13 November 2007 External T.I. 2007-0250731E5 - exempt amount as defined in proposed 94(1)

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 either of two types of transfers to a deemed resident trust will qualify as an "exempt amount" such that the deemed resident trust will not be required to withhold Part XIII tax on distributions of income (other than amounts not deductible by the trust under 104(7.01)) to the non-resident beneficiaries. The response addresses the issuance of shares of a US corporation to the deemed resident trust in exchange for cash (on a commercial basis) and the payment of a trust expense by a beneficiary.

Position: Provided the issuance of shares by the US corporation is not part of a series of transactions within the meaning of 248(10) that includes a contribution, the issuance of shares for cash equal to the FMV of those shares will likely meet the definition of "arm's length transfer" such that the transfer will not be a "contribution" for the purpose of (c)(iv) of the def'n of "exempt amount". However, the payment of a trust expense will likely qualify as a "contribution" (and thus a subsequent distribution of income other than income described in paragraph 104(7.01) will not be an "exempt amount") with the result that the trust would be deemed resident for the purposes set out in 94(3)(a)(ix) and other provisions at all times after the payment of that expense.

XXXXXXXXXX 								2007-025073
									Annemarie Humenuk
November 13, 2007

Dear XXXXXXXXXX:

Re: Deemed Resident Trust and the Definition of "Exempt Amount" in Proposed Subsection 94(1)

This is in reply to your letter of August 28, 2007 in which you ask for our views on the application of the proposed non-resident trust rules to a particular fact situation.

In the situation you described, a non-resident of Canada established a trust before 2003 for each of his three sons. The trust for the son resident in Canada is resident in Canada but the trustees of the two trusts established for the benefit of the two sons resident in the U.S. are resident in the U.S. such that those two trusts are considered resident in the U.S. for U.S. tax purposes. The settlor of the three trusts has since immigrated to Canada and had been resident in Canada for more than 60 months before the beginning of 2007 such that the trusts established for the benefit of the sons living in the U.S. will be deemed to be resident in Canada for 2007 and subsequent taxation years provided that the amendments to section 94 are enacted in substantially the same form as proposed in Bill C-10 as passed by the House of Commons on October 29, 2007 ("Proposed Legislation").

Your concern is whether the annual distribution of income from the deemed resident trusts to the respective U.S. beneficiary of each trust would each be an "exempt amount" as described in paragraph (c) of that definition in proposed subsection 94(1). To this end, you would like confirmation that the word "contribution" as used in proposed subparagraph (c)(iv) of the definition of "exempt amount" means any amount that meets the definition of "contribution" and excludes any amount transferred to the trust that qualifies as an "arm's length transfer" as those terms are defined in proposed subsection 94(1).

In particular, you ask whether the payment of an invoice of trust by a beneficiary of the trust, including a non-resident beneficiary, would be sufficient to cause the subsequent distributions of income from that trust to non-resident beneficiaries to lose their characterization as an "exempt amount" as defined in proposed subsection 94(1). In addition, you ask whether the investment of the trust property in various partnerships and U.S. corporations carrying on business in the U.S. (with the resulting transfer of shares or a partnership interest to the trust) would result in the subsequent distributions of income from those trusts to their respective non-resident beneficiaries to lose their characterization as an "exempt amount" as defined in proposed subsection 94(1).

As explained in Information Circular 70-6R5, dated May 17, 2002, this Directorate does not comment on transactions involving specific taxpayers except by way of an advance income tax ruling in respect of proposed transactions. However, we are prepared to provide you with the following general comments.

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") and all references to proposed legislation are references to the Proposed Legislation.

