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.
Principal Issues: (1) Filing requirements in respect of a capital dividend; (2) nature of a capital dividend (income or capital of a trust/estate); (3) impact of a distribution of the capital dividend to a beneficiary other than the surviving spouse on the applicability of 70(9.3).
Position: (1) Return has to be filed; (2) a cash capital dividend is income, unless the intention of the settlor/testator is to make it capital and only to the extent that it represents proceeds of disposition of the asset which was transferred to the trust/estate or of the underlying assets; (3) no effect on 70(9.3).
Reasons: (1) Wording of the act; (2) case law; (3) a capital dividend is not income for the purposes of 70(6).
XXXXXXXXXX 2004-006016
Yves Moreno
Attention: XXXXXXXXXX
September 17, 2004
Dear Madam:
Re: Capital Dividend Received by a Spousal Trust
This is in reply to your letter of February 2, 2004, in which you ask the following three questions:
1. Would a trust be required to file a trust return to report the receipt of a capital Dividend as defined in section 248 of the Act?
2. Would the capital dividend be considered to be income or capital of the trust?
3. Would the payment of the capital dividend by the trust to the surviving spouse taint the trust for the purposes of subsection 70(9.3).
Our responses to your questions, as explained in subsequent paragraphs, are:
1. Yes.
2. It may be income for "trust law" purposes and for the purposes of some provisions of the Act.
3. No.
The T3 Trust Guide summarizes when a trust should file a T3 return. Paragraph 150(1)(c) and subparagraph 150(1.1)(b)(i) of the Income Tax Act, R.S.C. 1985 (5th supp.) c. 1 (the "Act") indicate that a trust is required to file a return for a taxation year where tax is payable for that year. Paragraph 150(1)(c) of the Act has to be read in conjunction with Regulation 204 which provides that "every person [...] receiving income, gains or profits in a fiduciary capacity, or in a capacity analogous to a fiduciary capacity, shall make a return in prescribed form in respect thereof". Although a capital dividend does not have to be included in the trust's income according to subsection 83(2) of the Act, the trust is required to file a return and to designate the amount of the dividend in the year that it becomes payable to a beneficiary (subsection 104(20) of the Act and page 32 of the T3 Guide).
Whether the capital dividend would be considered to be income or capital of the trust is an issue which can be viewed from different perspectives.
At law, such determination has to be made in light of the of the trust indenture and the applicable private law. As indicated by the Supreme Court in the case of Waters v. Toronto General Trusts Corporation, [1959] S.C.R. 889, "it may be said that while, for the purposes of the Income Tax Act, a company's undistributed profits may be 'capitalized', such need not be the result for all purposes".
Where the trust indenture does not specifically provide which beneficiary is entitled to receive dividends and the trust is governed by civil law, we have opined in 2001-007684 that a capital dividend paid out of the retained earnings is income and that proceeds from the redemption of shares are capital. Similarly, where the trust indenture does not specifically track the amount of a capital dividend to a given beneficiary and the trust is governed by Canadian common law, the Waters case, stands for the proposition that a cash dividend is income and that the distribution of a stock dividend is on capital account because "here form is substance; and the moment form has changed the character of the earnings as assets, the intention follows that change".
Where the trust indenture does indicate which beneficiary is entitled to receive dividends and the trust is governed by Canadian common law, the cases of Smith Estate v. Smith Estate, 37 E.T.R. (2d) 151 and Re Welsh, (1980) 28 O.R. (2d), 403 stand for the proposition that a cash capital dividend received by a trust governed by Canadian common law is capital where two conditions are met.
First, the amount being distributed by way of cash capital dividend must arise from the disposition of assets which have been bequeathed or transferred to a trust as capital. Smith Estate dealt with the transfer by a deceased of shares of a company which, in the process of being wound up a few months after the testator's passing, disposed of its main asset and distributed a capital dividend to the estate. Re Welsh dealt with an individual bequeathing his shares of a corporation, the assets of the corporation being disposed of shortly after the testator's passing and the corporation distributing those proceeds by paying dividends to the estate three years after that moment. In both cases, the Court concluded that the dividend was of a capital nature.
Second, the trust indenture shall clearly and specifically provide that the settlor/testator's intention was to have the proceeds of disposition or the value of those assets treated as capital. The length of the time lapse between the creation of the trust/estate and the moment of that disposition will play a determining role in making that determination. Rand J. suggests that this condition would have been met in the Waters case had the testator "made it clear that the shares, in the value based on the assets then existing, were to be treated as capital and the income thereafter to be related to subsequent earnings only; but he did not do that; what he did was to bequeath the 'income'". In the Smith Estate case, the terms of the trust directed all stock dividends to be dealt with as capital and authorized the trustees to retain such shares or the proceeds thereof as they see fit. The Court indicated that "it is clear from that clause that the testator intended that the proceeds on the shares of stock be dealt with as capital".
Absent one of those two conditions, the cases where cash capital dividends are characterized as income at law are consistent with the approach dictated by the Supreme Court of Canada and such dividends are on income account, irrespective of the source of the money being distributed by way of dividend and of the fact that the dividend stems out of a capital account for tax purposes (Re Zacks, 17 E.T.R. 206, National Victoria & Grey Trust Co. Ltd. v. Baker, 24 E.T.R. 306, Re Allan's Trust, (1986), 37 Man. R. (2d) 203)).
As indicated in 2001-0076845, we do not recognize the exercise by a trustee of a power to characterize the nature of the amounts that it receives as income or capital, unless the trustee applies the above mentioned principles.
The fact that a capital dividend is not capital of the trust does not mean that it is income for all purposes. Subsection 108(3) of the Act provides that the capital dividend is not considered to be part of income for the purposes of some provisions. Also, the capital dividend is not included in the computation of the trust's income according to subsection 83(2) of the Act. Accordingly, the trust cannot deduct the amount distributed to a beneficiary in respect to a capital dividend according to paragraph 104(6)(b) of the Act and the beneficiary is not required to include that amount in computing his income according to paragraph 104(13)(a) of the Act. However, for the purposes of part XIII, subsection 212(11) of the Act indicates that any distribution out of a trust to a non-resident beneficiary (which includes distributions of capital dividends) is considered to be paid or credited as income of the trust.
Finally, as far as subsection 70(9.3) of the Act, the distribution by a trust which otherwise qualifies under subsection 70(6) of the Act of the amount of a capital dividend to either the surviving spouse or to a person other than the surviving spouse would not disqualify the trust (subsection 108(3) of the Act). Accordingly, in either case, the trust will still be in a position to avail itself of the rollover provided in subsection 70(9.3) of the Act.
This opinion is provided in accordance with the comments in paragraph 22 of Information Circular 70-6R5.
We trust our comments will be of assistance.
Theresa Murphy
Manager
Trust Section
International & Trusts Division
Income Tax Rulings Directorate
Policy and Planning 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, 2004
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, 2004
Email this Content