There are several tax considerations to examine when transferring property from one spouse to another after a separation or divorce. Partners may not spend much time dealing with the tax considerations since it is assumed a property will qualify as a principal residence and there will be no tax consequences arising from the transfer. It may come as a surprise this is not always the case.
Consider the following example.
John and Jane Doe owned their Toronto home together since 2010. The purchase price was $600,000.
In January 2023, the couple separated. John stayed in the home while Jane moved to Calgary to be closer to her family. The property was worth $1,500,000 at the time of separation.
The couple plans to transfer the home to John’s sole name while settling the couple’s property rights, and John plans to transfer assets or cash of $750,000 to Jane. The tax implications of a transfer of property other than real property have been discussed in a separate article, where it is assumed a taxable capital gain may result. However, where the property is personal‑use real estate, the couple’s expectation may be a tax‑free transfer. Any unanticipated tax consequences will affect the amount John should pay Jane in the division of property.
In advising the couple concerning the division of property, it is important to know the couple’s history of ownership of any real estate that may have been used as a home.
The answer to these questions may affect whether the transfer of the property to John will be eligible for the principal residence exemption. We will assume Jane and John only owned one property. To qualify for the principal residence exemption on the transfer of Jane’s 50% interest of the home to John, the following steps need to be taken:
What if John and Jane owned a cottage from 2015 and the property is still owned by both of them (nine full or part years of ownership)? The cottage’s cost was $300,000, and its value is $1,000,000. John and Jane plan to put the cottage on the market and sell it as soon as possible.
The potential gain per year of ownership of the Toronto home ($900,000 total gain/14 years of ownership = $64K per year) is lower than the potential gain per year of ownership of the cottage ($700,000/9 years of ownership = $78K per year). It is more advantageous for John and Jane to designate the cottage as their principal residence for 2016‑23, (i.e., 8 plus one equals 9 years) and the Toronto home for 2010‑15 (6 plus one equals 7 years). The steps outlined previously should be amended to take this into consideration.
Professional assistance is required to appropriately sort out the tax implications of the principal residence designation. Talk to a Segal GCSE advisor for more information.
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We previously sent out articles about the new expanded trust reporting rules and the new form Schedule 15 (as part of the T3 trust reporting) that will require certain trusts to file tax returns and provide information about “reportable entities,” which include beneficiaries, trustees, settlors and persons with the ability to exert influence over trustee decisions (“protectors”) of a trust. The first reporting under these rules will be March 30, 2024 (not March 31, 2024, due to 2024 being a leap year).
Lawyers are in a unique situation in that they often have trust accounts for their clients. The legislation exempts a lawyer’s general trust account. These would be funds that are required under the professional conduct rules – as well as federal or provincial rules – for a purpose that is regulated under these rules. However, all trust accounts are not created equal.
Trust accounts that would not be exempt could be the following:
For those trust accounts not automatically exempt, they could be exempt if they meet one of the following conditions:
The information that will have to be provided for each of the above is:
If an entity ceased to be a reportable entity in the tax year, the information is still required but won’t be carried forward to the next tax year. That is, if there was a trust account in existence for six months during the year, it would have to be reported even if it didn’t exist as of December 31 of the year in question. It is the CRA’s position the trustees must make best efforts to obtain required information from beneficiaries.
There is a section of the form to provide information about beneficiaries the trustee cannot list by name. This could be relevant where trust funds are being held as part of a lawsuit where the beneficiaries of the funds have not yet been determined.
Failure to file the required information discussed above will result in a penalty of $25 per day, with a minimum penalty of $100 to a maximum of $2,500.
If it is deemed the failure to file was made knowingly or because of gross negligence, there were false statements or a failure to respond to a CRA demand to file, there will be an additional penalty equal to the greater of $2,500 or 5% of the fair market value of all the property held by the trust. As an example, if there are funds with a fair market value of $20 million held by the trust, this gross negligence penalty could be $1 million per year!
The cost of non-compliance is significant. If you think you or your firm would be affected by these rules, please contact us.
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Prescribed rate loans provide an opportunity to split income with a spouse, a common‑law partner, children or other family members. Although the prescribed rate is at the highest level since 2007, the timing might be right to make such a loan. We will discuss how to use the prescribed rate to your advantage by making a loan directly to family members – or using a family trust where minors are involved.
Income splitting is the transferring of income (or capital gain) from a high‑income family member to a lower‑income family member. There is no attribution of capital gains earned by minor children. Since our tax system has graduated tax brackets, by having the income taxed in the lower‑income earner’s hands, the overall tax paid by the family may be reduced. Prescribed rate loans can be used to help fund minor children’s expenses, such as paying for private school or extracurricular activities.
