7 September 1990 Income Tax Severed Letter - Cemetary companies — capital gains versus income on trust fund investments

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.

Subject: Cemetery Companies: capital gains versus income on trust fund investments

This is in reply to your memorandum of June 12, 1990 requesting our comments on the above noted issue.

Facts

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Ontario Cemeteries Act (1980):

Subsection 38(1) requires a cemetery owner selling pre-need supplies or services to get up a pre-need assurance fund. Subsection 27(2), which applies to pre-need assurance funds by virtue of subsection 38(3), requires the trustee to pay the income from the fund to the cemetery owner.

Regulation 91, contains the rules for maintaining the pre-need assurance fund. Subsection 4(2) states that 65% of a pre-need supply and service sale is to be transferred to the fund. Section 7 requires a minimum deposit in the fund of 50% and 65% respectively of pre and post January 1, 1966 contracts for supplies and services that have not yet been fulfilled, and sections 5 and 6 permits the trustee to pay these amounts to the owner upon fulfilling the contract.

Therefore the objective of the 1980 Cemeteries Act, regarding the pre-need assurance funds, appears to have been only to maintain the original percentage of the contract price until it is fulfilled. There was no requirement to leave the funds grow in the trust to off-set anticipated higher costs in the future to provide these supplies or services.

Ontario Cemeteries Act (1989):

The revisions of the Act resulted in considerable changes to procedures for maintaining the pre-need assurance fund. Subsection 36(3) requires all amounts received for the pre-need supplies or services to be transferred to the fund.

Income earned in the fund must be retained and paid out as explained below. When a portion of the contract for supplies or services is completed, the trustee can pay to the cemetery owner the lesser of the current market price and the customer payment plus income. If the payment plus income exceeds the current market price at that time, the trustee will pay the excess to the owner (per 36(6)) who in turn pays it to the purchaser or his estate (per 36(9)). Section 24 and subsections 36(7) and 36(8) permit the purchaser to cancel his contract any time before delivery of pre-need supplies or services. Upon cancellation the trustee pays the original payment plus income to the owner who in turn pays it to the customer, after retaining a service fee.

75(2) of the Income Tax Act:

Subsection 75(2) of the Income Tax Act deems income and gains earned on property transferred to a trust to be that of the transferor where the property may revert to the transferor. The 1980 version of the Cemeteries Act contains no provision for returning funds to the customer upon cancellation of a prepaid arrangement. XXX

With the 1989 revisions to the Cemeteries Act, a customer had the right to cancel a contract for pre-need supplies and services and get a refund of his money plus income. Because of the cancellation right subsection 75(2) is applicable to the arrangement. Even if a contract did not provide for a refund upon cancellation, presumably, the Cemeteries Act would override it with the result that subsection 75(2) of the Income Tax Act would apply.

The above comments are restricted to the province of Ontario. To determine if subsection 75(2) applies to other provinces it would be necessary to review the respective provincial acts and contracts of the local cemetery companies.

These comments are consistent with our position on prepaid funeral arrangements and we are currently advising funeral directors of this.

Gains versus Income

• 1. Neither the fact XXX can direct the trust, nor the fact the trust is required to be created by provincial legislation is very relevant to the income versus gains determination. A trust is a separate entity for tax purposes and the income versus gains question should be determined by analyzing the course of conduct of the trust. Paragraphs 10 to 13 of IT-479R list various factors to consider in ascertaining whether the course of conduct indicates the carrying on of a business. Also, as indicated in paragraph 9 of IT-479R, some transactions may be on account of income while others are on account of capital.

If, after examining the activities of the trust, it is concluded that the trust is carrying on a business in securities trading and all transactions are on account of income there will be no gains to allocate to the beneficiaries. Under the 1980 Cemeteries Act the beneficiaries would be the cemetery owners while it would be the customers under the 1989 Act.

• 2. XXX. The 1989 Act requires 100% of the amounts received for supplies and services to be transferred to the pre-need assurance fund and any income must be held in the fund. While the 1980 version only required 65% of the amount received to be transferred and no income withheld.

However, as previously indicated, the main determinant of the income versus gains questions would be the trust activity and not the legal requirements regulating the trust. Also, for insurance companies, this determination would be based on activity and not on legislation. For more information on the Department's position regarding insurance companies we suggest you contact Mary Loveday of the Specialized Industries Section, Special Audits Division.

• 3. Subsection 104(21) of the Income Tax Act permits a Canadian resident trust to flow capital gains through to its beneficiaries including corporate beneficiaries.