Principal Issues: [TaxInterpretations translation] Who should be taxed where there is a usufruct?
Position: The usufructuary
Reasons: 248(3)
XXXXXXXXXX 2004-009172
Alain Godin
April 11, 2005
Dear Madam,
Subject: Request for technical interpretation
This is in response to your request of August 16, 2004 concerning the situation described below.
In summary, you described the following situation. Your client is a resident of Canada and not a tax resident of France. He wishes to make an inter vivos gift to his daughter, a resident of Canada, giving her the bare ownership of an income property located in France, while retaining the usufruct of the property. Your client's accountant in France advised him that in the case of an inter vivos gift to his daughter, under French rules, he is considered the owner of the property until his death and must declare the rental income and, if applicable, a capital gain.
According to you, at the time of the gift, the father will have to declare a deemed capital gain in Canada equal to the difference between the acquisition cost and the fair market value of the property. Furthermore, according to Canadian law and the rental income guide, it is the owner of the property, the daughter, who will have to declare the rental income and, if applicable, the capital gain. However, according to you, the daughter could not claim a tax credit for the tax paid by her in France and, as a result, Article 23 of the tax treaty between Canada and France on non-discrimination would not be satisfied.
Question
You wish to know if there is any relief so that the daughter is not taxed in Canada on the income from the property, given that in reality she receives no income because the father retains the usufruct.
Our Comments
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is the practice of the Canada Revenue Agency (the "CRA") not to issue written opinions on proposed transactions otherwise than by way of advance rulings. Nevertheless, we offer the following comments. These comments are general in nature and may not apply in their entirety to your situation.
The Income Tax Act (the "Act") contains rules in subsection 248(3) that apply to certain arrangements under civil law. Those rules have been in effect for a number of years; however, amendments to those rules were proposed on October 30, 2003. Under the proposed amendments to the Act, which will apply for taxation years beginning after October 30, 2003, where a property is subject to a usufruct, the usufruct is deemed to be a trust. In addition, the property is deemed, where the usufruct was not created by will, to have been transferred at the time it became subject to the usufruct, to the trust by the person who granted the usufruct and to be held in trust and not otherwise throughout the period that it is subject to the usufruct (paragraph (a)). Paragraph (d) provides that a person who has a right, whether immediate or future and whether absolute or contingent, to receive all or any part of the income or capital in respect of property subject to a usufruct is deemed to be beneficially interested in the trust.
Several tax consequences follow from these provisions. First, the transferor is deemed to have disposed of the property to the deemed trust. The transferor may therefore realize a capital gain or loss on the disposition of the property and income attribution rules such as subsection 75(2) may be applicable, depending on the circumstances. The person who has the usufruct of the property is considered to be the recipient of the income and the person who has the bare ownership of the property is considered to be the recipient of the capital. The usufructuary, as the income beneficiary of the deemed trust, must include the income of the deemed trust in that person’s income pursuant to subsection 104(13) and paragraph 12(1)(m), with the income being payable to that person, except where the election in subsection 104(13.1) is made. Also, this income is normally considered to be income from property that is an interest in the trust pursuant to paragraph 108(5)(a). Under the Canada-France tax treaty, France may tax income from real property located in France and the usufructuary may therefore be liable for taxes in France on the rental income from the property. Since Canadian residents are taxable on their worldwide income from all sources, a Canadian resident who derives income from real estate located abroad would therefore be taxable in Canada on his rental income generated from the real estate located abroad. In this case, the tax paid to the foreign country in respect of such income may generally be deducted as a foreign tax credit pursuant to section 126. However, by virtue of the presumption in subsection 248(3), the usufructuary's rental income is considered to be income from property that is an interest in the trust pursuant to paragraph 108(5)(a). Since the taxpayer's source of income is the taxpayer’s interest in the trust, the income would not be qualifying income from sources in France for the purposes of paragraph 126(1)(b). Note that this difficulty is circumvented by subsection 104(22). Indeed, where the provision applies, it has the effect of deeming the trust's income to be that of the beneficiary and this allows the beneficiary to claim a foreign tax credit pursuant to section 126.
A resident of Canada who has received bare ownership of a building located abroad as a result of a usufruct created under French private law, does not have to pay tax on rental income received by the usufructuary of such a building. However, when the usufruct is extinguished, the deemed trust is considered to be dissolved. The provisions of subsection 107(2) apply so that the trust disposes of its property at its cost amount and the bare owner receives the property at that same cost. At this point there is a merger of ownership and the bare owner is subject to tax on the rental income from that point on.
We hope that these comments are of assistance.
Best regards,
Alain Godin
for the Director
International Operations and Trusts Division
Income Tax Rulings Directorate
Policy and Planning Branch