Principal Issues: [TaxInterpretations translation] Various questions about the deductibility of expenses related to the holding by a trust of property that is not used to earn business or property income and the benefits conferred by a trust as a result of the use of that property by different persons.
Position: If the property is not used to earn property or business income, the expenses will not be deductible and there will be no loss. When disposing of the property, it will be necessary to consider whether the property satisfies the definition of personal use property as a loss on disposal would be deemed to be nil.
The CRA has taken the position that the use by a beneficiary or a person related to a beneficiary of personal-use property held by a trust does not confer a benefit on that beneficiary or person related to the beneficiary. In other cases, there would be a benefit conferred by the trust on the person using the property. With respect to the payment of expenses, there may be situations where there is a benefit conferred on the user of the property.
Reasons: Deductibility of expenses and loss: 18(1)(a) and 40(2)(g)
Benefit conferred: Previous position in Income Tax Technical News No. 11
October 19, 2006
Roch Méthot
Quebec Tax Services Income Tax Rulings Directorate
165 de la Pointe-aux-Lièvres
Québec QC G1K 7L3 Sylvie Labarre
(613) 957-89532006-017326
Subject: Advantage conferred by a trust
This is in response to your email of February 21, 2006, in which you requested our opinion regarding the application of section 105 of the Income Tax Act (the "Act") in the four situations described in your email. We apologize for the delay in responding to your request.
In each of these situations, a trust holds property that is not used to earn income, such as a home, cottage, boat or car. One or more persons may be beneficiaries of the trust. Depending on the situation, the beneficiary, a person related to the beneficiary, or a person unrelated to the beneficiary may have the use and enjoyment of the property held by the trust.
For example, in the first situation, Mr. X is a beneficiary and has the use and enjoyment of the property held by the trust. In the second situation, Mr. X is a beneficiary and a person related to him has the use and enjoyment of the property held by the trust. In the third situation, Mr. X is a beneficiary and an unrelated person has the use and enjoyment of the property held by the trust.
In the fourth situation, the trust is discretionary and has several beneficiaries. The beneficiaries are Mr. X, X's spouse, X's child, X's grandchildren and a corporation in which X's spouse is a shareholder. The fourth situation is multi-faceted, taking into account the different scenarios of use and enjoyment of the property held by the trust considered in the first three situations.
Questions
For each of the first three situations:
1. Does subsection 105(1) apply to a person because the person uses trust property without making a payment? How is the benefit calculated, if at all?
2. Does subsection 105(2) apply to allocate maintenance costs, taxes or property taxes to a person? If subsection 105(2) of the Act applies, what is the tax impact on the trust's taxable income?
3. If the trust pays interest, electricity, heating or other costs related to the property it holds, is there a benefit to be included in a person's income?
4. If the trust has borrowed from the trustee or a bank to acquire the property, is the interest deductible from the trust's income?
5. If the trust does not receive rental income from the property and incurs expenses, can it deduct expenses and can it deduct a loss?
6. Would any loss on the personal-use property reduce the trust's other sources of income?
7. Will providing in the trust deed for the payment of expenses related to the property it holds have an impact on the amount of the benefit or on the deductibility of the expenses?
For the fourth situation:
1. Would the answers given to the questions for each of the first three situations be different?
2. Who would be taxed on the benefit if the trustee had or had not designated a beneficiary?
3. If the trust holds a residence and names the corporation as beneficiary, does it lose the principal residence exemption for that period?
4. If the corporation is the user of the property held by the trust and makes it available to its shareholder, will the shareholder be required to include a taxable benefit in her income? Should this benefit be calculated as if the corporation held the property and not the trust?
Our Comments
First three situations
Subsection 105(1)
The Canada Revenue Agency (CRA) has reiterated its position on the application of subsection 105(1) where personal-use property is used by certain persons in Income Tax Technical News No. 11.
The CRA's position is that, while the CRA considers the use of trust property by a beneficiary of the trust to be a benefit under subsection 105(1), in the case of personal-use property owned by the trust, the CRA generally does not assess the benefit arising from the use of that property.
