FCA Upholds Sommerer re Subsection 75(2) and FMV Sales
The FCA has upheld the TCC's decision in Sommerer (2012 FCA 207). The decision will be well received by taxpayers and their advisers with respect to the application of subsection 75(2). It remains to be seen whether the CRA will seek leave to appeal the decision to the SCC.
In Sommerer, a Canadian-resident taxpayer sold shares at FMV to an Austrian private foundation of which he was a beneficiary. Some time later, the foundation sold the shares to arm's-length parties and realized sizable capital gains. The Crown took the position that subsection 75(2) applied to attribute the gains back to the taxpayer. The taxpayer appealed to the TCC.
Subsection 75(2) applies to attribute income, losses, capital gains, and capital losses to a person who transfers property to a trust if the property or property substituted therefor may revert to that person, that person may determine who will receive the property, or the property cannot be disposed of without that person's consent or direction. Another adverse consequence arises if this attribution rule applies to a trust at any time: a tax-free rollout of property from the trust to beneficiaries is not available (unless the distribution is made to the transferor or the transferor's spouse). The result is that the trust is deemed to dispose of property at FMV on a distribution to a beneficiary other than to the transferor or the transferor's spouse.
The TCC held that subsection 75(2) does not apply where a trust acquires property from a beneficiary at FMV (2011 TCC 212). Writing for the FCA, Sharlow J agreed with the statutory interpretation analysis and conclusion of the TCC and added that a purposive interpretation of subsection 75(2) should be adopted. The FCA described a scenario in which a mother settles a trust for her children with cash and names herself as a contingent beneficiary. The trust uses the cash to purchase a painting from one of the children, and then sells the painting for a gain. Under the Crown's interpretation, this gain is attributed both to the mother (because the painting is property substituted for the cash she contributed and she is a beneficiary) and to the child (because the child has sold property to the trust and is also a beneficiary). The FCA held that Parliament could not have intended such an absurd outcome, and therefore subsection 75(2) does not apply to attribute income, losses, capital gains, or capital losses to a transferor who receives FMV consideration from the trust.
Provided that the FCA's interpretation is not reversed through a possible appeal, the result is that the application of subsection 75(2) has been greatly narrowed. This will broaden planning opportunities for taxpayers and their advisers.
Matthew Cho and Ian Pryor
Cadesky and Associates LLP, Toronto