7 December 1989 Ministerial Correspondence 59084 F - Preferred Beneficiary Election under Testamentary Spouse 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.

Dear Sirs:

This is in reply to your letter of November 17, 1989 concerning the designation available under subsection 104(13.1) of the Income Tax Act (the "Act").

You are concerned that the payment of a trust's tax liability arising as a result of a subsection 104(13.1) designation may adversely affect the status of the trust if it is a testamentary trust or an inter-vivos trust described in subsection 122(2) of the Act, or may prevent the trust from qualifying as a "spouse trust" described in subsection 70(6) of the Act.

Whether or not the above results occur where a trust's tax liability arising out of a subsection 104(13.1) designation has been paid cannot be definitively determined without first reviewing the particular trust document(s).  Such a review would be made by the relevant district taxation office in respect of an existing situation, or by this office where the designation is the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R.  We nevertheless offer the following general comments with respect to the issues raised in your letter.

1.     Where a subsection 104(13.1) designation is made and a beneficiary makes, or is considered to have made, a payment to the trustee to enable the trustee to pay the tax liability of the trust caused by the designation, the following results would occur:

(a)     Where the trust is a testamentary trust, the payment would represent a contribution to the trust for the purposes of subparagraph 108(1)(i)(ii) of the Act.  The result would be that the trust would no longer qualify as a testamentary trust.

(b)     Where the trust is an inter-vivos trust of the type described in subsection 122(2) of the Act, the payment might constitute a gift for the purposes of paragraph 122(2)(d) of the Act.  If it is a gift, this would cause the trust to be taxed under subsection 122(1) of the Act.  We are prepared to pursue this further if the issue is the subject matter of an advance income tax ruling request.

2.     Where a subsection 104(13.1) designation is made by a trust and the trust pays the resulting tax liability out of trust income, rather than out of trust capital, the requirement in subparagraphs 70(6)(b)(i) and 104(4)(a)(iii) of the Act would not be met.  However, as stated in paragraph 10 of Interpretation Bulletin IT-305R3, the "trust income" for the purposes of those subparagraphs is described in subsection 108(3) of the Act to exclude amounts that are income for income tax purposes but not for trust purposes (e.g., taxable capital gains).  Thus, payment of the taxes out of taxable capital gains of the trust would not in and of itself preclude the trust from qualifying under paragraph 70(6)(b) as a spouse trust.  Also, as indicated in paragraph 7 of IT-305R3, payment of the taxes out of trust income would not affect the status of a previously qualified spouse trust.  It may, however, bring into play other provisions of the Act such as subsections 106(2) or 107(4).

Where a subsection 104(13.1) designation affects the status of a testamentary trust or a subsection 122(2) trust, or prevents a trust from qualifying as a spouse trust, you suggest that this could be prevented by regarding the tax paid by the trust as having been paid by the trustee as agent for the beneficiary.  In this regard, we can only say that whether or not a trustee is acting as agent for someone else is a question of fact.  In any event, the tax liability is that of the trust not that of the beneficiary.  We therefore fail to see how the trustee, in paying taxes owing by the trust, could be said to be paying those taxes on behalf of a beneficiary of the trust, given the absence in the Act of a relevant deeming provision.

Alternatively, you suggest that the tax payable by the trust could be "accepted" as a proper charge against the trust income, thereby entitling the beneficiary to only the trust income less the applicable tax.  Again, we can only say that whether or not such is the case is a question of fact.  If the tax is paid by the trust, the comments in 1 above are irrelevant whereas the comments in 2 above are relevant.

The above comments reflect expressions of opinion only and as such they are not binding upon the Department.  We trust however that they will be of assistance to you.

Yours truly,

for DirectorFinancial Industries DivisionRulings Directorate