Thursday, 20 February 2020

Passing Down the Farm



Farming is a fundamental part of our Canadian society and history. Entire generations of families have lived, thrived, and survived on the same land. However, farms today are increasingly large and complex operations. As such, various tools have been developed over the years to deal with one big question: How do I pass the farm down to the next generation when I retire?

This article will briefly discuss the options available for transferring farm property from parent to child while the parent is alive. 

Two major questions that a farming-parent should consider when transferring farm property to a child are: 1) When do I want the disposition to be effective? and 2) What are the tax implications on the disposition?

Transferring Farm Property to a Child

Generally, farmland values have skyrocketed over the last few decades. Land acquired decades prior by the parent has often doubled, tripled or more in value. This means, without proper planning, capital gains tax triggered upon the disposition can be significant.

The other issue is when should the disposition happen? There will be a deemed disposition on death, so the question really is whether you want to transfer the land upon death or sometime before death.

There are three options for transfer:
  1.  Fair market value disposition;
  2. Section 73 rollover; or
  3. a transfer to the child in bare trust.
 Fair market value disposition

A fair market value disposition occurs at, unsurprisingly, fair market value.  This triggers the full capital gains on the transfer. This means that the child who buys the land will then have an adjusted cost base (“ACB”) equal to the fair market value. 
However, the parent may be able to use his or her lifetime capital gains exemption (“LCGE”) to offset the capital gains tax. 
Farmers receive a $1,000,000 LCGE (compared to $883,384 (2020) for non-farmers) for dispositions on farm property (usually shares in farm corporation or farm land[1]).

For farm corporation shares, generally, throughout any 24-month period before disposition, more than 50% of the fair market value of the corporation’s property must be attributable to property that was used principally[2] in the course of carrying on a farming business in Canada in which the individual, his or her spouse or common-law partner, child, or parent (or beneficiary of a trust if the individual is a trust) was actively engaged on a regular and continuous basis.[3]

For farmland, if the land was acquired after June 18, 1987, the land must have been owned for any 24-month period before disposition by, generally, the individual, his or her spouse or common-law partner, child, parent (either owned directly or owned through a personal trust[4]). If the land was owned by a farm partnership, the partnership interests must be held by the individual or his or her spouse or common-law partner. We will refer to this person as the “Operator”. In addition to the 24-month ownership test, during any two-year period of ownership, the land must be used principally in a farming business, a farm corporation or a farm partnership carried on in Canada in which the Operator (or beneficiary, if Operator is a trust) was actively engaged on a regular and continuous basis. 

If the land was acquired before June 18, 1987, then there are two ways to qualify for the LCGE. The first option is if, in the year of the disposition, the land was used principally in the course of carrying on a farm business in Canada by the individual, his or her spouse or common-law partner, child or parent; or by a farm corporation, a farm partnership; or by a beneficiary of a personal trust[5] or by a personal trust in which the individual acquired the property. The second option is if the land was both owned and used principally by these same categories of persons or individuals in the course of carrying on a farming business in Canada in any 5-year period. 

It is important to confirm with a tax practitioner that your farm property qualifies for the LCGE before claiming it as the test is quite technical and may be complicated to apply in practice.

Section 73 rollover

A section 73 rollover is one in which the disposition of farm property is deemed pursuant to subsections 73(3) to (4.1) of the Income Tax Act to occur on a tax-deferred “rollover” basis. This means the land and farm property may be transferred at the ACB so the child inherits the same ACB that the parent had. There are no capital gains triggered on this disposition.[6]
 
In order to qualify for the tax-rollover under subsection 73(4) and 73(4.1) (farm corporation and partnership shares):

  •  the child was a resident in Canada immediately before the transfer; and
  •  the property was, immediately before the transfer, a share of the capital stock of a family farm or fishing corporation of the taxpayer or an interest in a family farm or fishing partnership of the taxpayer (as defined in subsection 70(10)).
 In order to qualify for the tax-rollover under section 73(3) and (3.1) (farmland):
  • the property was, before the transfer, land in Canada or depreciable property in Canada of a prescribed class, of the taxpayer;
  • the child of the taxpayer was a resident in Canada immediately before the transfer; and
  • the property has been used principally in a farming or fishing business in which the taxpayer, the taxpayer's spouse or common-law partner, a child of the taxpayer or a parent of the taxpayer was actively engaged on a regular and continuous basis

Again, these seemingly straightforward requirements can be complicated in practice, so we recommend you confirm with a tax practitioner that the transfer will qualify if you intend to rely on the provision.

