Principal Issues: [TaxInterpretations translation] Various issues relating to the application of subsection 104(18) of the Act where a trust has certain characteristics as to the distribution of its capital, the allocation or payment of its income.
Position: See details of the positions taken in each section of the letter.
Reasons: The fact that the trustee has discretion to determine the amount that vests in a minor beneficiary has the effect of preventing the application of subsection 104(18). The entitlement of a beneficiary who has not attained 21 years of age must be vested and must not be subject to any future conditions except that he or she live to an age not exceeding 40 years.
XXXXXXXXXX 2004-009360
November 2, 2005
Dear Sir,
Subject: Clarification of subsection 104(18) of the Income Tax Act
This is in response to your request of August 31, 2004, regarding our interpretation of subsection 104(18) of the Income Tax Act (the "Act") with respect to certain features that may be present in an inter vivos personal trust whose beneficiaries are individuals under 21 years of age and individuals 21 years of age or older. You stated in your letter that the attribution rules do not apply to your situation. You asked us various questions to determine the characteristics of a personal trust that could have an impact on whether the conditions of subsection 104(18) of the Act are satisfied. We apologize for the delay in responding to this request.
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is the practice of the Canada Revenue Agency (CRA) not to issue written opinions on proposed transactions otherwise than through advance 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, which we hope you will find helpful. These comments may not, however, apply to your particular situation in certain circumstances.
Capital distribution
The first question concerns capital distributions. You asked whether the trust indenture must provide that capital distributions, if any, will not diminish the value of the trust property to a value less than the value of the income accounts acquired for the beneficiaries within the meaning of subsection 104(18). In that regard, we are of the view that subsection 104(18) applies only to the income of the trust. However, the distribution of capital could have an impact when determining whether paragraphs 104(18)(c) and (d) are satisfied. Those paragraphs provide that the entitlement to the portion of the income that is not payable must be acquired by a beneficiary who is under 21 years of age and must not be subject to any future conditions, other than living to an age not exceeding 40 years. Thus, subsection 104(18) could not be applied if the trust deed provided that the portion of the capital that represented the non-payable income accumulated for beneficiaries under 21 years of age will be distributed at the discretion of the trustee or will be distributed to a beneficiary other than the one entitled to it in situations not covered by paragraph 104(18)(d). However, the manner in which the other portion of the capital is distributed, such as the initial capital, will have no impact on whether the conditions of subsection 104(18) are satisfied.
Income generated by the amounts acquired by the beneficiaries
Secondly, you inquired as to the ownership of the income generated by the amounts acquired by the minor beneficiaries. For the purposes of complying with the conditions of subsection 104(18), we are of the view that there is no obligation for the income generated by the amounts acquired by the beneficiaries within the meaning of subsection 104(18) to accrue to the benefit of those beneficiaries. Such income generated may therefore be commingled with the other income of the trust and be allocated according to the provisions of the trust deed.
Power to deem certain amounts of capital to be income
You inquired as to the impact that a general power granted to the trustee to deem certain amounts (the taxable portion of a capital gain, a deemed dividend under the tax laws, etc.) to be income may have on compliance with paragraph 104(18)(c). Similarly, you are concerned where it is the specific provisions of the trust deed that deem certain amounts to be income.
The CRA and the jurisprudence do not recognize clauses that give the trustees of a trust complete discretion in determining what constitutes capital or income. As we do not recognize such clauses, we will not discuss their impact on compliance with paragraph 104(18)(c). Furthermore, the income to which subsection 104(18) may apply is income determined in accordance with the provisions of the Act.
On the other hand, specific clauses in the trust deed clearly providing that certain types of payments will constitute income of the trust are acceptable. In this case, if the types of payments deemed to be income represent income for tax purposes, consideration should be given to whether some or all of that income is not payable and whether the conditions for the application of subsection 104(18) apply in respect of the portion of that income that is not payable. The fact that the trust deed provides that certain types of payments will constitute income does not, in and of itself, determine whether the conditions of subsection 104(18) of the Act are satisfied, including the condition referred to in subsection 104(18)(c).
Distribution of income by source or by property
For the purposes of subsection 104(18), you wish to know whether a trust instrument may provide for an allocation of income between minor and adult beneficiaries based on the source or nature of the income such as dividends, interest and other income or, alternatively, based on the income produced by a specific property or groups of properties.
