Spousal Trusts Have Limited CGD Access

A spousal trust (including a common-law partner trust) can be an important tool for non-tax reasons: many individuals who draw up wills (especially in blended-family situations) want to provide income for the lifetime of a spouse while preserving capital for residual beneficiaries. However, a spousal trust has two drawbacks that may lead the testator to consider having the spouse own the property directly:
  1. Any capital gains deduction (CGD) that the surviving spouse might have been able to claim can be claimed only in circumstances where the spousal trust sells qualified property during the lifetime of the spouse (which, as discussed below, may defeat the testator's intentions).

  2. There is no ability to use the spouse's CGD on death.

At present, a spouse beneficiary can use his or her CGD with respect to property held in a spousal trust only in circumstances where the qualified property is sold during the lifetime of the spouse. Subsection 104(21.2) allows a trust to designate an amount in respect of the trust's net taxable capital gains to a beneficiary; for the purposes of section 110.6, such capital property is deemed to have been disposed of by the beneficiary in that taxation year. Practically speaking, however, many spousal trusts prohibit or severely restrict the trust's ability to sell property during the lifetime of the spouse because to do so would, in many cases, defeat the original intention of the testator in trying to preserve the capital of the trust for the residual beneficiaries. As a result, the use of a spousal trust may be detrimental from an income tax perspective if the spouse could have utilized his or her CGD had the property been transferred directly to the spouse rather than to a spousal trust.

Surviving spouses have not always been unable to utilize their CGDs in the spousal trust context on death, and it is hoped that a legislative response by the Department of Finance will fix what may have been an oversight in recent legislative amendments. Specifically, paragraph 104(4)(a) provides that a spousal trust is deemed to have disposed of all of its property at the end of the day on which the spouse has died. Before 2016, any income realized on this deemed disposition was payable to the spousal trust, but subsection 110.6(12) allowed the trust to utilize the unused CGD of the deceased beneficiary in computing its taxable income for the taxation year in which the beneficiary died. From a policy perspective, this outcome was appropriate, given that the spouse would have been able to utilize any remaining CGD on death if the property had been transferred to him or her directly. However, with the passing of Bill C-43 and the introduction of subsection 104(13.4), subsection 110.6(12) was repealed for 2016 and later taxation years.

As subsection 104(13.4) initially read, it would have allowed a spouse's estate to claim the CGD on the deemed disposition of spousal trust assets on the death of the beneficiary, but it also created a disconnect between the party responsible for the income tax and those who received the trust property. An amendment in 2016 fixed the latter inequity, but there was no reintroduction of a rule similar to former subsection 110.6(12). It is hoped that the Department of Finance will reintroduce a provision similar to former subsection 110.6(12) to ensure that a spouse who is the beneficiary of a spousal trust will have the same opportunity to utilize his or her CGD as a spouse who received such qualified property directly.

Dane ZoBell
Felesky Flynn LLP, Edmonton

Canadian Tax Focus
Volume 8, Number 1, February 2018
©2018, Canadian Tax Foundation