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 the trust may designate pursuant to subsection 104(19) its taxable dividend income deemed received in the year to a corporation to which the beneficiaries’ capital interests in the trust had been assigned.
Reasons: In this case the assignee corporation is not a beneficiary of the trust.
June 8, 2018
|XXXXXXXXXX Tax Services Office
Audit case: #XXXXXXXXXX
Income Tax Rulings Directorate
We are writing in reply to your enquiry regarding the above referenced audit case in which you request our views regarding the interpretation of, inter alia, the term “beneficiary” as defined in subsection 108(1) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Suppl.) (the “Act”, to which all statutory references herein relate).
In the situation described, a personal family trust (the “Trust”) with non-resident beneficiaries was approaching a 21-year deemed realization date for purposes of paragraph 104(4)(b). Tax planning was implemented which included the incorporation of a new unlimited liability corporation (“ULC”). After the non-resident beneficiaries interests in the Trust had vested, the non-resident beneficiaries undertook to assign their capital interests in the Trust to the ULC in exchange for common shares of ULC.
Specifically, you asked whether the Trust may designate its taxable dividend income deemed received in its XXXXXXXXXX taxation year to the ULC, the shares of which are owned by the individuals who had assigned their respective capital interests in the Trust to that ULC.
Selected facts, including those provided by the taxpayer’s representative, relevant to the current case include the following:
- The Trust was settled in and is governed by the laws of the Province of XXXXXXXXXX and is irrevocable.
- The Trust’s assets include XXXXXXXXXX common shares of a holding company (“Holdco”).
- The beneficiaries of the Trust include two non-resident individuals “Y” and “Z”.
- The Trust indenture provides that the Trust is fully discretionary as to disbursement of income and capital of the Trust to or for the benefit of any one or more of the beneficiaries, even to the complete exclusion of any one or more of the beneficiaries. In XXXXXXXXXX the corporate group that includes Holdco underwent a reorganization that included the incorporation of ULC, the common shares of which were issued one each to Y and Z.
- As part of the corporate reorganization, the trustees of Trust, the sole shareholder of Holdco signed a series of special resolutions whereby the stated capital of the common shares of Holdco was increased. Holdco filed an election to treat a portion of the deemed dividend arising on this increase as a capital dividend pursuant to subsection 83(2). The balance of the amount attributable to the increase in stated capital comprised taxable dividends deemed as paid to the Trust.
- The trustees of the Trust resolved to distribute an equal share of the Trust’s assets to each of Y and Z to the complete exclusion of any other beneficiary on a date to be determined subsequent to the resolution (the “vesting”).
- After the vesting, Y and Z purportedly assigned their respective capital interests in the Trust to ULC under subsection 85(1) effected by asset purchase agreements whereby they sold their capital interests in the Trust to ULC in exchange for XXXXXXXXXX common shares each in the capital of ULC.
- The Trust reported in its XXXXXXXXXX T3 return a total of actual amount of dividends of $XXXXXXXXXX received from taxable Canadian corporations.
- In its XXXXXXXXXX T3 return, the Trust designated to ULC the taxable dividends received by the Trust in the year.
Whether ULC is a beneficiary under the Trust
We understand that the taxpayer’s representative has advised that the amount paid by the Trust to ULC equivalent to the taxable dividend deemed received by the Trust, was paid to ULC as a beneficiary under the Trust. This presupposes that ULC became a beneficiary under the Trust as a result of the asset purchase agreements executed between Y and Z, respectively, and ULC (hereinafter referred to as the “assignment”).
The definition of “beneficiary” in subsection 108(1) applies for the purposes of subdivision k of Division B of Part I of the Act. Subsection 108(1) defines a “beneficiary” under a trust to include a person beneficially interested therein.
Paragraph 248(25)(a) provides that a person beneficially interested in a trust “includes any person…that has any right (whether immediate or future, whether absolute or contingent or whether conditional on or subject to the exercise of any discretion by any person…) as a beneficiary under a trust to receive any of the income or capital of the particular trust either directly from the particular trust or indirectly through one or more trusts.…” We regard beneficiary in paragraph 248(25)(a) to refer to a person who can be identified as a beneficiary of a trust in the ordinary sense.
