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: Can the distributions from a trust to a beneficiary who is both an income and capital beneficiary be considered to be a distribution of income to the extent of the trust's income for the year?
Position: The trustee of a discretionary trust can normally choose to make a payment from the income or capital of the trust to the extent of the trust's income and capital at the time of the distribution.
Reasons: In the case under review, there appears to be sufficient capital available to be distributed to the beneficiary in accordance with the terms of the trust deed and the minutes of the trustee's decisions.
July 28, 2003
XXXXXXXXXX Tax Services Office HEADQUARTERS
XXXXXXXXXX Annemarie Humenuk
Attention: XXXXXXXXXX
2003-001367
XXXXXXXXXX - Distributions
This is in response to your memorandum of April 14, 2003, concerning the distributions made by the above noted trust to XXXXXXXXXX during the period from XXXXXXXXXX.
All statutory references in this memorandum are references to the provisions of the Income Tax Act, R.S.C. 1985 (5th supp.) c. 1, as amended (the "Act"). Our understanding of the relevant facts are as follows:
Facts
1. XXXXXXXXXX (the "Trust") was settled by XXXXXXXXXX on XXXXXXXXXX under the laws of XXXXXXXXXX with $XXXXXXXXXX.
2. XXXXXXXXXX has been a non-resident of Canada since XXXXXXXXXX. While her last known address is in XXXXXXXXXX, we understand that she has filed her XXXXXXXXXX income tax returns for the period XXXXXXXXXX as a person who is not domiciled in the XXXXXXXXXX.
3. The trustee of the Trust is XXXXXXXXXX, a company incorporated under the laws of XXXXXXXXXX. Presumably the company is resident in XXXXXXXXXX such that prima facie, the Trust is considered resident in XXXXXXXXXX . The protector of the Trust is XXXXXXXXXX.
4. The beneficiaries are XXXXXXXXXX.
5. The terms of the Trust provide that, until the death of XXXXXXXXXX, the trustee has the discretion to pay all or part of the income to any of the beneficiaries as well as the discretion to distribute all or part of the capital of the Trust to any of the beneficiaries. Upon XXXXXXXXXX death, the trustee shall distribute the Trust's property according to XXXXXXXXXX will, or if XXXXXXXXXX does not exercise this power of appointment in her will, to the XXXXXXXXXX or any successor thereto. The XXXXXXXXXX is presumably a charitable foundation.
In addition, the terms of the Trust provide XXXXXXXXXX with the ability to re-acquire the Trust's property by providing the Trust with other property of equivalent value. The power to distribute the income and capital of the Trust to one or more of the beneficiaries is subject to the requirement that the trustee consult with tax lawyers in the country in which the beneficiary is resident. XXXXXXXXXX has also provided the trustee with a letter of wishes which states, among other things, that she intends that any income earned by corporations controlled by the Trust be "XXXXXXXXXX".
6. Under the category of administrative powers conferred on the trustee by clause XXXXXXXXXX of the trust deed, clause XXXXXXXXXX purports to give the trustee the power to determine whether dividends and other income received by the Trust are income for the purposes of administering the Trust.
7. The trustee resolved to make the following distributions of capital to XXXXXXXXXX as evidenced by the various memoranda of decisions submitted with your request:
XXXXXXXXXX.
No distributions were made to any other beneficiaries of the Trust.
Your view
It is your view that the distributions to XXXXXXXXXX should be treated as distributions of income to the extent of any income earned by the Trust in the year of the distribution. In support of your position, you note that the trustee does not have the power at law to re-characterize income as capital as suggested by clause XXXXXXXXXX of the trust deed and that "income" for the purpose of subsection 104(13) is income for the purposes of the Act, and not income for trust law purposes. As the income beneficiaries of the Trust are identical to the capital beneficiaries of the Trust, the distinction between an income and a capital distribution does not affect the trustee's ability to distribute the amount in question to XXXXXXXXXX; thus there is nothing in the terms of the Trust that precludes the distributions to XXXXXXXXXX from being characterized as a distribution of income.
Your analysis of the Trust's financial statements suggests that the capital of the Trust was not available for distribution to XXXXXXXXXX on the dates specified, particularly the amount specified in the memorandum of decisions dated XXXXXXXXXX. Furthermore, as the Trust's capital has not been eroded by the full amount of the distributions, you believe it is reasonable to conclude that the Trust has, in fact, used its income to fund the distributions. We understand that you have not yet received any formal representation from the taxpayer on this issue.
We will limit our comments to the primary issue you raised, which is whether all or part of the distributions from the Trust to XXXXXXXXXX during the period from XXXXXXXXXX are required to be included in her income under subsection 104(13) in one or more of the relevant taxation years.
