CRA indicates that the reasonable return TOSI exclusion can apply to interest-bearing promissory notes issued in satisfaction of family trust distributions

Where a family trust distributes its income to an adult beneficiary with no involvement in a related business owned directly or indirectly by the trust, would the beneficiary be able to rely on the “reasonable return” exception in either s. (f)(ii) or (g)(ii) of the “excluded amount” definition where interest accrued and paid on the note is equivalent to that which would have been charged between arm’s length parties?

After noting that the interest income did not appear to qualify as an excluded amount under s. (f)(ii) since the note did not appear to be “arm’s length capital,” CRA stated, regarding the reasonable return exceptions in s. (g)(ii):

In a situation where the individual has not assumed any risk, whether an arm’s length rate of interest charged is a reasonable return is a mixed question of fact and law … .

In determining whether something constitutes a reasonable return, the CRA does not intend to generally substitute its judgment about what would be considered a reasonable amount where the taxpayer has made a good faith attempt to do so based on the reasonableness factors set out in the definition of “reasonable return."

Neal Armstrong. Summary of 15 June 2021 STEP Roundtable, Q.3 under s. 120.4(1) – reasonable return.