Principal Issues: [TaxInterpretations translation] 1) Can you elaborate on the criteria for determining what a bona fide loan is? 2) Can you confirm that subsection 75(2) would not apply if Mr. X was a beneficiary of the trust? 3) Can you confirm that subsection 75(2) would not apply if Mr. X was the sole trustee (and not beneficiary) of the trust?
Position: Provided that the loan made by Mr. X to the trust is, in accordance with the true legal relationship between the parties, legally a loan rather than a contribution of capital to the trust, the fact that Mr. X was a beneficiary or a trustee of the trust, as the case may be, would not be itself result in the application of subsection 75(2).
Reasons: The question of whether a particular transaction legally constitutes a loan to a trust rather than a contribution to the capital of the trust is a mixed question of law and fact that can only be resolved after a full analysis of all the facts and relevant documents specific to each situation as well as applicable private law, either the civil law or the common law, as the case may be. Provided that the loan made by Mr. X to the trust is, in accordance with the true legal relationship between the parties, legally a loan rather than a contribution of capital to the trust, the fact that Mr. X was a beneficiary or a trustee of the trust, as the case may be, would not be itself result in the application of subsection 75(2).
Financial Strategies and Financial Instruments Roundtable, 5 October 2012
2012 APFF Conference
Question 21 – Loan at prescribed rate to a trust and application of subsection 75(2)
Generally speaking, we understand that with respect to a loan to a trust, the administrative position of the Canada Revenue Agency (the “CRA") is that a "bona fide loan" to a trust will not, in itself, be subject to the application of subsection 75(2).
We understand that prior to Howson v. The Queen, 2007 DTC 141 (TCC) ("Howson"), the CRA took a restrictive position on what constituted a "bona fide loan". It should be noted that following that decision, the CRA has repeatedly confirmed its acceptance of the court's interpretation that property transferred under a bona fide loan is not subject to the application of subsection 75(2) and, for a loan to be considered bona fide for the purposes of that paragraph, it is not necessary that interest be paid or that a security be given. As a result, we understand that the current position of the CRA is that subsection 75(2) would not apply to the extent that a loan is independent of a trust deed (i.e., the loan must not be part of the trust deed) and to the extent that it is a loan (i.e. a "bona fide loan") and not a contribution to the capital to the trust.
That being said, consider the following situation:
Facts
1. A discretionary family trust is formed for the benefit of the spouse, and the minor and adult children, of Mr. X;
2. The Trust has three (3) trustees who are not beneficiaries or settlors of the Trust. Mr. X is one of the trustees. None of the trustees has a veto right and decisions must be made by majority decision.
3. Mr. X lends $300,000 (the "Loan") to the Trust;
4. A loan agreement is signed between the Trust (i.e. the Trustees) and Mr. X (the "Loan Agreement");
5. The Loan Agreement is independent of the Trust Deed and so the Loan is not governed by the terms and conditions of the Trust Deed;
6. The Loan Agreement provides that the Loan will bear interest at the prescribed rate in effect at the time the Loan was made;
7. The Loan Agreement provides that the interest payable will be paid in the year or no later than 30 days after the end of that year in order to satisfy the conditions of subsections 56(4.2) and 74.5(2);
8. The Loan will be used to acquire property that will produce income from property (for example, a portfolio of investments (stocks and bonds) or a rental property).
9. The Trust does not hold any shares in the capital stock of a corporation that is not listed on a designated stock exchange.
10. The income produced by the assets of the Trust will be used first to repay interest on the Loan.
11. The balance could be used to directly finance the expenses (for example, education, recreation) of the minor and adult children. Money could also be given directly to adult children either to pay their expenses or for savings.
12. Since the income will be paid or payable to the beneficiaries in the year, the trustees could deduct those payments from the taxable income of the trust pursuant to subsection 104(6), thereby rendering them taxable in the hands of the beneficiaries.
Question to the CRA
1. Can you elaborate on the criteria for determining what a bona fide loan is?
2. Can you confirm that subsection 75(2) would not apply if Mr. X was a beneficiary of the trust?
3. Can you confirm that subsection 75(2) would not apply if Mr. X was the sole trustee (and not a beneficiary) of the trust?
CRA Response
These questions appear to us to be matters of application of subsection 75(2) respecting a particular situation. However, it is not the CRA's practice to comment on proposed transactions involving specific taxpayers otherwise than through advance tax rulings. Furthermore, when it comes to determining whether a completed transaction has received appropriate tax treatment, the determination is made first by our Tax Services Offices as a result of their review of all facts and documents. which is usually performed as part of an audit engagement.
The question of whether a particular transaction legally constitutes a loan to a trust rather than a contribution to the capital of the trust is a mixed question of law and fact that can only be resolved after a full analysis of all the facts and relevant documents specific to each situation as well as the applicable private law, either the civil law or the common law, as the case may be.
Provided that the loan made by Mr. X to the trust is, in accordance with the true legal relationship between the parties, legally a loan rather than a contribution of capital to the trust, the fact that Mr. X was a beneficiary or a trustee of the trust, as the case may be, would not by itself result in the application of subsection 75(2).
Alexandro Pace
(613) 952-1506
2012-045359
October 5, 2012