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.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
XXXXXXXXXX A. Godin
January 10, 1996
Re: Foreign Trusts
Subsections 75(2) and 94(1) of the
Income Tax Act (Canada) (the "Act")
This is in reply to your letter dated March 16, 1994 in which you requested the Department's views with respect to certain aspects of the taxation of foreign trusts and the beneficiaries of foreign trusts. You describe the following situation.
A trust (hereinafter the "Trust") was created before 1971 and after 1959 under the laws of a country other than Canada by Mrs X at a time when Mrs X was not a resident of Canada. Mrs X has since the establishment of the Trust become a resident of Canada and has been for more than 60 months. The terms of the Trust are such that Mrs X is the settlor as well as the life income beneficiary of the Trust. Her children or their issue are the capital beneficiaries of the Trust.
The actual terms of the Trust are such that Mrs X has the power to appoint, during her lifetime, the proportion of the estate allocable to the beneficiaries. The appointment may be made to certain beneficiaries to the exclusion of others. Mrs X is not a trustee of the Trust. Should Mrs X die without exercising her power to appoint, the capital will be divided among the capital beneficiaries in accordance with the terms of the trust document.
Under the laws of the country under which the trust was established, the trust is a resident of that country. The Trust is not taxable in its home country on income payable to Mrs X, however, it would be taxable in the home country on any capital gains arising in the trust.
You indicate that the Trust appears to be a discretionary trust by virtue of Mrs X's ability to appoint capital to particular beneficiaries to the exclusion of others. The Trust would, in your view, be subject to paragraph 94(1)(c) and would accordingly be deemed to be a person resident in Canada pursuant to subparagraph 94(1)(c)(i) of the Act. Moreover, you indicate that subsection 75(2) also applies as the situation described above satisfies the conditions set out in subparagraph 75(2)(a)(ii) of the Act. You raise several questions and ask for our opinion on a number of issues.
The situation outlined above relates to a specific taxpayer appears to involve actual contemplated transactions. As explained in Information Circular 70-6R2 dated September 28, 1990 ("IC-70-6R2"), assurance as to the tax consequences of proposed transactions can only be obtained in the context of an advance income tax ruling. The procedures for requesting an advance ruling are outlined in IC-70-6R2. Nevertheless, we offer the following comments. These are intended to be general in nature and may or may not apply to your particular fact situation.
You ask several questions, most with two or more parts. We will address each question individually.
QUESTION 1 - Subsections 75(2) and 94(1) of the Act
In your view, subsection 94(1) provides a mechanism for utilizing foreign tax credits to avoid double taxation. However, there appears to be no similar relief for income attributed pursuant to subsection 75(2). In the circumstances of a non-resident trust, you ask if the Department would apply the more specific provisions of subsection 94(1) (which you consider more fair because it provides a mechanism for utilizing foreign tax credits), or the more general provisions of subsection 75(2)? In addition you ask, if subsection 75(2) is applicable, whether it would cease to apply where the terms of the trust were varied to remove Mrs X's power to appoint?
It continues to be our opinion that the specific rules set forth in subsection 94(1) would generally take precedence over the general provisions of subsection 75(2) in the circumstances described in the September 10, 1984 letter you referred us to. However, we could endeavour to invoke the latter provisions in appropriate circumstances such as where the transactions have been consummated as part of a tax avoidance transaction.
Subsection 75(2) will attribute any income or loss from the property and any taxable capital gain or allowable capital loss from the disposition of the property back to the person from whom the trust acquired the property. As you pointed out, there is no mechanism in this provision for the utilization of foreign tax credits by the person who is subject to the attribution rule. Accordingly, any non-business income tax that has been paid to the government of a foreign country by a trust cannot be considered, for the purposes of subsection 126(1) of the Act, to have been paid by a person to whom the income from the transferred property is attributed pursuant to subsection 75(2).
Subsection 75(2) is a deeming provision that provides that the income from property transferred to a trust will revert to the transferor when the conditions specified for its application are present. If these conditions cease to exist at any time, for example as a result of a change in the conditions establishing the trust, then the attribution rules under subsection 75(2) will also cease to apply at that time.
QUESTION 2 - Subsection 104(4)
a) Does subsection 104(4) apply to a foreign trust which is a deemed resident of Canada under paragraph 94(1)(c) and does the Department agree with the comments set out in your letter in regards to this matter?
b) If the rules in subsection 104(4) are intended to apply to all trusts, both resident and non-resident, then are the deemed disposition rules restricted to only certain property that would otherwise be subject to tax by non-residents (i.e., dispositions of taxable Canadian property) or are they extended to foreign properties held by the trust as well such that they would be caught under clause 94(1)(c)(i)(B)?
c) If the rules do apply to foreign property to cause deemed dispositions of such property and related foreign accrual property income (FAPI), would the adjusted cost base of such property to the trust be the original cost of the property to the trust adjusted for valuation day considerations or the gain as may reasonable be considered to have accrued after its 1975 taxation year in accordance with the definition of "foreign accrual property income"?
Pursuant to 94(1)(c), a trust is deemed a resident of Canada whose taxable income is the total of the three elements described under clauses (A), (B) and (C) of that provision. Subsection 104(4), which applies to all trusts, deems a disposition of the assets of a trust at certain times. In our view, such deemed dispositions of property by the trust must be taken into account when computing the taxable income of the trust under subsection 94(1) or of a person to whom income is attributed pursuant to subsection 75(2).
Under clause (A), a trust must include the amount that would, if the trust was not deemed a resident of Canada, be its "taxable income earned in Canada" for the year as defined in subsection 115(1). This includes taxable capital gains from the disposition of taxable Canadian property. Where subsection 104(4) applies to a trust, the trust will be taxable on its gains from the disposition of its taxable Canadian properties pursuant to clause (A). The actual disposition of the property subsequently should not pose any particular problems since the trust would have a stepped up adjusted cost base.
