30 November 1997 Ruling 9728233 - 21-YEAR DEEMED DISPOSITION RULE

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) Are the income beneficiaries considered to have disposed of their income interests in the trust as a consequence of the proposed amendments to the trust agreement resulting in an income inclusion under subsection 106(2)?

2) Can subsection 107(2) be utilized on the distribution of the trust property to the capital beneficiaries?

3) Will subsection 245(2) apply to the proposed transactions?

Position: 1) Yes 2) Yes and No 3) No

Reasons:

1) Whether all of a trust's capital can be distributed to the capital beneficiaries to the exclusion of the income beneficiaries in order to terminate the trust. In several previous rulings, we were of the view that capital interests may be satisfied before and to the exclusion of income interests where the trust indenture so permits. This continues to be our view. As a result, the income beneficiaries of the trust will not be considered to have disposed of their income interests in the trust and subsection 106(2) will not apply.

2) The transfer by the trust of Note A and the Newco common shares to the resident beneficiaries is a distribution of property by the trust in satisfaction of all of the capital interests of those beneficiaries and subsection 107(2) would apply to such distributions. In similar rulings (3-4150 and 900733), we were of the view that subsection 107(2) would apply to such distributions. However, the transfer by the trust of Note B to the non-resident beneficiary is a distribution of property by the trust in satisfaction of that beneficiary’s capital interest and subsection 107(5) would apply to this distribution.

3) This issue was referred to the GAAR Committee and it was recommended that GAAR not apply to the proposed transactions.

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Attention: XXXXXXXXXX

XXXXXXXXXX, 1998

Dear Sirs/Mesdames:

Re: Advance Income Tax Ruling
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This is in reply to your letter of XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above-noted trust and certain beneficiaries under the trust and your subsequent correspondence of XXXXXXXXXX, in respect of the income tax consequences arising out of the proposed transactions described below.

We understand that to the best of your knowledge, and that of the taxpayers involved, none of the matters considered in this ruling request are:

(a) in an earlier return of the taxpayers or related persons;

(b) being considered by a tax services office or tax centre in connection with a previously filed tax return of the taxpayers or related persons;

(c) under objection by the taxpayers or related persons;

(d) before the courts; or

(e) the subject of a ruling previously issued by this Directorate to the taxpayers or related persons with the exception of ruling 3-4150.

In this letter, unless otherwise indicated, all statute references are to the Income Tax Act (Canada) (R.S.C. 1985, 5th Supplement, c.1, as amended) (the “Act”), and the following terms have the meanings specified:

“Trust” means XXXXXXXXXX;

“TrustCo” means XXXXXXXXXX;

“Mr. L” means XXXXXXXXXX;

“Mrs. L” means XXXXXXXXXX;

“Mr. T” means XXXXXXXXXX;

“Mrs. X” means XXXXXXXXXX;

“Mr. X” means XXXXXXXXXX;

“Child A” means XXXXXXXXXX;

“Child B” means XXXXXXXXXX;

“Child C” means XXXXXXXXXX.

The names and addresses of the taxpayers who are parties to this ruling request, as well as the tax services office or tax centre where their returns are filed, are listed in Schedule A.

Our understanding of the relevant facts, proposed transactions and purpose thereof is as follows:

FACTS

1. The Trust is an inter vivos trust that was established before 1972 by Mr. L (the “Settlor”) who is now deceased.

2. The beneficiaries of the Trust are defined in the Declaration of Trust and Agreement (the “Trust Agreement”) as the “Class of Beneficiaries” and are those persons from time to time included in the class of persons consisting of Mrs. X, the husband or widower of Mrs. X, the issue of Mrs. X and the spouses, widows, and widowers of the issue of Mrs. X. Mrs. X is the daughter of the settlor of the Trust and was married to Mr. X who is now deceased. She has three children, Child A, B and C, and five grandchildren ranging in age from about 9 to about 22. Mrs. X, Child B and Child C are resident in Canada for purposes of the Act. Child A is a non-resident for purposes of the Act.

3. The trustee (the “Trustee”) of the Trust is TrustCo. The Trust is resident in Canada and is a “personal trust” as defined in subsection 248(1) of the Act as none of the beneficiaries of the Trust have acquired an interest in the Trust for consideration payable to the Trust or to any other person.

