Life TRUST Planning

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Application

This bulletin cancels and replaces Interpretation Bulletin IT-394R dated July 14, 1989.

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Summary

This bulletin deals with post-1995 elections that may be made by a trust and a preferred beneficiary to have a portion of the trust's accumulating income taxable in the hands of the preferred beneficiary rather than in the trust.

For a trust's taxation year that ends after 1996, a preferred beneficiary under a trust generally means an individual beneficiary who is eligible for a disability tax credit or an adult beneficiary for whom a dependent tax credit can be claimed by another individual because of the beneficiary's mental or physical infirmity. However, for a trust's taxation year that ends before 1997, a preferred beneficiary is generally restricted to an individual beneficiary who is eligible for a disability tax credit.

Any amount elected by a trust and a preferred beneficiary under the trust cannot exceed the allocable amount for the preferred beneficiary for a taxation year. The allocable amount for a preferred beneficiary for a taxation year generally means the trust's accumulating income for the taxation year.

A trust's accumulating income for a taxation year generally means its income for the taxation year calculated before deducting any amount included in computing income of a preferred beneficiary because of a preferred beneficiary election.

A preferred beneficiary election for a trust's taxation year must generally be filed within 90 days from the end of the trust's taxation year. Late, amended or revoked elections can be made in limited circumstances.

The above topics are discussed more fully below, as well as other topics relating to preferred beneficiary elections.

 

Discussion and Interpretation

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Election by Trust and Preferred Beneficiary

1. Subsection 104(14) provides that a trust and a preferred beneficiary under the trust may jointly elect for a trust's taxation year as prescribed by section 2800 of the Regulations to have a portion of the trust's accumulating income for the trust's taxation year, not exceeding the allocable amount for the preferred beneficiary, included in computing the income of the preferred beneficiary for the beneficiary's taxation year in which the trust's taxation year ended. Such elected amount is also excluded from the income of any beneficiary under the trust (not necessarily the beneficiary making the election) for a subsequent taxation year in which it is paid.

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Restricted Meaning of Trust

2. A trust listed in any of paragraphs (a) to (g) of the definition of "trust" in subsection 108(1) and its preferred beneficiaries are precluded from making preferred beneficiary elections. Such list includes an amateur athlete trust, an employee trust, a master trust, a related segregated fund trust, a retirement compensation arrangement trust, trusts governed by deferred income plans, a trust whose direct beneficiaries are one of the above-mentioned trusts, a communal organization, a trust governed by an eligible funeral arrangement or a cemetery care trust, a unit trust and certain trusts in which all interests have been vested indefeasibly, and in which no interest can become effective in the future (generally referred to as a commercial trust).

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Preferred Beneficiary

3. A preferred beneficiary under a trust for a trust's taxation year that ends after 1996 generally means an individual beneficiary who is eligible for a disability tax credit under subsection 118.3(1) or a beneficiary 18 years of age or older for whom a dependent tax credit under subsection 118(1) can be claimed by another individual. More specifically, a preferred beneficiary under a trust for a trust's taxation year that ends after 1996 is a beneficiary under the trust at the end of the trust's taxation year who is resident in Canada at that time and who meets either of the following conditions:

(a) the beneficiary is an individual

(i) who is entitled to a disability tax credit under subsection 118.3(1) for the beneficiary's taxation year that ends in the trust's taxation year (or would be so entitled if there were no deductions claimed for an attendant or care in a nursing home for the beneficiary), and

(ii) who is the trust settlor, the settlor's spouse or former spouse, a child, grandchild or great grandchild of the settlor or a spouse (but not a former spouse) of a child, grandchild or great grandchild of the settlor; or

(b) where the beneficiary does not meet the condition set out in (a) (i) above, the beneficiary is an individual

(i) who meets the condition set out in (a) (ii) above,

(ii) who attained the age of 18 years before the end of the beneficiary's taxation year that ends in the trust's taxation year,

(iii) who was a dependent (within the meaning assigned by subsection 118(6)) of another individual for that beneficiary's taxation year and was dependent on the other individual because of a mental or physical infirmity, and

(iv) whose income for that beneficiary's taxation year does not exceed $6,456 (subject to annual indexing after 1996).

