FOR ALL CANADIANS

Attribution Rules

Learn these rules in just 25 minutes of listening to this.

Interested in more podcasts like this?

I. Overview of Attribution Rules (Sections 74.1 - 74.4)

The Income Tax Act (Canada) includes "attribution rules" designed to prevent individuals from reducing their tax liability by transferring or lending property to certain related individuals or entities who are subject to a lower tax rate. These rules effectively "attribute" the income, losses, or capital gains/losses generated from the transferred or lent property back to the original transferor or lender.

II. Detailed Breakdown of Key Sections

Section 74.1: Transfers and Loans of Property (Income/Loss Attribution)

• Subsection 74.1(1) - Spouse or Common-law Partner:
  • Rule: If an individual transfers or lends property to their spouse or common-law partner, any income or loss from that property (or substituted property) is deemed to be the income or loss of the transferor/lender for the period they are resident in Canada and the recipient remains their spouse/common-law partner.
  • Exception: Does not apply to assignments of retirement pensions under the Canada Pension Plan or comparable provincial plans.
  • Purpose: Prevents income splitting with a spouse/common-law partner to benefit from their potentially lower tax bracket.
• Subsection 74.1(2) - Minors:
  • Rule: If an individual transfers or lends property to a person under 18 years of age who is not dealing at arm's length or is their niece or nephew, any income or loss from that property (or substituted property) is deemed to be the income or loss of the transferor/lender while they are resident in Canada.
  • Exceptions:Does not apply if the minor attains 18 years of age before the end of the taxation year.
  • Excludes amounts received under subsection 122.61(1) (Child Benefit) or section 4 of the Universal Child Care Benefit Act.
  • Purpose: Prevents income splitting with minor children, nieces, or nephews.
• Subsection 74.1(3) - Repayment of Existing Indebtedness:
  • Rule: If transferred or lent property (or substituted property) is used to repay borrowed money used to acquire other property or to reduce an amount payable for other property, a proportion of the income or loss from that other property is included in computing income from the original transferred/lent property.
  • Calculation: The proportion is based on the fair market value of the transferred/lent property used relative to the cost of the other property.
  • Effect: Expands the attribution rule to cover situations where transferred funds are used indirectly to generate income from other assets.

Section 74.2: Gain or Loss Deemed that of Lender or Transferor (Capital Gains/Losses Attribution)

• Subsection 74.2(1) - Spouse or Common-law Partner:
  • Rule: Similar to 74.1(1), if property is lent or transferred to a spouse or common-law partner, any taxable capital gains, allowable capital losses, gains, or losses from the disposition of that property (or substituted property) are attributed back to the transferor/lender.
  • Specifics:Attribution applies to both non-listed personal property and listed personal property.
  • The recipient's capital gains/losses from such property are not considered their own for tax purposes, except for the purpose of the attribution calculations.
  • Purpose: Prevents capital gains splitting with a spouse/common-law partner.
• Subsection 74.2(2) - Deemed Gain or Loss for Specific Sections:
  • Rule: When an amount is deemed a capital gain/loss of an individual under certain attribution rules (including 74.2(1)), that gain or loss is treated as if it arose from the disposition of that property by the individual for the purposes of sections 3, 111, and 110.6 (e.g., capital gains deduction, net capital losses).
  • Effective Date: The property is deemed to have been disposed of by the individual on the day it was disposed of by the other person.
• Subsection 74.2(3) & (4) - Election for Emigration Disposition:
  • Rule: Subsection (1) (capital gains/losses attribution to spouse/common-law partner) generally does not apply to a deemed disposition upon emigration (paragraph 128.1(4)(b)) by the recipient, unless the recipient and the original transferor/lender jointly elect for it to apply.
  • Assessment Impact: An election can lead to an assessment adjustment, but it does not affect interest or penalties for periods before the taxpayer's filing-due date for the year of disposition.
  • Purpose: Provides flexibility in specific emigration scenarios.

Section 74.3: Transfers or Loans to a Trust

• Subsection 74.3(1) - Attribution Rules for Trusts:
  • Rule: If property is lent or transferred to a trust in which a "designated person" (in respect of the individual) is beneficially interested, attribution rules apply for both income (as per 74.1) and capital gains (as per 74.2).
  • Income Attribution (for 74.1 purposes): The designated person's income from the lent/transferred property is deemed to be the lesser of the amount included in their income under paragraph 12(1)(m) (trust income) and a proportion of the trust's income from that property.
  • Capital Gains Attribution (for 74.2 purposes): The lesser of the amount designated under subsection 104(21) (capital gains flow-through from trust) and the trust's net capital gains from the lent/transferred property is deemed to be a taxable capital gain of the designated person.
  • Purpose: Extends attribution to trusts used to benefit related individuals.
• Subsection 74.3(2) - Definition of "designated person": Refers to subsection 74.5(5) for the meaning of "designated person."

Section 74.4: Transfers and Loans to Corporations

• Subsection 74.4(1) - Definitions:
  • Designated person: Refers to subsection 74.5(5).
  • Excluded consideration: Indebtedness, shares, or rights to receive indebtedness or shares.
• Subsection 74.4(2) - Deemed Interest on Loans/Transfers to Corporations:
  • Rule: If property is lent or transferred to a corporation, and a main purpose is to reduce the individual's income and benefit a "designated person," the individual is deemed to have received interest on the outstanding amount of the loan/transfer.
  • Conditions for attribution:
    • The designated person is a designated person throughout the period.
    • The designated person would have been a "specified shareholder" (with modifications to the definition).
    • The individual was resident in Canada.
  • The corporation was not a "small business corporation."
  • Calculation of Deemed Interest: Prescribed rate interest on the outstanding amount minus any actual interest received, certain dividends received as consideration for the transfer/loan, and certain "split income" dividends received by a specified individual.
  • Purpose: Prevents income splitting through private corporations.
• Subsection 74.4(3) - Outstanding Amount Calculation: Provides specific rules for calculating the "outstanding amount" of a transferred property or loan, taking into account consideration received (excluding "excluded consideration").
• Subsection 74.4(4) - When Benefit is Not Granted to a Designated Person:
• Rule: One of the main purposes of a transfer/loan to a corporation is not considered to be to benefit a designated person if:
  • The designated person's only interest is a beneficial interest in shares held by a trust.
  • The trust terms prevent the designated person from receiving or using trust income/capital while being a designated person.
• The designated person has not actually received or used trust income/capital, and the trust has not made deductions in their favour under subsections 104(6) or (12) (trust income/capital gains allocations).
• Purpose: Provides a safe harbor for certain trust structures.

III. General Principles and Considerations

• Direct or Indirect Means: The attribution rules apply whether property is transferred or lent directly, indirectly, by means of a trust, or by any other means whatever. This broad language captures various schemes.
• Property Substituted Therefor: The rules extend to "property substituted therefor," meaning if the original property is sold and the proceeds are reinvested, the new property and its income/gains are also subject to attribution.
• "At Arm's Length": A key concept in tax law, generally meaning independent parties transacting freely. The rules specifically mention "not at arm's length" for minors.
• "Main Purpose": For corporate attribution (74.4), the "main purpose" test is crucial. If reducing the individual's income and benefiting a designated person is one of the main purposes, the rule applies.
• Resident in Canada: The attribution rules generally apply for periods throughout which the individual (transferor/lender) is resident in Canada.

=

Source: https://laws-lois.justice.gc.ca/eng/acts/I-3.3/page-49.html#docCont

Interested To Learn More About Tax Foundations with AI?