31 January 2006 External T.I. 2005-0148772E5 - ACBadj on cap int in unit trust wher XII.2 applies

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: In the case of a unit trust that is not a MFT that has a beneficiary resident in Canada and a beneficiary not resident in Canada and the trust has designated income under 210(1), is the Canadian beneficiary required to adjust the ACB of his or her units in the trust?

Position: No

Reasons: Provided that the trustee makes designations under subsection 210.2(3) and 104(21) in respect of the beneficiary resident in Canada, the beneficiary's income inclusion under 104(13) and amount designated under 104(21) will equal the full amount of the distribution

XXXXXXXXXX 							2005-014877
								Annemarie Humenuk
Attention:  XXXXXXXXXX 

January 31, 2006

Dear XXXXXXXXXX:

Re: Part XII.2 Tax and the Adjusted Cost Base of a Capital Interest in a Trust

This is in reply to your letter of August 22, 2005, in which you ask for our comments on the interaction of the provisions of the Act relating to Part XII.2 tax and paragraph 53(2)(h)(i.1). 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").

You describe a particular fact situation in which a trust has two beneficiaries, one who is resident in Canada and one who is not. All of the net income and all of the capital gains of the trust are distributed to the beneficiaries in the taxation year in which the amounts are earned or realized. Since one of the beneficiaries is a designated beneficiary within the meaning of section 210, the designated income of the trust as determined under subsection 210.2(2) is subject to tax under Part XII.2. Under subsection 104(30), the trust is entitled to a deduction for the amount of tax paid under Part XII.2. If the trust makes a designation under subsection 210.2(3), an amount determined by formula will be deemed to have been paid as tax on behalf of the beneficiary and subsection 104(31) will deem that amount to be income payable to the beneficiary for the purposes of subsection 104(13).

If the trust's sole source of income for the year was the capital gain realized by the trust on the disposition of taxable Canadian property, it is your view that the deduction of the amount of tax paid under Part XII.2 as permitted by subsection 104(30) would reduce the amount of income payable to the beneficiaries and thus, the amount that could be designated as a taxable capital gain of the beneficiary resident in Canada. If the trust is unable to designate the full amount of the resident beneficiary's share of the taxable capital gain of the trust under subsection 104(21), the corresponding distribution of the capital may result in an adjustment to the beneficiary's adjusted cost base of his or her capital interest in the trust under subparagraph 53(2)(h)(i.1). In your view, the adjustment would be required because the exception in subclause 53(2)(h)(i.1)(B)(I) is based on the amount that has been designated by the trust under subsection 104(21) in respect of the beneficiary and if the amount designated to be a taxable capital gain under subsection 104(21) is less than the beneficiary's share of the taxable capital gain realized by the trust, the amount of capital which can be distributed without an adjustment to the adjusted cost base of the beneficiary's capital interest in the trust will also be reduced. You ask if we agree with your conclusion.

Provided that the trustee makes the designation under subsection 210.2(3) in respect of the beneficiary resident in Canada and makes the appropriate designation under subsection 104(21), no adjustment should be required under paragraph 53(2)(h)(i.1) to the ACB of the resident beneficiary's capital interest in the trust. As noted in your letter, the requirement to pay Part XII.2 tax will reduce the income of the trust and thus, the amount of income that is actually paid to the beneficiaries. However, the amount of Part XII.2 tax that is designated by the trustee in respect of that beneficiary is deemed to be income of the trust that is payable to beneficiary such that the amount included in the beneficiary's income under subsection 104(13) is the amount that would have been payable to the beneficiary under the terms of the trust if no amount had been payable under Part XII.2. As a result of such a designation, a greater portion of the distribution is included in the beneficiary's income under subsection 104(13) and no adjustment is required in respect of the capital portion of the distribution.

The interaction of these provisions can be illustrated, using your example, as follows:

Facts

• The trust is a unit trust that is not a mutual fund trust, such that the trust is subject to Part XII.2 tax on distributions of designated income to designated beneficiaries.
• The total income of the trust for the taxation year in question is a capital gain of $200 realized on the disposition of taxable Canadian property.
• The trust has two unitholders; a resident of Canada who holds 75% of the units and a non-resident of Canada who holds 25% of the units.
• After the payment of the Part XII.2 tax of $36, the trust distributes 75% of the remainder, or $123, to the beneficiary resident in Canada and 25% of the remainder, or $41, to the non-resident of Canada after withholding the appropriate amount of Part XIII tax from the distribution of income to the non-resident beneficiary.

Income of the unit trust that is not a mutual fund trust

Taxable capital gain of the trust: $100
Less: Part XII.2 tax (36)
Net income of the trust available for distribution: $64

Computation of the income payable to the beneficiary resident in Canada

According to the terms of the trust, 75% of the net income, after the payment of taxes is payable to the beneficiary resident in Canada: $48
Portion of the Part XII.2 tax that is deemed to be income of the trust payable to the beneficiary resident in Canada under subsection 104(31):$27
Total amount included in the income of the beneficiary resident in Canada under subsection 104(13): $75
Amount available to be designated to the beneficiary resident in Canada under subsection 104(21) - the portion of the trust's net taxable capital gains of $100 that can reasonably be considered to be included in the beneficiary's income under subsection 104(13): $75
According to the terms of the trust, an amount of capital equal to the taxable capital gains is payable to the beneficiary resident in Canada as a distribution of capital(75% x 100): $75

Adjustment, if any, required under paragraph 53(2)(h)(i.1) in respect of the resident of Canada:
Amount payable to the resident of Canada, including the amount that is deemed payable under subsection 104(31): $150
Less: Amount described in clause 53(2)(h)(i.1)(A) $75
Amount described in clause 53(2)(h)(i.1)(B) 75 150
ACB Adjustment: Nil

The amount described in clause 53(2)(h)(i.1)(A) is the amount of the distribution that is included in the beneficiary's income under subsection 104(13), or $75 in your example. The amount described in clause 53(2)(h)(i.1)(B) is the sum of the amounts described in subclauses clause 53(2)(h)(i.1)(B)(I) to (III), of which clause 53(2)(h)(i.1)(B)(I) is relevant to your example. Since the amount that is included in the beneficiary's income under subsection 104(13) is $75 and the trust has no other source of income, it is reasonable to consider that the beneficiary's share of the taxable capital gain, or $75, can reasonably be considered to be part of the net taxable capital gains of the trust that were included in the Canadian resident beneficiary's income under 104(13) and can be designated to that beneficiary under subsection 104(21).

Thus, provided the trustee makes the appropriate designations under subsections 104(21) and 210.2(3), the beneficiary resident in Canada would not be required to adjust the ACB of his or her capital interest in the trust under subparagraph 53(2)(h)(i.1) because the full amount of the payment to that beneficiary would be excluded from the ACB adjustment by reason of clauses 53(2)(h)(i.1)(A) and (B).

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

We trust our comments are of assistance to you.

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