Would s. 75(2) apply in the following independent scenarios?
(a) A taxpayer settles an alter ego trust and contributes an interest in a limited partnership, with the trust then being allocated business income by the partnership.
(b) The trust realizes a capital gain, reinvests the proceeds and realizes another capital gain.
(c) The trust earns income, reinvests the income and earns income on the reinvestment (second generation income).
CRA indicated:
(a) Although the business income or loss that is allocated to the trust from the limited partnership will not be attributed to the settlor (s. 75(2) does not attribute business income), the settlor of an alter ego trust must be entitled to receive all of the income of the trust that arises before the settlor’s death. Thus, the business income earned by the trust, will be generally included in the settlor’s income under s. 104(13), and s. 108(5) will generally treat the resulting income inclusion as income of the beneficiary from a property.
Where the partnership allocates dividend income to the trust and s. 75(2) applies, the dividend will retain its character as a dividend pursuant to s. 82(2).
(b) The proceeds received for the disposition of trust property would be considered “property substituted for the property,” for purposes of s. 75(2) and, similarly, if the proceeds were then reinvested in securities, the securities would also be considered substituted property, such that any income or loss from those securities, and any taxable capital gain or allowable capital loss resulting from their disposition, would also be attributed to the settlor.
In light of s. 248(5), the attribution would continue to apply if the securities were then repeatedly sold and reinvested in other securities: the corresponding proceeds of disposition and other securities would continue to be substituted property.
(c) Where a trust earns income from a property contributed or a property substituted therefor, and reinvests that income, any income or loss derived from the reinvestment of the earnings (the "second generation income") would not be attributed to the contributor. Thus, the income earned on the substituted-property securities is attributed pursuant to s. 75(2) as first-generation income, but any income earned on that income will not be attributed.
However, as is similar to (a) above, the trust would need to make the second generation income earned by it payable to the beneficiary under s. 104(13), so that s. 108(5) will generally apply to the income included in the beneficiary’s hands subject to recharacterization under a designation such as s. 104(19) or 104(21).