15 December 1997 Internal T.I. 9729556 - SUBSECTION 104(4) AND ARTICLE XXIX B OF U.S.

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 double taxation occurs as a result of the application of subsections 104(4) and 70(5) and Article XXIB of the Canada-U.S. Income Tax Convention.

Position:

Yes, in the situation described in the memo.

Reasons:

Because Article XXIX B of the Convention only applies to the year of death. Since the trust is not a QDOT or a subsection 70(6) spousal trust, otherwise paragraph 3(g) of Article XXVI of the Convention may apply to avoid double taxation.

		December 15, 1997

	Teresa Murphy	International Section
	Acting Chief	S. Leung
	Trust Section	957-2115

		972955

Subsection 104(4) of the Income Tax Act
(the "Act") and Article XXIX B of the
Canada-U.S. Income Tax Convention (the "Convention")

We are writing to reply to your request for our comments on a statement made by your client with respect to the interaction of subsection 104(4)of the Act and paragraph 6 of Article XXIX B of the Convention. Your client stated that where a non-resident trust (the “Trust”) has been deemed to have disposed of its property at fair market value under subsection 104(4) of the Act (the “21 year rule”), on death of the sole income beneficiary of the Trust in a subsequent year, the Third Protocol to the Convention “does not appear to allow a credit 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”. Your client further stated that “(t)his could result in double taxation”.

Facts of the Situation

Mrs. X while a citizen and resident of the U.S. created a trust in 1968 (the “Trust”). The sole trustee (the “Trustee”) of the Trust is a U.S. Trust company which replaced the original sole trustee who was an individual after the individual’s death in 1995.

Under the Trust all of the income each year is to be paid to or for the benefit of Mrs. X and, under a later amendment, the Trustee has power to pay capital gains taxes imposed on Mrs. X with respect to the trust property.

Mrs. X has power to appoint the capital of the Trust on her death by her Will among her spouse, her issue or charitable corporations. If she fails to exercise the power of appointment, after the death of Mrs. X, the Trust is to continue until the death of Mrs. X’s last surviving issue, provided she has issue, or until required to terminate by law, if earlier, and the Trustee is to pay so much of the income and capital as in their discretion they consider necessary or desirable for the support, maintenance, medical care, education and enjoyment of the issue. Upon termination, the trust fund then remaining is to be transferred to her issue or, if she has none, to a U.S. charity.

Mrs. X has the right to amend or revoke the Trust but only with the written consent of the individual trustee. It is not clear whether the present trustee which is a corporation has the power to consent.

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 consist of U.S. marketable securities which are publicly traded. They are and have been since the beginning of the Trust situated in the U.S.

Our Comments

It is not clear whether the term “the deemed disposition prior to death of a beneficiary” in your client’s statement refers to the deemed disposition as a result of the application of the 21 year rule or as a result of death of the beneficiary. We take it to refer to the former as it appears that the issue at hand is the possibility of double taxation as a result of the application of subsection 104(4) of the Act.

As discussed with you, it appears that the Trust is a U.S. grantor trust where, for U.S. tax purposes, the income of the Trust would be taxable in the grantor’s hands and the grantor (settlor) would be considered to own the Trust property.

It is our understanding that subsection 75(2) of the Act applies to the Trust in the situation at hand and the Trust is not a qualified domestic trust (“QDOT”) in the U.S. or a trust described in subsection 70(6) of the Act or is treated as such under Article XXIX B of the Convention.¹ It is not clear, however, whether Mrs. X is also the sole capital beneficiary of the Trust while she is at present time the sole income beneficiary.

In a year where subsection 104(4) of the Act 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 as a result of the deemed disposition would attribute to Mrs. X , the settlor of the Trust, by virtue of subsection 75(2) of the Act.² In a case where Mrs. X dies in a year subsequent to the year of the application of the 21 year rule, any U.S. estate taxes payable as a consequence of 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 relief such double taxation, even after taking into account paragraph 3(g) of Article XXVI of the Convention. However, U.S. estate taxes payable by 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.

If the death of Mrs. X occurs in the same year in which the 21 year rule applies, provided that on Mrs. X ‘s death the gross value of her 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 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 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 XXIX B of the Convention.

In situations where the gross value of the estate of Mrs. X is 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. marketable securities 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.

Chief
International Section
Reorganisations and International Divisionendnotes

¹ If the Trust is a QDOT or a trust described in subsection 70(6) of the Act or is treated as such under paragraph 5 of Article XXIX B of the Convention, paragraph 3(g) of Article XXVI of the Convention may apply to provide relief from double taxation.

² Please note that subsection 75(2) takes precedence over subsection 94(1) of the Act. In this regard, please refer to a paper titled “Section 94 Trusts Where Subsection 75(2) Applies” written by Olli Laurikainen (file #962276), dated October 27, 1997.