Principal Issues: [TaxInterpretations translation] See below
Position: See below
Reasons: See below
FINANCIAL SERVICES ROUND TABLE
2004 APFF CONFERENCE
Question 6
12(4) I.T.A. and personal trusts
A personal trust may from time to time invest in certain investments including prescribed debt obligations as defined in Regulation 7000. This Regulation provides for computing the amount, on Regulation 7000 debt obligations such as stripped coupons, that will be included in income under subsections 12(4) and (9).
The trust generally does not receive the income generated by the stripped coupon until the coupon matures, but still must recognize tax on the annually accrued income without having received the funds and, therefore, without having distributed them to the beneficiaries. In addition, when the security is disposed of, if market interest rates have increased between the date of purchase of the security and the date of sale, the trust will realize a capital loss that it will not be able to distribute to the trust's beneficiaries.
Can a trust allocate annually to beneficiaries "phantom income" from the annual taxation of accrued income on a prescribed debt obligation such as a stripped coupon, and if so, what terms must the trust provide to allow this allocation?
CRA Response
Paragraph 104(6)(b) provides that there may be deducted in computing the income of a trust for a taxation year the amount claimed by the trust but not exceeding the amount that is the income of the trust that became payable to a beneficiary in the year. The amount payable is defined in subsection 104(24), which provides that an amount shall be deemed not to have become payable to a beneficiary in a taxation year unless it was paid in the year to the beneficiary or the beneficiary was entitled in the year to enforce payment of the amount. Deemed interest income under subsection 12(9) from Regulation 7000 debt obligations is not income of the trust under the Civil Code. Consequently, such income is not likely to constitute income payable to a beneficiary in the year under a trust indenture. However, as stated at the STEP (Society of Trust and Estate Practitioners) Conference earlier this year, we allow a deduction pursuant to subsection 104(6) in respect of deemed income if the terms of the trust indenture are such that the trustee is required to pay an amount equal to that income to the beneficiary, or if the trustee may, under the trust indenture, pay or make payable an amount equal to the amount deemed to be income under the I.T.A., if the trustee exercises that discretion irrevocably and unconditionally before the end of the trust's taxation year.
Fouad Daaboul
957-2053
October 8, 2004
2004-009083