Lifetime Dispositions and at Death General Principles

Transcription

1 TAX FUNDAMENTALS FOR THE ESTATE PRACTITIONER PAPER 1.1 Lifetime Dispositions and at Death General Principles These materials were prepared by Sadie Wetzel of Davis LLP, Vancouver, BC, for the Continuing Legal Education Society of British Columbia, February The author gratefully acknowledges the assistance of Deanna Brummitt, Articled Student. Sadie Wetzel

2

3 1.1.1 LIFETIME DISPOSITIONS AND AT DEATH GENERAL PRINCIPLES I. Introduction...1 II. Basic Income Tax Concepts...2 A. Adjusted Cost Base...2 B. Capital Gains...2 C. Capital Property...2 D. Proceeds of Disposition...2 III. Inter Vivos Gifts...3 A. Gifts of Cash and Bank Accounts...3 B. Gifts of Appreciated Property...3 C. Transfers to Trusts Spousal Trusts Alter Ego Trusts Joint Partner Trusts...5 IV. Joint Ownership and Fraudulent Conveyances...5 A. Joint Ownership...5 B. Fraudulent Conveyances...6 V. Deemed Dispositions on Death...7 VI. Summary...8 I. Introduction Tax considerations form an essential component of estate planning. Solicitors practising in this area must have a basic understanding of the tax consequences associated with death and with inter vivos gifts. Moreover, estate practitioners should be aware of recent developments surrounding joint tenancies and fraudulent conveyances. When contemplating the transfer of assets, the practitioner should ask: Who will receive the property? What is the nature of the property? Why is the property being transferred? When will the property be transferred? The answers to these questions will largely determine the tax consequences associated with the proposed transaction.

4 1.1.2 The scope of this paper is meant to be introductory in nature and applies only to taxpayers who are Canadian citizens and residents. It is not meant to be a comprehensive guide to estate planning or an exhaustive review of the provisions of the Income Tax Act (Canada) (the ITA ). For a more detailed discussion of many of the issues addressed in this paper, please see British Columbia Estate Planning and Wealth Preservation (CLE Society of BC) or CCH Canadian Estate Planning Guide (CCH Canadian Limited). II. Basic Income Tax Concepts A few basic income tax concepts need to be defined at the outset 1 : A. Adjusted Cost Base The adjusted cost base ( ACB ) of a property is the cost of the property plus any expenses incurred to acquire the property, such as commissions to a real estate agent. If any additions or improvements have been made to the property, those expenses may also be included in calculating the ACB. B. Capital Gains A capital gain is triggered when capital property is sold, or deemed to have been disposed of, and the amount received for the property is more than the property s ACB. A capital gain is the difference between the proceeds of disposition (defined below) received for the property and the property s ACB. Consider the following example: Mary owns shares and sells them for $101,500. She purchased the shares for $1,000 and paid a $500 commission. The capital gain on the sale would be calculated as follows: Proceeds of disposition $101,500 Expenses $500 ACB $1,000 Capital Gain $100,000 C. Capital Property Capital property is any property that, when sold, triggers a capital gain or a capital loss. Capital property is usually purchased for investment purposes, or to earn income, and can include vacation property and securities such as stocks and bonds. D. Proceeds of Disposition Proceeds of disposition are the amounts you receive or will receive for the property. Usually this is the sale price of the property, or in the case of a gift, the fair market value of the property. 1 ITA, s. 248 and related sections. See the Canada Revenue Agency s website for helpful definitions of these and other income tax related terms,

