.

3. Rollovers to Children

A deceased individual may pass limited types of property to his or her children on a rollover

basis. Under certain circumstances, a deceased individual may transfer, on a rollover basis,

unmatured RRSP's and RRIF's are available to financially-dependent children or

grandchildren.!0 A deceased individual can also pass "farm property" on a rollover basis to his

8 Subsection 248(1) - definition of"common-law partner".9 Subsection 70(6).10 Subsections 146(1) ~ definition of "refund of premiums", and 146(8.9) - RRSP's to a child or grandchild of theannuitant that was financially dependent on the annuitant for support; Subsection 146.3(6.11) and Paragraphs

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or her child, grandchild, great grandchild and/or to a person who, at any time before the person

attained the age of 19 years, was wholly dependent on the taxpayer for support and of whom the

taxpayer had, at that time, in law or in fact, the custody and control (hereinafter collectively

referred to as a "child" or "children"). I I Note also that a child for these purposes includes a child

whether born within or outside a marriage, the spouse or common-law partner of a child, a step­

child and an adopted child. 12 The "farm property" relevant for the purposes of the rollover

provisions of the Act consists of farm land and depreciable property of a prescribed class used in

the business of farming in Canada,13 as well as shares in the capital stock of family farm

corporations and partnership interests in family farm partnerships.14 Generally speaking, the

provisions of the Act dealing with intergenerational rollovers of farm property require that the

individual, spouse and/or children be involved in the business of farming with respect to the

"family farm" on an active and continuous basis. In order to maintain the status of a corporation

or partnership as a "family farm corporation" or "family farm partnership", the Act requires that

"all or substantially all" of the FMV of the property of that corporation or partnership be

attributable to property used by it principally in the course of carrying on the business of farming

in Canada in which the taxpayer, spouse or child is actively engaged on a regular and continuous

basis. IS The CCRA interprets the phrase "all or substantially all" to mean 90% or more. 16 If a

corporation or partnership owns too many passive-investment assets (such as cash or savings not

required in the business of farming), those assets could jeopardize the status of the corporation as

a "family farm corporation" or the partnership as a "family farm partnership" under the Act.

60(l)(iii) and (v)(B.l) - RRIF's to a child or grandchild of the annuitant that was financially dependent on theannuitant for support because of physical or mental infirmity.II Subsection 70(10) - definition of "child".12 Subsection 252(1).13 Subsection 70(9).14 Subsection 70(9.2).15 Subsection 70(10) - definitions of "interest in a family farm partnership" and "share of the capital stock of afamily farm corporation".16 See Interpretation Bulletin IT-268R4 - Intervivos transfer of farm property to child (dated April 15, 1996),paragraph 19. Some court decisions have not accepted, in the context of other provisions of the Act and the ExciseTax Act, R.S.C., 1985, c. E-15, as amended (hereinafter the "ETA") that include the phrase "all or substantially all",that the phrase "all or substantially all" necessarily requires a mathematical determination of "90% or more"; rather,a lesser percentage (e.g. 80%) may satisfy this test. See, for example, WoodY. R., [1987] 1 e.T.e. 2391 (T.e.e.);Ruhl v. R., [1998] G.S.T.e. 4 (T.e.e.); Noseworthy v. R., [1996] 2 e.T.e. 2006 (T.e.e.); McKay v. R., [2000]G.S.T.e. 93 (T.e.e.); Eberle v. R., [2001] 1 e.T.e. 2598 (T.C.C.).

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B. PROBATE LEVIES

Probate fees are assessed by the Province of Saskatchewan under Subsection 51 (2) of The

Administration ofEstates Act!7 at the rate of $7.00 for each $1,000.00 (or fraction thereof) of the

sworn "value of the estate". For the purposes of this legislation, Section 8 of The Administration

of Estates Regulations provides that the "value of an estate" is the value of all real and personal

property of a deceased person at the time of death provided that:

• In calculating the value of the deceased person's property, there shall be a deduction

for the amount of any indebtedness at the date of death on any loan, mortgage or

agreement for sale relating to any real property in excess of insurance payable to

discharge such indebtedness; and

• The following assets are not considered property of the deceased person in calculating

the value of an estate:

• real property held jointly by the deceased person and another person;

• insurance payable to a named beneficiary;

• Canada Pension Plan payments to a surviving spouse or child;

• pensions and annuities payable to a spouse, child or any other named beneficiary;

• joint deposit accounts;

17 S.S. 1998, c. A-4.1. Up until a few years ago, probate fees were levied under the Queen's Bench Rules of Court.In Re Eurig Estate, [1998] 2 S.C.R. 565 (S.C.C.), the executor of an estate in Ontario challenged theconstitutionality and legality of the probate fee regime in that province. On October 22, 1998, the Supreme Court ofCanada held that Ontario's probate fees were unconstitutional. A majority of the Court concluded that probate feeswere a tax, as opposed to a fee. The tax was held not to be validly levied by the province because it was imposed byregulation and not properly authorized by the legislature. Although the Supreme Court of Canada concluded thatprobate fees in their existing form were illegal, it suspended the declaration of invalidity for six months to allow theprovince of Ontario (and other provinces) to amend their legislation or find an alternative means of replacing therevenue base. In Ontario, the government introduced The Estate Administration Tax Act, S.O. 1998, c. 34. That Actreceived Royal Assent on December 18, 1998 and retroactively established probate fees as taxes. The response of

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• personal property outside Saskatchewan, if the deceased person was domiciled

outside Saskatchewan on the date of death; and

• real property outside Saskatchewan.

