Elie Roth, Tim Youdan, Chris Anderson, Kim Brown, "Classification of Trusts for Income Tax Purposes", Chapter 2 of Canadian Taxation of Trusts (Canadian Tax Foundation), 2016.

Summaries

Increase in value only/debt assumption (p. 59)

[T]he CRA [in 2015-0596841E5] appears to be of the view that a beneficial interest in a trust may be acquired when a contribution increases the value of the trust interest, even if the beneficiary's percentage interest I in the trust remains unchanged. [fn 11: See also…9507605…]

The CRA has stated that an otherwise qualifying personal trust does not lose personal trust status when it borrows funds to acquire shares and distributes the shares to a beneficiary on the condition that the beneficiary assume the indebtedness owing on the loan, provided that the beneficiary's interest is established under the terms of the trust.

GRE may terminate before 36 mos. (p. 62)

It appears that the 36-month period is an upper limit; therefore, an estate ceases to be a graduated rate estate earlier if its administration has concluded earlier under general law principles. [fn 18: If, for example, a spousal trust or a trust for the deceased's children is established from assets of the deceased's estate pursuant to the will before the 36-month period expires, the spousal or children's trust is not a graduated rate estate. See Society of Trust and Estate Practitioners (STEP)/CRA round tables, June 25, 2015 and June 10, 2016.]

Multiple testamentary trusts under will (p. 63)

[T]he estate of a deceased individual and other trusts funded from the estate generally qualify as testamentary trusts for the purposes of the Act. [fn 27: 2012-0442931C6] Therefore, when the will of an individual provides, for example, for a trust for her spouse during the spouse's lifetime, followed by division of the trust property into separate trusts for the benefit of her children, the estate, the trust for the spouse, and each trust for the children are testamentary trusts. …

Purpose (p. 64)

[T]his rule [in para. (d)] was implemented to prevent beneficiaries in the top marginal tax bracket from lending money to a testamentary trust so that the trust could invest the funds and earn income that was taxable at graduated rates. [fn 30: David C. Blom, "Losing Testamentary Trust Status" (2009) 6:6 Tax Hyperion 1, at 7.]

Waiver as contribution (p. 66)

On the basis of the ruling in Greenberg Estate [97 DTC 1380], the CRA has stated that the waiver of income by a beneficiary in favour of a trust may disqualify the trust as: a testamentary trust because the waiver may signify a voluntary payment to increase the capital of the trust. [fn 35: …2005-0141181C6…] However, the ruling in Greenberg Estate also indicates that when an income beneficiary repays an excessive annual income distribution from a trust, the repayment may not disqualify the trust as a testamentary trust…. [fn 36:…9721035…]

Receipt of insurance proceeds (pp. 66-7)

A trust that is created pursuant to the terms of a will should not lose its status as a testamentary trust if it receives proceeds of an insurance policy on the life of the deceased,- provided that the trust receives- the insurance proceeds because it is the beneficiary of the Insurance policy. [fn 37:…2005-0132271C6…]…

General effect of formula (p. 70)

[T]he amount: of the recovery tax is calculated in accordance with a complicated formula in paragraph 122(1) (c) whose effect is to calculate the amount of the tax that would have been paid in any previous year if the trust had been subject to the highest rate of tax, and if the taxable income of the trust for that year had excluded amounts that were subsequently distributed as capital to an electing beneficiary.

Satisfaction of redemption requirement (p. 72)

[T]he CRA has ruled that the redemption requirement was satisfied when a trust indenture provided for the distribution of cash and a 25-year promissory note in satisfaction of the redemption price of the units of the trust. However, the property received by the unitholder must be of a type that does not discourage the unitholder from redeeming the units of the trust. In addition, the property must be given as an absolute payment of the redemption price. [fn 55: The CRA stated that "[p]ayment other than by way of cash will be acceptable if, among other things, the property received by the unit holder represents an investment vehicle that would not discourage a unit holder from requesting redemption from the fund and such property is given as absolute payment of the redemption price" (CRA document no. 9403285, February 28, 1994).]…

[I]f there is a discount on the redemption price, the trust must be able to demonstrate that the discount does not discourage unitholders from exercising their redemption right.

