CRA finds that s. 104(13), unlike s. 104(19), can apply contemporaneously with a trust dividend distribution, and that ss. 186(2) and 251(1)(b) can apply synergistically
A personal trust wholly-owns Opco, which also has a December 31 year end, and has a corporate beneficiary ("Holdco") with a September 30 taxation year end. On September 20, 20X1, Opco pays a taxable dividend of $5,000 to the Trust, which immediately on-pays that amount to Holdco.
CRA reiterated previous positions (most recently, in 2018-0757591I7 F and 2020-0839891C6) that a s. 104(19) designation by a trust cannot be effective until the trust’s year end. Accordingly, if by the effective time of the deemed dividend payment as a result of the designation (December 31, 20X1), the above trust had disposed of Opco to a third party, whether Opco was connected for Pt. IV tax purposes would be tested at that time, so that there would be no exemption from Pt. IV tax under s. 186(1)(a).
However, a similar timing issue would not arise if, for some reason, Holdco ceased, after the receipt by it of the $5,000 from the Trust (September 20, 20X1) and before the trust year end (December 31, 20X1), to be a trust beneficiary, but with Opco continuing to be connected on December 31, 20X1 with Holdco pursuant to s. 186(4)(a) by virtue of common control as described in s. 186(2). CRA stated:
[A] taxpayer does not have to be a beneficiary of a trust throughout the taxation year of the trust in which an amount becomes payable to the taxpayer in order for that amount to be included in computing the beneficiary's income pursuant to subsection 104(13),”
[S]ince Holdco is a beneficiary of the Trust at the time the $5,000 became payable to Holdco, the condition in paragraph 104(19)(b), that Holdco be a beneficiary of the Trust in the Trust's taxation year, is satisfied. The Trust could therefore designate the $5,000 amount to Holdco in accordance with subsection 104(19) if all the other conditions for the application of that provision are otherwise satisfied.
The question addressed by CRA was premised on Opco initially being connected with Holdco under ss. 186(4)(a) and 186(2) on the basis that Holdco was controlled by a person (X) who did not deal at arm's length with the person who controlled Opco. CRA indicated that there would be no effect on Holdco's liability for Pt. IV tax if Holdco, while continuing as a beneficiary of the trust, ceased to be controlled by X. The reason: the trust and Holdco were deemed not to deal with each other at arm's length by virtue of s. 251(1)(b), so that (under the control test in s. 186(2)) more than 50% of the fully-voting Opco shares belonged to a person (the Trust), which did not deal at arm's length with Holdco.