In the author's experience, clients are often very interested in taking steps to avoid probate fee

levies. As outlined later in this paper, steps take to reduce probate fees can sometimes have

unintended, and unpleasant, consequences to a deceased's heirs.

C. GOODS AND SERVICES TAX

1. Effect of the Individual's Death

When an individual dies, the passing of his or her property to the executor or administrator of the

estate and vesting of that property in such legal representative does not result in goods and

services tax. The reason for this is that the estate of the individual is treated as though it were the

individual himself or herself. ls For all intends and purposes, the executor or administrator of the

estate of the deceased operates, for GST purposes, as the deceased and continues with the same

GST registration number and the same GST status as the deceased. A new reporting period is

deemed to start on the day the individual dies.

Subsection 267.1 of the ETA requires the estate to satisfy every obligation otherwise imposed

upon the estate under the ETA. Those obligations would include the obligation to pay GST as a

registrant, the obligation to collect GST on taxable supplies made by the estate and the obligation

to file GST returns. The executors, if there are more than one, are jointly and severally liable

with the estate for all GST obligations of the estate. The GST obligations of the estate include

amounts that became payable or remittable prior to the person becoming an executor, except that

the executor is liable for GST that became payable or remittable before he or she became an

the Saskatchewan legislature was also swift with a legislative amendment being passed to what ultimately becameThe Administration ofEstates Act (Saskatchewan).18 ETA, Section 267.

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executor only to the extent of the property and money of the estate under the control of the

executor.19

2. Distribution of Estate Property

Section 269 of the ETA deems property distributed by an estate to be a "supply". It will not be a

"taxable supply" (and therefore will not be subject to GST) unless the supply is made in the

course of a commercial activity or is a supply of property used in the course of a commercial

activity. Consider the GST implications with respect to distributions of the following different

types ofproperties:

• Cash: The definition of "property" for GST purposes does not include money.20

Thus, distributions of money from an estate would not be subject to GST.

• Exempt Property: A distribution of "exempt property", such as shares of

corporations21 or residential real estate22, will not be subject to GST.

• Commercial Real Property: A distribution from the estate of commercial real

property (i.e., property that is not exempt from GST under the ETA, Schedule V, Part

I) could be subject to GST. An example of this can frequently be seen in

Saskatchewan in an estate that owns farmland and proceeds to distribute that

farmland to a beneficiary. Under these circumstances, the estate must collect GST

from the beneficiary on the transfer of the farmland, unless the beneficiary is a

registrant for GST purposes?3 If the beneficiary is a GST registrant, the estate is

relieved of the obligation, with respect to the transfer of the farmland, to collect GST

19 ETA, Subsections 267.1(2) and (3).20 ETA, Subsection 123(1) - definition of "property".21 ETA, Schedule V, Part VII exempts "financial services" from the GST. The definition of "financial service" inSubsection 123(1) includes the transfer of ownership of a "financial instrument". A "financial instrument" includesan "equity security", both tenns being defined in Subsection 123(1), which means a share of the capital stock of acorporation or any interest in or right to such a share.22 ETA, Schedule V, Part I.23 ETA, Paragraph 221(2)(b). Also see Technical Interpretations 6G0019 - Transfer of fannland and residentialestate property to beneficiaries of estate (dated June 22, 1995), and 111950-1 and CN132 - Distribution of RealProperty from Estate to Beneficiary (dated July 18, 1995).

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from the beneficiary; rather the beneficiary who receives the farmland from the estate

is required to self-assess the GST?4

• Business Assets: A GST rollover of business assets is also possible where (i)

immediately before death, the individual held property for consumption, use or

supply in the course of a business carried on immediately before the individual's

death; (ii) the estate of the deceased individual makes a supply, in accordance with

the individual's Will or laws relating to succession of property on death, of the

property to an individual who is a beneficiary of the estate and a GST registrant; (iii)

the property is received for consumption, use or supply in the course of commercial

activities of the beneficiary; and (iv) the estate and the beneficiary jointly elect not to

have GST payable in respect of the supply.25

A distribution of property from the estate to a beneficiary is deemed to be made for

consideration, for GST purposes, equal to the amount determined under the Income Tax Act

(Canada) to be the proceeds of disposition of the property?6 In most circumstances, a

distribution of property by the estate will take place, for income tax purposes (and therefore for

GST purposes), for proceeds of disposition equal to the estate's tax cost of that property.27

III. SELECTED TAX ISSUES

A. AVOIDING PROBATE LEVIES - SOME PITFALLS

Lawyers often give clients advice on simple steps that may be taken to avoid probate levies. For

example, the value of real property or deposit accounts held in joint tenancy by the deceased

individual at the time of death will typically not be subject to probate levies in Saskatchewan.

Furthermore, the value of an RRSP, RRIF or pension plan which has a designated beneficiary

will not typically be subject to probate levies. The designation of a beneficiary in these types of

financial instruments may avoid probate levies. However, as the following examples

24 ETA, Subsection 228(4).25 ETA, Subsection 167(2).26 ETA, Section 269.27 ITA, Subsection 107(2).

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demonstrate, this type of estate planning can also lead to significant problems for the estate and

the deceased's beneficiaries.

