20 June 2023 STEP Roundtable Q. 7, 2023-0959581C6 - Deemed Resident Trust and the Resident Portion

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: Questions regarding a deemed resident trust and the resident portion.

Position: General comments provided.

Reasons: See below.

2023 STEP CRA Roundtable – June 20, 2023
QUESTION 7. Deemed Resident Trust and the Resident Portion

Assume a trust is initially constituted as a non-resident trust where property is contributed only from a non-resident person who has never been a Canadian resident. Some time later, the trust becomes a deemed resident trust by receiving one or more contributions of property from a Canadian resident person. Assume that the trust makes a valid election to have paragraph 94(3)(f) of the Income Tax Act (the “Act”) (footnote 1) apply to the trust.

A. Assume that each of these transfers is not an “arm’s length transfer” as defined in subsection 94(1). We are interested in the CRA’s views in general as to how the “resident portion” as defined in subsection 94(1) is calculated in the following situations:

(1) A Canadian resident beneficiary uses a residential property owned by the trust and pays certain bills of the trust in respect of the property (i.e., the beneficiary does not pay the trust directly).

(2) A loan is made to a Canadian resident beneficiary. Assume the loan can be considered debt.

(3) The loan above is subsequently repaid in full.

B. Assume that 49% of the shares of a corporation not resident in Canada (a “foreign corporation”) owned by the trust are included in the resident portion but the trust holds 100% of the shares in all. Is that foreign corporation a “controlled foreign affiliate” as defined in subsection 95(1) and if so, how would foreign accrual property income (“FAPI”) be calculated?

CRA Response

For the purposes of this response, the terms “arm’s length transfer”, “contribution”, “contributor”, “resident contributor”, “resident portion”, and “non-resident portion” are defined in subsection 94(1). “Foreign affiliate” is defined in subsection 95(1).

For the purposes of Part A, we are to assume that none of the transfers described is an arm’s length transfer. However, it is important to note that whether a transfer is an arm’s length transfer depends on all of the particular facts and circumstances.

Part A (1)

In this scenario, the payment of a bill of the deemed resident trust by a beneficiary would constitute a contribution to the trust. The legislation provides certainty in this determination because paragraph 94(2)(a) provides that a person or partnership is deemed to have transferred property to the trust in situations where the person or partnership transfers property to a third party and by reason of that transfer, the liability or potential liability of the trust decreases at that time. As provided above, we are to assume that the transfer is not an arm’s length transfer and is thus, a contribution. Since the beneficiary has made a contribution to the trust, the beneficiary will be considered to be a contributor to the trust. Additionally, since the beneficiary is resident in Canada and a contributor to the trust, the beneficiary will be considered to be a resident contributor to the trust.

Subclause (a)(ii)(A)(II) of the definition of resident portion in subsection 94(1) provides that, where clause 94(2)(a)(ii)(B) is applicable in respect of a decrease in a liability or potential liability, the trust must select property, that would not otherwise be included in the resident portion of the trust and that has a fair market value (“FMV”) at least equal to the absolute value of the decrease in the liability or potential liability of the trust, that will be allocated to the resident portion of the trust. If the trust does not make the selection, the Minister may select appropriate property. All of the property in the non-resident portion would be transferred to the resident portion in the event that the absolute value of the decrease in the trust’s liability or potential liability is greater than the FMV of all property held in the non-resident portion.

Part A (2)

Pursuant to subparagraph 94(2)(g)(iv), each acquisition of property by a particular person or partnership is deemed to be a transfer of the property, at the time of the acquisition of the property, to the particular person or partnership from the person or partnership from which the property was acquired, namely, the acquisition by the particular person or partnership of a debt owing by a person or partnership from the person or partnership.

For the purposes of Part A (2), we are to assume that the loan can be considered to be debt. While the debt owing involves a transfer of property to the beneficiary in the form of the loaned funds, subparagraph 94(2)(g)(iv) provides that, for greater certainty, it also involves the acquisition of the debt owing by the trust. As such, very generally, when a person issues a debt, they are deemed to have transferred the debt owing.

In this scenario, the acquisition of property by the trust is deemed to be a transfer of the property, at the time of the acquisition of the property, to the trust from the beneficiary from which the property was acquired, namely, the acquisition by the trust of a debt owing by a beneficiary from the beneficiary.