Public benefit requirement (p. 81)

There are two distinct components to the public benefit requirement. First, in general an objectively measurable and socially useful benefit must in fact be conferred Second, the benefit must be available to a sufficiently large section of the public that it is not determined by reference to a personal relationship to a particular individual or corporation (except in the- context of the relief of poverty, discussed below.

Four (Pemsel) heads of charity (p. 822)

[T]he four heads of charity described in Pemsel [[1891] AC 531] [are] relief of poverty, advancement of education, advancement of religion, and other purposes beneficial to the community.

Relief of poverty (p. 82)

[A] trust for a person's poor relations can be a valid charitable trust….

Advancement of education (p. 83)

[R]esearch may also qualify as a charitable activity if it increases and disseminates knowledge. Trusts supporting the arts are also considered to be charitable as being for the advancement of education.

Advancement of religion (p. 84)

[T]he public benefit requirement is generally presumed, and courts do not consider the merits of the beliefs to be promoted, as long as they have a religious tendency and do not undermine morality or religion.

Non-application to bare trusts (p. 86)

[T]he non-applicability of the Act to bare trusts has been recognized by the courts. [fn 107: …Brookview Investments Ltd… v. MNR, 63 DTC 1205 (Ex. Ct.): and De Mond v. The Queen, 99 DTC 893 (TCC).]…

Different settlor/multiple beneficiaries (p. 87)

In principle, there seems to be no reason why the beneficiary of a bare trust needs to be the settlor. There also seems to be no reason in principle why a bare trust cannot have more than one beneficiary. Moreover, it should be possible for beneficiaries to control their rights and obligations inter se by contract, without creating a trust for tax purposes.

Right of spouse to enforce payment of income (pp. 90-1)

It seems that the spouse or common-law partner must each year be able to enforce payment of all income of the trust arising during the year until his death. However, in a technical interpretation in 2003 [fn 121:…2003-0008285…] the CRA responded ambiguously in respect of a testamentary spousal trust that allocated the spouse all of the income that arose before her death, provided that she could force a distribution of income only every three years, with a "catch up" in the year of death….

[T]he cautious position is not to include in the terms of the trust a right of the trustees to postpone the distribution of the annual income to the spouse or common-law partner.

The requirement that the spouse or common-law partner be entitled to all of the income of the trust during his lifetime applies to income for trust law purposes…Therefore, capital gains realized by the trust are treated as capital….

Capital v. income of spousal trust (p. 92)

Although generally the terms of the trust determine whether the spousal or common-law partner trust requirements are satisfied, these terms cannot determine whether a payment is income of the trust, to which the spouse or common-law partner must be entitled, or capital….

Payment of income to “or for benefit” of spouse (p. 93)

Does drafting that provides for the payment of income by the trustees to or "for the benefit" of the spouse or common-law partner taint a spousal or common-law partner trust?...[I]t appears to be the view of the CRA that these provisions don not disqualify a trust... [fn 129: See Interpretation Bulletin IT-305R4 (Archived), "Testamentary Spouse Trusts," October 30, 1996, at paragraph 15.]

Disclaimer of tainting interest (p. 98)

Since a disclaimer results in the disclaiming beneficiary being treated as never having had the property or interest in question, it should be possible for a disclaimer to untaint an otherwise tainted spousal or common-law partner trust. For example, if a trust that otherwise qualifies as a spousal, trust includes a power to encroach on capital during the life of the spouse in favour of a person other than the spouse, it should be possible for that person to disclaim her potential entitlement and thereby untaint the trust.

Unfortunately, a contrary position was taken in Gilbert Estate v. MNR. [fn 149: 83 DTC 645 (TRB).]…Bonner J [stated] that the disclaiming beneficiary could not, "by disclaimer or otherwise, . . . change the terms of the trust." This conclusion was incorrect since the disclaimer operates to void the interest of the disclaiming person ab initio: it changes the terms of the trust from the beginning.

