Principal Issues: See below.
Position: See below.
Reasons: See below.
XXXXXXXXXX Danielle Bouffard 2005-012735 February 2, 2006
Dear Sir,
Subject: Request for technical interpretation:
Subsection 75(2) of the Income Tax Act (the "Act")
This is in response to your letter of April 20, 2005, requesting our opinion on the above subject. We apologize for the delay in responding to this request.
Facts
1. A discretionary inter vivos trust, established under the laws of the Province of Quebec, has been created by a notarized deed of gift of movable property, the settlor of which is a third party dealing at arm's length with each of the trustees and any beneficiary (the "Trust").
2. The trustees of the Trust are Mr. A and his wife Ms. B (the "Trustees").
3. The beneficiaries of the income and capital of the Trust are (i) the two minor children of Mr. A and Ms. B, (ii) Mr. A and (iii) such other beneficiaries as the Trustees may designate from among their first degree descendants, collaterals or first degree ascendants (the "Beneficiaries").
4. Under the terms of the Trust Indenture, there must always be two (2) Trustees in office and their decisions must be made by unanimous vote.
5. Under the Trust Indenture, each of the Trustees has the right to provide for his or her own replacement and the terms thereof.
6. In addition, Mr. A may at any time, on ten (10) days' notice, at his discretion, appoint any other trustee to replace Ms. B, or to replace the trustee appointed by Ms. B in her stead.
7. In recent years, the Trust has acquired several income properties. Each of those acquisitions was financed as follows:
(i) the Trust took out a loan from a Canadian financial institution dealing at arm's length with the Trust, its Settlor, its Trustees and Beneficiaries. All material terms of the loans (interest rate, repayment, guarantees, etc.) are normal commercial terms between persons dealing at arm's length with each other (the "Bank Loans");
(ii) the capital outlays required to acquire the Income Properties were provided in the form of loans bearing interest at the prescribed rate made to the Trust by Mr. A (the "Prescribed Loans"); and
(iii) in respect of each of the Bank Loans referred to in 7(i) above, Mr. A provided the financial institution with personal guarantees to secure the Bank Loans (the "Guarantees").
Questions
Does subsection 75(2) apply to deem any income or loss or taxable capital gain or allowable capital loss arising from (i) property transferred to the trust, if any, or (ii) the disposition thereof to be income or loss or taxable capital gain or allowable capital loss of Mr. A? Specifically:
1) Assuming that the Prescribed Loans are genuine and authentic loans, do those loans, in and of themselves, constitute a holding of property by the Trust such that subsection 75(2) applies?
(a) Can the CRA explain what it means by the condition referred to in Interpretation 2000-0042505 "if the loan is outside and independent of the terms of the trust" and why the terms of the loan must be independent of the trust deed if a loan does not cause property to be considered "held"?
2) Does Mr. A's guarantee of the Bank Loans taken out by the Trust give rise to the application of section 75(2)?
3) Would the answers to questions 2 and 3 be different if:
(a) Mr. A was not a beneficiary of the Trust's capital?
(b) Mr. A did not have the discretion to replace Ms. B as Trustee of the Trust at any time; and
(c) under the Trust Deed, decisions of the Trustees were not to be taken unanimously?
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 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. These comments may, however, under certain circumstances, not apply to your particular situation.
Subsection 75(2) deals with situations where a person transfers, directly or indirectly, property to a trust and under the trust that property or property substituted for it may revert to the person, may be conveyed to persons to be designated by the person after the trust is created, or may not, during the person's lifetime, be disposed of without the person's consent or direction. Subsection 75(2) of the Act applies to any property held by a trust under the conditions set out in paragraph 75(2)(a) or (b), whether the property was transferred to the trust by the settlor or by any other person and whether or not the property was transferred at fair market value.
First question
The application of subsection 75(2) does not depend on whether there is a "loan" or a "transfer" of property, but rather on whether property is "held" by a trust under either of the conditions set out in subsection 75(2). In principle, money loaned to a trust could be considered to be "held" and subject to the provisions of subsection 75(2) since the trust would have to repay the money. However, the CRA's long-standing position is that a bona fide loan to a trust would not, in and of itself, result in property being "held" by the trust under one or more of the conditions described in subsection 75(2) (i.e., it would not, in and of itself, result in the application of subsection 75(2)), if the loan is external to and independent of the terms of the trust. The fact that a loan is external and independent of the terms of the trust is one of the factors in determining whether the relationship between the person making the loan and the trust is one of "lender/borrower" or "settlor/trustee".
No exhaustive statement can be made to establish the "genuineness" of a loan, but the borrower's written and signed acknowledgement of a loan and the borrower’s agreement to repay it within a reasonable period of time is usually acceptable evidence of the genuineness of the loan. If, in addition, there is evidence that the borrower has guaranteed the loan, paid interest on it or made payments to repay it, the genuineness of the loan is recognized.
Finally, if the proceeds of a loan are used to acquire property from the lender, that property may be subject to the application of subsection 75(2) if the lender controls the trust property in its capacity as trustee or under the terms of the loan.
Second question
The fact that a trustee guarantees bank loans made to the trust does not, in itself, give rise to the application of the provisions of subsection 75(2). However, the trustee may be subject to the attribution rules in subsection 74.5(7) where the bank loans are made directly or indirectly to or for the benefit of a specified person with respect of the trustee.
Third question
Taking into account the previous comments regarding bona fide loans and guarantees on bank loans, our answers to questions 1 and 2 would remain the same if Mr. A was not a capital beneficiary, if he did not have the discretion to replace Ms. B as trustee of the Trust, and/or if, under the trust deed, decisions of the Trustees did not have to be made unanimously.
These comments are not advance income tax rulings and are not binding on the CRA in respect of any particular factual situation.
Best regards,
Alain Godin
For the Director
International Operations and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch