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: The issue involves distributions from a non-resident trust on winding up prior to its 5th year. Where the trust receives cash income in the year and uses the cash to pay off loans, can it distribute the remaining property as a distribution of capital even though there was no accounting capital at the start of the year?
Position: No.
Reasons: Distributions must be from either income or capital, and the trustee cannot change the nature of income into capital. For example, if the trustee capitalized income during the year and distributed that capitalized amount to the capital beneficiary in the same year, it would nevertheless constitute a distribution of income (for tax purposes). While the trust agreement may permit this to be done, the tax effect is that the trustee would be distributing income.
Since the trust was wound up and all of its property was distributed, and the trust would not be entitled to make a designation under 104(13.1), it is our view that the beneficiary would have income pursuant to 104(13).
June 6, 2003
International Tax Directorate J.D. Brooks
Trusts Section Trusts Section
344 Slater Street, 6th Floor 957-2103
Ottawa ON
Attention: Linda Smith
2002-018343
XXXXXXXXXX
This is in reply to your memorandum of May 28, 2002, regarding the XXXXXXXXXX. Your memorandum contained a referral which you had received from XXXXXXXXXX TSO. We apologize for the delay in responding to you.
All statutory references in this memorandum are references to provisions of the Income Tax Act. The key issue is whether a particular distribution of property from the Trust was a distribution out of capital or income. We have summarized the relevant key facts below:
Relevant Key Facts
1. XXXXXXXXXX, settled the XXXXXXXXXX ("Trust") on XXXXXXXXXX, with a contribution of XXXXXXXXXX.
2. The Trust was a discretionary, non-resident trust governed by the laws of XXXXXXXXXX, and its income for XXXXXXXXXX was not subject to Part I tax pursuant to paragraph 94(1)(c).
3. XXXXXXXXXX was a capital beneficiary and an income beneficiary of the Trust.
4. The Trust incorporated XXXXXXXXXX . (the "Corporation"), resident in XXXXXXXXXX. The Trust was issued 1 common share (the "Common Share") for CAN$XXXXXXXXXX.
5. On XXXXXXXXXX subscribed for XXXXXXXXXX preferred shares (the "Preferred Shares") of the Corporation, providing consideration in the form of investments. The shares were redeemable at $XXXXXXXXXX per share.
6. On XXXXXXXXXX sold the Preferred Shares to the Trust for consideration consisting of a loan (the "Loan") in the amount of $XXXXXXXXXX evidenced by a non-interest-bearing promissory note.
7. XXXXXXXXXX became resident of Canada on XXXXXXXXXX.
8. In XXXXXXXXXX, the Trust received a cash dividend of $XXXXXXXXXX on the Common Share (representing the earnings of the Corporation since XXXXXXXXXX), and the Preferred Shares were redeemed for $XXXXXXXXXX cash, providing the Trust with cash totalling $XXXXXXXXXX.
9. Pursuant to the terms of the Trust, the trustee chose to use the cash dividend to repay some of the Loan instead of making a distribution to an income beneficiary. After paying off the balance of the Loan and other debts, the trustee distributed the remaining $XXXXXXXXXX to XXXXXXXXXX as capital beneficiary in XXXXXXXXXX, purportedly as a distribution out of the Trust's capital.
10. The Trust wound up in XXXXXXXXXX.
The Representative's Views
The representative of XXXXXXXXXX argues that the Trust spent its entire year XXXXXXXXXX income on debt repayment rather than as a distribution of income, and that the $XXXXXXXXXX distribution to XXXXXXXXXX was out of capital.
Your View
It is your view that, since the Trust had no accounting capital at the start of the year XXXXXXXXXX and the entire property of the Trust was distributed in the year, the amount distributed to XXXXXXXXXX must have been out of the Trust's income.
Our View
We will limit our comments to the primary issue you raised, which is whether the distribution from the Trust to XXXXXXXXXX was out of capital or income.
Under a discretionary trust, it is not unusual for the trustee to have the power to determine whether to distribute the trust's income or to use it for some other purpose. Often the income is kept in the trust, where it is added to capital after the trust's year-end and thus ceases to be an amount which the income beneficiary might receive, instead becoming an amount which the capital beneficiary may receive at some time. In your particular fact situation, the trustee chose to use the cash received as a dividend to pay off some of the Trust's liabilities. The effect of that action was to reduce the Trust's cash although the Trust's income (for tax purposes) remained in the Trust. The trustee's payment of cash to reduce the principal outstanding on the Loan cannot be considered to be a distribution to a beneficiary. It is irrelevant that XXXXXXXXXX was both beneficiary and lender, except that that would necessitate the trustee clearly demonstrating the legal effect of the payment - e.g., by reference to his powers and the actual steps taken in applying those powers.
After paying off the Trust's debts, the trustee distributed the remainder of the Trust's property to a capital beneficiary, XXXXXXXXXX, consisting of cash in the amount of $XXXXXXXXXX (although cash received plus cash on hand less liabilities amounts to $XXXXXXXXXX - so apparently there were additional trust expenses of $XXXXXXXXXX).
A trustee of a discretionary trust can, in fact, 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. If the trustee chooses not to distribute income to the income beneficiary, then a greater amount will be available for distribution to the capital beneficiary in future. However, the trustee cannot change the true nature of an income distribution by merely considering it to be a capital distribution.
It is true that the Trust had no net accounting capital at the beginning of the XXXXXXXXXX taxation year. It is also true that the Trust received cash dividends during the XXXXXXXXXX taxation year and wound up later that year.
The income of the Trust for the XXXXXXXXXX taxation year would be computed under Canadian rules pursuant to section 250.1 and would include the $XXXXXXXXXX dividends received. Given that the Trust was wound up in its XXXXXXXXXX taxation year and was not entitled to a subsection 104(13.1) designation, we agree that the income of the Trust was in fact paid to XXXXXXXXXX and is required to be included in her income pursuant to subsection 104(13). Conversely, had the Trust retained the dividends over the XXXXXXXXXX taxation year-end and wound up in XXXXXXXXXX would not have had a subsection 104(13) income inclusion as the Trust would have had no income for the XXXXXXXXXX taxation year.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the CCRA'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. You should make requests for this latter version 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 and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 2003
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 2003
Email this Content