10 May 1991 External T.I. 9103195 F - Preferred Beneficiary Election

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.

5-910319

Dear Sirs:

Re:  Preferred Beneficiary Election

This is in reply to your letter of January 28, 1991 concerning the computation under subsection 104(15) of the Income Tax Act (the "Act") of a preferred beneficiary's share in the accumulating income of a discretionary family trust.

Your particular concern relates to discretionary family trusts having attributes similar to those set out in the following two hypothetical trusts.  To show the effect where contingent beneficiaries are concerned, we have considered the grandchildren's rights to arise only on the death of a child.

1.     The first trust has the following attributes:

(a)  The trustees-are the settlor and two arm's-length individuals.

(b)  The sole capital beneficiary is the spouse of the settlor, while the only income beneficiaries are the children of the settlor.  On the death of a child, his/her children (i.e., the grandchildren of the settlor) become income beneficiaries.  (To respond more specifically to your questions, we will assume that there are two children and three grandchildren alive at the end of the particular taxation year.)

(c)  The settlor is not a beneficiary of any type.

(d)  The trust deed provides that any income not distributed to the beneficiaries, or that is income in respect of which a preferred beneficiary election has been made pursuant to subsection 104(14) of the Act, will be added to the capital of the trust.

2.   The second trust has attributes identical to those in 1 above except for the following:

(a)  The settlor is the grandfather rather than the father.

(b)  The sole capital beneficiaries are the son and daughter-in-law of the settlor while the only income beneficiaries are the son's children. On the death of a child, his/her children (i.e. the son's grandchildren) will become income beneficiaries.  (To respond more specifically to your questions, we will assume that the son has three children and four grandchildren alive at the end of the particular taxation year.)

It is your view that in each of the above situations, it is possible under paragraph 2800(3)(f) of the Income Tax Regulations (the "Regulations") to allocate all of the trust income for a particular taxation year to the children by way of preferred beneficiary elections.

Our Comments

The following commentary reflects our interpretation of the relevant provisions of the Act and Regulations as they apply generally.  Whether or not they are appropriate in a given situation will depend upon the facts peculiar to that situation.

As explained in paragraph 11 of Interpretation Bulletin IT-394R, the accumulating income of a trust for a taxation year will include taxable capital gains realized by the trust.  Consequently, as explained in paragraph 14 of IT-394R, where the right to the capital of the trust has vested in the preferred beneficiary as of the end of the particular taxation year of the trust, or there exists a power of encroachment on the capital of the trust in favour of the preferred beneficiary, that beneficiary will have an income interest in the accumulating income of the trust except where the trust document provides that capital gains are income for trust purposes.

Where there is no capital gain realized by a trust in a particular taxation year, a capital beneficiary's share of the accumulating income of the trust for that year will be nil by virtue of paragraph 104(15)(d) of the Act.

Where a preferred beneficiary's share in the accumulating income of a trust for a particular taxation year is to be determined under paragraph 2800(3)(f) of the Regulations, the number to be used in the calculation will include

(a)  all contingent preferred income beneficiaries, and

(b)  all contingent capital beneficiaries, where the trust document does not specify that taxable capital gains will be considered income for trust purposes,

who are alive at the end of that year, whether or not their rights are contingent on the death of another preferred beneficiary.  The Department's views in this regard are reflected in advance tax ruling 30, a copy of which is enclosed for your perusal.

Based on the above comments and on the assumption that there exists a power of encroachment on behalf of the capital beneficiaries, our views of the amount on which preferred beneficiary elections can be made with respect to the beneficiaries of the above two hypothetical trusts are as follows:

Capital Gains are Income for Trust Purposes

Paragraphs 104(15)(c) of the Act and 2800(3)(f) of the Regulations would apply to preferred beneficiary elections made jointly by the trust and the two children referred to in 1 (b) above.

