10 May 1999 External T.I. 9823605 - DISTRIBUTIONS FROM TRUST - 107(4.1)

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 Department.

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

Principal Issues:

Where property is distributed from a trust such that 107(4.1) applies, does 104(6)(b)(i)(B) apply so as to deny the trust a deduction with respect to capital gains that arise on the disposition? (There is a presumption that the capital gains could otherwise be allocated to the beneficiary who received the property that triggered the gain. Also, 75(2) is no longer applicable in the assumed facts of the hypothetical scenario.)

Position:

No.

Reasons:

A teleological interpretation of 104(6)(b)(i)(B) as it interacts with 107(4.1) would take into consideration that 107(4.1) merely employs the rules of 107(4). The restriction in 104(6)(b)(i)(B) with respect to amounts included in income by virtue of 107(4) is intended to deny a deduction by a trust for amounts distributed to a post-1971 spouse trust under certain circumstances. There is no reason to deny a deduction to a trust for gains required to be recognized by virtue of 107(4.1). It is reasonable to consider the gain to be payable to the beneficiary since the beneficiary will receive the property on which the trust will recognize a capital gain.

This interpretation accords with the December 1998 draft legislation which will revise 107(4.1) to refer to 107(2.1) instead of 107(4); while 104(6) will not be revised.

XXXXXXXXXX 	J.D. Brooks
		982360
Attention:  XXXXXXXXXX 

May 10, 1999

Dear Sirs:

This is in reply to your letter of September 2, 1998 in which you requested our views on the interaction between subsection 107(4.1) and paragraph 104(6)(b) of the Income Tax Act. You queried, in a scenario in which subsection 107(4.1) applies to a distribution from a trust to a capital beneficiary, whether clause 104(6)(b)(i)(B) would prevent the trust from making a deduction for capital gains that might arise on the disposition. That is, would the resultant taxable capital gains be taxed in the trust’s hands? In this scenario, subsection 75(2) is not currently applicable. We apologize for the delay in replying.

You expressed the view that you felt that the denial of the deduction was not intended to apply to gains arising by virtue of subsection 107(4.1). In support of your view, you noted that Interpretation Bulletin IT-381R3, Trusts - Capital Gains and Losses and the Flow-Through of Taxable Capital Gains to Beneficiaries, refers to the denial of the deduction in the spousal trust situation but does not refer to capital gains arising by virtue of the application of subsection 107(4.1).

Our Comments

Although you have asked for a technical interpretation, the scenario presented appears to be an actual fact situation. You should be aware that we do not provide binding interpretations of the Income Tax Act except by way of advance income tax rulings, as discussed in our Information Circular 70-6R3. We are, however, prepared to provide some general comments.

Where subsection 107(4.1) applies with respect to a distribution of property from a trust, the trust is deemed to have received proceeds of disposition equal to the fair market value of the property rather than the trust’s cost amount. The rule that yields this result is described in paragraph 107(4)(d). For purposes of discussion, we presume that this will result in the trust having greater income than it would if the proceeds of disposition were deemed pursuant to paragraph 107(2)(a) to be equal to the property’s cost amount.

Pursuant to paragraph 104(6)(b), a trust may deduct in computing its income, such part of the amount that it would otherwise choose to deduct that, but for subsection 107(4), inter alia, would be its income for the year as became payable in the year to a beneficiary. Accordingly, income resulting from the application of subsection 107(4) will be taxed in the trust. It is our view that where the conditions stated in subsection 107(4.1) are met, it is subsection 107(4.1), not subsection 107(4), that applies to increase the trust’s income. Thus, the amount by which the trust’s income increases on the application of subsection 107(4.1) may be taxed in the hands of the beneficiary rather than in the trust.

We note that the draft legislation of December 1998 contains revisions which are pertinent to your question. The draft proposes to revise subsection 107(4.1) to refer to (proposed) revised subsection 107(2.1) which will contain the rules that are to be followed. Since there is no proposed revision to subsection 104(6), subparagraph 104(6)(b)(i) will not prevent a trust from making a deduction with respect to gains that are triggered by subsection 107(4.1). This interpretation is based on relevant provisions of the draft legislation being enacted as presently worded.

As indicated in paragraph 22 of Information Circular 70-6R3 dated December 30, 1996, this opinion is not an advance income tax ruling and consequently, is not binding on Revenue Canada.

We trust our comments will be of assistance to you.

Yours truly,

T. Murphy
Manager
Trusts Section
Resources, Partnerships and Trusts Division
Income Tax Rulings and Interpretations Directorate
Policy and Legislation Branch
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