Transfer to the child in bare trust

The last option is for the parent to place the farm property in joint names with him or herself and the child. However, the child is a bare trustee, meaning that he or she has no beneficial ownership in the land until the parent(s) die. The parent(s), while alive, have all the control, pay the expenses, and reap all the benefits of the land. The disposition does not actually happen until the parent(s) die. 
At that point, provided the property qualifies, it is still possible to take advantage of the LCGE or do a tax-deferred rollover to the child.  

Other Considerations

When it comes to farms, there are many tools available to meet the unique challenges that farmers face. However, it is important to not let tax considerations lead your estate planning.  Farms are some of the most common types of property fought over in estate litigation, a process that not only wastes significant amounts of money, but also tears families apart. 
It is more important that your estate plan related to the family farm suits your family, not simply that it saves the most tax.

If you would like to discuss what options are available for your specific situation, we would be happy to meet with you. Please please contact any member of our Wills and Estates or Tax practice groups.


[1] May also dispose of farm partnership interests, which is not discussed in this article.
[2] “Principally” means more than 50%.
[3] LCGE can also be used for farm partnerships and qualified small business corporations. However, for simplicity, we only briefly touch on some LCGE areas, such as farm corporations and farmland.
[4] If the land is in a personal trust or was from a personal trust, the ownership test applies to, generally, the same categories of persons (except if the land was from a personal trust, the ownership test cannot apply to the recipient individual’s spouse).
[5] As described subparagraph (a)(ii) of the definition of “qualified farm or fishing property” in subsection 110.6(1). The beneficiary or his or her spouse, common-law partner, child or parent.
[6] Note, you can elect to transfer at an amount above ACB as well.

Thursday, 16 January 2020

Tax Obligations of an Estate and Executor

by Michelle Fong

In a recent Alberta case (Muth Estate, 2019 ABQB 922), the Court found that an Executor could not legally require beneficiaries to indemnify the Executor for the payment of taxes owed by the Estate.

The deceased died in 2008. His ex-wife (Ms. Muth) and a set of nieces and nephews first went to Court to determine how the Estate should be administered and distributed. They ultimately reached a mediated settlement in 2011 where it was agreed that Ms. Muth would apply for probate as the Executor and the Estate would be divided 55% to Ms. Muth and 45% to the nieces and nephews. Ms. Muth’s first accountant advised her to holdback $25,000 for taxes. She did so and distributed the balance of the Estate in accordance with the settlement. This first accountant did not file the required tax return. A second accountant was retained and advised that the holdback was insufficient. Ms. Muth paid the difference as well as other related expenses. She then sought indemnity from the nieces and nephews for 45% of these amounts. The Court ultimately found that she, as the Executor, was not entitled to be indemnified by the beneficiaries because her failure to obtain a final Clearance Certificate prior to distributing the property meant that she was personally liable for the taxes and related expenses.

This case serves as a good reminder that Executors can be found personally liable for unpaid taxes, interest and penalties of an Estate if he or she distributes the property of the Estate before obtaining a final Clearance Certificate. 

Applying for a Clearance Certificate


An Executor may apply to the Canada Revenue Agency (CRA) for a final Clearance Certificate. The final Clearance Certificate confirms that all of the taxes, interest and penalties owed by the Estate have been paid. Section 159(2) of the Income Tax Act requires an Executor (legal representative of the Estate) to obtain a final Clearance Certificate and section 159(3) holds the Executor personally liable for taxes, interest and penalties owed by the Estate if he or she distributes property prior to obtaining such certificate.
Prior to applying for a final Clearance Certificate, the Executor must[1],[2]: 
  1. File the final tax return;
  2. Receive the corresponding Notice of Assessment or Reassessment; and
  3. Pay all taxes, interest and penalties owed by the Estate based on the final tax return and/or Notice of Reassessment. 
Only after all of these steps have been completed can the Executor apply for a final Clearance Certificate. 
According to the CRA’s website, a final Clearance Certificate can take up to 120 days to obtain. However, in practice, the wait time can be up to a year or a year and a half.

When is a Clearance Certificate Not Needed?


First, a final Clearance Certificate is not needed if the Estate (or trust) continues to exist to pay income to beneficiaries. To be clear, there may be taxes owed, filing requirements and accounting obligations for the continuing Estate or trust, but the final Clearance Certificate is not required to pay income to beneficiaries from an ongoing trust.

Second, a final Clearance Certificate is not needed if there is no tax liability. But, there is no guarantee that there is no tax liability without a final Clearance Certificate confirming it. On the other hand, there can be circumstances where it is very likely there is no tax liability, such as an Estate with no capital property and no income (e.g. only asset is a non-interest-bearing cash account). In those circumstances, the Executor must balance the risks of not obtaining a final Clearance Certificate against the likelihood that no taxes, interest and penalties are owed.