The Directorate has commented generally regarding the determination of who is a beneficiary of a particular trust in document E2005-0112511E5 as follows:
…the determination of who is a beneficiary of a particular trust requires a finding of fact based on all the relevant information, including the terms of the trust and the settlor’s intent in establishing the trust. In essence, a beneficiary of a trust is a person (other than a protector) who has a right to compel the trustee to properly enforce the terms of the trust, regardless of whether that person’s right to any of the income or capital is immediate, future, contingent, absolute or conditional on the exercise of discretion by any person.
In the current case, article XXXXXXXXXX of the Trust indenture provides the following in part:
XXXXXXXXXX,…the Trustees may pay and apply the whole or such part or parts of the net annual income and the capital of the Trust Fund to or for the benefit of any one or more of the Beneficiaries from time to time living at such time or times and in such proportion or proportions as the Trustees may determine in their absolute discretion, to the complete exclusion of any one or more of the Beneficiaries…. (underline added)
Article XXXXXXXXXX of the Trust indenture includes the following definition of “Beneficiary”:
XXXXXXXXXX “Beneficiary” means any of “Y”, “Z” so long as Z remains Y’s spouse, and Y’s issue, and “Beneficiaries” means any two or more of such persons.
The beneficiaries of the Trust include two named individuals, Y and Z, and the class of beneficiaries that is Y’s issue. Article XXXXXXXXXX refers to “Beneficiaries from time to time living”, thereby referring to natural persons. ULC is not specifically created nor named by the terms of the Trust indenture. Moreover, there are no provisions under the Trust indenture that empower the trustees to vary the Trust or to add new beneficiaries under the Trust, including a corporate beneficiary. Therefore, based on the terms of the Trust indenture, the beneficiaries of the Trust are limited to Y, Z (so long as Z remains Y’s spouse), and Y’s issue.
Based on the definition of beneficiary as it applies to the facts in this case, including the terms of the Trust indenture, in our view as a result of the assignment ULC is not thereafter a beneficiary under the Trust that has a right to compel the trustee to properly enforce the terms of the Trust. Rather, in our opinion after the assignment Y and Z retain both capital and income interests in and remain the capital and income beneficiaries of the Trust.
Payments and transfers for the benefit of the Beneficiaries
Y and Z are the sole shareholders of ULC. Article XXXXXXXXXX of the Trust indenture states that the trustees may pay and apply the whole or such part or parts of the net annual income and the capital of the Trust Fund to or for the benefit of any one or more of the Beneficiaries. Hence, for example, if the trustees resolve to pay from the Trust tuition fees to a college in which Y is enrolled, at the request of Y, or with his acquiescence, the payment would not in our view make the college a beneficiary of the Trust. The fact that the trustees resolve to make the payment directly to the college does not alter our view that the payment would be received by the college for the benefit of Y.
Similarly, in this case the amount of the taxable dividend deemed received by the Trust is paid directly to ULC pursuant to the trustees’ resolution. As Y and Z are the sole shareholders of ULC, in our opinion ULC receives the amount for the benefit of the existing income beneficiaries of the Trust, namely Y and Z. Such amount as was paid in the taxation year to ULC for the benefit of Y and Z is included in computing the income of Y and Z for the taxation year for the purposes of subsection 104(13).
The facts, as provided, state that the trustees determined that the Trust assets should be transferred to ULC subsequent to the assignment. As stated above, in our view ULC is not a beneficiary with a capital interest in the Trust following the assignment and Y and Z remain the capital beneficiaries of the Trust. Thus it is our view that the transfer of the Trust’s assets to ULC subsequent to the assignment was for the benefit of Y and Z.
As Y and Z are non-residents of Canada, subsection 107(5) provides that subsection 107(2.1) applies to the distribution of the property by the Trust and subsection 107(2) does not apply. Under subsection 107(2.1), the Trust is deemed to have disposed of the distributed property for the property’s fair market value and the beneficiary is deemed to have acquired the property for the same amount.
Designation of a taxable dividend to a capital beneficiary
We have the following general comments regarding payment of a taxable dividend to a capital beneficiary under a trust.
