Working around the attribution rules
Parents and grandparents should be aware of CCRA’s (formerly Revenue Canada) Attribution Rules before gifting money to children under the age of 18.
Under Section 74.1(2) of the Income Tax Act, income earned from property transferred or lent, either directly or indirectly, by means of a trust or by any other means whatever, to or for the benefit of a person who was under 18 years of age, will be taxed in the hands of the transferor, if the minor is related and not dealt with "at arm’s length", or who is a niece or nephew. These rules are outlined in depth in Revenue Canada’s IT Bulletin #510.
In general, interest and dividend income earned by the gift must be reported by the transferor. However, there is no attribution on income classified as "capital gains", so the minor may report such earnings as income on his/her own return, provided that specific documentation requirements are met.
When informal trusts are set up by parents or grandparents for a minor, it is important to ensure that the transferor or "settlor" of the account, may not withdraw the funds later and use them for his/her own personal benefit. One must establish that the traferor has divested him/herself of the title to the property.
One way to do this is to ensure that the transferor does not have the right to withdraw the contributions or income from the account. If grandpa gives the money for investment , for example, and grandma manages the account on behalf of the minor child, the test of transfer will likely be met. In other words, grandma should the named trustee, and the children should be the named beneficiaries of the account, so that future capital gains are not be attributed back to grandpa.
It is also best to keep the amounts invested for each of the children in separate accounts. In that way, future re-investment of earnings by each child can be traced back easily for tax filing purposes. Remember that every child can earn the Basic Personal Amount ($7131 in 2000) before he/she will be taxable.
If the grandparent or transferor dies before the child requires to use the funds, a new trustee for the account will have to be named to manage the investments for the minor. The same rules described above would apply to this trustee, that is, one must ensure that the title of the property truly belongs to the minor and is not for use of the trustee.
Excerpted from The Jacks on Tax Online Update Newsletter.