Recent tax rulings may affect how estates should be handled
by Jamie Golombek
This past summer, the Canada Revenue Agency (CRA) released a technical interpretation and an Advance Tax Ruling both dealing with estate issues that raise common questions often asked by advisors and their clients.
Gifts in lieu of executor's fees
The technical interpretation (2007-0225651E5) dealt with a situation in which the beneficiaries of the estate (other than the executor) would make a gift to the executor "in lieu of" the compensation to which the executor would otherwise be entitled.
Since, under the Income Tax Act, executor's fees are generally taxable and a gift is non-taxable, the CRA was asked whether the above strategy was a legally tax-effective way to avoid tax that would otherwise be owing on executor compensation received.
Note that this scenario is likely referring to a situation in which the executor is not also a beneficiary under the estate. Where the executor is also a beneficiary under the estate, see the CRA's comments, discussed below.
The CRA explained that a gift is generally defined as "a voluntary transfer of property without consideration". Since there is indeed consideration in the form of services provided by the executor to the estate, the resultant transfer of property from the beneficiaries to the executor would not be considered to be a gift but rather viewed by the CRA as a "barter transaction".
Barter transactions, discussed in detail in CRA's Interpretation bulletin IT-490, are fully taxable under the Act and, accordingly, the value of the property received is taxable either as employment or business income.
A full discussion of the tax treatment of an executor's fees can be found in CRA's archived Interpretation Bulletin IT-377R, "Director's, Executor's and Juror's Fees".
On a positive note, however, the CRA added that quite often an executor who is a family member or friend of the deceased will choose not to exercise his or her right to compensation. In that case, the CRA acknowledged that if that individual also happens to be a beneficiary of the estate, the mere fact that he or she has waived his or her right to compensation would not, in and of itself, cause any portion of the bequest to be taxable.
Bargain purchase under a will
The Advance Tax Ruling (2007-0232421R3) involved another common scenario whereby the beneficiary of an estate purchases an asset from the estate for less than fair market value.
While the exact facts and specific details of the scenario discussed in the ruling have been deleted by the CRA to protect the taxpayer's privacy, it is possible to reconstruct the basic fact pattern through the following example.
Martha owned a vineyard and cottage in the Okanagan region at the time of her death. The property was valued at $1.2 million and she had purchased it years ago for $200,000 (her adjusted cost base or ACB).
In her will, Martha specified that her son, Stewart, had the option, but not the obligation, to purchase the property to be used in his retirement from her estate for $220,000, which Martha estimated should be sufficient to cover the capital gains tax owing on the accrued appreciation from the date of purchase to the date of death (i.e., [$1,200,000 - $200,000] X 22 per cent capital gains tax in B.C.).
Stewart decides to purchase the property, pays $220,000 to the estate for the property and the property is transferred from the estate into Stewart's hands.
The estate's executor files the terminal income tax return, reporting the deemed disposition of all property including the vineyard/cottage and uses the $220,000 to pay the tax liability thereon.
The CRA confirmed in its response to the ruling request that under the Income Tax Act, the property will be deemed to be disposed of by Martha in her terminal year at its FMV of $1.2 million, the value immediately before death.
This amount also forms the ACB of the property to her estate. The CRA further confirmed that the estate (which is a trust for tax purposes) can use the roll-out provision of the Act to transfer the property to the beneficiary of the estate - Stewart - at its new ACB of $1.2 million, despite the fact he only paid $220,000.
Thus the CRA confirmed that the estate won't realize a capital gain nor loss on the disposition of the property to Stewart and Stewart's new ACB of the property will be $1.2 million, the ACB of the property to the estate.
As a result, should Stewart later dispose of the property to a third party, he would only pay tax on any additional market appreciation above $1,200,000, despite him having paid merely $220,000.
Stewart won't complain about that!