3 March 2006 Internal T.I. 2005-0159081I7 - Timing of income inclusion for trust beneficiary

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: When must income amounts paid by a trust to a beneficiary be included in computing the beneficiary's income?

Position: The income amounts must be recognized by the beneficiary in the beneficiary's taxation year in which the relevant trust taxation year ends; the relevant trust taxation year being that in which the amounts became payable by the trust to the beneficiary.

Reasons: Paragraph 104(13)(a) of the Act.

 							March 3, 2006

Calgary TSO						Grant Nash
#420, 220 4th Avenue NE				Trusts Section
Calgary AB  T2G 0L1				International and Trusts Division
(613) 957-2134
Attention:  Gary Wong
							2005-015908

Timing of Income Inclusion: Income Amounts Received by Beneficiary from a Trust

This is in reply to your letter of November 9, 2005.

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").

Facts

Your letter describes circumstances involving a beneficiary under an inter vivos trust. We have assumed that the trust is not governed by an employee benefit plan.

The beneficiary is a corporation. The beneficiary's taxation year-end is November 30. We have assumed that the only 2003 taxation year of the beneficiary began on December 1, 2002 and ended on November 30, 2003.

The trust's taxation year-end is December 31. We have assumed that the only taxation year of the trust that ends in the beneficiary's 2003 taxation year is the trust's 2002 taxation year that began on January 1, 2002 and that ended on December 31, 2002.

Amounts are paid throughout each calendar year by the trust to the beneficiaries of the trust. These amounts are paid out of the trust's income (as determined under the Act). We have assumed that the trust does not designate an amount in respect of any beneficiary of the trust under subsection 104(13.1) or 104(13.2) or the Act.

Issue

When must the income amounts paid by the trust be included in computing the beneficiary's income for income tax purposes?

Discussion

The beneficiary's representative cites paragraph 104(13)(a) of the Act and the Canada Revenue Agency's (the "Agency") comments in paragraph 6 of Interpretation Bulletin IT-342R and in document 2001-0095445 in support of the proposition that amounts do not become payable to the beneficiary until the trust's taxation year-end.

You cite subsection 104(24) of the Act as support for the proposition that income received by the beneficiary from the trust is taxable when the payment is received. You also cite the Agency's document 9432699 in support of the view that the beneficiary must include in income for its taxation year amounts that became payable to the beneficiary in that taxation year of the beneficiary.

Although on these facts subdivision k of Division B of Part I of the Act properly applies - together with paragraph 12(1)(m) of the Act - to determine the outcome of the issue you raise, the statutory provisions cited in the preceding two paragraphs do not support the different propositions put forward by the taxpayer's representative and yourself. Moreover, none of those propositions describes the scheme under the Act of income taxation of the beneficiary on the amounts. In particular, subsection 104(24) does not apply to determine whether income received by a beneficiary from a trust is taxable and subsection 104(13) does not determine when an amount becomes payable.

A. Subsection 104(24)

There are a number of provisions in the Act that require a determination that an amount has become payable in order for the provision to apply in respect of an amount. Each of subparagraph 53(2)(h)(i.1) and subsections 104(6), 104(7), 104(13), and 104(20) of the Act is such a provision. These five provisions - involving the income taxation of trusts and their beneficiaries - apply in respect of an amount only to the extent that an amount has become payable. Therefore, in order to apply the provisions, it must first be determined that the relevant amount has become payable.

The determination of whether an amount has become payable ordinarily is made by reference to the meaning of "payable" under the applicable general law. See, for example, the discussion in the Agency's document 2005-0130461I7. However, for purposes of subparagraph 53(2)(h)(i.1) and subsections 104(6), 104(7), 104(13), and 104(20) of the Act, subsection 104(24) provides a rule of application that alters the ordinary result.

In considering the effect of subsection 104(24), it is important to note that although the earlier enactments of what is now subsection 104(24) used language that arguably could be read as "defining" what constitutes an amount payable, subsection 104(24) as presently enacted does not define whether or when an amount has become payable. Nor does subsection 104(24) suspend the condition that an amount become payable in order for subparagraph 53(2)(h)(i.1) and subsections 104(6), 104(7), 104(13), and 104(20) to apply in respect of an amount.

Rather, for purposes of subparagraph 53(2)(h)(i.1) and subsections 104(6), 104(7), 104(13), and 104(20), subsection 104(24) deems amounts not to have become payable to a beneficiary in a taxation year. An amount that has not otherwise become payable would not be affected by this rule; that is, the rule applies only to amounts that have otherwise become payable and applies to suspend this determination. This deeming rule does not apply, however, in respect of an amount that has otherwise become payable where the amount is paid in the taxation year to the beneficiary or the beneficiary was entitled in the taxation year to enforce payment of the amount.

(i) Has an amount become payable?

Accordingly, a formal analytical framework for determining whether an amount has become payable to a beneficiary for purposes of subparagraph 53(2)(h)(i.1) and subsections 104(6), 104(7), 104(13), and 104(20) of the Act would be as follows:

1. determine what under the applicable general law (i.e., without regard to the Act) constitutes an amount payable - this is to ascertain what the requirement is for an amount prima facie to have become payable;
2. determine what under the applicable general law (i.e., without regard to the Act) constitutes the payment of an amount or an entitlement to enforce payment of an amount- this is to ascertain what the requirement is to meet one or both of the exceptions to the deeming rule in subsection 104(24); and
3. apply the principles from steps #1 and #2 to the facts (determined, for example, by reference to the terms of the trust).

Using this analytical framework, only if on the applicable facts an amount has first been determined to have become payable to a beneficiary and then also been determined either to be paid in a particular taxation to the beneficiary or become subject to an entitlement in the particular taxation year on the part of the beneficiary to enforce payment of it will the amount's status as an amount that has become payable in the particular taxation to the beneficiary be preserved for purposes of subparagraph 53(2)(h)(i.1) and subsections 104(6), 104(7), 104(13), and 104(20) of the Act.

Notwithstanding the above, our administrative practice has been to accept that an amount has become payable in a taxation year to a beneficiary for purposes of subparagraph 53(2)(h)(i.1) and subsections 104(6), 104(7), 104(13), and 104(20) of the Act if, in the circumstances, it has been paid in the taxation year to the beneficiary or the beneficiary is entitled in the taxation year to enforce payment. In effect, our practice has been to ignore step #1 of the analytical framework described above in determining whether an amount has become payable for purposes of the identified provisions for which subsection 104(24) applies. It is in light of this position that Agency publications continue to sometimes refer to subsection 104(24) as "defining" whether an amount has become payable for the applicable provisions.

Note that subsection 104(18) of the Act also applies in a relatively narrow set of circumstances to alter the ordinary result for determining whether an amount has become payable for purposes of subsections 104(6) and 104(13). Subsection 104(18) is different from subsection 104(24) in that subsection 104(18) provides that amounts that have not otherwise become payable under the applicable general law are deemed to have become payable in applying subsections 104(6) and 104(13) in the circumstances described in subsection 104(18). In this regard, subsection 104(18) can be seen as extending in those limited circumstances the ordinary meaning of "amount payable" for purposes of 104(6) and 104(13), unlike subsection 104(24), which seeks to limit the ordinary meaning. However, subsection 104(18) does not apply in the present circumstances and a more detailed discussion of it is beyond the scope of this letter.

(ii) If an amount has become payable, at what time does this happen?

Each of subparagraph 53(2)(h)(i.1) and subsections 104(6), 104(7), 104(13), and 104(20) of the Act also requires a determination of when an amount has became payable. Subparagraph 53(2)(h)(i.1) refers to amounts that have become payable before the time at which the beneficiary is computing the adjusted cost base to it of its capital interest in the trust. Subsections 104(6), 104(7), 104(13), and 104(20) refer to amounts that have become payable to a beneficiary of a trust in a taxation of the trust.

As noted above, the Agency's position is that, for purposes of the identified provisions, an amount has become payable to a beneficiary if, in the circumstances, it has been paid to the beneficiary or the beneficiary is entitled to enforce its payment. Accordingly, in circumstances where an amount is at a given time paid to the beneficiary or - for example because of an action taken by the trustee - the beneficiary becomes at an identifiable time entitled to enforce its payment, we would generally take the position that, for purposes of the identified provisions, the time at which an amount becomes payable to a beneficiary is the earlier of the time of payment and the time at which the beneficiary became entitled to enforce payment. This determination will depend on the applicable facts.

B. Paragraph 104(13)(a)

Subsection 104(13) serves two general purposes: it identifies certain amounts as income of a beneficiary of a trust and it determines when the beneficiary must recognize such amounts for income tax purposes.

(i) Is the amount income of the beneficiary?

In determining whether an amount is income of a beneficiary of a trust, paragraph 104(13)(a) requires first a determination of whether the amount in question is part of the trust's income determined under Part I (without reference to the deductions in subsections 104(6) and 104(12)) of the Act for a taxation year of the trust. This determination involves two steps. The trustees must resolve - or the terms of the trust provide - that the amount is part of the income of the trust. However, this alone will not be sufficient to determine whether paragraph 104(13)(a) applies to require that the beneficiary include the amount in income. The determination will also require that the trust compute for the relevant taxation year its income under Part I (without reference to the deductions in subsections 104(6) and 104(12)) of the Act. (Note that we have opined in the past that the fact that this computation is not made until after the end of the trust's relevant taxation year will not affect the determination that the amount is part of the trust's income for the relevant taxation year.) These two steps will permit a determination of whether the amount in question is part of the trust's income for the relevant taxation year.

