23 February 1998 External T.I. 9629675 - TWENTY -ONE YEAR RULE AND 94(1)

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: applicability of 104(4) to foreign trust

Position: a104(4) applicable for purposes of computing amt. determined under clause 94(1)(c)

Reasons: confirmed by dept of finance

XXXXXXXXXX 							L. Holloway
								962967
Attention:XXXXXXXXXX 

February 23, 1998

Dear Mesdames:

Re: Technical Interpretation Request - Subsections 104(4) and 94(1) of the Income Tax Act (the “Act”)

This is in response to your letter of September 3, 1996 requesting a technical interpretation on the operation of subsections 104(4) and 94(1) to a non-resident trust. The scenario outlined in your letter appears to be an actual fact situation and written confirmation of the tax implications inherent in factual circumstances should be addressed to your local Tax Services Office. Consequently, we offer you general comments on a generic scenario as follows:

Mrs. X, while a citizen and resident of the U.S. settled a Trust in the late 1960's. Under the Trust terms, Mrs. X is entitled to all income during her lifetime and the Trustee (a U.S. Trust company) has the discretion to pay out capital gains taxes imposed on Mrs. X with respect to trust property. Mrs. X has retained a power to appoint the capital of the trust upon her death by Will. Failing appointment, the Trust is to continue as a discretionary trust in favour of the issue of the settlor. Upon termination of the Trust, the property then remaining is to be transferred to her issue or, if none, to a U.S. charity. Mrs. X became a resident of Canada in the mid-1980's and has resided in Canada for more than 60 months. The assets of the Trust, since inception, have consisted of U.S. marketable securities which are publicly traded and situated in the U.S.

Specifically you have asked whether the Trust would be subject to the deemed disposition rule in subsection 104(4) and if so whether the 21-year period commences as of January 1, 1972 or on the date Mrs. X became a resident of Canada.

Your Comments

Your letter makes several statements on the applicability of specific sections of the Act in a situation similar to the one described above. You state that where a settlor retains a power of appointment, the trust, if resident in Canada, would be subject to subsection 75(2). Where a discretionary trust with a Canadian resident beneficiary is deemed to be resident in Canada under subparagraph 94(1)(c)(i) you submit that it's foreign accrual property income "at most would include capital gains from actual dispositions of property under Section B of Subsection 95(1) and not capital gains on deemed dispositions." You maintain that the deemed disposition rules in subsection 104(4) should not be applied to the Trust even though it appears to be deemed to be resident in Canada under subparagraph 94(1)(c)(i).

Lastly, you comment that on the death of the Canadian resident beneficiary, U.S. estate tax will be payable in respect of the assets of the Trust. If assets were owned by the beneficiary personally, then under the new Protocol to Canada-U.S. Tax Convention, a credit would be available with respect to U.S. estate tax paid against capital gains tax payable on the death of the person in Canada. As the Protocol does not appear to allow a credit, however, for tax claimed by Canada on a deemed disposition prior to the death of a beneficiary of the Trust against U.S. estate tax payable on the death of the beneficiary, this could result in double taxation.

Our Comments

Deemed dispositions are generally treated in the same manner as actual dispositions for purposes of the Act. We acknowledge that it may not be clear whether the 21-year deemed disposition rule in subsection 104(4) (the "21-year rule") could apply pursuant to clause 94(1)(c)(i)(B) read with paragraph 94(1)(d) with respect to assets of a discretionary trust that are not taxable Canadian property. However, in two prior technical interpretations we opined that subsection 104(4) would apply in such situations. In this respect, the Department of Finance confirmed that the policy intent is that the 21-year rule apply for purposes of computing the amount determined under clause 94(1)(c)(i)(B).

With respect to your comment on subsection 75(2), we note that the residency of the trust is not relevant for purposes of that provision. Thus, as an additional complicating factor in the scenario described above, subsection 75(2) is also applicable. In our opinion, given the wording in paragraphs 94(2)(a) and 94(5)(a), subsection 75(2) takes precedence over subsection 94(1).

