Canada: Tax Treatment Of Charitable Donations From Spousal Trusts

Last Updated: April 22 2016
Article by Andrew Valentine and Amanda J. Stacey

Charities and advisors in the area of gift planning must ensure that they fully understand the rules surrounding donations to registered charities from spousal trusts. These rules have changed recently as a result of new legislation related to the taxation of estates and donations on death.

The tax rules affecting charitable giving by estates were modified substantially by changes introduced in the 2014 federal budget. These changes provided that, for deaths occurring after 2015, estates will generally only have access to graduated marginal rates of tax for the first 36 months after death, during which time the estate is known as a "graduated rate estate" or "GRE". After 36 months, the estate will be taxed at the highest marginal rate of tax.

Along with the introduction of the concept of GRE were several changes to the treatment of charitable donations on death. The prior rules had required a complicated analysis of whether a gift provided for in a taxpayer's Will constituted a "gift by Will" or a "gift by the estate".

The result of this analysis determined whether the resulting donation tax credits would be available against the deceased's final two tax returns or against income in the estate. The new rules provide that so long as the estate transfers the gifted property to charity while the estate is still a GRE (i.e., within the first 36 months after death), the estate trustees have flexibility to allocate the resulting tax credits against any of the deceased's final two tax returns and against income earned by the estate in the year of the gift or any prior estate year.

Further changes introduced in 2016 provide that where a charitable gift is made within 24 months of the estate ceasing to be a GRE (i.e., within 5 years of death), the estate will have the ability to allocate the donation tax credits against income on the deceased's final two tax returns or against estate income in the year of the gift.

The new rules affect charitable giving by spousal trusts. Under the Income Tax Act, an individual can, by Will, transfer capital property on a taxdeferred basis to a trust that is established to support the individual's spouse or commonlaw partner for the remainder of the surviving spouse's life.

Upon the death of the surviving spouse, there is a deemed disposition of all capital property, triggering tax on any accrued capital gains. Under the rules that applied prior to 2016, this tax would be paid by the trust. The new rules, however, provided that the tax incurred on this deemed disposition would be taxed in the estate of surviving spouse rather than in the trust.

This treatment of capital gains created a mismatch where the property in the spousal trust was designated to be gifted to charity on the death of the surviving spouse.

The consequence of such a gift is that the trust is considered to have made the gift and to be entitled to the tax credits, but the income resulting from the deemed disposition of the trust assets would be incurred in the estate. This effectively stranded the donation tax credits.

New legislation introduced in January of 2016 has addressed this issue. It provides generally that the tax incurred on the death of a surviving spouse will be taxed in the trust unless the trust and surviving spouse's estate jointly elect otherwise. It also provides that where a spousal trust makes a gift to a registered charity after the death of the life interest beneficiary (i.e., the surviving spouse), the resulting tax credits will be allocated to the trust's taxation year in which the death occurs. This allows the charitable donation tax credits to be used to shelter capital gains incurred on the deemed disposition of the property in the spousal trust.

These changes have been welcomed by estate planners and gift planners, as they remove the mismatch in the taxation of estate gifts and allow for the effective use of donation tax credits, as well as to provide more flexibility in the allocation of capital gains on death of a surviving spouse. It is clear that care must be taken in estate planning involving the use of spousal trusts and any related charitable giving so as to ensure the most tax effective treatment.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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