Principal Issues: In a situation where one of the trustees of a spousal trust under paragraph 70(6) is changed and the trustees have, under the trust, the power to encroach on the capital for the benefit of the spouse, would paragraph 256(7)(i) apply to deem the control of a corporation not to have been acquired solely because of the change in the trustee?
Position: No.
Reasons: Subparagraph 256(7)(i)(ii) could not be met when the trustees of a spousal trust have the discretion to encroach on the capital of the spousal trust for the benefit of the spouse.
FEDERAL TAX ROUNDTABLE OCTOBER 7, 2019
2019 APFF CONFERENCE
Question 9
Acquisition of control and trusts
By virtue of paragraph 256(7)(i), control of the corporation is deemed not to be acquired solely because of a change in the trustee or legal representative having ownership or control of the trust’s property if the following two conditions are satisfied:
- the change is not part of a series of transactions or events that includes a change in the beneficial ownership of the trust’s property, ((subparagraph 256(7)(i)(i)); and
- no amount of income or capital of the trust to be distributed, at any time at or after the change, in respect of any interest in the trust depends upon the exercise by any person or partnership, or the failure of any person or partnership, to exercise any discretionary power. (subparagraph 256(7)(i)(ii)).
That paragraph was added to the Income Tax Act as a result of the CRA's positions in inter alia Technical Interpretation 2004-0087761E5 and Income Tax Technical News ITTN-3412 that the replacement of a trustee of a trust that controls a corporation would result in an acquisition of control of the corporation since it is the trustees who have legal ownership (and therefore control) of the shares and that there is a presumption that the trustees constitute a group that controls the corporation.
Furthermore, in order for a spousal trust to qualify as such under paragraph 70(6)(b), the following conditions, among others, must be satisfied:
- the taxpayer’s spouse or common-law partner is entitled to receive all of the income of the trust that arises during his or her lifetime (subparagraph 70(6)(b)(i)), and
- no person except the spouse or common-law partner may, before the spouse’s death, receive or otherwise obtain the use of any of the income or capital of the trust (subparagraph 70(6)(b)(ii)).
In technical interpretation 2002-0126775, the CRA stated that:
“[T]he phrase "entitled to receive" all of the income of the trust means to have a legal right to enforce payment of that income. For a spouse to have a legal right to enforce payment of the income of the trust, it is our opinion that discretion to receive all or part of the income of the trust must be solely in the hands of the spouse beneficiary. If the trustee(s) of a trust may, under the terms of the trust agreement, restrict the payment to the spouse of any portion of the trust's income it is our view that the spouse is not "entitled to receive" all of the income of the trust within the meaning of subparagraph 70(6)(b)(i) of the Act and the trust will not be a spousal trust. Therefore, a qualifying spousal trust cannot be discretionary with respect to the entitlement of the spouse, as beneficiary of the trust, to enforce payment of the income of the trust.
Such an interpretation was accepted by the Court in Executors of the Estate of the Late Wilbert Peardon v. M.N.R., 86 DTC 1045 (T.C.C.), where it was found that the provision that income and capital be paid to the spouse in the executor's absolute discretion did not meet the condition provided in subparagraph 70(6)(b)(i) of the Act. In this case, the Court accepted that the word "entitled" in subparagraph 70(6)(b)(i) of the Act means "a claim of right". The Court added, at page 1047, that the spouse's rights with respect to the income of the trust "must be exclusive and no other person can have any intrusionary rights vis à vis the trust be they immediate or in the future while the spouse is living."”
As stated above, in order for a trust to qualify as a spouse trust under paragraph 70(6)(b), the trust must provide that no person other than the spouse may, before the death of the spouse, receive or otherwise obtain the use of any part of the income or capital of the trust. In this regard, the Court confirmed, in Estate of Albert N. Gilbert v. M.N.R., 83 DTC (T.R.B.), that the word "may" in subparagraph 70(6)(b)(ii) must be interpreted as "permissive" (see also section 11 of the Interpretation Act). Such an interpretation was also accepted in Peardon, where the Court added the following comment (p. 1047):
« There does not have to be any benefit obtained by any person, other than the spouse; the mere possibility is enough to say that the trust does not comply fully with the provisions requisite of the Act. »
It follows from these decisions that the mere existence of a power to deal with the capital or income of the trust for the benefit of a person other than the spouse, before the death of the spouse, is sufficient to disqualify the trust as a spousal trust. The same result would occur if the trustees of a trust were given complete discretion with respect to the distribution of the income and capital of the trust among the taxpayer's family members during the lifetime of the spouse. Similarly, the requirement for a trust to pay amounts to persons other than the spouse during the lifetime of the taxpayer would disqualify the trust as a spouse trust.
Questions to the CRA
(a) Do the trustees of a trust that qualifies as a spousal trust under subsection 70(6) have discretionary power with respect to distributions of income, notwithstanding that the trustees do not have discretion as to whether or not to pay the income to the spouse or the power to distribute the income to persons other than the spouse?
(b) Do the trustees of a trust that qualifies as a spousal trust under subsection 70(6) have discretionary power with respect to capital distributions, notwithstanding that the trustees may have discretion as to whether or not to encroach on capital for the benefit of the spouse, but do not have discretion with respect to the allocation of the capital, since capital cannot be distributed to persons other than the spouse during his or her lifetime?
(c) If the answer to each of (a) and (b) above is no, does the CRA agree that the condition in subparagraph 256(7)(i)(ii) is satisfied?
CRA Response
The question of whether the trustees of a spousal trust within the meaning of paragraph 70(6)(b) have discretion respecting distributions of income following the death of the spouse or common-law partner or distributions of capital is one of fact, and that determination requires an analysis of the terms of the trust indenture. However, the CRA is generally of the view that the trustees of such a trust who have the power to encroach on the capital in favour of the spouse or common-law partner have a discretionary power respecting the capital of the trust.
Subparagraph 256(7)(i)(ii) is broadly worded and provides that at any time at or after the replacement of the trustee, no amount of income or capital to be distributed in respect of an interest in the trust depends upon the exercise, or the failure to exercise, by any person or partnership of a discretionary power. Consequently, depending on the circumstances and terms of the Trust Indenture, the condition set out in subparagraph 256(7)(i)(ii) could not be satisfied in the case of a spousal trust as defined in paragraph 70(6)(b), which would result in paragraph 256(7)(i) not applying to deem there to be no acquisition of control of the corporation. This could be the case inter alia where the trustees of a spousal trust have a power to encroach on the capital in favour of the spouse or common-law partner.
Nathalie Boyer
(450) 926-7039
October 11, 2019
2019-081278
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 CANADA REVENUE AGENCY, Technical Interpretation, 2004-0087761E5, May 24, 2005.
2 CANADA REVENUE AGENCY, Income Tax - Technical News No. 34 (April 27, 2006).
3 CANADA REVENUE AGENCY, Technical Interpretation 2002-0126775, May 3, 2002.