Saturday, January 30, 2016

Alberta Court Orders Beneficiary of Registered Retirement Income Fund to Bear the Tax Burden on the Annuitant's Death

When the annuitant of an Registered Retirement Savings Plan or Registered Retirement Income Fund dies, taxes in respect of either type of  registered plan are generally borne by the deceased’s estate, rather than by the beneficiary of the registered plan. There are some exceptions, including significantly the ability to defer taxation if the proceeds are paid to the annuitant’s spouse (I have written about the taxation of registered plans in greater depth in a previous post). The tax rules may create unintended consequences when the annuitant names a beneficiary of the registered plan. If the proceeds of the registered plan are large, the effect may be to significantly deplete the deceased annuitant’s estate, thereby reducing the amount available to the beneficiaries of his or her will. If the annuitant is well advised, he or she may take the taxation into account when naming a beneficiary of a registered plan, but I suspect that all too often, the annuitant may not be aware of the impact of tax.

Mr. Justice Graesser of the Alberta Court of Queen’s Bench dealt with this issue in a unique way in a Morrison v. Morrison, 2015 ABQB 769. In a previous post, I wrote about his reasons for judgment in this case on the issue of whether the designated beneficiary of a Registered Retirement Income Fund was entitled to retain the proceeds or whether he held them in trust for his father, the annuitant’s estate.

I will repeat some of the key facts from my previous post, and add a few more relevant to this issue.

John Robert Morrison died on November 10, 2011 leaving four children surviving him. In his will, he divided his estate equally among his four children, except that $11,000 was to be deducted from his son Robert Morrison’s share and distributed equally among John Morrison’s grandchildren. Before his death, John Morrison sold his house, and distributed $25,000 to each of his children from the sale proceeds. John Morrison also designated his son Douglas Morrison as the beneficiary of his Registered Retirement Income Fund.  

If John Morrison intended that his son Douglas Morrison was entitled to the proceeds of the Registered Retirement Income Fund, and Mr Justice Graesser found on the evidence that he did, and if the estate bears the tax in respect of the proceeds, the estate would be depleted to the point where there would be insufficient funds from Robert Morrison’s one-quarter share of the estate to pay $11,000 to John Morrison’s grandchildren.

There was no direct evidence of whether John Morrison understood that the way the income tax provisions work, the tax on the Registered Retirement Income Fund proceeds is borne by the estate, but Mr. Justice Graesser inferred that he likely did not. If he did not, it would be unfair for Douglas Morrison to receive the benefit of the proceeds, without bearing the full burden of the taxes. Mr. Justice Graesser wrote:

[76]           However, the matter does not end there. There is the question of the tax paid on the RRIF. It is manifestly unfair that the Estate bear the burden of the tax while Douglas enjoys the benefit of the RRIF.
[77]           It is impossible to go into Mr. Morrison’s brain and determine his understanding of the implications to his estate of designating a non-spouse as beneficiary of the RRIF. That results in a tax liability to the estate, leaving the estate to pay the tax on the RRIF from its other assets. In this case, the tax on the RRIF has denuded the Estate to such an extent that it is unable to pay all of the specific bequests.
[78]           The only evidence I have of any understanding on Mr. Morrison’s part is in relation to the sale of his home, shortly before his death. None of the children suggest that he was in any way confused or lacking capacity at the time of the sale or the distribution of $25,000 to each of them.
[79]           In the absence of the tax on the RRIF being paid out of his estate, there was just enough left in his estate (after payment of debts and expenses) to create the $11,000 specified to be divided among his grandchildren.
[80]           It would seem highly unlikely that Mr. Morrison, by giving each of his children $25,000, intended to leave insufficient funds in his estate to satisfy the bequests to his grandchildren. That suggests to me, and I draw the inference, that Mr. Morrison was unaware of the tax consequences of designating his son as a beneficiary. He must have been under the impression or understanding that Douglas would bear any tax liability on the RRIF and no burden would fall on his estate.
[81]           This is another area that should be of particular concern to the investment community. I wonder how many investment advisors who give advice concerning beneficiary designations are aware of the tax consequences of the designation?
[82]           If Mr. Morrison had been aware that the RRIF would be taxable in his estate’s hands, it is unlikely that he would have given as much as he did to his children out of the sale proceeds of his house. If he had been aware of those consequences, I infer that he would have changed his will or changed the designation making the designation conditional on Douglas paying the tax.
[83]           I draw the inference and find on a balance of probabilities that whatever motivated Mr. Morrison to designate Douglas as beneficiary for the RRIF, he did not intend Douglas to be the beneficiary of the tax payable by his estate on the RRIF.
[84]           I thus find that Mr. Morrison either intended Douglas to be responsible for the tax on the RRIF and expected that the tax would be deducted from the RRIF when it was transferred or paid to Douglas, rather than left to be paid by the Estate, or that Mr. Morrison was mistaken about the tax treatment of his RRIF having designated Douglas as beneficiary based on the above intention and expectation.
[85]           In either circumstance, Douglas has received an unintended and unexpected benefit from the Estate.
Mr. Justice Graesser held that in these circumstances he had jurisdiction to provide a remedy to the unfairness of the tax falling on the estate based on equitable principles. He wrote at paragraphs 98 and 99:

