23 October 2001 External T.I. 2000-0052505 - Trust Becoming Resident in Canada

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: An individual becomes resident in Canada. This individual is the settlor and sole trustee of a trust. The individual may receive part of the income and the capital of the trust. On death of the settlor, the residue of the trust is to be transferred to a non-resident beneficiary. Specific questions on some of the fiscal consequences for the individual and the trust if the trust becomes resident in Canada or does not become resident in Canada.

Position: General comments.

Reasons: Insufficient facts.

XXXXXXXXXX 				2000-005250
					Éric Allard-Pouliot
October 23, 2001

Dear XXXXXXXXXX:

Re: Technical Interpretation Request - U.S. Charitable Remainder Trust

We are writing in response to your letter of October 17, 2000 in which you requested our comments on certain taxation issues related to a U.S. Charitable Remainder Trust and its Canadian beneficiary. In your request, you describe the following situation.

Situation

An individual resident in the United States irrevocably settled a trust with the contribution of publicly traded securities. At the time the trust was created, the individual was not a resident of Canada. The sole trustee of the trust is the individual. Under the terms of the trust, the individual is entitled to receive from the trust each year, a fixed percentage of the value of the property of the trust. In any given year, the amount received by the individual may be greater or less than the income of the trust for that year. On the death of the individual, the residue of the trust will be transferred to a U.S. charity. Several years after the creation of the trust, the individual becomes a Canadian resident.

Our comments

You have asked ten questions regarding the application of subsection 75(2) and other provisions of the Income Tax Act (the "Act") as they would apply to the above situation. As explained in Information Circular 70-6R4, it is not this Directorate's practice to comment on completed transactions. The confirmation of the tax consequences applicable to your particular client would require a thorough examination of the trust indenture, the will and other relevant information. You may wish to submit the relevant facts and documentation of your situation to the appropriate Tax Services Office for their views.

While we are not in a position to give a definitive response to your enquiry, we can offer the following general comments which we hope will be of assistance. We will deal with each question separately.

Question 1

Does subsection 75(2) of the Act apply to attribute all of the income of the trust to the individual? In this regard could it be said that the individual has a reversionary interest in the trust?

Would the answer to this question be different if the individual resigned as trustee of the trust before becoming a resident of Canada? More specifically, would proposed paragraph 75(3)(c.2) apply to exempt the application of subsection 75(2) of the Act?

Comments

Subsection 75(2) of the Act applies when property is held by a trust on the condition that it, or property substituted for it, may revert to the person from whom it was received. Subsection 75(2) of the Act also applies when property is held by a trust on condition that during the existence of the person who transferred the property to the trust, the property can only be disposed with the person's consent or in accordance with the person's direction. Hence, when the terms of the trust are such that there is a possibility that the person who transferred the property to the trust may reacquire the property (or property substituted for such property), or when the person who transferred the property to the trust is the sole trustee of the trust, subsection 75(2) of the Act may apply. In the situation you described, there is a possibility under the terms of the trust, that the individual could reacquire the property that was transferred to the trust. Moreover, the author of the trust is also its sole trustee. Although pursuant to subsection 75(2) of the Act any income, gain or loss incurred in respect of any property held by a trust under one or more of the conditions provided under paragraphs 75(2)(a) or (b) of the Act is attributed to the person from whom such property was received by the trust only during a period when that person is resident in Canada, the attribution rules do not depend upon the person having been resident in Canada at the time the property was received by the trust. Moreover, subsection 75(2) of the Act may apply whether the trust is resident in Canada or not.

Subsection 75(3) of the Act contains exceptions to the application of subsection 75(2) with respect to property held by certain trusts. The Legislative Proposals on Taxation of Non-Resident Trusts and Foreign Investment Entities issued in August 2001 by the Department of Finance adds paragraph (c.2) to subsection 75(3) of the Act. This proposed amendment provides that subsection 75(2) of the Act does not apply to property held in a taxation year by a trust that is non-resident, for the purpose of computing its income for

the year, because a contributor (within the meaning assigned by subsection 94(1)) to the trust is an individual (other than a trust) who was, at the end of the year, resident in Canada for a period, or periods the total of which is, not more than 60 months. This amendment, if enacted as proposed, would apply to trust taxation years that begin after 2000.

