13 March 1997 External T.I. 9531165 - ACCUMULATING INCOME - CAPITAL ENCROACHMENT

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:

Is accumulating income reduced by the amount of the taxable capital gain where a capital encroachment power is exercised and the property or substituted property is distributed to a beneficiary in the same year as the gain is realized?

Position: Yes.

Reasons:

The income of the trust for tax purposes includes the realized taxable capital gain. The exercise of the capital encroachment power in the same year in which the trust realizes a capital gain entitles the beneficiary to receive an amount of income for tax purposes. Thus, an amount up to the taxable capital gain is included in the income of the beneficiary and is deductible from the income of the trust. Accumulating income is reduced by the amount of the taxable capital gain which is payable to the beneficiary. See files: E58371 dated August 29, 1989, E52860 dated May 21, 1987.

A secondary issue brought out by this file is whether 104(6) & (13) and 107(2) can apply simultaneously to the same amount. It appears they can; see by analogy the amendments to 104(6)(b) re spousal trusts to deny a deduction re 104(4) deemed gains. Articles written concerning 107(5) presume that the gain follows the property that is distributed to the beneficiary.

XXXXXXXXXX 953116

Attention: XXXXXXXXXX

March 13, 1997

Dear Sirs:

Re: Accumulating Income and the Preferred Beneficiary Election

This is in reply to your letter dated November 28, 1995, concerning the meaning of "accumulating income" as defined in subsection 108(1) of the Income Tax Act (the "Act"). We apologize for the delay in responding to your letter.

In the scenario described in your letter, the following events occur in the same taxation year of the trust:

1.the trust sells a property, realizes a capital gain and acquires a replacement property, and

2.the trust exercises a capital encroachment power and a beneficiary of the trust receives property from the trust consisting of the replacement property and another property.

Our Comments

Although capital gains form part of income for tax purposes, generally they are not income for trust purposes and form part of trust capital. Nevertheless, in the scenario outlined above, it is our opinion that the beneficiary is required to include in income the amount of the capital encroachment to the extent of the taxable capital gain and the trust is entitled to deduct an equivalent amount in computing it's income. Thus, the accumulating income of the trust is reduced accordingly.

In your letter you refer to a letter (#9428005) written by this directorate in April, 1995, in which we had opined that "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." This letter continued by saying that both subsections cannot apply to the same "payment". After further consideration of the issue, the more precise term would have been that both subsections cannot apply to the same "amount" where the property that was the subject of an election under subsection 110.6(19) was distributed to a beneficiary. Thus, while a capital encroachment power in and by itself would not "flow through" a deemed gain, the distribution of the property that was the subject of the deemed gain would "flow through" the deemed gain. The result would be that the beneficiary would include in income, and the trust would deduct in computing income, an amount equal to the taxable capital gain of the trust. Where the fair market value of the property distributed exceeds the amount of the taxable capital gain, the difference would represent a capital distribution as comtemplated under subsection 107(2).

The above comments represent our general views on the subject matter of your letter. As indicated in paragraph 22 of Information Circular 70-6R3, this opinion is not a ruling and, accordingly, it is not binding on Revenue Canada.

Yours truly,

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