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.
Principal Issues: Is income earned by a testamentary spousal trust after the death of the surviving spouse, taxable to the trust or to the residual beneficiary?
Position: Question of fact - depends on the terms of the trust and the nature and extent of the trustee's discretion as to whether an amount in considered "payable"
Reasons: Meaning of payable - 104(24) for purposes of subsection 104(6)
QUESTION #4 - TAXATION OF INCOME OF TESTAMENTARY SPOUSAL TRUST AFTER DEATH OF SPOUSE BENEFICIARY
Let's assume the following facts:
1. Spouse A dies.
2. The will of Spouse A creates a spousal trust for the benefit of Spouse B upon the death of Spouse A. It has all the usual terms for rollover pursuant to subsection 70(6).
3. Spouse B then dies and the terms of the testamentary trust provide for all of the capital to be transferred to a residual charitable beneficiary. For tax purposes, of course, there would be a deemed disposition of the testamentary trust assets as of the date of the Spouse B's death pursuant to the provisions of subsection 104(4).
4. During the period of administration of the testamentary spousal trust after Spouse B's death, the trustee either allocates the trust income to the residual beneficiary or will make a designation under subsections 104(13.1) or 104(13.2) to not have the income taxed in the hands of the residual beneficiary.
Given the above, we understand that the CRA has recently been taking the position that the residual charitable beneficiary is not entitled to the income of the testamentary trust after the death of Spouse B since the will of Spouse A does not clearly provide for the residual beneficiary to be an income beneficiary. Accordingly, all of the income of the testamentary trust from the date of Spouse B's death to the wind-up of the testamentary trust is apparently taxable in the testamentary trust as opposed to being allocated to the residual charitable beneficiary.
Assuming we correctly understand CRA's position, can you please explain your basis for the above position?
Paragraph 6 of Interpretation Bulletin IT-286R2, "Trusts - Amount Payable", discusses the notion of the "executor year" under common law for a testamentary trust. It is stated in this paragraph that where the initial taxation year of a testamentary trust coincides with the executor year and where the sole reason for the rights of a beneficiary being unenforceable is the existence of an executor's year, the CRA will consider the income of the trust for that year to be payable to the beneficiary or beneficiaries of the trust pursuant to subsection 104(24).
As stated in the T3 Trust Guide, "generally, you allocate income to the trust's beneficiaries according to the terms of the will or trust document". The T3 Trust Guide further points out that an amount can only be allocated to a beneficiary if one of the following applies:
- the beneficiary is entitled to the income in the year that it is earned by the trust, under the trust document;
- the trust makes a preferred beneficiary election to include the trust income in the beneficiary's income; or
- the beneficiary is paid income in the year that is earned by the trust, at the discretion of the trustee.
As noted in document 2007-0259841E5, "pursuant to subsection 104(6), there may be deducted in computing the income of an estate or trust for a taxation year, such amount as the estate or trust claims that would be its income for the year as became payable in the year to a beneficiary. Subsection 104(24) provides that, for the purposes of subsection 104(6), an amount is deemed not to have become payable to a beneficiary in the year for the purposes of subsection 104(6) unless the amount was actually paid to the beneficiary in the year, or the beneficiary was entitled in the year to enforce payment of it."
Therefore the determination as to whether income can be allocated to the residual beneficiary (and thus deducted by the trust in computing its income), in our view, will be a question of fact that will depend upon the terms of the trust.
It should be noted that if the income of the trust for tax purposes was comprised of items such as deemed dividends, capital gains or various phantom incomes, which were not specifically defined as income for trust purposes, then such amounts would not be deductible from the income of the trust, as they would not be payable as income to the beneficiary. Furthermore, subsection 104(6) does not allow for any of the gains deemed on the death of Spouse B to be allocated to the beneficiary.
June 2-3, 2011
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