These general rules apply regardless of whether the disposition occurs during the parent’s lifetime or after the parent’s death pursuant to the terms of his or her will.

In many cases, the application of these rules will result in Canadian income tax liabilities for the parent.

One important exception to these general rules relates to a special set of rules in the Income Tax Act intended to facilitate a tax deferred “rollover” of qualifying farm properties from parents to their children (farm rollover rules).

Some farm properties, including farm land in Alberta, have appreciated significantly in parents’ hands and absent the availability of the farm rollover rules, the parent or the parent’s estate may incur significant Canadian income tax liabilities upon transferring farm properties to his or her children.

Types of properties eligible for the farm rollover rules

In order to qualify under the farm rollover rules, the property must be qualifying farm property used principally in a farming business carried on in Canada in which a qualifying person (usually the parent) was actively engaged on a regular and continuous basis, or a share in a qualifying family farm corporation, or a partnership interest in a qualifying family farm partnership (individually, a “farm property”). The farm rollover rules have different technical requirements that must be satisfied depending on the type of farm property disposed of.

Application of the farm rollover rules

In general, the farm rollover rules operate to transfer a farm property at its “tax cost,” such that no gain or loss is realized by the parent and the child inherits the income tax attributes of the farm property to the parent. As a result, the child assumes the obligation for all the latent tax liability in the farm property.

Accordingly, these intergenerational transfers of farm properties are merely a deferral of income tax to the next generation, and not an absolute elimination of tax.

In some cases, it may be desirable to partially or wholly override the application of the farm rollover rules in order to utilize all or part of the parent’s $750,000 lifetime capital gains exemption, which may be available in respect of qualifying farm properties. (The capital gains exemption rules for qualifying farm properties will be discussed in greater detail in our next article.)

Use of the capital gains exemption in these cases may allow for a “bump up” of the tax cost of the farm property in the hands of the child, with little or no tax detriment to the parent.

Interestingly a farm property may qualify under the farm rollover rules but not under the capital gains exemption rules and vice-versa.

Further, the farm rollover rules can be overridden to the detriment of a parent transfer or if a child transferee seeks to use his or her own capital gains exemption on a subsequent disposition of the transferred farm property.

Proper advice from a qualified tax adviser can help avoid this potential pitfall.

Different farm rollover rules for inter vivos and testamentary dispositions

There are farm rollover rules that apply for testamentary dispositions (i.e., after the death of the parent) and other farm rollover rules for inter vivos dispositions (i.e., during the life of the parent).

While these rules are similar to each other, there are a few differences that may be important. Further, differing provisions in the Canadian Excise Tax Act for the application of the GST to these dispositions will need to be properly addressed.

Spin-off of family farm corporate assets

The farm rollover rules may be used in connection with a tax-deferred spin-off or “butterfly” of certain farming assets out of an existing family farm corporation into a new family farm corporation of which one or more of the children of the parent is a shareholder, while one or more of the other children of the parent is a shareholder of the existing family farm corporation, or another new family farm corporation.

In some cases, these corporate reorganizations will necessitate compliance with certain technical butterfly provisions in the Income Tax Act in order to implement the corporate reorganization on a tax-deferred basis.

In all cases, these reorganization transactions and related documents should be carefully and properly planned, drafted, and implemented by qualified tax advisers.

Proper due diligence, advice and documentation are essential

Use of the farm rollover rules singularly, or in conjunction with the capital gains exemption, can avail significant tax deferrals and savings for parents selling, gifting or otherwise disposing of farm properties to their children. In order for parents to properly avail themselves of the benefits of these rules, proper due diligence, tax advice, and legal documentation should accompany use of these rules.

For purposes of the Income Tax Act, a PHSP is, among other things, a contract of insurance in respect of hospital expenses, medical expenses or any combination of such expenses. In general, the contract of insurance requirement will be satisfied by an undertaking by a corporate employer to indemnify its employees from the cost of the employees’ qualifying medical expenses under the act.

A business owner who utilizes a PHSP to pay for his or her (and his or family’s) medical expenses must ensure that benefits provided under it are commensurate to those that would be provided to a similarly situated arm’s-length employee who is not a shareholder as part of a reasonable compensation package. (For example, if the business owner is the president of the employer corporation, then the PHSP benefits should not exceed those that would be provided to an employee president that is not a shareholder of the corporation, but is doing the same job in similar circumstances as the business owner.)

If this principle is not adhered to and the PHSP benefits are in excess as a result of the business owner’s shareholdings, Canada Revenue Agency could make an adverse assessment of the benefits received under the PHSP by the business owner.

As long as the receipt of benefits by an employee of the corporation under the PHSP is considered to be received in his or her capacity as an employee of the corporation, the corporation should be able to deduct benefits provided to its employees under the PHSP. Further, if such benefits are received in an employee capacity, the benefits should not be taxable to the employee.