4. As at XXXXXXXXXX, the property of the Trust consisted of a portfolio of stocks and bonds which are described in Appendix A and B. All property of the Trust described therein is “capital property” as defined in section 54 of the Act.

5. Pursuant to subsection 104(5.3) of the Act, the Trust filed Form T1015, Election by a Trust to Defer the Deemed Realization Day, on XXXXXXXXXX. On this form Mr. L is identified as the “designated contributor” in respect of the Trust and Mrs. X is listed as the only living “exempt beneficiary” of the Trust for purposes of the Act. As a result of the election, the deemed realization day for the Trust which would otherwise have occurred on January 1, 1993 pursuant to subsection 104(4)(b) of the Act was deferred toJanuary 1, 1999. Since the election was filed before March, 1995, paragraph 104(5.3)(b) of the Act will not apply to distributions made by the Trust after February 1995.

6. Clauses 2(e) and 16 of the Trust Agreement define the term “Person Entitled to Change Trustees.” Clause 16 also requires the person who is entitled to change the Trustees of the Trust to ensure that one Trustee of the Trust must always be a corporation entitled to carry on the business of a trustee which has assets under its administration with an aggregate value of not less than 20 times the value of the capital of the Trust.

7. Clause 19(b) of the Trust Agreement provides that the Person Entitled to Change Trustees may by deed add to, change or delete any of the powers and provisions of the Trust Agreement other than the provisions relating to the power to change Trustees and the qualifications of the Trustees set out in paragraph 6 above.

8. Mrs. X is currently the only Person Entitled to Change Trustees and the only person currently entitled to add to, change or delete the powers and provisions of the Trust Agreement.

9. Clause 5 of the Trust Agreement describes the general powers of the Trustee.

10. Clause 6(a) of the Trust Agreement provides that the capital of the Trust may, with the written consent of the Person Entitled to Change Trustees, be invested in any manner whatsoever.

11. Clause 7(a) of the Trust Agreement provides that, subject to special powers contained in Clauses 8 and 9 of the Trust Agreement, the capital of the Trust, together with all undistributed accumulated income, shall be distributed at the expiration of XXXXXXXXXX years from the death of the last survivor of Mrs. L (the wife of Mr. L), Mrs. X, Mr. T (the brother of Mrs. X), Mr. X, Child A, Child B and Child C. Clause 7(b) of the Trust Agreement provides that such capital shall be distributed to those persons to whom the income of the Trust would be distributed under the provisions of Clause 11 thereof.

12. Clause 8 of the Trust Agreement provides the Trustee with the discretionary power to distribute capital, for the purposes of relieving distress, to those persons to whom the income of the Trust would or may be paid.

13. Clause 10 of the Trust Agreement provides for the accumulation of income where such accumulation is permitted by law. By virtue of the provisions of the Accumulation Act (Ontario), the accumulations period has now expired and therefore all income of the Trust is distributed under the provisions of Clause 11 thereof.

14. Clause 11 of the Trust Agreement provides for the distribution of income of the Trust and specifies that the persons entitled to receive such income are those persons who are included in the Class of Beneficiaries whose possibility of benefiting is not completely extinguished by any valid or existing disclaimer and who satisfy the Conditions Precedent set out therein. This Clause also provides that the Trustee of the Trust has the discretion to pay all or any part of the income of the Trust to such of the eligible beneficiaries as the Trustee may from time to time determine as evidenced by an instrument in writing signed by the Trustee. Where the Trustee does not exercise its discretion, the income is paid to those beneficiaries in the order set out in this Clause. During her lifetime, Mrs. X is entitled to all income of the Trust in default of a determination by the Trustee. After her death or during disqualification or failure to satisfy a Condition Precedent, the income will be paid to her husband or widower and to her children (Child A, B and C).

PROPOSED TRANSACTIONS

15. Mrs. X, in accordance with the powers set out in Clause 19(b) of the Trust Agreement, will, by deed, change the provisions of the Trust Agreement. These changes will include:

(a) Clause 5, which sets out the general powers of the Trustee, will be amended to allow the Trustee to incorporate and organize a corporation under the laws of any jurisdiction in Canada for the purpose of investing all or any part of the Trust’s property in shares or other securities of such corporation.

