2016-0663971I7 104(6)(b), whether amount became payable

Principal Issues: 1. Whether an amount became payable in the year to a beneficiary for the purposes of paragraph 104(6)(b) 2. Whether an amount paid under the trust to a beneficiary is included in income under subsection 105(1)

Position: 1. No 2. Yes

Reasons: 1. Wording of paragraph 104(6)(b); meaning of became payable in the year 2. Wording of subsection 105(1)

Author: deLang-Lenters, Saskia
Section: 104(6)(b), 104(13), 104(24), 105(1)

                                                                                                                                        November 1, 2016

XXXXXXXXXX Tax Services Office                                                                                Income Tax Rulings Directorate
XXXXXXXXXX                                                                                                                S. deLang-Lenters

                                                                                                                                        2016-066397

XXXXXXXXXX

Dear XXXXXXXXXX,

We are writing in reply to your email of August 31, 2016 in which you requested our views regarding the interpretation of subsections 104(6), 104(13), and 105(1) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Suppl.) (the “Act”, to which all statutory references herein relate). We also acknowledge our telephone conversations with you of October 5 and 24, 2016 concerning your request.

In the situation described, the beneficiaries of a personal family trust included minor children. An article of the trust indenture stipulates that no minor beneficiary shall receive or otherwise obtain the use of any of the income or capital of the trust while being a “designated person” as defined in the Income Tax Act in respect of the minor beneficiaries’ father. The relevant definition of “designated person” in subsection 74.5(5) provides that a “designated person” in respect of an individual, includes a person who is under 18 years of age and who does not deal at arm’s length with the individual. Notwithstanding the terms of the trust, for the taxation year in question, amounts were paid under the trust to the minor beneficiaries. The taxpayer purported to include such amounts in income of the minor beneficiaries under subsection 104(13).

Specifically you have asked:

1.    whether the trust may deduct under subsection 104(6) amounts paid to minor beneficiaries given the terms of the trust indenture regarding subsection 74.5(5);

2.    whether the amounts paid to minor beneficiaries are to be included in income of the minor beneficiaries under subsection 104(13) or under subsection 105(1).

Our comments

Is an amount deductible by the trust under subsection 104(6)?

The midamble of paragraph 104(6)(b), as it read for the taxation year in question, provides that in computing its income for the year, a trust may deduct an amount, provided that amount does not exceed the portion of its income for the year that became payable in the year to a beneficiary of the trust. The Finance Consolidated Explanatory Notes underscore that the amount is such an amount that became payable to a beneficiary under the trust.

The Directorate has published its views regarding whether, and if so when, an amount has become payable for the purposes of certain provisions of the Act, including subsections 104(6) and 104(13). Document 2005-0159081I7 discusses these and other related issues and states the following, in part:

There are a number of provisions in the Act that require a determination that an amount has become payable in order for the provision to apply in respect of an amount.  Each of subparagraph 53(2)(h)(i.1) and subsections 104(6), 104(7), 104(13), and 104(20) of the Act is such a provision.  These five provisions - involving the income taxation of trusts and their beneficiaries - apply in respect of an amount only to the extent that an amount has become payable.  Therefore, in order to apply the provisions, it must first be determined that the relevant amount has become payable.

The determination of whether an amount has become payable ordinarily is made by reference to the meaning of “payable” under the applicable general law.  See, for example, the discussion in the Agency’s document 2005-0130461I7. However, for purposes of subparagraph 53(2)(h)(i.1) and subsections 104(6), 104(7), 104(13), and 104(20) of the Act, subsection 104(24) provides a rule of application that alters the ordinary result.
….   
(i) Has an amount become payable?

Accordingly, a formal analytical framework for determining whether an amount has become payable to a beneficiary for purposes of subparagraph 53(2)(h)(i.1) and subsections 104(6), 104(7), 104(13), and 104(20) of the Act would be as follows:

1.    determine what under the applicable general law (i.e., without regard to the Act) constitutes an amount payable - this is to ascertain what the requirement is for an amount prima facie to have become payable;

2.    determine what under the applicable general law (i.e., without regard to the Act) constitutes the payment of an amount or an entitlement to enforce payment of an amount - this is to ascertain what the requirement is to meet one or both of the exceptions to the deeming rule in subsection 104(24); and

3.    apply the principles from steps #1 and #2 to the facts (determined, for example, by reference to the terms of the trust). (italics added)

Using this analytical framework, only if on the applicable facts an amount has first been determined to have become payable to a beneficiary and then also been determined either to be paid in a particular taxation year to the beneficiary or become subject to an entitlement in the particular taxation year on the part of the beneficiary to enforce payment of it will the amount’s status as an amount that has become payable in the particular taxation year to the beneficiary be preserved for purposes of subparagraph 53(2)(h)(i.1) and subsections 104(6), 104(7), 104(13), and 104(20) of the Act. (italics added)
…

Applying the formal analytical framework to the current query, has an amount become payable to a minor beneficiary of the trust under applicable general law? In this case, the principles from steps #1 and #2 of the formal analytical framework may be applied to the facts with reference to the terms of the trust.

