30 March 2004 External T.I. 2004-0062291E5 - Discretionary interest in a non-resident 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.

Principal Issues:

1. Whether an interest in a discretionary non-resident trust would be a participating interest in a foreign investment entity?

2. Whether the FMV of an interest a discretionary non-resident trust is nil?

Position: 1. Yes, assuming the proposed legislation is enacted as proposed.

2. Not necessarily.

Reasons: 1. The Canadian resident beneficiaries are "beneficially interested" in the non-resident trust, by virtue of subsection 248(25).

2. It would be unreasonable to conclude in all cases that the FMV of an interest in a discretionary trust holding property with significant value has no value.

XXXXXXXXXX 2004-006229
S. E. Thomson
March 30, 2004

Dear XXXXXXXXXX:

Re: Interest in a Discretionary Non-Resident Trust

This is in reply to your letter of February 13, 2004 in which you ask for our views on the taxation of an interest in a discretionary non-resident trust. The hypothetical facts that you have presented to us are as follows:

? A trust is settled by a non-resident individual (the "Settlor"). The Settlor is never resident in Canada. The trustees of the trust are also non-residents of Canada.

? The beneficiaries of the trust include certain Canadian resident individuals.

? The beneficiaries are not "testamentary beneficiaries", as that term is defined in proposed subsection 94(1) of the Income Tax Act (the "Act").

? The trust document empowers the trustees to distribute capital and income to one or more beneficiaries to the exclusion of other beneficiaries.

? The assets of the trust are shares and debt of various arm's length public corporations.

? The trust is resident in a non-treaty country.

? The non-resident trust is not subject to proposed subsection 94(3) of the Act.

? The interest in the non-resident trust in not an "exempt interest", as that term is defined in proposed subsection 94.1(1) of the Act.

You would like to know:

1. Would we consider the interest in the discretionary non-resident trust to be a "participating interest" in a "foreign investment entity", as those terms are defined in proposed subsection 94.1(1) of the Act?

2. Assuming proposed subsection 94.1(4) of the Act applies to the interest in the non-resident trust, would we consider the "designated cost", as defined in proposed subsection 94.1(1), of the interest to be nil?

OUR COMMENTS

Your questions appear to involve actual taxpayers and a factual situation. As such, we are unable to definitively reply to your question until we have had the opportunity to review all the facts and related documentation. Such a review is conducted by the relevant tax services office where the query relates to a completed transaction, or by this directorate where the arrangement is the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5. We nevertheless offer the following general comments regarding the relevant proposed provisions of the Act. Since these comments are general in nature, they may or may not apply in your situation and are not binding on the Canada Revenue Agency.

1. Assuming the October 30, 2003 draft legislation is enacted as proposed, it is our view that the interest in the non-resident trust that you have described above would be a participating interest in a non-resident entity, as defined. A "participating interest" includes a "specified interest" (as defined in proposed subsection 94.1(1) of the Act) in a non-resident trust. By virtue of paragraph (b) of the definition, a "specified interest" includes an interest of the individual as a beneficiary under the trust if the interest includes at that time a right of the individual as a beneficiary under the trust to receive at or after that time income or capital of the trust, unless the individual is a testamentary beneficiary under the trust, as defined in proposed subsection 94(1) of the Act.

In proposed subsection 94.1(1), the term "beneficiary" is given (except for the purpose of proposed paragraph 94.2(11)(f)) the meaning assigned by the definition of "beneficiary" in proposed subsection 94(1). By virtue of paragraph (a) of the definition of "beneficiary" in proposed subsection 94(1), a beneficiary under a trust includes an entity that is beneficially interested in the trust. The phrase "beneficially interested" is defined in subsection 248(25) for purposes of the Act. A person will be beneficially interested in a trust if that person has any right (whether immediate or future, whether absolute or contingent or whether conditional on or subject to the exercise of any discretion by any person) as a beneficiary under the trust to receive any of the income or capital of the trust.

Note that the term "entity" in proposed subsection 94(1) includes a natural person, whereas the term "entity" in proposed subsection 94.1(1) does not. In our view, based on the reasoning in The Queen v. Erling Marvin Olsen 2002 DTC 6770, since the term "beneficiary" in proposed subsection 94.1(1) assigns to that term the meaning in proposed subsection 94(1), the term "beneficiary" can only have the meaning in proposed section 94. Therefore, a "participating interest" referred to in proposed subsection 94.1(4) includes a "specified interest" as defined in proposed subsection 94.1(1) that is a right of a natural person as a beneficiary to receive income or capital of a trust.

2. The term "designated cost" as defined in proposed subsection 94.1(1) includes the fair market value of the participating interest to the extent that it exceeds the cost amount, either by virtue of variable D or variable F, depending on when the participating interest was acquired.

At the 1992 Canadian Tax Foundation B.C. Conference, we admitted that it would be difficult to quantify the value of an interest in a discretionary trust. However, in our view, it would be unreasonable to conclude in all cases that an interest in a discretionary trust holding property with significant value has no value. The CRA does not have a general valuation position or policy with respect to the valuation of an interest in a discretionary trust. Given that trusts are established through legal documents that can materially differ from one trust to another, each situation must be judged on its own merits. The valuation of an interest in a trust involves an analysis of all relevant information, and the exercise of judgment in determining the appropriate method of valuing such an interest. Matters concerning the valuation of property, including the valuation of an interest in a trust are referred to the Valuations Section of the relevant Tax Services Office. As part of the CRA Future Directions project, Valuation Services is now offering a limited pre-valuation service that may provide some assistance to outside practitioners in this area.

We trust that we have been of some assistance.

Yours truly,

Olli Laurikainen, C.A.

Manager
for Director
International & Trusts Division
Income Tax Rulings Directorate