Last November, we blogged about the coming-into-force on January 1, 2016 of new subsection 104(13.4). We warned that the legislation, if not amended, would have a “catastrophic and devastating effect on many estate plans involving alter ego trusts, joint spousal and common-law partner trusts, and spousal and common-law partner trusts” (collectively “Life Interest Trusts”).
Briefly, subsection 104(13.4) deemed a Life Interest Trust’s income for a year as a result of the death of the last surviving life interest beneficiary (a “Life Interest Beneficiary”) to have become payable to the Life Interest Beneficiary in that year. In effect, the Life Interest Beneficiary’s estate would be subject to the tax liability arising from the deemed disposition of the assets of the Life Interest Trust on the death of the Life Interest Beneficiary. This is problematic, firstly, because the tax liability of the Life Interest Trust would be effectively borne by the beneficiaries of the Life Interest Beneficiary’s estate who may not be beneficiaries of the Life Interest Trust and, therefore, do not benefit from the assets giving rise to the deemed capital gains and attendant income tax liability. Secondly, subsection 104(13.4) could also result in the “stranding” of donation tax credits generated from charitable gifts given by a Life Interest Trust.
On January 15, 2016, the Department of Finance released new legislative proposals relating to the taxation of trusts and estates. Newly proposed paragraph 104(13.4)(b.1) states that the rules in subsection 104(13.4) will not apply to a trust unless:
(ii) the trust is, immediately before the death, a testamentary trust that
(A) is a post-1971 spousal or common-law partner trust, and
(B) was created by the will of a taxpayer who died before 2017, and
(iii) an election—made jointly between the trust and the legal representative administering the individual’s graduated rate estate in prescribed form—that paragraph (b) applies is filed with,
(A) the individual’s return of income under this Part for the individual’s year, and
(B) the trust’s return of income under this Part for the particular year; and…
The application of subsection 104(13.4) is now completely elective and applicable only to testamentary spousal trusts in respect of deaths prior to 2017. Presumably, rather than simply repeal subsection 104(13.4), the subsection will continue to exist it this vestigial form so as to not adversely impact taxpayers who have planned into the application of subsection 104(13.4) as part of their estate planning. Subsection 104(13.4) will, however, live only in the tax history books after 2016.
Subsection 104(13.4) had been a topic of much discussion among tax and estate practitioners throughout 2015, with much commentary written discussing the negative side-effects it could have had on the taxation of trusts and estates. It is encouraging that Finance appears to have heard the emphatic calls from the tax community to amend or repeal the provision, showing that the sizable amount of ink was not spilled in vain.
Further explanatory notes about the new proposals can be found here: