16 January 2006 External T.I. 2005-0116041E5 - allocation of income earned by an estate

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. Can different types of income of an estate be allocated to different beneficiaries?

2. If the will provides for an equal allocation between two beneficiaries, can one beneficiary be allocated all of the income and the other beneficiary be allocated capital of an equal amount?

Position: 1. Question of fact, but generally yes.

2. One must look to the wording of the will to determine whether or not the income is payable to the beneficiaries and in what proportions.

Reasons: 1. Prior position, see document 2001-0112945.

2. Unless the terms of the will clearly provide for an unequal allocation of income and capital among the beneficiaries, the even hand principle would suggest that, to the extent that the income is payable to the beneficiaries, it is payable to them in proportion to their respective interests in the estate.

XXXXXXXXXX 	2005-011604
		Annemarie Humenuk
January 16, 2006

Dear XXXXXXXXXX:

Re: Allocation of Income Earned by an Estate

This is in reply to your letter of February 9, 2005, concerning the allocation of income and capital among the various beneficiaries of an estate. We acknowledge our conversations of July 29 and August 22, 2005 (XXXXXXXXXX/Humenuk), in which you clarified your concerns. We apologize for the delay in our response.

You note that a typical will might provide that the residue of the estate, after paying the debts of the deceased, will be divided into equal shares for the named beneficiaries of the estate. You note that the will is often silent on the distribution of any income that is earned by the estate but that some wills may contain a provision which provides the executor with the discretion to make any allocation, election, designation or distribution that is in the best interest of the estate as a whole. In the situation where the will is silent as to the distribution of any income earned during the period of administration of the estate, you ask whether is it possible to allocate one type of income to one beneficiary and another type of income to another beneficiary. You note that this might be in the overall best interest of the beneficiaries where one beneficiary is a charity and the other beneficiary is a person who is subject to tax. In addition, where each of the beneficiaries is entitled to an equal share of the residue of the estate, you ask whether it would be possible to distribute all the income to one beneficiary and then divide the capital between them such that each one receives an equal amount of the property of the estate. As noted above, this might be acceptable to the beneficiaries if the beneficiary receiving the income is a charity that is exempt from paying income tax.

The circumstances outlined in your letter relate to a specific fact situation. As explained in Information Circular 70-6R5, Advance Income Tax Rulings, this Directorate does not comment on transactions involving specific taxpayers except by way of an advance income tax ruling in respect of proposed transactions. When the situation involves a specific taxpayer and a completed transaction, the question should be directed to the appropriate Tax Services Office for their views, along with all relevant facts and documentation, including a copy of the will where appropriate. As the transactions in question are not proposed transactions and we do not have all the relevant documentation, we cannot provide you with a ruling. However, we are prepared to offer the following general comments which will hopefully clarify our position with respect to the allocation of various types of income and capital to the beneficiaries of an estate.

All statutory references in this letter are references to the provisions of the Income Tax Act, R.S.C. 1985 (5th supp.) c. 1, as amended (the "Act").

Interpretation Bulletin IT-446R, Legacies [Archived], sets out the income tax treatment of income earned from a legacy. The T3 Guide states that income can be allocated to the beneficiaries in accordance with the terms of the will or other document governing the estate or trust. The term "allocate" is further explained in the glossary found at the beginning of the T3 Guide. An amount of income earned by an estate or trust in a particular taxation year can be allocated to a beneficiary if:

? it is paid to the beneficiary in that year;
? the beneficiary is entitled to enforce payment of that income in that year; or
? the estate or trust makes a preferred beneficiary election in respect of a beneficiary.

For the purpose of this letter, we have assumed that the executor has not made a preferred beneficiary election in respect of any beneficiary and that the will contains no specific legacies.

On the death of an individual, the individual's property comes under the control of an executor or other personal representative and thus the property is held in an estate, which is treated as a type of trust for purposes of the Income Tax Act. It is the executor's role to administer the estate, which involves determining and paying creditors and distributing the remaining assets of the estate to the beneficiaries as soon as possible. Generally, the law provides the executor with a year (often referred to as the executor's year) to administer an estate, during which time the beneficiaries cannot demand the distribution of property held by the executor. After this time, it is a question of fact as to whether the executor is able to distribute property and whether the income of the estate is payable to the beneficiaries.

