Help your client avoid losing GRE status

The graduated rate estate (GRE) has become an important estate planning tool in Canada since its introduction in 2015. Whereas most trusts are subject to taxation at the highest marginal tax rate, the GRE provides up to three years post-death when an estate may use graduated tax rates, providing clients with significant tax savings and some income splitting.

GRE requirements are well understood in the planning community: the estate must designate itself as a GRE on its tax return for its first taxation year, no other estate of the individual can be designated as a GRE, and the estate must use the deceased’s social insurance number on each tax return during the 36-month period following death.

What is less understood is how easily an estate’s GRE status can be lost.

Take for instance the hypothetical case of Joan, the well-intentioned administrator of her late brother Harold’s estate. Harold’s estate can be best described as asset rich but cash poor. Joan, concerned that the estate won’t be able to pay its debts in a timely fashion, decides to transfer $5,000 from her own savings to the estate account as a gift. The transfer will also mean that more residue is available for Harold’s children, who are the beneficiaries of the estate and Joan’s favourite niece and nephew.

Unfortunately, Joan neglects to consider how her contribution may affect the estate’s status as a GRE. According to Section 108(1)(b) of the Income Tax Act (ITA), if property is contributed to a trust other than by the deceased after the date of death, the trust will no longer qualify as a GRE.

Joan notices that this section of the ITA refers to property, and she wonders if her voluntary payment will be considered a contribution.

The Tax Court has provided some guidance. In Greenberg Estate v The Queen the court considered what “contribution” means and determined it was any “voluntary payment, made for no consideration and for the purpose of increasing the capital of the estate.” In other words, by making a gratuitous gift to the estate, Joan has placed its status as a GRE and the advantageous taxation associated with that status in jeopardy.

When the issue was explained to Joan, she decided she wouldn’t make a gift to Harold’s estate but would simply pay some of the estate’s debts herself, doing so as a loan. In particular, she decided to pay Harold’s funeral bill and his date of death tax indebtedness. Harold’s estate could pay her back when it becomes more liquid.

Does Joan’s revised plan negatively affect the estate’s GRE status? Maybe. It depends on how long it takes to reimburse Joan. Section 108(1)(d) of the ITA provides, among other things, that where an estate incurs a debt to a person with whom the estate doesn’t deal at arm’s length and the debt isn’t repaid within 12 months, the amount is considered a contribution. Joan will have to tread carefully and ensure she’s repaid within the year. If Harold’s estate isn’t in a position to reimburse her within that time period, the GRE status will be lost.

Harold’s estate also has an asset that Joan finds somewhat confusing, and she wonders if it may affect the estate’s GRE status. Harold and Joan’s father created an inter vivos family trust about six years ago. Each year, Harold and Joan receive an income payment from the trust. The capital held in the trust is to be divided between Harold and Joan when their father dies.

Harold died about five months before his father. Under the trust’s provisions, Harold’s share of the trust’s capital was deposited to his estate account. Does that contribution affect Harold’s estate’s status as a GRE?

The Canada Revenue Agency seems to think it does. It issued an interpretation bulletin stating that this situation was a contribution after death by someone other than the deceased, which would negatively affect GRE status. The same issue may surface with an alter ego trust where the trust states that, upon the death of the income beneficiary, the capital in the trust is to be paid to a beneficiary’s estate.

(The situation could have been avoided if the father’s will stipulated that the trust’s capital be paid directly to Harold and Joan.)

The lesson for Joan is to proceed with caution.  What may seem like routine steps in the estate’s administration can have adverse tax consequences.

Keith Masterman, LLB, TEP, is vice-president, Tax, Retirement and Estate Planning at CI Global Asset Management. He can be reached at kmasterm@ci.com.

Keith Masterman

Tax & Estate

Keith Masterman, LLB, TEP, is vice-president, Tax, Retirement and Estate Planning at CI Global Asset Management. He can be reached at kmasterm@ci.com.