The Directorate has followed jurisprudence which restricts the ability of the trustees to characterize, at their discretion, what is income and what is capital and in particular has cited Succession Terrill v. M.R.N., 87 DTC 492 (T.C.C.) (“Terrill”), and Munro v. Common, (1992), 47 ETR 5 (Que. SC) (“Munro”) in this regard. For example, document E 2001-0076845 provides the following in part:
The Canada Customs and Revenue Agency’s (the “CCRA”) view is that a discretionary power granted to the trustee of a trust to distinguish income and capital items cannot change the nature of an amount of income or deductible expense into a capital receipt or expenditure and vice versa. The CCRA does not accept that a trustee can, at his discretion, determine what is income and what is capital. The decisions rendered in [Terrill] and [Munro], support such a conclusion.
In the current case, based on the decisions in Terrill and Munro, we would not accept that the trustees may recharacterize as capital the taxable dividend income deemed received by the Trust.
Application of subsection 56(2)
Subsection 56(2) generally provides that where a taxpayer directs or concurs in the payment of an amount to another person, that amount shall be included in the taxpayer’s income where, if it had been paid to the taxpayer, it would have been included in the income of the taxpayer.
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.
Despite our views as summarized above, in the event that it were argued that subsection 104(13) does not apply to Y and Z on the basis that an amount had not become payable to them in the year, then in our view, it is reasonable to conclude that subsection 56(2) applies to attribute to Y and Z the taxable dividend amount paid to ULC. Furthermore, if no amount became payable in the year to a Beneficiary of the Trust, then no corresponding deduction pursuant to subsection 104(6) would be available to the Trust.
Application of subsection 105(1)
In the event that it were argued that subsection 104(13) and 56(2) do not apply to Y and Z in respect of the taxable dividends, then in our view, it is reasonable to conclude that a subsection 105(1) benefit has been conferred on ULC. Subsection 105(1) provides that the value of all benefits received or enjoyed by a taxpayer from or under a trust, are to be included in the taxpayer’s income except to the extent that the value,
(a) is otherwise required to be included in computing the taxpayer’s income for a tax year, or
(b) (generally speaking) has been deducted in computing the adjusted cost base of the taxpayer’s interest in the trust under paragraph 53(2)(h).
In the current case, paragraph 105(1)(b) has no application because in our view, ULC is not a capital beneficiary under the Trust.
Subsection 105(1) can apply to a taxpayer other than a beneficiary under the Trust as confirmed in external interpretation E 9238075 which states in part that there is no requirement in subsection 105(1) that the taxpayer who receives a benefit from a trust has to be a beneficiary of the trust.
The taxpayer’s representatives stated that the taxable dividend amount was directed to ULC. However, as discussed the taxable dividends are not an amount that the trustees can recharacterize as capital of the Trust and distribute to ULC given that ULC is not a Beneficiary of the Trust. Therefore, in our view the amount of the taxable dividend deemed received by the Trust that was paid to ULC would be included in the income of ULC under subsection 105(1) as neither of the two exceptions therein are met.
The facts, as provided, state that the trustees determined that the Trust assets should be transferred to ULC subsequent to the assignment. As stated above, in our opinion ULC is not a beneficiary with a capital interest in the Trust following the assignment. In the event that it were viewed that subsection 107(2.1) would not apply regarding the transfer of the Trust’s assets to ULC for the benefit of Y and Z, then, in our view, it would be reasonable to conclude that any transfer of assets to ULC would likewise be a benefit conferred on ULC by the Trust for the purposes of subsection 105(1).
Application of paragraph 212(1)(c)
Y and Z were non-residents of Canada at the time of the transactions in the current case. As discussed, in our view Y and Z remain the income and capital beneficiaries of the Trust subsequent to the assignment.
Pursuant to subparagraph 212(1)(c)(i), Part XIII withholding tax applies generally to income from a trust to the extent that the amount is included in computing the income of the non-resident person under subsection 104(13). Accordingly, Part XIII withholding tax applies to the amount of the taxable dividend paid to ULC for the benefit of the income beneficiaries, namely Y and Z.
Pursuant to subparagraph 212(1)(c)(ii), Part XIII withholding tax applies to an amount that can reasonably be considered to be a distribution to a non-resident of a capital dividend received by a trust from a corporation resident in Canada. Accordingly, Part XIII withholding tax applies to the amount of the capital dividend paid to Y and Z.
Section 116 clearance certificates
We express no opinion in respect of any clearance certificates issued regarding the assignment pursuant to subsection 85(1).
We trust these comments will be of assistance to you.
Phillip Kohnen, CPA, CMA, TEP
Manager, Trust Section I
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 2018
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 2018