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Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP.

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Presentation on theme: "Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP."— Presentation transcript:

1 Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP (416-218-1491) Bruce Harris - PricewaterhouseCoopers LLP (416-218-1403) Elena Hoffstein - Fasken Martineau DuMoulin LLP (416-865-4388) Patricia Robinson - Goodmans LLP (416-597-4144)

2 Case Study # 1 Inheritance Trust NRT Non-Canadian settlor (only contributor) Beneficiaries: - Canadian residents Trustees: - Non-resident 1

3 Case Study #1 Inheritance Trust QUESTIONS: 1. Will the non-resident trust (NRT) be subject to proposed 94(3)? 2. Will the beneficiaries be subject to the proposed 94.1 FIE rules in respect of their interest in the NRT? 2

4 Case Study #1 Inheritance Trust The NRT will not be deemed resident in Canada under proposed 94(3) if: –Non-Canadian settlor was never resident in Canada (or was resident in Canada <60 months) –Therefore no connected contributor or resident beneficiary as defined in proposed 94(1) 3

5 Case Study #1 Inheritance Trust FIE rules apply …in respect of a participating interest in a non-resident entity non-resident entity is defined in proposed 94.1(1) to include a non-resident trust participating interest in the case of a non-resident trust is defined in proposed 94.1(1) to mean a specified interest in the trust –Therefore, a beneficiarys interest in the NRT will be subject to the FIE rules if beneficiary has a specified interest in the NRT 4

6 Case Study #1 Inheritance Trust –Interest will not be a specified interest if: Every amount of income and capital of the trust that the beneficiary may receive at or after that time depends on the exercise by any entity or individual of, or the failure by any entity or individual to exercise a discretionary power Impact of default clauses? OR the beneficiary is a successor beneficiary as defined in proposed 94(1) (as modified by subparagraph (b)(i) of the specified interest definition) –Therefore Canadians interest in a NRT must be discretionary or must be drafted as a successor beneficiary to avoid FIE rules 5

7 Case Study #2 Will Planning – Creation of NRTs in Wills Deceased (Canadian Resident) Canadian Estate Canadian resident executors Canadian Resident Trust NRT US resident trust 50% - Cdn resident beneficiaries - Cdn resident trustees - US resident beneficiaries - US resident trustees 6

8 Case Study #2 Will Planning – Creation of NRTs in Will Question: Will the US resident trust be deemed resident in Canada under proposed 94(3)? 7

9 Case Study #2 Will Planning – Creation of NRTs in Will The deceased individual is not a resident contributor to the US NRT since he is not living The estate will be a resident contributor to the US NRT while the estate exists. Therefore: The US NRT will be subject to proposed 94(3) if the estate is in existence on December 31 st of the year in which the US NRT is created Timing of creation of US NRT in law? US NRT subject to 94(5) departure tax rule if 94(3) applies Planning – draft wills that transfer estates assets to new trusts and the estate should cease to exist to avoid 94(3) Consider Form T1141 and section 116 requirements 8

10 Case Study #2 Will Planning – Creation of NRTs in Will 94(3) also applies if US NRT has a resident beneficiary The deceased is deemed to have contributed property to the US NRT under proposed 94(2)(n). Therefore: –The deceased will be a connected contributor to the US NRT if he was resident in Canada for more than 60 months before his death and –If US NRT includes any Canadian residents as beneficiaries, other than successor beneficiaries or specified charities, the Canadians will be resident beneficiaries and the US NRT will be deemed resident in Canada under proposed 94(3) Planning – exclude Canadians as beneficiaries or ensure Canadians qualify as successor beneficiaries or specified charities 9

11 Case Study # 3 Estate and Spouse Trust Planning Rob Brown died owing non-voting Hi/Lo preferred shares and voting non-participating preferred shares of a CCPC (Holdco) Robs will bequeathed the voting preferred shares to a voting trust and the Hi/Lo preferred shares of Holdco to a trust for his spouse, Mary Under the terms of the will, after the death of Mary: Certain bequests to related and unrelated godchildren and certain donations are made and the residue of the spouse trust is to be held in three separate trusts for each of Robs and Marys three children 10

12 Case Study # 3 Estate and Spouse Trust Planning After the death of Rob the ownership structure of Holdco is as follows: Spouse Trust Inter-vivos Family trust Holdco Vtg p/s Non-vtg p/s Non-vtg c/s Opco Voting Trust - $5 M insurance – joint last to die to pay tax on death 100% 11

13 Case Study # 3 Estate and Spouse Trust Planning Identify the tax issues that would need to be considered and addressed while Mary is living and in designing the post-mortem transactions to minimize income tax 12

14 Case Study # 3 Estate and Spouse Trust Planning Tax issues to discuss Whether the requirements of subsection 70(6) have been met for a spousal rollover: Watch out for terms in will that allow non-commercial loans to someone other than the spouse while the spouse is alive Consider including a general override clause in will that provides that no power given to trustees in the will can be exercized if it causes subsection 70(6) to not apply Whether Part VI.1 tax will apply on dividends paid to spouse trust while spouse is living 14

