2020-0837001C6 STEP 2020 - Q17 - Trust Pass-Through of CGE

Principal Issues: 1) Where a trust makes a designation pursuant to subsections 104(21) and 104(21.2) with respect to an amount paid to a second trust and third trust, who are beneficiaries of the trust, whether the second trust and third trust can make designations pursuant to subsections 104(21) and 104(21.2) with respect to the same amount paid to their own beneficiaries? 2) If yes, can the individual beneficiaries of the second and third trust claim the capital gains exemption, assuming that all other conditions are met?

Position: 1) & 2) Yes.

Reasons: 1) & 2) See document below.

Author: Bogdan, Aleksandra
Section: 104(21); 104(21.2); 110.6(1); 110.6(2.1)

2020 STEP CRA Roundtable – November 26, 2020

QUESTION 17. – Trust pass-through of Capital Gains Exemption

Assume that a Graduated Rate Estate (Trust 1) holds shares that qualify as qualified small business corporation (QSBC) shares, as defined in subsection 110.6(1).  Trust 1 has two beneficiaries – Trust 2 and Trust 3, which are both testamentary trusts and personal trusts. Trust 2 and Trust 3 each have various individuals (other than trusts) as beneficiaries.

Trust 1 sells its QSBC shares and allocates the taxable capital gain realized to each of Trust 2 and Trust 3 in the year. Then, Trust 2 and Trust 3 each allocate their respective taxable capital gains to their respective various individual beneficiaries in the year. Trust 1, Trust 2 and Trust 3 do not dispose of any other properties in the year.  Cash payments are made in accordance with the allocations in the year. Designations are also made under subsections 104(21) and 104(21.2). All relevant designations, allocations and payments are made in accordance with the will of the deceased taxpayer.  The payments made by Trust 2 and Trust 3 are received by the respective beneficiaries for their own account and benefit.  The amounts received are retained by each respective beneficiary.

Under these circumstances, can the individual beneficiaries of Trust 2 and Trust 3 claim the capital gains exemption assuming that all other conditions are met?

CRA Response

When all of the conditions set out in subsection 104(21) are met, this subsection provides that for the purposes of sections 3 and 111, except as they apply for the purposes of section 110.6, an amount in respect of a trust’s net taxable capital gains, as defined in subsection 104(21.3), for a particular taxation year of the trust is deemed to be a taxable capital gain of the recipient beneficiary from the disposition of a capital property, for the taxation year of the beneficiary in which the particular taxation year of the trust ends.

Subsection 104(21) does not apply for the purposes of section 110.6. Accordingly, a designation under subsection 104(21.2) is also required in respect of the trust’s eligible taxable capital gains, in order for the beneficiaries to be able to claim the capital gains deduction under subsection 110.6(2.1).

When a personal trust designates an amount to a beneficiary under subsection 104(21) in respect of its net taxable capital gains for a particular taxation year, paragraph 104(21.2)(a) provides that the trust must also designate an amount in its income tax return for the year, in respect of its eligible taxable capital gains, if any, in respect of the beneficiary equal to the amount calculated under subparagraphs 104(21.2)(b)(i) and (ii).

Subsection 108(1) defines “eligible taxable capital gains” of a trust as the lesser of: (i) its “annual gains limit" for the year, as defined in subsection 110.6(1); and (ii) the amount of its “cumulative gains limit” at the end of the year, as defined in subsection 110.6(1), less the total of all amounts designated under subsection 104(21.2) by the trust in respect of beneficiaries for taxation years before that year.

When an amount is designated under subsection 104(21.2), paragraph 104(21.2)(b) provides that, for the purposes of section 120.4 and for the purposes of sections 3, 74.3 and 111 as they apply for the purposes of section 110.6, the beneficiary is deemed to have disposed of a capital property that is either a qualified farm or fishing property or a QSBC share, as the case may be, as defined in subsection 110.6(1).  Paragraph 104(21.2)(b) also provides that the beneficiary is deemed to have a taxable capital gain equal to the amount determined by the formula set out in each of clause 104(21.2)(b)(ii)(A) or (B), as the case may be, for the taxation year of the beneficiary in which the taxation year of the trust ends.

The result is that for the purposes of calculating the “annual gains limit” of the beneficiary, the amount calculated in element A takes into consideration the taxable capital gain designated by the trust under subsection 104(21.2) in respect of the beneficiary, in order to permit the beneficiary (if they are an individual other than a trust) to claim the capital gains deduction under subsection 110.6(2.1).

In the situation described, in order to compute the “annual gains limit” of each of Trust 2 and Trust 3, it is necessary to take into account the amount designated by Trust 1 under subsection 104(21.2) in respect of each of Trust 2 and Trust 3. Paragraph 104(21.2)(b) provides that for the purposes of sections 3, 74.3 and 111 as they apply for the purposes of section 110.6, Trust 2 and Trust 3 shall be deemed to have disposed of capital property that is a QSBC share, and to have a taxable capital gain equal to the amount determined by the formula in clause 104(21.2)(b)(ii)(B).

Consequently, where Trust 1 has made designations under subsections 104(21) and (21.2) in respect of amounts distributed to Trust 2 and Trust 3, Trust 2 and Trust 3 can also make designations under subsections 104(21) and 104(21.2) in respect of the amounts distributed to their respective beneficiaries, provided all of the conditions are met. The designations made under subsection 104(21.2) by Trust 1 in respect of each of Trust 2 and Trust 3 must be taken into consideration in order to determine the eligible taxable capital gains of Trust 2 and Trust 3, respectively. Furthermore, where designations are made by Trust 2 and Trust 3 under subsections 104(21) and (21.2) in respect of amounts distributed to the individual beneficiaries of Trust 2 and Trust 3, the respective individual beneficiaries of each of Trust 2 and Trust 3 will be deemed to have disposed of capital property that is a QSBC share, and to have a taxable capital gain equal to the amount determined by the formula in clause 104(21.2)(b)(ii)(B), to allow them to claim the capital gains deduction under subsection 110.6(2.1) provided all the other conditions are met.

As a result of the above, the position set out in Technical Interpretation #2016-0667361E5 no longer represents the position of the CRA.

Aleksandra Bogdan
2020-083700

All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without the prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5.

© Her Majesty the Queen in Right of Canada, 2020

Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistribuer de l'information, sous quelque forme ou par quelque moyen que ce soit, de façon électronique, mécanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.

© Sa Majesté la Reine du Chef du Canada, 2020