Principal Issues: [TaxInterpretations] 1. Would subsection 75(2) continue to apply following a renunciation?
2. If 75(2) does not apply to the transferor, will the other capital beneficiaries be able to claim a capital gains deduction in respect of the capital gain on qualified small business corporation shares held by the trust?
3. Are there any tax consequences of paying the non-taxable portion of the capital gain to the capital beneficiaries if the trust indenture so permits?
4. If the renunciation is legally valid, would subsections 56(2) and (4) apply?
5. If the renunciation is legally valid and is not made to someone, would there be a disposition of the equity interest and what would be the proceeds of disposition?
Position: 1. If the renunciation is legally valid and the individual could not in any event become a beneficiary of the property or property substituted therefor (including the proceeds of disposition of the property), subparagraph 75(2)(a)(i) no longer appears to apply. However, other attribution rules could apply.
2. If subsection 75(2) does not apply, subsections 74.2 and 74.3 would apply in respect of the capital gain that would be allocated and designated to the spouse pursuant to subsection 104(21), thereby not permitting the spouse to benefit from the capital gains deduction. For the other beneficiaries, the taxable portion of the capital gain would have to be payable to them in the year, and the trust would have to allocate and designate an amount to them by virtue of subsection 104(21) and under the provisions of subsection 104(21.2).
3. If the payment of the non-taxable portion of the capital gain is made in cash and is described in paragraph (i) of the definition of disposition in subsection 248(1), the payment would not constitute a disposition. However, in such a situation, paragraph 107(2.1) would have no tax consequences.
4. No
5. If the renunciation is legally valid and is not made to someone, there would be a disposition of the equity interest but the proceeds of disposition would be nil.
Reasons: 1. We have no documentary evidence that would allow us to say that the other provisions of subsection 75(2) do not apply. In addition, we do not have the documents and we are not mandated to give a legal opinion on the validity of the waiver.
2. Wording of the Act.
3. Wording of the Act.
4. 56(2): the capital interest (the renounced property) would not have been included in the individual's income.
56(4): the individual renounced the entire property and not only the right to income.
5. Subsection 69(1) does not apply because the disposition is not to any person.
XXXXXXXXXX 2008-027974 Sylvie Labarre, CA December 16, 2008
Dear Madam,
Re: Waiver to avoid the application of subsection 75(2)
This is in response to your fax of May 27, 2008 in which you asked our opinion regarding an aspect of planning that would be put in place to ensure that subsection 75(2) of the Income Tax Act (the "Act") does not apply in respect of the capital gain realized when a family trust sells qualified small business corporation shares so as to allow the other beneficiaries to claim the capital gain deduction in respect of the shares.
In the situation you described, an individual transfers shares to a trust of which he is the trustee, and a capital and income beneficiary. His spouse and minor children are the other capital and income beneficiaries. All the beneficiaries are Canadian residents. Subsection 75(2) would apply in respect of the capital gain realized on the disposition of the shares transferred by the individual, which would not permit the gain to be split among the other beneficiaries so as to benefit from the capital gain deduction. To correct the situation, the individual is considering renouncing his beneficial interest in the trust's capital a few days before the sale of the shares and resigning as trustee, renouncing the receipt any property he transferred to the trust, the proceeds of disposition of such property and any property substituted therefor.
Questions
1. Does subsection 75(2) cease to apply when the individual renounces his right to be a capital beneficiary of a trust?
2. If so, is each beneficiary of the family trust to whom the capital gain is allocated entitled to claim the capital gains deduction on the sale of the qualified small business corporation shares?
3. Can the non-taxable portion of the capital gain that remains in the trust be allocated to any capital beneficiary of the trust without immediate tax consequences, to the extent that the trust indenture so permits?
4. Could subsection 56(2) or subsection 56(4) apply in this context?
5. Is the fact that the individual remains an income beneficiary, but is not entitled to receive the qualified small business corporation shares or their proceeds of disposition or property substituted therefor, problematic in the circumstances?
6. Can the renunciation made immediately before the sale of the qualified small business corporation shares give rise to a disposition of taxable property on the basis that the Act's definition of "property" includes "a right of any kind whatever"? If so, how should the fair market value of the interest be determined?
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.