It is our opinion that a non-resident discretionary trust would be taxable on a gain arising from the deemed disposition of trust property under subsection 104(4) of the Act where the property owned by the trust would not qualify as excluded property as this term is defined in subsection 108(1) of the Act.
This provision generally brings into the income of the trust the FAPI of any foreign affiliates of the trust. Subsection 104(4) does not seem relevant in the computation of the FAPI of the affiliates of the trust.
QUESTION 3 - Immigration and section 128.1
a) Does the Department agree with the comments on immigration and emigration set out in your letter to the effect that the non-resident trust will be deemed, pursuant to paragraph 128.1(1)(b), to have disposed of each property owned by it immediately before becoming resident of Canada for proceeds equal to their fair market value? This would give rise to FAPI that would be subject to tax in the hands of the trust in accordance subparagraph 94(1)(c)(i).
b) You state that the new section 128.1 appears to tax gains accrued on foreign property of non-resident trusts at the time they take up Canadian residence and appear to be much harsher than would be the case for an individual or corporate immigrant unless the deemed disposition rules do not extend to foreign property. In addition, the broader scope of subsection 128.1(4) appears unfair to the extent a taxpayer may have immigrated as an income beneficiary and received no cost basis for the value of the income interest at that time. Are the above results intended and are there specific policy objectives behind the changes behind proposed paragraph 128.1(1)(b) and 128.1(4) other than those outlined in the technical notes?
We agree with your interpretation in paragraph 4, page 4 of your March 16th letter. Subsection 128.1(1) applies for the purposes of the Act and generally deems a taxpayer who is a trust and who becomes a resident of Canada to have disposed of each property owned by him at that time for proceeds equal to the fair market value of the property. This should generally not give rise to any taxable income in the hands of a trust for the purposes of clause 94(1)(c)(i)(A) because the deeming rule does not apply to taxable Canadian property pursuant to subparagraph 128.1(4)(b)(i). Other exceptions are also provided in subparagraphs (ii) to (v). However, any property of the trust that does not fall within one of the exceptions would be deemed to have been disposed of by the trust and this could lead to the inclusion of an amount pursuant to clause 94(1)(c)(i)(B), since FAPI includes an affiliate's taxable capital gains. In addition, the deemed disposition of property by a non resident trust as a result of subsection 128.1(1) applying could give rise to capital gains for the trust that could be attributed to the transferor of the property in accordance with subsection 75(2).
Your query concerning this issue relates to the possible emigration of an income beneficiary of a trust as defined in subsection 108(1) of the Act. In particular you suggest that the tax implications of departure under the new subsection 128.1(4) are "much broader" than its predecessor, subsection 48(1), which dealt with only capital gains and losses.
We agree with your comments that subsection 128.1(4) does not limit the tax implications of ceasing to be a resident of Canada to capital gains and losses such that there is a deemed disposition by a beneficiary of an income interest in a trust on emigration and that the deemed disposition by the beneficiary will result in a full income inclusion equal to the fair market value of the income interest. New section 128.1 of the Act applies to all properties except the properties specifically excluded from such rules under paragraph 128.1(4)(b).
You mentioned that subsection 128.1(4) appears unfair to the extent that a taxpayer may have immigrated as an income beneficiary and received no cost basis for the value of the income interest at that time. We note that paragraph 128.1(1)(c) provides that a taxpayer who is deemed by virtue of paragraph 128.1(1)(b) to have disposed of a property immediately before becoming a resident of Canada for proceeds of disposition equal to its fair market value, shall be deemed to have reacquired the property at a cost equal to the proceeds of disposition. As such, the taxpayer will receive a cost basis equal to the deemed proceeds of disposition on immigration. However, should the taxpayer cease to reside in Canada, he will be deemed to have disposed of all his property (including as you have suggested his income interest in a trust). This we agree, would generally give rise to an income inclusion equal to the proceeds of disposition of the property pursuant to subsection 106(2), and no amount would be deductible pursuant to subsection 106(1) in respect of the amount so included pursuant to subsection 106(2) since the taxpayer's cost of his interest in the trust would be deemed nil by virtue of subsection 106(1.1). With respect to this specific tax consequence, we are not aware whether this result was intended or whether there was any specific policy objective behind the changes. Questions relating to the tax policy objectives should be directed to the Tax Policy Branch of the Department of Finance.
QUESTION 4 - Subsection 106(2): release or surrender of an income interest in a trust
If Mrs X were to give up her income interest in the trust without exercising her power to appoint, would the Department consider the conditions of IT-385R2, paragraph 9 were met such that the taxpayer would not be considered to have received any proceeds of disposition for purposes of subsection 106(2)?
It continues to be the Department's position that where a beneficiary gives up his income interest in a trust and does not direct in any manner who is entitled to receive the benefits, that the taxpayer would not be considered to have received any proceeds of disposition for purposes of subsection 106(2) as stated in IT-385R2 paragraph 9. It is not possible to confirm any tax consequences arising in a specific situation in the context of a technical interpretation.
We hope we have answered your questions. In closing, we would like to say that we sincerely regret the lengthy delay in responding. The delay was attributable to a number of factors, and especially to our workload, staff changes and the complexity of the issues raised.
The foregoing represents our general views with respect to the subject matter of your letter. The foregoing opinions are not rulings and in accordance with the guidelines set out in Information Circular 70-6R2 dated September 28, 1990 are not binding on Revenue Canada, Customs, Excise and Taxation.
Reorganizations and Foreign Division
Income Tax Rulings and
Policy and Legislation Branch
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