Canada: Loss restriction events for the family trust
27 January 2015
Posted by: Author: Ken H. Jiang
Author: Ken H. Jiang (Thorsteinssons LLP, Vancouver)
Assume that a non-beneficiary of a trust previously qualified as a majority-interest beneficiary (hereinafter, a "deemed majority-interest beneficiary”) because he or she was affiliated with a person who held more than 50 percent of the FMV of the trust’s capital or income interests. A recent TI confirms that if that person actually acquires more than 50 percent of the FMV of the trust’s capital or income interests, that change should not trigger a loss restriction event for the trust under section 251.2, either technically or from a tax policy standpoint.
A loss restriction event applies to a trust when a person becomes the majority-interest beneficiary (paragraph 251.2(2)(b)). Generally, a majority-interest beneficiary is a person (or an affiliated person) who holds a beneficial interest that constitutes at least 50 percent of the FMV of all of the trust’s income or capital interests. A loss restriction event may trigger undesirable tax consequences, such as the application of loss-streaming rules to the trust, a deemed year-end of the trust immediately before the loss restriction event, and a deemed acquisition of the control of any trust-controlled corporation at the time of the loss restriction event.
The loss restriction event rules are intended to limit trust loss-trading transactions that typically involve the arm’s-length acquisition of an interest in a trust that has unused losses in order to set off those losses against the acquiror’s future income. Previously, only a corporation was subject to rules that constrain loss trading; section 251.2 extends similar rules to trusts. According to the 2013 budget, the loss restriction event rules are not intended to apply to typical transactions that involve changes in a family trust’s beneficiaries due to the continuity-of-ownership rules (but the comment implies that some typical transactions will trigger a loss restriction event). Moreover, the budget said that the result reflected appropriate tax policy. A number of mechanisms in section 251.2 prevent loss restriction events from applying when a family member becomes a trust beneficiary, and they are thus in keeping with that tax policy. One exception applies if the new beneficiary was a deemed majority-interest beneficiary before he or she actually acquired a trust interest.
Under subsection 251.1(3), a non-beneficiary may nonetheless be deemed to be a majority-interest beneficiary: the term’s definition is fulfilled if the person meets the required ownership of actual (if any) and attributed (from affiliated persons) ownership of income and capital interests, which have an FMV greater than 50 percent of all trust interests. The phrase "if any” in subsection 251.1(3) appears to permit a non-beneficiary to qualify as a majority-interest beneficiary if he or she is affiliated with persons who hold sufficient trust interests to surpass the 50 percent FMV threshold.
In TI 2014-0534841C6 (October 10, 2014), the taxpayer’s wife had an income interest that represented more than 50 percent of all income interests. The CRA concluded that because the taxpayer was affiliated with his wife, he was thus a majority-interest beneficiary even though he actually held no trust interest. The CRA said that the definition of "majority-interest beneficiary” is substantially similar to the definition of "majority-interest partner”: a majority-interest partner need not be a partner, and thus a majority-interest beneficiary need not be a trust beneficiary.
The TI’s conclusion indicates that if the husband became an actual beneficiary, a loss restriction event should not be triggered—regardless of the nature of interest acquired by the husband—because he was already a majority-interest beneficiary. This conclusion should apply whenever two persons are affiliated, including natural persons connected by blood relationship, marriage or common-law partnership, or adoption (the expanded meaning of "affiliated” in subparagraph 251.2(5)(a)(ii)).
Assume that a trust beneficiary holds more than 50 percent of the trust’s income or capital interests. The following persons are affiliated with that beneficiary, and each is a majority-interest beneficiary for the purpose of the loss restriction rules, even if any of them is not actually a trust beneficiary: (1) a child and grandchild and a spouse of either of them; (2) a parent and a grandparent; (3) a sibling and his or her spouse; (4) a spouse and his or her parent, grandparent, and sibling; and (5) a corporation controlled by the beneficiary or by his or her spouse.
Assume that a majority-interest beneficiary who actually owns more than 50 percent of a trust’s income interests has a child who later becomes an actual majority-interest beneficiary by acquiring ownership of more than 50 percent of the trust’s capital interests. The child’s becoming an actual majority-interest beneficiary is not a loss restriction event, because the child was already a deemed majority-interest beneficiary by virtue of the parent’s being an actual majority-interest beneficiary. In the absence of the saving provision in subparagraph 251.2(3)(a)(ii), however, the child’s becoming an actual majority-interest beneficiary may result in another person’s becoming a deemed majority-interest beneficiary.
Further assume that the child has a brother-in-law who is not affiliated with the parent but is affiliated with the child by a marital connection (subparagraph 251.2(5)(a)(ii)). The brother-in-law becomes a deemed majority-interest beneficiary when the child acquires more than 50 percent of the capital interests in the trust, but the brother-in-law’s becoming a deemed majority-interest beneficiary does not trigger a loss restriction event. For that purpose, a person is deemed not to have become a majority-interest beneficiary only because a person previously affiliated with the trust (for example, a majority-interest beneficiary thereof) acquired a trust income or capital interest (subparagraph 251.2(3)(a)(ii)). The child was already a deemed majority-interest beneficiary, and thus was already affiliated with the trust when he or she became an actual beneficiary.
These examples show that it is critical that a non-beneficiary be able to qualify as a majority-interest beneficiary in order to protect a family trust from loss restriction events and to ensure that section 251.2 properly reflects its underlying tax policy.
After this article was written, Finance issued a comfort letter dated December 23, 2014 confirming its agreement with TI 2014-0534841C6: under the current legislation, a non-beneficiary is nonetheless a majority-interest beneficiary of the trust if that person is affiliated with another person who is a majority-interest beneficiary of the trust. However, Finance is prepared to recommend an amendment to provide that for the purposes of the loss restriction event rules, a majority-interest beneficiary of a trust, at any time, means a person or partnership that is at that time both a beneficiary (including any person who is "beneficially interested” in the trust under subsection 248(25)) and a majority-interest beneficiary of the trust. The comfort letter did not identify the exact policy concern behind the contemplated amendment. Furthermore, it is not clear to what extent the amendment would affect family trusts, because the term "beneficially interested” is extremely broad. Many family members who do not have any interest in the trust would still be deemed to be beneficially interested in the trust under paragraph 248(25)(b). Given these uncertainties, it is likely that there will be further development of section 251.2 in the near future.
This article first appeared on ctf.ca.