You just found out that you, along with your sister, were named as the co-beneficiaries on your late father’s registered retirement income fund (RRIF). You each received nearly $100,000, equal to half the fair market value of your late father’s $200,000 RRIF. You pay off your mortgage, perhaps buy a new car, and go on a three-week African safari, only to return home to find a letter from the taxman demanding you turn over the full $100,000 you received as the beneficiary of dad’s RRIF. Your sister receives a similar letter.
If this Kafkaesque twist of fate seems implausible, you may wish to take heed of a recent Tax Court of Canada case, decided last week, involving two sisters, their late father’s RRIF and the Canada Revenue Agency.
The facts
The sisters’ father died on June 8, 2011. Prior to their father’s death, he designated each of his daughters as co-beneficiaries of his Life Income Fund (LIF). A LIF is a type of RRIF that is used to hold locked-in pension funds. In his last will and testament, the father also named his daughters as trustees, executrices and beneficiaries of his estate.
Approximately seven weeks later, on July 26, 2011, $96,641 was transferred to each of the sisters from the LIF. The problem was that at the date of transfer, the father had an outstanding tax liability owing to the CRA for the 2011 tax year that was greater than $96,641. The sisters were each assessed $96,641 under the special non-arm’s length transfer rule of the Income Tax Act for monies each of them received from their late father’s LIF.
The law
Under the special non-arm’s length transfer rule, if an individual has transferred property, “directly or indirectly, by means of a trust or by any other means whatever,” to their spouse, partner, a minor, or a non-arm’s length person, the transferee and transferor are “jointly and severally … liable” to pay any taxes owing to the CRA, up to the value of the property that was transferred.
A non-arm’s length person is defined in the IncomeTax Act and includes “related persons.” For the purposes of the Act, related persons are individuals connected by blood relationship, marriage or common-law partnership or adoption. Persons are connected by blood relationship if one is the child or other descendant of the other or one is the brother or sister of the other.
The primary purpose of the non-arm’s length transfer rule is to prevent a taxpayer from transferring their property to a related person in order to frustrate the CRA’s efforts to collect tax that is owed by the taxpayer. The rule acts as an important collection tool because it “thwarts attempts to move money or other property beyond the tax collector’s reach by placing it in presumably friendly hands.”
No longer related?
While the sisters admitted that their father may have “indirectly transferred property” to them and that he died owing significant tax, they attempted to argue that the transferor (their father) and the transferees (the sisters) were dealing with each other at arm’s length at the time of the transfer. They based their argument on the fact that while their father died on June 8, 2011, they only received the LIF proceeds on July 26, 2011. In other words, their position was that “at the time of the transfer (their father) was now dead, did not exist, and therefore he was not a related person within the meaning of (Tax Act), and he therefore was not in a blood relationship with them and therefore was at arm’s length at all times, to the extent that he can of course again even be said to exist.”
The CRA disagreed saying that the sisters had “a non-arm’s length relationship by blood … (as they were) daughters of the deceased, and that’s a relationship that is not by contract…. That’s a relationship that cannot be taken away.”
The ruling
The judge first reviewed whether the non-arm’s length transfer rule could even apply to amounts received under a registered plan, such as an RRSP, RRIF or even TFSA. Finding that it could, the judge cited prior jurisprudence, which concluded that “the words ‘directly or indirectly, by means of a trust or by any other means whatever’ used in (the Act) are language broad enough to capture the passing of an entitlement to an RRSP from one person to another by way of a designation.” He concluded this would apply to an RRIF as well.
The next question was whether the daughters were related to the taxpayer, their father, who was now deceased. The judge quoted the Tax Act, which unequivocally states that persons are connected by blood relationship if one is the “child or other descendant” of the other. As the judge wrote, “There is no ambiguity in the wording of this provision. A parent and his or her children are connected by a blood relationship…. This relationship did not end on (the father’s) death. The (sisters) continue to be the children of (their father.)”
Since the sisters accepted the fact that their father transferred the LIFs to them, this is simply “a transfer from a father to his children. It does not matter that the transfer began before his death, crystallized on his death and was completed after his death. It was a transfer between persons connected by a blood relationship. Such persons are deemed … not to deal with each other at arm’s length. Thus the transferor (the father) transferred the property to persons (his daughters) with whom he did not deal at arm’s length.”
The judge concluded that the non-arm’s length transfer rule applied to each of the transfers from the father to his daughters and found in favour of the CRA, which had the right to collect the LIF proceeds from each daughter in satisfaction of their late father’s debt to the CRA.