5 April 2002 External T.I. 1999-001243A - Trust Units Held on Income Account

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:

Whether distributions of the non-taxable portion of capital gains realized by a mutual fund trust can be received tax-free by a taxpayer which holds its units in the trust on income account.

Position:

Yes, technically.

Reasons:

Where a taxpayer obtains a benefit from a trust, 105(1) requires the value of the benefit to be included in the taxpayer's income unless the amount was already so included or was deducted in calculating the taxpayer's ACB of his interest in the trust or would have been so deducted if 53(2)(h) applied and 53(2)(h)(i.1)(B) did not exist. I.e. the benefit will be subject to tax in the year or will result in a deferred recognition by way of a decrease to the ACB of the trust interest, except to the extent the distribution from the trust is the non-taxable portion of the trust's net taxable capital gains or is a capital dividend. For example, if there were only 1 beneficiary of a trust and the trust realized a capital gain and paid it out to the unitholder, the trust would take a deduction under 104(6) with respect to the taxable capital gain and the taxable portion would be included in the beneficiary's income pursuant to 104(13). Under 104(21) the taxable portion of the capital gain paid out of the trust's net taxable capital gains may be designated as a taxable capital gain of the beneficiary. The untaxed portion of the trust's capital gain would be distributed to the beneficiary without being subject to tax due to 105(1)(b)(ii). 105(1) does not take into consideration whether the interest in the trust is held on capital or income account.

XXXXXXXXXX 1999-001243
J. D. Brooks
(613) 957-2103

Attention: XXXXXXXXXX

April 5, 2002

Dear Sirs:

This is in reply to your letter of August 11, 1999, in which you requested our views on the interpretation of subsection 104(21) of the Income Tax Act. You presented a hypothetical situation wherein a taxpayer is a beneficiary of a mutual fund trust that is resident in Canada. The taxpayer holds its units in the trust on income account. You queried whether the taxpayer would be exempt on one-quarter¹ of the trust's net capital gains that pertain to the net taxable capital gains designated under subsection 104(21) with respect to the taxpayer. We apologize for the delay in replying. As explained below, before replying, we had hoped to receive comments from the Department of Finance.

Our comments

The situation outlined in your letter appears to relate to an actual situation. Confirmation of the tax implications of proposed transactions is given only in reply to an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R4. Where the particular situation relates to transactions that have been completed, the enquiry should be directed to the local tax services office where the taxpayer's returns are filed. While we are unable to comment on the particular situation described in your letter, the following general comments may be of assistance to you.

For ease of presentation, we assume that there is only one unitholder in the mutual fund trust in the hypothetical example and that the inclusion rate for capital gains is 75%.

Where a mutual fund trust realizes a capital gain and distributes the entire amount of the gain to its unitholders, subsection 104(21) enables the trust to designate an amount with respect to each beneficiary in respect of the trust's net taxable capital gains. The amount of such designation with respect to a beneficiary cannot exceed the amount of the trust's net taxable capital gains that is included in the beneficiary's income from the trust. Subsection 104(13) requires that amounts that become payable to a beneficiary must be included in the beneficiary's income to the extent that the amounts would be the trust's income were it not for subsections 104(6) and (12). Thus, if the trust in the hypothetical situation realized a capital gain of $1,000 and distributed the entire $1,000 to the beneficiary (the unitholder), making an appropriate designation pursuant to subsection 104(21) for $750, the unitholder would be deemed to have realized a taxable capital gain of $750. This is so because the trust's income would otherwise, except for subsection 104(6), have been $750 if it did not distribute its income to the beneficiary. Thus, the trust's income is nil and the unitholder's income is $750, which is considered to be a taxable capital gain.

Subsection 104(21) is silent concerning the distribution of the non-taxable portion of the trust's capital gains, and thus one must consider the application of subsection 105(1), since the unitholder has received a benefit in the form of a distribution from the trust. Paragraph 105(1)(a) prevents the taxable capital gain from being taxed a second time. Paragraph 105(1)(b) ensures that an amount is not taxed as income if it was deducted under paragraph 53(2)(h) from the adjusted cost base of the unitholder's trust units. Subparagraph 105(1)(b)(ii) ensures that if the benefit conferred on a unitholder consisted of a distribution of the non-taxable portion of the trust's capital gains in respect of which a designation was made under subsection 104(21), the value of such benefit is not taxed under subsection 105(1) even though no amount was actually deducted under paragraph 53(2)(h). Thus in the example, of the total benefit of $1,000 received by the unitholder from the trust, $750 would be excluded from subsection 105(1) by virtue of paragraph (a) and $250 would be excluded by virtue of subparagraph (b)(ii). Since subsection 105(1) does not make a distinction as to whether an interest in a trust is held on capital or income account, it is our view that the non-taxable portion of a trust's capital gains can be distributed to a unitholder that holds its trust interest on income account, without being subject to tax.

We are uncertain whether such results are in accordance with tax policy and, accordingly, we brought this matter to the attention of the Department of Finance. We have not yet received a response from them.

We trust that these comments are of assistance to you.

Yours truly,

T. Murphy, Manager
Trusts Section
International and Trusts Division
Income Tax Rulings Directorate

ENDNOTES

¹ It is noted that at the time of your letter, the inclusion rate for capital gains was 75%.

??