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 75(2) would apply to attribute the trust income to the beneficiary
Position: Most likely
Reasons: It is our view that property was transferred by the capital beneficiary to the trust and the subject share is a substituted property of the property transferred and the said share may revert to the beneficiary.
September 20, 2013
Andrew Winkelstein, Team Leader HEADQUARTERS
Aggressive Tax Planning, Audit Division Dominic Tiu
Toronto Centre TSO (416) 973-8002
1 Front St. West, 4th Floor
Toronto ON M5J 2X6
2013-049921
The "XXXXXXXXXX"
We are writing in response to your July 25th, 2013 email request for our comments as to whether the "XXXXXXXXXX" (the "Trust") is a valid trust under trust law and for Canadian tax purposes. It is our understanding that you are considering the validity of the Trust in your review of a dividend stripping arrangement the Trust may be party to that involved the use of subsection 75(2) of the Income Tax Act (the "Act").
In common law and equity, a trust exists where three certainties exist: intent, object and subject matter. In the current case, these three certainties would appear to exist and as such, it would be difficult to argue that the Trust is not a validly constituted trust under trust law and for Canadian tax purposes.
It is our view however that XXXXXXXXXX (the "Beneficiary") transferred property to the Trust when he gave up his XXXXXXXXXX% economic interest in XXXXXXXXXX to the Trust between XXXXXXXXXX corresponding to the issuance of the one Class C common share to the Trust and the subsequent declaration and issuance of the $XXXXXXXXXX in dividend on the said share. In effect, the one Class C common share, together with the related $XXXXXXXXXX in cash payment, constitutes substituted property for the XXXXXXXXXX% economic interest in XXXXXXXXXX given up by the Beneficiary. As a capital beneficiary of the Trust, the one Class C common share in XXXXXXXXXX may revert back to the Beneficiary and therefore, it is our opinion that subsection 75(2) of the Act would apply to the Beneficiary in respect of the said one Class C common share and as such, an argument could be made that the $XXXXXXXXXX dividend in income received by the Trust from XXXXXXXXXX would attribute to the Beneficiary.
Facts
1. On XXXXXXXXXX, XXXXXXXXXX was incorporated and the Beneficiary is the sole shareholder, sole director and president of the company. XXXXXXXXXX was also incorporated on XXXXXXXXXX and the Beneficiary is also the sole shareholder, sole director and president of the company.
2. Until the company's reorganization on XXXXXXXXXX, the Beneficiary was the sole shareholder of XXXXXXXXXX. As at the time of reorganization, XXXXXXXXXX was valued at about $XXXXXXXXXX. The reorganization primarily created XXXXXXXXXX new classes of common shares and all of the original shares held by the Beneficiary were converted into XXXXXXXXXX Class A common shares.
3. On XXXXXXXXXX, the Trust was created and settled by XXXXXXXXXX with XXXXXXXXXX for the benefit of the Beneficiary, his spouse ("Spouse") and their issue ("Issues"). XXXXXXXXXX was appointed original trustee of the Trust on XXXXXXXXXX. It is interesting to note that subparagraphs XXXXXXXXXX of the trust indenture of the Trust effectively made the benefits of Spouse and Issues as contingent benefits, contingent upon the death of the Beneficiary. Subparagraphs XXXXXXXXXX state that (emphasis added)
XXXXXXXXXX.
4. It is also interesting to note that "time of distribution" is defined in subparagraph XXXXXXXXXX of the trust indenture of the Trust as follows (emphasis added)
XXXXXXXXXX;
5. On XXXXXXXXXX, the Trust subscribed to one Class C common share of XXXXXXXXXX for total consideration of $XXXXXXXXXX.
6. On XXXXXXXXXX, XXXXXXXXXX declared and issued a $XXXXXXXXXX dividend on the one Class C common share owned by the Trust. The Beneficiary, as the controlling shareholder of XXXXXXXXXX, "consented" to the declaration and issuance of the dividend to be paid by XXXXXXXXXX.
7. On XXXXXXXXXX, XXXXXXXXXX paid the dividend by transferring $XXXXXXXXXX to a bank account owned by XXXXXXXXXX As a result, the Trust beneficially received the dividend and was the beneficial owner of $XXXXXXXXXX held in XXXXXXXXXX's bank account.
