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Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP (416- 218-1491) Bruce Harris - PricewaterhouseCoopers LLP (416- 218-1403) Elena Hoffstein - Fasken Martineau DuMoulin LLP (416-865-4388) Patricia Robinson - Goodmans LLP (416-597-4144)

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Page 1: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Tax rules RULE in drafting Wills and Trust Terms

SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUMOCTOBER 21, 2005

Kathy Munro - PricewaterhouseCoopers LLP (416-218-1491)Bruce Harris - PricewaterhouseCoopers LLP (416-218-1403)Elena Hoffstein - Fasken Martineau DuMoulin LLP (416-865-4388)Patricia Robinson - Goodmans LLP (416-597-4144)

Page 2: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study # 1“Inheritance Trust”

NRT

Non-Canadian settlor(only contributor)

Beneficiaries:- Canadian residents

Trustees:- Non-resident

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Page 3: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study #1Inheritance Trust

QUESTIONS:

1. Will the non-resident trust (“NRT”) be subject to proposed 94(3)?

2. Will the beneficiaries be subject to the proposed 94.1 FIE rules in respect of their interest in the NRT?

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Page 4: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study #1Inheritance Trust

• The NRT will not be deemed resident in Canada under proposed 94(3) if:

– Non-Canadian settlor was never resident in Canada (or was resident in Canada <60 months)

– Therefore no “connected contributor” or “resident beneficiary” as defined in proposed 94(1)

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Page 5: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study #1Inheritance Trust

• FIE rules apply “…in respect of a “participating interest” in a “non-resident entity””

• “non-resident entity” is defined in proposed 94.1(1) to include a non-resident trust

• “participating interest” in the case of a non-resident trust is defined in proposed 94.1(1) to mean a “specified interest” in the trust– Therefore, a beneficiary’s interest in the NRT

will be subject to the FIE rules if beneficiary has a “specified interest” in the NRT

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Page 6: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study #1Inheritance Trust

– Interest will not be a “specified interest” if: • Every amount of income and capital of the trust that the

beneficiary may receive at or after that time depends on the exercise by any entity or individual of, or the failure by any entity or individual to exercise a discretionary power

• Impact of default clauses? • OR the beneficiary is a “successor beneficiary” as

defined in proposed 94(1) (as modified by subparagraph (b)(i) of the “specified interest” definition)

– Therefore Canadian’s interest in a NRT must be discretionary or must be drafted as a successor beneficiary to avoid FIE rules

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Page 7: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study #2Will Planning – Creation of NRTs in Wills

Deceased(CanadianResident)

CanadianEstate

Canadian residentexecutors Canadian

ResidentTrust

NRTUS

residenttrust

50%

50%

- Cdn resident beneficiaries

- Cdn resident trustees

- US resident beneficiaries

- US resident trustees

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Page 8: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study #2Will Planning – Creation of NRTs in Will

Question:

• Will the US resident trust be deemed resident in Canada under proposed 94(3)?

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Page 9: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study #2Will Planning – Creation of NRTs in Will

• The deceased individual is not a “resident contributor” to the US NRT since he is not living

• The estate will be a “resident contributor” to the US NRT while the estate exists. Therefore:

• The US NRT will be subject to proposed 94(3) if the estate is in existence on December 31st of the year in which the US NRT is created

• Timing of creation of US NRT in law?• US NRT subject to 94(5) departure tax rule if 94(3)

applies• Planning – draft wills that transfer estate’s assets to new

trusts and the estate should cease to exist to avoid 94(3)• Consider Form T1141 and section 116 requirements

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Page 10: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study #2Will Planning – Creation of NRTs in Will

• 94(3) also applies if US NRT has a “resident beneficiary” • The deceased is deemed to have contributed property to the

US NRT under proposed 94(2)(n). Therefore:– The deceased will be a “connected contributor” to the US

NRT if he was resident in Canada for more than 60 months before his death and

– If US NRT includes any Canadian residents as beneficiaries, other than “successor beneficiaries” or “specified charities”, the Canadian’s will be “resident beneficiaries” and the US NRT will be deemed resident in Canada under proposed 94(3)

• Planning – exclude Canadian’s as beneficiaries or ensure Canadian’s qualify as “successor beneficiaries” or “specified charities”

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Page 11: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study # 3Estate and Spouse Trust Planning

• Rob Brown died owing non-voting Hi/Lo preferred shares and voting non-participating preferred shares of a CCPC (“Holdco”)

• Rob’s will bequeathed the voting preferred shares to a “voting trust” and the Hi/Lo preferred shares of Holdco to a trust for his spouse, Mary

• Under the terms of the will, after the death of Mary:• Certain bequests to related and unrelated godchildren

and certain donations are made and • the residue of the spouse trust is to be held in three

separate trusts for each of Rob’s and Mary’s three children

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Page 12: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study # 3Estate and Spouse Trust PlanningAfter the death of Rob the ownership structure of Holdco is as follows:

SpouseTrust

Inter-vivosFamily trust

Holdco

Vtg p/s Non-vtg p/s Non-vtg c/s

Opco

VotingTrust

- $5 M insurance – joint last to die to pay tax on death

100%

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Page 13: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study # 3Estate and Spouse Trust Planning

Identify the tax issues that would need to be considered and addressed while Mary is living and in designing the “post-mortem” transactions to minimize income tax

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Page 14: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study # 3Estate and Spouse Trust PlanningTax issues to discuss

• Whether the requirements of subsection 70(6) have been met for a spousal rollover:

• Watch out for terms in will that allow non-commercial loans to someone other than the spouse while the spouse is alive

• Consider including a “general override” clause in will that provides that no power given to trustees in the will can be exercized if it causes subsection 70(6) to not apply

