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:

1) Whether the fact that the trustee of a testamentary trust can encroach on the capital of the trust for the benefit of the deceased's children will cause the trust not to meet the definition of a pre-1972 spousal trust (as defined in subsection 108(1)).

2) Whether a preferred beneficiary election under paragraph 104(15)(b) in respect of an elected capital gain under 110.6(19) can be made by a pre-1972 spousal trust for preferred beneficiaries other than the beneficiary spouse in the case where the beneficiary spouse died in the year.

Position:

1) The trust will meet the definition of a pre-1972 spousal trust despite the fact that there is a power to encroach on the capital in favour of the deceased's children.

2) The preferred beneficiary election under paragraph 104(15)(b) is available to designate the elected taxable capital gain of the trust to the capital beneficiaries.

Reasons:

1) The other criteria in the definition are met and the trustee did not encroach on the capital of the trust for the benefit of the children prior to the beneficiary spouse's death.

2) Since the beneficiary spouse is not alive at the end of the year, paragraph 104(15)(a) does not apply. The elected taxable capital gain forms part of the accumulating income of the trust and at the end of the taxation year of the trust the children's right to one-third of that accumulating income has vested in them.

								February 28, 1996

	Surrey Taxation Centre			Trusts Section
	T3 Assessing					C.R. Bowen
	Unit 564-10					(613) 957-8585
	Tim Dubeau, Manager

	Attention:  Merian Smith
								952704

Pre-1972 Spousal Trust and Preferred Beneficiary Election

We are writing in reply to your facsimile dated October 12, 1995, and further to several telephone conversions (Smith/Bowen), wherein you requested our comments as to whether the trust (the "Trust") created under the will of the late XXXXXXXXXX meets the definition of a pre-1972 spousal trust in subsection 108(1) of the Income Tax Act (the "Act"). In addition, you asked whether the Trust could make a preferred beneficiary election for preferred beneficiaries other than the beneficiary spouse in respect of the capital gain that the Trust elected to report under subsection 110.6(19) of the Act. We apologize for the delay in responding to your letter.

A) Background

1) Pre-1972 spousal trust

XXXXXXXXXX

The accountant for the Trust indicated verbally that the trustee of the Trust never exercised his discretion to pay any capital to XXXXXXXXXX children (who are the capital beneficiaries of the Trust), nor did any of the children receive any income, capital or benefit from the Trust during XXXXXXXXXX lifetime. Therefore, it is the accountant's opinion that the Trust meets the definition of a pre-1972 spousal trust and the first deemed realization date of the Trust occurred on XXXXXXXXXX (pursuant to subparagraph 104(4)(a.1)(i) of the Act).

Upon reviewing the Will, an individual at the Vancouver Tax Services Office concluded (as supported by a statement in Canadian Tax Reporter quoted below) that the terms of the Trust do not meet the definition of a pre-1972 spousal trust since XXXXXXXXXX children could have received or obtained use of the trust capital before XXXXXXXXXX died if the trustee had exercised his discretion.

2) Preferred beneficiary election

Form 94-115 (Election to Report a Capital Gain on Property Owned by a Personal Trust at the end of February 22, 1994) was filed in the Trust's 1994 T3 trust income tax and information return (which has a December 31 year end) and the elected taxable capital gain was designated in equal shares by way of a preferred beneficiary election (pursuant to paragraph 104(15)(b) of the Act) to each of the XXXXXXXXXX. Since XXXXXXXXXX was alive on February 22, 1994, it is your opinion, based on comments received from an individual at Vancouver Tax Services Office, that XXXXXXXXXX is the only individual for whom a preferred beneficiary election could have been made.

B) The Wills

XXXXXXXXXX

The Will is silent as to the treatment of capital gains. In recent years, the Trust has had only one trustee.