1. Taxpayer Dies Owning an RRSP - Who Pays the Income Tax?

Where an individual dies owning an unmatured RRSP, the individual is deemed to have received

the FMV of the property in such RRSP immediately before his or her death.28 Under certain

circumstances, rollover provisions exist which will allow a deferral of the recognition of the

income from the RRSP upon the individual's death. In order to achieve this deferral (or

rollover), typically the RRSP must be left to the deceased's spouse or common-law partner, or to

"financially-dependent children or grandchildren".29

Consider a situation where you are the lawyer for Robert Johnson and Shirley Johnson. Mr. and

Mrs. Johnson are husband and wife. This is a second marriage for both of them. Fifteen years

ago, when they were first married to one another, they entered into an interspousal contract with

each other. At that time, Robert Johnson and Shirley Johnson were each independently

represented and advised on that contract by lawyers who are not associated with you or your

office. Under the terms of the interspousal contract, property owned by each of Mr. and Mrs.

Johnson, whether owned at the time the contract was entered into or subsequently acquired,

could be disposed of by either of them during their lifetime or upon their deaths, in whatever

manner they choose. Notwithstanding the terms of the written interspousal contract, Mr.

Johnson had always verbally indicated to his wife that he would leave her the house that they

live in.

You have acted as the lawyer for Robert and Shirley Johnson for approximately five years. They

have come to see you about their estate planning. The house is registered solely in Mr.

Johnson's name. True to his word, he instructs you, as his lawyer, to prepare his Will with a

clause leaving all of his right, title and interest to and in the house to his wife, Shirley Johnson.

The house is worth $300,000.00. Mr. Johnson's only other significant asset is his RRSP which

has a FMV of $700,000.00. Mr. Johnson has decided to leave his RRSP to his son, Terry

28 Subsection 146(8.8).29 Subsections 146(8.8) and (8.9).

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Johnson. In order to avoid probate levies, Mr. Johnson designates in his son as the beneficiary of

his RRSP. Mr. Johnson's son is 30 years of age and is not considered a "financially dependent

child" for the purposes of any ofthe rollover provisions under the Act respecting RRSP's.

Shortly after Mr. Johnson's death, the financial institution which had issued the RRSP to Mr.

Johnson transfers the property within the RRSP to Mr. Johnson's son. That property is not part

of the estate. Withholding taxes, to the extent taken by the financial institution are remitted to

the government; the withholding taxes are insufficient to cover the entire tax liability of Mr.

Johnson's estate in respect of the RRSP. The only asset in Mr. Johnson's estate is the house

worth $300,000.00. When the "terminal" income tax return is prepared for Robert Johnson, the

entire $700,000.00 FMV of the RRSP is included in income. The income tax liability resulting

from the RRSP income inclusion is an estate liability. The only asset that can satisfy that

liability is the house, which must now be sold by the executor.

Needless to say, Mrs. Johnson is extremely unhappy. She is threatening litigation against you.

You acted as the lawyer for both Mr. and Mrs. Johnson in devising the estate plan; you have a

duty of care to both persons. By failing to realize the income tax consequences of the estate plan

described above and warning your clients of those consequences, you are arguably exposing

yourselfto liability to Mrs. Johnson.30

2. Estate Property and Loss Carrybacks

Under certain circumstances, the rules under the Act permit some income tax losses, incurred in

the first taxation year of the estate, to be carried back and deducted against income in the

deceased taxpayer's terminal income tax return. Assume that your client dies owning an RRSP,

and no tax rollover is available. Assume further that the value of the investments and property

that had been in the RRSP fall substantially in the first taxation year following the taxpayer's

death. The property that had previously been in the deceased's RRSP is received by the executor

or administrator of the deceased taxpayer's estate (assuming that there is no designated

30 See 285614 Alberta Ltd. and Kathleen Maplesden v. Burnet, Duckworth & Palmer [1993] 4 W.W.R. 374 (Alta.Q.B.), where a solicitor was held liable with respect to advice given in structuring a shareholder's loan for thepurchase of a home, with a resulting income tax liability, without advising the plaintiff of the risk of income taximplications.

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beneficiary separate and apart from the estate). The executor or administrator of the estate now

owns this property, which could consist of investments such as bonds, stocks in companies and

mutual funds. Usually, these types of property are treated as "capital property,,3) for income tax

purposes.

Under Subsection 164(6) of the Act, where in the course of administering the estate of a

deceased taxpayer, the taxpayer's legal representative has, within the first taxation year of the

estate, disposed of capital property of the estate with a resulting capital loss (in excess of any

capital gains from the disposition of estate property), the legal representative may elect that such

capital losses are deemed to be capital losses of the deceased taxpayer from the disposition of

properties by the taxpayer in his or her last taxation year. The net capital losses incurred by the

estate in its first taxation year can be carried back and used in the deceased's terminal income tax

return as a deduction against taxable capital gains reported in that year; any excess net capital

losses may thereafter be deducted against other income of the deceased in the year of death

(albeit only to the extent that such losses exceed the capital gains exemption claimed by the

d d · . ) 32ecease III prevIOUS years .

