20 June 1994 Internal T.I. 9409396 - SCHOLARSHIP PAID OUT OF A 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.

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.

Principal Issues:

Are scholarships paid out of a trust deductible under s.s. 104(6) of the Act? Are the amounts taxable under 56(1)(n) or 104(13)?

Position TAKEN:

	If the amounts are paid as scholarships for the benefit of the general public, the amounts are deductible under 	paragraph 104(6)(b) and the recipients are taxable under paragraph 56(1)(n) as the amounts were received as or on account of a scholarship and not under any other claim or right; the recipients are entitled to the $500 exemption.  If paid only for the benefit of the settlor and his family, the amounts are deductible under 104(6)(b) but are taxable for the recipients under 104(13), not as scholarships under 56(1)(n); the recipients are not entitled to the $500 exemption.

Reasons FOR POSITION TAKEN:

The net income paid by the trust to the recipients is deductible whether or not it is paid as or on account of a scholarship or as trust income. On the other hand, if the amount is received by the recipient as or on account of a scholarship, the amount is taxable under par. 56(1)(n). However, if it is received as trust income, it is taxable under s.s. 104(13).

							June 20, 1994

	Assessment of Returns Directorate	HEAD OFFICE
	T2 and T3 Programs Division		Rulings Directorate
							Alain Marchand
	Attention:  Mr. W.A. Mizuik 		957-8953
	            Chief
            T3 Programs Section
							7-940939

Scholarship Paid Out of a Trust

This is in reply to your memorandum dated April 12, 1994, following a letter from XXXXXXXXXX, requesting clarification on three different trust agreements, all of which in varying ways provide that funds from a trust be used directly or indirectly for the payment of scholarships or bursaries.

Facts:

The first agreement provides that the net income of the trust be paid to a specified University to be applied by the University for the payment of scholarships or bursaries.

The second agreement deals with an irrevocable inter vivos trust established to provide scholarship payments to beneficiaries who are children, grandchildren or great-grandchildren of the settlor.

The third trust was set up in accordance with the terms of the will of the deceased, ten years after the death of the deceased. The net income from the residue is to be used in perpetuity to provide scholarships to individuals to be identified each year by the trustee.

Questions:

The following questions were raised by XXXXXXXXXX for each trust:

-Should a T3 Supplementary be issued to the beneficiaries in any situation (in the first situation, T4A to the University)?

-Can a deduction be claimed by the trust for the amount of the scholarships paid, and if so, on what basis?

Furthermore, you raised the following questions:

-Can a scholarship paid out of a trust be brought into the income of the recipient as scholarship income to be eligible for the $500 deduction and be eligible for a deduction under subsection 104(6) of the Income Tax Act (the Act)?

-If, at a later date, the amount is paid out of the capital of the trust, is the amount taxed in the recipient's hands as a scholarship without a corresponding deduction for the trust?

-What factors must be considered to determine whether an amount qualifies as a scholarship to the recipient?

Our Comments:

The general rules concerning the deduction in computing income of a trust is that an amount may be deducted by a trust provided that it "became payable in the year to a beneficiary or was included under subsection 105(2) in computing the income of a beneficiary". If this condition is not met, no amount is deducted by the trust under subsection 104(6) of the Act.

As you mentioned in your memorandum, the Department's policy on amounts received from a trust is outlined in paragraph 36 of Interpretation Bulletin IT-75R3. In such a situation, the recipient receiving scholarship, fellowship, bursary, etc... must include the amount in his/her income under paragraph 56(1)(n) or (o) of the Act, rather than as income from a trust under subsection 104(13) or 105(1) and, he/she is entitled to the $500 exemption. However, the Bulletin does not deal with the deduction of amounts paid out by a trust.

In respect of the first situation, the amounts paid by trust A to the University as scholarships for the students selected will be deductible by the trust under paragraph 104(6)(b) of the Act. On the other hand, the recipient will be taxable on the scholarship received from the trust under paragraph 56(1)(n) and not under subsection 104(13) because the amount is received by him/her as or on account of a scholarship, not as trust income. Furthermore, the trust has to file a T3 return and the amounts paid to students must be reported on T4As by the trust.

In the second situation, the trust has been formed only for the benefit of the settlor and his family, not for the benefit of the general public in the way a charity operates for the public benefit. The children, grandchildren and great-grandchildren are all beneficiaries entitled to trust income of the trust as income to be used for post secondary education, not as scholarships under paragraph 56(1)(n) of the Act. The mere use of the word "scholarship" does not create scholarship.

In delivering the judgment of the House of Lords in Commissioners of Inland Revenue v. Wesleyan and General Assurance Society (1948), 30 T.C. 11, Viscount Simon said at page 25:

"It may be well to repeat two propositions which are well established in the application of the law relating to Income Tax. First, the name given to a transaction by the parties concerned does not necessarily decide the nature of the transaction. To call a payment a loan if it is really an annuity does not assist the taxpayer, any more than to call an item a capital payment would prevent it from being regarded as an income payment if that is its true nature. The question always is what is the real character of the payment, not what the parties call it".

As a result, the beneficiaries would be taxable under subsection 104(13) of the Act and would not be entitled to the $500 exemption. However, the amounts paid out of the trust to the beneficiaries are deductible under paragraph 104(6)(b) of the Act. The trust has to file a T3 return as well as T3 Supplementary forms to report the trust income paid to beneficiaries.

In the third situation, the fact that the funds of the trust might be used to establish scholarships only at the end of ten years from the date of death of the settlor does not change the rules that may apply. In such a case, our comments in respect of the first situation apply.

In response to your first question, it is our view that an amount can be both brought into the income of the recipient as scholarship income eligible for the $500 exemption and be eligible for a deduction under subsection 104(6) of the Act by the trust. As mentioned above, an amount will be included in the income of the recipient under paragraph 56(1)(n) of the Act if it is "an amount received by him as or on account of a scholarship, fellowship or bursary ...". The fact that it is taxed under 56(1)(n) does not affect the deduction by the trust.

With regard to the amounts paid out of the capital of the trust, we offer you the following comments. In situations similar to the first and third agreements, if the amounts are paid out of the capital of the trust, the trust is not entitled to a deduction under paragraph 104(6)(b) of the Act as this is a distribution of capital. However, the recipients of the capital are taxable under paragraph 56(1)(n) of the Act because they receive it as scholarship. On the other hand, in a situation similar to the second agreement, the trust is not entitled to get a deduction in computing its income as this is a distribution of capital. Furthermore, the beneficiaries are not taxable under paragraph 56(1)(n) of the Act as the amounts were not received by him/her "as or on account of a scholarship", but as capital distribution under subsection 107(2) of the Act.

Concerning your last point, in order to decide whether or not an amount qualifies as a scholarship to the recipient, it is important to determine if an amount was received by the recipient as or on account of a scholarship and not under any other claim or right. If it meets this criterion, it qualifies as a scholarship under paragraph 56(1)(n) of the Act. "Scholarship" is not defined in the Act. However, paragraph 5 of Interpretation Bulletin IT-75R3 says that "scholarships and bursaries are amounts paid or benefits given to students to enable them to pursue their education." It also mentions that "normally, a student is not expected to do specific work for the payer in exchange for a scholarship or bursary."

Should you need additional information, please do not hesitate to call the author.

Acting Section Chief
Manufacturing Industries, Partnerships
and Trusts Section
Manufacturing Industries, Partnerships
and Trusts Division
Rulings Directorate