Canadian Tax

New Trust Tax Reporting Rules

There are new trust reporting requirements beginning in 2021. For the 2021 taxation year and beyond, most trusts will be required to report additional information to Canada Revenue Agency (“CRA”) regarding the beneficial ownership of the trust. This enhanced reporting requirement stems from a global effort to improve the transparency of corporate structures through beneficial ownership. Please note, these new trust reporting requirements are not applicable to Graduated Rate Estates. A Graduated Rate Estate is an estate that arises as the result of the death of a person on or after December 31, 2015, for 36 months after the person’s death.

With these new reporting requirements, the trust will be required to include a new schedule with its annual T3 return reporting the identity of all trustees, beneficiaries and settlors of the trust, as well as the identity of each person who has the ability to exert control over the trustees’ decisions regarding the distribution of income or capital of the trust. The specific information that must be provided regarding the identity of each person is as follows:

• Full name,
• Address,
• Date of birth (if an individual),
• Jurisdiction of residence, and
• Taxpayer identification number (e.g. Social Insurance Number).

Any person listed or acting as trustee or beneficiary of the trust in the calendar year 2021 will need to have the above information disclosed to CRA. In order to avoid the disclosure of a person’s information, that person cannot be a trustee or beneficiary of the trust after December 31, 2020. Before a beneficiary or trustee gives up their position or interest in the trust, please consult with your Baker Tilly advisor to ensure there are no negative tax consequences.

The responsibility to report this additional information is placed on those individuals that administer the trust (e.g. trustees or executors). Any false or omitted information or non-filing of the information can result in a penalty assessed to the trust.

For further details on how to prepare for the new rules, see the additional information in Appendix A below.

Please note, if you believe that your trust no longer serves a purpose, it may be preferable to formally wind up the Trust prior to December 31, 2020 so that the trust does not need to comply with the new trust reporting requirements. The wind up of a trust can have significant tax consequences, so should you desire to wind up the Trust, please your Baker Tilly advisor as at your earliest convenience to assist with tax planning and providing instructions to your lawyer.

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In times of crisis, people can be opportunistic, and this economic turmoil can allow for certain tax planning opportunities. The current economic downturn caused by the COVID-19 pandemic has negatively affected the valuation of many Canadian businesses. Accordingly, it is wise to revisit any estate freeze transactions that may have been implemented at a time in a prior year when the economy was booming.

What is an estate freeze?

An estate freeze is an estate planning technique by which the current value of shares in the capital stock of a private corporation is frozen and locked-in for one individual (commonly a parent) with any future increase in value of a private corporation accruing to another (e.g., the parent’s children or a trust settled for the benefit of their children).

An estate freeze is typically structured such that the parent retains control of the private corporation by exchanging, on a tax-deferred basis, their common shares of the corporation for voting, fixed value, redeemable and retractable preference shares, with the newly-issued common shares going to the children or a trust settled for the benefit of the children. The redemption value of the preference shares will be equal to the value of the old common shares at the time of the exchange.

The parent effectively divests themselves of the future growth in the value of the private corporation on a tax-deferred basis. In doing this, the parent is able to limit their potential capital gain upon death to the value at the time the freeze was executed.

Why a “refreeze” transaction?

In some cases, an estate freeze is undertaken at a time when the economy is booming, and the value of a private corporation is high. However, in times of an economic downturn, it may turn out that the value of the frozen corporation has since declined. This could result in situations where the redemption value of the preference shares that were issued on the initial estate freeze are higher than the company’s current market value. Under these circumstances, a “refreeze” transaction could be considered.

Types of “refreeze” transactions

There are a few different methods of implementing a “refreeze” transaction, but the most common method is having the holder of the high value preference shares exchange such shares for new preference shares, which would have a fixed redemption value equal to the currently declined value of the company. This exchange may be done on a tax-deferred basis.

Benefits of a “refreeze” transaction

The following are some of the benefits of implementing a “refreeze” transaction:

• A lower locked-in value will reduce the shareholders’ tax resulting from the deemed disposition that will occur upon their death in the event the company’s value rebounds.
• A lower locked-in value may allow dividends to be paid on other preference or common shares that could be restricted under the circumstances. Most preference shares issued in an estate freeze transaction have what is commonly referred to as a “non-impairment” clause. This clause prevents the payment of dividends on other shares of a corporation if the payment of such a dividend would impair the ability to redeem the “estate freeze” preference shares. The lower value of the new re-freeze preference shares may now allow for the payment of dividends and thus potentially improve income splitting opportunities. Any income splitting through corporate structures would be subject to the tax on split income (TOSI) rules.
• A lower locked-in value prior to the holder’s death may avoid issues with the Canada Revenue Agency (CRA) challenging the fair market value of the company upon an audit of the deceased’s terminal income tax return.  The “refreezing” effectively resets the redemption value of the preference shares. This lower redemption amount will be set by a directors’ resolution confirming the value and new redemption amount.

