Subsection 106(1) - Income interest in trust
Administrative Policy
S6-F2-C1 - Disposition of an Income Interest in a Trust
Cost to the beneficiary
1.20 For the purpose of determining the deduction available under subsection 106(1), the cost to a beneficiary of the income interest is generally nil, pursuant to subsection 106(1.1). This will be the case except where any part of the interest was acquired from a person who was the beneficiary in respect of the interest immediately before that acquisition or where part of the interest was at any time determined not to be nil under the taxpayer migration rules in section 128.1.
1.21 Therefore, for the purposes of subsection 106(1), the cost to a taxpayer of an income interest in a trust acquired directly from a person who was the prior beneficiary of the income interest will generally be the amount paid for it. However, if the income interest was acquired from a prior beneficiary in a non-arm's length transaction for an amount that exceeded its FMV, paragraph 69(1)(a) will deem its cost to be its FMV. If the income interest was acquired from the beneficiary by way of gift, paragraph 69(1)(c) will deem its cost to be its FMV.
Example 2
…Mr. X establishes a personal trust (the Trust) in favour of his son, Mr. A, and grandson, Mr. B. He settles the Trust by transferring to the Trust, property consisting of 100 shares of XCorp and a parcel of land. Mr. A is the income beneficiary and Mr. B is the capital beneficiary. Mr. X is now deceased. …
| Locations of other summaries | Wordcount | |
|---|---|---|
| Tax Topics - Income Tax Act - Section 256 - Subsection 256(7) - Paragraph 256(7)(b) | 110 | |
| Tax Topics - Income Tax Act - Section 67.6 | 281 |
Scenario 2
In a particular tax year, the Trust had income of $25,000 that it allocated to Mr. A. The Trust did not have enough funds to pay that amount in that year. However, Mr. A was entitled to enforce a payment of $25,000 by the Trust. Pursuant to subsection 104(13), Mr. A included the amount of $25,000 in computing his income from the Trust for that year.
In the following year, Mr. A decides to gift his income interest to the other beneficiary, his adult son, Mr. B. This gift constitutes a disposition of Mr. A's income interest in the Trust. The FMV of Mr. A's income interest is determined to be $200,000. If the income interest disposed of includes the right to enforce payment of the $25,000 by the Trust, then the following are the tax implications on the disposition of Mr. A's income interest:
- The disposition of Mr. A's income interest triggers the application of subsection 106(2). Since it is a non-arm's length transaction, Mr. A's proceeds of disposition will be the FMV of his income interest in the trust pursuant to paragraph 69(1)(b). The income interest disposed of includes a right to enforce payment of $25,000, which was already included in Mr. A's income under subsection 104(13) in the previous year. This means that the income inclusion under subparagraph 106(2)(a)(i) will be reduced by $25,000 under subparagraph 106(2)(a)(ii). Therefore, pursuant to subsection 106(2), Mr. A will include $175,000 [$200,000-$25,000] in computing his income from the disposition of the income interest in the Trust. Any taxable capital gain or allowable capital loss for Mr. A will be deemed to be nil.
- Pursuant to subsection 106(1.1), the cost of the income interest to Mr. A is deemed to be nil.
- Pursuant to paragraph 69(1)(c), the cost of acquisition of the income interest to Mr. B is its FMV of $200,000.
Scenario 3
Adopt the same additional facts as outlined in Scenario 2. Assume further that the Trust distributes $100,000 of income to Mr. B in the first tax year (Year 1) after he has acquired the income interest from Mr. A, and $150,000 in the second year (Year 2).
| The following table shows the tax consequences for Mr. B, with calculations shown where applicable: | ||
Description
Year 1
Year 2
$100,000
$150,000
- ii) $200,000 ($200,000 - $NIL)
Lesser amount is $100,000
- ii) $100,000 ($200,000 - $100,000)
Lesser amount is $100,000
$50,000 ($150,000 - $100,000)
Therefore, at the end of Year 2, Mr. B would have fully offset the cost of acquisition of his income interest in the Trust.