Third, a final Clearance Certificate is not needed if there is a sufficient holdback for taxes, interest and penalties. However, as seen in Muth, there is a risk that the holdback will be insufficient. 

Conclusion


Overall, an Executor of an Estate should ensure that all obligations owed to the CRA by the Estate (and all other liabilities) are satisfied prior to distributing the property of the Estate. A final Clearance Certificate is a confirmation of satisfaction. Failure to obtain a final Clearance Certificate exposes the Executor to personal liability if the property of the Estate has already been distributed.

The process to apply and obtain a final Clearance Certificate can be quite lengthy (i.e. prepare and file tax return, prepare application for certificate, wait for certificate, etc.). Therefore, it is recommended that the Executor communicate the lengthy process to the beneficiaries so that they understand why it may take a year or more before they receive their distributions. Navigating through the process of administering an Estate can be confusing, especially when taxes are involved. As such, it is also recommended that the Executor consider if or when a lawyer and/or an accountant conversant in estate matters should be brought in to provide assistance.

If you have further questions about the administration of an Estate or other tax issues, please contact any member of our Wills and Estates or Tax practice groups.

[1] Information Circular IC82-6R11 (Canada Revenue Agency, 2016) at para 11


[2] If the Estate creates a trust and the property is held in trust prior to distribution to beneficiaries, then there are additional steps that must be completed prior to applying for a Clearance Certificate. These additional steps are found at Information Circular IC82-6R11 (Canada Revenue Agency, 2016) paras 11 - 13

Wednesday, 11 September 2019

Proposed Changes to Foreign Affiliate Dumping Rules: Individuals, Trusts and Estates May Now Be Caught



The government is proposing changes to the Income Tax Act which could impact many Canadian corporations with foreign affiliates.

Of particular concern are situations where controlling interests in such corporations are owned by 
  1. individuals emigrating from Canada, or 
  2. trusts or estates where any beneficiaries may be, or may become, non-residents of Canada.
Anyone who thinks they could be caught should keep an eye out in the coming months to see what happens with these proposals. Depending on what changes are passed, some may wish to take steps to mitigate potential added tax costs.

Proposed changes to FAD rules


Since being introduced in 2012, the Income Tax Act’s Foreign Affiliate Dumping Rules (the “FAD” rules) were generally of little concern to most because of the rules limited applicability to circumstances with a non-resident parent corporation controls a corporation resident in Canada (a “CRIC”), which in turn invests in a foreign affiliate.

However, earlier this year, first in the federal budget in March and then in revised legislative proposals in July, the Department of Finance proposed changes to broaden the application of the FAD rules so they would not just apply to CRIC’s controlled by non-resident corporations, but also to cases where a CRIC is “controlled” by non-resident individuals, including through a trust or estates.

With respect to trusts and estates in particular, under the proposed FAD rules a trust or estate is assumed to be a corporation with a capital stock of 100 common shares (the “Contrived Shares”), and each beneficiary under the trust owns a portion of shares equal to their interest in the trust based on fair market value (“FMV”).

If the beneficiaries interest in the trust or estate is discretionary, then the FMV of each beneficiaries’ interest is deemed to be equal to 100% of the Contrived Shares unless the trust is

(i)                 a resident of Canada and
(ii)               “it cannot reasonably be considered that one of the main reasons for the discretionary power is to avoid or limit the application of” the FAD rule.

And no, it’s not entirely clear how one would prove that this second requirement has been met.

The proposed changes could cause the FAD rules to apply in several common situations, including, but not limited to, when:

  • an individual controlling a CRIC with a foreign affiliate emigrates for personal or business reasons (such as to grow the foreign subsidiary), becoming a non-resident;
  • a beneficiary of a discretionary family trust resident in Canada becomes a non-resident of Canada and the family trust controls a CRIC with a foreign affiliate; and
  • the death of an individual results in control of a CRIC with a foreign affiliate being left to an estate with non-resident executors or beneficiaries.

If passed, the proposed amendments would be effective retroactively to March 19, 2019, the date of the 2019 budget.

What to do if you think you, your estate or your trust might be caught


The question is what should you do if you think you, your estate or your trust might be caught by these proposed changes.

The tax consequences of having the FAD rules apply are quite severe – resulting in constructive upstream dividends subject to non-resident withholding tax. As a result, it is almost certainly in taxpayers best interests to avoid their application if possible.

Should taxpayers, therefore, be reorganizing corporations, amending trust deeds and revising wills?!

