The dissolution of a marriage or common-law relationship almost always has significant financial consequences for clients. As a result, the decisions that the former partners make while settling the end of their relationship will likely have major long-term financial repercussions.
Apart from issues related to division of property that will need to be discussed with a lawyer, you will have to cover certain financial and taxation matters related to the separation in discussions with the Client.
- Transferring assets between former partners: the tax principle
One of the first matters that must be dealt with when a marriage or common-law relationship is dissolved is often the division of property between the former partners. Different legal rules will likely apply based on the status of the parties 1. To avoid triggering detrimental tax impacts for the concerned parties, the Income Tax Act 2 has a provision allowing an automatic tax rollover so that taxes can be settled on the division of property from their marriage or common-law relationship. This provision allows the former partners to transfer to each other their depreciable property at the proportion of the asset’s undepreciated capital cost (UCC). Non-depreciable assets can be transferred at their adjusted cost base (ACB). It is not necessary to file a tax form to benefit from this tax provision; a simple written agreement between the parties will suffice. It is important to understand that this rollover rule ensures that the tax liability is transferred to the person who will dispose of the property in the future.
It is therefore important to inform the parties of this delayed tax impact. Lastly, it is fairly common for former partners to settle a divorce or dissolution of their partnership without an official division of property; instead, both former partners keep some of the property that would have been divided, each retaining assets of approximately equal value.
Sometimes though, ignoring the tax rules may turn an equal division into something unequal. For example, one partner may decide to keep the principal residence, worth $400,000, while the other partner may decide to keep RRSP accounts worth the same amount.
Although this strategy provides each partner with assets of equal value, it does not reflect the after-tax value of those assets. This is because the owner of the principal residence can still benefit from the principal residence exemption during resale, while immediate or future RRSP withdrawals will be taxable. If they were to each liquidate their assets, after tax the partner with the principal residence would have $400,000 in their hands, while the other partner would have $400,000 minus the tax owing on the RRSP withdrawal. This aspect should be discussed with the Clients.
- Transferring retirement plans, RRSPs and RRIFs
During a divorce, legal separation or dissolution of a common law relationship, there are tax provisions 3 that allow one partner to make a direct RRSP or RRIF transfer to the other partner with no immediate tax impact. Note that a divorce judgment, decree of judicial separation or written separation agreement for common law partners will be required to take advantage of these tax provisions.
It is also possible to avoid immediate tax impacts when dividing either credits registered under the Canada Pension Plan (CPP) or the value of a registered pension plan according to its terms. For more details on dividing CPP on the dissolution of a marriage or common law relationship, see the Canada Pension Plan’s website.
- Joint and several tax liability among partners
One tax provision that is often ignored during the dissolution of a marriage or common-law relationship is the joint and several liabilities for taxes that could result from a transfer of property between spouses or partners. This rule4 tries to prevent a partner with tax liabilities from transferring assets they own to the other partner for less than fair market value, in order to put those assets beyond the reach of the Canada Revenue Agency when they declare bankruptcy or become insolvent. In that case, the recipient of the asset could be liable for part or all of their former partner’s tax liability. However, there is an exception:5 if the asset is transferred as part of a written separation agreement or under a court order with certain conditions, the recipient will not be responsible for the other party’s tax debt.
- Designating a partner as beneficiary in a life insurance policy
The dissolution of a partnership will have different impacts on a life insurance policy beneficiary designation, depending on the marital status of the partners. Separation and divorce do not terminate an existing beneficiary designation (revocable or irrevocable) in the common law provinces 6. In Quebec, in the event of a legal separation, the partner’s designation as beneficiary will be maintained unless otherwise declared by a court order 7. The event of divorce does terminate that designation, however. Finally, the dissolution of a common law relationship has no effect on the designation of a common-law partner as beneficiary. As a result, their designation as beneficiary will be maintained. It will nevertheless be possible for the policyholder to revoke their former partner’s beneficiary status if the designation is revocable. If the designation is irrevocable, the policyholder must obtain approval from their former partner to revoke their designation on the policy. Language in a domestic contract stating parties waive entitlement to amounts payable under insurance contracts will not usually render an existing beneficiary designation ineffective. The policy holder must change the designation itself.
- Status after dissolution of a marriage or partnership
Dissolution of the client’s marriage or partnership inherently entails a change in their marital status. In the event of divorce or the dissolution of partnership, the former partners should update their personal information with government and tax agencies so that they can benefit from all available social programs and tax credits, including:
- The federal Canada child benefit
- The Guaranteed Income Supplement (GIS) for seniors
- The goods and services tax (GST)
- The federal tax credit for an eligible dependant
Finally, you should look to obtain accurate receipts for child care expenses and verify whether certain legal fees are tax deductible.
The dissolution of a client’s marriage or partnership will likely have significant financial and tax consequences for them. Depending on the status of the parties, there may be several different impacts. As advisor, you play a very important role. You must listen to the client’s needs and help them make informed decisions during this emotional time. However, considering the magnitude of the subject, it could be a good idea to refer the client to a specialized divorce lawyer to help answer some of their questions. It may also be good practice to give up one spouse as a client, in effort to avoid privacy issues or other accusations. One spouse may feel that you’re helping the other spouse more, or sharing information. Of course, you can make such decisions when weighing the specifics of a particular situation.
This document is intended to provide general information only. Sun Life Assurance Company of Canada does not provide legal, accounting or taxation advice to advisors or their clients. Before a client acts on any of the information contained in this document, or before you recommend any course of action, make sure that the client seeks advice from a qualified professional, including a thorough examination of their specific legal, accounting and tax situation, as required.
1 Generally, married couples in the common law provinces (all provinces except Quebec) have rights to an equalization of family property under their family law statutes. The same rights do not extend to those living common law – where “common law” refers to a type of marriage rather than a legal code –although common law spouses may have rights to some property under doctrines like constructive and resulting trusts.
2 Subsection 73(1) ITA
3 Subsection 146(16) ITA for RRSPs and subsection 146.3(14) ITA for RRIFs.
4 Section 160 ITA.
5 See subsection 160(4) ITA.
6 See Richardson Estate v. Mew, 93 O.R. 3rd 537, 300 D.L.R. 4th 503 (S.C.J.), affirmed 96 O.R. 3rd 65 (Ont. C.A.). This case is the law in Ontario. Those living in the other common law provinces should confirm this result in their province.
7 See article 2459 CCQ.