For the purpose of the condition in (b) (iii) above, an individual qualifies as a "dependent" of another individual for a taxation year if the individual is dependent on the other individual for support at any time in the taxation year and is:

• the child or grandchild of the other individual or the other individual's spouse; or

• resident in Canada at any time in the taxation year and is the parent, grandparent, brother, sister, uncle, aunt, niece or nephew of the other individual or of the other individual's spouse.

The expression "dependent" is also discussed in the current version of Interpretation Bulletin IT-513, Personal Tax Credits.

For the purpose of the income limit in (b)(iv) above, the beneficiary's income for a taxation year must be computed without reference to any amount designated under a preferred beneficiary election and allocated to the beneficiary. If the income limit above is satisfied for a beneficiary's taxation year that ends in the trust's taxation year, the trust and the beneficiary can elect any amount (not exceeding the beneficiary's allocable amount) whether or not this amount exceeds the income limit for the beneficiary's taxation year.

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4. For a trust's taxation year that ends before 1997, the conditions set out in 3(b) above must be ignored in determining whether a beneficiary under a trust is a preferred beneficiary. Also, the condition set out in ¶ 3(a)(i) above is satisfied only if the beneficiary is entitled to the disability tax credit for the beneficiary's taxation year in which the trust's taxation year ends (and not for the beneficiary's taxation year that ends in the trust's taxation year).

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5. Subsection 108(1) defines the expression "settlor" for the purposes of the provisions dealing with trusts and their beneficiaries. Under this definition, an inter vivos trust may have no settlor or may lose its settlor after its creation. For example, an inter vivos trust has no settlor if it was created by more than one individual (other than the individual and his or her spouse). In these circumstances, no preferred beneficiary election can be made on the trust's accumulating income as there would be no preferred beneficiary under the trust. This expression is also discussed in the current version of Interpretation Bulletin IT-374, Meaning of "Settlor."

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6. A "child of the settlor" includes the following:

• a person of whom the settlor is the natural parent whether the child was born within or outside marriage;

• a person wholly dependent upon the settlor for support and who is presently, or was immediately before attaining the age of 19 years, under the custody and control of the settlor; and

• a child of the settlor's spouse, an adopted child of the settlor, and the spouse of a child of the settlor.

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7.  A "spouse of the settlor" generally includes a common-law spouse of the settlor. A common-law spouse of the settlor is a person of the opposite sex who has been cohabiting in a conjugal relationship with the settlor for at least 12 consecutive months or who is a natural or adoptive parent of a child of whom the settlor is also a natural or adoptive parent.

Accumulating Income

 

8.  A trust's accumulating income for a taxation year generally means its income for the taxation year after deductions under subsection 104(6) but without regard to amounts elected under preferred beneficiary elections. Income held by a trust for a minor beneficiary that is deemed to be "payable" under subsection 104(18) is deductible by the trust under subsection 104(6) and thus reduces its accumulating income.

 

9. Although a taxable capital gain may not form part of trust income under trust law, for the purpose of computing a trust's accumulating income for a taxation year, income is computed pursuant to the provisions of section 3 and as a consequence generally includes net taxable capital gains. Except as stated in 10 below, a trust may allocate the net taxable gains (including those arising as a result of the 21-year deemed disposition rule) to a preferred beneficiary under the trust by making a preferred beneficiary election and by virtue of making a designation under subsection 104(21). (See also the current version of Interpretation Bulletin IT-381, Trusts -- Capital Gains and Losses and the Flow-Through of Taxable Capital Gains to Beneficiaries.)

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10. Any income (including net taxable capital gains) arising from deemed dispositions of trust property under subsections 104(4), 104(5), 104(5.2) and 107(4) is excluded from the trust's accumulating income for a taxation year if it is one of the following:

• a post-1971 spousal trust as described in paragraph 104(4)(a);

• a pre-1972 spousal trust as defined in subsection 108(1) at the end of the taxation year; or

• a trust that elected for a preceding taxation year under subsection 104(5.3) to defer the date of the 21-year deemed disposition.