The trust indenture provides that no minor beneficiary shall receive or otherwise obtain the use of any of the income or capital of the trust while being a “designated person” as defined in the Act. A designated person includes, pursuant to subsection 74.5(5), an individual under 18 years of age who does not deal at arm’s length, in this case, with the individual’s father. In our view, it is prima facie not possible, pursuant to subsection 104(6), for an amount to become payable in the year to a beneficiary that is a designated person under the terms of the trust indenture. The requirement of subsection 104(6) is simply not met for the particular taxation year. Accordingly, in this circumstance, no amount is deductible to the trust pursuant to subsection 104(6) for the particular taxation year in respect of the payments to the minors.

As stated above, subsection 104(24) provides a rule of application that alters the ordinary result where and only if, on the applicable facts, an amount has first been determined to have become payable to a beneficiary. As no amount has become payable to a beneficiary pursuant to subsection 104(6), subsection 104(24) has no application.

Impact of the Cooper case

The taxpayer’s position is that even if in our view the payments to the minor beneficiaries were prohibited transactions under the trust indenture, based on the judge’s comments in Cooper (cited below) this should have no bearing on the applicability of subsection 104(6) and the assessment of tax. The taxpayer cites from our technical interpretation 9528037 in this regard:

“…regardless of whether the investment was a prohibited transaction, liability for income tax is assessed on the basis of what a taxpayer has actually done. See Steven Cooper v. Her Majesty the Queen, 88 DTC 6525 (FCT-TD), at page 6535:

‘A well-established principle of income tax law states that the illegality (if any) of actions of the taxpayer, in this case the payment to the Plaintiff in relation to the terms of the trust, is irrelevant in the assessment of tax liability. The obligation of the trustees to place the money loaned to the Plaintiff in income-generating investments is not a factor in my decision.

...The Minister has no interest in the proper administration of trust funds. This is the function of the provincial court systems, more particularly in this case the Probate Court, and any questions regarding the propriety of the actions of Mr. Cooper and his mother as trustees should be raised in that forum alone.’”

In our view, the Cooper case is inapplicable in the current fact scenario. Justice Rouleau’s comments in Cooper were made in the context of the trustee’s failure to fulfill their obligation to place the money loaned to the plaintiff in the case in income-generating investments. The trustees were arguably in breach of trust for failing to do so. In Cooper, the illegality (if any) of actions of the taxpayer, in that case the payment to the plaintiff in relation to the terms of the trust, were determined to be irrelevant in the assessment of tax liability. Document 9528037 concerned whether an amount was a loan from an estate and whether the amount was to be included in the executor’s income under subsection 15(2) or 105(1). The comments related to any illegality of the taxpayer’s actions were made in the context of which provision of the Act to properly assess income tax. 

In your file, the taxpayer posits that the rationale in Cooper should be applied in what we view to be a different context – arguing that such that an illegality should be ignored to permit a taxpayer to obtain a particular tax benefit under the Act. However, in our opinion, the comments in Cooper do not extend to provide that the illegality (if any) of actions of the taxpayer may be used to obtain a tax benefit or to claim a deduction from income where such a benefit or deduction does not meet the requirements under a plain reading of the Act.

Is the amount income to the beneficiary under subsection 104(13)?

The fact that amounts were paid under the trust and received by the minor beneficiaries is not in dispute. The taxpayer’s position is that the amounts are included in the respective minor beneficiaries’ incomes under paragraph 104(13)(a) and as such cannot be included under paragraph 105(1)(a).

Subsection 104(13) includes in the income of a beneficiary for a taxation year such part of the amount (without regard to subsections 104(6) and (12)) that would be the trust’s income for the particular taxation year of the trust “as became payable in the trust’s year to the beneficiary”.

The wording in quotations is similar to that used in subsection 104(6). Document 2006-0185631C6 (2006 STEP Round Table question 16) clarifies that it is subsection 104(13), and not subsection 104(24) that determines whether and when an amount must be included if the beneficiary’s income:

If an amount has, with regard to subsection 104(24), become payable to a beneficiary by a trust, the determination of whether that amount must be included in the beneficiary’s income for tax purposes is not made under subsection 104(24) of the Act. Rather, the determination of whether and, if so, when the amount must be included in the beneficiary’s income is made with regard to subsection 104(13) of the Act.

It was opined above that it is prima facie not possible, pursuant to subsection 104(6), for an amount to become payable in the year to a beneficiary who is a designated person under the terms of the trust. By analogous rationale, in our view no amount may be included in computing the income for the year of a minor beneficiary under the trust pursuant to subsection 104(13) in this case.

Is the amount paid to the beneficiary a benefit under subsection 105(1)?

Subsection 105(1) of the Act provides that the value of all benefits received or enjoyed by a taxpayer from or under a trust, are to be included in the taxpayer’s income except to the extent that the value,

(a)   is otherwise required to be included in computing the taxpayer’s income for a taxation year or,

(b)   (generally speaking) has been deducted in computing the adjusted cost base of the taxpayer’s interest in the trust under paragraph 53(2)(h).

In the current case, paragraph 105(1)(b) has no application as the provision does not apply to an interest in a personal trust that has never been acquired for consideration. In our view, the value of the amount is also not included in income of the minor beneficiaries under 104(13) as discussed above.

The fact that the amounts received by the minor beneficiaries should be included in income is not in dispute as the taxpayer’s purported to include such income under subsection 104(13). In our view, the amount is properly included in income under subsection 105(1), as the two exceptions to the provision are not met.

We trust these comments will be of assistance to you.

Yours truly,

Phil Kohnen
Manager, Trust Section I
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

c.c.  Brett Evers and Hui Ling Li
       Technical Applications Section I

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