(b) Clause 6, which deals with the administration of the Trust’s capital, will be amended to specifically authorize the Trustee, with the written approval of the Person Entitled to Change Trustees, to invest the Trust’s capital in a corporation organized by the Trustee in accordance with Clause 5.

(c) Clause 7, which deals with the distribution of the capital and undistributed income of the Trust, will be amended to provide that the capital together with all of the undistributed income of the Trust will be distributed at such times and in such shares as Mrs. X may by deed or will appoint to or among any one or more of her children or grandchildren from time to time alive, and in the absence of an effective appointment, such capital or income will vest absolutely in her children alive on XXXXXXXXXX in equal shares.

(d) Clause 8 will be amended so as to specifically empower the Trustee of the Trust to distribute, in its absolute discretion, all or any of the capital or undistributed income of the Trust among Mrs. X and her children and grandchildren in such shares as the Trustee shall, in its absolute discretion, determine.

16. The Trust will incorporate a Canadian private corporation (“Newco”) under the laws of the Province of XXXXXXXXXX. The authorized capital of Newco will consist of:

(a) an unlimited number of voting common shares (the “Common Shares”);

(b) an unlimited number of non-cumulative, redeemable, retractable, voting preferred shares (the “Class A Preferred Shares”); and

(c) an unlimited number of non-cumulative, convertible, redeemable, retractable, voting preferred shares (the “Class B Preferred Shares”).

The Class A and Class B Preferred Shares will be issued for $XXXXXXXXXX per share, and entitle the holder thereof to non-cumulative annual dividends of $XXXXXXXXXX per share. The Class A Preferred Shares will rank in priority to the Class B Preferred Shares and the Common Shares. The Class B Preferred Shares will rank in priority to the Common Shares and each Class B Preferred Share will be convertible into one Common Share at the option of the holder. Each Common Share, Class A Preferred Share and Class B Preferred Share of Newco will entitle the holder thereof to one vote per share at all general meetings of shareholders.

17. The Trust will transfer the property in paragraph 4 above to Newco for consideration consisting of Newco Common Shares and promissory notes. Mrs. X will consent to the Trust investing in the Newco Common Shares and in the promissory notes. The Trust and Newco will jointly file an election in accordance with the provisions of subsection 85(1) of the Act in respect of the transfer by the Trust of its property to Newco pursuant to which they will elect for each property transferred, the lesser of the fair market value of such property and the adjusted cost base of such property to the Trust. (The aggregate of such elected amounts will hereinafter be referred to as the “Aggregate Elected Amount.”) On the transfer of the property by the Trust to Newco, Newco will issue to the Trust:

(a) two promissory notes, Note A and Note B (collectively referred to as the “Notes”), with aggregate principal amounts equal to the Aggregate Elected Amount, and

(b) one Newco Common Share for each dollar that the aggregate fair market value of the property transferred by the Trust to Newco exceeds the Aggregate Elected Amount.

The principal amount of Note B will be equal to one-half of the amount for which the Newco Common Shares are issued by Newco to the Trust. The principal amount of Note A will be equal to the amount by which the Aggregate Elected Amount exceeds the principal amount of Note B.

18. Subsequent to the transactions described in paragraphs 15 to 17 above, the Trustee of the Trust will exercise its discretion, in accordance with the provisions of Clause 8 of the Trust Agreement (as amended), and distribute the capital of the Trust to Mrs. X and to her children. The Newco Common Shares will be distributed equally to Child B and to Child C. Note A will be distributed to Mrs. X and Note B will be distributed to Child A. As a result of these distributions, the Trust will no longer have any property and will terminate.

19. Mrs. X will subscribe for and be issued Class A Preferred Shares of Newco having a subscription amount equal to the principal amount of Note A. Note A will be tendered to Newco by Mrs. X to satisfy the subscription amount. Child A will subscribe for and be issued Class B Preferred Shares with a subscription amount equal to the principal amount of Note B. Note B will be tendered to Newco by Child A to satisfy the subscription amount.