Personal-use property is defined in section 54 as property owned by the taxpayer that is used primarily for the personal use or enjoyment of the taxpayer or for the personal use or enjoyment of one or more individuals each of whom is the taxpayer, a person related to the taxpayer, or where the taxpayer is a trust, a beneficiary under the trust or any person related to the beneficiary.
The CRA has extended its administrative position to cases where the property is used by a person related to a beneficiary because the property is, in this situation, personal-use property of the trust. Consequently, in response to your first question, subsection 105(1) would not apply in the first and second situations. However, the property held by the trust would not satisfy the definition of personal-use property in the third situation since it is for the personal use or enjoyment of someone unrelated to the beneficiary of the trust. Thus, the administrative position would not apply and the user of the property (the unrelated person) would be required to include a benefit under subsection 105(1) of the Act. This benefit would generally be based on fair market value, i.e., the rent for comparable property, less any consideration paid for the use of the property. However, if such fair market value cannot be determined, or if it is inappropriate in the circumstances, you may rely on paragraph 11 of Interpretation Bulletin IT-432R2 to calculate the value of the benefit. However, in a particular situation, it would be necessary to examine all the facts to be certain that the unrelated person is not a beneficiary because of the right to use the property, to be certain that the unrelated person is not paying any amount for the use of the property, or to be certain that a benefit has actually been conferred on the unrelated person.
Subsection 105(2)
A benefit will be included in the income of a beneficiary or tenant for life in certain circumstances where amounts are paid for the upkeep, maintenance or taxes of or in respect of trust property. For there to be a benefit, the amount paid for these expenses must be paid out of the trust's income. If the trust has no income, the amounts would be paid out of the capital of the trust, a circumstance that would not give rise to a benefit under subsection 105(2). Furthermore, as an additional condition for subsection 105(2) to apply, the trust agreement must provide that the trust property will be maintained for the use of a tenant for life or a beneficiary.
In the situations you have presented, the trust does not appear to have any income. Consequently, subsection 105(2) could not apply. If the trust were to begin to have income, one would have to look at what the trust document provides to determine whether there is a tenant for life for whom the property is to be maintained or whether the property is to be maintained for Mr. X. For example, if the property were to be maintained for Mr. X and the expenses referred to in subsection 105(2) were paid out of trust income, it would be Mr. X who would be required to include a benefit under subsection 105(2). In such a case, paragraph 104(6)(b) provides a deduction in computing the trust's income for an amount included under subsection 105(2) in computing the income of a beneficiary.
Alternatively, if subsection 105(2) does not apply, it will be necessary to consider whether the payment of the expenses represents a benefit to a taxpayer pursuant to subsection 105(1). Whether a benefit is conferred on the occupant of the premises where expenses are paid from the capital of the trust and whether an amount is required to be included in a taxpayer's income by virtue of subsection 105(1) is a question of fact. Further explanation is provided in the section below entitled Payment of Expenses Related to Trust Property.
Payment of Expenses Related to the Trust Property
As stated, regarding expenses of upkeep, taxes and property taxes paid out of the capital of the trust, it is a question of fact whether there is a benefit to a taxpayer for the payment of other expenses related to the trust property that are not deductible from trust income.
One would need to examine the trust document and determine whether it contains a provision directing the trustee to pay expenses as a distribution of capital to the user of the property who would then be a beneficiary of the trust or whether the trust document provides the reason for the trustee paying such an expense or allowing such a use of the property. If there is a distribution of capital to someone who is beneficially interested, there would be no benefit conferred pursuant to subsection 105(1).
If this is not the case, it would be necessary to consider the category of expense paid: an expense incurred by reason of the ownership of the property such as interest; or an expense incurred by reason of the occupation of the property such as electricity or heating. If it is an expense incurred as a result of owning the property, payment of the expense would not necessarily be a benefit to the user of the property since even if the user had not used the property, the trustee would have had to pay the expense. This is the kind of expense that would generally be recovered through the payment of rent. Consequently, reference should be made to the previous section on our position on the use of property without payment set out in Income Tax Technical News No. 11 to see if, under that position, there is a benefit pursuant to subsection 105(1). However, it is our view that the payment of an expense incurred as a result of occupancy such as electricity, heating, certain maintenance costs (the second category of expenses) is not covered by the position in Income Tax Technical News No. 11. Consequently, the payment of such an expense that would be neither a distribution of capital nor a distribution of income would represent a benefit to the user of the property of the premises that would be in addition to the beneficiary’s income pursuant to subsection 105(1).
