2015-0581951C6 2015 STEP – Q14 - Question 6 on the T3 Return

Principal Issues: Where a trust has made an income amount payable to a beneficiary, but the amount has yet to be paid, should this be disclosed in response to question 6 when filing the T3 return?

Position: Yes, if the beneficiary is not at arm's length with the trust.

Reasons: A debt has been incurred by the trust.

Author: Kohnen, Phil
Section: 122(2)(e)

STEP CRA Roundtable – June 18, 2015

Question 14.  Requirements for Question #6 on page 2 of the T3 Return

Question 6 of the T3 return reads as follows:

Did the trust borrow money, or incur a debt, in a non-arm's length transaction since June 18, 1971? If yes, state the year, and, if during this tax year, attach a statement showing the amount of the loan, the lender's name, and the lender's relationship to the beneficiaries.

In many cases, amounts of trust income are allocated to the beneficiaries of the trust but the corresponding amounts are not actually paid.  Instead, the trustees ensure that the amounts are due to the beneficiaries and such amounts are legally enforceable against the trust property (in order to ensure that the conditions of subsection 104(24) are met). Given such, are amounts that are due to the beneficiary for reasons described above required to be disclosed pursuant to question #6 of the T3 return?  The T3 Guide does not seem to address this specific question. 

CRA Response

For the purposes of various provisions in the Income Tax Act (the “Act”), including 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.

As Justice Rip (as he then was) noted in his decision in Fingold et al v MNR (92 DTC 2011):
A debt is a sum of money owed in respect of which a plaintiff has a right to bring and maintain an action [Re Kerr and Smith (1894), 24 O.R. 473.].

Accordingly, where a trust allocates income to a beneficiary in a particular tax year, but rather than paying out the income at that time, provides the beneficiary with the right to enforce payment, in our view, it thereby establishes a debt to that beneficiary.

The instructions for responding to the questions on page 2 of the T3 Trust Income Tax and Information Return (the “T3 Return”) can be found on page 21 of the 2014 T3 Trust Guide (Publication T4013). The instructions for question 6 refer the reader to Interpretation Bulletin IT-406R2 – Tax Payable by an Inter Vivos Trust (the “IT”). As is noted in paragraph 2 of the IT, graduated rate taxation, rather than flat rate tax on income, as is the general rule pursuant to subsection 122(1), is available to certain grandfathered trusts that meet all of the conditions of subsection 122(2) of the Act.

Note that the requirement in paragraph 122(2)(e) is that the trust has not, after June 18, 1971, incurred

(i) any debt, or

(ii) any other obligation to pay an amount,

to, or guaranteed by, any person with whom any beneficiary of the trust was not dealing at arm's length.

Reference may be made to Folio S1-F5-C1 – Related persons and dealing at arm’s length, for discussion as to the meaning of the term “at arm’s length”.

Note that paragraph 12 of the IT states that:

Paragraph 122(2)(e) is not contravened by a debt or other obligation of the trust to pay to a beneficiary an amount required by the terms of the trust, provided it is paid out to the beneficiary during the reasonable time needed to discharge the debt or obligation. A reasonable time will usually not be considered to extend beyond the end of the taxation year following the year in which the debt or obligation became payable by the trust. However, where subsection 104(18) applies with respect to the income of a trust in which a minor beneficiary has a vested interest, a reasonable time will usually not be considered to extend beyond the end of the taxation year following the year in which the child reaches the age of majority.

In response to the question posed, if a beneficiary not at arm’s length with a particular trust has been provided with rights to enforce payment of income in a taxation year of that trust, then the information requested in question 6 on page 2 of the T3 Return should be provided upon filing.

Phil Kohnen
2015-058195

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