Waiver by spouse of entitlement to income under spousal trust (p. 92)

The terms of a spousal or common-law partner trust may include a provision conferring on the spouse or common-law partner the discretion to waive his entitlement to income and instead to capitalize it. [fn 125:… 2003-004617E5…2003-0014515] Even without such a provision, the spouse or common-law partner may waive receipt of the trust income. [fn 126:…9926255…2003-0014515]

Regarding whether a spouse or common-law partners election is a contribution by the spouse or common-law partner to the trust (and therefore potentially tainting what would otherwise be a testamentary trust and attracting the application of subsection 75(2)), the CRA has distinguished the following two situations:

Where the trust instrument provides that the spouse can elect not to receive the income of a trust for a specific year before the amount becomes payable, the election will result in a disposition of property for the spouse when that right is exercised. However, such release or surrender would not generally be viewed as increasing the capital of the trust nor will it be considered as a contribution to the trust. …

Joint spousal trust (p. 100)

Paragraph 73(1.01)(c) might seem to indicate that only one spouse can transfer property to a particular joint spousal trust. However, the CRA has expressed the position that a trust may qualify as a joint spousal trust when both spouses create the trust by the joint contribution of property, and either or both spouses subsequently transfer property to the trust. …[fn 160:…2001-0099055]

Numerical example of refundable tax (pp. 104-5)

Assume that a qualifying environmental trust has a single beneficiary in a taxation year and earns $1,000 of investment income in the year. The beneficiary is a corporation whose federal income tax, after taking into account subsection 107.3(1), is nil because of other deductions to which it is entitled. In this case, the $1,000 of investment income is treated as income of the trust for the purposes of part XII.4. The same $1,000 is treated as the corporations income. The qualifying environmental trust is subject to federal tax under part XII.4 in the amount of $150. The corporation is then considered to have paid $150 under subsection 127.41(3) on account of its tax payable under part I. Since no tax is payable by the corporation, the corporation should be entitled to an income tax refund of the full amount of part XII.4 tax paid by the trust ($150).

Overview

[U]nlike mutual funds, segregated funds cannot be structured as trusts because a life insurer is prohibited from acting as a trustee in respect of any services that it provides to the public….

Under the rules that apply to related segregated fund trusts, the income of the trust is deemed to be payable to the policyholder beneficiaries, and any capital gains or losses of the trust are deemed to be those of the beneficiaries. The income and gains are therefore taxed in the hands of the investors, even if the funds are not made payable. To avoid the potential for double taxation when the interest in the segregated fund is disposed of by the beneficiary, the adjusted cost base of the interest is increased by the amount of the income and capital gains that is deemed to be attributed to the policyholder. The amount of income attributable to a particular beneficiary is determined by reference to the terms and conditions of the segregated fund policy, and the CRA has stated that the Act does not require a particular allocation methodology. [fn 186:…2005-0156951E5]

Services rendered to subsidiary (p. 116)

[P]art XI.3 imposes a refundable tax on an RCA equal to 50 percent of the amount of any contributions to the trust….The tax is refunded to the RCA (without interest) when benefits are paid from the trust at a rate equal to 50 percent of the distributed amount.

Under paragraph 20(1)(r), the employer is entitled to deduct contributions to the RCA, provided that they relate to services that are rendered by an employee or former employee. The CRA has taken the position that the deduction is not available when contributions are made in respect of services that are rendered to a person other than the contributor, such as a subsidiary, notwithstanding that the definition of an RCA contemplates that contributions may be made by a person who does not deal at arm's length with the employer. [fn 220: … 2007-025985117…2010-0388761R3]

Distributions to Canadian-resident employees from the RCA are taxed in the year in which they are received under paragraph 56(1)(x), and are subject to withholding tax under paragraph 212(1)(j),…