19 November 1998 External T.I. 9821665 - 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:

1. Whether a trust qualifies as spousal trust?

2. Whether the interests have vested indefeasibly?

3. Whether any interest will "become effective in the future," within the meaning of paragraph (g) of the definition of "trust" in subsection 108(1)?

Position:

1. No (unless if it previously qualified).

2. No.

3. Yes.

Reasons:

1. Spouse does not have an "entitlement" to all income.

2. Neither the identification of the beneficiaries nor the amount of the capital account is known with certainty.

3. According to the Department of Finance's Explanatory Notes in 1987, the 21-year rule was designed to prevent the use of trusts to defer indefinitely the recognition for tax purposes of gains accruing on capital properties, resource properties and land inventories. I.e., the rule was intended to prevent the use of trusts in estate planning arrangements to defer indefinitely the recognition of capital gains which would otherwise occur on the death of the individual (or on his ceasing to reside in Canada). In 1987, an exclusion was provided for in the draft legislation, for trusts in which every interest was vested indefeasibly in possession or was to be so vested upon the death of the settlor or the spouse. Such trust arrangements would not permit the deferral of capital gains beyond the lifetime of the holders of such interests. The then-proposed ss.104(5.3) introduced 2 exceptions: the first concerning commercial trusts (in which case the beneficiaries had to have a present right to income and capital), and the second concerning transfers from a settlor to the settlor's children (in which case there had to exist a right which would become operative in the future upon the death of the settlor or spouse). In the 1993 revision, the formerly proposed 104(5.3) became encompassed in the definition of trust in 108(1), and the concept of a right not being in possession until some future time was dropped. If all interests are presently being enjoyed, the transfer of property has already effectively occurred and thus the inoperability of the 21-year rule puts the beneficiary in the same position as if the beneficiary owned the property (since the 21-year rule does not apply to individuals other than trusts).

XXXXXXXXXX J.D. Brooks
982166

Attention: XXXXXXXXXX

November 19, 1998

Dear Sirs:

This is in reply to your letter of August 21, 1998 in which you requested our views on the interpretation of paragraph 104(4)(a) and the definition of "trust" in subsection 108(1) of the Income Tax Act. You presented a factual situation for our consideration.

Since the situation you presented is an actual fact situation, we are not able to provide any specific comments other than by way of an advance income tax ruling. The procedure for requesting an advance income tax ruling is laid out in Information Circular 70-6R3 dated December 30, 1996. Nevertheless, we are prepared to provide some general comments.

Our Comments

Subsection 104(4) of the Income Tax Act provides a general rule that every trust will be deemed to have disposed of certain properties and to have reacquired them every 21 years. Paragraph 104(4)(a) provides an exception to that general rule, and states that the time at which a qualifying spousal trust is first deemed to have disposed of and reacquired property will be the day on which the settlor's spouse dies. Where a trust was created by the will of a taxpayer who died after 1971, subparagraph 104(4)(a)(i) provides that the trust must have met the requirements of subparagraphs 104(4)(a)(iii) and (iv) at the time the trust was created.

The requirement stated in subparagraph 104(4)(a)(iii) is that the spouse of a deceased taxpayer must be "entitled to receive all of the income of the trust that arose before the spouse's death." It is our view that, in order to be considered to be entitled to receive the income of the trust, the spouse would have to have an enforceable right to receive such income. If payment of the income is at the discretion of the trustees, the spouse would not be entitled to receive all of the income of the trust.

The requirement stated in subparagraph 104(4)(a)(iv) is that "no person except the spouse could, before the spouse's death, receive or otherwise obtain the use of any of the income or capital of the trust." Thus, whether or not another person actually obtained the use of the income or capital of the trust, the trust would not qualify if the trust agreement enabled another person to use the income or capital of the trust.

With respect to a trust that does not qualify under paragraph 104(4)(a), one would have to determine whether the definition of "trust" in subsection 108(1) provides relief from the application of subsection 104(4). Paragraph (g) of the definition of "trust" in subsection 108(1) requires all interests in the trust to have vested indefeasibly and that there be no interest which may become effective in the future. Where the terms of the trust enable the trustees to encroach on the capital of the trust, the capital interests of persons other than the spouse would not have vested indefeasibly. Furthermore, if the capital interest of a person other than the spouse terminates if that person predeceases the spouse, that person's interest would not have vested indefeasibly.

Even if all interests in a trust are vested indefeasibly, a trust will not fall within paragraph (g) of the definition of "trust" in subsection 108(1) if there is any interest in the trust which may become effective in the future. To illustrate, there may be a trust in which there is an income interest and a capital interest, and both interests are vested indefeasibly. That is, the beneficiary with the income interest is entitled to receive all of the income of the trust during that beneficiary's lifetime; however, the beneficiary with the capital interest is not entitled to the capital of the trust until the beneficiary with the income interest dies. In that case, the capital beneficiary's interest will become effective at the time of the income beneficiary's death.

As we stated in our telephone conversation of October 16, 1998 (Brooks/XXXXXXXXXX), our comments do not take into consideration the actual trust arrangement nor the historical facts of your specific situation. Where a testamentary trust was created by the will of a taxpayer who died after 1971 and, at the time it was created, was a trust which met the requirements of subparagraphs (iii) and (iv), the trust would have qualified under paragraph 104(4)(a) at the time of its creation and would have continued to so qualify thereafter. Since the determination of any particular trust's status upon creation is a matter of historical record, it would be appropriate to obtain the views of the relevant Taxation Services Office.

As indicated in paragraph 22 of Information Circular 70-6R3 dated December 30, 1996, this opinion is not an advance income tax ruling and consequently, is not binding on Revenue Canada.

We trust our comments will be of assistance to you.

Yours truly,

T. Murphy
Manager
Trusts Section
Resources, Partnerships and Trusts Division
Income Tax Rulings and Interpretations Directorate
Policy and Legislation Branch

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