Principal Issues: Does subsection 75(2) of the Act apply to property acquired with the proceeds of a loan made to a trust that is independent of the terms of the trust?
Position: Where a loan (independent of the terms of the trust) is made to a trust, the income from the property acquired with the borrowed amounts will not be subject to the presumption of subsection 75(2) as long as the property acquired is not, in and of itself, property held under any of the conditions referred to in subsection 75(2). Thus, subsection 75(2) could apply if the property was acquired from a capital beneficiary of the trust, whereas it would not apply if the property acquired was shares issued from the treasury.
Reasons: Wording of the subsection.
XXXXXXXXXX 2008-026812 Sylvie Labarre, CA June 23, 2008
Dear Sir,
Subject: Assets acquired paid for with borrowed funds
This is in response to your letter of February 12, 2008 in which you requested our opinion regarding the application of subsection 75(2) of the Income Tax Act (the "Act") in the following hypothetical situation.
An individual makes an interest-free loan to a discretionary trust. The individual and his children are the beneficiaries of the discretionary trust. The trust subscribes to a certain percentage of the participating shares of a private corporation that the corporation issues to the trust and pays the subscription amount using the borrowed amounts.
You wish to know if subsection 75(2) applies to such a situation for the purpose of attributing income from borrowed amounts and from property acquired with the borrowed amounts.
Our Comments
As stated in paragraph 22 of Information Circular 70-6R5 of May 17, 2002, it is the practice of the Canada Revenue Agency (CRA) not to issue written opinions on proposed transactions otherwise than by way of advance income tax rulings. Furthermore, when it comes to determining whether a completed transaction has received appropriate tax treatment, that 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 we hope may be helpful to you. These comments may, however, under certain circumstances, not apply to your particular situation.
As confirmed by the Tax Court of Canada in Howson v. The Queen, 2007 DTC 141, subsection 75(2) does not apply to loans to trusts. However, we are of the view that this position applies only if the loan is independent of the terms of the trust. Furthermore, the fact that a loan does not bear interest or that the lender is also a beneficiary of the trust does not, in and of itself, alter this position. The issue is therefore whether, legally, it is a loan rather than a contribution to the capital of the trust and whether the loan is independent of the terms of the trust.
Where a loan (independent of the terms of the trust) is made to a trust, the income from the property acquired with the borrowed amounts will not be subject to the subsection 75(2) deeming rule as long as the property acquired is not, in and of itself, property held under any of the conditions referred to in subsection 75(2). For example, if the borrowed amounts are used to acquire the participating shares held by the capital beneficiary of the trust, the participating shares may be held under one of the conditions referred to in subsection 75(2) and that subsection may apply. On the other hand, if the borrowed amounts are used to acquire the participating shares from a third party (to which we could not attach any of the conditions set out in subsection 75(2)) or are used to pay for the subscription to new shares issued from treasury, subsection 75(2) would not apply to such property even if the borrowed amounts used to pay for them originate from the beneficiary of the trust.
We hope that these comments are of assistance.
Best regards,
Alain Godin
for the Director
International Operations and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.