2019-0798511C6 STEP 2019 - Q14 - TOSI and PBE

Principal Issues: 1) Can CRA explain its reasoning for its comments regarding subsection 104(19) in document 2018-0759521E5? 2) Will CRA grant relief for previous years in which a preferred beneficiary election was made?

Position: 1) Reasoning provided. 2) No relief will be granted.

Reasons: 1) See below. 2) see below.

Author: Holloway, Lena
Section: 104(13); 104(14); 104(19); 105(2) and 120.4(1)

2019 STEP CRA Roundtable – June 7, 2019

QUESTION 14.  TOSI and the Preferred Beneficiary Election

In the Summary portion of Technical Interpretation 2018-0759521E5, the CRA indicated that if a designation under subsection 104(19) is made in respect of a preferred beneficiary income amount resulting from an election under subsection 104(14), the amount would be includable in the definition of “split income” by virtue of paragraph (a) of that definition. However, the CRA did not provide any explanation for this statement in the body of the External Interpretation document. By referring only to trust income under subsections 104(13) and 105(2) in paragraph (c) of the split income definition, it appears to us that the provision was deliberately drafted to exclude a preferred beneficiary elected income amount, and this has been the case since the introduction of the kiddie tax rules in 2000.  We submit that it was always common practice to make the subsection 104(19) designation in respect of any dividend income allocation made under a preferred beneficiary election to allow the beneficiary to access the gross-up and dividend tax credit regime, and in fact, all major tax return preparation software automatically preserve dividend characterization (in effect making the subsection 104(19) designation) whenever a trust receives dividend income that is allocated to a preferred beneficiary. Can the CRA (i) elaborate on its reasoning behind its comment regarding subsection 104(19) in Technical Interpretation 2018-0759521E5, (ii) confirm its position on this matter for minor preferred beneficiaries for years prior to 2018, (iii) provide guidance on how a T3 return and slip should be prepared to avoid a subsection 104(19) designation when allocating a taxable dividend to a preferred beneficiary, and (iv) consider granting relief for all historical preferred beneficiary elections made?

CRA Response

i)    The fact scenario that we were asked to comment on in Technical Interpretation 2018-0759521E5 was such that there was no dividend income received by the trust that made the subsection 104(14) election.

Accordingly, our response noted that the amount included in the income of the preferred beneficiary in that case would not be considered to be split income by virtue of paragraph (c) of the “split income” definition.

The Summary section of Technical Interpretation 2018-0759521E5 qualifies the statements made in the body of the letter to highlight what might be best categorized as an exception to the general conclusion that amounts subject to a preferred beneficiary election are not considered to be split income, by virtue of paragraph (c) of the “split income” definition. An election by a trust and a preferred beneficiary to include such part of the accumulating income of the trust in the preferred beneficiary’s income would not be subject to TOSI unless a designation is made under subsection 104(19) in respect of that income, as indicated in our response in Question 13.  This comment was made upon considering that:

*     subparagraph (a)(i) of the definition of “split income” in subsection 120.4(1) includes in computing income an amount “in respect of taxable dividends received by the individual in respect of shares of the capital stock …”;

*     subsection 104(19) deems the amount so designated to be a taxable dividend received by the taxpayer (the preferred beneficiary) for all purposes of the Act other than Part XIII; and

*     there is no legislated exclusion from TOSI for dividends designated under subsection 104(19).

ii)   This position is not a new interpretation. It is consistent with the statements made in Technical Interpretation 2000-0056385, which was published in 2000. In addition, it should be noted that the 2018 T3 Guide (Publication T4013) points out on page 44 that:

      “The tax on split income applies to all of the following:

taxable dividends allocated by the trust (other than dividends from shares of a class listed on a designated stock exchange and those of a mutual fund corporation)”

This wording is consistent with the wording contained in each T3 Guide since 2000, the year the Kiddie Tax (now TOSI) legislation became effective.

iii)  In order to “avoid” a subsection 104(19) designation when allocating a taxable dividend to a preferred beneficiary the T3 slip can be prepared showing the amount so allocated in box 26 “Other Income”.

iv)   We have discussed this issue with the Department of Finance and have confirmed that our interpretation of this matter is consistent with tax policy. As such, the CRA will not be granting relief for all historical preferred beneficiary elections made.

Lena Holloway
2019-079851

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