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.
942534
XXXXXXXXXX L. Holloway
(613) 957-8953
Attention: XXXXXXXXXX
February 24, 1995
Dear Sirs:
Re: Capital Gains Exemption and Trusts - Proposed Subsection 110.6(19) of the Income Tax Act (the "Act")
This is in reply to your letter dated September 26, 1994, in which you pose several questions concerning the operation of proposed subsection 110.6(19) of Bill C-59 and the meaning of the word "payable" for purposes of subsections 104(6) and 104(13) of the Act. In particular your letter presented the three following hypothetical scenarios for our comments. All references to sections or parts thereof that follow are references to the Act.
You have assumed for all scenarios that there are two Canadian resident individuals, A and B who are the only beneficiaries of a trust. The trust is fully discretionary with respect to distributions of trust income and the trustee has a discretionary power to encroach upon the capital of the trust for the benefit of the beneficiaries. The trust is not able to make a Preferred Beneficiary Election.
Scenario 1.
Assume the trust has only two assets: $1,000 of cash, and a $10,000 5-year guaranteed investment certificate that earns interest at 10%. The interest on the GIC is compounded and is not paid until the certificate matures at the end of the 5 years.
During the first year $1,000 of interest accrues on the GIC and is required to be included in the trust's income for that year. During the year the trust pays its $1,000 of cash to beneficiary A. The trustees' resolution authorizing the payment refers to this as a distribution of the trust's income, not a capital distribution.
You have asked if the $1,000 payment represents income of the trust for the year which became payable in the year to a beneficiary, and if so, is the trust therefore entitled to a $1,000 deduction under paragraph 104(6)(b) in computing its income for the year?
Alternatively, you asked if it is it the Department's view that since the trust did not actually receive the interest income it is impossible that it paid the income to a beneficiary?
Scenario 2.
Assume the same situation as above except the trust's only asset is now the GIC. It has no cash.
Prior to the end of the year the trustees resolve to distribute the $1,000 of interest income to beneficiary A. In conjunction with that resolution the trustees issue to beneficiary A a promissory note in the amount of $1,000 which is payable upon demand and bears no interest.
You questioned if it is the Department's view that by passing the above resolution and issuing the promissory note the trust's income for the year has become payable to beneficiary A and the trust is entitled to deduct $1,000 pursuant to paragraph 104(6)(b).
Scenario 3.
Assume that the trust's only assets are units of a mutual fund trust that have an unrealized capital gain as at February 22, 1994 of $10,000. The trustees make an election under proposed subsection 110.6(19) which causes the trust to realize the $10,000 capital gain in 1994.
Prior to December 31, 1994, the trustees resolve to issue non-interest bearing, demand promissory notes in the amount of $5,000 to each of beneficiary A and B. This is done with the intention of allocating the capital gain out of the trust and causing it to be included in the income of the beneficiaries.
Would the trust be entitled to a $10,000 deduction under paragraph 104(6)(b) on the basis that this much of its income for the year became payable, since the election is effective for tax purposes only?
Would it make any difference if the trust indenture defined "income" for purposes of the trust as income calculated in accordance with the Act?
It is our understanding that "phantom income" such as that which is created by an election under subsection 110.6(19) or that which arises on the accrual of interest receivable cannot be defined as income for trust law purposes. However, such amounts will be paid or payable within the meaning of subsection 104(24) if the terms of the trust specifically require such amounts to be paid or payable, or the trustee has sufficient discretion to make such amounts paid or payable.
Scenario 1
If the terms of the trust provide that the amount, or part thereof, of accrued interest receivable must or may be paid to the beneficiaries by virtue of the exercise of the capital encroachment power, then such amounts will be considered payable within the meaning of subsections 104(24),(13) and (6).
Scenarios 2 and 3
The issuance of a promissory note does not itself create a debt. Rather, a promissory note is given and received as acknowledgement of the existence of a debt and/or as conditional payment of debt. A trustee cannot create a right of entitlement to any trust property in favour of any beneficiary unless the terms of the trust allows or requires him to do so. In order for an amount to be payable within the meaning of subsections 104(24),(13) and (6) the beneficiary must be "entitled to enforce payment" of the deemed capital gain. Therefore the terms of the trust must allow or require payment of the deemed capital gain to the beneficiary. A promissory note can be given to the beneficiary as evidence of the amount that had become payable.
It should be noted that in order for a designation to be made under subsections 104(21) it must be with respect to such portion of the net taxable capital gains as "may reasonably be considered (having regard to all the circumstances including the terms and conditions of the trust arrangement) to be part of the amount that by virtue of subsection (13) or (14) or section 105, as the case may be, was included in computing the income...".
Consequently, in order to remove any uncertainty as to the validity of a designation pursuant to subsections 104(21) and (21.2) vis à vis a deemed taxable capital gain triggered by an election pursuant to subsection 110.6(19), the trust indenture should provide specifically for the discretionary or non-discretionary payment of deemed capital gains.
We trust that these comments will be of assistance.
Yours truly,
Section Chief
Trusts Section
Rulings Directorate
Legislation and Policy Branch
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