2017-0695141C6 2017 STEP – Q4 - U.S. grantor trust

Principal Issues: In the situation provided, 1) Whether a resident contributor to a U.S grantor trust can claim the foreign tax credit in respect of the foreign taxes paid by the contributor where the income of the trust is designated pursuant to subsection 104(22). 2) Whether the contributor can claim the foreign tax credit where the contributor elects to have subsection 94(16) apply and the trust designates the income under paragraph 94(16)(c). 3) Whether the contributor can deduct an amount under subsection 20(11) in respect of the foreign taxes paid, where the trust designates the income under subsection 104(22), or the contributor elects to have subsection 94(16) apply. 4) Whether the contributor can deduct an amount under subsection 20(12) in respect of the foreign taxes paid, where the trust designates the income under subsection 104(22), or the contributor elects to have subsection 94(16) apply.

Position: 1) Yes; a designation under subsection 104(22) is not necessary to obtain this result. 2) Yes. 3) A deduction is available under subsection 20(11) where the trust distributes its income to Mr. X in the year. No deduction under subsection 20(11) is available where Mr. X elects to have subsection 94(16) apply. 4) A deduction under subsection 20(12) is available in both situations.

Reasons: 1) Paragraph 94(3)(a) does not refer to subsection 108(5); accordingly the amount paid or made payable by the U.S. trust is foreign source income to the beneficiary for purposes of section 126, without the subsection 104(22) designation. 2) Paragraph 94(16)(c) provides that the amount designated is foreign source income to the electing contributor for purposes of section 126. 3) Where income is distributed to Mr. X, see reasons in 1). Where the contributor elects to have subsection 94(16) apply, paragraph 94(16)(b) deems the amount determined in paragraph (a) to be from a source in Canada. The designation under paragraph 94(16)(c) applies for purposes of paragraphs 94(16)(c), (d) and section 126 only and does not extend to subsections 20(11) and (12). This option does not satisfy the condition in subsection 20(11) that the income is from a source outside Canada. 4) As the Canadian resident individual includes a distribution from the trust in their income under subsection 104(13), and subsection 108(5) deems the income to be income from a property that is an interest in the trust, the "in respect of" condition in subsection 20(12) is satisfied. The same result occurs where the individual includes an amount in income pursuant to subsection 94(16).

Author: Fron, Steve
Section: 94(1); 94(3)(a), 94(3)(b); 94(16); 104(22), 104(22.1); 126(1), 126(7)

STEP CRA Roundtable – June 13 2017

Question 4.  US Grantor Trust

A Canadian resident individual (Mr. X) who is a citizen of the United States (U.S.) settles a revocable living trust for the benefit of himself and his family members.  Assume for Canadian tax purposes, the trust is factually resident in the U.S. (i.e., the central management and control of the trust resides in the U.S.). 

The trust property consists of certain real estate interests situated in the U.S. and marketable securities from which the trust earns U.S. source property income.

As the trust is viewed as a “grantor trust” under the Internal Revenue Code, Mr. X reports all income earned by the trust on his U.S. income tax return and pays the related U.S. income tax.  However, the trust is a trust for Canadian income tax purposes, and is not an arrangement that is deemed not to be a trust as described in subsection 104(1).  Further, as Mr. X is a “resident contributor” to the trust, as defined in subsection 94(1), the trust is deemed to be resident in Canada for certain purposes of the Act by virtue of subsection 94(3).  As a result, the trust is subject to Canadian income taxation on its worldwide income. 

Since Mr. X is liable for and pays the U.S. income tax in respect of the trust’s U.S. source property income each year, the trust cannot claim a foreign tax credit under section 126 for that tax.  Similarly, the trust cannot claim a deduction under subsection 20(12) in respect of the tax paid by Mr. X.  To deal with the mismatch of foreign income and foreign tax paid, the trustee has two possible alternatives to transfer the foreign source property income to Mr. X.  Under the first alternative, the trust can make all of its income payable to Mr. X in the year and make a subsection 104(22) designation such that the income retains its character as U.S. source income in Mr. X’s hands.  Second, instead of having the trustee allocate the trust income to the beneficiaries, Mr. X can elect to have subsection 94(16) apply to himself and the trust.  As Mr. X is the sole contributor to the trust, the application of subsection 94(16) would result in the trust’s income being attributed to Mr. X. 

Could the CRA comment on the availability of deductions under subsections 20(11) and 20(12), and the foreign tax credit?

CRA Response

For purposes of discussion, we further assume that Mr. X has no other U.S. source income.  Furthermore, we assume that the U.S. taxes paid by Mr. X are in accordance with the provisions of the Canada-U.S. Tax Convention and are, therefore, not refundable to Mr. X.