To illustrate the potential implications of these rules, assume an individual dies with an RRSP

having a value of $100,000.00 immediately before the individual's death. The sum of

$100,000.00 (in the absence of any rollover rules) must be included in the terminal income tax

return of the deceased individual. Following the individual's death, the property of the RRSP is

distributed to his or her estate. Assume the sole property in the RRSP consisted of shares of a

publicly-traded technology company. Within the first year of the taxpayer's death, the

technology company becomes insolvent and the shares are worthless. The estate disposes of the

shares in its first taxation year and incurs a capital loss of$100,000.00. The tax results, using the

above-noted provisions of the Act, that are ultimately reflected in the terminal income tax return

of the deceased are as follows:

31 See Section 54 - Definition of "capital property".32 See Subsection 111(2). Also see Technical Interpretation 9322965 - Executor's year - loss carryback to year ofdeath return (dated November 30, 1993).

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Income in terminal income tax return(FMV of RRSP)

Net capital loss (~of$100,000) carried back from estate toterminal income tax return [Subsection 164(6)]

Net income inclusion to estate in respectofRRSP

$ 100,000.00

$ (50,000.00)

$ 50,000.00

These rules require a disposition of "estate property". If the RRSP is not estate property, no

capital loss may be carried back to the deceased's terminal income tax return. Thus, where the

designated beneficiary under the RRSP is someone other than the estate (eg., the deceased's

child), then arguably the loss carryback rules under Subsection 164(6) are unavailable.33

B. RE-WRITING THE WILL

Sometimes, following an individual's death, his or her surviving spouse, children or other family

members take the position that they were not adequately provided for in the Will or other

testamentary dispositions. This can lead to disputes and litigation. The resolution of those

disputes typically involve dispositions of property. Those dispositions frequently have income

tax consequences.

Where the estate property consists of significant amounts of cash, guaranteed investment

certificates and similar debt instruments, the resolution of estate disputes can usually take place

with minimal adverse tax consequences. Generally speaking, the transfer or payment of money

(unless it is held in a foreign currency) does not give rise to "deemed dispositions" of property.

Having said that, depending upon what the money is being paid for (eg., the receipt of services or

the transfer of other property), income tax consequences can result. For the most part, a payment

of money in satisfaction of a claim under The Family Property Act34 or The Dependants' Relief

33 See, for example, Technical Interpretation 2001-0093137 - Beneficiary's Losses or Estate's Losses (datedDecember 21,2001) where the significance of the loss being incurred by the estate, rather than by a beneficiary, isdiscussed.34 S.S. 1997, c. F-6.3, as amended.

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Act, 199635 would not normally result in a taxable transaction to either the deceased taxpayer's

. estate (typically the person paying the money) or the recipient.

Tax complications can arise in circumstances where the property being transferred is something

other than cash, and the taxpayer's Will or a trust constituted thereby is being varied either by

way of agreement or court Order. One of the challenges for the tax advisor in these

circumstances is to persuade the parties to the dispute to resolve the dispute in a manner that

results in the least adverse way from a tax perspective.

1. Varying Testamentary Gifts

As noted earlier in this paper, the general rule is that when an individual dies, all of his or her

property is deemed to have been disposed of for proceeds of disposition equal to the FMV

thereof immediately before death. Where the deceased taxpayer's property is left to a surviving

spouse or common-law partner (or, with respect to limited types of property, to a child), and the

property vests indefeasibly in that surviving beneficiary within 36 months of the deceased

taxpayer's death, a tax rollover is frequently available. In order for these rollover rules to apply,

there must be a property transfer to the beneficiary "on or after the taxpayer's death and as a

consequence thereof'. It is important to understand when that occurs for the purposes of the Act.

(a) Disclaimers, Releases and Surrenders

Subsection 248(8) of the Act contemplates a transfer, distribution or acquisition of property as a

consequence of the death of the taxpayer under the following circumstances:

• Under the Will or other testamentary instrument of the taxpayer;

• As a result of the laws of intestacy; or

35 S.S. 1996, c. D-25.01, as amended.

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• As a result of a "disclaimer" or a "release or surrender" by a person who is a

beneficiary under the Will or other testamentary instrument, or under the laws of

intestacy.

For the purposes of the Act, a "disclaimer,,36 includes a renunciation of a succession that is not

made in favour of any person, but does not include any disclaimer made after a period ending 36

months after the death of the taxpayer unless written application therefor has been made to the

Minister by the taxpayer's legal representative within that period and the disclaimer is made

within such longer period as the Minister considers reasonable in the circumstances. A "release

or surrender,,3? means a release or surrender made under the laws of the province that does not

direct in any manner who is entitled to benefit therefrom. Once again, the release or surrender

must have been made within 36 months after the death of the taxpayer or, where written

application therefor has been made to the Minister by the taxpayer's legal representative within

that period, within such longer period as the Minister considers reasonable in the circumstances.

At law, a "disclaimer" typically operates by way of avoidance of the gift; it is an act by which a

person refuses to accept a gift of property.38 It is not entirely clear what is meant at law by the

phrase "release or surrender". This expression was added to the Act in 1985, apparently as a

substitute for what was previously referred to as a renunciation. A renunciation is different from

a disclaimer, and typically contemplates an abandonment of property for no consideration and

without any direction or transfer of that property to another person.39

For income tax purposes, a "release or surrender" does not result in a disposition of property by

the beneficiary.4o It is not as clear, as a matter of law, that a "disclaimer" does not result in a

disposition under the Act. Generally speaking, however, it appears that the CCRA's

36 Subsection 248(9).37 Subsection 248(9).38 Biderman v. R. [2000] 2 C.T.C. 35 (F.C.A.).39 Generally see M. Cullity and C. Brown, Taxation and Estate Planning, 3rd ed. (Scarborough, Ontario: Carswell,1992),439-443.40 Paragraph 248(8)(c).