Paragraph 6 of Interpretation Bulletin IT-286R2, Trusts - Amounts Payable, states that the income earned in the first 12 months of the estate will be considered payable to the beneficiaries, even though the estate is still under administration and the beneficiaries are not able to enforce payment of such income, provided that none of the beneficiaries object to such treatment. Note that this position only applies to the executor's year. That is to say, where the only reason that an amount of income is not payable to the beneficiaries is that it was earned in the initial 12 months of the estate, the income can be considered payable to the beneficiaries provided that all beneficiaries agree to such treatment. This would not apply to any other situation in which the amount was not payable to the beneficiaries because the terms of the will did not provide for such a distribution or in which the income was not allocated to the beneficiaries in proportion to their respective shares of the estate.

As stated in a paper, Post Mortem Tax Planning, presented by Mary Louise Dickenson at the 1984 Canadian Tax Foundation:

"Generally, beneficiaries are entitled to the income of the estate according to the terms of the will. If under the will income is payable to beneficiaries, the income must also be allocated by the personal representatives. If, on the other hand, income is not payable to beneficiaries, it must be included in computing the estate's income for tax purposes. If the personal representatives have discretion regarding the payment of income and can pay or accumulate it, the personal representatives have considerable flexibility, subject to the even-hand principle and other fiduciary considerations."

Thus, if the terms of the will provide that the income is payable to beneficiaries, the income is allocated to them by the executor unless a designation is made under subsection 104(13.1) or (13.2). If, on the other hand, income is not payable to beneficiaries, it must be included in computing the estate's income for tax purposes.

Where the will is silent on the issue of the distribution of the income or the issue is otherwise ambiguous, the executor may seek the guidance of the courts in determining whether or not an amount is payable to the beneficiaries. Where the terms of the will provide the executor with the discretion regarding the distribution of the income earned by the estate, the executor can choose the type and source of income that they wish to distribute to each of the beneficiaries, as stated in CRA document 2001-0112945. It is a question of fact as to whether any particular wording provides the degree of flexibility required in order to distribute one type of income to one beneficiary and other type to the other beneficiaries. However, where the will is silent on the matter, the even-hand principle would suggest that, to the extent that the income can be distributed to the beneficiaries, it is be distributed proportionately, according to each beneficiary's share.

With respect to your second question, the entitlement to income or capital of the estate is also determined according to the terms of the will. As stated above, the Canada Revenue Agency will accept that the income earned in the first 12 months of the estate can be considered payable to the beneficiaries provided that all beneficiaries agree to such treatment. In addition, a provision in the will which provides the executor with the discretion to make any allocation, election, designation or distribution that is in the best interest of the estate as a whole, would provide the executor with the authority to distribute the estate's income to the beneficiaries in the year that it is earned such that the income would not be taxable in hands of the estate. However, unless the terms of the will clearly provides for an unequal allocation of the income among the beneficiaries, it is our view that the even-hand principle would suggest that any distribution of income authorized by such a provision in the will would require the income to be distributed proportionately, according to each beneficiary's share of the residue.

When the beneficiaries of the estate include a registered charity or other qualified donee as defined in subsection 149.1(1), there is an additional consideration to be taken in account in determining whether a particular distribution includes any of the income earned by the estate. When the will provides for a gift to a qualified donee, subsection 118.1(5) deems the gift to have been made immediately before the individual died with the result that the executor may claim a charitable donation in respect of that gift on the final income tax return of the deceased individual. As the gift is deemed to have been made immediately before the deceased individual's death, no portion of such a gift can be considered payable out of the income of the estate. Refer to the T3 Trust Guide and the commentary on line item 25 to Schedule 11 relating to testamentary trusts in particular for additional information on whether a particular transfer of property to a charity is considered a donation or an allocation of income.

This opinion is provided in accordance with the comments in paragraph 22 of Information Circular 70-6R5.

We trust our comments have clarified our position with respect to these issues.

T. Murphy
Section Manager
for Division Director
International & Trusts Division
Income Tax Rulings Directorate
Policy and Planning Branch