This week on Hull on Estates and Succession Planning, Ian and Suzana continue their discussion about rolling assets into Trusts and issues surrounding deferring tax on Capital Gains.

Deferring Tax on Capital Gains - Hull on Estate and Succession Planning Podcast #85

Posted on November 6^th, 2007 by Hull & Hull LLP

Suzana Popovic-Montag:  Hi, and welcome to Hull on Estate and Succession Planning.  You’re listening to Episode #85 of our podcast on Tuesday, November 6^th, 2007.

Welcome to Hull on Estate and Succession Planning, a series of podcasts hosted by

Ian Hull and Suzana Popovic-Montag, that will provide information and insights into estate planning in Canada, from the offices of Hull Estate Mediation in Toronto, Ontario, Canada.  Here are Ian and Suzana.

Ian Hull:  Hi Suzana.

Suzana Popovic-Montag:  Hi there Ian.

Ian Hull:  So we’ve survived Halloween.

Suzana Popovic-Montag:  We have.  Did you have fun?

Ian Hull:  More food for me not to eat.

Well, we had a good discussion last podcast about deferring tax on capital gains and dealing with those sort of fundamental planning issues.  Let’s…I think we might, but why don’t we spend a few minutes winding up on that issue a little bit and then talking a little bit about some drafting issues if we have time.

Suzana Popovic-Montag:  That’s a great idea, Ian.  Because we were just getting into, you know, different ways that a spousal trust could be tainted and what the consequences of that were.  And one of the things we pointed out was that in these situations, you wouldn’t have any rollover available to the estate.

Ian Hull:  So this whole rollover idea is our great deferring step and there’s this whole theory of tax planning with estates, but with everything and that is, is that even if you have to pay the tax, let’s wait to the very last moment in time to pay it.  So husband wife, happily married, one of the spouses dies before the other.  That spouse doesn’t have to pay tax if you roll it over to the surviving spouse and you’re essentially deferring it.  You’re not avoiding the tax, which is important.  But it’s deferring it.  And there’s a cost to deferring it.  In this case we talked about is that we’re putting it into a trust.  So there’s a certain lack of control.  You’re not giving it all to the surviving spouse.  Or you can have rollover available when you give it to the person 100%.  Like, for example, you would rollover your house.  It might be held in joint tenancy or you pass it on pursuant to your Will to your spouse.  There’s a rollover in that sense.  Full control to that surviving spouse.  That surviving spouse can do with that asset as they see fit.  But when you put it into a trust, you lose control and therefore Revenue Canada says, or CRA now, says wait a minute, if you’re going to keep…take advantage of this trust arrangement, we’re not going to let you make it go to anybody, or allow any income in that trust to anyone other than the surviving spouse.

Suzana Popovic-Montag:  One of the neat things that does arise in some situations, Ian, is where you, even though a spousal trust has somehow become tainted, it may be possible to untaint the trust.

Ian Hull:  Yeah, and that’s a very…certainly from our perspective, when we do this kind of work in the litigation side, it’s a dangerous game.  We tend to tell our clients that the cleaning of the trust is not a guarantee and ultimately CRA may have some difficulties with it.  And a classic scenario was, years ago, they used to have in the trusts the ability to borrow and if the language wasn’t perfectly drafted, CRA used to say that that was a tainted trust.  And we went into Court and tried to cleanse those trusts.  But we would have to say to our client that the cleansing from a Court Order doesn’t necessarily bind CRA.  So you left yourself exposed.  So you really want to try to avoid the cleaning if you can help it, but it is, you’re so right, available.  And it’s not the end game if the trust has been tainted or made dirty, so to speak.

Suzana Popovic-Montag:  Now another thing that I try to keep in mind when I’m speaking with clients is the fact that a rollover can be available on transfers to either a spouse directly or to a spousal trust that may arise as a result of a disclaimer by a beneficiary of the estate or a release or a surrender by a beneficiary, who’s other than the spouse of a deceased.

Ian Hull:  That’s right.  And there’s also transfers that are available as a result of a variation of the trust application.  There’s an Act in Ontario and throughout Canada, the Variations of Trust Act, that allows for a variation or amendment to the trust.  Dependent’s relief claims can also allow for this.  So there are some, as you talked about earlier, there’s ways to cleanse the trust.  There are some creative angles that are available, what we call post-mortem as well, after death, to help enjoy some of these important rollover benefits.

Suzana Popovic-Montag:  Now Ian, let’s turn perhaps to just a brief discussion about what happens then on the death of that second spouse, once that rollover has expired, so to speak.

Ian Hull:  Yeah.  Well, that’s the day of reckoning and lots of people try to avoid it.  Even on that day of reckoning, depending on how you set it up, there is some wiggle room.  But the basic rule is, is that tax on capital gains becomes payable on the disposition by that spouse or by that spousal trust, however it’s been established.

Suzana Popovic-Montag:  And so there’s a deemed realization of the capital property that’s in that spousal trust on the death of the survivor or if that survivor then transfers it to someone else other than the spouse.

Ian Hull:  That’s right.  So we…finally CRA gets their money.

Suzana Popovic-Montag:  isn’t that always the case?

