30 October 2012 Ontario CTF Roundtable, 2012-0462891C6 - Application of 56(2) to discretionary trust

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: Would we apply 56(2) where sole trustee & also beneficiary distributes trust income to other discretionary beneficiaries aside from him/herself

Position: Perhaps

Reasons: Depends on facts..... we would not automatically apply ss 56(2) in all situations...however we have seen several instances where elaborate arrangements are made to divert professional or business income where 56(2) would apply; also McClurg's outcome should be contained to similar situations...involving shares - not transferrable to trust situation where relationship between trustees & beneficiaries are different from those involving directors and shares.

Ontario CTF Conference – October 30, 2012

Question 19
Trustees and subsection 56(2)

McClurg v. The Queen, 91 DTC 5001, stands for the proposition that subsection 56(2) of the Income Tax Act does not apply when a director of a company, who is also a shareholder of a class of shares of that company that allows for sprinkling dividends, declares dividends on a separate class of shares of the company held by persons related to the director, to the exclusion of the director. Will the CRA confirm that in the context of a fully discretionary trust where the sole trustee is also a discretionary beneficiary of the trust, subsection 56(2) will not apply to the trustee in respect of distributions made in favour of discretionary beneficiaries related to the trustee where no similar distribution is made to the trustee in the trustee's capacity as a discretionary beneficiary?

CRA Response

Subsection 56(2) is an anti-avoidance provision intended to ensure that a taxpayer cannot avoid receipt of a payment that would be included in the taxpayer's income by arranging to have the payment made to some other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the recipient.

Subsection 56(2) will apply where all of the four conditions set out in the provision are met: (i) there is a payment or transfer of property to a person other than the taxpayer; (ii) the payment (or transfer of property) must be made pursuant to the direction or with the concurrence of the taxpayer; (iii) the payment (or transfer of property) is for the benefit of the taxpayer or for the benefit of another person whom the taxpayer desired to benefit; and (iv) the payment (or transfer of property) would have been included in the taxpayer's income if it had been received by the taxpayer. In some cases, the courts have also implied a fifth condition that the payment (or transfer of property) is not included in the recipient's income.

While the Supreme Court has held that subsection 56(2) will not apply to the payment of dividends, this rule is not directly transferrable to the situation you have described. Whether subsection 56(2) applies will depend on a review of the facts and circumstances of each case. Therefore we cannot confirm, as requested, that subsection 56(2) will not apply in every case where the sole trustee (who is also a beneficiary) of a fully discretionary trust makes distributions in favour of other beneficiaries related to the trustee, but no similar distribution is made to the trustee.

Lena Holloway
2012-046289
October 30, 2012