IT-385R2 "Disposition of an Income Interest in a Trust"
Subsection 106(2) - Disposition by taxpayer of income interest
Administrative Policy
2022 Ruling 2021-0919101R3 - Ruling Letter
Background
Daughter1 and Daughter2 (sisters) had been the equal income beneficiaries of a testamentary trust (the Fund). However, on the death of Daughter2, ½ of the Fund property had been distributed in accordance with the Fund terms to her issue.
Proposed transactions
- Daughter1, who has no children, will now execute a written renunciation of her income interest in the Fund. However, she also will, for greater certainty, disclaim any capital interest that might accrue to her as a result of such renunciation.
- Each of Daughter1, and Daughter2’s children and grandchildren (all adults) will sign a consent to the distribution of all of the capital property of the Fund to Daughter2’s children as described below.
- The Trust Company (which, with Daughter1, is the trustee of the Fund) will prepare a scheme of distribution that divides the property in the Fund (mostly marketable securities and mutual fund trust units) into three shares, each representing 1/3 of the FMV and contemplates in specie distribution of most of the property, to each child of Daughter2 - other than some of the mutual fund units, which are not permitted to be transferred and, instead, must be sold for cash, with the cash proceeds being so distributed. Daughter1 will approve of the scheme before it is sent to Daughter2’s children.
- After an interim distribution, filing of the final T3 return, approval of accounts and receipt of a clearance certificate, the final distribution will be made in accordance with the scheme of distribution.
- 1/3 of the taxable capital gains realized from the sale of the MFT units referred to in 3 above, will be allocated to each of the children.
Rulings
The transactions, other than the property distributions by the Fund, will not result in a disposition of any property of the Fund.
The renunciation by Daughter1 of her income interest in the Fund will not result in Daughter1 being considered to have received any proceeds of disposition for purposes of ss. 40(1), 106(2) and 107(1).
The consent provided by Daughter1, Daughter2’s children and grandchildren will not result in any of them being considered to have received any proceeds of disposition for purposes of ss. 40(1), 106(2) and 107(1).
S. 107(2) will apply to the distributions of the Fund property to each of Daughter2’s children.
| Locations of other summaries | Wordcount | |
|---|---|---|
| Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Disposition | aunt’s renunciation of her trust income interest, and her approval of the resulting scheme of distribution to the residual beneficiaries, did not entail a disposition | 186 |
S6-F2-C1 - Disposition of an Income Interest in a Trust
Offset
1.6 Pursuant to paragraph 106(2)(a), where a taxpayer disposes of an income interest in a trust that includes a right to enforce payment of an amount by the trust, the proceeds of disposition of the income interest are offset by the amount that has been included in the taxpayer's income under subsection 104(13) in respect of that right. However, where property of the trust is distributed in satisfaction of an income interest of the beneficiary, paragraph 106(2)(a) does not apply.
Meaning of disclaimer
1.10 Generally, a disclaimer is an outright refusal to accept a gift or interest. A taxpayer who executes a valid disclaimer (not in favour of any person) of an income interest in a trust will be considered not to have acquired that income interest. Therefore, in such a situation, subsection 106(2) will have no application. To be a valid disclaimer the refusal must occur:
- within a reasonable time after the recipient becomes aware of the gift or interest; and
- before the acceptance of any funds or benefits in respect of the gift or interest.
1.11 When subsection 248(8) applies (occurrences as a consequence of death) a disclaimer must meet the requirements of the definition of a disclaimer found in subsection 248(9). …
1.12 A person who has accepted any funds from the trust in respect of an income interest in the trust, or who has executed a disclaimer in respect of an income interest in the trust in favour of another person, would be considered to have acquired the income interest and therefore would be unable to execute a valid disclaimer. …
Meaning of release or surrender
1.13 A release or surrender is either an extinguishment or discharge of a legal right or claim, or a transfer of a legal right or claim to another person. Where a taxpayer formally releases or surrenders all or any part of an income interest in a particular trust in respect of future payments (amounts not due and payable at the time of the release or surrender) in favour of one or more other persons, paragraph 69(1)(b) will deem the taxpayer to have received proceeds of disposition equal to the FMV of the income interest at the time of the release or surrender. The taxpayer must include that amount in income pursuant to subsection 106(2). …
1.14 … Pursuant to paragraph 248(8)(c), a release or surrender by a beneficiary with respect to any property that was property of a deceased individual immediately before death, is not considered to be a disposition of the property by the beneficiary . However, paragraph 248(8)(c) does not apply to an income interest that arises upon the death of the deceased, as such an interest could not have been property of the deceased immediately before death.
