Section 74.5

Where an individual (the transferee) has acquired an income-producing property from his spouse and given to the transferor a demand promissory note bearing interest at the prescribed rate in effect at the time of the transfer, a subsequent lowering of the interest rate to the prescribed rate in effect at the subsequent time would result in the condition in s. 74.5(1)(b)(i) no longer being satisfied. Accordingly, the attribution rules would apply in respect of the property from the time of the resetting of the interest rate.

If, instead, the promissory note was forgiven, the requirement in s. 74.5(1)(b)(i) would no longer be satisfied.

No payment will be considered to occur pursuant to an agreement between the parties to the effect that interest on a promissory note will be deemed to be paid and then loaned back to the borrower.

An individual, who used a loan ("Loan 1") bearing interest at the prescribed rate (2%) to purchase securities for $100,000, now wishes to refinance the loan at 1%. Accordingly, half the securities (which have doubled in value) are sold for $100,000, which is used to repay Loan 1, and $100,000 is borrowed at the new prescribed rate of 1% ("Loan 2") to purchase new investments.

CRA confirmed that the attribution rules in ss. 74.1 and 74.2 will cease to apply after the repayment of Loan 1, and that the s. 74.5(2) exception from the attribution rules could apply to Loan 2 if the usual conditions were met.

S. 74.1(3) - which CRA described as ensuring that the attribution rules continue to apply where a new loan is used, e.g., to repay an existing loan that was used to acquire property - would not “technically” apply, because the proceeds from Loan 2 were not used to repay Loan 1..

Can the interest rate on a loan to a spouse or other family member remain fixed at the current prescribed rate of 1% (so that there is no income attribution) where the loan is a demand loan with no term, or it has a term of say 20 years? CRA stated:

Income and gains will not be attributed to the transferor (pursuant to subsections 74.1(1) and (2), and section 74.2) if the loan is set at the prescribed rate "at the time the indebtedness was incurred" as stated in subsections 74.5(1) and 74.5(2).

An individual (the Transferee) acquired an income producing property from the Transferee’s spouse (the Transferor) in consideration for a demand promissory note bearing interest at the prescribed rate at that time. Subsequently, the Transferor makes a fresh loan (at a lower prescribed rate) to the Transferee, who uses the proceeds to repay the first loan.

CRA considered that “the exception in 74.5(2) of the Act would cease to be applicable,” so that the attribution rules would commence applying, given that “the proceeds of the [second] loan are used to repay the demand promissory note (i.e., the proceeds would never generate any income or result in a gain),”

Where a loan is made on September 30, 1991 with interest payable annually, the exemption will apply only if the interest due on September 30, 1992 is paid within 30 days after the end of the 1992 calendar year.

No attribution of income will be made in the situation where father loans a newly-established trust with his minor children as beneficiaries the sum of $100 at a commercial rate of interest, followed by the trust buying common shares of a small business corporation for $100 which then pays a dividend on its common shares which enables the trust to repay the loan plus the accrued interest thereon.

Two common-law partners - within the meaning of s. 248(1) - separated on June 1, 2012 and started living separate and apart because of a breakdown of their common-law relationship. On separation, a rental property was transferred between them for no consideration, and the transferee (the “Transferee”) died on August 14, 2012.

1. Is the 90-day limit stated in the definition of "common-law partner" in subsection 248(1) applicable to subsection 74.5(3)?

2. Which of the transferor ("Transferor") or the Transferee is taxed on the rental income from June 1, 2012 to August 14, 2012, on the taxable capital gain and recapture of depreciation from the deemed disposition on death?

CRA responded:

1. Subsection 74.5(3) does not require a minimum time for individuals to be considered as living separate and apart from one another because of the breakdown of a common-law relationship. Thus, in the particular situation, the two taxpayers could, according to the facts, be considered as living separate and apart from each other for the purposes of subsection 74.5(3), notwithstanding the fact that they are deemed living together in a conjugal relationship for the purposes of the definition of "common-law partner" in subsection 248(1).

Respecting Q.2, CRA noted that, in light of s. 74.5(3)(a), s. 74.1(1) would not apply to the 2 ½ months’ of rental income and the recapture, so that it would be included in the Transferee's income; and that provided a s. 74.5(3)(b) election was made, s. 74.2(1) would not apply to attribute the amount of the taxable capital gain to the Transferor.

In 1991, the spouses jointly purchased an immovable ("Immovable1" located in Canada which was intended to serve as their principal residence upon their return to Canada. Their separation in 1992 did not constitute a judicial separation and was not effected pursuant to a written separation agreement. Upon their return to Canada, the wife bought a house in 1992 ("Immovable2 ") which immediately became her principal residence, but remained as a co-owner of Immovable1. The husband became a co-owner of Immovable2 in order to assist her in securing a mortgage, but did not make any monetary disbursements, nor lived there. Immovable1 has been the husband's principal residence since May 1995;

Between the time of the purchase of Immovable1 and May 1995, Immovable1 was used to earn rental income. The wife has never lived in Immovable1.