Therefore, the acquisition by the trust of a debt owing by a beneficiary is deemed to be a transfer of the property from the beneficiary to the trust. As provided above, we are to assume that this transfer is not an arm’s length transfer and is thus, a contribution to the trust. Since the beneficiary has made a contribution to the trust, the beneficiary will be considered to be a contributor to the trust. Additionally, since the beneficiary is resident in Canada and a contributor to the trust, the beneficiary will be considered to be a resident contributor to the trust.

Paragraph (a) of the definition of resident portion includes inter alia all of the trust’s property that is property in respect of which a contribution has been made at or before the particular time to the trust by a contributor that is at the particular time a resident contributor. As such, the debt owing from the beneficiary will be included in the resident portion.

Part A (3)

A contribution to a trust by a particular person or partnership includes a transfer or loan (other than an arm’s length transfer) of property to the trust by the particular person or partnership. The term transfer has a broad meaning that encompasses virtually any means by which ownership or title to property is conveyed from one person to another, including to a trust.

Therefore, the repayment of the loan would be considered a transfer of property to the trust from the beneficiary. As provided above, we are to assume that the transfer is not an arm’s length transfer and is thus, a contribution to the trust. Since the beneficiary has made a contribution to the trust, the beneficiary will be considered to be a contributor to the trust. Additionally, since the beneficiary is resident in Canada and a contributor to the trust, the beneficiary will be considered to be a resident contributor to the trust.

As noted above, paragraph (a) of the definition of resident portion includes inter alia all of the trust’s property that is property in respect of which a contribution has been made at or before the particular time to the trust by a contributor that is at the particular time a resident contributor. As such, the cash proceeds from the loan repayment will be included in the resident portion.

However, it is expected that the resident portion will no longer include the debt owing from the beneficiary once that property has ceased to exist.

Part B

Generally, paragraph 94(3)(f) provides the deemed resident trust with the option of making an election to deem a non-resident portion trust (“NRPT”) to be created that would be deemed to hold the non-resident portion of the trust’s property. Accordingly, the deemed resident trust (referred to as the “particular trust” in paragraph 94(3)(f)) is considered to hold the property in the resident portion. Such an election essentially enables the trust to reduce income that is taxable in Canada.

The deemed resident trust is deemed to be resident in Canada throughout the particular taxation year for the purposes of determining whether a foreign affiliate of a taxpayer (other than the trust) is a controlled foreign affiliate of the taxpayer pursuant to subparagraph 94(3)(a)(x).

Subparagraphs (b)(i) and (ii) of the definition of controlled foreign affiliate in subsection 95(1) provide that a controlled foreign affiliate, at any time, of a taxpayer resident in Canada can include:

(b) a foreign affiliate of the taxpayer that would, at that time, be controlled by the taxpayer if the taxpayer owned

(i) all of the shares of the capital stock of the foreign affiliate that are owned at that time by the taxpayer,

(ii) all of the shares of the capital stock of the foreign affiliate that are owned at that time by persons who do not deal at arm’s length with the taxpayer…

In this scenario, the foreign corporation would be a foreign affiliate of the particular trust.

Pursuant to subparagraph 94(3)(f)(viii), the particular trust and the NRPT are deemed at all times to be affiliated with each other and to not deal with each other at arm’s length. Since the NRPT does not deal at arm’s length with the particular trust, all of the shares of the capital stock of the foreign affiliate that are owned at that time by the particular trust (49%) and the NRPT (51%) would be included in the computation to determine whether the foreign affiliate would, at that time, be considered to be controlled by the particular trust.

In this scenario, since all of the shares of the capital stock of the foreign affiliate are owned by the particular trust and the NRPT, the foreign affiliate would be considered to be controlled by the particular trust and as such, the foreign corporation will be considered a controlled foreign affiliate of the particular trust.

FAPI is defined in respect of a particular foreign affiliate. That is, it is calculated first at the entity level and there is nothing in this scenario which alters the nature of that calculation. The Canadian income inclusion under subsection 91(1) is then determined on a share-by-share basis. Again, there is nothing in the question which alters the nature of that calculation. If the foreign affiliate only has common shares outstanding, and the particular trust’s investment is a direct one, identifying the participating percentage is quite straight forward. However, with more complex equity structures, one may need to look to section 5904 of the Income Tax Regulations. Of course, if the FAPI of the foreign affiliate is $5,000 or less, the participating percentage is nil.

Additionally, if the investment is structured in a manner designed to minimize the FAPI inclusion, various anti-avoidance provisions could be relevant to determining the Canadian income tax results.

Katie Robinson
2023-095958

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 Unless otherwise expressly stated, every statutory reference herein is a reference to the relevant provision of the Act.