—Michael Goldberg, Tax Partner, Minden Gross LLP, MERITAS law firms worldwide and founder of "Tax Talk with Michael Goldberg", a quarterly conference call about current, relevant and real-life tax situations for professional advisors who serve high net worth clients. This article is the second instalment in a four-part series that will appear in Tax Notes over the next few months.
Hopefully the first instalment of this Series of articles grabbed your attention and made you interested (scared) enough to keep on reading! As promised, the second instalment of the Series will begin the arduous task of providing a high-level review of the Section 94 NRT Rules, including providing some context as to just how expansive these rules are. Ready or not. . .
Policy — Application of the Section 94 NRT Rules
From a policy perspective Parliament has made its intentions quite clear: it wants to restrict the ability of trusts to qualify as Pure NRTs. To that end, the Section 94 NRT Rules have been drafted to broadly expand Canada's right to tax otherwise Pure NRTs by deeming them to be Section 94 NRTs that are tax residents of Canada for most purposes of the Income Tax Act including making Section 94 NRTs taxable on their worldwide income.2
The Section 94 NRT Rules will apply whenever there is either a:
(1) "resident contributor", or
(2) "resident beneficiary",
at the end of any relevant period, which is generally, but not always, the end of a trust's fiscal period.3
Before reviewing when a trust will have a resident contributor or a resident beneficiary, it is worth reviewing the "contributor" and "contribution" definitions, which are key building blocks to the resident contributor and resident beneficiary definitions.
Contributor and Contribution Definitions
Most of the key definitions in section 94, including the contributor and contribution definitions, are found in subsection 94(1).4 A contributor is any person, including a corporation, trust, and other entities, that has made a contribution to a trust. A person will continue to be a contributor, regardless of whether or not the person (when human) has died, or (when not human) has ceased to be in existence.
There are some modest exceptions to who will be a contributor, but the list of "exempt persons" is generally limited to government and tax exempt entities.
Clearly the contributor concept covers an extremely broad group of persons. However, since the contributor definition requires there to be a contribution, the importance of the definition does not become clear until one understands the types of acts that will constitute contributions.
Generally, a contribution will involve any direct or indirect transfer or loan of property, or an obligation to make a transfer or loan of property, to a trust. This is an extremely broad concept and is considerably broader in scope than the general process that one thinks of as necessary to establish a trust in Canada (i.e., by direct settlement of property that is provided by a settlor and that is accepted by the trustees of a trust).
It is worth mentioning that as defined in subsection 248(1), "property" is an extremely broad concept and includes property of any kind whatever, whether real or personal, immovable or movable, tangible or intangible, or corporeal or incorporeal.
Thankfully, certain loans or transfers are excluded from being contributions if they are dealt with in the interpretive provisions in subsection 94(2) or if those loans and transfers qualify as "arm's length transfers", a concept that will be discussed below.
Even though some of the subsection 94(2) interpretive rules place limitations on when a contribution will be considered to have occurred,5 other rules in subsection 94(2) contain complex deeming rules, which make the scope of transfers and loans that will constitute contributions exceptionally wide.
For example, pursuant to paragraph 94(2)(a), unless the transfer is determined to be an arm's length transfer, the making of any loan or transfer of property by a person to any other person will be considered to have been a transfer to a trust if:
(1) the fair market value ("FMV") of a property or properties owned by a trust increases, or
(2) a liability or potential liability of a trust decreases,
at the time of the transfer by the person.
The rules in paragraph 94(2)(a) are economic based concepts. They are intended to capture loans or transfers of property that may give rise to the accretion of wealth in a jurisdiction other than Canada, by whatever means, including the reduction of liabilities.
Other key deeming rules in subsection 94(2) will deem, among other things, the issuance of shares, partnership or trust interests,6 and the provision of services by a person7 to be transfers by the issuer or provider of services to a trust. Due to even more complex deeming rules that are beyond the scope of the series, indirect transfers need to be reviewed carefully.
Hopefully by now it is clear that the contributor and contribution concepts cover not only an incredibly broad group of people but also a very wide group of actions by those people in respect of a trust.
Arm's Length Transfer
The term arm's length transfer, which is defined in subsection 94(1), is a bit misleading since the concept applies to both transfers and loans. In any case, if a loan or transfer qualifies as an arm's length transfer it will not result in a contribution having been made to a trust.
There are a number of categories of transactions that are listed in paragraph (b) of the definition that can be considered arm's length transfers. However, pursuant to paragraph (a) of the definition, in order to be an arm's length transfer, it always needs to be reasonable to conclude that none of the reasons for the loan or transfer of property is the acquisition of an interest in a non-resident trust.8
Still, this exception can be quite narrow. For example, the arm's length transfer exception will generally not apply in typical estate freeze situations, since such transactions tend to involve shares that will generally be "restricted property." In addition, as is the case with all arm's length matters, the determination of what transactions will qualify as arm's length is subjective.9
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1 Unless otherwise noted, defined terms in this article have the meaning designated in the first instalment of the Series.
2 Because a Section 94 NRT is still factually non-resident, Canadian persons making distributions to such trusts will be obligated to withhold without treaty relief. Pursuant to the provisions in paragraph 94(2)(g), the Section 94 NRT will be entitled to treat amounts withheld as a credit against its Canadian tax liability. Complex rules are applicable where Section 94 NRTs make distributions to non-resident beneficiaries. For more on this topic, see the articles by Harris et al. and Schweitzer and Brodlieb, both of which were referred to in the first instalment of the Series.
3 See subsection 94(1) "specified time" definition (when a trust ceases to exist, the specified time will be the time immediately before the trust ceased to exist).
4 Unless otherwise noted, defined terms in the Act that are used in the Series can be found in subsection 94(1).
5 No attempt will be made to address such limitations in the Series.
6 See paragraph 94(2)(g).
7 See paragraph 94(2)(h).
8 Interestingly, although nearly all of the categories of transactions listed in paragraph (b) of the arm's length transfer definition appear to require loans or transfers to be carried out using an arm's length standard (subparagraphs (b)(ii) and (vi) do not explicitly contain language requiring such a standard), subparagraph (b)(i), dealing with payments of interest, dividends, rent, royalties, other returns, and substituted returns in respect of property, only seems to be concerned with situations that would involve returns to a trust that are designed to overcompensate a trust. As a result, provided that the terms giving rise to a particular loan or transfer were themselves carried out in an arm's length manner, then based on this interpretation it would appear the payment of non-arm's length returns that act to the detriment of a trust and that otherwise would have resulted in contributions being made to that trust would be considered arm's length transfers and therefore not contributions.
9 For a more detailed discussion on this subject see the article by Harris et al. (cited in the first instalment of the Series).
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.