As noted in Tax Primer 7, Tax is triggered by specific
events (such as the sale of an asset).
Some events, while seemingly innocuous in real life, can trigger a deemed disposition of an asset – a
disposition that occurs without an actual sale of the asset.
A deemed disposition is a bit of income tax
make-believe. In certain circumstances,
income tax legislation will deem you to have sold assets for fair market value
proceeds (even though you did not in fact sell the asset and even though you
have not actually received any money).
The most common deemed disposition events are gifts and
death. Giving up Canadian residence can
also result in a deemed disposition of assets, but that will be discussed in a
separate article.
Gifts
You may have heard that Canada does not have a gift
tax. Technically, that is a true
statement. What Canada has, however, is
a deemed disposition of a gifted asset.
For example, assume that you own a painting by A.J. Casson, one of the
Group of Seven painters. Assume that you
paid $10,000 for the painting and that it is now worth $100,000. If you decide to give it to your son for his
40th birthday, the Income Tax Act will deem you to have sold the
painting for $100,000. You will have a
capital gain of $90,000 and will have to pay the government for the privilege
of being generous to your son. In other
words, the gift to your son also results in a forced “gift” to the government.
This is technically not a gift tax because the tax applies
only to the gain and not to the entire value of the gift. In the case of an asset with a very low cost
and a very significant gain, however, this distinction has no substantive
difference. A tax is a tax is a tax.
Of course, a gift of Canadian cash will not attract any
tax. If you have $100 in Canadian cash,
you have already paid tax when you earned that cash. Accordingly, you can gift the $100 in Canadian
cash to your son without having to pay tax.
The deemed disposition rules trigger tax only in respect of assets that
have increased in value. The tax applies
to the increase in value since the date on which the asset was acquired. If the asset was acquired before 1972, the
Income Tax Act taxes only the increase in value since 1972.
Death
Nothing is surer than death and taxes. In Canada, death and taxes go together.
On death, the deceased is deemed to dispose of all assets
for fair market value. An exception
applies in respect of assets transferred to a surviving spouse of the deceased,
but this merely defers the deemed disposition to the death of the surviving
spouse.
The deemed disposition on death may well produce very
significant capital gains tax. For
example, assume that you decide that your 40-year-old son is too young to have
a Casson painting and you decide to keep the painting until your death. In your will, you bequeath the painting to
your son. On your death, you will be
deemed to have disposed of the painting for its fair market value (measured at
the time of your death). If the painting
has increased in value to $200,000 by the time of your death, you will now have
a deemed capital gain of $190,000. As
well, you may have a capital gain on other assets that you own at the date of
your death.
While the Canada Revenue Agency would not be able to come
after you personally for the taxes – there is no taxation beyond death (yet) –
the executor of your estate would have to pay this tax bill before distributing
assets to your heirs. Taxes are a major
cause of estate shrinkage. The heirs
receive only what is left after the payment of taxes.
Technically, Canada does not have an estate tax. However, the deemed disposition on death
provisions are a form of estate tax in everything but name.
It is usually advisable to take steps to manage the amount
of tax that will arise on death so that you heirs are not forced to sell valuable
investment assets in order to pay tax.
Visit the Dwyer Tax Law web site
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for information about our services and lawyers' profiles.
The above article provides general commentary of an educational nature. It does not constitute advice for any specific person or any specific set of circumstances. Because circumstances vary, readers should consult professional advisers in order to obtain advice that is applicable to their specific circumstances.