8. XXXXXXXXXX reported the $XXXXXXXXXX dividend as income in its tax return for the year ending XXXXXXXXXX, pursuant to subsection 75(2) of the Act. We note that subparagraph XXXXXXXXXX of the trust indenture of the Trust states that
XXXXXXXXXX.
9. On XXXXXXXXXX, the Beneficiary borrowed $XXXXXXXXXX from the Trust pursuant to a loan agreement between the Beneficiary and the Trust. The Beneficiary beneficially received the loan proceeds from the Trust by way of the Trust "transferring" its interest in the $XXXXXXXXXX held in XXXXXXXXXX's bank account, to the Beneficiary. It is unclear at this time whether the loan has been repaid by the Beneficiary.
10. Immediately thereafter also on XXXXXXXXXX, the Beneficiary subscribed for and purchased XXXXXXXXXX Class B common shares of XXXXXXXXXX for a total consideration of $XXXXXXXXXX. XXXXXXXXXX received payment from the Beneficiary by way of the Beneficiary "transferring" his interest in the $XXXXXXXXXX held in XXXXXXXXXX's bank account, to XXXXXXXXXX.
11. On XXXXXXXXXX, XXXXXXXXXX passed a resolution to pay $XXXXXXXXXX as a return on capital, to the Beneficiary as the holder of the Class B common shares. It is your understanding that on, or shortly after XXXXXXXXXX, XXXXXXXXXX paid the $XXXXXXXXXX to the Beneficiary.
12. In response to question #19 during the 2011 STEP conference and detailed in our severed document E2011-040195 dated June 3rd, 2011, we stated that (emphasis added)
Dividend strips are an arrangement involving the use of a trust to funnel dividend income to beneficiaries. The arrangements are structured to invoke subsection 75(2) in a manner which purports to insure that neither the trust nor the beneficiaries are taxable on the income. A typical arrangement may involve a family operating company making a contribution to a family trust, which uses those contributed funds to acquire shares in a new corporation. The series of transactions is designed to culminate in the new corporation paying a large dividend to the trust, using funds stripped from the operating company, with the intent that the dividend be attributed back to the operating company.
The CRA is challenging these arrangements on the basis that the income is required pursuant to paragraph 12(1)(j) of the Act and in some cases, subsection 104(13) of the Act, to be added to the income of the trust and/or the beneficiaries, depending on the circumstances. It appears that paragraph 10 of Interpretation Bulletin IT-369R - Attribution of trust income to settlor, is being relied upon to prevent taxation of the dividend in the trust, or in the hands of the beneficiaries. It should be noted, however, that paragraph 10 of the IT is a general administrative concession; it is not law. CRA is of the view that this concession does not apply to such schemes. It is our alternative position that the GAAR applies to deny tax benefits arising from these arrangements.
Whether the Trust is a validly constituted trust for tax purposes
13. In common law and equity, a trust exists where three certainties exist: intent, object and subject matter. In the current case, these three certainties would appear to exist and as such, it would be difficult to argue that the Trust is not a validly constituted trust under trust law and for Canadian tax purposes.
Whether subsection 75(2) would apply to the Beneficiary
14. It is a question of fact whether a transfer of property from the Beneficiary to the Trust occurred so as to engage the attribution provisions in subsection 75(2) of the Act. We note the following:
- On XXXXXXXXXX, as noted in item (2) above, XXXXXXXXXX was valued at about $XXXXXXXXXX. Immediately before that date, the Beneficiary was the sole shareholder of XXXXXXXXXX.
- On XXXXXXXXXX, as noted in item (5) above, the Trust subscribed to one Class C common share of XXXXXXXXXX for a total consideration of $XXXXXXXXXX.
- On XXXXXXXXXX, as noted in item (6) above, XXXXXXXXXX declared and issued a $XXXXXXXXXX dividend on the Class C common share owned by the Trust, an amount representing about XXXXXXXXXX% of the economic interest of the Beneficiary in XXXXXXXXXX at that time.
15. In our severed document E2010-0366301I7 dated November 2nd, 2010, we dealt with the above noted issue albeit in the context of a somewhat more elaborate series of transactions. The relevant portion of the previous analysis relates to our citing of the case of The Queen v Kieboom, 92 DTC 6382 (FCA).
