Translation disclaimer
This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: Whether a testamentary trust is tainted where a beneficiary (institute) pays taxes owed by a trust on income taxed as a result of a designation under subsection 104(13.1)?
Position: No
Reasons: Interpretation of the Act and previous positions.
XXXXXXXXXX
2012-043220
Danielle Bouffard
March 11, 2013
Dear Sir,
Subject: Tax payments in the context of a substitution of the residue
This letter is in response to your December 24, 2011 e-mail regarding the above subject. We took into account the information you provided on December 14, 2012. We apologize for the delay in responding to you.
Unless otherwise indicated, all statutory references herein are to the provisions of the Income Tax Act (the "Act").
We understand that an individual intends to bequeath property worth approximately $500,000 by way of substitution to the individual’s surviving spouse. Under the individual’s will, the property thus bequeathed, which the spouse does not alienate or donate during the spouse’s lifetime and which remains the spouse’s property (the “residue”) is required to be paid to the children upon the death of the spouse. The spouse would be entitled to all of the income from the property subject to the substitution from the commencement of the substitution and could encroach on the capital. The commencement of the substitution would be upon the death of the spouse. Only the spouse would be entitled to receive or otherwise obtain the use of any part of the income or capital of the residue of the substitution before the spouse’s death. Approximately $25,000 in annual income (interest, dividends) would result from this bequest by way of substitution. In your opinion, the substitution of the residue is a testamentary trust for which a T3 Statement of Trust Income Allocations and Designations must be filed.
If the annual income of the bequeathed substituted property is taxed in the trust, you wish to know:
- Are the taxes of this trust to be paid by the trust or by the spouse out of the spouse’s personal assets?
- If the spouse pays the taxes of the trust, does the payment constitute a contribution to the capital of the trust that disqualifies the trust as a "testamentary trust" within the meaning of subsection 108(1)?
Our Comments
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is the practice of the Canada Revenue Agency (the "CRA") not to issue a written opinion regarding proposed transactions otherwise than by advance rulings. Furthermore, when it comes to determining whether a completed transaction has received adequate tax treatment, the determination is made first by our Tax Services Offices as a result of their review of all facts and documents, which is usually performed as part of an audit engagement. However, we can offer the following general comments that may be helpful to you.
Clause 248(3)(a)(i)(B) provides that a substitution created by will is deemed to be a trust created by will. In addition, under Clause 248(3)(a)(ii)(A), the property subject to such substitution is deemed to have been transferred to the trust on and as a consequence of the death of the testator. In our view, these provisions apply to the residual substitution created by a will. The trust rules in the Act therefore apply in respect of such property. Under paragraph 248(3)(d), the donee and the residuary beneficiaries are deemed to be beneficially interested in the trust.
Subsection 70(6) permits a rollover where a capital property referred to in subsection 70(5) is transferred on the death of a taxpayer to a spousal trust. Paragraph 70(6)(b) refers a trust, created by the taxpayer’s will, that was resident in Canada immediately after the time the property vested indefeasibly in the trust and under which
• the taxpayer’s spouse or common-law partner is entitled to receive all of the income of the trust that arises before the spouse’s or common-law partner’s death, and
• no person except the spouse or common-law partner may, before the spouse’s or common-law partner’s death, receive or otherwise obtain the use of any of the income or capital of the trust.
In the situation described, the capital assets bequeathed to the spouse with a substitution of the residue could benefit from the rollover rules provided in paragraph 70(6)(b).
Subsection 104(13) provides that a beneficiary of a trust must include in computing its income for the year the portion of the income of the trust that became payable to it in the year. Subsection 104(24) specifies the circumstances in which an amount becomes payable in a year. Essentially, an amount becomes payable by a trust in a taxation year, if the trust paid that amount to the beneficiary or if the beneficiary was entitled to demand payment during the year.
Since the deduction under paragraph 104(6)(b) in respect of income payable to a beneficiary is discretionary, the trust may claim less than the amount determined under that paragraph. Where the trust deducts less than the amount of income payable to the beneficiary, subsections 104(13.1) and 104(13.2), depending on the type of income, allow the trust to designate an amount to a beneficiary according to the formulas provided in those paragraphs. This amount will not be considered to have been paid or become payable during the year so that the beneficiary will not have to include it in the beneficiary’s income. The ability to designate an amount to a beneficiary, among others, by virtue of subsection 104(13.1), effectively allows the trust to be subject to tax on that income even if it was paid or is payable to the beneficiary.
As stated in paragraph 19 of Interpretation Bulletin IT-381R3 -- Trusts -- Capital Gains and Losses and the Flow-Through of Taxable Capital Gains to Beneficiaries (Footnote 1), an income beneficiary may agree to pay a trust's tax liability arising from a designation under subsection 104(13.1) or (13.2). That payment is not a contribution for the purpose of paragraph (b) or (c) in the subsection 108(1) definition of "testamentary trust". The payment must equal the tax payable by the trust on the income that is deemed not to have been paid or payable to the beneficiary because of the designation. The payment can be made by
(a) reimbursing the trustee,
(b) providing a cheque payable to the taxing authority, or
(c) receiving a net amount from the trustee reflecting the beneficiary's share of income less the relevant taxes payable by the trust.
For taxation years ending after December 20, 2002, the definition of "testamentary trust" in subsection 108(1) is amended, inter alia, by the proposed addition of paragraph (d) (footnote 2). This paragraph essentially provides that a trust ceases to be a testamentary trust when it incurs a debt or other obligation of which a guarantor or creditor is, in particular, a beneficiary. However, the status of a testamentary trust is not tainted when, among other things, the debt or obligation is incurred in settlement of the beneficiary's right to require the payment of an amount out of the income or capital gains payable by the trust by receiving a portion of the capital of the trust.
The forms of payment of tax payable described in paragraph 19 of IT-381R3 should not normally give rise to a debt or obligation of the trust to the beneficiary.
We emphasize that this opinion is not an advance ruling and does not bind the CRA with respect to a particular factual situation.
We hope that our comments will be of assistance.
Best regards,
Louise J. Roy, CPA, CGA
Manager}
or the Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 You can consult this Interpretation Bulletin by visiting the CRA's Web site at http://www.cra-arc.gc.ca/E/pub/tp/it381r3/README.html
2 Proposed amendments in subsection 236(3) of Bill C-48, making technical amendments to the InomeTax Act, 2012 (First Reading: November 21, 2012)
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