Budget 2013 proposes to amend the rules with respect to non-resident trusts to ensure that Canadian resident taxpayers who contribute property to a non-resident trust and maintain control over the trust will be taxed on the income and capital gains derived from the property, even if the property was transferred to the trust for fair market value consideration or loaned to the trust on commercial loan terms.
These proposed changes are designed to overrule The Queen v Sommerer. In that case, both the Federal Court and the Federal Court of Appeal held, among other things, that there was no attribution of capital gains back to Mr. Sommerer on the sale of shares by a non-resident trust, even though Mr. Sommerer had sold the shares to the trust and was an ultimate beneficiary of the trust, because he had sold the shares to the trust for fair market value and therefore could not be considered to be a person who had contributed property to the trust.
To avoid the Sommerer result in the future, Budget 2013 proposes to effectively apply the trust attribution rules in subsection 75(2) of the Income Tax Act (Canada) (the "Tax Act") to non-resident trusts with modifications to capture any transfer or loan.
Subsection 75(2) which applies to attribute income and losses and capital gains and capital losses earned or realized by a trust with respect to a property (or substituted property) back to the person who transferred the property to the trust if any of certain conditions are met. The conditions (the "s. 75(2) conditions") are that:
the property or property substituted for it may
- revert to the person from whom the property (or substituted property) was directly or indirectly received, or
- pass to persons to be determined by the transferor after the trust was created, or
- the property is held on condition that, during the existence of the person, the property shall not be disposed of without the person's consent or in accordance with the person's direction.
This provision is very broad, and would cause attribution, for example, if an individual transferred securities to a trust of which the individual was the trustee with the right to subsequently decide which of his children would receive income or capital from the trust. The underlying theory is that if any of the s. 75(2) conditions apply, the person has continued to maintain control over the property and should continue to be regarded as the owner.
Other provisions of the Tax Act would cause a non-resident trust to be deemed to be a Canadian resident trust (and thus subject to Canadian income tax) if certain conditions are met. One of the conditions under which a non-resident trust could become subject to Canadian income tax is if a person resident in Canada contributes property to the non-resident trust.
Budget 2013 proposes to revise subsection 75(2) to make it applicable only to trusts resident in Canada and also to revise section 94 (pertaining to non-resident trusts) by providing that if any of the s. 75(2) conditions apply, any transfer or loan to the trust will be treated as a contribution to the trust by the Canadian resident transferor or lender. The deemed residence rules would then apply so as to deem the trust to be resident in Canada and subject to Canadian income tax.
A further provision of the Tax Act states that trusts to which subsection 75(2) apply are deemed to sell trust property at fair market value (thus realizing any inherent capital gains) if property of the trust is transferred to anyone other than the person referred to in the s. 75(2) conditions. Budget 2013 proposes to extend this deeming rule to non-resident trusts if the s. 75(2) conditions apply to the non-resident trust.
All of these provisions are to apply to taxation years that end on or after March 21, 2013. As trusts created other than as a result of an individual's death have a December 31 year end, if these proposals are passed as presented, these provisions will apply to attribute income and gains on property transferred in 2013 prior to the announced measures, which may have not otherwise been subject to any attribution rule. In this regard, the proposed measures have retroactive effect.