Choose the Right Beneficiary to Avoid Tax Pitfalls

Relevant Facts

The Appellant, Mrs. Marlene Enns was married to Mr. Peter Enns. Mr. Enns designated Mrs. Enns as the sole beneficiary of his RRSP, meaning his RRSP would be directly transferred to her upon his death, as opposed to going through his estate.

Upon Mr. Enns’ death, his RRSP (valued at $102,789.52) was directly transferred to Mrs. Enns. However, Mr. Enns also had outstanding tax liabilities exceeding the fair market value of his RRSP.

The Canada Revenue Agency (“CRA”) assessed Mrs. Enns under section 160 of the ITA, which is a collection provision preventing taxpayers from transferring their assets to non-arm’s length parties for less than fair market value in return when the taxpayer owes a tax debt.[2] In particular, paragraph 160(1)(a) provides when the taxpayer transfers property to their “spouse or common-law partner”, then the spouse or common-law partner is liable up to the fair market value of the property transferred.[3]

The CRA argued that paragraph 160(1)(a) applied because Mrs. Enns remained a “spouse” and was, therefore, liable for the value of his RRSP transferred to her after Mr. Enns’ death. Mrs. Enns’ position was that she ceased to be his spouse upon his death for purposes of applying this provision.

The Tax Court’s Analysis

The Tax Court (per Russell J.) agreed with the CRA’s position.[4] It reviewed two Tax Court decisions that addressed this issue but reached opposite conclusions.[5] Ultimately, Justice Russell decided to rely on and follow Kuchta because the case specifically addressed the interpretation of “spouse” as the main issue, and he agreed with the Court’s textual, contextual, and purposive analysis.

Mrs. Enns appealed the Tax Court’s decision to the Federal Court of Appeal, arguing that the Tax Court’s interpretation of “spouse” was an error in law.

The FCA’s Analysis

On appeal, the FCA overruled the Tax Court’s decision and concluded that two individuals are no longer “spouses” upon the death of one for purposes of applying section 160.

The FCA found it an error in law not to consider the definition of “common-law partner” set out in the ITA, given that spouses and common-law partners are to be treated the same for purposes of section 160 and the statutory definition of “common-law partner” applies to the entire ITA.

In reviewing the statutory definition, it was clear that individuals cease to be common-law partners upon the death of one individual. Therefore, the Tax Court’s interpretation of “spouse” creates an inconsistent result between those who are married versus in a common law relationship before death.

Further, the FCA noted that the Tax Court’s conclusion would have caused Mrs. Enns to withdraw the RRSP to pay her the section 160 assessment, and she would have to pay tax from her own personal funds on the withdrawal of the RRSP. The FCA states “[i]t is far from clear that Parliament would have intended this result following the death of a person’s partner”[6].

Open Questions for Other Non-Arm’s Length Transfers

While this decision provides clarity for spouses and common-law partners in applying section 160, it leaves open other key issues regarding section 160’s post-mortem application to other non-arms-length relationships. Specifically, transfers set out in paragraphs 160(1)(b) (to minors) and (c) (to non-arm’s length parties) are not addressed.

For example, it remains unclear whether section 160 would apply to a post-mortem transfer where the deceased had named a minor child or grandchild or another non-arms length party, such as a parent or sibling, as the designated beneficiary of an RRSP. It appears that rules surrounding the definition of minors appear clearer, and if an RRSP is passed to a minor beneficiary after death, the minor could likely be liable under section 160.

This creates potential inequities, as a spouse who is a designated beneficiary escapes liability, whereas a minor or another non-arms length person might not. It is unlikely that Parliament would have intended a different result for these scenarios.

Given these potential inconsistencies, legislative reform may be forthcoming to align tax treatment across different beneficiary relationships.

The CRA’s Collection Leak: Will Parliament Plug the Leak?

This ruling limits the CRA’s ability to recover unpaid tax debts from a deceased taxpayer’s RRSP if a spouse is the designated beneficiary. In Mr. Enns’ case, this decision likely means the CRA cannot collect his outstanding tax liability.

It is unlikely that the Supreme Court of Canada will agree to hear this case. Instead, this decision may prompt Parliament to introduce a legislative amendment defining “spouse” to include a deceased spouse for purposes of paragraph 160(1)(a).

Actionable Steps for Estate Planning

For taxpayers and advisors, the Enns case reinforces the importance of careful estate planning, particularly in naming beneficiaries for registered accounts. While the decision provides a reassuring precedent for spouses and common-law partners, it also signals the need for vigilance in structuring estate plans to mitigate unforeseen tax liabilities.

To safeguard assets and minimize post-mortem tax risks, we recommend that taxpayers

1. Review Beneficiary Designations – Ensure registered accounts, such as RRSP and TFSA, beneficiaries align with estate and tax planning objectives;
2. Engage a Tax Advisor – Assess potential tax liabilities under section 160 and develop a proactive strategy to mitigate potential liability; and
3. Monitor Legislative Developments – Stay informed about potential legislative amendments that could affect wealth transfers.
   

Closing Thoughts

The Enns decision underscores the importance of strategic planning to minimize unexpected tax burdens. Engaging with tax professionals ensures estate plans remain effective amid evolving legal interpretations.