Note to readers: Within the tax community, there has been some controversy with respect to the new trust legislation enacted in 2014. Accordingly, the author advises readers to remain alert to the possibility of proposed changes in 2015/2016.
The Federal Budget of 2014 introduced several tax measures that affect charitable donations and estate planning. The new legislation applies to deaths after 2015, and strives to provide greater flexibility for executors to use charitable donation tax credits (DTC) from property donated on or after an individual’s death.
Donations made by will are deemed to have been made by the deceased individual immediately prior to death. The donation value is determined as of the date of death, and the DTC may be claimed on the terminal return or the immediately preceding return. Excess DTCs cannot be claimed by the estate. The current rules rely heavily on the CRA’s interpretation of the individual’s will to determine whether the donation is claimed by the individual or the estate. A mismatch between the taxpayer and/or the taxation year can result in the inability to use the DTC to shelter the tax liability on death.
Key legislative changes
The new legislation introduces the graduated rate estate (GRE). A GRE is defined as a testamentary trust that results on, or as a consequence of, death, and has existed no more than 36 months from the date of death of the individual. If a deceased individual has created multiple trusts, only one can be designated as a GRE. GRE status is required in order to take advantage of the new charitable donation rules.
If a GRE makes a gift of property it acquired on or as a consequence of death, or a gift of substituted property, the executor of the deceased’s estate will have the flexibility to allocate all or a portion of the gift among the following:
- The individual’s terminal return;
- The individual’s prior-year return;
- The taxation year of the GRE in which the donation was made; and
- An earlier taxation year of the GRE.
In addition, the executor has the option of having all or a portion of the gift carried forward by the trust for five taxation years.
The donation will be deemed to have been made by the estate and valued at the time that the property is transferred to the charity. Gifts made by will are no longer deemed to have been made by the individual immediately before death. Where a charity has been designated as the beneficiary of an RRSP, TFSA, RRIF, or death benefit on the life insurance policy of the deceased, the donation will be deemed to have been made by the estate and, therefore, will be eligible for the new rules.
Donations claimed on the terminal return or on the prior-year return continue to be 100% eligible for the DTC, whereas the 75% threshold continues to apply for donations claimed by the estate. Gifts made by a trust or an estate that is not a GRE may be claimed by the trust and carried forward five years. The new legislation also allows individuals to claim donations made by their spouse.
Implications of the new rules
To illustrate the effect of some of these changes, consider an example where an individual (“John Doe”) dies holding the following:
- An RRIF worth $500,000, with a charity designated as a beneficiary;
- $50,000 in shares of a public company (“ABC Co.”), with an adjusted cost base of nil, to be donated to charity;
- $1,000,000 in shares of a wholly owned private holding company (“XYZ Co.”). The adjusted cost base and paid-up capital of these shares is nil; and
- An alter-ego trust (AET) with his children named as beneficiaries. This AET holds all of his other assets, some of which have accrued capital gains.
As John’s will creates only one estate, this estate would be designated as the GRE.
The gift of the $500,000 RRIF is deemed to have been made by the GRE, and John’s executor has the flexibility to choose whether to claim the gift on John’s terminal return, on his prior-year return, or on his GRE’s return.
The gift of publicly listed securities
Here again, the executor has the flexibility of choosing whether to claim the $50,000 gift on John’s terminal return, on his prior-year return, or on his GRE’s return.
The current rule whereby a zero taxable capital gain rate arises from the deemed disposition of public company shares on death now requires that the gift be made by a GRE. A zero taxable capital gain rate would be reflected on John’s terminal return as a result of his GRE’s gift of ABC Co. shares. (If, unlike in our example, John’s estate was not designated as a GRE, a capital gain of $50,000 would be included on his terminal return.)
Life interest trusts
Spousal trusts, AETs, and joint partner trusts are not GREs and, therefore, do not benefit from the flexibility the new legislation offers for donations. These trusts will have a deemed year-end on the death of the individual beneficiary, and any capital gains arising on the deemed disposition of the trust property on this date will be taxed on the deceased’s terminal tax return. This makes it difficult to shelter the tax liability through use of a DTC, as the tax liability on the terminal return cannot be offset with donations made by the trust. Even if the deemed gain were taxed in the trust, the deemed year-end would prevent the trustee’s ability to shelter the related tax by making a donation in the same taxation period.
Therefore, accrued capital gains in the AET will be taxed on John’s terminal return. Since all of his other assets are held by the AET, there are limited assets available within the estate to fund the tax liability. If the AET were to pay the estate’s tax liability, this could be considered a contribution to the estate, and the estate could lose its GRE status. This, in turn, would prevent John’s executor from being able to allocate donations to John’s terminal return, and would result in the loss of the zero taxable capital gain rate on the donation of public company shares.
Private company shares
When an individual dies owning private company shares, the potential for double tax arises—first on the capital gain on the deemed disposition on death, and then again on the subsequent sale of the underlying corporate assets, the payment of dividends, and/or the redemption of the shares. Post-mortem estate planning is required to prevent this double tax. If the individual wishes to make a donation to shelter the tax on the private company shares, careful planning is required to ensure that the DTC is available to the same taxpayer who owes the tax.
In the example of our John Doe, the estate will owe tax on the $1,000,000 capital gain arising from the deemed disposition of the XYZ Co. shares on his death. If his executor follows a “pipeline” or “bump” plan, the tax would continue to be payable on John’s terminal return. However, if the executor follows a subsection 164(6) loss carry-back plan, the tax would be payable by his estate rather than on his terminal return. As John’s estate is a GRE, his executor would have the flexibility to allocate the DTC from the RRIF and the shares of ABC Co. against either the terminal return or the estate’s return in order to shelter the tax on the gain.
Revisit all plans before 2016
All wills and estate plans should be revisited before 2016 to ensure that the results will remain favourable for taxpayers under the new rules. The planning for estates that have multiple trusts will be more complex; therefore, careful consideration should be given to ensure that the GRE status is designated to the right trust, and that the DTCs are available to offset any significant tax liabilities arising on death.
Stephanie Yu, CPA, CA, is a senior associate in the private client services group at PwC in Vancouver, specializing primarily in corporate taxation and estate planning for high-net-worth (HNW) individuals. She would like to thank Colleen Reichgeld, CPA, CA, a tax partner in PwC’s HNW group, for providing valuable input on this article.
- Bill C-43 was introduced in the 2014 federal budget and received Royal Assent on December 16, 2014. It will become effective for deaths occurring after 2015.
- See subsections 118.1(4) and 118.1(5) of Canada’s Income Tax Act (ITA), R.S.C. 1985, c.1 (5th supplement) as amended.
- See new legislation, ITA subsection 248(1). Please note that all subsequent references to the ITA refer to new legislation applicable to deaths that occur after 2015.
- The new legislation also introduced several changes specific to testamentary trusts, the details of which are outside the scope of this article.
- See ITA subsections 118.1(4.1) and 118.1(5.1).
- See ITA subsection 118.1(1) for a definition of “total charitable gifts.”
- See ITA subsection 118.1(5).
- See ITA subsections 118.1(4.1) and 118.1(5.2).
- See ITA subsection 118.1(1) for a definition of “total gifts.”
- It has been an administrative practice of the CRA to allow either spouse to claim donations. This flexibility has now been written into the law under ITA subsection 118.1(c)(i)(A).
- See ITA subsection 38(a.1)(ii).
- See ITA subsection 104(13.4). Changes to this subsection are included in the new legislation pertaining to trusts. The extensive changes to this section are outside the scope of this article.
- These are common post-mortem plans used to prevent double tax on private company shares on death. The details of these plans are outside the scope of this article.