Release or surrender for no consideration
1.15 A taxpayer who, for no consideration, validly releases or surrenders, in accordance with the terms of the trust and the relevant provincial law, an income interest in a trust in respect of future payments (amounts not due and payable at the time of the release or surrender ) and does not in any manner direct who is entitled to receive the benefits, will not be considered to have received any proceeds of disposition for the purposes of subsection 106(2). The result will be the same where the taxpayer designates or otherwise agrees which person or persons will benefit by reason of the release or surrender, if the same person or persons would be entitled to benefit in the same way under the trust without the taxpayer's designation or agreement. …
26 February 2007 External T.I. 2005-0159431E5 F - Renonciation aux revenus d'une fiducie
CRA found that the renunciation of the income of a spouse trust by the spouse under Art. 1285 of the Civil Code (or pursuant to a clause in the trust deed) would not engage s. 106(2).
| Locations of other summaries | Wordcount | |
|---|---|---|
| Tax Topics - Income Tax Act - 101-110 - Section 108 - Subsection 108(1) - Testamentary Trust - Paragraph (c) | renunciation of income not yet realized is not a contribution to the trust | 85 |
18 March 2005 External T.I. 2004-0089661E5 F - Fiducie personnelle-Résidence principale
Father acquired a rental property (the "Immovable") in 1956 and, on his death in 1994, devised the usufruct of the Immovable to his wife ("Mother") and the bare ownership of the Immovable to his daughter ("Daughter"), who had been living in and renting a housing unit in the Immovable since 1988, continued to pay rent after Father’s death. Mother renounced her usufruct during her lifetime in favour of Daughter or, alternatively, such usufruct was devised to Daughter upon Mother's death. CRA stated:
In the event that Mother renounces her income interest in favour of Daughter during her lifetime, paragraph 69(1)(b) would apply to deem Mother to dispose of her income interest in the Trust at FMV. In this case, subsection 106(2) would apply to cause Mother to include in her income the amount of that FMV.
In the event of Mother's death, the terms of her will could result in her income interest simply being extinguished. If this were the case, there should be no tax consequences to Mother.
| Locations of other summaries | Wordcount | |
|---|---|---|
| Tax Topics - Income Tax Act - Section 54 - Principal Residence - Paragraph (c.1) - Subparagraph (c.1)(ii) | the residence being leased to the specified beneficiary does not change that it may be a principal residence to the trust | 339 |
| Tax Topics - Income Tax Act - 101-110 - Section 107 - Subsection 107(4) | application of s. 107(4) to spouse trust respecting residence turned on whether such trust was terminated by such income interest being distributed to the capital beneficiary during the spouse’s lifetime or on her death | 282 |
30 November 1996 Ruling 9706043 - SURRENDER OF INCOME INTEREST
Where the income beneficiary of a family trust releases and surrenders all her interests in the trust, she will be considered to have disposed of her interests for no proceeds.
ATR-3 (29 Nov. 85)
In winding-up an estate, all the estate assets would be transferred to the capital beneficiaries who would agree to give to their mother (the life tenant) $21,000 a year for life (the approximate income level she was receiving before the winding-up). The proceeds taxable under s. 106(2) would be the capitalized value of the payments expected to be made to her.
IT-385R2 "Disposition of an Income Interest in a Trust"
Articles
Elie Roth, Tim Youdan, Chris Anderson, Kim Brown, "Taxation of Beneficiaries Resident in Canada", Chapter 4 of Canadian Taxation of Trusts (Canadian Tax Foundation), 2016.
Requirements for valid disclaimer of income interest (pp. 340
A taxpayer who executes a valid disclaimer of an income interest in a trust is generally considered not to have acquired the income interest….In order-to constitute a valid disclaimer for these purposes, the CRA's position is that the refusal must occur within a reasonable time after the recipient becomes aware of the gift or interest and before the recipient accepts any funds or benefits in respect of the gift or interest. However, if die taxpayer accepts any funds from the trust in respect of die income interest or executes a disclaimer in respect of the income interest in favour of another- person, the taxpayer is considered to have acquired the income interest and therefore cannot execute a valid disclaimer. [fn 174: [S6-F2-C1], at paragraphs 1.13 to 1.15. The CRA's position in this regard appears to be inconsistent with judicial authority in Ontario. In Re Coulson, 1977 Can1.II 1060 (ONCA), the Ontario Court of Appeal held that an income beneficiary who had been receiving income from a trust on an annual basis could validly disclaim the income from her interest in the trust in a particular, taxation year, and then continue to receive the income in subsequent taxation years….]
[I]n Murphy Estate…[t]he court noted that a disclaimer is a refusal to accept an interest that has been bequeathed to a disclaiming party. Its effect is to void the gift as if the disclaiming party never received it. The gift becomes part of the estate of the deceased and the disclaiming party has no right to direct who is to receive the gift.
Effect of McKenzie: amount distributed not also proceeds (p. 345)
[McKenzie]…confirms that when property is distributed by a trust to a taxpayer in satisfaction of all or any part of the taxpayer's income interest in the trust, the amount of the proceeds of disposition of the income interest need not be included in computing the beneficiary's income for the year, because the amount distributed to the beneficiary in satisfaction of the income interest could otherwise be subject to double taxation.
Distinction between disposition and termination (p. 349)
The CRA has considered a situation in which an estate of which the deceased's wife was the income beneficiary for life and her sons-were the capital beneficiaries was wound up in accordance with a court order, her income interest was terminated prematurely, and the capital was distributed to the sons. She agreed to relinquish her income interest for consideration provided by the sons—namely, a contractual undertaking to pay her a fixed dollar amount per year for life. [fn 186: ATR-3…cancelled September 30, 2012] The CRA characterized the transaction as the disposition by the wife of her income interest for proceeds equal to the actuarial value of the agreed upon annuity. The proceeds were treated as ordinary income pursuant to subsection 106(2).
This conclusion by the CRA appears to be incorrect because it assumes that paragraph 106(2)(a) can apply to a disposition of an income interest, even though no one acquires the interest and the disposition occurs in connection with the termination of the trust…. [S]ubsection 106(2)…is intended to apply to situations in which an income beneficiary voluntarily transfers an income interest to a third party (the acquiror) for consideration (or deemed consideration in the case of a gift), following which the acquiror becomes eligible to receive the income that would otherwise have been distributed by the trust to the transferor. The provision is premised on the continuation of the income interest, the trust, and the trust capital….
Demarcation between s. 106(2) and 106(3)
[S]ubsection l06(2) … is intended to apply to situations in which an income interest is disposed of to and acquired by a third party, while subsection 106(3) deals with the situation in which an income interest is disposed of to the trust itself and thereby eliminated. As explained in McKenzie, the purpose of subsection 106(2), consistent with the general scheme of tire Act, is to tax economic gains realized by an income beneficiary on the transfer of its trust interest to a third party for consideration. A subsidiary purpose is to tax the gains as ordinary income, and not as capital gains, since the beneficiary is monetizing a future income stream that would otherwise have been taxable as ordinary income in his hands. The apparent purpose of subsection 106(3) is to assimilate the taxation of the transactions to which it applies to a gift of trust property made by the settlor to the beneficiary.
Subsection 106(3) - Proceeds of disposition of income interest
See Also
McKenzie v. The Queen, 2011 DTC 1216 [at at 1274], 2011 TCC 289
The testator of a testamentary trust holding shares of a company provided that an executive employee of the company had an entitlement to the income from one-fifth of those shares until the termination of her employment. When the executive (the taxpayer) was subsequently dismissed, the taxpayer sued the capital beneficiary and the trust for wrongful dismissal, oppression and wrongful depletion and termination of her income interest. A settlement agreement provided for the payment by the trust to her of $1.7 million in satisfaction of her interest in the trust. Through a numbered company, the capital beneficiary issued a promissory note to the trust for $1.7 million in exchange for the shares held for the taxpayer. The trust issued a promissory note to the taxpayer in the same amount. The trust's law firm then gave the taxpayer a certified cheque for $1.7 million to discharge the trust's promissory note.
