The Budget introduces a significant change in the tax treatment of gifts made under a Will or beneficiary designation.
Under the current rules, where an individual makes a donation by Will, the donation is treated as having been made by the individual immediately before the individual’s death. Thus, the tax credits arising from the gift are applied to the donor’s final tax return. Where the full credit cannot be used on the donor’s final return, the excess credit can be carried back and used against the previous year’s income. The tax credits that arise on gifts made by Will are available only against the individual’s last two years’ income – they cannot be used to reduce tax that arises in the estate following the donor’s death.
By contrast, where a gift is directed to be made by the donor’s estate, the gift is available only against the tax that would otherwise be payable by the estate. Estate gifts cannot be used to reduce the donor’s income in the year of death or the prior year. Distinguishing between gifts by Will and gifts by an estate requires an analysis of the terms of the Will and the extent of discretion that is afforded to the executors. As we have discussed in past Newsletter Issues, determining whether a particular gift is a gift by Will or a gift by the estate is not always easy, and the tax implications can vary significantly depending on the answer.
The Tax Act also applies similar rules where an individual designates a qualified donee as the beneficiary of proceeds on death under an RRSP, RRIF, TFSA or life insurance policy. In these circumstances, the tax credit is available only against the individual donor’s last two years’ income.
The Budget proposes to provide flexibility with respect to the tax treatment of these gifts, where they occur as the result of a death after 2015. Rather than deeming gifts by Will and gifts by direct designation to have been made immediately before the individual’s death, they will be treated as having been made by the estate. The gift will be deemed to occur when the property is actually transferred to the charity. Executors will then have the discretion to allocate the available tax credits against any of the following:
- the taxation year of the estate in the year the gift was made;
- any earlier taxation year of the estate; or
- the last two taxation years of the individual prior to death.
The Budget confirms that the current requirements for determining whether an RRSP, RRIF, TFSA or life insurance policy is a direct designation will continue to apply. Generally, this means that the transfer of property to the estate must occur as a consequence of the death of the donor, and must occur within 36 months of death.
This set of changes is welcome in that it provides significant flexibility to executors and trustees when dealing with the taxes incurred by a deceased individual and the individual’s estate upon death. While the Budget does not include specific legislative language to implement this change, it appears that the executors and trustees will be able to allocate tax credits between the estate and the deceased individual.
The new rules also reduce the legal significance of the distinction between gifts by Will and estate gifts, but they do not eliminate this issue. It appears from the Budget document that the new flexibility to allocate tax credits to either or both of the estate and the individual is only available where the gift constitutes a gift by Will. Thus, where the ability to allocate is significant, it will be necessary to determine whether the gift constitutes a gift by Will. However, the increased flexibility will mean that the trustees can use either type of gift against the estate’s tax, thus avoiding the need to analyse the nature of the gift where it is sufficient that it can be used against the taxes arising in the estate.
This measure will apply to the 2016 and subsequent taxation years. It will be interesting to review the details of the legislation when released. Only then will we be able to determine the scope of the new flexibility more definitely. Although the proposal as announced is one that will be welcomed by the sector and estate planners, it is not clear whether the Budget proposals will deal with issues that can arise with the availability of tax credits for donations made from a spousal testamentary trust on the death of the spouse beneficiary. It is hoped that the legislation in its final form will address this issue.