Providing the CRA with a copy of a bona fide directors’ resolution is more advantageous than trying to argue with them that the market value at time of death is below the documented redemption value of the preference shares. The CRA will likely presume that the original redemption amount is equal to the current value of such shares and assess a higher tax balance. Undertaking a refreeze transaction may allow the deceased estate’s executors and advisors to avoid such conflicts with the CRA.

• Similar to avoiding conflicts with the CRA, refreezing to a lower value prior to a marital breakdown may reduce any net equalization payments and avoid the additional aggravation in trying to refute that the original redemption amount is higher than the shares’ value at the time of the breakdown.

The CRA’s view on refreeze transactions

In the past, the CRA’s view was that if a refreeze transaction was implemented, a benefit to the common or preferred shareholders may result. However, recently in document 2010-0362321C6 dated June 8, 2010, the CRA clarified its administrative policy on whether a shareholder benefit is conferred as a result of an estate refreeze transaction.

In that document, the CRA stated that a benefit is not conferred on the common or preferred shareholders of a corporation that implement an estate refreeze transaction provided that the decrease in value of the corporation is not the result of stripping the company of corporate assets and the value of the new preferred shares is equal to the value of the old preferred shares at the time of the refreeze.

The CRA provided examples of what it views as “corporate asset stripping” and it listed the following two examples:

1. Dividends that would be paid by the corporation on the common shares of its capital stock and that would impair the value of the original freeze’s preferred shares (i.e., contravening the non-impairment clause typically found in the attributes of most preferred shares issued in an estate freeze transaction); and
2. The payment by the corporation of a bonus or salary to the beneficiary of the freeze in connection with a post-freeze asset sale by the corporation, and such a bonus or salary is not commensurate with the value of the services performed and the responsibilities assumed by the beneficiary of the freeze.

Therefore, no benefit should arise where a corporation pays dividends if the dividends paid out do not impair the value of the original freeze preference shares and the corporation has sufficient retained earnings. However, the risk that the CRA assumes the decline in value occurred because of the dividends is higher if the refreeze is carried out shortly after dividends are paid.

The payment of bonuses and salaries should not negatively impact a refreeze transaction undertaken shortly after the payment, provided that such a bonus or salary is commensurate with the value of the services performed by the recipient.

Finally, it is highly recommended that any holder of preference shares that have declined in value should engage a Chartered Business Valuator to support such an impairment in the event that the CRA scrutinizes the valuation and attempts to assert that there has been no such decline in value.

The COVID-19 pandemic has resulted in a significant economic downturn that has led to devaluations of many private corporations. However, this may prove to be an opportunity for some to modify a previously implemented estate freeze and possibly reduce future taxes.

In today’s business and social environment, more and more owner-managers are struggling to keep their businesses alive. Many find it necessary to inject capital, including personal funds, into their companies. These funds might come from mortgaging their home, drawing on personal credit lines, or even friends and family. But investing in a business when there is an increased risk of struggle or failure requires that any investment should be planned with potential future loss in mind. Where such investments are made to private corporations, the investors or owner-managers may be entitled to a special type of loss known as a business investment loss (BIL). A BIL is a type of capital loss with one important advantage.

Advantage to claiming a BIL

Unlike regular capital losses, which may only be applied against capital gains, a BIL may be applied against any source of income. The deductible portion, which is equal to 50 per cent of the loss, is called an allowable business investment loss (ABIL). If the loss exceeds other sources of income for the current year, the remainder becomes a non-capital loss for that year, and may be carried back three years and carried forward ten years. If it cannot be deducted within that time frame, it becomes a net capital loss and may be applied against future taxable capital gains.

When does a loss become a BIL?

A BIL occurs when a taxpayer disposes (or is deemed to dispose) of either of the following types of qualifying property:

• debt owed by a small business corporation (SBC)¹; or
• shares of an SBC.

BIL – actual disposition

A BIL includes a capital loss from a disposition to an arm’s-length person of:

• a share of the capital stock of an SBC; or
• debt in a Canadian-controlled private corporation (CCPC) that is¹:
• an SBC;
• bankrupt and that was an SBC at the time it became bankrupt; or
• a corporation that was insolvent and an SBC at the time a winding-up order was made in respect of the corporation.

Generally, an SBC is a CCPC in that all or substantially all of the fair market value of its assets is attributable to assets used principally in an active business carried on primarily in Canada by the corporation or by a corporation connected to it, or debt or shares in other SBCs. The Canada Revenue Agency interprets “all or substantially all” as usually meaning 90 per cent or more. Although these criteria can be met at the time of the disposition of the shares or debt of the corporation, the corporation can also qualify as an SBC if it meets the criteria at any time in the 12 months preceding the disposition of the shares or debt.