5 1.1.3 III. Inter Vivos Gifts Clients often want to give property to friends and family during their lifetime. While the reasons for gifting property vary from client to client, some of the common reasons are: a desire to reduce probate fees and the burden of administration on the client s death; to avoid application of the Wills Variation Act, R.S.B.C. 1996, c. 490 (the WVA ) 2 and to make it easier for others to assist the client in managing his or her financial affairs. 3 From an income tax perspective, the general rule is that taxes will be triggered when a taxpayer disposes of property unless a specific exception or exemption applies. 4 The following discussion will look at several common types of gifts and the tax consequences associated with those gifts. As a practical matter, donees who make inter vivos gifts should execute a Deed of Gift. This will serve as evidence of the donor s intention and will help guard against resulting trust claims or claims that the gift is otherwise invalid. A. Gifts of Cash and Bank Accounts Generally, gifts of cash will not be subject to income tax. 5 B. Gifts of Appreciated Property A property has appreciated if the property s fair market value exceeds the property s fair market value at the time of acquisition. Generally, dispositions of appreciated property trigger a capital gain and are subject to income tax unless a specific exemption applies. Examples of appreciated property are real estate and stock portfolios. Under s. 69(1)(b) of the ITA the donor of a gift is deemed to have disposed of the gift at fair market value. Therefore, any accrued gain (the difference between the fair market value and the donor s costs of the gift) is taxable. As mentioned, there are exceptions to the rule that anytime a taxpayer disposes of property income tax will be triggered. For example, if a taxpayer gifts appreciated property to his or her spouse or common-law partner, no income taxes are triggered. This is because, under the ITA, a donee gifting to a spouse is deemed to sell the property at a value equal to the property s ACB. Thus, there is no capital gain and nothing to be taxed. Similarly, if property is transferred to a spousal trust, an alter ego trust or a joint partner trust, no income tax consequences will be triggered. A more detailed discussion of transferring property to trusts is found later in this paper. It should be noted that if the subject of the gift is real property, the transaction may attract property transfer taxes under the Property Transfer Tax Act, R.S.B.C. 1996, c A discussion of the WVA and its application are beyond the scope of this paper. 3 Due to some of the issues surrounding joint accounts, a power of attorney is typically preferred. For a discussion of the law on joint accounts see Rhys Davies, QC, Estate Litigation Update 2007: Joint Tenancy Update, CLE, November Section 69(1) of ITA. 5 Pursuant to s. 160 of the ITA, a recipient of a gift is jointly and severally liable along with the donor up to the fair market value of the gift received (less any consideration paid) if the donor owes income tax at the time of the transfer.

6 1.1.4 Individuals should also be aware of the tax consequences of selling property to people who are non-arms length for less than fair market value. For example, if a client wished to sell the family cottage to her son for half of its appraised value s. 69(1)(b) of the ITA would apply and the deemed proceeds of the sale are adjusted upward to the fair market value of the transferred property. Regardless of this, the recipient of the property is deemed to receive the property at the value paid for it. If the recipient were to then sell the property, he would be taxed on the difference between the reduced amount paid for the property and the fair market value at the time of sale. Consequently, there is the potential for partial double taxation. Under these circumstances an outright gift of the property would be more tax effective. For example, say Mary bought a cottage for $200,000. She decided to sell the cottage to her son, Philip, when it was valued at $300,000. She charged him $150,000. Mary would be deemed to have disposed of the cottage for fair market value or $300,000, thus she would be liable to pay taxes on her capital gain of $100,000. Philip would be deemed to acquire the cottage at the value paid for it, in this case $150,000. Philip decides the next day he would like to sell the cottage. His capital gain is calculated by taking the difference between the fair market value of the cottage ($300,000) and what he paid for it ($150,000). In other words, Philip pays capital gains tax on $150,000. Consequently, $100,000 of the value of the cottage has been taxed twice, once in Mary s hands and again in Philip s. C. Transfers to Trusts A disadvantage to giving away property during one s lifetime is that the donor loses control and beneficial enjoyment of his or her assets. Consequently, a client may prefer to transfer assets to an inter vivos trust. The general rule is that transferring assets to an inter vivos trust will trigger any capital gains associated with the asset. This general rule is subject to a number of exceptions, the most common of which are transfers to spousal trusts, alter ego trust and joint partner trusts. 1. Spousal Trusts A spousal trust is a special type of trust where the trustee holds property in trust for the spouse s lifetime. All of the income must be paid, or made payable, to the spouse and the property can only be used for the spouse s benefit during the spouse s lifetime. If a trust qualifies as a spousal trust, property may be transferred on a tax deferred basis. The transferor s proceeds of disposition are deemed to equal the ACB of the property and consequently, no gain is triggered when the property is transferred to the trustee of the trust. Income tax will be triggered when the spouse dies or the property is sold. 2. Alter Ego Trusts An alter ego trust is another type of trust that enjoys special income tax treatment. To qualify as an alter ego trust, all of the income of the trust must be paid, or made payable, to the settlor for his or her lifetime and no person other than the settlor may encroach on or otherwise obtain the benefit of the trust property during the settlor s lifetime. Further, an alter ego trust is only available to a settlor who is over the age of 65. Similar to a spousal trust, property may be transferred to an alter ego trust on a tax deferred basis. When property is transferred to the trustee of an alter ego trust, the settlor s proceeds of disposition are deemed to equal the settlor s ACB. Consequently, no capital gain is triggered. Taxes will be triggered when the settlor dies or the property is sold.

