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.
April 3, 1996
Regina Tax Services Office Trusts Section
J. Flett L. Holloway
Chief of Audit (613) 957-2104
Attention: Brenda McEachern
Business Audit
952293
Disposition of an Income Interest in a Trust
This is in reply to your memorandums dated August 4, 1995, and November 2, 1995, concerning the administration of the estate of the late XXXXXXXXXX. We apologize for the delay in our response. In particular, you requested that we examine if the actions undertaken by the trustee would result in the application of subsections 106(2) and 107(4) of the Income Tax Act (the "Act"). All references herein to sections or components thereof will be to the Act unless otherwise indicated. The following specific questions were posed:
1) Do the circumstances in this situation result in a disposition of an income interest per subsection 106(2), and
2) Will the actions of XXXXXXXXXX be considered to be a valid disclaimer?
The facts of the case presented in your memorandums ensue:
Facts
1) Relationships of the individuals involved
XXXXXXXXXX, deceased
XXXXXXXXXX, husband of the deceased
XXXXXXXXXX, son
XXXXXXXXXX, daughter
XXXXXXXXXX, daughter
XXXXXXXXXX, daughter
XXXXXXXXXX, daughter
XXXXXXXXXX, son-in-law
XXXXXXXXXX, son-in-law
2) XXXXXXXXXX died testate on XXXXXXXXXX. A valid will was signed on XXXXXXXXXX. No codicils or variations were subsequently prepared.
3) Under the terms of XXXXXXXXXX Last Will and Testament (the "Will"), XXXXXXXXXX was appointed Executor and Trustee. In the event that he was either unwilling or unable to act, the deceased directed that her son, XXXXXXXXXX, was to be appointed.
4) A spouse trust as defined in subsection 70(6) is created by Paragraph XXXXXXXXXX of the Will. It reads:
"XXXXXXXXXX."
5) The trustee's roles and responsibilities are outlined in Paragraph XXXXXXXXXX of the Will as follows:
"XXXXXXXXXX."
6) XXXXXXXXXX advised that he and his wife had received legal advice when the Will was prepared. XXXXXXXXXX was advised against immediate distribution to the children on her death in order to allow control of the family business (XXXXXXXXXX) to remain with XXXXXXXXXX. The Will was revised to accomplish this.
7) Probate of the estate was not required. A listing of assets at the date of death was provided to the Department.
8) Testamentary debts were paid from the estate account.
9) A formal written disclaimer was not executed by XXXXXXXXXX in his capacity as income beneficiary.
10) A partial distribution of the estate's cash and assets has been completed. XXXXXXXXXX, in his capacity as executor transferred an equal portion of the deceased's assets to each of the children. The transfers were based on independent appraisals obtained in determining the fair market value of the assets at XXXXXXXXXX date of death. No assets were transferred to XXXXXXXXXX. The following events have occurred in the administration of the estate:
a) Stock portfolios and bonds were converted to cash.
b) CCPC Shares:
i) The XXXXXXXXXX . shares were transferred to XXXXXXXXXX .
ii) The one share of XXXXXXXXXX was transferred on XXXXXXXXXX , IN TRUST for the following persons for the indicated fraction of one share:
TRANSFEREE FRACTION OF SHARE
XXXXXXXXXX
iii) The XXXXXXXXXX shares were transferred to the children on XXXXXXXXXX.
c) A term deposit of $XXXXXXXXXX and a savings account of approximately $XXXXXXXXXX remains undistributed in the Estate Account.
11) T3 Trust returns have been filed for the taxation years ending XXXXXXXXXX. Income reported on these returns has been taxed in the trust using a subsection 104(13.1) designation. The first year of the trust includes farming income for the period XXXXXXXXXX. The farmland and farm machinery was joint property of XXXXXXXXXX. Income after her date of death belongs solely to XXXXXXXXXX. A subsection 70(6.2) election was filed with respect to this property.
12) XXXXXXXXXX acts in a dual capacity relating to the estate. He is an income beneficiary under the terms of the Will and is the executor and trustee until his death. His roles must be clearly defined and his actions must be in his capacity as a beneficiary or as an executor.
13) Other events which have subsequently occurred:
XXXXXXXXXX transferred its shares back to XXXXXXXXXX for fair market value.
XXXXXXXXXX purchased XXXXXXXXXX shares of XXXXXXXXXX from XXXXXXXXXX for $XXXXXXXXXX in cash. This event has resulted in a deemed dividend being payable to XXXXXXXXXX. A request to grant a retroactive section 85 election was received on XXXXXXXXXX. This request will not be allowed.
Regina District Office Position
Once a spouse trust has been created, it remains a spouse trust regardless of whether the terms are varied (IT-305R3, Paragraph 7). Subsection 106(2) will apply unless a valid disclaimer has been executed. The Department's position is that a disclaimer is an outright refusal to accept a gift, share or interest under a will, with no stipulation as to how the disclaimed property should be distributed (IT-305R3). It is your position that XXXXXXXXXX did not execute a valid disclaimer as income beneficiary and, as a result, has disposed of his income interest in the trust.