The “attribution rules” in the Income Tax Act (ITA) prevent certain types of income splitting by generally attributing income or gains earned on money transferred or gifted to a family member back to the original transferor. The ITA does provide an exception to this rule if funds are loaned, rather than gifted, at the prescribed rate in effect at the time the loan was originated and the interest is paid annually within 30 days (i.e., Jan. 30) after the end of the year. The loan must have bona fide repayment terms, and if the interest on the loan is not paid within 30 days after the end of any year, the loan will be offside and caught by the income attribution rules.
Prescribed rates are set by the Canada Revenue Agency (CRA). Even though the prescribed rate has crept up gradually from 1% – in effect from July 1, 2020 to June 30, 2022 – to 5% beginning April 1, 2023, it is expected to continue to increase in the fourth quarter (October through December) of 2023.
For loans put into place before Oct. 1, 2023, the 5% rate would be locked in for the duration of the loan without being affected by any future increases.
If a loan is made when the prescribed rate is 5%, the net effect will generally be to have any investment return generated above the 5% prescribed rate taxed in the hands of the lower income family member. Even if the prescribed rate increases to 6%, you will only need to use the prescribed rate in effect at the time the loan was extended.
What happens if you made a loan to your family member when the prescribed rate was 5% (or higher) and the rate drops? To be eligible to use the lower prescribed rate (for determining if there will be attribution of income from the investments), the family member should sell any investments made with funds from the original 5% loan and repay the loan to you. You can then enter into a completely new loan agreement using the new, lower prescribed rate.
What if this results in unwanted tax consequences such as triggering tax on capital gains or brokerage fees? Furthermore, given market volatility, what if the fair market value of the investments is insufficient to pay off the original loan? In these cases, while you may be tempted to either adjust the rate on the loan or refinance it at the lower rate, both measures may put you offside.
You must enter a new loan for the lower prescribed rate to apply. In fact, the CRA has stated simply repaying a higher prescribed rate loan with a lower rate loan could trigger the attribution rules.
Be sure to obtain tax and legal advice before implementing a prescribed rate loan, to determine the best way to structure and operate this type of arrangement, as well the implications for your unique circumstances.
As a shareholder, the benefits you receive could have significant tax implications. In many cases, shareholders are unaware that a corporation – even if wholly owned – is a separate taxpayer. Money earned by a corporation is meant to be used for business purposes, paying for expenses or costs associated with the operations of the corporation. If a corporation pays for a shareholder’s personal expenses or permits its assets to be used by the shareholder for personal purposes, a taxable benefit may result.
The corporate bank account should not be considered the shareholder’s personal piggy bank. When money or property is extracted from the corporation other than through salaries, dividends, repayment of capital or loan or reimbursement of expense, a benefit may have been conferred by the corporation on the shareholder.
Any benefit conferred on a shareholder by a company must be reported on the shareholder’s personal tax return, unless the shareholder has reimbursed the company in a timely fashion or has credit in his or her shareholder loan before the benefit was received. There may also be GST/HST consequences that need to be addressed. If the Canada Revenue Agency (CRA) audits the corporation, the shareholder could be assessed a benefit in addition to the CRA denying such expenses as deductible to the corporation, and double taxation may result.
It may be difficult to determine whether an expense is incurred for business purposes if a personal element is involved. This could be the case with meals, entertainment, parties, gifts, travel with family members, etc. It is important to document the reason for the expense to demonstrate it was incurred for business purposes. Expenses that are not deductible to the business (such as golf club dues) may still be a benefit to the shareholder.
If corporate‑owned property (such as an aircraft, a luxury yacht or a cottage) is used by the shareholder for personal reasons, the benefit may be calculated as what the shareholder would have had to pay for the same benefit in the same circumstances if he or she had not been a shareholder of the company. In order to address this issue, the shareholder is charged with fair market value rent. On occasion, fair market value rent may not be adequate to provide the business with a reasonable return on the cost or the value of its investment, and the benefit will be computed based on a normal rate of return on the greater of the cost or the fair market value. An offset of the benefit may be possible if the shareholder provided the funds to purchase the property, and the offset will be equal to the foregone interest on the loan.
A shareholder can avoid the shareholder benefit rules by characterizing the extraction of corporate funds as a loan. In order to avoid the shareholder benefit rules, it is necessary to document a debtor‑creditor relationship. This may include a loan agreement and terms of repayment. In addition, one of the following conditions must also be met:
a) The company is in the money lending business. Under recent changes, more than 90% of the total outstanding loans at any time during which the shareholder loan is outstanding must be owed by arm’s‑length parties;
b) The loan is repaid no later than one taxation year after the year the loan is made, and the loan is not part of a series of loans and repayments. For example, a loan made on July 1, 2023 must be repaid by December 31, 2024 (assuming the corporation has a calendar year‑end). Annual dividends declared to clear out the loans are acceptable to the CRA; or
c) The loan has been provided to a shareholder who is also an employee by virtue of his/her employment. The loan must be provided to enable the employee to purchase a home, a car used for work or shares of the employer, and bona fide arrangements are made for the repayment of the loan. A loan can be considered to be given to the employee qua employment if it can be considered part of a reasonable employee remuneration package. Where the shareholder is also an employee, it is difficult to argue the loan is received as an employee unless other employees are given the ability to borrow funds for the same reasons.