Well… maybe not yet. The changes have not yet been implemented, and it is not certain what form they will finally take.

Due to the complex nature of the FAD rules and the fact that the proposed changes of the rules are fraught with unintended implications and uncertainty, the Joint Committee on Taxation of the Canadian Bar Association and Chartered Professional Accountants of Canada issued a submission to the government on May 24, 2019 outlining issues with the proposed FAD rules and provided recommendations for amendments.

On July 30, 2019, the Department of Finance released new proposed legislation to implement the proposed changes and have invited comments by October 7, 2019.

The July 30, 2019 proposed legislation appears to have partially addressed at least one of the main concerns tax professionals had with the initial proposed legislation: the proposed legislation released with the budget would have automatically had all beneficiaries of a discretionary trust deemed to own 100% of the Contrived Shares where the new July 30, 2019 proposed legislation provides an exclusion for Canadian trusts where it cannot reasonably be considered that one of the main reasons for the discretionary power is to avoid or limit the application of the FAD rules. That being said, without further guidance from the CRA and the Courts, it is unclear how useful that exclusion will actually be.

In any event, it is uncertain exactly what form the proposed changes to FAD rules will actually take. As a result, it is difficult to determine what changes, if any, would be advisable with regards to corporate structure, wills and trust deeds at this time.

However, it is definitely worth considering if you, your estate or trust might be caught and, if you think it might be, keep your eyes open for future posts on this blog addressing this topic further once we have more information.

This update is a general overview of proposed changes to the FAD rules and cannot be regarded as legal advice. Please contact MaryAnne Loney or Moe Denny to discuss any of the above items, or any of your other tax needs.

Monday, 28 January 2019

What Do The New Tax On Split Income (“TOSI”) Rules Mean For Trusts?

By: MaryAnne Loney


A recent tax change that has gotten a lot of attention is the tax on split income, or “TOSI”. Through design or inadvertently, many trusts will be affected by these rules. Many family trusts were set up at least partially to split income to family members. Even when income splitting is not an express purpose of the trust, where a trust owns property that earns money from the work or investment of a person (“source individual”) who is related to a beneficiary, there is a risk TOSI may apply.

Things Trustees and their advisors should know about TOSI


1.      TOSI doesn’t just apply to dividends
While dividends have gotten the most press, TOSI may apply to any income from a “related business”.

A related business is any business, whether operated personally or through a partnership, corporation or trust, where a source individual at any time during the year was “actively engaged on a regular basis in the activities” or in which he or she had a qualifying interest (for a corporation this is 10% or more).  TOSI may apply to any dividends, shareholder benefits, capital gains, or interest derived from a related business.

This means trustees need to look carefully at any source of income and ensure it is not caught under the TOSI rules. I recommend starting with the assumption that TOSI applies to any income, unless you can find a reason why it should be excluded.
2.      Beneficiaries of trusts cannot own “excluded shares” through a trust
One of the main exclusions to the TOSI rules is if the recipient owns “excluded shares”. Shares are excluded shares when an individual owns at least 10% of the shares of a corporation which meet specific criteria. Income earned on excluded shares, or gains earned on disposing of excluded shares, are not caught by TOSI.

Unfortunately, even if a trust owns shares that would otherwise be excluded shares, income allocated through the trust to a beneficiary on those shares owned by the trust will not qualify as shares “owned by the specified individual”, (and therefore not “excluded shares”) since the beneficiary and not the trust would be the specified individual.

This is a significant disadvantage of owning what otherwise might qualify as excluded shares through a family trust. In some cases, it may make sense to distribute shares owned by a trust to a beneficiary so they do qualify as excluded shares for that particular beneficiary.
3.      Some exclusions from TOSI will still apply to allocations from trusts
There are, however, exclusions that will still apply to payments through a trust.

While capital gains from a related business are now generally caught by TOSI, capital gains that qualify for the capital gains exemption are specifically excluded, including for allocations from trusts.

A second exemption is that if the income derives from a business which is an “excluded business” for the beneficiary, then it will not be caught by TOSI.

A business will be an “excluded business” if the beneficiary was actively engaged on a regular, continuous and substantial basis in the activities of the business in either the taxation year or any prior five taxation years.

While “actively engaged” is not defined, if the beneficiary works at least an average of 20 hours per week in the business (while the business operates), the beneficiary will be deemed to be actively engaged.

Recent CRA publications and responses to questions at conferences have also suggested that passive investment income earned on the investment of income from a related business, is not itself necessarily income from that related business.

This suggests that, with the right structure, investment income earned on income itself caught by TOSI could be an excluded amount.

