24 February 1995 External T.I. 9428005 - TRUST & CAPITAL GAINS EXEMPTION

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.

		942800
XXXXXXXXXX		L. Holloway
(613) 957-8953
Attention:  XXXXXXXXXX

February 24, 1995

Dear Sirs:

Re: Subsections 104(13) and 104(21.2) of the Income Tax Act (the "Act")

This is in reply to your letter of October 25, 1994, requesting our comments on the meaning of the word "payable" as found in subsection 104(13) of the Act and in particular where a beneficiary of a trust is attempting to utilize his capital gains exemption with respect to unrealized capital gains on property held by the trust on February 22, 1994.

Specifically you had asked whether we agreed with your interpretation of the tax consequences of the following hypothetical example. All subsequent references to sections and parts therein are references to the Act.

Scenario

During the taxation year of a trust that includes the taxation year in which the trust has elected to recognize taxable capital gains pursuant to proposed subsection 110.6(19), the trustee of the trust exercises a discretionary capital encroachment power to distribute the property on which the deemed taxable capital gain had occurred to the beneficiaries of the trust. In your opinion, as this distribution would represent a distribution of capital of the trust pursuant to subsection 107(2), it follows that the deemed taxable capital gain was paid in the particular year to the beneficiary. Accordingly you were of the opinion that subsection 104(13) applied in such circumstances and thus the designation under subsections 104(21) and (21.2) could be made by the trust.

Our Comments

Where a power to encroach on capital has been exercised in favour of a capital beneficiary, the facts of the particular case will determine whether the distribution is being made under subsections 104(24), (13), and (6) or whether an amount is being paid out in partial satisfaction of a beneficiary's capital interest in the trust, in which case subsection 107(2) would be applicable. However, both subsections cannot apply to the same payment.

It is our understanding that "phantom income" such as that which is created by an election under subsection 110.6(19) cannot be defined as income for trust law purposes. However, such amounts will be paid or payable within the meaning of subsections 104(24),(13) and (6) 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, even if under trust law the payments are out of capital.

It should be noted that in order for a designation to be made under subsections 104(21) and (21.2) 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. In addition, the trustee resolution authorizing the payment should make it clear that the distribution is in payment of the amount of the deemed capital gain and not in partial satisfaction of a beneficiary's capital interest in the trust.

We trust that these comments will be of assistance.

Yours truly,

Section Chief
Trusts Section
Rulings Directorate
Legislation and Policy Branch