As a result, there is preferential tax treatment availed to the use of a PHSP for employee compensation, as in almost all other cases, benefits provided by an employer to an employee are taxable to the employee. (The tax policy for this preferential treatment appears to be to motivate employers to pay for employees’ medical expenses, perhaps as a means to reduce the state’s obligations to assist with these expenses.)

By way of illustration, suppose a corporation that qualifies for the small business deduction rate of tax (i.e., 14 per cent) pays $10,000 in respect of the medical expenses of Alberta resident employees who are subject to tax at the highest marginal rate (i.e., 39 per cent).

The use of the PHSP in this scenario results in a approximate net cost of $8,600 for the medical expenses vis-à-vis a net cost of between $9,900 and $12,500 if no PHSP is used; in other words, PHSP savings of between $1,300 and $3,900. (The savings range in the foregoing example occurs as all, some or none of the medical expense tax credit may be available for employees paying for their own medical expenses.)

The savings from the use of a PHSP result because the PHSP utilizes pre-tax corporate dollars to pay for medical expenses instead of after-tax personal dollars, and because most employees are unable to fully utilize the medical expense tax credit as a means to reduce the cost of their medical expenditures.

In appropriate circumstances, a corporation may be able to avoid the use of a third-party service provider to administer its PHSP by administering it internally, thus avoiding the five to 10 per cent administration fees chargeable by the provider. In any event, PHSP and related documents should be carefully prepared to adhere to the statutory requirements, as well as the administrative policy of the CRA to avoid disagreements.

In view of the inherent flexibility of a PHSP and potential business and tax benefits from the use thereof, a business owner should consider utilizing a PHSP as part of the corporation’s employees’ remuneration packages.

That column also discussed some of the mechanics of forming and using an EPSP.

This column focuses on some of the tax benefits from using an EPSP.

One potential tax benefit from the use of an EPSP is that, unlike salary or bonus payments to employees, neither contributions by a corporation to an EPSP trust nor allocations by an EPSP trustee to employees is subject to income tax withholdings.

This provides income tax deferral opportunities for employees, including the business’s owner-manager.

To illustrate, suppose a corporation with a taxation year ending Dec. 31, 2008, wishes to pay its key employees a bonus of $100,000. It could accrue the payment in its 2008 year-end financial statements and tax filings.

For the bonus to be deductible for that taxation year, the bonus must be paid within 179 days after year-end, in this case before June 27, 2009.

The corporation’s remittance obligations will require it to remit withholding tax on the bonus upon payment of it in the first half of 2009.

The amount of this withholding tax would be 39 per cent of $100,000, or $39,000, assuming the key employees are taxed at the highest marginal rate in Alberta.

On the other hand, if the corporation establishes an EPSP and makes a $100,000 contribution to the EPSP trust between Jan. 1, 2009, and April 29, 2009, the contribution will be deductible in the corporation’s Dec. 31, 2008, taxation year.

The $100,000 contribution received by the EPSP trust must be allocated to employee beneficiaries in 2009 (i.e., between Jan. 1, 2009, and Dec. 31, 2009).

The employee beneficiaries would report the allocation as employment income in their 2009 personal income tax returns and pay combined federal and Alberta income tax of approximately $39,000 by April 30, 2010.

ºHence, the opportunity for an income tax deferral.

Another potential tax benefit from the use of an EPSP is that no Canada Pension Plan (CPP) or Employment Insurance (EI) withholdings appear to be required on either the contribution to the EPSP trust by the corporation or the allocation by the EPSP trustee to the employee beneficiary.

Accordingly, in the case of CPP, as the maximum annual employer and employee contribution for CPP in 2009 is $2,118.60 (or $4,237.20 in the aggregate), a corporate employer and its employee may not be subject to this annual cost through the use of an EPSP.

Of course, the use of an EPSP in this case may compromise or reduce the employee beneficiaries’ abilities to receive benefits from CPP and EI (if applicable) in the future, although the business owner could elect to invest those savings in his or her own personal retirement planning.

Thus, if the business owner-manager and his or her spouse are employees of the corporation, the potential savings from the elimination of the cost of CPP for them alone can be greater than $7,000 (net of benefits for employee’s tax credits for his or her CPP payments), on an annual basis.

As a result of these savings opportunities, some business owners have used an EPSP as the primary source of remuneration from their corporations.

There has been at least one Tax Court of Canada decision upholding this type of tax planning by a business owner.

Other tax benefits, beyond the scope of this article, also may be available from the use of an EPSP.

In view of the inherent flexibility of an EPSP and potential business and tax benefits from the use thereof, consideration should be given to utilizing an EPSP in business and tax planning for a corporation and the business owner.

— Benjamin Franklin

This week, I will continue my discussion of some of your responsibilities under the Canadian Income Tax Act if you are appointed as the executor or executrix (“personal representative”) of a deceased relative or friend.

In my previous column, I focused on income tax consequences to the deceased and some of your obligations relating thereto. In this column I will focus on the income tax consequences to the estate of the deceased and some of your obligations and tax planning opportunities relating thereto.