Subsection 104(22) designation by the trust

Where the conditions in subsection 104(22) are met and the trust designates an amount of its foreign source income in respect of a beneficiary under the trust in the trust’s return of income for the particular taxation year, the amount so designated is deemed for the purposes of subsection 104(22), subsection 104(22.1) and section 126 to be foreign source income of the beneficiary and not the trust for purposes of section 126.  A trustee of a deemed Canadian-resident trust might make a designation under subsection 104(22) where the trust has paid foreign tax, and wants to “flow-through” the foreign income and foreign tax to the trust’s beneficiaries such that the beneficiaries may claim the foreign tax credit.  However, in this situation it is relevant to note that paragraph 94(3)(a) deems the U.S. trust to be resident in Canada for purposes of only the provisions noted in subparagraphs (i) to (x).  As subsection 108(5) is not included in the provisions contemplated in paragraph 94(3)(a), the question of territorial source of income is one of fact and must take into account all the surrounding circumstances.  On the basis of the assumptions provided, we would generally expect that an amount included in Mr. X’s income pursuant to paragraph 104(13)(a) in respect of the U.S. trust would be U.S. source income, and have assumed this throughout this analysis.  As Mr. X has paid the U.S. tax, he may claim the foreign tax credit in respect of the foreign tax paid, subject to the conditions and calculations in section 126.  A subsection 104(22) designation is not needed to effect this result.

Except as otherwise provided in Part I, a beneficiary’s income from a trust is deemed by paragraph 108(5)(a) to be income from a property that is an interest in the trust and not from any other source.  Subsection 20(11) refers to “the income of an individual from a property, other than real property…that is income from a source outside Canada…”.  On the basis that an amount included in Mr. X’s income pursuant to paragraph 104(13)(a) in respect of the U.S. trust would be U.S. source income, Mr. X should be able to claim a deduction under subsection 20(11).  We note that even though the trust has a source of income that is U.S. real property, because of paragraph 108(5)(a), none of Mr. X’s income from the trust is from a source that is real or immovable property.  Even if the trust did make a designation under subsection 104(22), this would still be the case because subsection 104(22) does not apply for purposes of subsection 20(11).  Any amount deductible under subsection 20(11) will reduce the amount of the non-business-income tax paid by Mr. X for purposes of the calculation of the foreign tax credit in subsection 126(1) and determining the amount deductible under subsection 20(12).

Subsection 20(12) allows a taxpayer who is resident in Canada to deduct, in computing income for a taxation year from a business or property, non-business income taxes paid to a foreign government in respect of the income.  As noted, paragraph 108(5)(a) applies to deem any amount included in Mr. X’s income under paragraph 104(13)(a) to be his income from a property that is an interest in a trust.  It is our view that a deduction may be claimed under subsection 20(12) in respect of  U.S. income tax paid by Mr. X in respect of the trust’s income that was paid or made payable to him by the U.S. grantor trust in the year.  Any amount claimed as a deduction under subsection 20(12) will reduce the amount of the non-business-income tax for purposes of the calculation of the foreign tax credit in subsection 126(1).

Election to have subsection 94(16) apply

Where Mr. X elects as described in the definition of “electing contributor” in subsection 94(1) to have subsection 94(16) apply to himself and the trust, the amount of the trust’s income that is required to be included in Mr. X’s income is determined by the formula in paragraph 94(16)(a).  As Mr. X is the only contributor to the trust, the result of the A/B fraction in the formula is 1; therefore Mr. X will report 100 percent of the income earned by the trust. 

Paragraph 94(16)(b) provides that the income required to be included in the electing contributor’s income is deemed to be income from a source in Canada, subject to the amount designated under paragraph 94(16)(c).  Paragraph 94(16)(c) provides that for the purposes of paragraphs 94(16)(c) and (d) as well as section 126, where certain conditions are met, the trust’s income from a source in a country outside Canada is deemed to be income of the electing contributor from that source.  Thus, Mr. X can claim the foreign tax credit under subsection 126(1) in respect of the foreign source income that the trust designates under paragraph 94(16)(c). 

As paragraph 94(16)(c) does not apply for purposes other than those set out therein, Mr. X’s paragraph 94(16)(a) income remains sourced to Canada for purposes of subsection 20(11) in accordance with paragraph 94(16)(b).  As a result, Mr. X cannot claim a deduction under subsection 20(11).

Mr. X may claim a deduction under subsection 20(12) in respect of U.S. income tax income paid in respect of income that is attributed to him under paragraph 94(16)(a).  Any amount claimed as a deduction will reduce the amount of the foreign non-business-income tax paid for purposes of determining the foreign tax credit in subsection 126(1).

Steve Fron
Terry Young
2017-069514

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