11 August 1997 External T.I. 9714075 - REPURCHASE OF SHARES - TESTAMENTARY SPOUSAL TRUST

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:

A testamentary spousal trust owns shares of a "Canadian-controlled private corporation" at the time of the spouse's death and the corporation repurchases its shares immediately after the spouse's death and before the regular year-end of the trust. In the taxation year in which the spouse dies,

1. would that trust be taxable on the capital gain arising on the deemed disposition?

2. would that trust be taxable on the deemed dividend when the shares are repurchased and realize a capital loss that could be available to offset the capital gain which has arisen in the trust?

Position:

1. Yes
2. None

Reasons:

1. Paragraph 104(4)(a) of the Income Tax Act.

2. Question of fact.

5-971407
XXXXXXXXXX Sylvie Labarre

Attention: XXXXXXXXXX

August 11, 1997

Dear Sirs:

Re: Testamentary spousal trust

This is in reply to your letter dated May 27, 1997 wherein you requested our comments relating to the taxation of income in a testamentary spousal trust (the "trust") in the taxation year in which the spouse dies where the trust owns shares of a "Canadian-controlled private corporation" as defined in subsection 89(1) of the Income Tax Act (the "Act") and where the corporation repurchases its shares immediately after the spouse's death and before the regular year-end of the trust.

According to the information provided in your letter, the shares would be capital property of the trust and, at the time of the death of the spouse, the trust would not be affiliated (as defined in section 251.1 of the Act) with the corporation. In your letter, you have provided different assumptions concerning the provisions of the will related to the distribution of assets after the spouse's death. You have asked that we confirm your understanding of the income tax consequences in each situation.

As explained in Information Circular 70-6R3, it is not the Department's practice to comment on proposed transactions other than in the form of an advance income tax ruling. Taxpayers seriously contemplating a proposed transaction are best advised to seek a formal ruling, submitting a complete statement of facts and issues as well as copies of all relevant documents. Should your situation involve completed transactions, you should submit all relevant facts and documentation to the appropriate Tax Services Office for their views. We are therefore not in a position to give a definitive response to your enquiry. However, we can offer you the following general comments which may be of assistance although, in certain circumstances, they may not be appropriate to your specific situation.

Our comments

1.We are unable to confirm that your understanding of the income tax consequences is correct under the different assumptions you provided. The income tax consequences would depend on whether the trust would still be in existence after the death of the spouse and on whether the trust would still be the owner of the shares at the date the shares are redeemed. There is no provision in the Act which deems a distribution to the beneficiaries to occur or deems the end of the trust. It is a question of fact which can only be determined based on the relevant laws of the province and the trust document or the will and testament of the testator whether a spousal trust would remain in existence after the death of the spouse or whether the shares have already been distributed before the redemption. The trust document and the relevant laws of the province would determine whether the trustee has the right to dispose of the property of the trust and distribute the cash to the beneficiaries or to simply distribute the property to the beneficiaries.

2.Assuming the trust is a spousal trust to which paragraph 104(4)(a) of the Act applies, we agree that at the date of death of the spouse there is a deemed disposition of the shares at fair market value which may result in a capital gain in the trust to the extent that the fair market value of the shares exceeds their adjusted cost base. The trust is deemed to reacquire the shares at that fair market value immediately thereafter and the adjusted cost base of the shares will be the fair market value thereof. The capital gain would be included in the trust's income for the taxation year which includes the date of death of the spouse.

3.There is no deemed trust year end as a consequence solely of the spouse's death. After the spouse's death, the trust would still have its regular testamentary year end if it is not wound up during that taxation year. As stated in the T3 Guide, if a testamentary trust is wound up during a taxation year, the taxation year of the trust will end on the date of the final distribution of the assets. It is a question of fact to determine the date of the final distribution and of the winding-up of the trust. In that determination, we would consider the date for Trust law purposes.

4.The share redemption would result in a deemed dividend to the owner of the shares to the extent that the redemption value of the shares exceeds the paid-up capital. The owner of the shares would have disposed of the shares. As per paragraph (j) of the definition of "proceeds of disposition" in section 54 of the Act, the proceeds of disposition for those shares to the shareholder will be deemed to be the amount received from the corporation less the amount deemed by subsection 84(3) of the Act to be a dividend received that is not deemed by paragraph 55(2)(a) not to be a dividend.

5.The owner of the shares would realize a capital loss from the disposition of the shares if the adjusted cost base of the shares exceeds the deemed proceeds of disposition. Where the corporation is affiliated with the shareholder immediately after the disposition, the loss from the disposition of the shares would be deemed to be nil pursuant to the proposed subsection 40(3.6).

6.Where the trust is not the owner of the shares at the redemption date, we agree with you that the trust would be taxable on the capital gain arising on the deemed disposition, the beneficiaries would be taxable on the deemed dividend when the shares are repurchased and the capital loss realized by the beneficiaries would not be available to offset the capital gain which has arisen in the trust.

7.Where the trust is the owner of the shares at the redemption date, the proposed subsections 112(3.2) and (3.3) could apply in certains situations to reduce the loss that may be claimed by the trust. The capital loss realized by the trust, if any, could be used to offset the capital gain arising from the deemed disposition under paragraph 104(4)(a) of the Act.

We are unable to confirm your understanding that no amounts become paid or payable to the capital beneficiaries until the trust is finalized and that the assets are distributed as this is a question of fact which can only be determined based on the trust document or the will and testament of the testator. Therefore, we cannot confirm your understanding that the deemed dividend of the trust would be taxable in the trust.

As indicated in paragraph 22 of Information Circular 70-6R3 dated December 30, 1996, this opinion is not a ruling and accordingly, is not binding on the Department.

We trust our comments will be of assistance to you.

Yours truly,

Marc Vanasse
Acting Section Chief
Resources, Partnerships and Trusts Section
Income Tax Rulings and Interpretations Directorate
Policy and Legislation Branch