16. The main issues in Kieboom were whether there had been a conferral of a benefit by the taxpayer under paragraph 245(2)(c) of the Act (as it formerly read) and whether there should have been a spousal attribution of certain dividend and other income under subsection 74(1). A subsidiary issue involved a consideration of former subsection 73(5).
There was no dispute as to the facts. Albert Kieboom ("Kieboom") carried on a business of selling carpets in Alberta, through Carpet Colour Centre (Red Deer) Ltd (the "Company"), which was incorporated on May 3rd, 1976. Kieboom acquired 9 common shares at incorporation and his wife, Adriana Kieboom ("Adriana"), acquired 1 common share.
Kieboom thus owned 90% of the equity of the company, while Adriana owned 10%. Kieboom and Adriana were the sole directors and shareholders of the Company.
17. In late 1979, new Class A common shares of the Company were created with each share being equal in equity to each original common share. On February 12th, 1980, Adriana subscribed to 8 Class A common shares for a nominal cost of $1 per share. On March 1st, 1981, the Company issued a further 8 Class A common shares to each of the three children of Kieboom and Adriana for a nominal cost of $1 per share.
18. The February 12, 1980 share subscription by Adriana of the 8 Class A common shares reduced Kieboom's share in the Company from 90% to 50% while that of Adriana, increased from 10% to 50%. The March 1st, 1981 share subscription by each of the three children of Kieboom and Adriana of 8 Class A common share each further reduced Kieboom's share in the Company from 50% to 21.4% and that of Adriana, reduced from 50% to 21.4%. The latter transaction gave each of the three children of Kieboom and Adriana a 19% share of the Company.
19. In 1982, the Company declared and paid a dividend of $4,000 per original common share and $3,750 per Class A common share.
20. In the decision in Kieboom, the judge stated that (emphasis added)
In this case, the taxpayer transferred property to his wife, that is, he gave a portion of his ownership of the equity in his company to his wife. The 40% capital interest in his company which he gave to his wife was clearly property. His beneficial interest in his company was reduced by 40% and hers was increased by 40%. The fact that this transfer of property was accomplished through causing his company to issue shares makes no difference. Subsection 74(1) covers transfers that are made "directly or indirectly" and "by any other means whatever." The transfer in this case was indirect, in that the taxpayer arranged for his company to issue shares to his wife, is nevertheless a transfer from the husband to the wife. There is no need for shares to be transferred in order to trigger this provision of the Act, as was erroneously concluded by the Tax Court judge. By this transfer of property to his wife, he divested himself of certain rights to receive dividends should they be declared. Hence, when the dividends were paid to the wife in 1982, which was income from the transferred property, the said dividend was rightly, attributable to the taxpayer. In addition, the property transferred to Mrs. Kieboom in 1980 was a portion of his ownership equity. As a result of the transfer, the taxpayer's entitlement of 40% was transferred to Mrs. Kieboom. Moreover, the shares which Mrs. Kieboom acquired are also taxable as "substituted property" pursuant to subsection 248(5), as it may be said that she substituted the shares she purchased for the property she received from her husband. Mrs. Kieboom disposed of part of that interest when she transferred a part of that equity to the children. On the same reasoning as above, the section 69 deemed capital gain on that disposition must also be attributed to the taxpayer under subsection 74(2).
21. In the current case, it is our view that the Beneficiary transferred property to the Trust when he gave up his XXXXXXXXXX% economic interest in XXXXXXXXXX to the Trust between XXXXXXXXXX corresponding to the issuance of the one Class C common share to the Trust and the immediate subsequent declaration and issuance of $XXXXXXXXXX in dividend on the said share. In effect, the one Class C common share, together with the related $XXXXXXXXXX in cash payment, constitutes substituted property for the XXXXXXXXXX% economic interest in XXXXXXXXXX given up by the Beneficiary.
22. Based on the above and as a capital beneficiary of the Trust, the one Class C common share in XXXXXXXXXX may revert back to the Beneficiary and therefore, it is our opinion that subsection 75(2) of the Act would apply to the Beneficiary in respect of the said one Class C common share and as such, an argument could be made that the $XXXXXXXXXX dividend in income received by the Trust from XXXXXXXXXX would attribute to the Beneficiary.
Yours truly,
Phil Kohnen
for Director
Trusts Section I
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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