Boyle J. found that s. 106(3) applied to the settlement payment, and therefore that s. 106(2) did not apply. The three elements of s. 106(3), that the $1.7 million was property of the trust when paid, that the alleged trust property was distributed to a beneficiary, and that the distribution was in satisfaction of the taxpayer's income interest, were all met. Boyle J. rejected the Minister's argument that the money was never the property of the trust, but rather was property of the beneficiary's numbered company. The transfer of promissory notes was a transfer of trust property. He stated (at para. 21):
Surely [the Minister] would not seriously have contested a bill of exchange involving a bank and I have been provided with no persuasive argument that enforceable promissory notes from solvent entities should be treated any differently.
Boyle J. also found that the property had been distributed to the taxpayer. He stated (at para. 22) that "[t]here is no apparent reason put forward to suggest that the term 'distributed' should not be given its ordinary meaning." Finally, he found that the distribution was in satisfaction of an income interest. He rejected (at paras. 26-27) the Minister's argument that the lump sum payment to the taxpayer, which was contrary to the existing terms of the trust, amounted to an impermissible amendment of the trust deed. The rule in Saunders v. Vautier permitted the beneficiaries and the trust to modify the operation of the trust by entering into a termination agreement.
| Locations of other summaries | Wordcount | |
|---|---|---|
| Tax Topics - General Concepts - Payment & Receipt | payment through back-to-back promissory notes | 228 |
Administrative Policy
3 November 2023 APFF Financial Strategies and Instruments Roundtable Q. 4, 2023-0990531C6 F - Life insurance policy transfer
A private company (Aco) was the beneficiary and holder of a policy, on the life of Mr. X, with an adjusted cost basis (ACB), cash surrender value (CSV) and FMV of $50, $150 and $250, respectively. All of the common shares of Aco were held by a discretionary family trust (Trust X) of which Xco (a holding company controlled by Mr. X) was a capital and income beneficiary.
In the year immediately preceding that sale on January 1 of all the shares of Aco, Aco paid a dividend in kind of the policy to Trust X, so that the policy was deemed to be disposed of for the greatest of its ACB, CSV and the (nil) consideration received, or $150.
On December 31 of that year, Trust X then distributed the policy to Xco as a dividend pursuant to ss. 104(6) and (13), and made a s. 104(19) designation.
Regarding the distribution by Trust X, would s. 106(3) prevail over s. 148(7), so that the policy would be deemed to have been disposed of for its FMV?
CRA indicated that where the amount paid was of income under the applicable private law, then s. 106(3) could apply to deem a disposition of the policy for its FMV.
CRA considers that where a trust transfers the policy to its beneficiary, the beneficiary is regarded as giving consideration for the transfer that is all or any part of the beneficiary's income or capital interest, as applicable. Here, it would be reasonable to consider that such consideration had an FMV of $250.
Thus, it made no difference which of s. 106(3) and s. 148(7) prevailed over the other.
| Locations of other summaries | Wordcount | |
|---|---|---|
| Tax Topics - Income Tax Act - Section 148 - Subsection 148(7) | a trust distribution of a life insurance policy to a beneficiary was made for FMV consideration equal to the part of the beneficiary’s capital or income interest that is satisfied | 450 |
| Tax Topics - Income Tax Act - 101-110 - Section 107 - Subsection 107(2) | s. 107(2) inapplicable to distribution in satisfaction of a trust debt owing to the beneficiary | 296 |
31 August 2001 External T.I. 2001-0087865 F - Accélération de remise de capital
Regarding a resident qualifying spousal trust that provided that on the death of the surviving spouse, the residue of the trust property was to be distributed in equal shares to the surviving spouse's children, CCRA discussed the consequences to the surviving spouse of disposing of their income interest in the spousal trust for a lump sum, followed by an accelerated distribution of the capital to the children. Regarding the resulting disposition of the spousal beneficiary’s income interest, it indicated that there would be no amount to include in the beneficiary’s income pursuant to s. 106(2) as s. 106(3) would apply – but s. 106(3) would have no adverse consequences assuming that the property distributed was cash.
| Locations of other summaries | Wordcount | |
|---|---|---|
| Tax Topics - Income Tax Act - 101-110 - Section 107 - Subsection 107(2.1) | generally favourable consequences of early termination of spousal trust pursuant to s. 107(2.1) | 236 |