The estate: creation of a new taxpayer — For the purposes of the Income Tax Act, on the day a taxpayer dies a new taxpayer is created — the estate of the deceased. Although an estate is a property concept, relating to the property of the deceased, the estate is also a testamentary trust for purposes of the act.

Under the act, the estate is subject to tax at a natural person’s progressive tax rates and is taxable on the income earned or realized on the property of the estate during the administration period (e.g., deemed dividends resulting on redemptions by private corporations of a deceased’s shares, after his or her death).

The personal representative is responsible for filing the income tax return(s) of the estate throughout its existence. The estate ceases to exist once administration of the estate is complete.

The will of the deceased may provide for the creation of testamentary trusts, other than the estate itself, also subject to tax at a natural person’s progressive tax rates.

Income and capital distributions from the estate to a beneficiary — During administration of the estate, the personal representative may decide to distribute income of the estate to beneficiaries before the administration of the estate is complete (subject to consideration whether, as a result of such distribution, the estate will continue to be able to satisfy its liabilities).

Certain provisions of the act permit the income of the estate to be “flowed through” to a beneficiary and taxed in his or her hands to the extent that such amounts are paid or payable in the year to a beneficiary.

However, given that the marginal tax rates of an individual apply to the estate, it may be beneficial to have the income of the estate taxed in the estate rather than in the hands of the beneficiaries of the estate.

Once administration of the estate is complete, a personal representative may distribute remaining property of the estate to the appropriate beneficiaries.

In these circumstances (and in circumstances in respect of any distributions made during the administration of the estate), the estate/trust may be able to distribute the property on a tax-deferred basis.

A personal representative should always consider obtaining a “clearance certificate” from the Canada Revenue Agency, prior to making a distribution of estate property to a beneficiary. A personal representative can be held personally liable for taxes of the deceased if they distribute estate property and have insufficient funds in the estate to pay any outstanding taxes of the deceased.

A clearance certificate should protect a personal representative from this liability. In absence of a clearance certificate, a personal representative should withhold sufficient funds to pay any outstanding taxes of the deceased or legally bind the beneficiaries to pay the taxes of the deceased if the estate does not have sufficient resources to pay any outstanding taxes.

(I)n this world nothing can be said to be certain, except death and taxes.

— Benjamin Franklin

Many of us have been, or will be, appointed as the executor or executrix (“personal representative”) of a deceased relative or friend. This column discusses some of your responsibilities as a personal representative under the Canadian Income Tax Act.

This week, I will focus on income tax consequences to the deceased and some of your tax obligations and planning opportunities relating thereto. In my next column, I will focus on the estate of the deceased.

Final tax return for the deceased

A personal representative is required to file a final tax return of the deceased in respect of the year of death of the deceased. A deceased’s final income tax return (“terminal return”) covers the period from Jan. 1 of the year of death through to the date of death (“terminal year”).

Tax consequences to the deceased at death

Under the Income Tax Act, the deceased is deemed to have disposed of each of his or her items of capital property (e.g., shares of corporations, including properties in owned joint tenancy) and received proceeds of disposition therefor equal to the fair market value (“FMV”) of such property immediately before death.

Any resulting capital gains or losses (and, if the capital property is depreciable capital property such as a rental property, recapture or terminal losses) will be included in computing the income of the deceased for his or her terminal year.

There are similar rules for land inventories and resource properties.

There are planning opportunities to reduce taxes payable in the terminal return resulting from this FMV disposition, in particular for properties that are shares of private corporations, as well as others.

There are important exceptions to the FMV disposition rule.

One exception applies if, as a consequence of the death of the deceased, the deceased’s property is transferred or distributed to the surviving spouse or common-law partner (collectively “spouse”) who was resident in Canada immediately before the death of the deceased or to a qualifying spouse trust. In these cases, there may be a deferral until the death of the spouse or the disposition of the properties by the spouse or qualifying spouse trust.

Accordingly, proper will planning should consider gifting assets that are highly taxable to the deceased’s spouse or qualifying spouse trust (e.g., RRSPs), if possible.

In addition to a rollover to a spouse or a spouse trust, other rollover provisions may be applicable, such as those in respect of qualifying farm property, shares of a family farm corporation, or interests in a family farm partnership of a deceased taxpayer.

However, there may be circumstances in which it is desirable to have an FMV disposition take place rather than a rollover to a spouse or qualifying spouse trust. The Income Tax Act permits a personal representative to elect to have a FMV deemed disposition. There are similar excepting rules for inter-generational transfers of farm properties.

Opportunity for separate tax return

One opportunity for the personal representative is to elect to have a deceased’s rights or things (e.g., unpaid salary) taxed in a separate tax return. The advantage of making such an election is that the rights or things may be taxable at a lower marginal rate and, subject to certain limitations, a separate rights or things return enables the personal representative to double up on certain tax credits claimed in the terminal return.