RRIFs, seg funds and insolvent estates

A recent judgment from the Tax Court of Canada illustrates some of the potential pitfalls. The June decision, Sandra Higgins v. The Queen, involved two sisters who split a RRIF and a seg fund, both issued by London Life, after their father’s death. Karen Kinnis, one of the sisters, dealt with the CRA and testified. The father, Arthur Higgins, died in February 2002 without a will and was so uncommunicative about his affairs that the sisters were not aware of the RRIF or the seg fund: after the father’s death a cousin mentioned that the father may have had an “insurance policy,” (the seg fund).

When contacted, London Life reps revealed that indeed there was a seg fund of about $10,000 (at that time, both sisters believed it to be a traditional life insurance policy). There was also a RRIF with London Life, valued at close to $30,000. By the end of February, London Life had paid out the full amounts in both funds, divided equally between the sisters, who were the named beneficiaries on both products.

However, as there was no will, no assets left inside the father’s estate (all sums in a small bank account were used for funeral expenses), and the sisters had no legal standing as representatives of the estate, they did not initially take further steps to administer the estate. Kinnis eventually filed a return for the estate in an effort to comply with CRA demands. It was assessed with about $2,500 owing.

In the following years, there were a variety of communications between Kinnis and the CRA, including a variety of inconsistent conversations. At one point, a CRA employee refused to speak with Kinnis because she had no standing to represent the estate. She was also told on three different occasions by CRA employees that no taxes were owing by either of the sisters. Yet, in 2010, the collections department of the CRA assessed the sisters for tax on the seg fund, the RRIF and the estate, using section 160 of the ITA.

That section gives the CRA extensive powers of collection when a tax debtor transfers property to a non-arms length person who receives no “payment” for the property. In such circumstances, the recipient may be liable for all of the tax owing. Non-arms length persons are generally family members. It does not matter if the recipient of the property is aware of the tax debt or even of the transfer.

Laurie Armstrong, a tax litigator in Victoria, B.C., successfully defended the sisters. He noted that, while the central purpose of section 160 may be valid (to pursue tax debtors who transfer property to avoid the debt) it can be draconian in effect. That’s partly because there is no limitation period on its operation; the result is that tax debts may arise following a reassessment that changes the debtor’s tax status at the time of the property transfer to a family member. So, even if there is no connection between the debt and gift, the recipient could be liable for tax under section 160. “That’s the unfairness,” says Armstrong. “The section has been [described] by courts as being draconian, if it is used in that manner, at its extremes.”

Over the decade following the father’s death, various assessments of the estate were issued, although Kinnis testified she did not receive some of them. In December 2002, an assessment of the estate was issued for $2,477 including interest and penalties. By 2005 the tax bill against the estate set by the CRA was close to $11,000, although Kinnis testified she never saw this bill. In 2010, the file was passed to the collections department with a total bill of $18,000.

Each sister was assessed for $5,096.08, the entire amount that each received from their father’s seg fund, under section 160. Each was also assessed for $6,047.10 with respect to the payments they received from their father’s RRIF, under section 160.2 of the ITA, which deals specifically with RRIFs. That calculation included amounts in the father’s bank account.

When it came to the seg fund, the government argued it was not a life insurance policy because the father had periodically withdrawn small sums from the fund, and because the designation of the beneficiaries was revocable. It also argued that the transfer to the sisters was an “indirect” transfer by the estate.

But the court found that the fund, a non-registered freedom fund segregated fund, was essentially a life insurance policy. “This appears to be a hybrid comprised of an insurance policy and a regular investment,” the decision says. “It is important to classify this fund as it will dictate whether [the father] transferred the property, either directly or indirectly, to the [sisters],” the decision adds.

In concluding that the fund was essentially a life policy, and was beyond the reach of section 160, the court noted that it created a contractual obligation on London Life to transfer the proceeds of the policy to the beneficiaries on the death of the father. It rightly passed outside of the estate, and was not in the same category as the RRIF, as the government had contended. The assessment against those funds was therefore vacated.

The court also ordered that the calculations for tax on the RRIF be re-assessed without including other amounts left by the father (the bank account). The assessments were ordered “referred back to the Minister for reconsideration and reassessment on the basis that each appellant is liable only to the correct amount of income tax attributable to the specific sum each received from the RRIF.”