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: The issue involves distributions from a non-resident trust prior to its 5th year. Where the trust receives cash income in the year and uses the cash to pay off loans, can we consider the payment to be a distribution of income (the note-holder is also the income beneficiary)?
Position: No. (question of fact)
Reasons: Since it is a discretionary trust, the Trustee is able to determine whether to retain cash income, to use cash income to pay expenses or repay debt, or to distribute cash income to the income beneficiary. In the fact situation, the Trustee used the cash to repay loans.
June 6, 2003
International Tax Directorate J.D. Brooks
Trusts Section 957-2103
344 Slater Street, 6th Floor
Ottawa ON
Attention: Linda Smith
2002-014326
XXXXXXXXXX
This is in reply to your memorandum of May 28, 2002, regarding the XXXXXXXXXX. Your memorandum contained a referral which you had received from XXXXXXXXXX TSO. We apologize for the delay in responding to you.
The key issue is whether the amounts that were paid from the trust were paid to two persons as note-holders or as beneficiaries. The relevant key facts are outlined below:
Relevant Key Facts
1. XXXXXXXXXX , settled the XXXXXXXXXX (the "Trust") in XXXXXXXXXX with a payment of US$XXXXXXXXXX to the Trustee, XXXXXXXXXX.
2. Upon the Trust being settled, XXXXXXXXXX sold XXXXXXXXXX ordinary shares of XXXXXXXXXX (the Corporation") worth $XXXXXXXXXX and XXXXXXXXXX sold XXXXXXXXXX ordinary shares of the Corporation worth $XXXXXXXXXX , to the Trust. The sales were at fair market value and the consideration consisted of non-interest bearing promissory notes (the "Notes").
3. The Corporation is a XXXXXXXXXX private company with XXXXXXXXXX ordinary shares issued and outstanding.
4. The income beneficiary of the Trust is XXXXXXXXXX, and the capital beneficiaries of the Trust are XXXXXXXXXX.
5. On XXXXXXXXXX immigrated to Canada from XXXXXXXXXX. Neither XXXXXXXXXX had previously resided in Canada.
6. Subsection 75(2) of the Income Tax Act does not apply as the shares of the Corporation may not revert to either XXXXXXXXXX by virtue of section XXXXXXXXXX of the Trust Indenture.
7. The Trust reported dividend income on its shares of the Corporation amounting to $XXXXXXXXXX in its year ended XXXXXXXXXX, and $XXXXXXXXXX in its year ended XXXXXXXXXX; totalling $XXXXXXXXXX.
8. On XXXXXXXXXX, the Trust repaid $XXXXXXXXXX of Notes held by XXXXXXXXXX; and on XXXXXXXXXX, the Trust repaid $XXXXXXXXXX of Notes held by XXXXXXXXXX.
9. On XXXXXXXXXX, a purchase and sale agreement was entered into for the sale of XXXXXXXXXX shares of the Corporation from the Trust to XXXXXXXXXX at their fair market value of $XXXXXXXXXX.
Our Views
We will limit our comments to the primary issue you raised, which is the tax consequence of the Trust using its cash dividend income to make loan repayments.
The Trust received dividend income of $XXXXXXXXXX in XXXXXXXXXX and $XXXXXXXXXX in XXXXXXXXXX and used these amounts to repay part of the Notes held by XXXXXXXXXX . While the source of cash for the repayments was dividends, the repayments cannot be viewed as a "distribution" of Trust property. A true repayment of a loan cannot be characterized as a distribution of either income or capital of the Trust. Rather, it is a use of Trust property. The fact that the lenders are beneficiaries of the Trust is inconsequential although it indicates that the Trustee's actions need to be scrutinized in order to ensure what transpired.
XXXXXXXXXX, as income beneficiary of the discretionary Trust, was not automatically entitled to receive any income of the Trust. Since the Trustee did not exercise discretion in any year to make any of its income payable to XXXXXXXXXX, no income can be considered to have become payable to XXXXXXXXXX.
According to paragraph XXXXXXXXXX of the Trust Indenture, the Trustee has power to determine whether disbursals are to be charged to income or to capital. From a trust law perspective, the use of cash income to repay a portion of the Notes would reduce the amount of cash available for distribution to the income beneficiary. From a tax law perspective, the repayment by the Trust of some of its debt did not reduce its income. The dividend income was merely a source of cash which was used to repay some of its debt.
In this particular fact scenario, since the Note-holders were also beneficiaries, the powers and actions of the Trustee will determine whether an amount was paid on a loan or was distributed to a beneficiary. It seems clear from the facts that the Trustee repaid a portion of the Notes payable.
It is also noted that no property was distributed to any beneficiary in the year the Trust repaid debt and thus it is not an issue as to whether a beneficiary received a distribution of income rather than capital.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the CCRA's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
Theresa Murphy
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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