Principal Issues: Where a first trust makes a designation pursuant to subsection 104(21.2) with respect to an amount paid to a second trust, whether the second trust can make a designation pursuant to subsection 104(21.2) with respect to the same amount paid to its own beneficiaries to allow them to claim the capital gains deduction under subsection 110.6(2.1)?
Position: Yes.
Reasons: To determine the "eligible taxable capital gains", as defined in subsection 108(1), of the second trust, it is necessary to take into account the effect of the designation under subsection 104(21.2) that the first trust has made in respect of its beneficiary, the second trust. The effect of paragraph 104(21.2)(b) is that, for the purposes of sections 3, 74.3 and 111 as they apply for the purposes of section 110.6, the beneficiary, the second trust, is deemed to have disposed of capital property that is qualified small business corporation shares, and have a taxable capital gain from such disposition equal to the amount determined by the formula set out in clause 104(21.2)(b)(ii)(B). Therefore, the second trust will be able to make a designation under subsection 104(21.2) in respect of its own beneficiaries as its "eligible taxable capital gains" include the amount designated by the first trust under subsection 104(21.2). This will allow the second trust’s beneficiaries, who are individuals other than trusts, to claim the capital gains deduction under subsection 110.6(2.1), provided all the other conditions are met. As a result of the above, the position set out in document 2016-0667361E5 no longer represents the position of the CRA.
FINANCIAL STRATEGIES AND FINANCIAL INSTRUMENTS ROUNDTABLE, OCTOBER 7 2020
2020 APFF CONFERENCE
Question 1
Designation of eligible taxable capital gains through two trusts
Consider a situation where an inter vivos trust, Trust 1, holds shares that qualify as qualified small business corporation ("QSBC") shares within the meaning of subsection 110.6(1) of the Income Tax Act (footnote 1). Trust 1 has two beneficiaries, Trust 2 and Trust 3, which are personal trusts. Each of Trust 2 and Trust 3 has several individuals (other than trusts) as beneficiaries.
Trust 1 disposes of its shares that qualify as QSBCs and designates the taxable capital gain realized in the year to its beneficiaries Trust 2 and Trust 3. Thereafter, Trust 2 and Trust 3 designate their taxable capital gains in the year to their respective beneficiaries. Trust 1, Trust 2 and Trust 3 did not dispose of any other property during the year. Cash payments are made in accordance with the designations during the year. Designations pursuant to subsections 104(21) and 104(21.2) are also made. All designations and payments are made pursuant to the terms of the trust indenture governing each such trust. Payments made by Trust 2 and Trust 3 are received by their respective beneficiaries for their own account and benefit. Amounts received are retained by each beneficiary.
Question to the CRA
In these circumstances, can the beneficiaries of Trust 2 and Trust 3, who are individuals other than trusts, claim the capital gains deduction under subsection 110.6(2.1) to the extent that all the conditions set out in that subsection are satisfied?
CRA Response
Where all of the conditions set out in subsection 104(21) are met, this subsection provides that for the purposes of sections 3 and 111, except as they apply for the purposes of section 110.6, an amount in respect of a trust’s net taxable capital gains, as defined in subsection 104(21.3), for a particular taxation year of the trust is deemed to be a taxable capital gain of the recipient beneficiary from the disposition of a capital property, for the taxation year of the beneficiary in which the particular taxation year of the trust ends.
Subsection 104(21) does not apply for the purposes of section 110.6. Accordingly, a designation under subsection 104(21.2) is also required in respect of the trust’s eligible taxable capital gains, in order for the beneficiaries to be able to claim the capital gains deduction under subsection 110.6(2.1).
Where a personal trust designates an amount to a beneficiary under subsection 104(21) in respect of its net taxable capital gains for a particular taxation year, paragraph 104(21.2)(a) provides that the trust must also designate an amount in its income tax return for the year, in respect of its eligible taxable capital gains, if any, in respect of the beneficiary equal to the amount calculated under subparagraphs 104(21.2)(b)(i) and (ii).
Subsection 108(1) defines “eligible taxable capital gains” of a trust as the lesser of its “annual gains limit” (footnote 4) and the amount of its “cumulative gains limit” (footnote 5) at the end of the year less the total of all amounts designated under subsection 104(21.2) by the trust in respect of beneficiaries for taxation years before that year.
Where an amount is designated under subsection 104(21.2), paragraph 104(21.2)(b) provides that, for the purposes of section 120.4 and for the purposes of sections 3, 74.3 and 111 as they apply for the purposes of section 110.6, the beneficiary is deemed to have disposed of a capital property that is either a qualified farm or fishing property or a QSBC share, as the case may be (footnote 6), as defined in subsection 110.6(1), and to realize a taxable capital gain equal from such disposition equal to the amount determined by the formula set out in clause 104(21.2)(b)(ii)(A) or (B).
The result is that for the purposes of calculating the “annual gains limit” of the beneficiary, the amount calculated in element A takes into consideration the taxable capital gain designated by the trust under subsection 104(21.2) in order to permit the beneficiary to claim the capital gains deduction under subsection 110.6(2.1).
In the situation described, in determining A in the computation of the “annual gains limit” of each of Trust 2 and Trust 3, it is necessary to take into account the amount designated by Trust 1 under subsection 104(21.2) to them. Paragraph 104(21.2)(b) provides that for the purposes of sections 3, 74.3 and 111 as they apply for the purposes of section 110.6, the beneficiaries, Trust 2 and Trust 3, shall be deemed to have disposed of capital property that is a QSBC share, and to realize a taxable capital gain from such disposition equal to the amount determined by the formula in clause 104(21.2)(b)(ii)(B).
Consequently, where Trust 1 has made designations under subsections 104(21) and (21.2) on account of its taxable capital gains in respect of amounts distributed to Trust 2 and Trust 3, Trust 2 and Trust 3 can also rely on subsections 104(21) and (21.2) in respect of the amounts designated to their respective beneficiaries, provided that all conditions are satisfied. The subsection 104(21.2) designation made by Trust 1 must be taken into consideration in order to determine the eligible taxable capital gains of Trust 2 and Trust 3. Thereafter, where amounts are designated to the respective beneficiaries of Trust 2 and Trust 3 pursuant to subsections 104(21) and (21.2), such designations will also deem each of such beneficiaries to have disposed of capital property that is a QSBC and to realize a taxable capital gain from such disposition equal to the amount determined by the formula in clause 104(21.2)(b)(ii)(B). This would allow them to claim the capital gains deduction under subsection 110.6(2.1), provided that all other conditions set out therein are satisfied.
Considering these comments, the position set forth in Technical Interpretation 2016-0667361E5 no longer represents the CRA's position.
Nathalie Boyer
(450) 926-7039
October 7, 2020
2020-085276.
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 R.S.C. 1985, c. 1 (5th Supp.) (the "Act").
2 Within the meaning of subsection 104(21.3)
3 Within the meaning of subsection 110.6(1).
4 Within the meaning of subsection 110.6(1).
5 Being one of the capital properties referred to in clauses 104(21.2)b)(ii)(A) or (B).