Once it has been determined that the amount in question is part of the trust's income for the taxation year, the second determination under paragraph 104(13)(a) is the determination (the discussion above regarding subsection 104(24) applies in this regard) of whether that part of the trust's income has become payable in that taxation year of the trust to the beneficiary. If so, that part (referred to below as "the income amount") must be included in computing the income of the beneficiary.

(ii) If the amount is income of the beneficiary, when must it be recognized?

Having determined that the amount in question must be included in computing the income of the beneficiary, paragraph 104(13)(a) also applies to determine when the beneficiary must recognize the amount. This step of the analysis speaks directly to the issue raised in your letter.

This "timing" or "recognition" issue requires a determination of the taxation years of the beneficiary and the trust. The determination of a taxation year is, for the purpose of subsection 104(13), made by reference to section 249 and, in some circumstances, certain deeming rules (e.g., section 128.1 and subsection 149(10)).

Paragraph 104(13)(a) requires the beneficiary to include an income amount (as defined above) in computing the beneficiary's income for a particular taxation year of the beneficiary only if the income amount became payable in a taxation year of the trust that ends in that particular taxation year of the beneficiary.

In this regard, you refer to the Agency's comments in paragraph 6 of Interpretation Bulletin IT-342R "Trusts - Income Payable to Beneficiaries" (March 21, 1990). The relevant portion of paragraph 6 of IT-342R states:

6. The amounts required to be included in computing the income of a beneficiary for a taxation year under subsections 104(13) and 105(2) are considered to have been earned by the beneficiary on the last day of the taxation year of the trust and are thus in respect of the taxation year or years of the trust which ended in the taxation year of the beneficiary. [...].

Based on the current provisions of the Act, the comments in paragraph 6 of IT-342R should be read as applying only where the factual circumstances do not otherwise allow for a determination of when exactly an amount becomes payable. The comments in paragraph 6 of IT-342R do not apply where the timing of when an amount became payable is otherwise known. For example, where an amount has not been paid in a trust's taxation year to a beneficiary of the trust, but under the terms of the trust and without need for any action on the part of the trustee the beneficiary is entitled in the taxation year of the trust to enforce payment of the amount (i.e. the amount has become payable to the beneficiary in the taxation year), it may be difficult to ascertain on the facts at what precise time in the trust's taxation year the amount became payable. In these circumstances, paragraph 6 of IT-342R provides the factual assumption regarding timing that is required to apply subsection 104(13) in respect of a particular taxation year of a beneficiary. With that factual assumption - namely, that the time at which the amount became payable is the end of the trust's taxation year - the statutory framework under subsection 104(13) can be applied to determine the beneficiary's taxation year in which an income amount under that provision must be included in computing the beneficiary's income.

The comments in paragraph 6 of IT-342R do not, however, supplant the statutory framework for determining the timing of the beneficiary's income inclusion and whether (as opposed to when) an amount has become payable. Those comments also do not apply in respect of provisions other than subsections 104(13) and 105(2).

Result

Returning to the facts set out above, those parts of the trust's income for its 2002 taxation year that became payable to the beneficiary during the trust's 2002 taxation year (i.e. that became payable to the beneficiary on or after January 1, 2002 and on or before December 31, 2002) are, under paragraph 104(13)(a) of the Act, income amounts of the beneficiary. Because the trust's 2002 taxation year ends in the beneficiary's 2003 taxation year, those income amounts are, under paragraph 104(13)(a), required to be included in the beneficiary's income for its 2003 taxation year.

You have cited subsection 104(13) in expressing concern that the amounts that became payable by the trust to the beneficiary during the period that began on or after January 1, 2003 and that ended on or before November 30, 2003 were not included in the beneficiary's 2003 income tax return.

Subsection 104(13) does not impose such a requirement. The period in question is in the trust's 2003 taxation year and, therefore, those amounts have become payable in the trust's 2003 taxation year. Assuming that those amounts are ultimately determined to be part of the trust's income for its 2003 taxation year, the amounts will, under paragraph 104(13)(a), be income amounts of the beneficiary. However, paragraph 104(13)(a) requires the beneficiary to include the income amounts only for the beneficiary's taxation year in which the trust's 2003 taxation year ends. Assuming that the taxation years of the trust and the beneficiary do not change, the trust's 2003 taxation year ends in the beneficiary's 2004 taxation year. Accordingly, those income amounts must be included in computing the beneficiary's income for its 2004 taxation year.

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
Trusts Section
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch