Principal Issues: Would 78(1) apply to amounts payable by a trust to a beneficiary that remain unpaid at the end of the second tax year following the year they were deducted?
Position: No.
Reasons: Not a "deductible outlay or expense" in the context of 78(1)
STEP CRA Roundtable – June 2012
Question 1
Would subsection 78(1) of the Income Tax Act (the “Act”) apply in respect of amounts payable by a trust to a beneficiary where the amounts so payable remained unpaid at the end of the second taxation year following the year that such amounts were deducted from the trust’s income under subsection 104(6)? The question raised asks the Canada Revenue Agency to explain their position and interpretation of the meaning of the words “deductible outlay or expense” in the preamble of 78(1) and to comment on their IT-109R2.
CRA Response
We are unclear as to the context in which you were seeking our comments in respect of Interpretation Bulletin IT-109R2 – Unpaid Amounts.
Subsection 104(6) generally permits a trust to deduct, in computing its income for a taxation year, an amount not exceeding the portion of its income otherwise determined for the year that becomes payable in the year to a beneficiary under the trust. On the other hand, subsection 78(1) applies to an amount in respect of a deductible outlay or expense owing by a taxpayer if
(a) the amount is unpaid at the end of the second taxation year following the taxation year in which the outlay or expense was incurred, and
(b) the taxpayer and the person to whom the amount is owing were not dealing at arm's length, both at the time the expense was incurred and at the end of the second taxation year following the taxation year in which the expense was incurred.
In such cases, the amount owing is included in the taxpayer's income for the third taxation year following the taxation year in which the outlay or expense was incurred. This is so even if the amount is paid in that third taxation year, or in a later one, unless an agreement is filed under paragraph 78(1)(b).
In our view, the deduction of a portion of, what would otherwise be its income, under subsection 104(6) would not constitute a “deductible outlay or expense” of the trust in the context of subsection 78(1) for the following reasons:
- The Oxford Dictionary defines “outlay” as an amount of money spent on something. The deduction under subsection 104(6) is not an amount of money spent on something but is rather an allocation of trust income to beneficiaries.
- The concept of a “deductible outlay or expense” can be found in paragraph 18(1)(a), pursuant to which an outlay or expense incurred by a taxpayer generally is deductible to the extent that it is incurred for the purpose of producing income from property or from a business of the taxpayer. The deduction in subsection 104(6) is of a portion of the trust’s income (but for 104(6)), and could not be said to be an outlay or expense incurred by the trust for the purpose of producing income from property or from a business of the trust.
- A deductible outlay or expense of a trust could include, for example, trustee fees subject to the limitations in paragraphs 18(1)(a) and (b) and section 67 or fees paid to investment counsel subject to the limitations in paragraph 20(1)(bb) and section 67 (see for example question 3 in severed document 2008-0278801C6 presented at the 2008 STEP conference).
For the purposes of the deduction from income of the trust pursuant to subsection 104(6) and the inclusion in income of the beneficiary pursuant to subsection 104(13), an amount is deemed not to have become payable to a beneficiary in a taxation year under subsection 104(24) unless it was paid in the year to the beneficiary or the beneficiary was entitled in the year to enforce payment of it.
Phillip Kohnen
2012-044979
June 12, 2012