Question 2

If subsection 75(2) of the Act does apply, is it possible for the individual to pay tax on income that will never be received, as it will be left to the U.S. charity?

Comments

In our view, this is a distinct possibility. If under the terms of a trust, an individual is entitled to receive a fixed percentage of the value of the property of the trust, the amount received by the individual could be more or less than the income of the trust for that year. However, the amount attributed to the individual pursuant to subsection 75(2) of the Act would be equal to the amount of income or loss from the property contributed to the trust, or from property substituted therefor, and any taxable capital gain or allowable capital loss from the disposition of the property or of property substituted therefor.

Question 3

Is it possible that double taxation could apply such that the individual pays tax on income that is also taxable in the trust or that the individual pays tax on distributions from the trust that were otherwise taxable under subsection 75(2) of the Act?

Comments

There is no double taxation of income subject to subsection 75(2) of the Act where both the individual and the trust are residents of Canada. It is our view that where subsection 75(2) of the Act applies to attribute income to a person, that income is never income of the trust for tax purposes and consequently it is not taxable in the hands of the trust nor can it be paid or payable to any beneficiary of the trust for the purposes of subsection 104(13) of the Act. The attributed income becomes capital of the trust and distributions of this capital by the trust are generally not taxable. However, any income earned on this attributed income will not itself be attributable to the individual and will therefore generally be taxable to the trust to the extent that it is not paid or payable to any or all beneficiaries of the trust pursuant to subsection 104(13) of the Act or the subject of a preferred beneficiary election pursuant to subsection 104(14) of the Act.

On the other hand, if the trust is not resident in Canada there is a distinct possibility for double taxation since, as noted above, the individual would be taxable in Canada on the property income of the trust, and the trust could be subject to taxation on its property income in the U.S. Moreover, income distributions by the trust may be subject to taxation in the U.S., as this would not offend Article XXII of the Canada-U.S. Income Tax Convention. However, as stated in paragraph 3 of Article XXVI of the Convention, the competent authorities of the Contracting States could resolve by mutual agreement any difficulties or doubts arising as to the interpretation or application of the Convention, and in particular, the competent authorities of the Contracting States could agree to the elimination of double taxation with respect to the income distributed by a trust.

Question 4

Are the distributions from the trust taxable to the individual once the individual becomes a resident of Canada? Would the answer to this question be different if the individual resigned as trustee of the trust before becoming a resident of Canada and the trust did not become a resident of Canada?

Comments

For Canadian income tax purposes, trust distributions to an individual resident of Canada must generally be included in its income pursuant to subsection 104(13) of the Act. Paragraph 104(13)(a) provides generally that such part of the amount that, but for subsections (6) and (12), would be the trust's income for the trust's taxation year that ended in the particular year as became payable in the trust's year to the beneficiary, shall be included in computing the income for the particular taxation year of a beneficiary under the trust. However, as stated in our comments to question 3 above, where the income of a trust is attributed pursuant to subsection 75(2) of the Act, that income becomes capital of the trust and is not taxable when distributed, regardless of the residence of the trust.

Question 5

Will the taxability of the payments received by the individual be different depending on whether the trust has any income in a particular year?

Comments

As noted earlier, the income of a trust from any property, or property substituted therefor, held by the trust on one of the conditions provided under subsection 75(2) of the Act, is deemed to be the income of the person from whom the property was received and any subsequent distribution of that attributed income is generally not taxable to the individual recipient. Otherwise, payments that represent a distribution of the income of a trust are generally taxable in the hands of the individual recipient, whereas payments on account of the capital of the trust are generally not taxable when received, although there could be tax consequences for a trust that disposes of property in satisfaction of all or any part of a beneficiary's capital interest in the trust.

Question 6

Does the fact that the individual contributed property to the trust impact on the taxability of any distributions from the trust? In this regard, would the individual be considered to have paid for an interest in the trust?

Comments

The fact that an individual contributed property to a trust is one of the conditions of application of subsection 75(2) of the Act, but it does not impact directly on the amount attributed to an individual pursuant to subsection 75(2) of the Act since this is strictly a function of the amount of income realized on the property transferred to the trust by the individual.

