What the "Archived Content" notice means for interpretation bulletins

NO: IT-406R2

DATE: May 11, 1990

SUBJECT: INCOME TAX ACT
Tax Payable by an Inter Vivos Trust

REFERENCE: Subsection 122(2) (also sections 117, 117.1 and 127.53, subsections 96(1), 104(2), 104(18), 122(1), 122(1.1), 149(5) and 248(1), and paragraphs 125(7)(d) and (e))

Application

This bulletin cancels and replaces Interpretation Bulletin IT-406R dated June 21, 1982. Current revisions are indicated by vertical lines.

Summary

This bulletin sets out the rates of tax payable by inter vivos trusts. It also discusses the circumstances in which inter vivos trusts established before June 18, 1971 may receive more favoured treatment by being taxed at graduated individual rates.

Discussion and Interpretation

1. An inter vivos trust is subject to a flat rate of federal tax on its amount taxable for the year equivalent to the highest rate for individuals, except where all of the conditions set out in subsection 122(2) are met by the trust (see 2 below). For 1988 and subsequent taxation years, subsection 122(1) imposes a federal tax rate of 29 percent on inter vivos trusts. For the 1985 to 1987 taxation years, the rate was 34 percent. By virtue of subsection 122(1.1), an inter vivos trust may not claim the personal tax credits provided in section 118.

2. Where an inter vivos trust (other than a mutual fund trust) meets all of the conditions set out in subsection 122(2), it is taxed at the graduated federal tax rates for individuals which are set out in section 117. For 1988 those rates are: 17 percent on the amount taxable up to $27,500, 26 percent on the next $27,500, and 29 percent on the amount taxable in excess of $55,000. For 1989 and subsequent taxation years, section 117.1 establishes an indexing formula for adjusting these dollar values to reflect increases in the Consumer Price Index in excess of 3 percent. The conditions of subsection 122(2) are met if the trust:

(a) was established before June 18, 1971 (see 3 and 4 below),

(b) was resident in Canada on June 18, 1971 and without interruption thereafter until the end of the taxation year (see 5 below),

(c) did not carry on any active business in the year (see 6 and 7 below),

(d) has not received any property by way of gift since June 18, 1971 ( see 8 below), and

(e) has not, after June 18, 1971, incurred

(i) any debt or

(ii) any other obligation to pay an amount,

to, or guaranteed by, any person with whom any beneficiary of the trust was not dealing at arm's length.

3. Paragraph 122(2)(a) requires the trust to have been established before June 18, 1971. Variations in the terms of the trust must be examined to determine if a particular change is of such a nature as to constitute the establishment of a new, successor trust. Where a trust was established before June 18, 1971, a subsequent change in one or more of the trustees would not cause the trust to be viewed as a new trust as of the date of the change. Conversely, under the provisions of subsection 149(5), an inter vivos trust that is deemed to have been created in respect of a club, society or association cannot have come into existence prior to the end of 1971 even though the club, society or association was in existence prior to June 18, 1971.

4. Where a trust was in existence prior to June 18, 1971 and, on or after that date, a second inter vivos trust was created, with the circumstances of the two trusts being such that the conditions specified in subsection 104(2) are met, the two trusts may be designated by the Minister as being one trust and that trust will not meet the requirements of subsection 122(2). The creation of a second trust, in these circumstances, may be tantamount to a contribution of additional property to the first trust, which is a disqualifying event as specified in paragraph 122(2)(d).

5. Paragraph 122(2)(b) requires the trust to have been resident in Canada on June 18, 1971 and to have remained a resident of Canada at all times thereafter. For this purpose, the normal rules for determining the residence of a trust are applicable. See the current version of IT-447 entitled Residence of a Trust or Estate.

6. As indicated in paragraph 122(2)(c), a trust fails to meet the requirements of subsection 122(2) if it carried on any active business in the year. In subsection 248(1), "active business" is defined to mean any business carried on other than a "specified investment business" or a "personal services business". Since each of the excluded types of business can only be carried on by a corporation (see paragraphs 125(7)(d) and (e)), any business carried on by a trust in the year is an active business. The word "year" in this context has reference to the taxation year of the trust, i.e., the calendar year, and not the fiscal period of any business. Unlike the other requirements of subsection 122(2) where, if any one of them is not met for a particular year the trust becomes subject to taxation under subsection 122(1) not only in that year but also in all subsequent years, a failure to meet the requirement in paragraph 122(2)(c) in one year does not necessarily affect the trust in subsequent years.

7. Where the trust is a partner (whether a general or limited partner) in a par tnership which carries on a business, the trust and each of the other partners is viewed as carrying on that business. The assumption in subsection 96(1), namely, that the partnership, as distinct from the partners, is to be viewed as if it were a separate person that carries on the business, is only for the purpose set out in subsection 96(1) and has no relevance for purposes of subsection 122(2).

8. In paragraph 122(2)(d) there is the requirement that the trust must not have received any property by way of gift after June 18, 1971. For this purpose, the word "gift" is not considered to include a property received as a bequest under the will of a deceased taxpayer or under the terms of a testamentary trust, even where the deceased taxpayer was the settlor of (or other contributor to) the inter vivos trust receiving the property.

9. In paragraph 122(2)(e) it is provided that a trust becomes subject to subsection 122(1) if, after June 18, 1971, it incurred any debt or any other obligation to pay an amount to any person with whom any beneficiary of the trust was not dealing at arm's length. This rule applies also where the debt or other obligation of the trust is guaranteed by such a person. The trust would not be considered to have incurred an "obligation to pay an amount" in the sense contemplated by subparagraph 122(2)(e)(ii) where, in return for immediate payment of fair market value consideration, a trust acquires property or assets from a person with whom any beneficiary of the trust was not dealing at arm's length. (For further discussion of the meaning of "arm's length", see the current version of IT-419.)

10. If a settlor (or other contributor to a trust) and a beneficiary are connected by blood relationship, marriage or adoption, then they are deemed not to deal with each other at arm's length. Even if the settlor (or other contributor) is not so related to any beneficiary, the circumstances may indicate that the settlor (or other contributor) and at least one beneficiary do not in fact deal with each other at arm's length. In either of these situations, if an amount is owing by the trust to the settlor (or other contributor to the trust), or if the trust assumes responsibility for any debt or other obligation guaranteed by such a person, the requirement in paragraph 122(2)(e) would not be met.

11. The debts or other obligations of a trust referred to in 9 and 10 above do not include ordinary operating debts or bank loans (other than those guaranteed by or owing to a person not dealing at arm's length with a beneficiary).

12. Paragraph 122(2)(e) is not contravened by a debt or other obligation of the trust to pay to a beneficiary an amount required by the terms of the trust, provided it is paid out to the beneficiary during the reasonable time needed to discharge the debt or obligation. A reasonable time will usually not be considered to extend beyond the end of the taxation year following the year in which the debt or obligation became payable by the trust. However, where subsect ion 104(18) applies with respect to the income of a trust in which a minor beneficiary has a vested interest, a reasonable time will usually not be considered to extend beyond the end of the taxation year following the year in which the child reaches the age of majority.

13. For the purposes of the "Alternative Minimum Tax", paragraph 127.53(1)(b) allows an exemption of $40,000 to an inter vivos trust which meets the criteria of subsection 122(2). A single such exemption must be allocated among multiple trusts that arose as a consequence of contributions by the same individual.