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Transferring assets to your family members: Common mistakes to avoid - YouTube
Channel: Cloudiverse CPAs
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My name is Aman, and I am a CPA practicing
in the Metro Vancouver region of British Columbia,
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Canada.
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This video will talk about the latest update
on
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You see, whenever we deal with related parties,
especially from the tax angle, the CRA is
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worried that the transaction does not relate
to an arms-length transaction.
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Now you might ask what Arm's length.
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Although the term at Arm's length is used
throughout the Income Tax Act, the Act does
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not contain any precise definition of the
term.
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As I want my video to be simple and understandable,
I will not focus on the technical definition
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from my point of view.
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Arm's length means someone who is not required
to act, and there is no tie or bond, on the
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other hand in non-arm's length; for example,
if your kid asks you for money, you might
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feel obligated to act, you have a motivation
which is not based on your interest, there
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is a kind of tie or a bond, a relationship
which makes you act.
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The suspicion is always that the transactions
might be done at a beneficial rate, so you
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are doing something in particular to meet
your goals, so the worry here is whether you
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may be trying to pass on some of your worldly
goods to your family members at a rate where
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you are trying to avoid taxes, so I am talking
about spousal transactions, transactions with
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children, transactions with brothers and sisters
etc., so when you deal with non-arm length
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transactions, there are a specific set of
rules that are in place.
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It becomes your problem to prove you did act
at Arm's length; the burden of proof is on
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you.
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You need to be very careful while doing transactions
with family members because many negative
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tax consequences such as double taxation come
into play when you do not act at Arm's length.
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Lets discuss the dangers of Double Taxation
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In the context of this video, double taxation
is when you don't get credit for having paid
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tax or get double penalized because you paid
the wrong amount in tax.
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So double taxation is to encourage taxpayers
to do transactions at fair market value, which
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avoids the double taxation issue, preventing
them from trying to avoid taxes.
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Let me give you some examples of Non-Arms
Length Transactions.
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Mark has 100 shares of a tech company that
have a fair market value of 10,000 dollars
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and a cost of 2000.
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Mark is currently in the highest tax bracket;
he thinks that his shares' value is going
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to grow.
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Mark starts thinking, I don't want to hold
these shares, and I want to give them to somebody
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in my family so that they can benefit from
the shares.
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Let's say Mark wants to sell the shares at
Fair Market Value.
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He says to his brother Tom, I have a really
good deal for you, buy the shares at fair
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market value and a couple of months from now,
they will be worth more.
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So, first of all, brother is blood-related,
a direct relationship, so absolutely will
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be defined as a related party, i.e.
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Non-Arm's length in this scenario.
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You see, the definition of fair market value
is what an arms-length person is willing to
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pay.
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To protect himself from CRA, he should be
able to come up with a market quote or a broker's
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statement to indicate the shares' fair market
value.
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So in this case, what ends up happening is
that the deemed proceeds will be the amount
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which he actually receives and on the other
side, Marks brother gets the deemed cost of
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acquisition at what he paid, so because both
Mark and his brother are getting credit for
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what was received or what was paid, there
is no double taxation in this case.
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So this will be an example of CRA says what
you should do, i.e. do the transaction at
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fair market value.
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Let's take another scenario in the same example,
Mark loves his brother so much, and he feels
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that since he is so successful, he does not
need to get anything in return for the shares
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from his brother and so he just gifts the
shares to his younger brother.
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Well, you might be surprised that this is
not a bad option, the sale proceeds will be
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deemed to be at Fair Market Value, but the
good thing is that the costs will also be
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deemed at fair market value, and so in this
case, again, there is no double taxation.
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However, Mark will have an immediate tax consequence,
and that is part of the problem, he will have
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to pay taxes on it with no income as he just
gifted the shares.
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In the third scenario, let's say he is indifferent
to his brother, he is going to trick him,
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so he is going to say, oh, you know, I have
a situation where I have shares and shares
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will double the value in a couple of months,
but you know I will let you have them for
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a particular some of money.
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Suppose Mark sells the shares to the brother
at more than fair market value.
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In that case, the issue is that the sale proceeds
will be deemed to be at actual value, so Mark
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will pay tax based on the actual sale value,
so let's say the shares were worth 10,000
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dollars.
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Still, he makes his brother pay 12,000 dollars,
in that case, Mark will be charged to tax
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based on the sales value of 12,000; however,
for this brother, the cost will be 10,000
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dollars even though he paid 12000 dollars,
which means he loses 2000 dollars from the
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cost, so when Marks brother sells the shares
later, let's say at 20,000 dollars, he will
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have to pay tax on the capital gain, i.e.
20,000-10000=10000 dollar instead of the difference
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between 20,000 and 12000, i.e. 8,000 dollars.
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So, in this case, there is double taxation,
because, for that 2000 dollars, they have
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to pay tax on it twice, as Mark is paying
tax on 12,000 and the brother is only getting
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the credit for 10,000.
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So that was the example for Mark and his brother;
things get a little bit different when we
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talk about Mark and his wife.
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So when it is a spouse, there is always an
assumption that transfer has happened at the
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Original Cost.
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So there are no tax consequences.
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It is a tax-free rollover.
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You see, the tax implications are deferred
until the sale is made to an outside third
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party.
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Unlike the USA, we don't see the Husband and
Wife as one for tax purposes in Canada.
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In the United States, you file one tax return
for a married unit.
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In contrast, in Canada, each person needs
to file their own taxes.
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Suppose you are trying to set off your losses,
and you want to trigger a capital gain to
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do the set-off.
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In that case, you can do it by electing out
of the rollover; you see, you can elect not
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to have the spousal transfer at cost.
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Beware, once you do the transaction, you can
not go back and elect out of the rollover.
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So you will need to elect out of a rollover
before the transaction actually happens.
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Another thing to keep in mind here is that
if Mark sells the shares to his wife at a
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value other than the fair market value, there
might be income attribution.
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Even if he gifts the shares to his wife, there
will be income attribution.
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I don;t want to go into the details of income
attribution in this video as I want to keep
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the video short.
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To give justice to the topic of income attribution,
I will discuss the income attribution rules
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in my next video.
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If you want to be notified about our new tax
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channel.
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Thanks for watching, and see you in my next
video.
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