Some lawyers think it’s likely the federal government will amend section 160 of the Income Tax Act to ensure that transfers to spouses by beneficiary designation are caught because the recent decision in Enns v Canada ‘creates a leak in the CRA’s tax collections ability.’iStockPhoto / Getty Images
A recent Federal Court of Appeal (FCA) decision in a case involving a woman found not liable for her late husband’s unpaid taxes highlights the importance of reviewing beneficiary designations on RRSPs and other registered plans, tax experts say.
The Canada Revenue Agency (CRA) assessed the widow for the value of the assets transferred from her deceased husband’s RRSP under section 160 in the Income Tax Act (ITA), which allows the agency to attach a tax liability to a spouse or other non-arm’s length person who has received property from the tax debtor for consideration that is less than fair market value.
However, the woman argued that because her husband was dead, she was no longer his spouse under section 160. The FCA found for the widow.
The FCA also noted that because the widow had received the RRSP directly by way of a beneficiary designation, the plan did not form part of the deceased’s estate and, therefore, was out of the reach of the estate’s creditors, including the CRA.
Tax experts say the FCA’s ruling provides clarity as to the definition of spouse for the purposes of section 160.
“[It] gives us a little bit more security that when [a widow or widower is the beneficiary of an RRSP], the CRA can’t just come in and take [it] and force a tax upon someone,” says Paul Thorne, director of advanced planning with Sun Life Financial Inc. in Dartmouth, N.S.
Although the court found in favour of the taxpayer in this case, the ruling shouldn’t necessarily lead clients to name their spouse as beneficiary of their registered plans automatically without considering their broader estate planning goals, says Sébastien Desmarais, vice president, tax and estate planner and business succession advisor at TD Wealth in Ottawa.
“We don’t do estate planning because of tax debt,” he says. “We do estate planning for efficiency, to provide for loved ones, to save or minimize taxes, but I have yet to see estate planning to avoid tax liability of the deceased.”
In Enns v Canada, a man who died in 2013 designated his wife as sole beneficiary of an RRSP valued at $103,000 at the time of his death. He also died owing the CRA $146,000 in taxes.
The CRA assessed the widow for part of the man’s debt, but she appealed the assessment to the Tax Court of Canada (TCC) arguing she was no longer his spouse. The TCC, reviewing case law, found for the CRA.
In its decision to overturn the TCC’s ruling, the FCA noted that the term “spouse” is not defined in the ITA, but the term “common-law partner” is. As the definition of a common-law partner involves a taxpayer “who cohabits” with another person in a conjugal relationship, that definition couldn’t be met following the death of one of the two people, the court said.
Thus, the FCA found that in cases in which there’s a transfer of an RRSP to a surviving partner as the designated beneficiary, the transfer isn’t to someone who is a “common-law partner”, under section 160. To ensure common-law partners and married couples are treated equally, the court said a transfer of a deceased’s RRSP to their widow or widower beneficiary can’t be a transfer to a spouse.
However, the court also noted that other provisions in the ITA that govern the transfer of property on death do use wording that references the spouse of someone who died, which suggests that for the purposes of those provisions, lawmakers intended that a spouse continue to be a spouse after death. The court noted that section 160 does not contain similar language.
Tax advisors point out that the court focused only on that part of section 160 that deals with a transfer of property by the designated beneficiary to a spouse or common-law partner, not transfers to minors or other non-arm’s length individuals.
“I don’t think we can expand the decision yet to other family members,” Mr. Desmarais says.
However, the FCA decision likely would apply to transfers of other registered plans, not just RRSPs, to spouses and common-law partners “as long as it’s a direct transfer outside of the estate either by way of a designated beneficiary or successor annuitant,” Mr. Desmarais says.
He adds proceeds of insurance policies are already likely not subject to section 160 reassessments because they don’t represent a transfer from the tax debtor to a non-arm’s length party.
Tax advisors typically advise clients to consider a range of factors when deciding whether to designate a beneficiary on a registered plan or to have the distribution of a plan governed by their will.
Naming a beneficiary means the assets held in a registered plan are not part of an estate, which avoids probate tax. In addition, the distribution of plan assets to a beneficiary can typically be achieved more quickly relative to the distribution of assets through an estate.
On the other hand, designating a beneficiary can lead to unintended negative consequences, such as family conflict if heirs receive unequal amounts, for example. In addition, disgruntled heirs may dispute a beneficiary designation if the deceased did not document their intentions.
“If you know all your assets are going [directly] to your spouse, and not to a trust for your spouse, [for example], then naming a beneficiary makes sense,” Mr. Thorne says. “But if there are other complications in the estate, then I think that you need to be more careful in reviewing [designations] because simply avoiding probate or simply avoiding [a tax liability] may undo all your planning.”
Although the CRA could seek leave to appeal the Enns decision to the Supreme Court of Canada, it’s unlikely that the top court would hear it, says Jennifer Mak, an associate with Counter Tax Litigators in Toronto.
“I don’t believe the Supreme Court will consider this a matter of national importance and it doesn’t have a broad enough impact,” she says. “The court rarely hears tax cases.”
Citing confidentiality reasons, a spokesperson for the CRA declined to respond directly to a question from the Globe as to whether the agency would appeal.
However, Ms. Mak says she thought it was likely the federal government would amend section 160 to ensure that transfers to spouses by beneficiary designation were caught, as the Enns decision “‘creates a leak in the CRA’s tax collections ability.’”
Mr. Thorne agrees Ottawa might consider a legislative change, which would be easier to do than trying to appeal. “They just need to change the wording [of section 160] a little bit.”