Principal Issues: [TaxInterpretations translation] A taxable capital gain of $375,000 was allocated to Beneficiary A of a discretionary family Trust for which an amount is payable to him but not yet paid. Can the CRA confirm that the interest income earned by the Trust over the course of a taxation year on the amount of $375,000 not yet paid and invested by the Trust may be allocated in the course of that taxable year to Beneficiary B as income from property that is an interest in the trust, and not to Beneficiary A to whom the $375,000 was originally payable?
Position: Yes, assuming that interest income is payable under the trust indenture and at the discretion of the trustee to Beneficiary B over the course of that taxation year.
Reasons: Under article 909 of the CCQ, capital, inter alia, is property that produces fruits and revenues, the reinvestment of the fruits and revenues, or the price for any disposal of capital or its reinvestment. Article 910 CCQ provides that the fruits and revenues are that which is produced by property without any alteration to its substance. Revenues comprise sums of money yielded by property, such as rents, interest and dividends. Under the applicable provisions of the CCQ, the capital gain realized by a trust is generally part of the capital of the trust. However, for tax purposes, the taxable portion of a capital gain realized by a trust is part of the income of the trust. In this regard, the definition of income in subsection 108(3) does not apply in respect of subsections 104(6), (13) and (21).
FINANCIAL STRATEGIES AND INSTRUMENTS ROUNDTABLE 5 OCTOBER 2012
2012 APFF CONFERENCE
Question 17 - Allocation of investment income earned on property that is payable but not yet distributed
A taxable capital gain of $375,000 was allocated to Beneficiary A of a discretionary family trust ("Trust") for which an amount is payable to him or her but not yet paid. The unpaid amount to Beneficiary A is acknowledged as debt of the Trust. The debt does not bear interest and has a very long term.
For example, the Trust holds $375,000 in assets, and has $375,000 of interest-free debt with a 25-year term payable to Beneficiary A. The $375,000 was invested at a 1% annual return, generating $3,750 in interest income to the Trust.
Pursuant to the Deed of Trust, the Trustee annually allocates and distributes the annual interest income of $3,750 to Beneficiary B and nothing to Beneficiary A. Beneficiary B pays tax annually on the $3,750 received. Beneficiaries A and B are capital and income beneficiaries.
Can the CRA confirm that the interest income earned by the Trust in a taxation year can be allocated to Beneficiary B as income from property that is an interest in the trust, and not to Beneficiary A to whom the $375,000 was originally payable?
CRA Response
With respect to the validity of the Trust's acknowledgement of debt reflecting the taxable capital gain payable to Beneficiary A, we refer you to the CRA's response to question 33 at the Federal Taxation Roundtable presented at the 2010 APFF Conference (see document 2010-0373431C6). In that response, the CRA stated, among other things:
…[W]here the deed of trust permits a trustee to issue a promissory note payable on demand of the beneficiary, without the beneficiary’s rights being subject to conditions, we are of the view that the issuance of such a note will generally constitute an amount that became payable by a trust within the meaning of subsection 104(24) for the taxation year in which the beneficiary received the note. However, if the beneficiary cannot demand payment of the promissory note because of a contingency or restriction, we are of the view that the conditions of subsection 104(24) are not satisfied because that beneficiary does not have the right to demand the payment of the promissory note before the end of the year.
In light of the foregoing, the acknowledgement of debt does not appear, in our view, to satisfy the conditions set out above. As a result, the conditions of subsection 104(24) would not be met.
For the purposes of our response, we have assumed that we are dealing with a discretionary personal trust established by virtue of the CCQ.
The question of whether income is payable to a beneficiary for a particular taxation year by virtue of subsection 104(13) is a mixed question of law and fact that cannot be determined without taking into account all relevant facts and legal documents pertaining to a particular situation, including the provisions of the trust indenture. As outlined in T4013 T3 – Trust Guide ("Guide"), the income of a trust is generally allocated among the beneficiaries according to the terms of the will or trust document. In addition, the Guide states that an amount can only be allocated to a beneficiary in one of the following situations:
- under the terms of the trust the beneficiary is entitled to income in the year when the income is earned by the trust,;
- the trust makes a preferred beneficiary election to include the income of the trust in the income of the beneficiary; or
- the beneficiary receives income in the year where the income is earned by the trust, at the discretion of the trustee.
Under Article 909 CCQ, capital includes property that produces fruits and revenues, the reinvestment of the fruits and revenues, or the price for any disposal of capital or its reinvestment. Article 910 CCQ provides that the fruits and revenues are that which is produced by property without any alteration to its substance. Revenues comprise sums of money yielded by property, such as rents, interest and dividends, except those representing the distribution of capital of a legal person. Thus, absent a contrary provision in the deed of trust, the capital gain realized by a trust is generally part of the capital of the trust under the applicable provisions of the CCQ. However, for tax purposes, the taxable portion of a capital gain realized by a trust is part of the income of the trust. In that regard, the CRA is of the view that the definition of income in subsection 108(3) does not apply in respect of subsections 104(6), (13) and (21).
In your example, the interest income earned on the capital of the Trust in the course of a taxation year which, by virtue of the deed of trust and at the discretion of the trustee, is payable to Beneficiary B in the course of that taxation year is deemed to be income earned by Beneficiary B for the year on property that is an interest in the Trust.
Danielle Bouffard
(613) 590-2155
October 5, 2012
2012-045358