• Whether Part VI.1 tax will apply on dividends paid to spouse trust while spouse is living

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Page 15: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study # 3Estate and Spouse Trust PlanningTax issues to discuss

• Whether the “double tax” structure needs to be addressed and if so whether a post-mortem bump or loss carry back plan is to be implemented

• If Holdco can be sold (instead of Opco), then there is no “double tax” in the corporate structure

• If postmortem “bump” is to be used then need to meet technical requirements for bump (family trust may be an issue; a comfort letter has been issued to address some family trust issues – doc #2004-008855)

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Page 16: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study # 3Estate and Spouse Trust PlanningTax issues to discuss• If loss carry back plan is to be used then will need to address:

• Double tax is only avoided if ACB of some of Holdco’s assets is increased (e.g. shares of Opco) – not by redemption of p/s for a note

• Whether the terms of the spouse trust allow it to continue in law for up to three years after the death of Mary to allow the carry back of the loss under section 111

• Whether capital loss carry back plan will result in insufficient income in the year of death and year before death to use donations (in situation where John dies last)

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Page 17: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study # 3Estate and Spouse Trust PlanningTax issues to discuss

• Part VI.1 tax issues on redemption of the preferred shares held by spouse trust

• Consider subsection 191(4)• Watch out for paragraph 191(3)(d)• Consider paragraph 110(1)(k) deduction• In this case the issue (unless subsection 191(4) applies) may depend upon what happens to voting preferred shares and when

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Page 18: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study # 3Estate and Spouse Trust PlanningTax issues to discuss

• Subsection 40(3.6) stop loss rule (note that subsection 40(3.61) does not apply to a spouse trust) and review “new” affiliated person rules in section 251.1

• The issue is whether the spouse trust is affiliated to Holdco immediately after the redemption

• If de jure control is held by voting trust, is the spouse trust affiliated to Holdco?

• Watch out for “de facto” control of Holdco and that “control” for affiliation includes de facto control

• Subsection 112(3.3) stop loss rule regarding insurance and other CDA of Holdco or Opco

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Page 19: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study # 3Estate and Spouse Trust PlanningTax issues to discuss

• Acquisition of control rules• Is a spousal trust part of the estate for clause 256(7)(a)

(i)(C)?• Is the voting trust part of the “estate” for clause 256(7)

(a)(i)(C)?• Will clause 256(7)(a)(i)(D) apply if voting shares are

distributed from voting trust?• Impact of a change of trustee – see CRA doc#2004-

008776 and question 7 of CRA Sept 2005 roundtable• Do we care if the “acquisition of control rules” apply in

this case?

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Page 20: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study # 3Estate and Spouse Trust PlanningTax issues to discuss

• Donation claims by spousal trust are problematic based on CRA’s stated position:

• No donation if charity receives property as a capital beneficiary – trustees should have discretion to make donations from spouse trust after death of spouse

• Matching tax with donation – timing issue

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Page 21: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study #421 year rule planning

• Harvey Smith settled the Smith Trust with a $100 bill 20 years ago

• Harvey’s son John, Mary Smith (John’s spouse) and John’s children and grandchildren are the discretionary beneficiaries

• Trustees of the trust are John, Mary and a family friend• John and Mary have 4 children and 6 grandchildren• All of the beneficiaries live in Canada with the exception of

John’s son Stanley, who is a resident of Israel and John’s daughter Barb who is a resident of the U.S.

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Page 22: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study #421 year rule planning

• The trust owns all of the common shares of Holdco, which the trust purchased 20 years ago upon the estate freeze of John’s interest in Holdco – shares were purchased with a bank loan

• The current fair market value of the common shares is $8 million

• John owns the voting preferred shares of Holdco • Holdco owns:

• investment portfolio that has a current FMV of $3 million• Canadian rental properties that are leased to arm’s length

persons• 100% of the shares of Opco that have an FMV of $15

million

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Page 23: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study #4Current Structure

Smith Trust

Holdco

Opco

John

100% c/sVoting p/s

100% CSFMV ≈ $15M

DiscretionaryBeneficiaries:

• John• Mary• 4 children – 2 non-resident• 6 grandchildren

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Page 24: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study #4Issues to discuss• Holdco shares must be distributed to Canadian resident

beneficiaries prior to 21st anniversary to avoid realization of accrued gain on shares

– How discretionary is a discretionary trust?• Review trust terms to ensure 75(2) has never applied to trust

– If 75(2) applied and individual is still alive, 107(4.1) will deny rollout of Holdco shares to any person

• No tax-deferred rollout if shares distributed to non-resident children/grandchildren:

– Part XII.2 tax of 36% would apply to taxable portion of gain (“TCG”) unless the trust elects under 107(2.11) to have the TCG taxed in the trust under Part 1

– If no 107(2.11) election is made, the after tax portion of the TCG would be subject to Cdn withholding tax

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Page 25: Tax rules RULE in drafting Wills and Trust Terms SENIOR ESTATES AND TRUSTS PRACTITIONERS FORUM OCTOBER 21, 2005 Kathy Munro - PricewaterhouseCoopers LLP

Case Study #4Tax Issues to discuss (cont’d)• Possible planning:

– Post security for unpaid tax – subsection 220(4.6) – Non-resident children incorporate a Canadian company

(“Canco”) and trust distributes a portion of Holdco shares to Canco in satisfaction of its capital interest – trust terms must include corporations as beneficiaries or trust terms must be varied – consider tax implications of variation to add new beneficiaries, or

– Non-resident children transfer capital interest in trust to Canco and the trust distributes a portion of the shares to Canco:

• CRA may apply GAAR (see ATR #2002-0136333 where CRA would not rule that GAAR would not apply

– Consider tax consequences in foreign jurisdiction

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