15 April 2004 Internal T.I. 2003-0051731I7 - distributions from a non-resident trust

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Whether the comments in file 2002-018343 are still valid given the comments in file 2003-0013677.

Position: Yes.

Reasons: They are different situations as explained in the letter.

 									April 15, 2004

Toronto North TSO 						Annemarie Humenuk
Appeals Branch

Attention:  Susan Shaw
									2003-005173

XXXXXXXXXX

We are writing in response to the memorandum to Linda Smith of the International Tax Directorate concerning our file 2002-018343 which was referred to us for reply. Specifically, you have asked whether the opinion rendered in that file is still valid given the comments in our file 2003-0013677.

We remain of the view that the opinion expressed in file 2002-018343 is valid and that there is no contradiction between the opinions rendered in the two files.

In commenting on whether the Canadian resident beneficiary received an amount out of income or capital in file 2003-0013677 we stated:

As you noted, even where the trust deed purports to grant the trustee the power to do so, the trustee cannot, at his discretion, determine what is income and what is capital of the Trust. This view is supported by the decision rendered in the Terrill Estate v. M.N.R., 87 DTC 504...To the extent that the income of a trust is not distributed in a particular year, it forms part of the capital of the trust for the following year, such that a series of capital distributions combined with the retention of the income of the trust will not erode the trust capital by the full amount of the capital distributions.

...the question arises as to whether the capital of the Trust was available for distribution to [XXX] at the time of the distributions. Although the Trust initially received [$XXX] in capital, the trial balance indicates that approximately [$XXX] of capital was loaned to the [XXX] (presumably before [XXX] when the capital distribution was declared). Thus, it is questionable as to whether the Trust had sufficient capital available to be distributed to [XXX] to make the distribution so authorized by the memorandum of decisions dated [XXX]. There is no evidence that the distribution was delayed or that money was borrowed to make the capital distribution as was the case in Queen v. Bronfman, 87 DTC 5059. However, there is also no evidence that the [XXX] income was available for distribution at that time since the [$XXX] interest income for that year was presumably still receivable from the [XXX] as well.

Conversely, in file 2002-018343, in commenting on whether the Canadian resident beneficiary received an amount out of income or capital we stated:

A trustee of a discretionary trust can, in fact, choose whether to make a certain payment out of income or out of capital - at least, to the extent of the trust's income and capital. If the trustee chooses not to distribute income to the income beneficiary, then a greater amount will be available for distribution to the capital beneficiary in future. However, the trustee cannot change the true nature of an income distribution by merely considering it to be a capital distribution.

...the Trust had no net accounting capital at the beginning of the year...the Trust received cash dividends during the XXXXXXXXXX year and wound up later that year.

The income of the Trust would be computed under Canadian rules pursuant to section 250.1 and would include the [$XXX] dividends received. Given that the Trust was wound up in its XXXXXXXXXX taxation year...we agree that the income was in fact paid to [XXX] and is required to be included in her income pursuant to subsection 104(13).

In file 2002-018343, as opposed to file 2003-0013677, we were of the view that there was no net capital available for distribution and the fact that the investment was liquidated for proceeds equal to cost and equal to the amount of the loan payable did not change the situation. There was a receipt of dividend income that was distributed to the beneficiary in the year.

As we understand the representative's argument in the current Appeals file, he is suggesting that the repayment of the loan reduces the income of the trust such that the remaining distribution must be from capital. In our view, this is an untenable position as illustrated by the following example. Assume that a trust is settled with $10 and obtains a loan of $10,000. The trust has $10 in capital and available cash on hand of $10,010. If we assume there is no activity in the trust until the year in which the trust is wound up and that the trust earns $10,000 in the year the trust is wound up, the trust will have $10 in capital, $10,000 in income and available cash of $20,010. If the trust repays the loan, the trust will still have $10 capital and $10,000 in income as the repayment of the loan reduces neither the income nor the capital of the trust. As a result, in this example, the maximum distribution of capital in the year of wind-up would be $10 and the remaining distribution would be out of the income of the trust. This would be true regardless of whether the terms of the trust state that the trustee has the discretion to distribute either income or capital to the beneficiary since the trust only has $10 of capital. In file 2002-018343, the numerical analysis provided to us suggested that any capital that was previously contributed to the trust had previously been distributed such that no capital remained in the trust in the year of the distribution which is in dispute.

As requested, we are returning the documents you sent with respect to your inquiry. If you have any further questions concerning our position, please contact Annemarie Humenuk at (613) 957-8585.

Yours truly,

T. Murphy
Manager
Trusts Section
International and Trusts Division
Income Tax Rulings Directorate

c.c.: Linda Smith
International Tax Directorate
344 Slater Street, 6th Floor
Ottawa ON