5 March 2002 External T.I. 2001-0113735 - Meaning of "income" under subsection 108(3)73(1.01)(c)

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: Whether it is possible for a trust, which provides that the amount which is payable to the income beneficiary in any year during the beneficiary's lifetime is defined as a percentage of the total value of the trust property at the commencement of that year, to qualify as a spousal trust, an alter ego trust or a joint spousal or common-law partner trust.

Position: No.

Reasons: In order for a trust created by a taxpayer to qualify as a spousal trust, an alter ego trust or a joint spousal or common-law partner trust, the taxpayer's spouse or common-law partner in the case of a spousal trust, the taxpayer in the case of an alter ego trust, and the taxpayer in combination with the taxpayer's spouse or common-law partner in the case of a joint spousal or common-law partner trust, must be entitled to receive all of the income of the trust. For the purposes of this requirement, the income of a trust, as provided under subsection 108(3) of the Income Tax Act, is the income of the trust computed for trust accounting purposes minus certain specified dividends.

XXXXXXXXXX 	2001-011373
		Annemarie Humenuk
March 5, 2002

Dear XXXXXXXXXX:

Re: Unitrusts or Percentage Trusts

This is in reply to your letter of November 29, 2001, in which you ask for further clarification of our position as set out in our response to you of November 19, 2001, with respect to the issue of whether subsection 73(1) could apply to property transferred to a unitrust or a percentage trust.

It is our understanding that the terms "unitrust" and "percentage trust" are used to describe a trust which provides that the amount payable to an income beneficiary in any year during the beneficiary's lifetime is defined as a percentage of the total value of the trust property at the commencement of that year. One of the advantages of such a trust is that the trustee's duty to act impartially towards both income and capital beneficiaries (the even hand principle) is not an issue in setting the investment policy of the trust. Such a trust can benefit both income and capital beneficiaries by providing a more predictable source of funds for the income beneficiaries and by encouraging the trustee to make investment decisions that are more likely to increase the overall value of the trust property even though such investments may generate less income. In our previous letter, we stated that if the income beneficiary's entitlement to the income of the trust is limited to a certain percentage of the total value of the trust's property, the trust will not qualify as a trust described in paragraph 73(1.01)(c) since the person described in that paragraph will not necessarily be entitled to receive all of the income of the trust arising before his or her death.

You asked us to reconsider our position on the basis that the income of a trust under trust law may be modified by the terms set out in a trust indenture or testamentary instrument and that such modifications do not ordinarily preclude the application of subsection 73(1) or 70(6) to a transfer of property to a trust which otherwise meets the conditions set out

in those subsections. As an example, you note that the income of a trust under trust law is generally computed without any deduction for depreciation in respect of depreciable property unless the terms of the trust indenture or testamentary instrument expressly permit such a deduction. If the income referred to in paragraph 73(1.01)(c) is the income of the trust as determined under the terms of the trust indenture (as modified by subsection 108(3)), it is your view that the condition in subparagraph 73(1.01)(c)(i) would be met with respect to a unitrust or percentage trust. If the income referred to in paragraph 73(1.01)(c) is the income of the trust computed without reference to the terms of the trust indenture, then any term of the trust indenture which reduced the income of the trust as otherwise computed under trust law, including a provision which provided for depreciation, would disqualify the trust as a trust described in paragraph 73(1.01)(c).

Our research suggests that there is no universal set of rules for determining what is income or capital under trust law. While generally accepted accounting principles may assist in determining whether an amount is income or capital, judicial direction in equity or under the relevant provincial laws may be required to settle the matter. It is our understanding that a term of the trust that seeks to clarify the particular accounting principle to be used in determining the income of the trust does not alter the computation of the income and capital of the trust but merely clarifies the calculation of such income. A provision that sets out the circumstances under which depreciation may be claimed, is an example of a provision that simply seeks to clarify the computation of income.

A unitrust, on the other hand, is similar to a trust with an apportionment clause in that the income under trust law is not relevant in determining the amount to be distributed to the income and capital beneficiaries. Under trust law, the classification of an amount as income or capital takes on added importance where the income of the trust is payable to one class of beneficiaries and the capital is payable to another. As a result, the terms of a trust may also include provisions which guide the trustee in apportioning the entitlement to certain amounts between income and capital beneficiaries. An apportionment clause, which allows the trustees to determine in their absolute discretion whether a particular amount is income or capital, effectively allows the trustees to distribute that which is essentially income to a capital beneficiary or that which is essentially capital to an income beneficiary. However, an apportionment clause does not change the nature of an amount of income or deductible expense into a capital receipt or expenditure or vice versa. As a result, even where the trust deed purports to grant the trustee the power to do so, the trustee cannot, at his discretion, determine what is income and what is capital. This view is supported by the decision rendered in the Terrill Estate v. M.N.R., 87 DTC 504. Similarly, the manner in which an entitlement to income and capital is determined under a unitrust or percentage trust does not convert that which is capital of the trust to income or vice versa, but rather ensures an equitable distribution of property to all beneficiaries.

Thus, as stated in our letter of November 19, 2001, it is our view that a trust which limits the income beneficiary's entitlement in the manner described above would not qualify as an alter ego trust, a joint spousal or common-law partner trust or a post-1971 spousal trust since the income beneficiary would not be entitled to receive all of the income of the trust within the meaning of subsection 108(3) of the Act.

We trust our comments have clarified our position.

T. Murphy
for Director
International and Trusts Division
Income Tax Rulings Directorate