7 3. Joint Partner Trusts Joint partner trusts are similar to alter ego trusts, except that the settlor s spouse is also a beneficiary of the trust. Similar to an alter ego trust, property may be transferred to a joint partner trust on a tax deferred basis. Income tax will be triggered when the property is sold or on the death of the last of the settlor and the spouse. IV. Joint Ownership and Fraudulent Conveyances Since many legitimate estate planning techniques involve inter vivos transfers of property, whether to trusts or as outright gifts, estate planners should be aware of recent developments regarding joint ownership and the Fraudulent Conveyance Ac, R.S.B.C. 1996, c. 163 (the FCA ). When contemplating a transfer of property, practitioners must be aware of what is motivating their client. A. Joint Ownership 6 It is not unusual for elderly clients to want to transfer bank accounts (and other assets) into joint tenancy with an adult child. Joint tenancy is a type of ownership where two or more individuals share ownership of property jointly. Each joint tenant has an undivided interest in the property that is identical to that of the other joint tenant. For income tax purposes, the Canada Revenue Agency ( CRA ) treats each joint tenant as owning an interest proportionate to the number of joint tenants. For example, if there are two joint tenants the CRA takes the position each tenant owns 50%. Following the decision of the Supreme Court of Canada in Pecore v. Pecore, 2007 SCC 17, there appear to be three possible results when an account is transferred from the original account holder to the original account holder and another person, as joint tenants: true gift where the original account holder decides to hold the account jointly with another person with the intention that the other person gets the account (by way of right of survivorship) when the original account holder dies; bare trust where the original account holder decides to hold the account jointly with another person but does not intend for that person to get the proceeds of the account when the account holder dies. The other person only has legal (and not beneficial) title to the account and the proceeds of the account form part of the original account holder s estate on death. Pecore situation where the original account holder decides to hold the account jointly with another person on the understanding that that person will not access or use the funds for his or her benefit until the original account holder dies at which point the other person becomes the legal and beneficial owner of the account by right of survivorship. The hybrid type of joint ownership was recognized in Pecore. In Pecore, the Supreme Court of Canada held that when a parent chooses to hold property jointly with his or her adult child there is a presumption of resulting trust. This means that despite the fact the adult child is a joint tenant and has title to the bank account it is presumed that the proceeds of the bank account should fall back into the estate. In order to rebut this presumption (and create the third hybrid type of joint ownership), the 6 For an excellent discussion of joint ownership, see Maureen De Lisser, Update on the Taxation of Jointly Owned Property, Personal Tax Planning, (2008), vol. 56, no.2 Canadian Tax Journal,

8 1.1.6 surviving joint tenant must prove that the transferor intended to gift whatever assets are left in the account to the survivor. Consequently, the giftor must be aware of this when putting a bank account into joint tenancy if they want the joint tenant to have the contents of the account upon their death they must make that intention clear. The income tax liabilities associated with transferring an account into joint tenancy depends on the nature of the relationship and the donor s intention. From a tax perspective, in order to constitute a gift, a transfer of property must include a transfer of legal and beneficial title. If there is no change in beneficial ownership, the CRA takes the position there has been no disposition and thus there are no income tax consequences. The distinction is made between true gifts, in which beneficial and legal title are shared, and gifts of convenience, in which only legal title is shared. For tax purposes, the former are considered transfers while the latter are not. The income tax consequences of a Pecore arrangement are less clear. It may be that CRA is of the view that income taxes are deferred until the death of the original account holder because the surviving joint tenant only becomes entitled to beneficial ownership by right of survivorship. B. Fraudulent Conveyances Estate practitioners should also be aware of a series of recent BC decisions concerning the FCA that these cases suggest there is a possibility that property transferred for legitimate estate planning purposes may be set aside under the FCA. On September 30, 2009, the BC Supreme Court handed down judgment in Antrobus v. Antrobus, 2009 BCSC This case involved a daughter who challenged a conveyance made by her parents to hold a piece of real property in joint tenancy with other siblings. Lynn Smith J., made a number of notable findings. First, she confirmed that a person did not have to be a creditor in the traditional sense of the word to bring a claim under the FCA. So long as the person claiming had at least some legal or equitable claim to the property during the owner s lifetime they would qualify as an other and have standing to bring a FCA claim. 8 Second, a transfer of property to near relatives for little or no consideration was sufficiently suspicious to shift the burden to the transferor to prove that the transaction was not fraudulent. 9 Lynn Smith J., went on to hold the parents had made the conveyances in order to protect their property from a claim by their daughter. She had a resulting trust claim for work she had done for her parents who had promised her compensation. The parents claim that they had transferred the property to their other children as part of a bona fide estate plan was rejected. 10 On November 24, 2009, the BC Court of Appeal released its judgment in the case of Abakhan & Associates Inc. v. Braydon, 2009 BCCA 521. This case addressed the issue of what constitutes the requisite intention to execute a fraudulent conveyance under the FCA. While this case involved a commercial transaction, it was effected in part for tax reasons (to take advantage of the tax free rollover available under s. 85 of the ITA). Even though the plaintiff s conceded the transferor had no dishonest intent or any intent to defraud creditors, Finch J. writing for the Court held that the transfer was a fraudulent conveyance. In coming to this conclusion, Finch J. clarified that it was not necessary to prove the transferor had a dishonest intent or mala fides. 11 It was enough to show the transferor had the intent to try and place property outside the reach of creditors or others even if there was no intent to defraud them. 12 Further, the Court held that others could include individuals with potential claims at the time of the conveyance. 7 Affirmed by the Court of Appeal, 2010 BCCA At para At para At para At para At para. 73.