A discretionary trust which is not resident in Canada would be deemed by paragraph 94(1)(c) to be a person resident in Canada on the first day of the first taxation year of the trust during which the criteria in paragraphs 94(1)(a) and (b) are met. However, the 21-year period for purposes of the 21-year rule commences as of the date applicable in subsection 104(4) and not on the date the trust is deemed to become resident in Canada. Hence, in circumstances similar to the one above, the 21-year period would commence on January 1, 1972. The cost of the property held by the trust would be determined as set out in subsection 128.1(1) or subsection 48(3), whichever is applicable.

In response to your concerns about possible double taxation under the new Protocol to the Canada-U.S. Convention, our comments are as follows. In a year where subsection 104(4) applies, the Trust would be deemed to dispose of all of its property at fair market value. Any income or gains so earned or realized by the Trust would be attributed to Mrs. X pursuant to subsection 75(2). In a case where Mrs. X dies in a year subsequent to the application of the 21-year rule, any U.S. estate taxes payable as a consequence of the death of Mrs. X on property held by the Trust would not be creditable under paragraph 6 of Article XXIX B of the Convention against the Canadian federal income tax paid by Mrs. X for the year in which the 21-year rule applied. This is so because the Canadian federal income tax for the year of the application of the 21-year rule is not a tax "payable by the individual for the taxation year in which the individual died" as stipulated in paragraph 6(a) of Article XXIX B of the Convention. The result would be the same if there had been an actual disposition of the Trust assets followed by a substitution of other U.S. situated property prior to death. Even if it is appropriate to consider such a result as double taxation, unfortunately there is no provision in the Convention or the Act to relieve such double taxation, even after taking into account paragraph 3(g) of Article XXVI of the Convention. However, U.S. estate taxes payable by the estate of Mrs. X in respect of the Trust property situated in the U.S. are creditable against Canadian federal income tax to the extent that Canadian federal income tax is payable in respect of the deemed disposition of Mrs. X's capital interest, if any, in the Trust as a result of the death of Mrs. X, provided that the gross value of the estate of Mrs. X exceeds U.S. $1.2 million.

On the other hand, if the death of Mrs. X occurs in the same year in which the 21-year rule applies, provided the gross value of Mrs. X's estate exceeds U.S. $1.2 million, a credit for U.S. estate taxes in respect of property situated in the U.S. can be claimed against Canadian federal income tax payable by Mrs. X on income or gains earned or realized by her as a result of the application of subsection 75(2) and the 21-year rule and from the deemed disposition of her capital interest, if any, in the Trust as a consequence of her death. This is so because such Canadian federal income taxes otherwise payable in the year of death of Mrs. X can be said to be attributable to property situated in the U.S. at the time of Mrs. X's death for the purposes of paragraph 6(a)(ii) of Article XXIV B of the Convention.

Where the gross value of the estate of Mrs. X is equal to or is less than U.S. $1.2 million, the Canadian federal income tax otherwise payable by Mrs. X may not be considered to be on any income, profits or gains of Mrs. X arising (within the meaning of paragraph 3 of Article XXIV) in the U.S. because the income or gains on the disposition of either Mrs. X's capital interest, if any, in the Trust or the U.S. assets held by the Trust may not be taxable in the U.S. in the hands of Mrs. X as a Canadian resident under the Convention (without reference to the savings clause therein) and thus may not be considered to be sourced in the U.S. within the meaning of paragraph 3 of Article XXIV of the Convention. In such a case, paragraph 6 of Article XXIX B of the convention will not apply to allow a credit for U.S. estate tax paid on the property in the Trust.

While we trust the above comments are of assistance to you, please note that they do not constitute an advance income tax ruling and consequently, are not binding on Revenue Canada. We also advise that the issues raised in your letter have been forwarded to the Department of Finance for their consideration.

Yours truly,

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

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