Tax for Estate Planners: Disclaimers
If you haven’t encountered it already, you will: a beneficiary unhappy with the terms of a will.
There’s countless reasons for it, and these disputes date back millennia. Some of the commentary in this note comes from cases I’ve read that are well over a century old.
In this note I address from a tax perspective a specific category of these circumstances: when a beneficiary rejects her interest in an estate. Done properly, this is called a “disclaimer”.
Dispositions
In these circumstances, something is being transferred: Beneficiary A was set to receive income or an asset; now Beneficiary B will receive it.
At tax law, transfers for no consideration are typically taxable to the donor as a capital gain. This gain is equal to the market value of the asset less its cost.
Here, what’s being transferred is an interest in an estate. Determining both the market value and cost of such an interest is complex and beyond the scope of this note. What’s important to understand is that tax consequences can arise in these cases—but if structured correctly, no tax may be triggered at all.
Disclaimers
For tax purposes, these transactions fall into two categories: valid and invalid disclaimers.
A valid disclaimer is “refusing to acquire the property of another”. Done correctly, the beneficiary will drop out of the running, as if she had predeceased the testator.
In this case, the will dictates who receives the disclaimed interest, bypassing the disclaiming beneficiary and flowing to the next designated recipient under the will.
From a tax perspective, assuming certain conditions are met, a disclaimer will trigger no tax consequences. This is because, under the Income Tax Act, a valid disclaimer is not considered a disposition at all.
Valid?
There are three preconditions to this tax treatment:
Timeliness. The beneficiary must disclaim within a reasonable time period (three years maximum, though in certain circumstances, the max might be earlier).
No benefit. The beneficiary disclaiming cannot derive any benefit from her interest prior to disclaiming.
No direction of interest. The disclaimer mustnot indicate who will receive the interest.
These conditions stem from case law and CRA commentary. The following passage from a leading case (Ginsberg) illustrates this:
At common law, a disclaimer in the strict sense is essentially a refusal to accept a gift. It does not act positively as an assignment or disposition of property, but negatively by preventing the property from vesting at all. If the donee does not disclaim within a reasonable time, acceptance will be presumed. If the donee does disclaim, the effect, for most purposes, is to avoid the gift ab initio.
This speaks to both the first and the second conditions: you can’t void an interest if you’ve already accepted it.
Direction
The third condition—directing the interest—comes up often.
Instruments like releases, surrenders or assignments of interest typically imply that the beneficiary has already accepted some benefit in respect of the interest. Assignments in particularly violate the “direction of interest” condition outright.
Each of these indicate that the beneficiary is disposing of her interest rather than voiding it.
Void
Voiding the interest, as if it never existed, is the goal from a tax perspective. This puts substantial limitations on these transactions. If you want positive tax treatment and also to determine who gets the interest, you’re out of luck!
Happy to discuss this, or any other tax question for that matter! I can be contacted directly at jonathan@rkwlaw.ca or 604.425.1123.