9 1.1.7 The third decision on fraudulent conveyances, Mawdsley v. Meshen, 2010 BCSC 1099, was released by the BC Supreme Court on August 5, In that case, the deceased, shortly before her death, transferred most of her assets into joint tenancy and divested herself of her remaining assets by way of outright gifts and an inter vivos trust. She effectively emptied her estate. The deceased s common law husband of 18 years alleged the movement of assets was part of a deliberate scheme to deprive him of his lawful remedies under the WVA and was therefore fraudulent under the FCA. Ballance J. concluded that the deceased lacked the intent required under the FCA for a transaction to be considered fraudulent. Ballance J. found that the deceased s movement of assets was not motivated by a desire to put them out of the reach of her common law husband because she did not believe that he would ever sue her estate. They had an understanding what was hers was hers and what was his was his. Consequently, the transfers were not fraudulent. 13 The outcome in Mawdsley does not insulate all transfers for estate planning purposes from the purview of the FCA. Mawdsley seems to leave the door open for individuals with WVA claims to make out claims under the FCA so long as the deceased had an intention to give a spouse less than they are entitled to under the WVA; in other words, for legitimate estate planning reasons. It should be noted that, in Hossay v. Newman, [1998] B.C.J. No (S.C.), the Court held that children with potential WVA claims do not have standing to bring a FCA claim. In light of Hossay and Mawdsley spouses and children may be treated differently with respect to having standing to bring FCA claims. Further discussion of this point is beyond the scope of this paper. Given that no dishonest intent or mala fides must be proven makes the test for fraudulent conveyances easier to meet. The potential for capturing transfers effected for estate planning or tax purposes is greater. Further, if the client has creditors, the solicitor must be alive to the possibility that transfers could be reversed. A transaction may be offside if creditor proofing is even one minor motive in the transaction. Solicitors should be aware of Professional Conduct Handbook, Chapter 4 Rule 6, which prohibits lawyers from engaging in any activity that the lawyer knows or ought to know assists in or encourages any dishonesty, crime or fraud, including a fraudulent conveyance, preference or settlement. V. Deemed Dispositions on Death The ITA provides that where a taxpayer dies, they are deemed to have disposed of each property they owned and receive the proceeds of these sales immediately prior to death. Proceeds from the dispositions are deemed to be the fair market value of the property. 14 The consequence of this deemed disposition rule is that no actual income is created and the taxpayer s estate receives no actual proceeds to fund the tax liability. The general rule is subject to a number of exceptions, most commonly the spousal rollover, the spousal trust rollover, the lifetime capital gains exemption and the principal residence exemption. If a rollover applies, income tax will typically be deferred whereas if an exemption applies, income tax will not be payable. RRSP and RRIF s are also deemed to be disposed of on death. When the annuitant of the plan dies, the full value of the property held in the plan will be included in the deceased s income for the year of death. A rollover may be available if the proceeds of the plan are used to purchase an annuity for a spouse or financially dependant child or grandchild. 13 At para ITA, s. 70(5)(a).

10 1.1.8 VI. Summary When contemplating the transfer of assets, the practitioner should be aware that: Who will receive the property? the transaction may qualify for a deferral of income tax because of the relationship between the parties (such as transfers to spouses) What is the nature of the property? certain types of properties (such as principal residences) may be exempt from income tax but may be subject to property transfer tax Why is the property being transferred? is the transaction likely to offend the FCA? does the transaction involve a transfer of beneficial ownership? When will the property be transferred? during the client s lifetime or as a result of death? The answers to these questions will largely determine the tax consequences associated with the proposed transaction.