Subsection 104(13) requires a beneficiary to include in income such portion of the amount that would be the trust's income, but for subsection 104(6) and (12), that is payable to beneficiary in the year. Under a discretionary trust, it is not unusual for the trustees to have the power to determine whether to distribute the trust's income or to retain the income in the trust. In the case of the Trust, clause XXXXXXXXXX of the trust deed gives the trustee this power. In addition, the trustee of a discretionary trust can normally choose whether to make a certain payment out of income or out of capital - at least, to the extent of the trust's income and capital. Again, clause XXXXXXXXXX of the trust deed authorizes the trustee to make distributions of capital or distributions of income to the beneficiary in such amounts as the trustee, in its absolute discretion decides, subject only to clause XXXXXXXXXX and clause XXXXXXXXXX of the trust deed (which are not relevant to the issue under consideration). If a trustee chooses not to distribute income to any of the income beneficiaries, then a greater amount is available for distribution to the capital beneficiaries in future. In this case, XXXXXXXXXX is both an income beneficiary and a capital beneficiary and can receive either income or capital distributions in any taxation year. However, the trustee cannot change the true nature of an income distribution by merely considering it to be a capital distribution.
As you noted, 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 of the Trust. This view is supported by the decision rendered in the Terrill Estate v. M.N.R., 87 DTC 504. Thus, it is our view that clause XXXXXXXXXX has no effect for the purpose of determining whether the amounts received by the Trust are income or capital. However, in the present case, there does not seem to be any dispute as to whether the income from the loan and other investments is income of the Trust. The question is whether the amount distributed to XXXXXXXXXX was payable from that income or from the capital of the Trust. The fact that XXXXXXXXXX is both an income and a capital beneficiary does not assist in resolving the issue nor does the fact that the Trust's capital was not eroded by the full amount of the distributions. To the extent that the income of a trust is not distributed in a particular year, it forms part of the capital of the trust for the following year, such that a series of capital distributions combined with the retention of the income of the trust will not erode the trust capital by the full amount of the capital distributions.
As stated in CCRA document 2000-0043847 which you referred to in your request, the amount of income to be included in a beneficiary's income under subsection 104(13) is the amount of the trust's income for tax purposes that has been distributed to the beneficiary. This does not mean that the CCRA can re-characterize the nature of a distribution properly characterized as capital by the trustees; rather, to the extent that a distribution of capital for trust law purposes is income for the purposes of the Act (i.e., the taxable portion of a capital gain), the amount will be required to be included in the beneficiary's income under subsection 104(13). For example, when a trust realizes a taxable capital gain on the distribution of capital to a beneficiary, the portion of the distribution that relates to the taxable capital gain is generally income to the beneficiary under subsection 104(13) unless the trust makes an election under subsection 107(2.11).
In this case, the trustee chose to make to various distributions to XXXXXXXXXX out of the capital of the Trust as evidenced by the various memoranda of decisions submitted with your request. However, as your analysis indicates, the question arises as to whether the capital of the trust was available for distribution to XXXXXXXXXX at the time of the distributions. Although the Trust initially received $XXXXXXXXXX in capital, the trial balance indicates that approximately $XXXXXXXXXX of that capital was loaned to the XXXXXXXXXX (presumably before XXXXXXXXXX when the capital distribution was declared). Thus, it is questionable as to whether the Trust had sufficient capital available to be distributed to XXXXXXXXXX to make the distribution so authorized by the memorandum of decisions dated XXXXXXXXXX. There is no evidence that the distribution was delayed or that money was borrowed to make the capital distribution as was the case in Queen v. Bronfman 87 DTC 5059. However, there is also no evidence that the XXXXXXXXXX income was available for distribution at that time since the $XXXXXXXXXX interest income for that year was presumably still receivable from the XXXXXXXXXX as well.
You state that the $XXXXXXXXXX was repaid by the XXXXXXXXXX. Thus, the full amount of the $XXXXXXXXXX capital less any previous capital distributions would be available for distribution to XXXXXXXXXX on each of the subsequent dates listed above on which the trustee decided to make a capital distribution. The fact that the Trust also had income available to be distributed on such dates does not alter the fact that the trustee chose to make a capital distribution on those dates, as authorized by clause XXXXXXXXXX of the trust deed. Thus, absent any argument that GAAR applies or that the memoranda of decisions are sham transactions, it would be difficult to argue that any of the distributions made in XXXXXXXXXX were paid out of the income of the trust rather than the capital of the trust.
In summary, we believe it would be difficult to argue that the distributions made by the trustee which are stated to be capital distributions in the memoranda of decisions listed above are required to be included in XXXXXXXXXX income under subsection 104(13).
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
Theresa Murphy
Section Manager
for Division Director
International & Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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