Therefore, such income does not qualify for inclusion in a beneficiary's income under a preferred beneficiary election.

 

11. Amounts that are paid from a net income stabilization account under the Farm Income Protection Act and as defined in subsection 248(1), unless paid to a testamentary spousal trust described in paragraph 70(6.1)(b) and before the death of the beneficiary spouse, are ignored for the purpose of computing a trust's accumulating income for a taxation year.

 

12. The following rules apply with respect to trusts' taxation years that end after July 19, 1995:

• If the trust fails to claim the maximum deduction under subsection 104(6), its accumulating income must be computed as if the trust had claimed the maximum deduction. Thus, the trust will not be able to pay all its income to a beneficiary, elect to have the income taxed in the trust under subsection 104(13.1), not claim the maximum amount as a deduction under subsection 104(6) and add the income to its accumulating income for the purpose of the preferred beneficiary election.

• If the trust is a post-1971 spousal trust (as described in paragraph 104(4)(a)) and the spouse died on a day in the trust's taxation year, its accumulating income will be computed as if any disposition by the trust before the end of that day of capital property, land described in an inventory of the trust, Canadian resource property or foreign resource property had not occurred. As a result, the trust will not be able to avoid the tax effect of a disqualification of a taxable capital gain from a deemed disposition described in 10 above for the purpose of the preferred beneficiary election by means of a disposition of the property before the spouse dies.

 

Allocable Amount for Preferred Beneficiary

13. Except as described in 14 below, the allocable amount for a taxation year for each preferred beneficiary (who has a right of any type to any portion of the trust's accumulating income that is not entirely contingent on the death of another beneficiary who has a capital interest in the trust but no income interest in the trust) is the trust's accumulating income for the taxation year. In any other case, the allocable amount is nil.

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14. However, where the trust is a post-1971 spousal trust (as described in paragraph 104(4)(a)) or a pre-1972 spousal trust (as defined in subsection 108(1)) and the preferred beneficiary spouse is alive at the end of the trust's taxation year, the spouse's allocable amount is the trust's accumulating income for the taxation year and the allocable amount for any other preferred beneficiary for the taxation year is nil.

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15. A trust and a preferred beneficiary under the trust may elect for a trust's taxation year upon any amount of the trust's accumulating income for the taxation year up to the allocable amount for the preferred beneficiary. As mentioned in 13 above, the allocable amount for a taxation year for each preferred beneficiary under a trust generally means the trust's accumulating income for the taxation year. Therefore, it is possible that the total allocable amounts for a taxation year exceed the trust's accumulating income for the taxation year if there is more than one preferred beneficiary under the trust. However, it is not advantageous for a trust and its preferred beneficiaries to elect amounts in excess of the trust's accumulating income because the trust's deduction is limited under subsection 104(12) to the trust's accumulating income (see 17 below).

 

16. A beneficiary under a trust includes a person beneficially interested in the trust (see subsection 108(1)) and beneficially interested is defined in subsection 248(25) to include a person who has any right whether immediate or future, whether absolute or contingent or whether conditional on or subject to the exercise of any discretionary power by any person or persons to receive any of the income or capital of the trust. Consequently, all beneficiaries (income beneficiaries and capital beneficiaries) who are preferred beneficiaries under a trust (as defined in 3 above) would generally be entitled to elect under subsection 104(14). As noted in 13 above, the only exception is a preferred beneficiary who has a right in the trust's accumulating income that is solely contingent on the death of another beneficiary who has a capital interest but does not have an income interest in the trust.

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Deduction in Computing Trust's Income

17. The total of all amounts elected under subsection 104(14) for a taxation year may be deducted in computing a trust's income for the taxation year by virtue of subsection 104(12) to the extent it does not exceed the trust's accumulating income for the taxation year (see15 above).