XXXXXXXXXX

C) Literature

1) Pre-1972 spousal trust

Page 9 of the 1994 T3 Guide and Trust Return (the "1994 Trust Guide") describes a pre-1972 spousal trust as follows:

A pre-1972 spousal trust includes...a testamentary trust created before 1972...where only the beneficiary spouse: 1) was entitled to receive trust income; 2) received trust income; and 3) had the use of trust income....The trust will not qualify as a pre-1972 spousal trust if,... (during the relevant period), a person other than the beneficiary spouse received or otherwise got the benefit of trust income or capital.

The Technical Notes to the June 19, 1992 Notice of Ways and Means Motion issued by the Department of Finance provide the following comments on the definition of a pre-1972 spousal trust:

(throughout the relevant period)...the beneficiary spouse is required to be entitled to receive all the income of the trust that arose before the beneficiary spouse's death. In addition, a trust is no longer a pre-1972 spousal trust where a person other than the spouse received or otherwise obtained the benefit of the trust income or capital before the end of that period.

It should be noted that a trust may qualify as a pre-1972 spousal trust even where there is a condition such that beneficiaries other than the spouse may have access to the income or capital of the trust - for example, in the event that a beneficiary spouse remarries. In such a case, the trust would cease to be a pre-1972 spousal trust only in the event that the beneficiary spouse actually did remarry.

Page 495 of Taxation and Estate Planning (third edition) by Maurice Cullity and Catherine Brown states the following:

Under the new rules, pre-1972 spousal trusts will have their first deemed realization on the later of January 1, 1993 and the date of the spouse's death. Such trusts will include all spousal trusts created before 1972 as long as no person other than the spouse received or obtained the use of any of the income or capital of the trust. The category will also include inter vivos or testamentary trusts that do not qualify as spousal trusts because of the existence of a power to encroach on capital for persons other than the spouse as long as that power has not been exercised. If income or capital of such a trust, or of a spousal trust, created before 1972 has been distributed to someone other than the spouse, the first deemed disposition will occur on January 1, 1993.

In an article entitled "Deemed Realization of Trust Property: Proposed Amendments to the 21 Year Rule" by Tim Edgar appearing in Volume 11, 1992, of the Estates and Trusts Journal, page 220 thereof indicates that:

...it is important to note that a trust loses its status as a pre-1972 spousal trust only if someone other than the spouse actually obtains the benefit of the income or capital. Therefore, unlike a post-1971 spousal trust, the terms of a pre-1972 spousal trust do not have to preclude all other persons from obtaining the benefit of the income or capital during the lifetime of the spouse. A trust will qualify so long as the circumstances that would permit another person to use the income or capital do not occur during the relevant period. This condition for status as a pre-1972 spousal trust recognizes that the concept of a spousal trust was introduced in 1972 and, therefore, a trust created before that time could not have been drafted with the usual entitlement conditions in mind.

The above views are contrary to that expressed on page 13,514 of the Canadian Tax Reporter by CCH Canadian Limited:

Not all pre-1972 trusts created for the benefit of an individual's spouse will qualify as a pre-1972 spousal trust. For example, a trust under which the trustees have the power to encroach on capital for the benefit of the settlor's children will not qualify.

2) Preferred beneficiary election

As indicated on page 67 of the 1994 Trust Guide, personal trusts can elect to report a capital gain for property owned on February 22, 1994 pursuant to subsection 110.6(19) of the Act, if, among other things,

-the election results in an increase to the eligible taxable capital gains of the trust designated to an individual or individuals (pursuant to subsections 104(21) and (21.2) of the Act) who were beneficiaries of the trust on February 22, 1994... (pursuant to subparagraph 110.6(20)(b)(i) of the Act); or

-the election results in an increase in the amount a spousal trust can deduct as a capital gains exemption for its taxation year that includes February 22, 1994, whose beneficiary spouse has died during that taxation year (pursuant to subparagraph 110.6(20)(b)(ii) of the Act). (We note that while this capital gains exemption may have been available to the Trust, we have not provided any comments on this matter as none were requested.)

