Principal Issues: Does subsection 107(2) apply to the distribution of a rental property if the beneficiary assumed the loan secured by a mortgage on a rental property?
Position: Question of fact. Likely yes if the initial loan and the assumption of debt by the beneficiary do not have an impact on the status of the personal trust. If the debt assumed by the beneficiary is an eligible offset pursuant to the definition of eligible offset of subsection 108(1), it reduces the proceeds of disposition of the capital interest of the beneficiary.
Reasons: Wording of the Act
Financial Strategies and Financial Instruments Roundtable, October 9, 2015
2015 APFF Conference
Question 8
Distribution of capital to a beneficiary who is also a creditor
Subsection 107(2) allows for an automatic tax rollover of property distributed to a Canadian beneficiary in consideration for its capital interest in a trust. In recent years, some technical interpretations have been published by the CRA in respect of situations where the beneficiary of the trust was also a creditor of the trust. In such circumstances, the CRA concluded, in particular in technical interpretations 2013-0488061E5, 2013-0503481E5 and 2014-0526551C6, that a portion of the property transferred to the beneficiary was used to repay the debt due to the beneficiary and thereby, that part could not be subject to a tax rollover under subsection 107(2).
In order to avoid a loss of the tax rollover, the following solution is considered. Assume that the trust wishes to distribute a rental property in the amount of $500,000 to a beneficiary in partial or full settlement of its capital interest. The property is encumbered with a $200,000 hypothec owing to the beneficiary in respect of a loan originally made by the beneficiary of the trust to enable the trust to acquire the rental property. The trust will therefore borrow $200,000 from a financial institution (who is granted a security interest in the rental property) and repay the debt owing to the beneficiary.
Thereafter, the trust would distribute the property in question to the beneficiary, with that rental property being subject to a hypothec of $200,000 granted to the financial institution. According to the CRA's position in question 8 of the October 2014 APFF Convention Federal Roundtable, interest on the assumed hypothec should continue to be deductible by the beneficiary if the rental property continues to be used to generate property or business income.
Question to CRA
Does the proposed solution permit a tax rollover under subsection 107(2) to apply to all of the rental property distributed to the beneficiary in partial or complete settlement of the beneficiary's capital interest?
CRA Response
Subsection 107(2) applies in particular when a personal trust distributes property to a beneficiary and there is a resulting disposition of all or part of the capital interest of the beneficiary in the trust. Furthermore, subsection 107(2) does not apply unless subsections 107(2.001), 107(2.002) and 107(4) to 107(5) do not apply.
The definition of personal trust in subsection 248(1) includes a trust in which no beneficial interest was acquired for consideration payable directly or indirectly to the trust or to any person or partnership that has made a contribution to the trust by way of transfer, assignment or other disposition of property.
The question of whether a loan made by a beneficiary or the assumption by the beneficiary of a hypothec constitutes consideration for the acquisition of an interest in the trust is a question of fact which cannot be determined before an examination of all the facts and relevant documentation.
To the extent that a loan made by the beneficiary or an assumption by the beneficiary of a hypothecary loan does not causes the trust to lose its status as a personal trust and all the other conditions for the application of subsection 107(2) are satisfied, the rollover in subsection 107(2) can apply to a distribution of the property.
If subsection 107(2) applies, paragraph 107(2)(c) provides, among other things, that the total of all amounts each of which is an eligible offset amount at that time reduces the proceeds of disposition of the capital interest disposed of by the beneficiary.
The definition of “eligible offset amount” in subsection 108(1) (the “Definition”) encompasses the portion of any debt or obligation which is assumed by the taxpayer in respect of all or part of the taxpayer’s capital interest in a trust, and that can reasonably be considered to be applicable to property distributed in satisfaction of the interest, if the distribution is conditional upon the assumption by the taxpayer of the portion of the debt or obligation.
In our view, in order for the assumption of the hypothecary loan by the beneficiary to be deductible under paragraph 107(2)(c), it must satisfy the conditions provided in the Definition.
However, the eligible offset amount does not apply in computing the proceeds of disposition of property of the trust under paragraph 107(2)(a) or to the cost of property acquired by the beneficiary under paragraph 107(2)(b).
Lucie Allaire
October 9, 2015
2015-059309