26 June 1998 Internal T.I. 9814340 - SPOUSAL TRUST VARIATION

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.

STRATEGY INSTITUTE - 1998 Round Table

Questions

Buy-out of Spouse’s Interest in Spousal Trust

After a few years of existence, a testamentary spousal trust (as defined in paragraph 70(6)(b)) distributes assets in satisfaction of the surviving spouse’s whole income interest in that trust, an amount equivalent to the fair market value of that interest. After the distribution, the spouse will no longer be “entitled to receive” any income from that trust and therefore the trust will cease to be a spousal trust pursuant to paragraph 70(6)(b).

1) Is there a disposition of the trust’s assets due to the change of the trust’s status? If so,

a) pursuant to which provision of the Income Tax Act, and

b) when will this disposition be deemed to have occurred?

2) If this trust is governed by the rules of the Quebec Civil Code and the sole income beneficiary stated in the trust document is no longer a beneficiary ( having received cash in satisfaction of his whole income interest), section 1286 stipulates that the income beneficiary’s right:

“passes (...) to the co-beneficiaries of the fruits and revenue (...) in proportion of the share of each. If he is the sole beneficiary of the fruits and the revenues of his rank, his right passes in proportion to the share of each, to the beneficiaries of the fruits and revenues of the second rank, or where there are no such beneficiaries to the beneficiaries of the capital.”

Since the trust agreement does not provide to whom the income right will pass to, the right of the income beneficiary will automatically pass to the capital beneficiary pursuant to the section 1286 of the Quebec Civil Code.

In such a case, for tax purposes,

a) Is there a “deemed” disposition of the trust’s assets?

b) Is there a “deemed” disposition of the capital interest held by the capital beneficiary (who is entitled under the trust agreement to receive solely the capital after the death of the surviving spouse) since he acquires a new right (due to section 1286 Quebec civil code)?

c) Does the answer remain the same if no income can be paid to him ( a non-spouse capital beneficiary): the trust agreement stating that the annual income can only be paid to the spouse during his or her lifetime?

STRATEGY INSTITUTE - 1998 Round Table

Questions (continued)

Buy-out of Spouse’s Interest in Spousal Trust

d) Does Revenue Canada agree that the capital beneficiary should rather be considered having acquired a separate interest in the trust (an income interest)? Therefore the capital interest should not be deemed to have been disposed of.

e) Is the answer the same even if the trust has never been a spousal trust under paragraph 70(6)(b) and the annual income can be paid to any of the income beneficiaries?

3) If an application to the Court to vary the terms of a trust agreement to enable the trustees to distribute 2/3 of the trust property to the capital beneficiary and to “redeem” 2/3 of the income interest is approved, would Revenue Canada consider that the variance is so significant that it will cause a deemed disposition of the trust’s assets and/or the beneficiary’s interest in the trust?

Responses

Part 1)

Pursuant to subsection 106(3), where property of a trust is distributed to a beneficiary in satisfaction of that beneficiary’s income interest in the trust, the trust is deemed to have disposed of the property for proceeds of disposition equal to the fair market value of the property at that time. The fact that the spouse is no longer an income beneficiary of the trust would not, in and by itself, result in the trust being considered to have disposed of its remaining assets. Further, the fact that the spouse is no longer an income beneficiary of the trust would not result in the trust ceasing to be a spousal trust. For purposes of the Act, the trust will always be a spousal trust. If, in accordance with the testator’s will, the remaining capital beneficiaries are not entitled to the capital until the death of that spouse the testamentary trust will remain intact.

Part 2)

Subsection 1286 of the Quebec Civil Code is not applicable to the scenario laid out in this part. This subsection applies only where a beneficiary “renounces his right, or if his right lapses” which is not the case here. Rather, in the scenario presented, the income beneficiary has in fact disposed of his or her interest for consideration, in which case, as described above, unless the terms of the trust are varied, the remaining beneficiaries would only be entitled to the capital upon the death of the beneficiary spouse. As there is no beneficiary otherwise entitled to income, any income earned on the capital remaining in the trust during the lifetime of that spouse would be taxed in the trust.

STRATEGY INSTITUTE - 1998 Round Table

Responses (continued)

Buy-out of Spouse’s Interest in Spousal Trust

Part 3)

Where a variation of a trust amounts to an acceleration of otherwise vested interests in that trust, generally the Department would not consider such a variation in and by itself to be so significant so as to cause a resettlement of the trust or a disposition of property either by the trust or by the beneficiaries.

Finally, the application of subsection 107(4) must be considered. This provision applies where a post-1971 spousal trust distributes capital property, resource property or land inventory during the beneficiary spouse’s lifetime to a beneficiary other than the spouse. Where it applies, the trust is deemed to have disposed of the property and to have received fair market value proceeds and the beneficiary is deemed to have disposed of all of part or the beneficiary’s capital interest for an amount equal to those same proceeds minus any debt assumed.

Lena Holloway
June, 1998
981434