Paragraph 104(15)(d) of the Act would apply to preferred beneficiary elections made jointly by the trust and the three grandchildren referred to in 1 (b) above.  This stems from the fact that their right to share in the accumulating income of the trust for the particular taxation year is not dependent upon the exercise or non-exercise of a discretionary power but, rather, upon the happening of a future event.  Therefore, although the trust and the grandchildren may jointly make a preferred beneficiary election, it would be meaningless in that the maximum amount that could be elected upon would be nil because, under paragraph 104(15)(d), that would be the grandchildren's share of the accumulating income of the trust for the year.  However, for the purposes of the calculation under paragraph 2800(3)(f) of the Regulations, the three grandchildren would be included.

The capital beneficiaries of each of the above trusts would be ignored for the purposes of the calculation under paragraph 2800(3)(f) of the Regulations.  This results from the fact that since capital gains are income for trust purposes, the capital beneficiaries could never share in the accumulating income of the trusts.

The two children would thus be entitled, jointly with the trust, to each make a preferred beneficiary election on an amount not exceeding 1/5 of the accumulating income of the trust for the particular taxation year.

If the three grandchildren were income beneficiaries rather than contingent income beneficiaries, each grandchild together with the trust could also elect on an amount not exceeding 1/5 of the accumulating income of the trust for the particular taxation year.

The above comments would also apply to the trust described in 2 above except that the fraction of 1/5 referred to in the two preceding paragraphs would instead be 1/7, given that there are three children and four grandchildren.

Capital Gains are not Income for Trust Purposes but the Trust does not Realize a Capital Gain in the Year

Paragraph 104(15)(d) of the Act would apply to the capital beneficiary of the trust described in 1 above (i.e., the spouse referred to in 1 (b) above) such that the capital beneficiary's share in the accumulating income of the trust for the particular taxation year would be nil.  Nevertheless, the capital beneficiary would have to be counted for the purposes of the calculation under paragraph 2800(3)(f) of the Regulations.

The two children referred to in 1 (b) above would thus be entitled, jointly with the trust, to each made a preferred beneficiary election on an amount not exceeding 1/6 of the accumulating income of the trust for the particular taxation year.

If the three grandchildren were income beneficiaries rather than contingent income beneficiaries, each grandchild together with the trust could also elect on an amount not exceeding 1/6 of the accumulating income of the trust for the particular taxation year.

The above comments would also apply to the trust described in 2 above except that the fraction of 1/6 referred to in the two preceding paragraphs would instead be 1/9, given that there are two capital beneficiaries, three children and four grandchildren.

Capital Gains are not Income for Trust Purposes and the Trust Realizes a Capital Gain in the Particular Taxation Year

Pursuant to paragraph 104(15)(c) of the Act, the spouse referred to in 1 (b) above would have a share in the accumulating income of the trust for the particular taxation year.  This share would be equal to the amount determined under subsection 2800(3) of the Regulations to be the spouse's discretionary share of the trust's accumulating income for the year.  By virtue of paragraph 2800(3)(e) of the Regulations, that amount would be 100% of the accumulating income of the trust for the year.  The spouse and the trust could thus jointly make a preferred beneficiary election on up to 100% of the accumulating income of the trust for the year.

Although each of the two children referred to in 1 (b) above could also make a preferred beneficiary election jointly with the trust, the election would be meaningless given that the maximum amount on which each child could elect would be nil by virtue of subparagraph 2800(1)(e)(iii) of the Regulations.

With respect to the trust described in 2 above, the two capital beneficiaries and the three children referred to in 2 (b) above would be entitled to each make a preferred beneficiary election jointly with the trust on an amount not exceeding 1/9 of the accumulating income of the trust for the particular taxation year.

If the four grandchildren referred to in 2 (b) above were income beneficiaries rather than contingent income beneficiaries, each grandchild together with the trust could also elect on an amount not exceeding 1/9 of the accumulating income of the trust for the particular taxation year.

You did not mention who the contingent capital beneficiaries would be and we have thus assumed that they would be the children and the grandchildren.  If they were someone else, the denominator of the fraction used for the purposes of the paragraph 2800(3)(f) calculations could be greater, depending upon the circumstances.

The above comments are an expression of opinion only and are not binding on the Department, as explained in paragraph 21 of Information Circular 70-6R2.  We trust, however, that they are of assistance to you.

Yours truly,

for DirectorFinancial Industries DivisionRulings Directorate