If the amount distributed by the trust to the individual is in satisfaction of all or any part of the individual's capital interest in the trust and the rules provided in subsection 107(2) of the Act apply, then the rules provided in subsections 107(1) and 107(1.1) of the Act will apply to compute the capital gain or loss realized by the individual on the disposition of its capital interest in the trust. Subsection 108(7) of the Act is a deeming rule that applies for the purposes of subsection 107(1). It provides, inter alia, that where all the beneficial interests in a particular inter vivos trust acquired by way of the transfer, assignment or other disposition of property to the particular trust were acquired by one person, any beneficial interest in the particular trust acquired by such a person is deemed to have been acquired for no consideration.

Considering the facts described in your letter, the only beneficial interest acquired by way of the transfer, assignment or other disposition of property to the trust is the beneficial interest acquired by the individual. Therefore, pursuant to paragraph 108(7)(b) of the Act, the beneficial interest of the individual in the trust would be deemed to have been acquired for no consideration for the purposes of subsection 107(1). However, the cost to the individual could be deemed to be an amount greater than nil pursuant to subsection 107(1.1) of the Act.

Question 7

If the U.S. withholds tax on distributions from the trust, will the individual be entitled to a foreign tax credit for this withholding tax? Would the answer to this question be different if the individual resigned as trustee of the trust before becoming a resident of Canada and the trust did not become a resident of Canada?

Comments

Subsection 126(1) of the Act provides, inter alia, that a taxpayer resident in Canada at any time in a taxation year, may deduct from its tax otherwise payable under Part I for such taxation year an amount equal to such part of any non-business-income tax paid by the taxpayer to the government of a country other than Canada as he may claim, not exceeding, however, that proportion of the tax payable under Part I that is determined under paragraph 126(1)(b) of the Act.

We do not have sufficient information to respond to your questions concerning the entitlement of the individual to a foreign tax credit in a situation where the trust is resident in Canada or in a situation where the trust did not become resident in Canada. From the information given in your letter, it is not clear whether there would be any business-income tax paid by the individual. To claim a foreign tax credit under subsection 126(1) of the Act for a particular year, the individual would have to determine, inter alia, whether he has paid a "non-business-income tax" to the U.S. for the year, whether he has "qualifying incomes" exceeding his "qualifying losses" from sources in the U.S., and whether a tax for the year is otherwise payable under Part I. In this regard, the expressions "non-business-income tax", "qualifying incomes" and "qualifying losses" are defined under subsection 126(7) of the Act.

Question 8

If the trust becomes resident in Canada, will it be required to file a tax return and pay tax on its income? If subsection 75(2) of the Act does apply, would the trust be considered to have income? If the trust becomes a resident of Canada, will it be entitled to a fair market revaluation of all of its property?

Comments

When a trust becomes a resident of Canada, it is entitled to a fair market re-evaluation of all of its property. Subsection 128.1(1) of the Act applies where at a particular time a taxpayer becomes resident in Canada. Where the taxpayer is a trust, the trust's taxation year that would otherwise include the particular time shall be deemed to have ended immediately before the particular time and a new taxation year of the taxpayer shall be deemed to have begun at the particular time. Pursuant to paragraph 128.1(1)(b) of the Act, the trust would be deemed to have disposed, at the time that is immediately before the particular time, of each property owned by it (except for certain exceptions) for proceeds equal to its fair market value at the time of disposition, and it would also be deemed, pursuant to paragraph 128.1(1)(c) of the Act, to have acquired at the particular time each property deemed by paragraph 128.1(1)(b) to have been disposed of, at a cost equal to the proceeds of disposition of the property.

Pursuant to paragraph 150(1)(c) of the Act, every trust resident in Canada is required to file a return of income in prescribed form for each one of its taxation year. A trust must file its tax return no later than 90 days after the end of its taxation year (taxation year end is December 31 for inter vivos trusts). The T3 Trust Guide 2000 contains information concerning who should file a T3 return. Pursuant to this guide, a trust has to file a return if income from the trust property is subject to tax, and the trust either:

• Has tax payable;
• Has a taxable capital gain or has disposed of a capital property;
• Has provided a benefit of more than $100 to a beneficiary for upkeep, maintenance, or taxes for property maintained for the beneficiary's use; or
• Receives from the trust property, any income, gain, or profit that is allocated to one or more beneficiaries, and the trust has:
• Total income from all sources of more than $500;
• Income of more than $100 allocated to any single beneficiary; or
• Allocated any portion of the income to a non-resident beneficiary.