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administrative position is that a "disclaimer" does not result in a disposition for income tax

purposes.41

In order to illustrate how these rules might work to the advantage of an estate and/or its

beneficiaries, consider a situation where Mr. Anderson dies owning two assets, his house (a

principal residence for income tax purposes) and common shares in a privately-held operating

company ("Opco"). The shares have a FMV of $1,000,000.00 and a nominal adjusted cost base

("ACB"). Under the terms of his Will, Mr. Anderson bequests his shares in Opco to his son,

Alfred Anderson, with the residue of his estate to be transferred and distributed to his spouse,

Mary Anderson. As a consequence of Mr. Anderson's death, there is a capital gain of

$1,000,000.00 in respect of the Opco shares; $500,000.00 of that capital gain can be sheltered

from income tax using the capital gains exemption.42

Mary Anderson is of the opinion that adequate provision has not been made for her by her

husband. She wants one half of her husband's shares in Opco. One way to accomplish this is as

follows:

• Alfred shall execute a disclaimer as it relates to one half of the Opco shares. The

disclaimer constitutes an outright refusal to accept those shares. There will be no

stipulation in the deed of disclaimer as to how the executor should distribute the

disclaimed property.

• The disclaimed property should, by operation of law, now be dealt with under the

"residue" clause of Mr. Anderson's Will. By virtue of that clause, the shares will

now be transferred to the surviving widow, Mary Anderson. Under Paragraph

248(8)(b) of the Act, a transfer of the shares as a consequence of the disclaimer is

considered to be a transfer of property as a consequence of Mr. Anderson's death.

These Opco shares can now be transferred to Mary Anderson on a tax rollover basis

under Subsection 70(6) of the Act.

41 See, for example, Technical Interpretation 2000-0059795 - Testamentary trust variation (dated November 8,2001); Ruling 2000-0059963 - Disclaimer of capital interest (2001).42 Section 110.6.

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(b) Dependants' Relief Legislation

One issue that has not been satisfactorily resolved by the Courts is whether a distribution of

property made pursuant to an Order under The Dependants' Relief Act, 1996 constitutes a

transfer or distribution of property made as a consequence of death. Subsection 248(9.1)

contemplates that a trust (which could include a spousal trust under Subsection 70(6) of the Act)

is considered to be created by a taxpayer's Will if the trust is created under the terms of the Will

or by an Order of a court in relation to the taxpayer's estate made under any law of a province

that provides for the relief or support of dependants. Separate and apart from using dependants'

relief legislation to create trusts that may be eligible for the tax rollover rules, however, the Act

appears to be silent about the use of court orders under dependants' relief legislation to qualify

property transfers for other rollover provisions.43 Notwithstanding the absence of specific tax

rules in this regard, however, the courts appear to hold the view that a transfer of property under

dependants' relief legislation does constitute a transfer as a consequence of death.44

Administratively, the CCRA takes the position with respect to RRSP's that payments made to

the surviving spouse of a deceased taxpayer can qualify for a tax rollover where a spouse

becomes entitled to receive the deceased's entire estate or the estate's interest in an RRSP as a

result of a court Order in relation to the estate made pursuant to any law of a province providing

for the relief or support of dependants.45

(c) Matrimonial Property Legislation

For many years, it was not clear whether a transfer "matrimonial property" from a deceased

person's estate to the surviving spouse resulted in a transfer of property "as a consequence" of

43 Subsection 248(23.1) may be broad to encompass a transfer of property "as a consequence of death" where thattransfer of property is made after the death of a taxpayer in favour of the spouse or common-law partner of thattaxpayer under dependants' relief legislation and/or matrimonial property legislation. However, this provision of theAct does not contemplate transfers of property under dependants' relieflegislation (or otherwise) to a person who isnot a spouse or common-law partner of the deceased taxpayer. Subsection 248(23.1) would not, for example, applywith respect to property transfers in favour of children ofthe deceased taxpayer.44 Hillis v. R., [1983] C.T.C. 348 (F.C.A.); Boger Estate v. R., [1993] 2 C.T.C. 81 (F.C.A.).45 Interpretation Bulletin IT-50OR: Registered retirement savings plans - death of an annuitant (dated December 18,1996), at para. 8.

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the deceased taxpayer's death. Any doubt in this area appears to have been removed for deaths

after December 21, 1992 as a result of the introduction into the Act of Subsection 248(23.1).46

2. Varying and/or Winding Up Testamentary Trusts

A testator may provide for a trust under the terms of his or her Will or other testamentary

instrument. Dissatisfied beneficiaries may dispute the terms of the Will or other testamentary

instrument(s) with the result that the testamentary trust is either varied or wound up. In order to

understand the income tax consequences of a variation or wind up of a trust, it is important to

understand the different types of "interests" in trusts that are recognized for income tax purposes,

namely "income interests" and "capital interests".

(a) "Income Interests" and "Capital Interests" in Trusts

Subsection 108(1) defines an "income interest" and a "capital interest" of a taxpayer in a trust:

"income interest" of a taxpayer in a trust means a right (whether immediate orfuture or whether absolute or contingent) of a taxpayer as a beneficiary under apersonal trust to, or to receive, all or any part of the income of the trust. ..

