16 July 1998 External T.I. 9728295 - CHARITABLE REMAINDER ANNUITY 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:

Whether a proposed donation to be made by a husband and wife (the “Individuals”) using a U.S. Charitable Remainder Annuity Trust (a “CRAT”) qualifies for a charitable tax credit under section 118.1.

Position TAKEN:

No.

Reasons FOR POSITION TAKEN:

The trustee of the CRAT will have a right to encroach on the capital of the trust, when the income of the trust is less than the annual amount to be paid to the Individuals. Consequently, in accordance with paragraph 6 of IT-226R, the Individuals will not be entitled to a tax credit in respect of the donation of an interest in the CRAT, and such a donation will not fall within the purview of IT-226R (this position was also taken in other files).

XXXXXXXXXX 7-972829
M. Azzi
Attention: XXXXXXXXXX

July 16, 1998

Dear Sirs:

Re: Charitable Remainder Annuity Trust

This is in reply to your letter of March 18, 1997, which was forwarded to us for reply by our Charities Division. You requested information on the Canadian tax treatment of a donation to be made using a U.S. Charitable Remainder Annuity Trust (a “CRAT”). For greater certainty, the CRAT will be a non-resident of Canada. We apologize for the delay in responding to your request.

We understand that a husband and wife (the “Individuals”), who are U.S. citizens, U.S. residents and non-residents of Canada, own a house in XXXXXXXXXX and inherited a 1/4 interest in another house in XXXXXXXXXX (hereinafter the XXXXXXXXXX house and the 1/4 interest in the other house are referred to as the “XXXXXXXXXX Properties”).

You indicate that the Individuals wish to create a CRAT to be funded with the XXXXXXXXXX Properties. The Individuals will transfer ownership of the XXXXXXXXXX Properties to the CRAT, the trustee of the CRAT will then sell these properties to an unrelated third party, and reinvest the sales proceeds in stocks and bonds. During the lifetime of the Individuals, the CRAT will pay to the Individuals an annual income stream equal to 5% of the fair market value of the assets which established the CRAT (i.e., 5% of the fair market value of the XXXXXXXXXX Properties at the time of transfer to the CRAT). Any income the CRAT earns in excess of the 5% amount will become additional trust capital. Upon the death of the last of the Individuals, the CRAT will terminate, and the trustee will transfer all trust assets outright to XXXXXXXXXX, a U.S. tax-exempt educational institution.

Our Comments

The Department’s position with respect to a gift of an equitable interest in a trust is found in Interpretation Bulletin IT-226R (copy enclosed). As indicated in the bulletin, a gift by an individual of an equitable interest in a trust to a registered charity or certain other organizations described in subsection 118.1(1) of the Income Tax Act (the “Act”) may qualify for the tax credit in respect of charitable gifts. XXXXXXXXXX is an organization described in paragraph (f) of the definition of “total charitable gifts” in subsection 118.1(1) of the Act, by virtue of section 3503 and Schedule VIII of the Income Tax Regulations.

An equitable interest in a trust is created upon the transfer of any property to a trust with the requirement that the property be distributed to a beneficiary at some future date (e.g., when an income interest of another person ends). A gift of an equitable interest could be made through a testamentary trust or an inter vivos trust. An example of an inter vivos gift of an equitable interest in a trust is where a taxpayer transfers a property to a trust and the trustee is instructed to pay all of the income earned by the trust to the taxpayer during the taxpayer’s lifetime and, on the death of the taxpayer, to transfer the property to a registered charity.

As stated in paragraph 2 of IT-226R, a particular donation must qualify as a gift in order to qualify for the tax credit under section 118.1 of the Act. Where the property donated consists of an equitable interest in a trust, the Department will consider a gift to have been made if all of the following requirements are met:

(a) There must be a transfer of property voluntarily given with no expectation of right, privilege, material benefit or advantage to the donor or a person designated by the donor.

(b) The property must vest with the recipient organization at the time of transfer.

A gift is vested if

(i) the person or persons entitled to the gift are in existence and are ascertained,

(ii) the size of the beneficiaries’ interests are ascertained, and

(iii) any conditions attached to the gift are satisfied.

(c) The transfer must be irrevocable.

(d) It must be evident that the recipient organization will eventually receive full ownership and possession of the property transferred.

Once it is established that a gift has been made, the value of the gift at the time of the transfer must be determined before it can be claimed for income tax purposes.

The method of valuing an equitable interest in a trust, whether it be for purpose of determining the amount of a charitable donation or other tax consequences, will vary according to the type of gift, other interests in the trust and documentation providing for the gift. The general approach is to value the various interests taking into consideration the fair market value of the property itself, the current interest rates, the life expectancy of any life tenants, and any other factors relevant to the specific case. As indicated in paragraph 6 of IT-226R, in cases where the size of an equitable interest at the time of the donation cannot reasonably be determined, such as when a life tenant or trustee has a right to encroach on the capital of the trust, no tax credit in respect of the donation will be allowed.

Based on the information provided, it appears that the trustee of the above-described CRAT will have a right to encroach on the capital of the trust, when the income of the trust is less than the annual amount to be paid to the Individuals. Consequently, in accordance with paragraph 6 of IT-226R, in our view, the Individuals will not be entitled to a tax credit in respect of the above donation of an interest in the CRAT, and such a donation will not fall within the purview of IT-226R.

As regards the tax implications of the transfer of the XXXXXXXXXX Properties to the CRAT, the Individuals will be deemed, pursuant to subparagraph 69(1)(b)(ii) of the Act, to have received proceeds of disposition equal to the fair market value of the properties at the time of transfer, and, under paragraph 69(1)(c), the CRAT will be deemed to have acquired the properties at that fair market value. Consequently, the transfer of the XXXXXXXXXX Properties will generally result in a capital gain for the Individuals (assuming, of course, that the XXXXXXXXXX Properties are capital properties of the Individuals), if the fair market value of the properties at the time of the transfer to the CRAT exceeds the adjusted cost base of the properties to the Individuals.

By virtue of subsections 2(3) and 115(1) of the Act, non-residents are subject to tax in Canada on taxable capital gains realized on dispositions of “taxable Canadian property”. Pursuant to paragraph 115(1)(b) of the Act, “taxable Canadian property” includes real property situated in Canada and an interest in real property situated in Canada. Consequently, the Individuals will be subject to Canadian tax on any taxable capital gain resulting from the transfer of the XXXXXXXXXX Properties to the CRAT. Similarly, if the subsequent disposition of the XXXXXXXXXX Properties by the CRAT results in a taxable capital gain, the CRAT would also be subject to Canadian tax by virtue of subsections 2(3) and 115(1) of the Act. In both cases, paragraph 1 of Article XIII of the Canada-U.S. Income Tax Convention would maintain Canada’s right to tax capital gains arising on such dispositions.

Furthermore, section 116 of the Act generally requires that a non-resident person disposing of taxable Canadian property provide notice to the Department of the disposition and pay a specified amount as, or on account of, the non-resident person’s Canadian tax liability, or furnish the Department with acceptable security in respect of the disposition. In certain circumstances, the purchaser may be liable for tax on behalf of the non-resident vendor. We have enclosed a copy of Information Circular 72-17R4, which explains the procedures to be followed when a non-resident person disposes or proposes to dispose of taxable Canadian property.

We trust that these comments will be of assistance.

Jim Wilson
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

- 4 -