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Election

18. By virtue of section 2800 of the Regulations, a preferred beneficiary election under subsection 104(14) must be filed with the Minister within 90 days from the end of the trust's taxation year for which the election is made. The election must consist of the following documents:

(a) A statement making the election for the trust's taxation year, stating the part of the accumulating income on which the election is being made, and signed by both the preferred beneficiary and a trustee having the authority to make the election; and

(b) A statement signed by the preferred beneficiary indicating the beneficiary's social insurance number, his or her relationship to the settlor of the trust and whether

(i) the beneficiary is claiming a disability tax credit (see 3(a)(i) above);

(ii) a supporting individual is claiming a disability tax credit for the beneficiary (if yes, provide the name, address and social insurance number of the supporting individual); or

(iii) the beneficiary is 18 years of age or older, and in the beneficiary's taxation year which ends in the trust's taxation year, another individual can claim a dependent tax credit for the beneficiary, or could claim the dependent tax credit if the beneficiary's income is calculated before including the income from the preferred elections (if yes, provide a statement from the doctor, optometrist or audiologist confirming the beneficiary's infirmity in the first year the claim is made).

 

19. In many cases, the preferred beneficiary under the trust may not have the capacity to sign the statements required above (e.g. a mentally infirm child). In such cases, the Minister will accept an election that is signed on behalf of the beneficiary by the legal guardian of the beneficiary's property (in most cases, the beneficiary's parent).

 

20. As noted in 18 above, a statement making the election must be signed by a trustee having the authority to make the election; thus only one signature is required. If the trust is governed by more than one trustee, the trustee signing the election must do so with the consent and authorization of the other trustees. Consequently, the signing trustee must be sufficiently authorized to bind the trust.

 

21. If there is more than one preferred beneficiary under a trust, it is not necessary that all of the preferred beneficiaries elect for a trust's taxation year. Also, there is no need for a preferred beneficiary to be consistent in electing or not electing from one taxation year to the next. It is not necessary that the elected amount in respect of a preferred beneficiary either be ultimately payable to the preferred beneficiary or be paid to any preferred beneficiary. Finally, it is not necessary that the elected amount be ultimately payable to a beneficiary who has an income interest in the trust.

 

22. If an election is filed late for a trust's taxation year, the Department will tax the accumulating income in the trust (see also no. 23 below for late, amended or revoked elections).

Late, Amended or Revoked Election

 

23. In limited circumstances (generally those beyond the control of the trustee and the beneficiary), late, amended or revoked preferred beneficiary elections are permitted if the trustee and the preferred beneficiary apply to the Minister and the Minister extends the time for making the election or grants permission to amend or revoke the election. (See the current version of Information Circular 92-1, Guidelines for Accepting Late, Amended or Revoked Elections.)

 

24. A late, amended or revoked preferred beneficiary election is subject to a penalty of $100 for each complete month from the due date of the election to the date of the request to a maximum of $8,000.

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Attribution Rules

25. If the preferred beneficiary is the spouse of the settlor or a child under the age of 18 years, application of the attribution rules (sections 74.1 to 74.5) may result in some or all of the elected amount being deemed to be income of the settlor or some other person who transferred or loaned property to the trust. Refer to the current versions of Interpretation Bulletins IT-510,Transfers and Loans of Property Made After May 22, 1985 to a Related Minor, and IT-511, Interspousal and Certain Other Transfers and Loans of Property, on this subject. Also, in situations where subsection 75(2) applies (see the current version of Interpretation Bulletin IT-369, Attribution of Trust Income to Settlor), income of the trust is attributed to the settlor or some other person who transferred property to the trust, regardless of any preferred beneficiary election made in respect of such income. Finally, depending on the facts of the situation, subsection 56(4.1) of the Act may apply to attribute some or part of the elected amount back to the settlor or some other person.

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Editors comment: Income included in the beneficiary’s tax return is an attribution and not income paid to the beneficiary. If the election causes the beneficiary to pay tax use the DTC to reduce the income tax. If the beneficiary she still owes tax the trust should pay the Receiver General. Do not deposit the funds into beneficiary’s bank to pay their tax. ODSP will include it as income.