"capital interest" of a taxpayer in a trust means all rights of the taxpayer as abeneficiary under the trust ... , but does not include an income interest in the trust;

The income tax consequences that result from a disposition of income interests in trusts differ

materially from those arising out of dispositions of capital interests in trusts.

(b) Disposing of Income Interests in Trusts

An income interest in a trust is not capital property. All proceeds of disposition arising from the

disposition an income interest in a trust are included as ordinary income in calculating a

taxpayer's income for the year. No taxable capital gain or allowable capital loss will arise from

46 For deaths arising on or before December 21, 1992, while the situation was not clear, note the decision of the Tax. Court of Canada in May Estate v. R., [1989] 2 C.T.C. 2305 (T.C.C.), where Revenue Canada conceded that atransfer of property to a surviving widow under the terms of The Matrimonial Property Act (Saskatchewan) satisfiedthe rollover provisions of Subsection 70(6) of the Act.

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the disposition of an income interest in the truSt.47 It should be noted, however, that if an income

interest in a trust is disposed of by a beneficiary to the trust, and property of the trust is

distributed to a beneficiary in satisfaction of all or any part of that taxpayer's income interest in

the trust, the beneficiary will have no income arising from that transaction. The receipt by the

beneficiary of the trust property is a tax-free receipt to the income beneficiary.48 Note that while

the receipt of the trust property is tax-free to the income beneficiary in these circumstances, the

trust is deemed to have disposed of the property so distributed to the income beneficiary for

proceeds of disposition equal to the FMV of that property.49 However, if the trust is distributing

cash in satisfaction of the income interest, there will be no gain or loss to the trust.

(c) Disposing of Capital Interests in Trusts

Usually, property within a trust may be distributed to beneficiaries in satisfaction of their capital

interests in the trust on a tax rollover basis5o. Notwithstanding this rule, the trust may elect out of

the rollover rules in certain circumstances.51 Where the rollover provisions are used, the trust is

deemed to have disposed of its property for proceeds of disposition equal to the "cost amount" of

that property to the trust.52 Usually, the beneficiary is deemed to have acquired the trust property

at a cost amount equal to the trust's tax cost of such property.53

A beneficiary who "disposes" of an interest in an estate in satisfaction of a distribution from the

estate, or otherwise, does not have to be concerned with GST being exigible in respect of the

disposition of the interest in the estate or trust. The reason for this is that the disposition of an

interest in an estate or trust is considered to be an "exempt supply" for GST purposes.54

47 Subsection 106(2).48 Paragraph 106(2)(a) and Subsection 106(3). Also see Interpretation Bulletin IT-385R2 - Disposition of an incomeinterest in a trust (dated May 17, 1991).49 Subsection 106(3).50 Subsection 107(2).51 Subsection 107(2.001).52 Paragraph 107(2)(a).53 Paragraph 107(2)(b).54 ETA, Schedule V, Part VII, exempts "financial services" from the GST. The definition of "financial service" inETA, Subsection 123(1) includes the transfer of ownership of a "financial instrument". A "financial instrument", atpara. (d) of that definition in ETA, Subsection 123(1), includes an interest in a trust or the estate of a deceasedindividual, or any right in respect of such an interest.

)(d) Varying a Testamentary Trust

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One of the primary duties of trustees is to preserve the trust property and carry out the terms of

the trust. Absent an express power in the deed of trust, trustees generally have no authority to

vary the terms of the trust, even if the trustees honestly and in good faith believe that such a

variation would be for the benefit of beneficiaries.55 Notwithstanding that the deed of trust may

not contain an express provision allowing the terms of the trust to be varied, a variation of the

trust terms can nevertheless proceed by way of application of the rule under Saunders v.

Vautier56, or alternatively by way of a court Order under The Variation ofTrusts Act5? The rule

in Saunders v. Vautier has been described as follows:

If there is only one beneficiary or if there are several (whether entitledconcurrently or successively) and they are all of one mind and he or they are notunder any disability, the specific performance of the trust may be arrested and thetrust modified or extinguished by him or them without reference to the wishes ofthe settlor or the trustees.58

If all of the beneficiaries of the trust cannot be ascertained, or all of the beneficiaries are not fully

capacitated, then the rule in Saunders v. Vautier is not applicable to the trust. This can happen,

for example, because of the existence of infant beneficiaries or the possibility of beneficiaries in

the future. Under these circumstances, it is necessary to apply to the court for approval under

The Variation of Trusts Act. Generally, approval of the court is forthcoming only if it can be

demonstrated that the variation or termination is for the benefit of those persons (i.e., infant or

contingent beneficiaries) on whose behalf the court is being asked to give approval. Typically, a

variation of a trust is achieved by an agreement among beneficiaries. Even where the variation

takes place by way of court Order, typically all capacitated beneficiaries have agreed upon the

variation, and the court is merely ruling on the propriety of the proposed variation from the

perspective of the infant or contingent beneficiaries.

55 D.W.M. Waters, Law ofTrusts in Canada, Second Ed. (Toronto: Carswell, 1984), 1055.56 (1841), Cr. & Ph. 240, 41 E.R. 482 (Ch.), affg. 4 Beav 115,49 E.R. 282 (S.C.).57 R.S.S. 1978, c. V-I.58 Maria Elena Hoffstein and Julie Y. Lee, "Restructuring the Will and the Testamentary Trust: Methods,Underlying Legal Principles and Tax Considerations" (1994) 13 Estates & Trusts Journal 42 - 99 at 70, citing DJ.Hayton, ed, Underhill's Law Relating to Trusts and Trustees, 11 th Ed. (London: Butterworths, 1959), Article 6.

