2019-0833061E5 Discretionary Trust and Safe Income

Principal Issues: If a discretionary trust receives a dividend that is only partially supported by safe income and allocates this dividend to two beneficiaries - one of which is a corporation and one of which is an individual - can the trustees of the discretionary trust exercise their discretion so that only the portion of the dividend received by the corporation will benefit from the safe income associated with the dividend?

Position: In our view the trustees of a discretionary trust would not have the discretion to allocate safe income to different portions of a dividend deemed to have been received by the trust’s beneficiaries pursuant to subsection 104(19). The safe income would be allocated to the different portions of the dividend received by the beneficiaries on a pro rata basis.

Reasons: The designation in subsection 104(19) provides that the beneficiary of a trust is deemed to have received a taxable dividend (or a portion of a taxable dividend) that would have otherwise been received by the trust. It does not provide the trustees of a trust with the discretion to divide the safe income associated with a dividend that would have otherwise been received by the trust amongst the portions of the dividend that are deemed to have been received by the beneficiaries of the trust.

Author: Witteveen, Tobias
Section: 55(2.1)(c), 55(5)(f), 104(6), (13) and (19)

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                                                                                                         T. Witteveen
January 27, 2020

Dear XXXXXXXXXX:

Re: Trust and Safe Income

This is in reply to your correspondence of December 2, 2019 wherein you have asked about the allocation of safe income to the portion of a deemed dividend that has been subject to a designation under subsection 104(19) of the Income Tax Act (the “Act”) by a discretionary trust.

In your correspondence (including your additional correspondence with Mr. Henry Chong of our Directorate subsequent to your original email) you asked about the following hypothetical scenario:

*     A holding corporation (Holdco) and an individual are the beneficiaries of a discretionary trust (the Trust) that holds the shares of an operating corporation (Opco) that were issued following an estate freeze.
*     The safe income on hand associated with the shares held by the Trust in Opco is $1,000.
*     Opco pays a dividend of $2,500 to the Trust.
*     The Trust makes a subsection 104(19) designation so that Holdco is deemed to receive a portion of the dividend that is equal to $1,000 and the remaining $1,500 portion of the dividend is deemed to have been received by the individual beneficiary.

You have asked whether, given the fact that the Trust is discretionary in terms of the payment of income and capital, the trustees’ discretion could be exercised in terms of determining the allocation of the safe income associated with the portion of the dividend received by the different beneficiaries. In particular, you have asked whether this discretion could be exercised to ensure that the portion of the dividend received by the corporate beneficiary will benefit from all of the safe income on hand that is associated with the dividend.

Our Comments

Written confirmation of the tax implications inherent in a particular transaction is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R9, Advance Income Tax Rulings. However, we are prepared to offer the following general comments that may be of assistance. Safe income on hand at a particular time with respect to a share of a corporation held by a particular shareholder refers to the portion of the income earned or realized by any corporation (i.e., safe income) during the relevant holding period that could reasonably be considered to contribute to the capital gain that would be realized on a disposition at fair market value of the share at that time. The safe income exception in paragraph 55(2.1)(c) of the Act is limited to safe income that could reasonably be considered to contribute to the capital gain that could be realized on a disposition at fair market value, immediately before the dividend of the share on which the dividend is received.

Subsection 104(19) of the Act permits a trust to designate a taxable dividend received by it in a taxation year on the share of a taxable Canadian corporation. Where the designation is made in respect of a beneficiary under the trust, the dividend is treated, for the purposes of the Act (other than Part XIII), as a taxable dividend received by the beneficiary from the corporation, and is treated, for the purposes of the dividend gross-up in paragraph 82(1)(b) of the Act and stop-loss rules in paragraphs 107(1)(c) and (d) of the Act and section 112 of the Act, as not having been received by the trust.

A corporate beneficiary of a trust in respect of which a designation is made is therefore deemed to have received the dividend for the purposes of section 55 and can benefit from the safe income exception in paragraph 55(2.1)(c). However, the deeming rule in subsection 104(19) does not provide an ability to the trustees of a trust to adjust the safe income associated with a portion of the dividend that has been allocated to a particular beneficiary. As such, the safe income on hand associated with the dividend would be allocated on a pro rata basis amongst the portions of the dividend received by the corporate and individual beneficiaries.

We trust that these comments will be of assistance.

Yours truly,

David Palamar
for Division Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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