When a private corporation shareholder passes away in Canada, their estate faces the risk of double taxation—so advisors often suggest a strategy known as a post-mortem pipeline plan. Here is a look at how this approach works along with how to effectively implement it based on recent Canada Revenue Agency (CRA) interpretations.
The post-mortem pipeline is a tax planning strategy designed to remove the double layer of tax following the death of a shareholder. At death, the estate will have a deemed capital gain on the private corporation shares and faces the risk of taxation again when the corporation’s assets are distributed as dividends to estate beneficiaries.
There are three main components to the post-mortem pipeline:
This results in the repayment of the note as a return of capital as opposed to a taxable dividend and avoids the second layer of tax—creating significant tax savings while complying with the Income Tax Act.
While this series of transactions may seem straightforward, the CRA recently released several views to provide further guidance when setting up these post-mortem pipelines.
The CRA reiterated at the 2024 STEP Canada roundtable that it will continue issuing favourable rulings for pipeline strategies. It noted that a well-timed, economically substantive pipeline will be considered consistent with the policy intent of the Income Tax Act and will not be considered a misuse or abuse of the Act.
Without a misuse or abuse, the CRA will not apply the general anti-avoidance rule (GAAR) to deny the tax benefit.
The following criteria must be met for a post-mortem pipeline transaction to not be considered a misuse or abuse of the Income Tax Act:
Additionally, the CRA published several views on the applicability of section 84.1 and subsection 84(2), which prevents the removal of corporate assets without appropriate tax. The CRA confirmed it will continue to consider issuing favourable rulings on their potential application on a case-by-case basis.
Taxpayers should still consider a cautious approach to any planning that will trigger these sections.
While pipelines are primarily used in post-mortem circumstances, the CRA also addressed whether a pipeline strategy in the context of the 21-year rule would trigger any anti-avoidance rules denying the tax benefit.
The 21-year rule applies to trusts that are deemed to dispose of all property—including shares of corporations owned by the trust—21 years after the trust is created. This is a taxable event and similarly may give rise to double taxation if the corporation’s assets are later paid out as dividends to the beneficiaries.
The CRA determined in its 104(4) ruling that none of the anti-avoidance rules applied in this context of a trust’s 21-year disposition with a subsequent transfer of value to the beneficiaries. This was a critical ruling as it affirmed that the CRA will treat trust post-anniversary pipeline strategies similarly to post-mortem pipelines.
The post-mortem pipeline remains a CRA-accepted and powerful estate planning tool when used correctly. Recent interpretations confirm that it is not abusive if structured with reasonable time, economic substance and without triggering the surplus stripping rules.
Families of private corporation owners can significantly reduce tax burdens—but they must follow CRA guidelines meticulously.