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A variation of the terms of a trust raises a number of tax issues. Does the variation result in a

disposition of the beneficiary's income interest or capital interest in the trust? Is the variation so

fundamental that it results in the establishment of a new trust? There is little guidance available

that provides assistance in answering the questions. There are very few decided income tax

cases or published technical interpretations or advance income tax rulings issued by the CCRA.

A consent by a beneficiary to a variation of trust may give rise to a partial disposition of his or

her interest in the trust. However, it would appear that if a beneficiary, as part of the trust

variation, disclaims an interest in the trust, or releases or surrenders an interest in the trust for no

consideration and without any direction as to who is entitled to receive the benefits thereof, then

no adverse income tax consequences will result.59 Where a variation of trust takes place, the tax

consequences to the beneficiary may also differ depending upon whether the beneficiary's

interest is vested under the terms of a non-discretionary trust, or whether the beneficiary merely

has an interest in a discretionary trust. There is a significant risk that a variation of trust where

vested trust interests are replaced with discretionary trust interests could result in deemed

dispositions at FMV for income tax purposes. In at least one Canadian case, the court ruled that

circumstances such as these could give rise to the application of the attribution rules under the

Act.60 While some authors have suggested that a trust variation resulting in the disposition of a

discretionary interest in the trust should have no adverse consequence because such interest has

no appreciable or determinable FMV61, that conclusion may not be justified in light of some

recent court decisions (particularly in the area of family law) that have considered the nature and

possible value of contingent interests in trusts. To date, there is no clear legal consensus

regarding the approach to be taken in determining the value of contingent interests in trusts;

rather, courts have identified several different options:

• Determining that the value of the interest in the discretionary trust is nominal;

59 Interpretation Bulletin IT-385R2 - Disposition of an income interest in a trust (dated May 17, 1991), paragraphs 7- 9. The CCRA has also stated that the assessment positions set out in this Interpretation Bulletin as they relate toincome interests are also applicable to similar transactions taken in connection with capital interests in the trust. SeeTechnical Interpretation 9506285 - Release/surrender income and capital interests (dated July 7, 1995).60 Murphy v. R., [1980] C.T.C. 386 (F.C.T.D.).61. Hoffstein & Lee, supra note 58, at p. 97. Also see William Innes and Joel T. Cuperfain, "Variation of Trusts: AnAnalysis ofthe Effects of Variation of Trusts under the Provisions of the Income Tax Act" in (1995) Vol. 43, No.1C.T.J. 16-38.

21

• Determining that the value of the interest in the discretionary trust may be attributable

to a certain group of beneficiaries, such as children62;

• Determining that the entire value of the property in the family trust is attributable to

the husband and wife where most of the income of the trust or corporations owned by

the trust were distributed to the husband and/or wife each year63, or by determining

the value of the property held by the trust and arbitrarily allocating that value equally

among all capital beneficiaries of the trust as of a particular valuation date64•

(e) Winding Up a Testamentary Trust

If transactions are carried out correctly, it is possible to wind up a trust without adverse income

tax consequences. Consider, for example, a situation where a taxpayer, Mr. Baker, dies. The

terms of Mr. Baker's Will provide that his farmland is to be held in a trust for the use and benefit

of his widow, Mrs. Baker, during her lifetime. Upon Mrs. Baker's death, the farm property will

be distributed equally among Mr. Baker's children (all of whom are adults and Canadian

residents). The trust is a testamentary trust under Subsection 108(1) of the Act. It is also a

spousal trust to which Subsection 70(6) of the Act applied as a consequence of Mr. Baker's

death. The terms of the spousal trust provide not only that all net income from the property of

the trust is to be paid to the widow annually, but also that there is a right of encroachment of

capital in favour of the widow. If the widow and the children, all of whom are adults and are

competent, decide to terminate the trust prior to the widow's death, it would be possible to do so

without adverse tax consequences by proceeding as follows65:

• The children must sign a document releasing and surrendering their respective

interests in the trust for no consideration. The children should not "direct" how the

property of the trust should be distributed. In these circumstances, the children will

not be considered to have received any proceeds of disposition pursuant to Subsection

62 Kachur v. Kachur, [2000] A.J. No. 1180 (Alberta Q.B.).63 Taylor v. Taylor, [1996] B.C.J. No. 2213 (RC.S.C.).64 Sagl v. Sagl, [1997] OJ. No. 2837 (Ont. Court of Justice, General Division).65 This "premature" wind up of the trust will proceed in reliance upon the rule in Saunders v. Vautier, supra.

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107(1) of the Act. The ACB to the children of their respective interests in the trust,

immediately before they execute the release and surrender, is deemed nil pursuant to

Subsection 107(1.1) and Paragraph 107(1)(b) of the Act. Furthermore, Subsection

106(2) will not apply to the children.

• Immediately following the execution of the "release and surrender" by the children,

the sole beneficiary of the trust is the widow. The trust would transfer and distribute

the trust property (consisting of farmland) to the widow. The trust property can be

transferred on a "rollover" basis to the widow pursuant to Subsection 107(2) of the

Act. She will receive the farmland from the trust at the ACB of that farmland. The

transfer of the farmland to the widow is in full satisfaction of her interest in the trust.