The distribution of the trust assets to the children while the spouse is alive will also result in a disposition of the property of the trust and of the capital interests in the trust under subsection 107(4). As an election under subsection 70(6.2) was made on the terminal return, this will have minimal tax implications to the trust.
Taxpayer's Position
XXXXXXXXXX position was that he did consult his lawyer and his accountant. Both gave him the advice to distribute the assets to his children. XXXXXXXXXX stated that the Will did not create a spouse trust and that Paragraph XXXXXXXXXX of the Will gave him as the executor the absolute authority to dispose of and distribute the assets as he saw fit. XXXXXXXXXX is not contending that he executed a valid disclaimer. His position is that no disclaimer was required, as he had absolute discretion as executor.
We agree with your opinion that XXXXXXXXXX did not execute a formal disclaimer of his income interest in the trust. We also agree with your opinion that the trust is in fact a spousal trust. We do not share XXXXXXXXXX view that Paragraph XXXXXXXXXX of the Will empowers him as trustee to distribute the assets when he pleased. Paragraph XXXXXXXXXX of the Will gives the trustee the powers of conversion, retention, and investment of the trust's assets it does not empower the trustee to distribute the assets to the capital beneficiaries before the income beneficiary's date of death.
As we are of the opinion that the trust is a spousal trust which was not formally varied before the assets were distributed, we must then ask the question if the distribution was illegal. However, the distribution cannot be ignored for tax purposes, whether or not it was made legally. This opinion is supported by various cases (ie. Minister of Finance v. Smith, (1927) A.C. 193, 1 DTC 92; Mann v. Nash, (1932) 1 K.B. 752, Lindsay et al. v. C.I.R., (1932) see also The Queen v. Fred E. Poynton 72 DTC 6329;) dealing mainly with the taxing of illegal profits. While these cases did not deal with dispositions made illegally, by inference the disposition in this case should not be ignored even if the trustee had no authority to distribute. In fact, in Steven Cooper v. The Queen, 88 DTC 6525, the following comments were made by Judge J. Rouleau:
"A well established principle of income tax law states that the illegality (if any) of actions of the taxpayer, in this case the payment of the Plaintiff in relation to the terms of the trust, is irrelevant in the assessment of tax liability.... The Minister has no interest in the proper administration of trust funds. This is the function of the provincial court system, more particularly in this case the Probate Court, and any questions regarding the propriety of the actions of Mr. Cooper and his mother as trustees should be raised in that forum alone."
Where a trustee has breached the terms of a trust, it is the beneficiaries that must seek remedy if they so desire. In this case, as the interests of the capital beneficiaries have been accelerated, it is only the income beneficiary who could object to such a distribution, and as XXXXXXXXXX is the sole income beneficiary, he would not object to his own decision in his capacity as executor.
We have previously dealt with cases whereby capital beneficiaries, otherwise entitled to distributions of capital only upon the death of an income beneficiary, have had their capital interests accelerated to a date preceding the income beneficiary's death. The Department's position is set out in paragraphs 8 and 9 of IT-385R2, "Disposition of an Income Interest in a Trust". These paragraphs state:
"8. Where a taxpayer formally releases or surrenders all or any part of an income interest in a particular trust in respect of future payments (amounts not due and payable at the time of the release or surrender) in favour of one or more other persons, the taxpayer will be deemed, by virtue of paragraph 69(1)(b), to have received proceeds of disposition equal to the fair market value at the time of the release or surrender of the income interest released or surrendered and must include that amount in income pursuant to subsection 106(2). It should be noted that paragraph 248(8)(c) does not apply to an income interest that arises upon the death of the deceased since such an interest could not have been property of the deceased immediately before death.
9. A taxpayer who for no consideration validly releases or surrenders an income interest in a trust in respect of future payments (not due and payable at the time the release or surrender is executed) and does not direct in any manner who is entitled to receive the benefits, will not be considered to have received any proceeds of disposition for the purposes of subsection 106(2). The result will be the same if the taxpayer designates or otherwise agrees which person or persons will benefit by reason of the release or surrender, if the same person or persons would be entitled to benefit in the same way under the trust without the taxpayer's designation or agreement. However, the attribution rules of subsections 74.1(1) and (2) are considered to apply if the person or persons who benefit under the terms of the trust as a consequence of the release or surrender are persons described in those subsections."
It is our opinion that XXXXXXXXXX actions should be treated as a valid partial release or surrender of his income interest in the trust. Therefore, he would not be considered to have received proceeds of disposition for the purposes of subsection 106(2). Subsection 107(4) will apply to all distributions from the trust prior to XXXXXXXXXX death.
XXXXXXXXXX
Conclusion
XXXXXXXXXX
As we are in agreement with your conclusion that this is in fact a spousal trust we suggest you proceed on the basis that subsection 107(4) would be applicable to the distributions to the children from the trust. Any income earned on assets remaining in the estate would be payable to XXXXXXXXXX under the existing terms of the trust and therefore taxable to him under subsection 104(13) unless a designation under subsection 104(13.1) were made by the trust.
T. Murphy
A/Section Chief
Resources, Partnerships and Trusts Division
Income Tax Rulings and Interpretations Directorate
Policy and Legislation Branch
Attachment
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