Even if the loan is exempted from income under one of the exceptions, interest at prescribed rate (currently 5%) less the amount paid on the loan no later than 30 days after the end of the year must still be calculated and included in income. If the loan is included in income, no interest benefit will need to be included. In addition, a repayment of the loan may be deductible.
The rules governing shareholder benefits are complex. It is important to identify whether such a situation exists on a timely basis and discuss the best path forward with your tax advisor.
We previously highlighted new expanded trust reporting rules, first announced in the 2018 federal budget, requiring certain trusts to file tax returns and provide information about “reportable entities” – including trust beneficiaries, trustees, settlors and persons able to exert influence over trustee decisions (“protectors”). However, implementation of these reporting requirements was delayed, only taking effect for taxation years ending after Dec. 30, 2023. The first reporting under the new rules is March 30, 2024 (not March 31, 2024, as it is a leap year).
The Canada Revenue Agency (CRA) has finally posted on its website the form with which trustees must begin reporting beneficial ownership information under the expanded reporting regime for trusts. However, the form left some questions unanswered. Some answers were provided during the CRA roundtable at the recent Society of Trust and Estate Practitioners (STEP) conference. We hope the 2023 Trust Guide will be updated to provide further clarity.
For many trusts, a completed Schedule 15 – Beneficial Ownership Information of a Trust – must be filed annually. Notable exceptions include Graduated Rate Estates (“GRE”), trusts in existence for less than three months at the end of the year and trusts holding assets with a total fair market value of less than $50,000 throughout the year, as long as the trust assets consist only of money and publicly traded securities.
At the 2023 STEP conference, the CRA confirmed a trust that owns collectible gold, silver coins or bars and has a dividend receivable will not qualify for this exemption. The dividend receivable would arise in situations where there has been a delay between the dividend declared and the actual payment date. The question posed to the CRA referred to public company dividends, but the CRA’s comments did not restrict its position to public company dividends. Trusts holding gold or silver coins as trust settlement property, or owning private or publicly traded shares that may have declared but unpaid dividends, should be aware of these exceptions.
Part A of the form is used to indicate whether the trust is reporting the beneficial information for the first time and whether the beneficial ownership for the trust has changed in the year. If the answer is “yes” to either question, the trustee must complete parts B and C (if applicable). If the answer is “no” to both questions, the schedule is complete. The trouble of having to obtain the necessary information may be a one‑time only exercise for most trusts.
A separate Part B must be completed for each reportable entity. If a person is more than one entity type (for example, both a trustee and settlor), a separate Part B is required for each. The information is required for all reportable entities on the trust’s first report. In future years, Part B is only required for any reportable entity added or modified in the tax year.
The trustee must specify whether the reportable entity is a natural person, corporation, trust or other, and provide the name, address, date of birth (if a natural person), jurisdiction of residence and taxpayer identification number for each reportable entity.
If an entity ceased to be a reportable entity in the tax year, the information is still required but won’t be carried forward to the next tax year. Part B must disclose all persons who are beneficiaries under the trust, regardless of how remote their interest is. It may not be possible for the trustee to obtain all necessary information. For example, it may not be desirable for various reasons to advise the beneficiary of his/her interest as a contingent beneficiary, or it may not be possible because the beneficiary does not yet exist – for example, an unborn grandchild or a future spouse of a beneficiary.
This may include persons who are beneficiaries under a “disaster clause,” which directs trustees to distribute assets to more remote family members if all primary family member beneficiaries have died or no longer exist. The clause is unlikely to be triggered if there are multiple primary beneficiaries, and the trustees may not know the identities of the contingent beneficiaries.
The CRA’s position is that trustees must make best efforts to obtain required information from beneficiaries. Known beneficiaries should be included in Part B only.
Part C of the form is used to provide information about beneficiaries the trustee cannot list by name, such as unborn children or grandchildren. The details of the terms of the trust extending the class of beneficiaries to unknown entities must be provided to the CRA in Part C.
Part C must be resubmitted annually in its entirety if any portion of the information requires amendment (not only the change in the unknown beneficiary). Failure to make efforts to obtain information required may result in significant penalties. Some trusts are drafted to include as many potential beneficiaries as possible for tax planning reasons. This practice should be reviewed in view of the reporting requirements.
To avoid any issues, reporting requirements should be discussed with your tax advisor as soon as possible.
Know your obligations