Cleansing Tainted Trusts
A qualifying spousal trust could inadvertently lose its special status by inadvertently putting capital in the hands of persons other than the spouse. In such situations, the Income Tax Act of Canada provides relief in two ways.
First, if the only third party receiving money is receiving that money for the purpose of the payment of any estate or income taxes with respect to the trust property, the trust is deemed to not be tainted (ITA, s. 108(4)).
Second, if the trust is tainted only because it provides for the payment of other specified debts, the ITA sets out a procedure for “cleansing” the trust. Essentially, the law regards trust assets with sufficient value to pay those debts to be regarded as having been disposed of at fair market value, and the remaining assets may be rolled over.
Created as a consequence of the death of a taxpayer in the same manner as an outright transfer, a qualifying spousal trust is subject to the same requirements of indefeasible vesting. That is, a property transferred to a qualifying spousal trust becomes subject to tax when it is in fact disposed of by the trust, and is subject to deemed realization when the surviving spouse dies, or when, during the lifetime of the surviving spouse, the trust transfers the property to a person other than the spouse (ITA, s. 107(4)).
Intergenerational Transfer of Farm Property
The taxpayer has another option. Immediately before his or her death, a taxpayer could also transfer property used by him or her, or his or her spouse or child, in the business of farming, or to his or her child resident in Canada on a rollover basis, subject again to the 36 month indefeasible vesting rule. When farm property is transferred to a qualifying spousal trust, the farm rollover will apply on the death of the spouse so long as immediately before the spouse’s death the property was used in the business of farming, and as a consequence of the spouse’s death, it has become vested indefeasibly in a resident child of the taxpayer.
Election to Avoid the Spousal Rollover
Election of assets subject to the deemed disposition rule is also possible, even when a spousal rollover is available (ITA, s. 70(6.2)), as to make this election with respect to some, but not all, of the deceased’s assets. This might make sense for an estate when such an election would have little negative impact on the deceased spouse (for example, he or she could have unused losses) and would have a positive impact (eventually) on the surviving spouse by increasing his or her cost base.
Don’t do anything before fully understanding your rights and obligations. Contact the lawyers at Levy Zavet PC (Levy Zavet) in Toronto, Ontario for more information about trusts and for all of your personal and business tax law needs.