The ACB to the widow of her interest in the trust, immediately before the disposition

of that interest, is deemed to be equal to the cost amount to the trust of the farmland

immediately before distribution.66 The widow is not considered to have received any

proceeds of disposition pursuant to Subsection 106(2), nor does Subsection 106(3) of

the Act apply to the trust.

A wind up of a testamentary trust following these steps has been approved in an advance income

tax ruling by the CCRA.67

When you are attempting to wind up a post-1971 spousal trust during the beneficiary spouse's

lifetime, care must be taken that the property of the trust is only transferred to the spouse. If the

trust property (whether it be capital property, resource property or land inventory) is transferred

to a beneficiary other than the spouse during that spouse's lifetime, the trust is deemed to have

disposed of such property and to have received FMV proceeds therefor, and the beneficiary is

deemed to have disposed of all or part of the beneficiary's capital interest for an amount equal to

those same proceeds, less any debt assumed.68 These restrictions, wherein the property of the

trust would otherwise have to be transferred to the spouse in order to obtain a rollover under the

66 Subsection 107(1.1), Paragraph 107(1)(a), and the definition of "cost amount" in Subsection 108(1).67 Ruling 9824473 - Wind up ofa trust (date: 1999).68 Subsection 107(4).

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Act, do not necessarily apply with respect to the wind up of other "personal trusts" which are not

post-1971 spousal trusts.69

C. CLEARANCE CERTIFICATES

Prior to distributing estate property to beneficiaries, executors and administrators should consider

the advisability of obtaining a clearance certificate under the Act and/or the ETA. Clearance

certificates will protect the executor or administrator from any claim made by the Canada

Customs and Revenue Agency for the deceased's or the estate's unpaid income taxes70 or unpaid

GST71• If estate property is distributed without a clearance certificate first having been obtained,

and it is later determined that there was a liability for income taxes or GST against the estate, the

executors could be liable for such taxes (at least up to the FMV of the property so distributed).

On occasion, clearance certificates are issued in error. While the executor or administrator may

not be held liable for taxes later discovered to be owing to the government if a clearance

certificate was properly obtained, the CCRA can still claim taxes against the estate itself (if

property is still held within the estate)72 or the beneficiaries73.

The liability of the executor or administrator under the Act or the ETA only arises to the extent

of the value of property under the "control" of the executor or administrator. What if title to a

deceased's property has not been transmitted to the executor or administrator following the

deceased's death because, for example, a beneficiary appropriates estate property without the

permission of the executors or administrators? Can it be said that the executor or administrator

ever had "control" over the property in these circumstances? I am aware of one estate situation

where an individual died owning several hundreds of thousands of dollars of guaranteed

investment certificates ("GIC's"). After obtaining Letters Probate, the executors took steps to

69 See, for example, Ruling 9402195 - Spouse release income interest in pre-1972 spousal trust (dated April 18,1994) which contemplated a wind up of a pre-1972 spousal trust in favour of beneficiaries other than the survivingspouse.70 Subsection 159(2).71 ETA, Section 270.72 Boger Estate v. R. [1991] 2 C.T.C. 168 at para. 47. The determination by the trial judge on this particular issuewas not appealed or commented upon when this case was heard by the Federal Court of Appeal (decision cited atnote 44).73 Bougie Estate v. R. [1990] 2 C.T.C. 239 (F.C.T.n.).

24

have title to the GIC's transmitted to them. All of the GIC's were part of the residue of the estate

which, under the terms of the Will, was ultimately to go to one particular beneficiary. Prior to

title to the GIC's being transmitted to the executors, the beneficiary convinced the financial

institution which had issued the GIC's to transfer title to the GIC's to the beneficiary. Some

years later, the CCRA discovered that a few hundred thousand dollars of investment income had

not been reported by the deceased during his lifetime or within the terminal income tax return of

the deceased. The CCRA is now threatening to issue reassessments and, if necessary, hold the

executors personally liable for the income taxes which had not otherwise been paid by the

deceased and his estate. One of the critical questions in this situation is whether the executors

ever had "control" over the GIC's. At the time of writing, this dispute with the CeRA is

unresolved.

IV. CONCLUSION

A tax "minefield" exists for lawyers who practice in the areas of estate planning, estate

administration, and estate and succession litigation. It is important to recognize that the tax

consequences of a particular action (e.g. designating a beneficiary of an RRSP, a RRIF or a

pension plan) could easily result in adverse results to the deceased person's estate and to the

beneficiaries thereof. After the death of an individual, court applications by disappointed

beneficiaries under dependants' relief or matrimonial property legislation may be used as a tool

to achieve a transfer or vesting of estate property in favour of those beneficiaries. Depending

upon the way in which those court applications are resolved, serious income tax consequences

could result. The property transferred under the court order or settlement may not qualify for a

tax rollover. Furthermore, when transactions occur (whether as a result of estate litigation or the

actions of beneficiaries) which result in a variation or wind-up of a trust, it is important to be

cognizant of the potential tax consequences. Where the lawyer is advising a client on a course of

action (whether at the stage of an estate plan or following the death of an individual) that mayor

will result in a disposition of property, that lawyer should ensure that the client obtains advice

regarding the tax consequences that could result. A failure to do so could potentially lead to an

unhappy client and a lawsuit against the lawyer.

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