15 Case Study # 3 Estate and Spouse Trust Planning Tax issues to discuss Whether the double tax structure needs to be addressed and if so whether a post-mortem bump or loss carry back plan is to be implemented If Holdco can be sold (instead of Opco), then there is no double tax in the corporate structure If postmortem bump is to be used then need to meet technical requirements for bump (family trust may be an issue; a comfort letter has been issued to address some family trust issues – doc #2004-008855) 15

16 Case Study # 3 Estate and Spouse Trust Planning Tax issues to discuss If loss carry back plan is to be used then will need to address: Double tax is only avoided if ACB of some of Holdcos assets is increased (e.g. shares of Opco) – not by redemption of p/s for a note Whether the terms of the spouse trust allow it to continue in law for up to three years after the death of Mary to allow the carry back of the loss under section 111 Whether capital loss carry back plan will result in insufficient income in the year of death and year before death to use donations (in situation where John dies last) 16

17 Case Study # 3 Estate and Spouse Trust Planning Tax issues to discuss Part VI.1 tax issues on redemption of the preferred shares held by spouse trust Consider subsection 191(4) Watch out for paragraph 191(3)(d) Consider paragraph 110(1)(k) deduction In this case the issue (unless subsection 191(4) applies) may depend upon what happens to voting preferred shares and when 17

18 Case Study # 3 Estate and Spouse Trust Planning Tax issues to discuss Subsection 40(3.6) stop loss rule (note that subsection 40(3.61) does not apply to a spouse trust) and review new affiliated person rules in section 251.1 The issue is whether the spouse trust is affiliated to Holdco immediately after the redemption If de jure control is held by voting trust, is the spouse trust affiliated to Holdco? Watch out for de facto control of Holdco and that control for affiliation includes de facto control Subsection 112(3.3) stop loss rule regarding insurance and other CDA of Holdco or Opco 18

19 Case Study # 3 Estate and Spouse Trust Planning Tax issues to discuss Acquisition of control rules Is a spousal trust part of the estate for clause 256(7)(a)(i)(C)? Is the voting trust part of the estate for clause 256(7)(a)(i)(C)? Will clause 256(7)(a)(i)(D) apply if voting shares are distributed from voting trust? Impact of a change of trustee – see CRA doc#2004- 008776 and question 7 of CRA Sept 2005 roundtable Do we care if the acquisition of control rules apply in this case? 19

20 Case Study # 3 Estate and Spouse Trust Planning Tax issues to discuss Donation claims by spousal trust are problematic based on CRAs stated position: No donation if charity receives property as a capital beneficiary – trustees should have discretion to make donations from spouse trust after death of spouse Matching tax with donation – timing issue 20

21 Case Study #4 21 year rule planning Harvey Smith settled the Smith Trust with a $100 bill 20 years ago Harveys son John, Mary Smith (Johns spouse) and Johns children and grandchildren are the discretionary beneficiaries Trustees of the trust are John, Mary and a family friend John and Mary have 4 children and 6 grandchildren All of the beneficiaries live in Canada with the exception of Johns son Stanley, who is a resident of Israel and Johns daughter Barb who is a resident of the U.S. 21

22 Case Study #4 21 year rule planning The trust owns all of the common shares of Holdco, which the trust purchased 20 years ago upon the estate freeze of Johns interest in Holdco – shares were purchased with a bank loan The current fair market value of the common shares is $8 million John owns the voting preferred shares of Holdco Holdco owns: investment portfolio that has a current FMV of $3 million Canadian rental properties that are leased to arms length persons 100% of the shares of Opco that have an FMV of $15 million 22

23 Case Study #4 Current Structure Smith Trust Holdco Opco John 100% c/s Voting p/s 100% CS FMV $15M Discretionary Beneficiaries: John Mary 4 children – 2 non-resident 6 grandchildren 23

24 Case Study #4 Issues to discuss Holdco shares must be distributed to Canadian resident beneficiaries prior to 21 st anniversary to avoid realization of accrued gain on shares –How discretionary is a discretionary trust? Review trust terms to ensure 75(2) has never applied to trust –If 75(2) applied and individual is still alive, 107(4.1) will deny rollout of Holdco shares to any person No tax-deferred rollout if shares distributed to non-resident children/grandchildren: –Part XII.2 tax of 36% would apply to taxable portion of gain (TCG) unless the trust elects under 107(2.11) to have the TCG taxed in the trust under Part 1 –If no 107(2.11) election is made, the after tax portion of the TCG would be subject to Cdn withholding tax 24

25 Case Study #4 Tax Issues to discuss (contd) Possible planning: –Post security for unpaid tax – subsection 220(4.6) –Non-resident children incorporate a Canadian company (Canco) and trust distributes a portion of Holdco shares to Canco in satisfaction of its capital interest – trust terms must include corporations as beneficiaries or trust terms must be varied – consider tax implications of variation to add new beneficiaries, or –Non-resident children transfer capital interest in trust to Canco and the trust distributes a portion of the shares to Canco: CRA may apply GAAR (see ATR #2002-0136333 where CRA would not rule that GAAR would not apply –Consider tax consequences in foreign jurisdiction 25


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