Under the Proposed Legislation, a deemed resident trust that makes a distribution to a non-resident beneficiary will be required to withhold Part XIII tax unless the distribution is an "exempt amount" as defined in proposed subsection 94(1). Among other things, an "exempt amount" includes an amount of trust income paid in a particular year (or within 60 days of the end of the trust's taxation year) by a trust created before October 30, 2003 directly to a beneficiary, as determined without reference to subsection 248(25), of that trust where the beneficiary is a natural person and acquired no portion of his or her interest in the trust for consideration, the amount was not included in computing an "exempt amount" for any other taxation year and no "contribution" has been made to the trust on or after July 18, 2005. Assuming the other conditions set out in paragraph (c) of the definition of "exempt amount" are met, the annual distribution of income from the deemed resident trust to the non-resident beneficiary named in the trust deed will not be subject to Part XIII tax provided that the trust has not received any contribution on or after July 18, 2005, including contributions from non-residents of Canada.

A contribution for this purpose is a "contribution" as defined in proposed subsection 94(1) and excludes a transfer of property that meets the definition of "arm's length transfer" in proposed subsection 94(1). The payment of a bill or invoice of the deemed resident trust by a beneficiary for no consideration would constitute a "contribution" as defined in proposed subsection 94(1). For greater certainty, proposed paragraph 94(2)(a) provides that an entity is deemed to have transferred property to the trust in situations where the entity transfers property to a third party and by reason of that transfer, the liability or potential liability of the trust decreases at that time. Thus, the payment of an invoice by a beneficiary without any consideration received in return would constitute a "contribution" as defined in proposed subsection 94(1) such that the payment of such an invoice in such circumstances at any time after July 17, 2005 would cause each subsequent distribution of trust income (other than an amount that is taxed in the trust by reason of paragraph 104(7.01)(b)) to lose its status as an "exempt amount" as defined in proposed subsection 94(1).

With respect to the investment in a corporation carrying on business in the U.S. by the deemed resident trusts, the issuance of shares of the corporation to either of the trusts would constitute a transfer by reason of the deeming provision contained in proposed paragraph 94(2)(g). Whether or not such a transfer would result in a "contribution" to a particular trust depends in large part on whether the transfer can be considered to be an "arm's length transfer" as that term is defined in proposed subsection 94(1).

In order for a particular transfer or loan to qualify as an "arm's length transfer":

• the transfer or loan must not involve the exchange of any "restricted property" as that term is defined in proposed subsection 94(1) either as part of the property transferred or loaned or as part of the property received in exchange for the property transferred;
• it must be reasonable to conclude that none of the reasons for the transfer is the acquisition by any entity of an interest in the trust; and
• the conditions set out in one of the subparagraphs of (b) of the definition of "arm's length transfer" are met with respect to the transfer.

While each of the conditions noted above involves a finding of fact in respect of any particular transfer, the issuance of shares by a corporation in exchange for an amount of cash equal to the value of the shares at that time would typically not involve the issuance of an interest in a trust to some other person unless the issuance of shares was part of a series of transactions, as defined in subsection 248(10), that included the issuance of an interest in a trust to any person. Note that if shares of the corporation are "restricted property", the investment in the underlying corporation by the trust would result in the corporation having made a "contribution" to the trust as that term is defined in proposed subsection 94(1).

In your letter, you ask whether the Canada Revenue Agency accepts that commercially reasonable terms and conditions would meet the requirements of proposed subparagraph (b)(iv) of the definition of "arm's length transfer". It is a question of fact as to whether any particular set of terms and conditions are considered "commercially reasonable" or whether the transaction meets the conditions set out in proposed subparagraph (b)(iv) of the definition of "arm's length transfer" in subsection 94(1). However, where the terms and conditions under which the shares are issued are the same as that which would be offered to any entity dealing at arm's length with the corporation and the terms and conditions do not involve any transaction other than the issuance of the shares and the cash received by the corporation in exchange for the shares, the conditions in proposed subparagraph (b)(iv) would likely be met.

The same principles apply in determining whether the issuance of a partnership interest by the partnership meets the definition of "arm's length transfer" as defined in proposed subsection 94(1).

In summary, provided that the shares or partnership interest is issued to the trust in circumstances where the conditions set out in the definition of "arm's length transfer" are met, the issuance of the shares or partnership interest to the trust would not result in the corporation or partnership having made a "contribution" to the trust solely by reason of such transfer.

Please note that this response does not take into account any potential tax implications under sections 94, 94.1, 95 or proposed section 94.1 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.

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