The Federal Court of Appeal (FCA) released its decision in The Queen v. Sommerer on July 13, 2012, concluding that subsection 75(2) of the Income Tax Act (Canada) does not apply on a fair market sale of property to a trust by a person who is a capital beneficiary of the trust. This decision overrules the Canada Revenue Agency’s (CRA’s) long-standing position that the wording of subsection 75(2) is broad enough to include the fair market value sale.
Until the Tax Court of Canada (TCC) decision in Sommerer v. The Queen, tax professionals usually followed the CRA’s position on the broad reach of subsection 75(2), structuring transactions and jumping through hoops to ensure a trust did not acquire any property from a capital beneficiary. In fact, many trusts were drafted prohibiting any purchase of property from a capital beneficiary, even a purchase for fair market value consideration, to prevent an unintentional application of subsection 75(2).
The application of subsection 75(2) can be catastrophic for certain tax planning structures using trusts. Subsection 75(2) attributes income, losses, capital gains and capital losses earned in respect of the contributed property (or substituted property) to the person who contributed the property.
In addition, pursuant to subsection 107(4.1), if subsection 75(2) ever applied in respect of any trust property and the contributor is still alive, only the contributor and his/her spouse can receive the trust property that he/she contributed (or property substituted for that property) on a tax-deferred rollover basis under subsection 107(2). No other tax-deferred rollover of property to a beneficiary is available.