20. A “New Trust” will be established, the provisions of which will provide that all income of the trust will be paid to Mrs. X during her lifetime and, on her death, the capital will be distributed to Child A or her assignee. New Trust will be resident in Canada. Child A will then transfer her Class B Preferred Shares to New Trust.

21. The shareholders of Newco (Mrs. X, Child A, Child B, Child C), and Newco will enter into an agreement which will provide, among other things, that upon Mrs. X's death the Class A Preferred Shares will be redeemed and the Class B Preferred Shares will be converted into Common Shares.

PURPOSE OF PROPOSED TRANSACTIONS

22. As a result of filing the election referred to in paragraph 5 above, but for the proposed transactions, the Trust would have a deemed disposition pursuant to subsection 104(4) and paragraph 104(5.3)(a) of the Act of all of the capital property owned by it on January 1, 1999. The purpose of this transaction is to enable a distribution of the Trust property to certain beneficiaries to occur prior to the date on which such deemed disposition would otherwise occur. This will have the effect of reducing or eliminating any tax which would otherwise be payable by the Trust as a result of such deemed disposition.

RULINGS GIVEN

Provided that the above statements are accurate and constitute complete disclosure of all the relevant facts, proposed transactions and purpose thereof and the proposed transactions are carried out as described herein, our advance income tax rulings are as follows:

A. By virtue of paragraph 104(5.3)(b.1) of the Act, the provisions of paragraph 104(5.3)(b) of the Act will not apply to the distribution by the Trust of the Notes and Common Shares of Newco.

B. The distribution by the Trust of Note A to Mrs. X and the Newco Common Shares to Child B and Child C will be a distribution by the Trust to taxpayers who are beneficiaries under the Trust in satisfaction of all or part of their capital interest in the Trust in accordance with the provisions of subsection 107(2) of the Act so that:

i) the Trust shall be deemed to have disposed of Note A and the Newco Common Shares for proceeds of disposition equal to the cost amount (adjusted cost base) to the Trust of such property immediately before that time;

ii) Mrs. X shall be deemed to have acquired Note A at a cost equal to the cost amount (adjusted cost base) to the Trust of Note A immediately before that time and Child B and Child C shall be deemed to have acquired their Newco Common Shares at a cost equal to their proportionate share of the cost amount (adjusted cost base) to the Trust of such shares immediately before that time; and

iii) Mrs. X, Child B and Child C shall be deemed to have disposed of their capital interest in the Trust for proceeds of disposition equal to the cost at which they are deemed to have acquired the property (Note A and Newco Common Shares) distributed by the Trust.

C. The distribution by the Trust of Note B to Child A will be a distribution by the Trust to a non-resident taxpayer who is a beneficiary under the Trust in satisfaction of all or part of that child’s capital interest in the Trust to which the provisions of subsection 107(5) of the Act will apply so that:

i) the Trust shall be deemed to have disposed of Note B for proceeds of disposition equal to its fair market value at that time;

ii) Child A shall be deemed to have acquired Note B at a cost equal to that fair market value; and

iii) Child A shall be deemed to have disposed of her capital interest in the Trust for proceeds of disposition equal to the adjusted cost base of such interest immediately before Note B was distributed by the Trust.

D. Subsection 106(2) of the Act will not apply to include an amount in the income of Mrs. X or any other person for any taxation year as a result of the amendments to the Trust Agreement referred to in paragraph 15 above or in respect of the distribution of the Notes and Common Shares of Newco referred to in paragraph 18 above.

E. Subsection 245(2) of the Act will not be applied to redetermine the tax consequences of Rulings A to D above as a result of the proposed transactions described herein.

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R3, Advance Income Tax Rulings, and are binding on Revenue Canada provided that the proposed transactions described above are completed and effective before XXXXXXXXXX.

COMMENTS

Nothing in this letter should be construed as implying that Revenue Canada has agreed to or accepted:

(a) the determination of the fair market value or adjusted cost base of any property referred to herein, or the paid-up capital of any shares, or

(b) any tax consequences arising from the facts or proposed transactions described above other than those specifically confirmed in the rulings given.

Yours truly,

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

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