The rules of Subdivision k of the Act (sections 104 to 108) generally apply to Canadian trusts and their beneficiaries. A trust is taxable under Part I of the Act on its income to the extent that such income is not paid or payable to any or all beneficiaries of the trust pursuant to subsection 104(13) of the Act. However, as mentioned in response to question 3 above, any income attributed to the individual pursuant to subsection 75(2) of the Act would not be considered income of the trust, but the income earned on such attributed income would constitute income of the trust.

In a situation where all or part of the income from the property held by the trust constitutes income of the trust, the trust has to determine if it is liable to pay tax under Part XII.2 of the Act. Generally, an inter vivos trust that is resident in Canada will be subject to Part XII.2 tax where one of its beneficiaries is a non-resident person and the trust has "designated income" within the meaning of subsection 210.2(2) of the Act. Pursuant to this provision, the "designated income" of a trust is its income consisting of net taxable capital gains from the disposition of taxable Canadian properties (as defined in subsection 248(1) of the Act) and income from real properties in Canada, timber resource properties, Canadian resource properties acquired by the trust after 1971 and businesses carried on in Canada, less any losses from these same sources. The amount of the Part XII.2 tax is computed pursuant to section 210.2 of the Act. Subsection 104(30) of the Act provides that the tax paid by the trust under Part XII.2, if any, can be deducted in computing the income of the trust under Part I. If the trust is subject to Part XII.2 tax, it can designate in respect of the individual, in its return, the amount of the tax paid determined by the formula in subsection 210.2(3) of the Act. The amount so designated by the trust would be deemed, pursuant to subsection 210.2(3) of the Act, to be an amount paid on account of the tax payable under Part I by the individual. This amount would also be deemed, pursuant to subsection 104(31) of the Act, to be an amount in respect of the income of the trust for the year that has become payable by the trust to the individual at the end of the year and would be included in the individual's income under subsection 104(13) of the Act.

Question 9

If the individual resigned as trustee of the trust before becoming a resident of Canada and the trust did not become a resident of Canada, would proposed subsection 94(3) (Legislative Proposals on Taxation of Non-Resident Trusts and Foreign Investment Entities issued in August 2001 by the Department of Finance) apply to the trust?

Comments

Generally effective for trust taxation years that begin after 2001, proposed subsection 94(3) of the Act would deem a non-resident trust (other than an exempt foreign trust1) to be a resident of Canada for the purposes, among others, of section 2 of the Act, where there is at that time a "resident contributor" to the trust or a "resident beneficiary" under the trust. Pursuant to proposed subsection 94(1) of the Act, a "resident contributor" to a trust at any time would mean an entity that is, at that time, both resident in Canada and a contributor to the trust, but would not include an individual who has not, at that time, been resident in Canada for a period of, or periods the total of which is, more than 60 months.

Based on the information provided in your letter, it appears that proposed subsection 94(3) of the Act could apply once the individual will have been a resident of Canada for a period of more than 60 months.

Question 10

On the death of the individual would there be any tax payable under either Part I or Part XIII of the Act on the final distribution of the remaining property of the trust to the U.S. charity, in a situation where the trust is resident in Canada? Would the answer to this question be different if the individual resigned as trustee of the trust before becoming a resident of Canada and the trust did not become a resident of Canada?

Comments

The final distribution of the remaining property of the trust would be in satisfaction of a non-resident taxpayer's capital interest in a trust resident in Canada, and as such, subsection 107(5) of the Act would apply to the distribution of a property (other than a share of the capital stock of a non-resident-owned investment corporation or property described in any of subparagraphs 128.1(4)(b)(i) to (iii) of the Act). This provision provides that subsection 107(2.1) of the Act applies in respect of such a distribution. Pursuant to paragraph 107(2.1)(a) of the Act, the trust would be deemed to have disposed of the property so distributed for proceeds equal to its fair market value at the time of the distribution. If a taxable capital gain results from this disposition and if the trust is resident in Canada throughout the year, the trust may deduct, in computing its income for the purposes of Part I of the Act, the amount of the taxable capital gain that became payable in the year to the non-resident beneficiary. As mentioned previously, the trust would also have to determine if it is liable to pay tax under Part XII.2 of the Act.

