| 24(1) | 5-901670 |
| A. Seidel | |
| (613) 957-8960 |
19(1)
November 28, 1990
Dear Sirs:
This is in reply to your letter dated July 12, 1990 with respect to preferred beneficiary elections.
It is a question of fact whether a preferred beneficiary election can be filed in any given situation. The critical factor with respect to the practical effect of the preferred beneficiary election is the calculation of the preferred beneficiary's share of accumulating income of the trust for that taxation year, which is the upper limit for purposes of the election. If a particular preferred beneficiary's share of accumulating income is nil for a given taxation year then, for practical purposes, an election cannot be made for that particular beneficiary pursuant to subsection 104(14) of the Income Tax Act (the "Act").
For a discretionary trust, in order for a particular preferred beneficiary to be able to elect on a share of the accumulating income of the trust which is greater than nil, that particular preferred beneficiary must be an income beneficiary for that particular taxation year. Where the trust indenture does not specify that capital gains are income, a capital beneficiary may also be an income beneficiary for purposes of paragraph 104(15)(c) in the year a capital gain is realized by the trust as discussed more fully below.
In the situation where there is a power of encroachment on capital in favour of any beneficiary, all preferred beneficiaries will be subject to the provisions of paragraph 104(15)(c) of the Act. The reason for this is that if encroachments are made, the accumulating income of the trust will be affected since the income earning assets of the trust would be reduced.
For a capital beneficiary to be subject to the provisions of paragraph 104(15)(c) of the Act where a capital gain has been realized by the trust in a given taxation year, a power of encroachment on capital of the trust must exist for that beneficiary and/or his capital interest must be vested at the end of the particular taxation year.
In the situation where there is no capital gain realized in the taxation year, a capital beneficiary's share of the accumulating income of the trust for a particular taxation year would be nil pursuant to paragraph 104(15)(d) of the Act.
Furthermore, in our opinion, the fact that income taxed in the trust would normally become tax-paid capital accruing for the benefit of the capital beneficiaries is not relevant for the purposes of the application of subsection 104(15) of the Act for a given taxation year of the trust.
Where a preferred beneficiary is subject to the provisions of paragraph 104(15)(c) of the Act, it is our opinion that the number to be used in the calculation pursuant to paragraph 2800(3)(f) of the Income Tax Regulations (the "Regulations") will include any preferred beneficiary who is alive at the end of the particular taxation year of the trust. By virtue of the fact that subsection 2800(4) of the Regulations does not apply where paragraph 2800(3)(f) of the Regulations is applicable, this number will include all contingent preferred income beneficiaries including those whose rights are contingent on the death of another preferred beneficiary. It will also include all contingent capital beneficiaries where the trust document does not specify that taxable capital gains will be considered income for trust purposes. If the trust document in fact does specify that capital gains are income for trust purposes, we would exclude all capital preferred beneficiaries (contingent or otherwise) from this calculation because we would consider them never to be entitled to share in the accumulating income of the trust for any taxation year.
In your hypothetical situation, a grandfather is the settlor of a trust. The trust's income beneficiaries are his four grandchildren and its capital beneficiary is his son. The trustee has absolute discretion to distribute all, some or none of the income of the trust each year or all, some or none of the capital each year. Any income not distributed to the grandsons within three months after the calendar year end becomes part of the capital of the trust. In the situation where the trustee chooses not to distribute the income earned by the trust in a year, our comments are as follows:
Since the trust contains a discretionary power of capital encroachment, the preferred beneficiaries share of the accumulating income would be determined pursuant to paragraph 104(15)(c) of the Act and paragraph 2800(3)(f) of the Regulations. All of the five preferred beneficiaries may be entitled to share in the accumulating income of the trust and each preferred beneficiaries share will be equal to one-fifth of the accumulating income. The grandchildren will each be entitled to elect pursuant to paragraph 104(15)(c) of the Act up to 1/5 of the accumulating income for the year. Since no capital gain has been realized by the trust, the son's share of the accumulating income of the trust for that year is nil.
While we hope our comments are of assistance to you they do not constitute an advance income tax ruling and therefore are not binding on the Department in respect of a specific situation.
Yours truly,
for DirectorFinancial Industries DivisionRulings Directorate