A BIL can also occur when a taxpayer is required to repay a debt of a corporation resulting from a guarantee made by the taxpayer. The loss will qualify as a BIL only where the lender was an arm’s-length party and the corporation was an SBC both at the time the debt was initially incurred and at any time during the 12 months before an amount first becomes payable under the guarantee.

BIL – deemed disposition

In addition, a loss on a “deemed disposition” of the debt or shares, does not require an arm’s length party in order to qualify as a BIL. As long as a taxpayer makes a prescribed election in their tax return, a deemed disposition will occur in respect of:

• a debt owing to the taxpayer at the end of a taxation year that is established to be a “bad debt” (it is wholly uncollectable) in the year; or
• a share in a corporation owned at the end of the year, where:
• the corporation has become bankrupt during the year;
• the corporation is insolvent and a winding-up order has been made in the year; or
• the corporation is insolvent, neither the corporation nor a corporation controlled by it carries on business, the fair market value of the share is nil, and it is reasonable to expect that the corporation will be dissolved or wound up and will not carry on business again.

When a taxpayer makes this election, there will be a deemed disposition of the qualifying property for $nil proceeds, which will result in a capital loss on the share or debt, leading to the BIL.

ABIL – reduced by previous capital gains exemption claimed

The amount of an individual’s ABIL is reduced to the extent that the individual previously claimed the capital gains exemption. That exemption allows an individual to receive tax-free capital gains of up to $883,384 for 2020 ($441,692 for taxable capital gains) during their lifetime from disposition of certain types of property, such as qualified SBC shares.

The reduced BIL remains a capital loss, one-half of which is an allowable capital loss that may be deducted against taxable capital gains.

Procedure for claiming a BIL

BILs must be recorded on a taxpayer’s income tax return for the taxation year in which the business ceased active operations. In addition, for a deemed disposition to occur, the taxpayer must file an election stating that the taxpayer wants the deemed disposition rules to apply. The election should be filed with the income tax return on time to avoid relying on the Minister’s discretion to accept a late-filed election. Be careful not to wait too long when deciding whether to file the election. The election deems the loss to have occurred at the end of the claimant’s taxation year; if the business ceased active operations more than 12 months prior to that deemed date, the BIL will be denied.

The CRA tends to audit BILs regularly. It is thus important to maintain proper supporting documentation. A BIL requires that the loan be made for the purposes of earning income. One way to ensure this requirement has been met is to charge an appropriate rate of interest on the loan. It is prudent to have that stipulation documented in writing in a loan agreement or other contract, along with supporting documentation showing the actual cash advance.

The 2019 federal budget introduced two new capital cost allowance classes (class 54 and class 55) providing an accelerated write-off of 100 per cent of the purchase price for new zero-emission vehicles purchased on or after March 19, 2019, and made available for use before 2024. This accelerated write-off is to be phased out between 2024 and 2028, and the write-off of zero-emission passenger vehicles is capped at $55,000 per vehicle.

The current definition of zero-emission vehicle used for classes 54 and 55 refers to an automotive vehicle designed or adapted to be used on highways and streets.

On March 2, 2020, the federal government proposed an amendment to add a third class providing an accelerated write-off of 100 per cent of the purchase price for eligible zero-emission automotive equipment and vehicles that currently do not meet the definition used in classes 54 or 55. The automotive equipment and vehicles would be included in new Class 56. The government intends, at an early opportunity, to introduce in Parliament a legislative proposal to implement the amendment.

To be eligible for this enhanced first-year allowance, a vehicle or equipment must be automotive (i.e., self-propelled) and fully electric or powered by hydrogen. Vehicles or equipment that are powered partially by electricity or hydrogen (e.g. hybrid vehicles and vehicles that require human or animal power for propulsion) would not be eligible.

Class 56 would apply to eligible zero-emission automotive equipment and vehicles that are acquired on or after March 2, 2020, and that become available for use before 2028, subject to a phase-out for equipment and vehicles that become available for use after 2023 (as shown in Table 1). A taxpayer would be able to claim the enhanced allowance in respect of an eligible zero-emission automotive equipment or vehicle only for the taxation year in which the equipment or vehicle first becomes available for use.

Table 1. Rates for the enhanced first-year allowance

	Enhanced first-year allowance
Announcement day – 2023	100%
2024 and 2025	75%
2026 and 2027	55%
2028 onward	–

Capital cost allowance would be deductible on any remaining balances in Class 56 on a declining-balance basis at a rate of 30 per cent. An election would be available to forgo Class 56 treatment and instead include property in the class in which it would otherwise be eligible.