The taxable capital gain payable to a non-resident beneficiary that is deducted in computing the trust's income for the purposes of Part I would constitute estate or trust income for the purposes of paragraph 212(1)(c) of the Act. Pursuant to this provision and Article XXII of the Canada-U.S. Income Tax Convention, such amount would be subject to a Part XIII withholding tax at the rate of 15%, even where U.S. securities have been disposed of by a Canadian trust upon its winding-up because, in our opinion, the capital gains arising from that disposition would generally be considered to be income arising in Canada.

You have asked whether the answer would be different if the trust did not become a resident of Canada. We cannot ascertain the fiscal consequences on the death of the individual relating to the trust's property and to its final distribution to its beneficiary as we do not know important details such as the year of death, the length of the period during which the individual will have been resident in Canada and the exact nature of the properties that would be held by the trust upon the final distribution of its properties. For example, in a situation where the individual has not been resident in Canada for a period of, or periods the total of which is, more than 60 months and the trust did not become a resident of Canada, there would be no tax payable by the trust under Part I and the final distribution amount would not be subject to a withholding tax under Part XIII of the Act. However, assuming that proposed section 94 is adopted as proposed in the Legislative Proposals on Taxation of Non-Resident Trusts and Foreign Investment Entities issued in August 2001, and is applicable to the taxation year of the trust, there would be some fiscal consequences in a situation where the individual has been resident in Canada for a period of, or periods the total of which is, more than 60 months, where the death of the individual occurs during a taxation year of the trust that immediately follows a taxation year of the trust throughout which it was resident in Canada for the purposes of the Act, and where the conditions of proposed subsections 94(5) or (5.1) of the Act are met.

Pursuant to proposed subsections 94(5) and (5.1), the trust would be deemed to have ceased to be resident in Canada at the time of the death of the individual. In such circumstances, the cessation of residence in Canada would result in the application of subsection 128.1(4) of the Act, thereby resulting in possible fiscal consequences for the trust and its beneficiaries.

It is also to be noted that a non-resident trust would be subject to tax under Part I of the Act on the capital gain, if any, realized upon the disposition of any of its property that is a "taxable Canadian property" within the meaning of subsection 248(1) of the Act. Pursuant to this provision, the shares of the capital stock of a corporation, whether resident in Canada or not, that are listed on a prescribed stock exchange do not constitute "taxable Canadian properties" of a taxpayer at any time, unless at any time during the 60-month period that ends at that time the taxpayer, persons with whom the taxpayer did not deal at arm's length, or the taxpayer together with all such persons owned 25% or more of the issued shares of any class of the capital stock of the corporation that issued the shares.

Additional comments

Residence of a trust

The views of the Canada Customs and Revenue Agency (the "CCRA") regarding the residency of a trust are contained in Interpretation Bulletin IT-447, "Residence of a Trust or Estate". The residence of a trust is a question of fact to be determined according to the circumstances of each case. However, a trust is generally considered to reside where the trustee or other legal representative who manages or controls the trust assets resides. Paragraph 2 of Interpretation Bulletin IT-447 outlines the powers or responsibilities that the CCRA considers in determining which trustee has management or control of the trust assets. In this regard, a determination of a trustee's powers and responsibilities as established under the terms of the trust and any other related trust document would be imperative in the determination of the trust's residence. Where an individual exercises the management and control of a trust, the residence of that individual is determined based on the normal factual tests for determining the residence of an individual.

An inter vivos trust, such as the one described in your request, that has as its sole trustee an individual who manages and controls the trust, would normally be considered to have become a resident of Canada at the time the individual became a Canadian resident, assuming the individual did not resign as trustee before becoming a resident of Canada.

We trust our comments will be of assistance to you. However, as indicated in paragraph 22 of Information Circular 70-6R4, this opinion is not a ruling and, accordingly, it is not binding on the CCRA.

Yours truly,

Alain Godin
for Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch

ENDNOTE

1. The trust described in your letter does not appear to be an exempt foreign trust.