Interest Deduction
If the trust does not use its property to earn business or property income, the interest paid on the loan taken out to acquire the property is not deductible.
Any benefit calculated under subsection 105(1) that is required to be included in computing the income of the user of the trust property is not income to the trust and the property is therefore not used to earn income from property.
Any benefit calculated pursuant to subsection 105(2) is not income of the trust and the trust cannot deduct interest paid as a result of that benefit.
Deduction of Expenses or Losses
If the trust has no income from the property it holds, it is not entitled to deduct any expenses by virtue of paragraph 18(1)(a). Since the trust cannot deduct its expenses, it has no loss. The comments under the heading Interest Deduction regarding for section 105 benefits also apply to this heading.
Loss from property for personal use
As stated above, a trust is not entitled to deduct expenses related to property that is not used to earn business or property income. It therefore does not incur a loss in that regard. Furthermore, a loss on the disposition of personal-use property other than listed personal property is deemed to be nil by virtue of paragraph 40(2)(g).
Payment of expenses under the trust deed
If a trust does not use its property to earn business or property income, it will not be entitled to any deduction for expenses incurred, whether or not the trust deed provides for their payment.
On the other hand, the fact that the trust deed allows the payment of expenses out of the income or capital of the trust could lead to a difference in the benefits provided for in section 105 because the payment could constitute a distribution of income or capital to a person rather than a benefit conferred under subsection 105(1).
Fourth situation
With regard to the answers given above to the questions asked for the first three situations, we are of the view that they would be identical in the fourth situation.
Furthermore, as noted under this heading, in situations where the CRA would apply subsection 105(1), it would be the user of the trust property that would benefit from the payment of the expenses and would be taxed on the resulting benefit.
Principal residence
In order for a personal trust to designate a residence as its principal residence for a year, certain conditions must be satisfied including that no partnership or corporation, other than a registered charity, is beneficially interested in the trust during the year.
Subsection 248(25) provides that a person or partnership beneficially interested in a particular trust includes any person or partnership that 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 or partnership) as a beneficiary under a trust to receive any of the income or capital of the particular trust either directly from the particular trust or indirectly through one or more trusts or partnerships.
The rules in subsection 248(25) mean that, in your example in Situation Four, the corporation would be beneficially interested in any year. The personal trust would then be unable to designate the residence as its principal residence.
Benefit conferred on a shareholder
As for the last question you had regarding the Fourth Situation, a distinction should be made between a situation in which the trust specifically grants a right to use the property to the corporation (a right that then constitutes property), which is transferred by it to its shareholder without consideration, and a situation in which the trust allows the shareholder to use the property held by the trust. If the trust does not grant a right to the corporation but allows the use of its property by the shareholder of the corporation, we are of the view that it is the individual (shareholder of the corporation) who would use the property held by the trust and not the corporation. Thus, the corporation would not confer any benefit on the shareholder as a result of the shareholder's use of the trust property, even if the corporation is a beneficiary of the trust. It would be necessary to consider, under our above-stated positions, whether a benefit is conferred on the shareholder by the trust as a result of the use of its property. In order to answer your question regarding the benefit on which the shareholder should be taxed, additional information would be needed on the relationship between the beneficiaries and the shareholder. With respect to the expenses referred to in the first three situations, additional information would be required on the payer of the expenses related to the trust property and on the trust deed.
On the other hand, if the trust has specifically given a right to use its property to the corporation and the corporation assigns that right to its shareholder, then it would be possible to consider that the corporation has conferred a benefit on its shareholder that would be taxable under subsection 15(1).
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, the electronic library version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
We hope you find these comments of assistance. If you require any further information regarding the content of this document, please do not hesitate to contact us.
Alain Godin
for the Director
International Operations and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch