Where a family trust distributes its income to a beneficiary by issuing an interest bearing promissory note, if the beneficiary is not a minor and has not performed any work, has not contributed any property or assumed any risk respecting a related business owned directly or indirectly by the trust, would the beneficiary be able to rely on the “reasonable return” exception in either s. (f)(ii) or (g)(ii) of the “excluded amount” definition where the interest rate is equivalent to that which would have been charged between arm’s length parties?
CRA indicated that the distribution of income by way of a promissory note rather than cash does impact whether the distributed amount is split income, and that the amount distributed presumably would be included in “split income” (under para. (d) of the definition thereof) and subjected to the tax on split income (TOSI) unless it was an excluded amount.
The interest income did not appear to qualify as an excluded amount under s. (f)(ii) since the note does not appear to be “arm’s length capital.”
Regarding the reasonable return exceptions in s. (g)(ii) (where the beneficiary is 24 years before the particular year), CRA stated:
In a situation where the individual has not assumed any risk, whether an arm’s length rate of interest charged is a reasonable return is a mixed question of fact and law … .
In determining whether something constitutes a reasonable return, the CRA does not intend to generally substitute its judgment about what would be considered a reasonable amount where the taxpayer has made a good faith attempt to do so based on the reasonableness factors set out in the definition of “reasonable return."