Each of the spouses now wishes to sell his or her undivided share of the immovables to the other spouse for $1. CRA assumed that the wife will designate Immovable2 as her principal residence for the years 1995 to 2006 inclusive (as well as 1992, 1993, and 1994) and that, as a result, the husband must designate the same property for the years 1995 to 2006 – in which case, Immovable1 would be treated as a capital property subject to the change-in-use rules.

The transfer by the wife of her interest in Immovable1 to the husband would occur under s. 73(1) at the ACB of her interest (assuming no election under s. 73(1)) and that provided the election under s. 74.5(3) was made jointly by the spouses, there would be no attribution of the capital gain realized on a subsequent sale of Immovable1. Furthermore, these results would not change if the transactions arose from a separation or divorce judgment relating to the division of spousal property.

As a result of a previous estate freeze, A holds the voting freeze preferred shares of Opco (which is not a small business corporation) and a discretionary family trust (“Initial Trust”), with spouse and children as beneficiaries, holds the non-voting common shares. Now a further freeze is implemented under which Initial Trust exchanges its shares for preferred shares, and New Trust, with spouse children, grandchildren and family corporations as beneficiaries, subscribes for new non-voting common shares. CRA stated:

[O]nly a person under the age of 18 who does not deal at arm's length with a trust could logically be a designated person in respect of a trust.

In light of the foregoing, Mr. A’s spouse cannot be a designated person in respect of Initial Trust.

After indicating that s. 74.4(2) nonetheless potentially might apply respecting A’s spouse viewed as a designated person in respect of A, on the basis “that the transfer of property made during this [2^nd] estate freeze was made indirectly by Mr. A by means of Initial Trust,” CRA also noted:

[A]n unborn child is not a person for the purposes of section 74.4 and subsection 74.5(5) and cannot constitute a designated person under paragraph 74.5(5)(b). In contrast, from birth, a grandchild may be a designated person in respect of an individual.

An individual transferred all the common shares of Cco (which, at no point, was a small business corporation) in a s. 85(1) rollover to a Newco (Bco) in consideration for common shares of Bco (being all its common shares). Two years later, Bco effected a s. 86 exchange of all its common shares of Cco in exchange for preferred shares of Cco, and a discretionary family trust (of which the individual’s wife and minor children were the beneficiaries) then subscribed for common shares of Cco for $100.

The correspondent submitted that even if the main purpose test in s. 74.2(2) was met, s. 74.2(2) would not apply since the transfer of the shares on the s. 86 reorganization “would be made by a corporation (Bco) to another corporation (Cco), and not by an individual to a corporation. CCRA rejected this submission, and indicated that, pursuant to s. 74.5(6), the common shares of Cco transferred by Bco (viewed under the terms of s. 74.5(6) as a “third party”) would be deemed to have been transferred by the individual to Cco.

Two individuals transferred the shares they held of a particular company to their respective holding companies which, in turn, each disposed of a portion of those shares to the individuals’ respective spouses in consideration for non-interest-bearing notes. Following an exchange of such shares for shares of another class, and an amalgamation of the company, the spouses disposed of the shares of Amalco at a gain. After finding that s. 74.2(1) applied, on the basis that there was an indirect transfer of the shares by the individuals to their spouses, the Directorate went on to indicate that this result was reinforced by s. 74.5(6).

A professional who formerly operated an unincorporated professional practice formed a corporation with him and his spouse each subscribing for shares, and her then gifting her shares to him so that he then was able to comply with a requirement that professional corporations be solely owned by professionals. Did s. 74.5(11) prevent attribution of dividend income to her on the shares which she had gifted to him?

After noting the submission that "the sole reason for the transfer of the shares from the spouse to taxpayer was to comply with the requirements of the corporation to qualify as a professional corporation," CRA stated that:

[I]t is possible that subsection 74.5(11) may apply… if one of the main reasons was to reduce the amount of tax that would…be payable under Part I on the income… derived from the property… .

A rental apartment building, generating net income after depreciation, was transferred on an s. 73(1) rollover basis for its FMV to the taxpayer's spouse, who financed its acquisition with a loan from an arm's length person. Regarding the deductibility of the interest on such loan, CCRA stated:

[I]nterest on borrowed funds will only be deductible under that paragraph if the funds were used to earn income from a business or property. That question can only be resolved, as regards the spouse who is the recipient of the transfer, after considering all the facts surrounding the transaction. Depending on the circumstances, the provisions of subsections 74.5(11) or 245(2) may apply.