18 April 1978 Income Tax Severed Letter E-239 - [Disposition by non-resident of income interest in trust and XXXX]

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.

XXXX

Tuesday, April 18th, 1978

REVENUE CANADA - TAXATION 400 Cumberland St. OTTAWA, Ontario (K1A 0X5)

ATTENTION: A. JOZWIAK Non-Resident Tax Section Source Deductions Division

RE: YOUR REFERENCE: 166-4-4 / 166-1-9-08 / 166-8-13 Disposition by Non-Resident of Income Interest in Trust and XXXX

Dear Sirs,

Further to our earlier representations in connection with the above matter, our contention remains that the disposition by XXXX of her income interest in the trust involves the realization of a capital asset the proceeds of which are not taxable in Canada pursuant to Article 12(3) of the Canada-United Kingdom Tax Agreement.

We would bring your attention to the following statement made at page 506 of Simon's Income Tax (London, 1948); Volume I:

". . . the principle underlying the decision in Paget v. I. R. Comrs . . . was, and still is, good law, namely, that apart from special legislation, the proceeds of the sale of a right to receive income in future are not income. Thus the proceeds of a sale of an annuity for a lump sum down are not income, though the annuity if and when received would be income."

In addition, we have the statement made by Viscount Simon in Tilley v. Wales, 1943, 1 All E.R. 280 at page 282:

". . . I should myself take the view that a lump sum paid to commute pension is in the nature of a cap- ital payment which is substituted for a series of recurrent and periodic sums which partake of the nature of income".

In view of these statements, and taking into consideration the various elements of capital transactions as defined in the very large body of jurisprudence concerned with this area, we are of the opinion that a right to receive income must itself be regarded as a capital asset the disposition of which results in a capital, as opposed to an income, receipt.

At our recent meeting reference was made by you to G. Evans v. M.N.R. (1960) S.C.R. 391 and, more specifically, to the statements made by Justice Cartwright at pages 395 and 398 to the effect that the right to income in question should not be considered as being a capital asset. It is our con- tention that these statements by Justice Cartwright must be regarded as being obiter dicta, the case having been decided upon other grounds which are outlined in the following para- graph which appears at page 398:

"The precise form in which the matter was submitted to the Court appears to me to be of no importance; the legal expenses paid by the appellant were expended by her for the purpose of obtaining payment of income; they were expenses of collecting income to which she was entitled but the payment of which she could not otherwise obtain. So viewed, it could scarcely be doubted that the expenses were properly deductible in computing the appellant's taxable income. This, in my opinion, is the right view of the matter . . .".

Accordingly, taking into account the very special circumstances of that particular case and the Court's obvious reluctance to disallow the deduction claimed by the appellant, it is our opinion that the comments of Justice Cartwright should not be considered as being binding in connection with the characterization of an income interest in a trust. Indeed, the comments made by Justice Cartwright with respect to the characterization of the income right are of necessity very much diluted by the manner in which he frames his judgment, i.e., "The precise form...appears to me to be of no importance . . .".

In support of our position we would draw your attention to a commentary on the Evans case by Russell Disney contained in the Butterworth Canadian Income Tax Series, Chapter 15, Part Two, at page 15.67:

"Gladys Evans is an important case involving the deductibility of amounts spent to preserve a capital asset, the taxpayer's right to a life interest in her father's estate. The Exchequer Court, following the Dominion Natural Gas decision, disallowed the deduction of Gladys Evans' legal expenses, but the Supreme Court held that her expenses had been incurred simply to maintain her rights in an existing income-producing asset and were therefore deductible."

In light of the above we feel that the Evans case cannot be viewed as a decision which renders any assistance in characterzing the nature of an income interest in a trust. The Evans case is solely concerned with the question of the deductibility of amounts spent in order to enforce payment of income owing under an income interest created under a will. The Supreme Court decided that such amounts were deductible against income and that consequently such amounts were not outlays on account of capital. In this context a crucial distinction is to be made between the situation where an outlay is made in order to bring into existence a right to receive income and the very different situation where an outlay is made in order to enforce the payment of income pursuant to an already existing right. In the Evans case the right to income was clearly created under the terms of the Will in question; however, the Executors decided not to recognize the validity of this right. The prospective re- cipient of the income was obliged to disburse funds in order to enforce payment of the sums owing to her, and the Supreme Court rightly regarded these expenses as being deductible as against the income received. Therefore, in spite of the obiter remarks of Justice Cartwright, this case cannot be regarded as authority for concluding that an income interest can never be regarded as being a capital asset. Indeed, on the facts of the Evans case that particular issue need not have arisen.

Accordingly, we feel that the correct view is that a disposition of a right to receive income should be considered as being a capital disposition. Aside from the jurisprudence cited above being entirely in agreement with this conten- tion, further support for our position may be found in the wording of the Income Tax Act itself. Section 106(2)(b) appears to specifically recognize the capital nature of any disposition such as the one in question. "Any taxable capi- tal gain or allowable capital loss of the taxpayer from the disposition shall be deemed to be nil...". If the disposi- tion of an income interest in a trust cannot be regarded as being a capital transaction, how is one to explain the reference contained in Section 106(2) (b) to "taxable capital gain or allowable capital loss"? Upon reflection, it ap- pears that the scheme of the statute is to tax as income what would ordinarily be considered as being a capital gain. According to Section 106(2)(a) the proceeds of disposition resulting from the alienation of the income interest are included in the computation of income and the capital gain which would otherwise result is deemed to be nil by Section 106(2)(b). Thus, while it is clear that the proceeds of disposition must be included in computing the income of the taxpayer, it seems equally clear that the statute unequiv- ocally recognizes the capital nature of the disposition by the wording employed in Section 106(2)(b). Section 106(2)(a) is the "special legislation" referred to in the excerpt quoted above from Simon's Income Tax. This "special legis- lation", while altering the income tax liability attaching to the disposition of an income interest, does not alter the legal nature of the transaction which is recognized in sub- section 106(2)(b).

However, while the provisions of the Income Tax Act modify what would be the normal tax treatment accorded to proceeds of disposition resulting from the alienation of an income interest in a trust, the present situation involves an alienator who is a resident of the United Kingdom. Thus the United Kingdom-Canada Tax Agreement comes into play. Accord- ing to Article 12(3) of the Tax Agreement, gains from the alienation of this kind of property are taxable only in the territory of which the alienator is a resident.

As discussed above, the Income Tax Act recognizes the capi- tal nature of a transaction involving the disposition of an income interest in a trust. Consequently, and pursuant to Article 12(3) of the Agreement, any tax levied in con- nection with XXXX disposition can only be levied in the United Kingdom.

In summary, therefore, it is our contention that XXXX in selling her income interest in the trust, is in receipt of an amount representing the capitalized value of her income interest. This amount, similar in nature to other amounts received by taxpayers other than in the course of carrying on business and upon the alienation of income producing properties, can only be characterized as being a capital sum and, as such, may only be taxed in the United Kingdom.

We look forward to hearing from you in due course.

Yours very truly,

XXXX