Conclusion 

The new TOSI rules will make things more complicated for trustees and their advisors when it comes to allocating income to beneficiaries. Existing trusts should be re-examined to determine whether they should be restructured or their operations changed. Potential settlors, trustees and their advisors will need to more carefully consider whether setting up a new trust is the best option.

However, trusts will continue to be used for non-tax reasons where it is advisable to separate legal and beneficial ownership and, depending on individual circumstances, trust will continue to make sense in certain tax plans.

Monday, 30 July 2018

The Value of Digital Assets and Why It Should Not Be Ignored in Estate Planning

Author: Marika Cherkawsky, Student-at-Law

Your house, children, jewelry and art, these are all the typical items a person will think about when planning their Estate.  However, what is often forgot about is a person’s digital assets. In a report on digital assets, Kimberly Whaley, defines digital assets as digital photos, word and excel documents, blogs, iTunes collection, tweets, or even Airmiles points. A report by Deloitte estimates that by 2020, the average Canadian will have accumulated over $10,000 in digital assets. Yet, BMO Wealth Institute finds over 57% of Canadians have failed to plan for their digital assets in their estate plans. With an increasing trend towards the digital way of life, it is key that one keeps their digital assets in mind when planning their Estate. This post attempts to demonstrate why digital assets are so important, and what steps can and should be taken to protect ones digital assets after death.
 
What is a Digital Asset and Why Should I Care
Whaley distinguishes between digital assets and digital accounts. As defined above, digital assets include any digital file a person owns. Similar to the physical and financial assets typically provided for in a Will, digital assets hold both sentimental and monetary value.   
Think about all of those photos stored on your computer or hard drive. Previously the boxes of physical photos could easily be found in the basement. But with digital photos, there needs to be clear instructions on how to find and access them if you wish to pass them on. What about your Facebook page? After death do you want your page shut down, or left up as a digital memorial site for your loved ones to visit?
On the monetary end of things, one simply has to think of Bitcoin, the first decentralized digital currency. Currently, the total value of Bitcoin supply in circulation is over $100 billion Without taking Bitcoin into consideration in estate planning, one could be simply throwing away real value. The same goes for loyalty programs such as Airmiles or cash back credit card accounts. 
Unlike digital assets, which are the digital files themselves, digital accounts are how one accesses those files. According to Whaley, digital accounts can be separated into three categories:

  1. accounts that contain virtual currency that could be transferred to your heirs and include a PayPal account, loyalty program accounts such as credit card accounts with cash back, and Bitcoin;
  2. accounts containing virtual property such as Kobo and iTunes accounts. For these accounts people only own a licence to use the digital files and therefore do not actually “own” them; and
  3. accounts containing information likely of personal or commercial interest such as personal email accounts, your Facebook page, Twitter, or LinkedIn.

When planning for your digital assets it is important to always take note of your digital accounts since without access to the digital accounts your digital assets may be subject to its provider’s terms of service. A further obstacle is most account providers will err on the side of caution when it comes to granting access to non-account holders out of fear of breaching Canadian privacy laws. What does this mean? Well, for example, without explicit instruction in a will, grieving family members may be facing a legal battle against big businesses, simply for access to a deceased’s Facebook, email or blog. Recently, in the United States, there have been a number of cases where grieving families embroiled in legal battles with Facebook over access to a deceased family member’s Facebook account.[1] 

What Should You Do

Currently, the law says little to nothing with respect to digital asset management after death. This means it is up to you to take steps to protect your digital assets and accounts. The following steps may assist in this process:

  • Identify all of your digital assets and accounts. This includes documenting the location of all mobile devices, computers and flash drives;
  • Instruct exactly what you want done with each digital asset and account. You may want to leave this responsibility with your chosen executor, or appoint a separate trustee who will be responsible for managing your digital assets;
  • Provide access to your chosen appointed person. This can be done by leaving a password-protected list of digital assets and digital accounts. An online password manager such as LastPass  or 1Password  may assist in this step; and
  • Update your digital assets and digital accounts as often as possible.

One final point is that it is important not to list any passwords to digital assets and accounts within the actual Will. The reason for this is that if, and when your estate goes through probate, the court process by which a Will is proven valid or invalid, the contents of the Will may become public record. Thus, putting your digital assets and accounts at risk. 





[1] Stassen v Facebook is a case from Wisconsin whereby the Stassen;s 21 year-old son committed suicide.  The Stassen’s wanted to access their son’s Facebook and Gmail accounts.  Facebook refused to release any information, citing concerns over breaching their client’s ownership rights.  Facebook refused to disclose their son’s personal account information even after a court order declared the parents the heirs to their son’s estate.