[98]           The alternative approach, and the one which I adopt in this case, is to apply s 8 of the Judicature Act, RSA 2000 c J-2. That section provides:
(8)        The Court in the exercise of its jurisdiction in every proceeding pending before it has power to grant and shall grant, either absolutely or on any reasonable terms and conditions that seem just to the Court, all remedies whatsoever to which any of the parties to the proceeding may appear to be entitled in respect of any and every legal or equitable claim properly brought forward by them in the proceeding, so that as far as possible all matters in controversy between the parties can be completely determined and all multiplicity of legal proceedings concerning those matters avoided.
[99]           The application of s 8 entitles me to fashion a remedy with the effect that Douglas reimburse the Estate the full amount of the tax paid by the Estate on the RRIF. I have found that Mr. Morrison did not intend Douglas to receive the RRIF and leave the tax burden on his Estate. Tax was to follow the RRIF.
Mr. Justice Graesser found that Douglas Morrison would be unjustly enriched if he were not required to bear the tax burden, or alternatively that he should bear the tax based on misstate. He imposed a constructive trust on the proceeds of the Registered Retirement Income Fund to the extent of the estate’s liability for taxes in respect of those proceeds.

[104]      Probate law’s origins are in equity, so I do not find it inappropriate to consider equitable remedies where the common law is inadequate to remedy a wrong.
[105]      In these circumstances, I find that the tax paid by the Estate conferred a benefit in that same amount to Douglas. He has been unjustly enriched by the payment. While the Estate was under a legal obligation to pay the tax, it was under no legal obligation to Douglas to pay it for him.
[106]      It would be unjust for Douglas to retain the benefit. Principles of unjust enrichment justify a direction that Douglas reimburse the Estate for the tax it paid on his behalf.
[107]      An alternative approach using equitable principles and remedies is that the tax paid by the Estate resulted from Mr. Morrison’s mistaken understanding of the consequences of the beneficiary designation. Reimbursement by Douglas flows from equitable principles surrounding mistake.
[108]      Either approach results in a declaration of a constructive trust on the proceeds of the RRIF received by Douglas to the extent of the Estate’s payment to CRA on account of the RRIF.
[109]      Requiring reimbursement by Douglas will replenish the Estate to the amount intended by Mr. Morrison to be available for distribution, and prevents the manifest injustice of having an unintended tax consequence of a beneficiary designation frustrate the testator’s intentions.
[110]      I recognize that the approach I have taken here may be viewed as extraordinary. But that is what s 8 is for: creating an equitable remedy where the law would otherwise leave the injured party (here, the Estate and beneficiaries other than Douglas) with no adequate remedy.
Although this decision is not binding on British Columbia courts, the Supreme Court of British Columbia might find the reasoning persuasive if the Court infers from the facts that the annuitant did not recognize the tax consequences of naming a beneficiary to his or her registered plan. The British Columbia Law and Equity Act has a similar provision to section 8 of the Alberta Judicature Act. Secion 10 of the Law and Equity Act says:
Avoidance of multiplicity of proceedings
10  In the exercise of its jurisdiction in a cause or matter before it, the court must grant, either absolutely or on reasonable conditions that to it seem just, all remedies that any of the parties may appear to be entitled to in respect of any legal or equitable claim properly brought forward by them in the cause or matter so that, as far as possible, all matters in controversy between the parties may be completely and finally determined and all multiplicity of legal proceedings concerning any of those matters may be avoided.

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