Ian Hull:  That’s right.

Just a comment, and we don’t pretend to be the drafting experts nor wanting to, in the podcast format, deal too much with the drafting issues.  But we talked about some of the answers that can get through the Court system if there are problems with the trust itself.  But why don’t we spend a couple of minutes just on drafting issues, to help maximize or help make sure this deferral is effective.

Suzana Popovic-Montag:  One of the things that sort of comes to mind in that situation, Ian, is where we’ve got a testator who decides to require some kind of remarriage clause, or wishes to include in his or her Will the ability to sprinkle income amongst the spouse and the children.

Ian Hull:  So, in a sense, there is someone who…the spouse is dying, and has died, and has created a document, a Will, that is tainted, so to speak, and wants to be tainted.

Suzana Popovic-Montag:  Right.  So they’re doing both a tainted and an untainted trust, is the way that I sort of think of it as.

Ian Hull:  That’s right.  And so we establish one or more spousal trusts, or one or more trusts that qualify as a spousal trust, and we also establish what might be a testamentary trust.  And a classic estate planning technique in that scenario is, and has been used for many years, and it’s not perfect for everyone, but there is a classic estate scenario when we set up these various trusts.

Suzana Popovic-Montag:  And I guess the idea really is to allow, in the untainted trust, you know, what we talked about in allowing for that rollover provision, but recognizing the fact that, you know, not every asset can be put into that kind of arrangement.  And so allowing a trustee or an executor the discretion to allocate the assets of the estate between the tainted and the non-tainted spousal trust.

Ian Hull:  And what will happen is, is that literally the Will will provide that trusts are to be established.  And the classic scenario is, we call it the kid’s trust and the spousal trust.  And the executors are told in the Will that they have to, on the date of death or the day after the date of death, whenever the trigger point is, they have to sit down and decide how much money is there and what would be the most appropriate.  So if there is a $500,000 estate, would you put all of that money into the spousal trust?  Would you put half of that money into the spousal trust, and the other half into the children’s trust?  Those are the kind of questions that you would have to push on to the executors to make that decision.

Suzana Popovic-Montag:  And I imagine they would be getting legal accounting tax advice in order to determine which assets, you know, for instance, had the greatest capital gain or recapture, that they’d want to allocate specifically to the qualifying spousal trust, and which they would put elsewhere, in order to actually maximize that deferral of tax for as long as possible.

Ian Hull:  That’s right.  Now that’s all well and good in theory, but we’ve talked about problems that get created.  And one of them is, of course, that the children or the spouse feels that they are not being treated properly.  And the executors have the curse of trying to make the decision of how much goes in the trust.  But they also have the legal curse around them in the sense that the surviving spouse has special rights.  So you can’t just give, for example on that $500,000 example, you can’t just say, let’s just willy nilly split it 50/50 for example, $250,000 to the kid’s trust and $250,000 to the spousal trust, because of the super-priority, so to speak, that the spouse has.

Suzana Popovic-Montag:  And I imagine you’re referring, Ian, to the right of the spouse to elect under, in Ontario, the Family Law Act.  Something that we’ve talked about in the past, just the entitlement of a surviving spouse, to say notwithstanding the terms of the Will, I’m actually going to elect to take half of the value of the estate.  And there’s a calculation that’s involved in that.  But that being sort of the big idea.

Ian Hull:  That’s right.  And it’s the community of property analysis that everybody whose married to another spouse for a long period of time, and what long means is always debated in the Courts.  But if you have a lengthy relationship, and it’s a married relationship, the Courts across Canada and in the United States say there is a community of property here.  So notwithstanding what the executors want to do, you have an override clause, so to speak.  And you also have many other claims that are available…not many…but I mean several other claims that are available to a surviving spouse in different jurisdictions.  So it seems to me that this, coming back to one of our important themes, is this is where you want to have some discussion before you die with your executors, with your family, to determine (a) does the two trust arrangement make sense and (b) how would, what would be a realistic and reasonable allocation of whatever money is left.

Suzana Popovic-Montag:  And I think tempering all of that, of course, with the recognition that despite all this wonderful planning and what the intention is, that at the end of the day, if a spouse chooses to, he or she can completely ignore that and pursue other remedies.

Ian Hull:  Absolutely.

Alright, well I think that’s a good start. What we might do in the next podcast is talk a little bit more about some capital gains issues and some of the family law issues that tie into that.  But we’ll also want to focus our attention away from the spousal trust arrangement into the testamentary trust, because in estate planning, the two core trust arrangements are, one is the spousal trust, and the other is a testamentary trust.  So I think we need to spend some time on that.  But we also need to wrap up some more of our considerations with the super-priority of the surviving spouse.

Suzana Popovic-Montag:  That’s great, Ian.  I look forward to our next podcast.

Ian Hull:  Thanks a lot, Suzana.

Suzana Popovic-Montag:  Thanks to you.

You’ve been listening to Hull on Estate and Succession Planning with Ian Hull and Suzana Popovic-Montag.  The podcast you have been listening to has been provided as an information service.  It is a summary of current legal issues in estates and estate planning.  It is not legal advice and you are reminded to always talk with a legal professional regarding your specific circumstances.

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