For the purposes hereof, we have assumed that the trust is discretionary. In the context of an advance ruling request or in the context of an audit engagement, it should first be ascertained from our Legal Services Department that a beneficiary holding a discretionary capital interest may renounce, prior to the exercise of the trustee's discretion, a specific property held by the trust as well as its proceeds of disposition and any substituted property. This is a legal issue on which we are not mandated to rule in the context of a request for technical interpretation. A similar question on a partial renunciation of an income interest in respect of a particular property held by a discretionary trust governed by common law rules was submitted to our Legal Department several years ago. At that time, they concluded, based on documentation provided by the taxpayer, that it was impossible for a beneficiary of a discretionary trust to partially forgo income from a specific property of the discretionary trust.
Consequently, our answers to your questions will vary depending on the answer we obtain as to the legal validity of the renunciation. We would disregard a renunciation that was not legally valid and, as a result, the capital gain would be attributed to the individual pursuant to subsection 75(2).
On the other hand, subject to a review of all relevant documents, if the renunciation of trust capital was legally valid, if it was made before the exercise of the trustees' discretion and if the individual could not in any event become a beneficiary of the property or property substituted therefor (including the proceeds of disposition of the property), subparagraph 75(2)(a)(i) would no longer appear to apply, even if the individual still remained an income beneficiary (within the meaning of the civil or common law). Even if subsection 75(2) no longer applied, the attribution rules in sections 74.1 and 74.2 would have to be considered in respect of amounts determined under section 74.3 Act, provided the exception in subsection 74.5(13) does not apply.
If subsection 75(2) no longer applied to attribute the capital gain on the disposition of the shares to the individual, it would be necessary, in order for the capital gains deduction to be available to the beneficiaries, that the taxable capital gain be payable to the beneficiaries in the trust's taxation year and be included in the beneficiaries' income under subsection 104(13) (assuming that a preferred beneficiary election is not available under subsection 104(14) and that the amount is not included pursuant to subsection 105(1)). In such cases, a trust that has realized taxable capital gains in a particular taxation year may, within the limits set by subsection 104(21), allocate and designate all or part of the amount of such gains to any of its beneficiaries as a taxable capital gain. Thus, any amount allocated and designated to a beneficiary pursuant to subsection 104(21) will be deemed to have been received by the beneficiary as a taxable capital gain rather than as trust income. If there is an amount designated to the spouse pursuant to subsection 104(21), subsection 74.3(1) could result in the taxable capital gain being reallocated to the individual pursuant to subsection 74.2(1). The spouse would therefore not be taxable in respect of that taxable capital gain and therefore would not benefit from a capital gains deduction. Furthermore, in order for the other beneficiaries of the trust to be entitled to the capital gains deduction under subsection 110.6(2.1) in respect of the taxable capital gain designated by the trust in pursuant to subsection 104(21), the trust must designate an amount in respect of its eligible taxable capital gains under subsection 104(21.2) so that the beneficiary is, inter alia, deemed to have disposed of qualified small business corporation shares if a taxable capital gain is determined in respect of the beneficiary under clause 104(21.2)(b)(ii)(B) for the beneficiary's taxation year in which the designation year ends.
If the trust indenture so permits, the trust will be able to make payment of the portion of the capital gain that is non-taxable to the beneficiaries of the capital without immediate tax consequences if the payment is made in cash and is described in paragraph (i) of the definition of "disposition" in subsection 248(1). Under that paragraph, where the property is a taxpayer’s capital interest in a trust, a payment to the taxpayer after 1999 in respect of the capital interest to the extent that, inter alia, the payment is out of the income of the trust (determined without reference to subsection 104(6)) for a taxation year or out of the capital gains of the trust for the year, if the payment was made in the year or the right to the payment was acquired by the taxpayer in the year.
Subsection 107(2.1) would still apply if the payment does not constitute a disposition by virtue of paragraph (i) of the definition of "disposition" in subsection 248(1). Even if subsection 107(2.1) applies, there should be no tax consequences either to the trust if the payment of the non-taxable portion of the capital gain is made in cash or to the beneficiary because the proceeds of disposition of the interest, as calculated by the provisions of that subsection, will be reduced by the payment referred to in paragraph (i) of the definition of "disposition" in subsection 248(1).
If paragraph (i) of the definition of "disposition" in subsection 248(1) does not apply, there would be a disposition of the interest pursuant to paragraph (d) of that definition. In such a circumstance, the application of subsection 107(4.1) with respect to the distribution to the children would have to be considered.
With respect to your other questions, we are of the view that if the renunciation of the trust's capital was legally valid and was not made to any person, the disposition of the individual's capital interest would not give rise to any tax consequences since the proceeds of disposition would be nil. Furthermore, it is our view that subsections 56(2) and (4) would not apply to such a valid renunciation made before the exercise of the trustees' discretion.
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.