24 June 2003 External T.I. 2003-000552A - Debt owed by a testamentary trust

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 a testamentary trust is tainted under the proposed amended definition in 108 in the December 2002 package where a beneficiary pays taxes owed by a trust on income taxed as a result of a designation under 104(13.1) or (3.2).

Position: Normally, no.

Reasons: We would not expect the trust to become indebted to the beneficiary.

XXXXXXXXXX 	2003-000552
		Yves Moreno
June 24, 2003

Dear Madam:

Re: Debt owed by a testamentary trust

This is in reply to your letter dated February 25, 2003, wherein you ask whether the payment by a beneficiary of tax owed at the trust level taints a testamentary trust under the modifications proposed in the measures announced on December 20, 2002. More specifically, you enquire whether such payment taints a testamentary trust where income paid to the beneficiary is designated under subsection 104(13.1) or (13.2) of the Income Tax Act (the "Act") to be taxed at the trust level.

The proposed amendment provides that a trust ceases to be a testamentary trust where it incurs a debt or any other obligation to pay an amount to a beneficiary. However, a testamentary trust is not tainted where the debt or obligation is incurred in satisfaction of a right to enforce payment of an amount of income or capital gains payable to the beneficiary or to receive any part of the capital of the trust.

Paragraph 19 of Interpretation Bulletin IT-381R3 provides that:

An income beneficiary may agree to pay a trust's tax liability arising from a designation under subsection 104(13.1) or (13.2). Often this is done because the payment of tax by the trust would reduce the value of the capital interests held by other beneficiaries. The payment of tax by the income beneficiary is not a contribution for the purpose of paragraph (b) or (c) in the subsection 108(1) definition of "testamentary trust", nor is it a gift for the purposes of paragraph 122(2)(d). The payment must equal the tax payable by the trust on the income that is deemed not to have been paid or payable to the beneficiary because of the designation. The payment can be made by

(a) reimbursing the trustee,

(b) providing a cheque payable to the taxing authority, or

(c) receiving a net amount from the trustee reflecting the beneficiary's share of income less the relevant taxes payable by the trust.

You opine that the payment of the debt by the beneficiary as described in that paragraph results in the trust becoming indebted to the beneficiary. We would not normally expect a debt to arise in such circumstances. The premise of the position previously stated is that the trustee, in an effort to remain impartial among the various beneficiaries, would make the designation provided under subsection 104(13.1) in a way that does not result in the tax onus being shifted from the beneficiary who receives the income to the other beneficiaries. That result is achieved where the beneficiary reimburses the trustee, where the trustee allocates to the beneficiary an amount of income net of the related taxes or where the beneficiary provides a cheque payable to the taxing authority in that respect. Where the trustee incurs a debt or any other obligation to pay an amount to a beneficiary or to any person with whom the beneficiary or the trust does not deal at arm's length in a way that is not contemplated by proposed subparagraphs (d)(i) and (ii) of the definition of "testamentary trust", the trust would be tainted.

This opinion is provided in accordance with the comments in paragraph 22 of Information Circular 70-6R5. In particular, our comments are based on the Act as currently enacted, and any draft legislation released to date. The effect of any future changes to the Act on the general tax consequences discussed above will depend on the nature of such changes.

Theresa Murphy
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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