In addition, that page also states that "if the trust makes...a preferred beneficiary election, the increase in its net taxable capital gain can be designated to the relevant beneficiaries...by way of preferred beneficiary elections" (pursuant to subsections 104(14) and (15) of the Act).

D) Our Comments

1) Pre-1972 spousal trust

While the Will clearly provides the trustee with the power to encroach on the capital on behalf of the children before XXXXXXXXXX death, as long as that power was not exercised before January 1, 1993 and the children did not receive any income or capital of the Trust before that date (as confirmed by the representative), it is our opinion that the Trust meets the definition of a pre-1972 spousal trust. Our opinion is supported by 1) the above noted comments in the literature other than the Canadian Tax Reporter and 2) XXXXXXXXXX.

2) Preferred beneficiary election

As noted above, subparagraph 110.6(20)(b)(i) of the Act requires, among other things, that the election to report a capital gain under subsection 110.6(19) of the Act must result in an increase to the eligible taxable capital gains of the trust designated to an individual or individuals who were beneficiaries of the trust on February 22, 1994. A beneficiary under a trust includes a person beneficially interested therein (per subsection 108(1) of the Act) and beneficially interested is defined in subsection 248(25) of the Act to include a person who has any right whether immediate or future, whether absolute or contingent under a trust to receive any income or capital of the trust. In view of the fact that the trustee had the power to encroach on trust capital during XXXXXXXXXX lifetime for the benefit of his children, those children were beneficiaries under the Trust on February 22, 1994.

Had XXXXXXXXXX been alive at the end of the 1994 taxation year of the Trust, he would have been the only person for whom a preferred beneficiary election could have been made in respect of the elected taxable capital gain (pursuant to paragraph 104(15)(a) of the Act). However, as this was not the case, it is possible that a preferred beneficiary election under either paragraph 104(15)(b) or (c) of the Act may have been available to designate the elected taxable capital gain to the children of the late XXXXXXXXXX

In order for a particular preferred beneficiary of a trust to be able to elect on a share of the accumulating income of the trust which is greater than nil, that beneficiary must have an interest in the accumulating income of the trust for the particular taxation year. Where a trust document is silent with respect to the treatment of capital gains (as is the case in the Will), we consider that any capital gains accrue only to the benefit of the capital beneficiaries since the concept of "income" under trust law does not include capital gains. For the purposes of subsection 104(15) of the Act and pursuant to the definition of accumulating income contained in subsection 108(1) of the Act, income of a trust will include the taxable capital gains arising under subsection 110.6(19) of the Act. Where a trust reports an elected taxable capital gain in a particular taxation year and the right to the capital of a trust has vested in a preferred beneficiary at the end of that year, that beneficiary will be considered to have an interest in the accumulating income of the trust.

As the accumulating income of a trust is determined as at its taxation year end, it is our opinion that the relevant time at which to establish whether a preferred beneficiary's share of the accumulating income of a trust is dependant on the exercise or failure to exercise any discretionary power by any person should be at the end of the taxation year of the trust. Prior to XXXXXXXXXX death, his children's share of the accumulating income of the Trust was dependant on the exercise of the trustee's discretion to encroach on the trust capital. However, at the end of 1994, the children's share of the accumulating income of the Trust did not depend on the exercise of any discretionary power by any person since their right to one-third of the capital of the Trust had vested in them (pursuant to the terms of XXXXXXXXXX will). Since the children are a member of a class of beneficiaries each of whom is entitled to share equally in the elected capital gain (which forms part of the accumulating income of the Trust), a preferred beneficiary election under subparagraph 104(15)(b)(i) of the Act could be filed by the Trust and the XXXXXXXXXX children.

In summary, it is our opinion that the elected taxable capital gain reported in the Trust's 1994 income may be designated in equal shares by way of a preferred beneficiary election to the XXXXXXXXXX children of the late XXXXXXXXXX.

We trust that our comments are of assistance.

for Director
Manufacturing Industries,
Partnerships and Trusts Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

Attachment