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: Whether the terms of a trust agreement will met the conditions set out in subsection 74.4(4) of the Act.
Position: No.
Reasons: The law.
XXXXXXXXXX 2005-012638
Michael Cooke
May 13, 2005
Dear XXXXXXXXXX:
Re: Application of Section 74.4
This is in reply to your letter of April 5, 2005 wherein you requested our opinion on the application of section 74.4 of the Income Tax Act (the "Act") in the following situation.
Briefly, in your letter you indicate that, as part of an estate freeze of a corporation carried out by an individual, new common shares of the corporation are acquired by a trust, the beneficiaries of which include a person who is a "designated person" as that term is defined in subsection 74.5(5) of the Act. The corporation is a "small business corporation", as that term is defined in subsection 248(1), at the time the estate freeze is carried out. However, in order to guard against the possibility that the status of the corporation as a small business corporation may change in the future, the trust agreement contains a term that essentially provides that no amount of income or capital of the trust can be distributed to a designated person, if as a result of such distribution, such amount will be required to be included in the income of the individual under subsection 74.4(2). Consequently, the terms of the trust agreement will allow for income or capital of the trust to be distributed to a person who is a designated person but only when the corporation is a small business corporation throughout the particular period in question.
Your question is whether the above described terms in the trust agreement will met the conditions set out in subsection 74.4(4) of the Act.
Where an individual (the "Individual") has transferred or loaned property, either directly or indirectly, by means of a trust or by any other means whatever, to a corporation and one of the main purposes of the transfer or loan may reasonably be considered to reduce the income of the Individual and to benefit, either directly or indirectly, a person who is a designated person in respect of that Individual, the rules in subsection 74.4(2) of the Act must be considered to determine what amount of deemed interest, if any, must be included in the Individual's income for each taxation year on the "outstanding amount" as defined by subsection 74.4(3).
Subsection 74.5(5) defines a designated person in relation to the Individual as such person's spouse or common law partner and any person under the age of 18 who either does not deal at arm's length with the Individual or is a niece or nephew of such person. Accordingly, a person's status as a designated person does not turn on whether the particular corporation is a small business corporation or not.
It is a question of fact as to whether one of main purposes of a transfer or loan of property may reasonably be considered to be to benefit, either directly or indirectly, a designated person under subsection 74.4(2). Subsection 74.4(4) provides for an exception from the "main purpose test" in subsection 74.4(2) where all the conditions described therein are satisfied. However, where the terms of a trust permit a person to receive distributions of income or capital from the trust at any time while such person is a designated person the condition described in paragraph 74.4(4)(b) would not be met. Further, where a designated person has actually received an amount from a trust and the trust deducted such amount under subsection 104(6) or (12), the condition described in paragraph 74.4(4)(c) would not be met.
Accordingly, in the situation described in your letter, since it appears that a designated person can receive distributions of income and/or capital from the trust, albeit, only while the particular corporation is a small business corporation, subsection 74.4(4) cannot be relied on to avoid the application of subsection 74.4(2) should the particular corporation cease to be a small business corporation.
We trust our comments are of assistance to you. These comments are provided in accordance with the practice and limitations outlined in paragraph 22 of Information Circular 70-6R5 issued on May 17, 2002.
David Palamar
Manager
Corporate Reorganizations Section III
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Planning Branch
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