7 November 1995 Internal T.I. 9528117 - CAPITAL GAINS ELECTION & TRUSTS

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. Where a trust is "non-discretionary" and the residual beneficiaries are required to share equally in the capital & income of the trust, is a special provision required in the trust indenture to make the 110.6(19) deemed capital gain payable to the beneficiaries?

2. Where the 110.6(19) election has been filed with the return, but the 104(14) election has not, can the taxpayer avail themselves of proposed 104(14.01)?

Position:

1. Yes
2. No

Reasons:

1. A deemed gain is not recognized for trust law purposes, therefore, it cannot be payable to beneficiaries unless the trust indenture specifically legitimizes it for trust law purposes,(ie. contains as a term that "the trustee can pay out amounts equal to 'deemed gains' as defined under the Income Tax Act").

2. Any late election filed under proposed 104(14.01) must relate solely to the change in the capital gains election under either 110.6(25), 110.6(26) or 110.6(27).

November 7, 1995

Edmonton Tax Services Office Trusts Section
Estates and Trusts Section L. Holloway
(613) 987-2104
Attention: Albert Iacavone

952811
XXXXXXXXXX

This is in reply to your memorandum dated October 24, 1995, concerning the capital gains election of the XXXXXXXXXX and the ability of the trust to allocate a deemed capital gain to its residual beneficiaries.

Under subsection 104(21), a trust may designate that part of any amount included in a beneficiary's income by subsection 104(13) or 104(14) or section 105 as a distribution of net taxable capital gains of the trust. Generally speaking, this means that the taxable capital gain must be paid or payable to the beneficiary or must be the subject of a preferred beneficiary election. Under trust law capital gains would be considered to be part of the capital of a trust and their distribution would be prohibited other than as a capital encroachment. Where a trust either realizes a capital gain or a capital gain is deemed to be realized (for example under subsection 110.6(19)), the taxable amount of this gain cannot be paid or payable to a beneficiary and thereby be included in a beneficiary's income under subsection 104(13) unless the amount was received or made payable. Subsection 104(24) states that an amount is considered to have become payable to a beneficiary in the year only if it was paid to the beneficiary or if the beneficiary was entitled in that year to enforce payment of the amount. The word "entitled" as used in subsection 104(24) refers to legal entitlement as would be dictated by the terms of a trust indenture. It is not possible to define a deemed capital gain to be income (or a capital gain) for trust purposes. It is a "nothing" for trust law purposes. As a deemed capital gain is not recognized as a capital gain for trust purposes, in order to have an amount payable for purposes of subsection 104(24), the terms of the trust must specifically permit an amount equivalent to the deemed capital gain to be paid or payable, or the trustees must have the discretionary power to pay out amounts that are defined as income under the Act.

XXXXXXXXXX

We maintain that unless the terms of the trust "legitimize" the deemed gain for trust purposes, the deemed gain could not be made payable as it is not recognized for trust purposes. This statement would apply to both discretionary and non-discretionary trusts.

Where a trust indenture is not specific enough to allow for amounts to be paid or payable under subsection 104(13), it may be possible to flow out the deemed gain under subsection 104(14). In order for a particular preferred beneficiary to be able to elect on a share of the accumulating income of the trust which is greater than nil, that particular preferred beneficiary must be an income beneficiary for that particular taxation year. For the purposes of subsection 104(15) and pursuant to the definition of accumulating income contained in subsection 108(1), income is computed pursuant to the provisions of section 3 and as a consequence will generally include taxable capital gains. Under trust law "income" does not normally include capital gains. Where the trust document is silent with respect to the treatment of capital gains, we would consider any taxable capital gain to accrue only to the benefit of the capital beneficiaries. In such a case, the capital beneficiaries (as income beneficiaries for tax purposes with respect to the taxable capital gains) together with the trust would be entitled to make preferred beneficiary elections for an amount not exceeding their share of the taxable capital gains of the trust pursuant to paragraph 104(15)(b).

With respect to the Estate of XXXXXXXXXX we agree with the observation made in your letter of September 26, 1995, to the trust's representative that the deemed taxable capital gain could not be made payable under subsection 104(13). However, allocations to the children of the deceased were available through the preferred beneficiary election. As members of a class of beneficiaries whose right to the capital of the trust had vested and each of whom shares equally in any capital gains forming part of accumulating income, the amount of the deemed gain that could have been allocated would be computed under subparagraph 104(15)(b)(i). In this case, however, late preferred beneficiary elections should only be permitted if the taxpayers apply to the Minister under subsection 220(3.2). Proposed subsection 104(14.01) is not applicable in this case as the sole reason for filing a late, amended, or revoked preferred beneficiary election is not to accompany changes brought about by a subsection 110.6(25), (26), or (27) (late, amended, or revoked) capital gain election. A preferred beneficiary election will be deemed to be filed on time where it is a direct result of and filed with a "valid late-filed capital gains election" (see page 8, item 9. of Verifications & Collections directive # ARD-95-02).

T. Murphy
A/Section Chief
Trusts Section
Manufacturing Industries, Partnerships
and Trusts Division
Income Tax Rulings and Interpretations Directorate
Policy and Legislation Branch