The trustee of a trust can make choices to affect the type of income earned by the trust and therefore also earned by the beneficiaries based on the investments made by the trustee or the use of trust property where a trust provides for such income allocation methods. However, once such income is earned by the trust, the trustee has no discretion as to which beneficiary is entitled to it. At that point, the entitlement to that income would not vest because of the exercise or lack of exercise of discretion. Consequently, we are of the view that the discretion referred to in paragraph 104(18)(c) does not extend to such a discretion. On the other hand, the trust indenture may provide that income from a particular source accrues to one beneficiary rather than another, which does not, in itself, prevent the application of subsection 104(18).
Discretionary power of a person
You also raised a question as to who has the discretion (as a fiduciary or otherwise, and of a trustee or another person). Paragraph 104(18)(c) provides that subsection 104(18) will not apply if the right to the income is acquired by reason of the exercise or failure to exercise by any person of a discretionary power. It is difficult to comment without specific examples. However, the wording of paragraph 104(18)(c) of the Act seems to us to be broad enough to cover discretion held by any person, whether a trustee or not, and broad enough to cover discretion that is exercised other than in a fiduciary capacity.
Future condition
You asked us for clarification on paragraph 104(18)(d). We believe that the position expressed in item (c) of question 27, dealing with paragraph 104(18)(d), at the 1998 APFF Conference Roundtable [9M18520] answers your question. That position reads as follows:
We are of the opinion that subsection 104(18) of the Act does not stipulate any requirement as to the date of handing over or payment of the income accumulated in the trust. The condition set out in paragraph 104(18)(d) of the Act states that the right to part of the amount is not subject to any future condition, other than a condition that the individual survive to an age not exceeding 40 years.
We are of the opinion that the provisions of this paragraph would not be met if the beneficiary’s vested right to part of the amount could be extinguished by reason of a future condition other than the condition of surviving to an age not exceeding 40 years. The exception referred to in paragraph 104(18)(d) of the Act would apply to situations where trust deeds contained a clause stipulating that the right of a beneficiary will be extinguished if the latter dies at an age not exceeding 40 years. We are of the opinion that a provision delaying the right to demand payment of the income held in trust, as mentioned, would not have the effect of rendering subsection 104(18) of the Act inapplicable.
Thus, if the entitlement to the portion of the income amount not payable is not subject to any future conditions, paragraph 104(18)(d) will be satisfied. Paragraph 104(18)(d) allows for the inclusion, if desired, of the condition of living to an age not exceeding 40 years.
Discretionary power over only part of the income
You described a situation where half of the trust income is accumulated in favour of beneficiaries under the age of 21. We have assumed for the purposes of this situation that the share of each of the beneficiaries under the age of 21 in that portion of the trust income is determined without the exercise or failure to exercise of discretion and that the trustee has discretion only as to the allocation of the second half of the trust income, i.e., the trustee can decide to whom that half will be paid, payable or not payable. Where such discretion exists in respect of the second half of the trust income, income not payable to a beneficiary under the age of 21 from that second half of income would vest because of the exercise or failure to exercise of a discretionary power.
On the other hand, with respect to the first half of the income that accrues to beneficiaries under the age of 21, it would be necessary to determine whether the trustee has any discretion as to the allocation among each of those beneficiaries under the age of 21. If the allocation of the first half of income to beneficiaries under the age of 21 is not dependent on the exercise or failure to exercise of a person's discretion, it is our view that paragraph 104(18)(c) would be satisfied in respect of the first half of the trust's income.
Amounts paid to a minor beneficiary
The discretion of a person to pay or not to pay an amount to a third party for the benefit of a minor beneficiary out of the trust's income for the year to which the minor beneficiary is entitled at the end of the year would not, in and of itself, preclude the application of subsection 104(18) in respect of the portion of that accrued income that is not payable to that beneficiary, so long as the trustee had no discretion as to the determination of the amount of income to which the minor is entitled.
We hope that these comments are of assistance.
Best regards,
Alain Godin
for the Director
International Operations and Trusts Division
Income Tax Rulings Directorate
Directorate General for Policy and Planning